When a company files for bankruptcy, how is it different than an individual filing? What happens to the interests of the company’s investors? Whether you are an investor or a business owner, understanding corporate bankruptcy is important, particularly in these unique economic times.
Under U.S. law, companies can file Chapter 11 bankruptcy or Chapter 7 bankruptcy. Chapter 11 is a type of bankruptcy that gives the business the chance to reorganize its debts and business structure in an attempt to start making a profit again. The day-to-day business operations do not change much, but big decisions are overseen by the bankruptcy court. This is the type of bankruptcy that company will file if they are not ready to shut their doors and want to try to continue running, but are dealing with crippling debt.
Under Chapter 7 bankruptcy, the company decides it can no longer proceed and is ready to go out of business. All operations stop, and the bankruptcy trustee appointed by the courts is given the task of liquidating all assets. The money gained from the liquidation sales is used to pay much of the debt.
In both of these situations, investors are treated like a creditor. Investors who have the least amount of risk, such as a secured creditor, are going to be paid first because there is some form of collateral behind that debt. Bondholders are paid next, followed by stockholders if there is any money left. Since stockholders basically own a portion of the company, they are in the most dangerous position when a company files bankruptcy, whether Chapter 11 or Chapter 7.
Most companies will file Chapter 11 and try to figure out the situation. If they do, the reorganization plan is determined by committees made up of creditors and stockholders in the company, along with the company’s owners and managers. This ensures that everyone’s interests are considered when attempting to restructure the company and return to profitability. The U.S. bankruptcy court will appoint a trustee to oversee all meetings and decisions. The plan must comply with the Bankruptcy Code in order to be approved by the court an implemented by the company.
Investors that hold stock or own bonds in a company may get some return on their investment in a Chapter 11 case, but only if the company is able to restructure and regain profitability. Those who hold stock in a company that files Chapter 7 lose all of their investment. Bonds typically retain some value as the assets are liquidated, but nowhere near the face value of the bond.
