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Must a Subsidiary File for Bankruptcy
If Its Parent Company Does So?
By Michael C. Dennis, MBA, CBF

The answer to this question is important if you are selling to subsidiary - particularly if the subsidiary's business seems to be thriving, but the parent company is in financial trouble.

The Answer to this question is the subsidiary will Not Necessarily file for bankruptcy protect. However, creditors should remember:

  • The stock of a subsidiary is an asset of the parent company.

  • In many cases, when a parent company files for bankruptcy protection its subsidiaries also file for bankruptcy protection.

  • Is it possible [but uncommon] for a subsidiary to be unaffected by the bankruptcy filing of its parent company?

  • A parent company cannot automatically place its subsidiaries into bankruptcy.

  • The subsidiary must meet the bankruptcy requirements --- meaning either [a] the subsidiary's liabilities exceed its assets, or [b] the subsidiary is not paying its debts as they come due.

In this scenario, other serious issues to consider include:

  • Are the assets of the subsidiary pledged to the parent company's bank as collateral for debts of the parent company?

  • Are there any loan covenants involving loans to the subsidiary that relate to the financial health of the parent company?

  • Will other creditors continue to support the subsidiary by providing open account terms while the parent is in bankruptcy protection?

  • Even if the subsidiary does not file bankruptcy, would the cash demands of the bankrupt parent company damage the subsidiary's liquidity to the point that selling to it on open account terms after the parent company's bankruptcy would be unwise?

  • Might talented employees leave the subsidiary over concerns about the viability of their employer?

Reprinted with permission from the Covering Credit Newsletter 9/25/02 Edition © 2001All Rights Reserved

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