What Happens to Outstanding Stock During Corporate Bankruptcy

Overview

Stock is a fantastic investment choice for many people. It offers potential for large gains and can often beat the market if the issuing company is doing well. However, there are many risks associated with owning stock. You are essentially becoming a small owner in the company and may lose 100% of your investment if the stock tanks. What if the issuing company files for Chapter 11 bankruptcy? What about Chapter 7 bankruptcy? What happens to all of the outstanding stock? Read further to learn more.

Corporate Bankruptcy

A corporation may need to file for bankruptcy when it can no longer pay for its outstanding liabilities. The company has two options depending on the severity of its corporate debts.

• Chapter 7 – A company will file for Chapter 7 bankruptcy when it goes out of business completely. The company will liquidate all assets and use the proceeds to pay off creditors and investors.
• Chapter 11 – When a company files for Chapter 11 bankruptcy, they are given the chance to reorganize the business to try to become profitable. The management team will stay in place. However, major decisions must be handled by a bankruptcy court.

What Happens to the Stockholders

Stockholders may or may not receive payment for the stock they own. It all depends on the type of bankruptcy the company is going through and how much debt is outstanding. Your broker should keep you informed about all issues surrounding the bankruptcy and your options moving forward. Here is what you can expect:

• Chapter 7 – After all the assets of the company have been liquidated, an appointed trustee will distribute the cash to creditors and investors. How much you will receive is largely dependent on the type of stock you own and how much money was owed by the company. Typically, low risk creditors are paid first. This would include the mortgage bank and other lines of credit. Bondholders are paid next. If there is any money left, preferred stockholders would be paid before common stockholders. Owners of common stock are paid last and will often not see any money in a Chapter 7 bankruptcy.
• Chapter 11 – A company filing for Chapter 11 bankruptcy will still trade its shares in the open market. It is common for these shares to be de-listed from the NASDAQ or NYSE and be traded on the OTCBB. It will be expected that shares of the stock will be almost worthless at this point. As the company goes through the reorganization process, it may issue secondary common stock shares. This will devalue all shares even more. You may be asked by the trustee to trade in your old shares of stock for the newly issued stock. Ultimately, the reorganization plan will determine how much money, if any, you are entitled to during a Chapter 11 Bankruptcy.

Can I Buy Chapter 11 Stock?

It is possible to purchase shares of a company going through Chapter 11 bankruptcy. However, this is a very speculative practice and should only be performed by experienced investors.

Tying It Together

By now, you can see how risky stocks can be for an investor. If you own shares of a company who goes bankrupt, it is very possible that you will lose your investment. It is highly recommend that you perform proper due diligence on any company prior to purchasing their stock. If in doubt, consult a licensed financial professional for advice.