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Chapter 18. Bankruptcy and Dissolution o... > Legal Rules Governing Bankruptcy and...

Legal Rules Governing Bankruptcy and Dissolution in the United States

U.S. law distinguishes between bankruptcies which are governed by Federal law and winding-up procedures (i.e., dissolution of the legal entity) which are governed by state law.

Bankruptcy

Once a company declares bankruptcy, it can undergo one of two processes. In the first process (Chapter 7 bankruptcy), the company is liquidated. In other words, the company ceases to operate, its assets are sold, and the proceeds are distributed among its debt holders and shareholders according to the priorities attached to the liabilities and to the company's equity. In this process, the proceeds are distributed according to the absolute priority rule, pursuant to which debt holders are entitled to the repayment of their debt before the shareholders. Among the debt holders, secured debt holders are paid before unsecured debt holders. Holders of debt which is unsecured by assets are paid according to the priority of their debt.


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