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 an investor's interests can be greatly affected when publicly traded corporations go bankrupt.

What Happens to the Company After Bankruptcy?

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. Which chapter they file for depends on its financial standing and prospects for recovery. 

Under Chapter 11, a company will:

1. Reorganize its business
2. Attempt to offload debt
3. Return to profitability

Under Chapter 7, a company goes out of business entirely and sells off (or liquidates) the remaining assets. The proceeds are used 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 corporate bankruptcy. 

Also, bondholders usually can 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?

A company's stock most likely will continue trading after a Chapter 11 bankruptcy filing. However, 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 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 canceled, 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. You may be able to exchange your old shares for new shares in the reorganized company. These new shares, however, 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.

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.

Old Stock Vs. New Stock in a Company Bankruptcy

A company emerging from bankruptcy may have two different versions of common stock: 

• The old stock that was trading when the company went bankrupt
• 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." This indicates 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.

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 
• 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 Bankruptcy Work?

The U.S. Trustee will appoint one committee to represent stockholders and creditors throughout the reorganization planning stage. 

All parties must accept the plan before the court confirms it. The court may approve the plan if it believes it is fair to all parties – even if the creditors or stockholders reject it. 

After confirmation by the court, the company must summarize the reorganization plan on Form 8-K.

Who Develops the Company's Reorganization Plan?

Committees made up of stockholders and creditors will develop the reorganization plan. These groups will negotiate with the company to decide which debts should be relieved to help the company successfully reemerge from its corporate bankruptcy. 

There are three main types of committees:

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.

Official Committee Representing Stockholders

May be appointed to address stockholders' specific concerns, but not a requirement.

Additional Committee(s) Representing Specific Class of Creditors

May be selected to represent employees, subordinate bondholders, or another distinct class of creditors.

Bankruptcy Code Rules for Plans

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 U.S. Securities and Exchange Commission (SEC) reviews the disclosure document to make sure:

• The company is properly disclosing key facts
• Stockholders are properly represented by a committee (if necessary)

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
• 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 will typically 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. A 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. A notice regarding the hearing date and deadline for filing objections to the plan (if applicable)

Even stockholders who do not vote are entitled to:

• A summary of the disclosure statement
• 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. Once these are paid off, the money will pay back creditors. 

Collateral (like a car) is returned to secured creditors. If the collateral fails to cover the debts, they are grouped with unsecured creditors for the remainder of their claim. 

Unsecured creditors, including bondholders, may receive some money if there is any left.

A company is not required to notify stockholders of the Chapter 7 filing. This is because they generally are not entitled to pay back if the shares have lost their value. If creditors are paid in full (which is rare), stockholders will be allowed to file claims.

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

In most cases, the stock of a company in Chapter 7 bankruptcy is entirely 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's investor relations department can provide you with more information on the bankruptcy proceeding, including the contact information for the court handling the case. The individual who sold you the investment should also be able to help you.

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.

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

A bankruptcy attorney can help your company file for chapter 13 or answer questions if you are an investor in a bankruptcy company.