The federal bankruptcy laws govern company bankruptcy proceedings. When a company goes bankrupt, it can either file for Chapter 7 or Chapter 11. Chapter 11 bankruptcy allows the company to reorganize its business and try to become profitable again. If the company files for Chapter 7, it will have to stop all its operations and close down its business. The company would then be liquidated and the money will be used to pay off its creditors.
Companies Prefer Chapter 11
Companies usually prefer to file under Chapter 11 because it allows them to continue running their businesses and control the bankruptcy process. Furthermore, it gives them a chance to come out of bankruptcy. Under Chapter 11, the goal is to let the company run its business and pay its creditors. And for this purpose a reorganization plan is drawn up.
Reorganization Plan
Several parties are involved in the drawing up of the reorganization plan. An official committee representing the unsecured creditors is created. This committee represents all unsecured creditors and also the bondholders. A bank hired by the company when it originally issued a bond usually acts as the “indenture trustee” and sits on the committee of the unsecured creditors.
Another official committee might be appointed to solely represent the stockholders. Still another committee is appointed to represent the secured creditors, employees, or subordinated bondholders.
All these committees of creditors and stockholders work together to draw up a plan that helps the company get back on its feet and also pay back some of its debts. However, in the end it is upto the bankruptcy court to give the final approval for the reorganization plan.
What Happens To The Bondholders And Stockholders
When a company files for Chapter 11 bankruptcy, the company’s investors, bondholders, and stockholders obviously want to know whether they will receive any payments or not. The general rule is that once the company’s assets are liquidated, the secured creditors are paid first. Banks are often the secured creditors of a company. Unsecured creditors are then paid next. Suppliers and bondholders are the unsecured creditors. Stockholders, who are the owners of the company, are paid last, that is only after the secured and unsecured creditors are paid off.
When a company files for bankruptcy, investors are obviously concerned about their stocks and bonds. When a company files for Chapter 11, many companies are unable to meet the listing standards in order for them to continue to trade on Nasdaq or the New York Stock Exchange. However, you can find their shares trading on either the OTCBB or the Pink Sheets. This is because there is no federal law that prevents a bankrupt company to trade in securities.
Buying Stocks Too Risky
Those who are thinking of buying stocks of a company going through Chapter 11 bankruptcy should proceed with caution. In most cases, the reorganization plan adopted by the company cancels the existing equity shares. Moreover, even if a company manages to emerge from bankruptcy as a viable entity, the bondholders and the creditors will become the new owners of the company. So remember that investing in a bankrupt company is a very risky affair.
What happens to the existing bondholders? During the bankruptcy proceedings, the bondholders will stop receiving any interest and principal payments. Instead they might receive new stock in exchange of their bonds. Or they many receive new bonds or a combination of bonds and stock.
On the other hand, if you are a stockholder of a company going through bankruptcy, you will stop receiving your dividends. Instead, the trustee will send you new shares in exchange for your old stock. It is not necessary that the new shares will be equal in worth to your old shares. The reorganization plan will list your rights as an investor and what you will receive from the company.
However, stockholders should always remember that in the end they might not receive anything at all. In the event that the company liabilities are more than its assets, your stock would become worthless. If you are a stockholder of a company filing for bankruptcy, it is best to find out where you stand, as soon as possible.