Corporate Bankruptcy: What Every Investor Should Know

Just like individual debtors, corporations sometimes find themselves in financial trouble and have no option but to file for bankruptcy. Most corporate bankruptcy cases are filed under Chapter 11, which provides the company with an opportunity to reorganize and restructure its debt. Other businesses may opt for a Chapter 7 “liquidation”bankruptcy.

While bankruptcy may be the best option for a corporation, it will have a significant impact on the company’s investors. Not only does bankruptcy disrupt business operations during bankruptcy proceedings, but it can also have a serious impact on the company’s future and credit rating.

This article explains what happens to a corporation during Chapter 11 restructuring or a Chapter 7 bankruptcy case. It also explores how a bankrupt company can affect the company’s assets and its investors.

If you own or operate a corporation and are considering bankruptcy, it goes without saying that you should consult a bankruptcy law attorney. They’ll review your financial situation and advise you as to whether bankruptcy is the best option. A skilled lawyer will also explain the bankruptcy process and guide you throughout the bankruptcy proceedings.

How a Corporate Bankruptcy Works

As with consumer bankruptcy, federal law governs corporate bankruptcy. The corporation files either a Chapter 11 or Chapter 7 bankruptcy. The chapter they choose depends on the company’s financial situation and prospects for recovery.

Under Chapter 11, a company will attempt to:

• Reorganize its business
• Attempt to offload debt
• Restructure remaining debt
• Return to profitability

Under Chapter 7, a company closes its doors and sells (or liquidates) its assets. The bankruptcy court will use the proceeds to repay liabilities owed to investors, lenders, and creditors.

With both Chapter 11 and Chapter 7 bankruptcies, secured creditors and other low-risk investors are paid first. Bondholders often have greater success with recovery than stockholders because secured bondholders have priority to their collateral. Unsecured bondholder recoveries vary and are not guaranteed.

Shareholders own a piece of the company. If the company goes out of business, stockholders receive nothing.

What Happens to the Company’s Stocks and Bonds?

A company’s stock usually continues to trade after a Chapter 11 bankruptcy filing. However, its listing on the Nasdaq or NYSE may disappear for failing to meet listing standards.

If one of the major stock exchanges removes the company from its list, it can still trade on the Pink Sheets or OTCBB (Over-the-Counter Bulletin Board). While these options may be available, a bankruptcy filing can decimate the value of a company’s stock.

From an investor’s standpoint, it’s important to understand that most companies that file for Chapter 11 cancel all existing shares of common stock even if the business returns to profitability. Furthermore, stockholders do not receive dividends during bankruptcy proceedings.

Common stock usually becomes diluted during bankruptcy. Investors may be able to exchange their old shares for new shares in the reorganized company. These new shares, however, will be fewer in number, and the valuation will be much lower.

If the bankruptcy judge determines that a company is insolvent, stockholders may not get anything after bankruptcy. If this is the case, the stockholders will be informed when they go over the reorganization plan during the 341 Meeting of Creditors.

Old Stock vs. New Stock After Corporate Bankruptcy

As stated above, the types and value of stocks change after a company files for bankruptcy. Business owners use Chapter 11 bankruptcy as a way to reorganize their company and restructure their debt.

As you might expect, stock movement is frozen during a Chapter 11 reorganization. Business owners and investors are may be in for an unpleasant surprise at the state of the company’s stock after the bankruptcy is over.

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

• Old stock that was trading when the company went bankrupt
• New stock the company issues during the reorganization

The old stock, which stockholders usually trade on the OTCBB or Pink Sheets, has a ticker symbol ending in”Q.”The new stock ends in the letter”V.”This indicates that the stock will trade”when issued.”

Once the shares become active on the stock market, the company will remove the”V.”Understanding the difference between old and new stock is crucial to making smart investment decisions.

Advantages of Filing a Chapter 11 Bankruptcy Case

Companies in financial trouble have the option of filing Chapter 7 or Chapter 11. Unless the company intends to close its doors, it is better off filing a Chapter 11 bankruptcy.

Some reasons an organization would choose to file Chapter 11 instead of Chapter 7 is that it:

• Allows the company to continue operating
• The company can continue to trade stocks and bonds during the Chapter 11 reorganization
• Provides an opportunity for a turnaround

While not all companies emerge from bankruptcy proceedings unscathed, Chapter 11 gives the owners and officers more control over the process. If the company continues to trade its stocks and bonds during the bankruptcy, it must report the bankruptcy on Form 8-K (SEC) within four days of filing.

How Chapter 11 Bankruptcy Works

After the corporation files its bankruptcy petition and accompanying bankruptcy forms, the court may assign a U.S. Trustee to oversee the case for cause. In most Chapter 11s, the debtor typically remains as a debtor in possession (DIP) and continues operating. The trustee oversees case administration and appoints official committees, but does not run the business.

When the business owner files for bankruptcy, they must submit a plan of reorganization. This plan must include specific details about which creditors the plan pays and how much they’ll receive. The plan is reviewed and shared with the company’s creditors and investors.

The proposed repayment plan is subject for review before it’s submitted to the bankruptcy judge for approval. The judge will take any creditor or investor objections into account when determining if the plan is appropriate.

It’s standard for all parties to agree to accept the reorganization plan before the court confirms it. However, the judge can approve the plan if they believe it’s fair to all parties. This is true even if the creditors or stockholders reject it.

After the court confirms the Chapter 11 plan, the corporation must summarize the reorganization plan on Form 8-K and submit it to the U.S. Securities and Exchange Commission (SEC).

Developing the Company’s Reorganization Plan

When an individual files for Chapter 13 bankruptcy, they are responsible for creating the proposed repayment plan. In a corporate bankruptcy, the trustee designates a committee of stockholders and creditors to develop the reorganization plan.

Members of the committee negotiate with the company in deciding which debts the court should relieve to help the company reemerge from its corporate bankruptcy. There are three types of Chapter 11 committees:

Official Committee of Unsecured Creditors

This mandatory committee represents all unsecured creditors. An”indentured trustee”(usually a bank hired by the company) often sits in.

Official Committee Representing Stockholders

The U.S. Trustee may appoint a committee to address stockholders’ specific concerns. While this is beneficial in many Chapter 11 bankruptcy cases, it is not a requirement.

Additional Committee(s) Representing a Specific Class of Creditors

Every bankruptcy is different, and so too are the classes of creditors. Specific classes may be created to represent employees, subordinate bondholders, or other distinct classes of creditors.

Bankruptcy Code Rules for Plans

Once all parties to the bankruptcy proceedings agree on a plan, the judge will decide whether it complies with the Bankruptcy Code. If it does, and the judge believes the plan is fair to all creditors and investors, they will start the confirmation process.

The plan confirmation can take a few months to complete. Once the court finishes with the plan, the parties will attend a confirmation hearing. Once concluded, the judge will issue an order and the company will be free to implement its reorganization plan.

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

Investors usually learn about corporate bankruptcies either through their broker or by reading about them in the news. People who hold stocks or bonds in their name will usually receive information about the bankruptcy in the mail.

As an investor or stockbroker, the court may ask you to vote on the reorganization plan. Stockholders, however, often can’t vote on the plan and end up receiving nothing from the company.

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

• Either a summary of the reorganization plan or a complete copy
• A disclosure statement including important facts about the company and its  court-approved plan 
• A ballot
• A notice regarding the hearing date and deadline for filing objections to the plan, if applicable

Stockholders who aren’t given the right to cast a vote are still entitled to a summary of the disclosure statement. They’ll also receive information about how they can file an objection to the plan.

How Corporate Chapter 7 Bankruptcy Works

Companies that decide to close their business and liquidate their assets usually file for Chapter 7 bankruptcy protection. In Chapter 7, the trustee liquidates all the filer’s assets and uses the proceeds to pay administrative and legal expenses. The remaining money is then goes to pay creditors. Just like a Chapter 11 bankruptcy, creditors are paid in order of priority.

If the company has secured creditors, as most do, collateral is returned to the secured creditors. For example, if the business had company cars or equipment, it must return them to the lenders who financed the property.

If the proceeds from the sale of the collateral fail to cover the filer’s secured debts, they are grouped with the company’s unsecured creditors. Unsecured creditors, including bondholders, may receive relief if there’s any left.

Unlike a Chapter 11, a company that files for Chapter 7 does not need to notify its stockholders of the bankruptcy filing. In general, stockholders are not entitled to receive compensation if their shares have lost their value. In the rare instance when the debtor has paid all creditors in full, stockholders are permitted to file a claim.

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

If you own stock in a company in financial distress that files Chapter 7 bankruptcy, you will likely receive no recompense. If you hold company bonds, you may retain a fraction of their face value.

If an investor has bonds that are secured by collateral, they may receive the fair market value of the collateral. Otherwise, they may lose their entire investment.

Getting More Information on the Proceedings

If you want information on a corporation’s bankruptcy proceedings, including the contact information for the court handling the case, talk to the representative who sold you the investment. If you aren’t successful in getting information from the company directly, you can always check the SEC’s”EDGAR”database, which contains all corporate filings submitted to the agency. This includes 8-K bankruptcy filings, which your stockbroker may also be able to provide.

If a company has a pending bankruptcy petition, the bankruptcy court will have a copy of it. When you have concerns about the financial health of a company you invested in, this can confirm any pending proceedings.

A Bankruptcy Attorney Can Help With a Corporate Bankruptcy

If you own a company in financial distress and are considering filing for bankruptcy, you should talk to a bankruptcy attorney. They can explain the bankruptcy process and answer any questions you may have.