Why do creditors usually accept a plan for financial rehabilitation rather than demand liquidation of the business?

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Why do creditors usually accept a plan for financial rehabilitation rather than demand liquidation of the business?

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Why do creditors usually accept a plan for financial rehabilitation rather than demand liquidation of the business?

Explanation & AnswerSolution by a verified expert

Explanation

The rehabilitation process involves extension and composition. In an extension, the company asks the creditors to postpone their payment dates during financial distress. By postponing the dates of repayment, the company gets time to make its financials sound to pay the debt payments. It is preferable by creditors as it promises full payment eventually. In a composition, the creditors voluntarily reduce their claims on the financially distressed company. The claims reduced by the creditors may include the reduced principal payments, lower interest rates on debt, accepting equity in exchange for debt, or a combination of all. These two processes promise most of the payment of the creditors.
In liquidation, the firm's assets are disposed of, and the obligations are paid on a pro-rata basis from the proceeds of the sale. This process does not lead to the payment of the creditors in full. This process also involves various charges and may decline the value of the assets. Thus, the rehabilitation process is better than the liquidation process.

Verified Answer

Rehabilitation gives the creditors a promise of repayment of their claims, whereas the creditors may not receive full payment for their claims in the company's liquidation. Hence, the creditors are more receptive of rehabilitation rather than liquidation.

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