Ethics in Question

“The rules about disclosing bankruptcy to the public are unclear, and so companies are able to make their own decisions about when to disclose the fact that they are filing for bankruptcy protection. The Wall Street Journal analyzed the bankruptcy filings of 90 large public companies and found that 29 did not disclose their bankruptcy preparations in any way. A few collapsed too quickly to report, but most made the decision not to let the public know. Is that a bad thing? On one hand, a free market relies on transparency and honesty. Bankruptcy filings are material information and, as such, investors have a right to know that a company is in distress. On the other hand, filing for bankruptcy protection is intended to help the company get out from under debt and keep operating. Disclosure can work against that process. With the introduction of innovations such as credit default swaps, creditors are less likely to be motivated to work with the company. Furthermore, employees with mobility are likely to begin departing once they know the company’s future is in doubt. Investors have a right to know, while stakeholders have a right to their livelihood. Where do we draw the line (9)?”

Corporate Bankruptcy Explained

Bankruptcy is a judicial process to provide an individual or a business that no longer can pay its debts with relief from financial obligations. It distributes a debtor’s property equitably among creditors and enables the debtor to start afresh. Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. The most common bankruptcies are Chapter 7 liquidations and Chapter 11 reorganizations. Under Chapter 7, the corporation must stop conducting all operations and goes completely out of business. A court appointed trustee liquidates the company’s assets and the money is used to pay off the debt with absolute priority, beginning with legal and administrative expenses (5). Whatever remains is distributed first to secured creditors such as banks, then to unsecured creditors such as suppliers and bondholders. Owners of the company have the last claim on assets and may not receive anything if the secured and unsecured creditors’ claims are not fully repaid; stockholders generally don’t receive anything in return for their investment (3). In chapter 11 of the U.S Bankruptcy Code, debtors attempt to reorganize their business and try to become profitable again. Management continues to run the day-to-day business operations, but all significant business decisions must be approved by a bankruptcy court (5). Public companies tend to file under Chapter 11 rather than Chapter 7 because it allows them to still run their businesses and control the bankruptcy process. Rather than turning over its assets to a trustee, a company undergoing Chapter 11 has the opportunity to work with an assigned committee to reorganize the company, restructure its financial framework, get it out of debt, and reshape it into a profitable entity (1). If a suitable reorganization plan cannot be determined, shareholders may not be able to stop their company’s assets from being sold off to pay creditors (3). After the committees develop a reorganization plan with the corporation, the bankruptcy court must find that it complies with the Bankruptcy Code before being implemented. This process, known as plan confirmation, is usually completed within a few months. Sometimes companies prepare a reorganization plan that is negotiated and voted on by creditors and shareholders before they actually file for bankruptcy. This shortens and simplifies the process, saving the company money (4).
Once a company files for bankruptcy under chapter 11, there is a document known as the disclosure statement which the debtor must file with the court in order to start the process of reorganization (12). “A disclosure statement is a plainly written, easy to understand statement that discloses information relevant to the companies chapter 11 reorganization (11).” The disclosure statement is then released to the public so that creditors, investors, and other stakeholders will be adequately informed about the company’s financial affairs, allowing them to make informed decisions moving forward (1). Information concerning any entity that files for bankruptcy protection is available to the public at large, but the bankruptcy court has the power to implement protection of information if necessary (6).
Bankruptcy cannot always be predicted, but common warning signs to watch out for are: employees laid off with little warning, perks such as bonuses getting cut, employees abruptly leaving company, falsified reports, or company equipment being sold (8). According to Forbes, Americas Energy falsified reports over and over as they transitioned into different company names until finally filing bankruptcy and being bought out by a Chinese company(10). Similarly, Enron faced several problems before being forced into bankruptcy. Beginning with the chief executive resigning in August of 2000, insider selling, and out-of-control valuation, Enron filed for bankruptcy after stock loses $67 billion in value (7). Enron’s stacking of little problems weren’t revealed until it was a disaster.

Ethical Dilemma Summary

When a corporation realizes that they are too deep into the hole, they must consider filing for bankruptcy protection. If the company must file Chapter 7, the process can be compared to ripping off an executive-sized band aid because it will quickly become public knowledge. However, under Chapter 11, the organization has time to prepare to make a comeback. At this point, the board of directors and executive management are focused on steps to reorganization, while stakeholders and investors are still left in the dark as if everything is “business as usual.” Should the company share this information with their stakeholders?
The ethical dilemma of this situation for the company is deciding whose interests matter most before taking action. While honesty is normally the best policy, bankruptcy laws don’t require preparation disclosure. “When a company declares bankruptcy, or has significant corporate changes, they must report it within 15 days on the SEC’s Form 8-K (4).” Corporate social responsibility encourages companies to take the interests of all stakeholders into consideration during decision making processes instead of making choices based solely upon the interests of shareholders. They must explore all ethical dimensions, both internal and external, in order to make educated and ethical decisions. Unfortunately, this dilemma will not be a winning situation for all parties.

Shareholder Dimension

The company’s owners, or shareholders, own at least one share of a company stock. A shareholder is strictly an investor who trades in shares and stocks of companies that are traded publicly. They are not personally liable for the company’s debts and obligations, nor do they play a major role in running the company. Shareholders, also called stockholders, benefit when the company performs well and share prices increase, but suffer if the company has poor performance (3). Common stockholders can inspect the company’s records, sue for misdeeds, and are able to vote on corporate matters. Shareholders will usually see a substantial decline in the value of their shares in the time leading up to a company’s bankruptcy declaration (3). An example of a shareholder is when the owner of shares in a business such as Apple is positively affected when the company releases a new phone, sees their stock prices rise. When preparing for bankruptcy, shareholders have an array of critical decisions to help make. Shareholders without any prior experience may begin to panic, making mistakes such as selling assets to try getting out of debt or making inside transfers to pay back business associates (13). They also have an obligation to avoid taking personal advantage of material information that is not disclosed to the investing public. In this ethical dilemma, the shareholders’ interests lie with whatever is ‘best’ for the company and their stock values. Although the shareholders may know that the company is in trouble, they also know that sharing this information will initiate a domino effect of chaos. Their goal is to get the company out of debt and to keep operating. This information asymmetry is unfair for other parties, but shareholders have an obligation to avoid taking advantage of material information that is not disclosed to the investing public. By not disclosing the material information, the company remains intact, stock prices continue to fluctuate minimally, and potential problems are temporarily avoided. They must work swiftly with the board of directors and executive management in preparing for reorganization in hopes to salvage the company and reshape it into a profitable entity. In the process of bankruptcy preparation, a disclosure statement is legally required to be written and released upon bankruptcy filing; however, this information is not required to be released until then. Although this approach is legally correct, it is not completely ethical for all parties.

Investor Dimension

Investors’ role in business is to invest money that is intended to help firms grow or complete projects, all with the anticipation of profits. However, these profits don’t come without a risk. Investors take a risk when they invest money with hopes of prices appreciating, and sometimes those prices depreciate dramatically. The market can be a cruel mistress sometimes, but the investors knew the risks when they initially invested. From an investor’s point of view, there isn’t much good to say about bankruptcy; once a business goes bankrupt, investors get a lower return on investment than once expected. Also, investors don’t have much say in a company’s restructuring plan. Investors have a right to know when a company is in distress, but it’s up to the company to ‘hit their distress button,’ or file for bankruptcy and submit a disclosure statement.
When the company does disclose their bankruptcy filings, investors may discover that they’ve lost as much as their entire life savings; investors will want to know where their investment has gone and are unlikely to ever invest with the company in the future. Full disclosure is supposed to be made regularly with information that might affect investment decisions, including “the nature and activities of the business, financial, and policy matters in the near future and in the longer term (9). From this point of view, the interests of the investing public are of utmost importance. Investors are sitting ducks in this situation. Even if the bankruptcy preparation information was disclosed to investors prior to filing, all investors would still react in a hectic manner, making matters worse for the company.

Stakeholder Dimension

A stakeholder can be a person, group, or organization that has interest, or stake, in an organization. They can affect or be affected by the organization’s actions, objectives, and policies. Some examples of stakeholders are creditors, employees, the government, owners, suppliers, and the community. Shareholders (owners) are stakeholders in a corporation, but stakeholders are not always shareholders. Stakeholders are interested in the performance of a company for reasons other than just stock appreciation. For instance, employees would not have a job without the company, customers may rely on the company for their goods or services, and suppliers may rely on the company for a consistent revenue stream (). An example of a negative impact on stakeholders is when a company needs to cut costs and plans a round of layoffs; this negatively affects the community of workers and the local economy. When a company begins preparing for bankruptcy protection, stakeholders such as employees deserve to know what is going on. Employees have a right to their livelihood, and not disclosing this information could have a large negative impact on their life. However, if they did know, would employees stay? These stakeholders will lack confidence in job security and advancement. Employees with mobility are likely to begin departing once they know the company’s future is in doubt.

Public Access and Potential Problems

The ethical dilemma in this case focuses on corporate disclosure rules with emphasis placed on how bankruptcy filings are sometimes never disclosed to the public. Generally the public has the right to inspect documents filed with the bankruptcy court, unless the document is protected by the Bankruptcy Code (6). Once the disclosure statement is filed, everyone and their mother should be able to see it. In most cases, the news media may obtain court records under the First Amendment. “Public access aids the administration of bankruptcy cases, promotes public trust and accountability in the system, and encourages legal compliance (2).” The public right to view these documents allows all current, potential, and non-potential stakeholders, shareholders, and investors to read all about the financial framework of a company and the debtor.
Corporate disclosure rules were very well-defined so that material information would be kept silent until made available to everyone equally, but once the information was released, more problems arose. In the bankruptcy process, debtors are required to submit a tremendous amount of information to the court. Debtors in bankruptcy are vulnerable to illegal and discriminatory practices when personal data such as medical expenses and bank accounts are part of the court record (2). Technology innovations allow anyone anywhere to access electronic court records on the Internet. This has led to the potential of debtors to experience threats of physical harm, harassment, and discriminatory profiling (6). A confidentiality breach releasing personal information increases the likelihood of the debtor becoming a target for scams.

Rules Are There For a Reason

When a company decides to prepare for bankruptcy protection, everybody has the right to know, but not until the time is right. Do investors have the right to full information about a company’s plans to file for bankruptcy? The shareholders have the ability to disclose their bankruptcy preparations, but are not legally required to do so until actually filing with the court. The company’s goal is to work out an arrangement that will allow the business to continue, and until bankruptcy is filed, the company has the right to keep the information private up to 15 days. However, by not disclosing the material information, the company remains intact, stock prices continue to fluctuate minimally, and potential problems are temporarily avoided. Whose interests are more important – the investors or the stakeholders who depend on the business? An investor can be considered a stakeholder, but not all stakeholders can be considered investors. The investing public has been named of paramount importance, while stakeholders still have a huge impact with corporate social responsibility.
Corporate disclosure rules can be stressful, but the simplicity of the rules makes it easy for everyone to understand. Ethically, I would like disclosure to be an easier process for stakeholders and investors to learn about from their companies, but legal entities have been put into place that not only creates a fair system for everyone, but also overrules ethical decision-making. If I were writing the rules for corporate disclosure, I would make it a requirement for every company that files for bankruptcy to be reported publicly. I don’t believe that other parties, involved or not, need to know the company is planning to file for bankruptcy; however, I believe that once a company files, it becomes public record. Whose interests matter? The company itself has priority interests, while the investors, stakeholders, and shareholders’ follow that as soon as the company files for bankruptcy protection and releases their disclosure statement.

Work Cited

1. Fishman, Robert, et al. "The Importance Of Being Earnest: Bankruptcy Disclosure Rules." Depaul Business & Commercial Law Journal 7.4 (2009): 627-653. Business Source Premier. Web. 27 Sept. 2014.

2. Holt, Theresa, and Peter Poznanski. "No Privacy In Bankruptcy." Journal Of Accountancy 200.5 (2005): 61-63. Business Source Premier. Web. 27 Sept. 2014.

3. "An Overview Of Corporate Bankruptcy." Investopedia. N.p., n.d. Web. 27 Sept. 2014. .

4. "Corporate Bankruptcy: What Every Investor Should Know - FindLaw." Findlaw. Thomson Reuters, n.d. Web. 27 Sept. 2014. .

5. "What Happens When a Corporation Files for Bankruptcy?" All Business. Dun & Bradstreet, n.d. Web. 27 Sept. 2014. .

6. Gordon, Gregory M., and Mark G. Douglas. "Public Right to Full Disclosure in Bankruptcy Extends to Rule 2019 Statements." Jones Day | Public Right to Full Disclosure in Bankruptcy Extends to Rule 2019 Statements. Jones Day, n.d. Web. 29 Sept. 2014. .

7. Gibbs, Lisa, Jeff Nash, and Nick Pachetti. "Enron: The Lessons For Investors." Money 31.1 (2002): 30. Academic Search Premier. Web. 29 Sept. 2014.

8. "Signs of Company Bankruptcy." EHow. Demand Media, 13 July 2010. Web. 29 Sept. 2014. .

9. Carroll, Archie B., and Ann K. Buchholtz. "Strategic Management and Corporate Public Policy." Business & Society: Ethics, Sustainability, and Stakeholder Management. 9th ed. Stamford: Cengage, 2012. 118-141. Print.

10. Barrett, William P. "Public Company Files For Bankruptcy--Very Quietly." Forbes. Forbes Magazine, 12 Dec. 2011. Web. 29 Sept. 2014. .

11. "Become Familiar with Chapter 11 Proceedings and Do What's Best with Your Bankruptcy Claim." Bankruptcy Disclosure Statements. N.p., n.d. Web. 30 Sept. 2014. .

12. Bulkat, Baran. "What Is the Disclosure Statement in Chapter 11 Bankruptcy? - AllLaw.com." Alllaw.com. Internet Brands, n.d. Web. 30 Sept. 2014. .

13. Eldridge, Tom. "Top 5 Mistakes Business Make When Considering Bankruptcy." Global Economic Intersection. Ecointersect, 2 Sept. 2012. Web. 30 Sept. 2014. .