Apart from raising capital in the form of equity, corporates also borrow money to run their business. The most common form of borrowing is bank borrowing, which is the first choice for any corporation. Apart from bank borrowing, corporations around the world also have access to corporate debt market where they can raise debt directly from the public by issuing debt securities. In countries such as US, there is a well-developed corporate debt market.
Types of Corporate Debt Securities
Corporations can issue four main types of corporate debt securities:
Corporate Bonds: Most common type of debt obligation, which may be secured or unsecured.
Medium-term Notes: Have a unique characteristic that notes are offered continuously to investors by an agent of the issuer. Maturities can vary from under 1 year to 30 years.
Asset-backed Securities: The term Asset-backed securities (ABS) is commonly used to refer to those securities whose underlying assets are not mortgage loans.
Commercial Paper: Commercial Paper (CP) is a short-term financial instrument, consisting of unsecured promissory notes issued in bearer form which can be therefore be readily traded. At maturity, the CP issuer pays the amount due to the person presenting the paper.
Rights of Bondholders in case of Bankruptcy
If corporations are not able to meet their financial obligations, they may file for bankruptcy. In general, the payments to bondholders will have priority over payments to equity holders. Within creditors, some creditors will have priority over others and the rules for this may differ from country to country.
When a corporation files for bankruptcy, it can make a choice to either go for liquidation or opt for reorganization.
In case of liquidation, all the assets of the company are liquidated and the proceeds are distributed to all claimholders (creditors, shareholders, etc.) as per the priority rules. After that the company ceases to exist.
In case of reorganization, the company is closed, and a new reorganized company is created. The bondholders may receive their dues partly in the form of cash and partly in the form of new securities issued by the new reorganized entity.
Under the bankruptcy, Chapter 7 deals with liquidation and Chapter 11 deals with the reorganization of a company.
Bankruptcy proceedings help both the corporate and the bondholders in settling the claims in the most amicable manner possible.