Created by FindLaw's team of legal writers and editors | Last updated July 11, 2018
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.
Stockholders, however, tend not to be so lucky. After restructuring, the company usually issues new stock, making the pre-reorganization stock worthless.
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