Chapter 11 Bankruptcy's Effects on Shareholders Equity
Here's why your stock may lose its value under bankruptcy
By CHIZOBA MORAH Updated March 14, 2023
Reviewed by JULIUS MANSA
Part of the Series
Bankruptcy
What Is Chapter 11 Bankruptcy?
When a company files for Chapter 11 bankruptcy, it is asking for protection from creditors while it reorganizes its business and restructures its debt. Chapter 11 is available to corporations, sole proprietors, and partnerships.
Under Chapter 11, the firm's management oversees daily operations. However, the company directs significant business decisions (e.g., debt or debt securities decisions) to the bankruptcy court for approval.
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KEY TAKEAWAYS
Chapter 11 bankruptcy allows businesses and some individuals to reorganize and restructure debt while receiving protection from creditors.
Stock values are adversely affected by bankruptcy speculation, and even more so by the actual filing.
After filing for Chapter 11, the company's stock will be delisted from the major exchanges.
Common stock shareholders are last in line to recover their investments, behind bondholders and preferred shareholders.
As a result, shareholders may receive pennies on the dollar, if anything at all.
Understanding Chapter 11 Bankruptcy
Obtaining Chapter 11 bankruptcy protection means that a company is on the verge of needing to cease operations, but believes that it can once again become successful if given an opportunity to reorganize its assets, debts, and business affairs.
Although the Chapter 11 reorganization process is complex and expensive, most companies prefer Chapter 11 to Chapter 7, under which companies totally cease operations and that leads to the total liquidation of assets to creditors. Filing for Chapter 11 gives companies another chance at to turn their businesses around.
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An Alternative: Chapter 7 Bankruptcy
Under Chapter 7, the company ceases operations and all assets are sold for cash. That cash is then used to pay off legal and administrative expenses incurred during the bankruptcy process. Then the company pays its creditors in the following order:
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1) Secured creditors
2) Unsecured creditors
3) Shareholders
Usually, little to nothing is left over for shareholders after paying the more senior creditors.
What Happens to Stock When a Company Goes Bankrupt?
While the firm is in Chapter 11, its stock will still have some value, though the price will likely plummet, and the stock will stop paying dividends. It may be delisted on the major exchanges, but over-the-counter (OTC) trading may still occur.
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When a company is listed on the pink sheets or Over-the-Counter Bulletin Board (OTCBB), the letter "Q" is added to the end of the company's ticker symbol to indicate that it is undergoing bankruptcy proceedings.
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When a corporation is on the verge of bankruptcy, its stock value reflects the risk of Chapter 11 becoming Chapter 7. For example, a company that previously traded at $50 may now trade at $2 per share due to bankruptcy speculation. After filing Chapter 11, the firm's stock price may fall to $0.10. This value is composed of the potential income that shareholders may receive after liquidation and the possibility that the firm may restructure and begin to operate successfully in the future. Private investors can buy and sell these 10-cent shares in the OTC market. The actual value does not reach zero unless the probability of restructuring is so low that a Chapter 7 filing is sure to follow or if the company does indeed end up in Chapter 7.
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However, if the company restructures and emerges from Chapter 11 as an improved organization, its share price may rise to higher levels than previously witnessed.
Bankruptcy Chapters
There are several types of bankruptcy chapters available in the United States, each with its own eligibility requirements, procedures, and outcomes. Chapter 1 deals with general provisions of the bankruptcy code, and Chapter 2 covers definitions. Chapter 3 deals with case administration, and Chapter 4 with the duties of debtors and trustees. Chapter 5 deals with creditors, debtors, and the estate.
The most common bankruptcy variations include:
Chapter 7: Also known as "liquidation bankruptcy," Chapter 7 involves the sale of a debtor's non-exempt assets to pay off its creditors and obligators. This is typically used by individuals with few assets and/or little income.
Chapter 9: Chapter 9 is available to fiscally troubled municipalities, such as cities, towns, and counties, allowing them to reorganize their debts and continue providing essential services to their residents.
Chapter 11: Chapter 11 bankruptcy is primarily used by businesses, allowing them to reorganize their debts and operations while under the protection of the court. It can also be used by individuals with high levels of debt who don't qualify for Chapters 7 or 13.
Chapter 12: Chapter 12 is similar to Chapter 11 but intended specifically designed for family farmers and fishermen.
Chapter 13: Chapter 13 bankruptcy involves developing a repayment plan to pay off creditors over a period of three to five years. It is typically used by individuals with regular income who are struggling with large, unsecured debts, such as credit card debt or medical bills.
Chapter 15: Chapter 15 is used for cross-border bankruptcies involving debtors, assets, or creditors in multiple countries. It allows for coordination between courts in different countries and helps to ensure that all parties are treated fairly.
If a company manages to emerge from Chapter 11 bankruptcy stronger than before, current shareholders may or may not benefit from the turnaround, as old stock may get canceled during the bankruptcy process, and new shares issued.
What Is Chapter 11?
Chapter 11 bankruptcy is a legal process in the United States whereby a failing business can be protected from creditors while it reorganizes its debts and operations. This allows a business to continue operating while it works on a plan to repay its creditors and future operations.
Who Can File for Chapter 11 Protection?
Any business, whether a sole proprietorship, partnership, LLC, or corporation, can file for Chapter 11 bankruptcy protection. Certain individuals who do not qualify for Chapter 7 or Chapter 13 bankruptcy may also file for Chapter 11.
What Are the Implications of a Chapter 11 Bankruptcy?
Filing for Chapter 11 can have both positive and negative implications, depending on the particular situation and context. On the plus side, Chapter 11 allows a business to reorganize and potentially emerge stronger and more profitable than before it failed. On the downside, the process can be costly and time-consuming, and the business may have to give up some control to creditors and the court. Shareholders are likely to lose some or all of the money they invested in the bankrupt company.
What Happens to Shareholders of a Bankrupt Company?
When a company files for bankruptcy, the value of its stock often declines significantly or becomes worthless, depending on the specifics of the bankruptcy proceedings. At that point, the shares are de-listed from exchanges and any dividends halted, but the residual shares may continue to trade over-the-counter (OTC). Equity shareholders are usually the last in line to receive any money from the sale of the company's assets, after creditors, bondholders, and other stakeholders like preferred shareholders have been made whole. In some cases, shareholders do not receive any compensation for their shares and will lose their investment entirely.
The Bottom Line
When a company files for Chapter 11 bankruptcy, it seeks legal protections from its creditors and other claimants while it reorganizes its business and restructures its debts. Under Chapter 11, the company's management still oversees daily operations, but must submit more major decisions to the bankruptcy court for approval. While a company is in Chapter 11, its stock may still have some value, but its price will likely have fallen dramatically and will have stopped paying dividends. Common stock shareholders are last in line to recover their investments, behind bondholders and preferred shareholders, and may receive pennies on the dollar - or nothing at all. If a company does manage to emerge from Chapter 11 bankruptcy, existing shareholders may or may not benefit from the turnaround, as the old stock may get canceled during the bankruptcy process with new shares issued.
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ARTICLE SOURCES
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Part of the Series
Bankruptcy
Bankruptcy Basics
Types of Bankruptcy
Personal Bankruptcy
Corporate Bankruptcy
Corporate Bankruptcy
Bankruptcy and Company Stock
Costs and Company Capital Structures
Shareholder Equity Under Chapt. 11
CURRENT ARTICLE
Profiting from Bankrupt Companies
Coming Back from Bankruptcy
Bankruptcy: Your Legal Rights
Bankruptcy Terms (341/A-B)
Bankrupty Terms (C-I )
Bankrupty Terms (J-Z)
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