Merits of Declaring Bankruptcy – A Nation’s Silent Shield

The title of my article may seem controversial and if you are thinking how a seemingly negative word like ‘Bankruptcy’ can actually be a boon for the country, you are not alone. But before diving in to the relevancy of my title, I believe it’s my responsibility to define two words which are always used side by side but are not the same.

Insolvency Vs Bankruptcy

Insolvency is a financial state, where an individual or a business is unable to pay their debts as they become due. This can happen in two primary ways:

• Cash-flow insolvency: The entity has more assets than liabilities, but they are not liquid (e.g., property, equipment) and therefore cannot be used to pay immediate debts like payroll, supplier invoices, or loan payments.
• Balance-sheet insolvency: The entity's total liabilities exceed its total assets. This is a more severe form of insolvency, as the entity owes more than it is worth.

Bankruptcy is a legal process. It is a formal procedure initiated through a court system to address the financial state of insolvency. It is a legal declaration that an insolvent party cannot repay their debts and an insolvent person or entity seeks relief from some or all of their debts.

All alkalis are bases, but not all bases are alkalis. In line with this famous statement of Chemistry, we can say that all bankruptcy are cases of Insolvency, but not all Insolvents become Bankrupts. Since the main focus of this article is on Bankruptcy rather than Insolvency, it was essential to understand the difference among them. Now that we have cleared understanding of the terminology, it’s time to look closely in to the title and explore how identification of bankruptcy is actually a boon for the nation’s economy.

(Also, for those of you who are wondering how insolvent avoid bankruptcy, I have included the case study of Apple Company at the end of this article illustrating how an almost insolvent avoids bankruptcy and eventually emerged as a market leader in later stages of the business.)

How spotting Bankruptcy early could save a Nation’s economy?

“For those producers who are too blind or too stubborn to change, continuing losses will force their businesses into bankruptcy, so that the waste of the resources available to the society will be stopped that way. That is why losses are just as important as profits, from the standpoint of the economy.” — Basic Economics, a book by American economist Thomas Sowell.

In order to better understand as well as feel the above statement, imagine a situation where your cellphone freezes completely and none of the buttons or touchscreen functions respond, even though the screen is still on. The phone becomes useless but continues to drain battery power. If you are lucky enough to have phone with a removable battery, you would likely remove the battery to stop the unnecessary power loss. In this analogy, the unresponsive buttons reflect a situation where no measures (such as debt restructuring, creditor negotiations, or asset sales) can revive the failing entity. The act of removing the battery represents the act of cutting off further waste—just as bankruptcy functions in the economic system. In such cases, the court’s declaration of bankruptcy is the final means to “pull the plug” and prevent further depletion of valuable economic resources in the form of capital and labor.

The saved resources can then be redirected toward other productive as well as effective activities and thus, help increase the country’s Gross Domestic Product. The increase in GDP per capita takes a poverty-stricken country towards prosperity. That is the reason why there are poor countries with rich natural resources and countries like Japan with relatively few natural resources but high standards of living.

Bankruptcy Encourages Economic Discipline

Recognizing and declaring bankruptcy boosts investor confidence in two ways:

a. The country with the system that clearly identifies bankruptcies builds trust in investors. The public and investors feel more confident when there’s accountability.
b. If bankruptcy is monitored and identified properly, companies are less likely to take reckless risks, as they are encouraged to act more responsibly. For instance, after the identification of one of the development banks of Nepal as a ‘Problematic Institution’ in late 2024, the boards and management teams of other banks should identify and rectify their practices to avoid receiving the same label.

When to pull the plug?

1. Stubborn and visionless promoters: The beauty of the efficient market condition is that market automatically replaces the business that:
a. Does not evolve with the technological advances, or
b. Does not change its product with the change in its user’s preferences, or
c. Keep up in the race with its business competitors.

Since, their value of output will be less than the value of output created by other producers using the same inputs, the business falling in above three categories shall soon have to be liquidated due to accumulation of business losses year after year.

2. Deviation from intended use of funds: The funds from shareholders as well as from creditors should be used as per their original purpose of raising the funds. When the funds go off track and the company uses that money for unrelated or unauthorized activities—such as: Paying executive bonuses, funding unrelated ventures, etc., the business may run into liquidity problem and in order to prevent further damages to the shareholders, debenture holders or creditors, it is better to liquidate the company through bankruptcy.

Who can file Bankruptcy Initiating Application in the court?

In Nepal, the bankruptcy is primarily governed by the Insolvency Act, 2006, along with some of the provisions of the Companies Act, 2006.

The government should also provide financial assistance and assurance to people who could not recover their fund from the bankrupt or problematic companies. Government-led insurance schemes or compensation frameworks could also be introduced to maintain trust in the financial ecosystem.

Prevention is better than cure

If many companies go bankrupt, it usually signals economic trouble, like a recession or poor management. So, bankruptcy is a problem, but identifying it properly is the helpful part. It is the responsibility of the government to implement policies which protects the investors as well as producers. Following are some of the improvement points to avoid bankruptcy in first place:

a. Increased monitoring of utilization of fund raised in the public companies.
b. Establishment of independent regulatory bodies for the separate types of industries. Industries like healthcare, education, construction and infrastructure, manufacturing, trading, mining, etc. require dedicated regulatory bodies.
c. In order to protect the efficient companies from bearing losses due to bad debts, strict laws should be passed against the defaulters. Harsher penalties for intentional defaulters and clear frameworks for asset recovery foster a culture of financial responsibility and contractual adherence.

Not all Insolvents become Bankrupt

An insolvent individual or business may explore other options to resolve their financial issues, such as debt restructuring, negotiating with creditors, or selling assets. Here’s a case study for your review:

Apple Co. – From Crisis to Tech Titan

After a series of poor products and management missteps post-Steve Jobs's departure, Apple was in dire straits and nearly declared bankrupt in 1997. In a dramatic turn, Microsoft invested $150 million in Apple. This investment not only provided critical funds but also ensured that Microsoft would continue supporting Office on Mac — helping Apple survive. Jobs returned as CEO in 1997, slashed unnecessary product lines, and concentrated on a few groundbreaking products.

Jobs swiftly streamlined the company's bloated product lines, choosing instead to focus on a select few, groundbreaking innovations. This renewed emphasis on simplicity and design led to the introduction of the iMac, which revitalized the personal computer market. This was followed by the revolutionary iPod, which transformed the music industry, and ultimately the iPhone, which redefined mobile technology and entire industries.

Following this incredible turnaround, Apple experienced unprecedented growth. It made history as the first U.S. company to be valued at $1 trillion in 2018, and its market capitalization has since soared to over $3 trillion, cementing its status as a global technology titan.

Conclusion

Bankruptcy, when understood and managed well, acts not as a sign of failure, but as a redirection of resources toward national productivity. Recognizing it early not only prevents deeper financial damage but also nurtures trust in the system—ensuring that a nation's economy remains agile, transparent and resilient.

Article By: CA Binesh Rauniyar