If you own stock in a company that's headed for a Chapter 11 bankruptcy filing, the news is not going to be good. When the company emerges from bankruptcy, your shares will most likely be worthless. However, you may receive shares in the "new" post-Chapter 11 company, and the price of those shares will be determined by the market.
A publicly held company can file for bankruptcy under either Chapter 7 or Chapter 11 of the U.S. Bankruptcy Code. Chapter 7 is bankruptcy in the classic sense: The company is going out of business. In that case, there's no doubt what's going to happen to the stock price; it will go to zero, because there's no longer a company behind it. A Chapter 11 case, on the other hand, isn't really a true "bankruptcy" but rather a restructuring of the company's debt under court supervision. The company will continue operating as it devises a plan to reorganize its operations, repay its creditors and re-emerge as a stronger and, if all goes well, profitable company.
When a company files for Chapter 11, the stock price invariably plummets. Stock, after all, represents ownership in a company, and if the company is so deep in the hole that bankruptcy court protection looks attractive, there's not much value there to "own." The exchange where the stock is traded will usually delist it -- that is, stop handling trades in the stock. However, trades may continue outside the exchange, known as trading "over the counter." People buy the stock in the hope that the reorganization plan will provide some kind of compensation to the stockholders. If the plan includes a payment of, say, 10 cents per share, then buying a million shares at 3 cents a share is a good investment. Unfortunately, the odds of getting any kind of return are poor. As of the time of publication, the Securities and Exchange Commission warns in boldface type on its website that investors who buy bankrupt stocks will likely lose their money.
Last in Line
The Chapter 11 reorganization plan has two purposes: taking care of the company's creditors, and getting the company back on its feet. Creditors get paid back according to the priority of their claims. Secured creditors -- those with collateral -- get paid back first, then come the unsecured creditors. The stockholders are last in line. They get money only if there's anything left after the creditors are repaid in full. But a company that goes into Chapter 11 typically doesn't have the money to fully repay its debts. (That's why it's in Chapter 11.) In 2011, "Bloomberg Businessweek" reported on research by Andrew Wood, a student working with UCLA bankruptcy law expert Lynn LoPucki. Wood found that of 41 public companies that went into Chapter 11 in 2009 and 2011, stockholders got of return of any kind in only four cases. In the other 37, their investments were completely wiped out.
Stock After Bankruptcy
What typically happens as a company emerges from Chapter 11 is that it simply cancels its existing stock and issues entirely new shares. When this happens, the old shares become worthless. The new shares usually go to the creditors: The company doesn't have the cash to pay those creditors, so it gives them a share of ownership. You might be given the opportunity to exchange your old shares for new ones, but your stake in the company will be considerably smaller. Once the company issues the new shares, their price will be determined by the same market forces that determine all stock prices. If the market believes that the reorganization created a viable, stable, potentially profitable company, the price will go up or at least hold steady. If the market believes the Chapter 11 was just delaying the inevitable, and that the company will fail again, the stock price will reflect it.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.