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Corporate Bankruptcy: What Every Investor Should Know

Companies sometimes must file for bankruptcy protection, either to restructure and reemerge debt-free or to wind down operations. But what happens to the investors' interests when publicly traded corporations go bankrupt? This article focuses on what investors should know about corporate bankruptcy. For more information, see Chapter 11 Bankruptcy and Basic Terms for Shareholders and Investors.

Corporate Bankruptcy: What Happens to the Company?

As with consumer bankruptcy, business-related bankruptcy is governed by federal law. The debtor, in this case a corporation, either files Chapter 11 or Chapter 7 bankruptcy, depending on its financial standing and prospects for recovery. Under Chapter 11, a company will reorganize its business as it attempts to offload debt and return to profitability. Under Chapter 7, a company goes out of business entirely and sells of (or "liquidates") its remaining assets, using the proceeds to pay back debts to investors as well as creditors.

Secured creditors, whose credit typically is backed by collateral, and other low-risk investors are the ones who get repaid first in a corporate bankruptcy. Also, bondholders usually are able to recover their losses much better than stockholders. While bondholders are guaranteed a return of their principal investment plus interest, stockholders own a piece of the company.

What Happens to the Company's Stocks and Bonds?

While a company's stock most likely will continue trading after a Chapter 11 bankruptcy filing, it often gets delisted from the Nasdaq or NYSE after failing to meet listing standards. If the stock is delisted from one of the major exchanges, it still may trade on the Pink Sheets or OTCBB. Practically speaking, companies usually take a significant hit to their stock value after a bankruptcy filing. Investors should understand that existing shares of common stock in a company filing for Chapter 11 usually are cancelled, even if the company emerges and returns to profitability. Also, keep in mind that stockholders will not receive dividends during a bankruptcy proceeding.

Common stock usually becomes diluted during bankruptcy, at best, but you maybe able to exchange your old shares for new shares in the reorganized company. These new shares, however, likely will be fewer in number and lower in value. If a company is determined by the court to be insolvent, stockholders may not get anything after bankruptcy. In any event, investors' rights will be explained in the reorganization plan.

A company emerging from bankruptcy may have two different versions of common stock: The old stock that was trading when the company went bankrupt, and the new stock issued during the reorganization. The old stock, usually traded on the OTCBB or Pink Sheets, has a ticker symbol ending in "Q." The new stock, if it was not issued (but rather authorized) by the company, will end in the letter "V," indicating that the stock will trade "when issued." The "V" will be removed once the company issues the stock itself. Understanding the difference between old and new stock is crucial to making smart investment decisions.

Bondholders, meanwhile, will not receive any payments during a corporate bankruptcy. But bondholders may be able to exchange bonds for new stock, new bonds, or some of each.

What is the Advantage of Filing Under Chapter 11?

Public companies typically prefer to file under Chapter 11 bankruptcy (as opposed to Chapter 7) because it allows the company to continue operating and provides an opportunity for a turnaround. A successful reemergence doesn't always work out, but Chapter 11 gives the company more control over the process. Also, the company may continue to trade its stocks and bonds while going through a reorganization, but must report the bankruptcy on Form 8-K (SEC) within 15 days.

How Does Chapter 11 Work?

At least one committee will be appointed by the U.S. Trustee to represent stockholders and creditors throughout the reorganization planning stage. All parties must accept the plan before the court confirms it. Still, the court may still confirm the plan even if it is rejected by the creditors or stockholders if it believes the plan is fair to all parties. After confirmation by the court, the company must provide a summary of the reorganization plan on Form 8-K.

Who Develops the Company's Reorganization Plan?

Committees made up of stockholders and creditors negotiate with the company to decide which debts should be relieved in order to help the company successfully reemerge from its corporate bankruptcy. The main types of committees are:

  1. Official Committee of Unsecured Creditors: This mandatory committee represents all unsecured creditors, with the "indentured trustee" (usually a bank hired by the company) often sitting in.
  2. Official Committee Representing Stockholders: May be appointed to address stockholders' specific concerns, but not a requirement.
  3. Additional Committee(s) Representing Specific Class of Creditors: May be appointed to represent employees, subordinate bondholders, or another distinct class of creditors.

Once a plan is agreed to by all parties involved, the court will decide whether it complies with the Bankruptcy Code. This process is known as plan confirmation and takes a few months to complete. After confirmation, the company is free to implement its reorganization plan.

What is the SEC's Role in Chapter 11 Bankruptcy?

In Chapter 11 filings, the SEC reviews the disclosure document to make sure the company is properly disclosing key facts and to make sure stockholders are properly represented by a committee, if necessary. But other than that, the SEC's role is limited.

However, the SEC may take legal action if it believes the company's executives and directors are involved in securities fraud, using bankruptcy law to hide from lawsuits, or otherwise affecting the rights of investors.

As an Investor, How Will I Know What's Happening?

Investors usually first learn about corporate bankruptcies in the news or through their broker. Those who hold stocks or bonds in their own name usually will receive information about the bankruptcy in the mail. You may also be asked to vote on the reorganization plan, but stockholders often can't vote and don't get anything back from the company.

If you are eligible to vote, the company will send you:

  1. Summary of the reorganization plan (or a complete copy of the plan)
  2. Disclosure statement including important facts about the company and its plan (approved by the court)
  3. A ballot
  4. If applicable, a notice regarding the hearing date and deadline for filing objections to the plan

Even stockholders who do not vote are entitled to a summary of the disclosure statement and information about filing objections to the plan.

What is Chapter 7 Bankruptcy?

Companies that decide they cannot continue to do business usually file under Chapter 7 bankruptcy protection. In Chapter 7, all assets are liquidated and the proceeds are used to pay administrative and legal expenses, followed by creditors. Collateral is returned to secured creditors, who are grouped with unsecured creditors for the remainder of their claim if the collateral fails to cover the debts. Unsecured creditors, including bondholders, may receive some money if there is any left.

But the company is not required to notify stockholders of the Chapter 7 filing, since they generally are not entitled to a payback if the shares have lost their value. If creditors are paid in full, which is rare, stockholders will be given the opportunity to file claims.

See FindLaw's extensive Chapter 7 Bankruptcy section for additional articles and resources.

Is My Stock or Bond Worthless After a Chapter 7 Filing?

In most cases, the stock of a company in Chapter 7 bankruptcy is completely worthless. Bonds, at best, may retain a tiny fraction of their face value. For bonds secured by collateral, repayment is based on the value of that collateral.

Where Can I Get More Information?

The Company: The company's investor relations department can provide you with more information on the bankruptcy proceeding, including the contact information for the court handling the case.

Your Broker: The individual who sold you the investment should be able to help you.

The SEC: Check the SEC's "EDGAR" database, which contains all corporate filings submitted to the agency, including 8-K bankruptcy filings. See the SEC's How to Request Public Documents for more information about obtaining company filings. Your stockbroker or the company may also be able to provide you with a copy of the 8-K filing.

Bankruptcy Court: You may be able to find information about a company in Chapter 7 that has not yet filed SEC reports by going to the bankruptcy court itself, located near the company or in its state of incorporation.

Corporate bankruptcy is relatively common and sometimes results in a leaner, better-positioned company. With the right information, investors sometimes are able to get some of their investment back. Consider speaking with a bankruptcy lawyer if you have additional legal questions.

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