What should you do if you own stock or bonds in a company that files bankruptcy?
When a company files for Chapter 11 bankruptcy protection, stockholders and bond owners are notified by the company.
Chapter 11 bankruptcy allows a company to continue functioning, but creditors and shareholders must approve the reorganization plan.
This plan will call for the renegotiation of contracts with suppliers, unions and any other creditors.
If creditors and shareholders don’t approve the plan, a bankruptcy judge can OK the plan if it appears to provide for an equitable resolution of debts.
Plan ApprovedOnce the plan is approved, the company suspends dividends to stockholders and premiums to bond owners.
The stock in a company filing Chapter 11 may continue to trade, however in many cases the stock will not meet the minimum requirements for listing on a major exchange.
One way creditors are paid off is through issuing a new class of stock as repayment of debt. For all practical purposes, the stock you hold will be worthless or close to it.
If this happens, you may be eligible to deduct the cost of your loss (usually to offset up to $3,000 in capital gains).
Check with Tax AdvisorYou should check with a qualified tax counselor for what your individual situation will allow.
In rare cases, the original stock may retain some value if no new stock is issued and the company comes out of Chapter 11 in sound financial shape.
If the company files Chapter 7 bankruptcy, you can be almost certain you have lost all your money invested in the company’s stock.
Bond OwnersWhat happens to bond owners?
As noted in Part 2 of this series, bondholders are second in line for proceeds in either reorganization (Chapter 11) or liquidation (Chapter 7).
Under the best of circumstances, bond owners may receive pennies on the dollar in a Chapter 11 and could possibly receive some of the proceeds from Chapter 7 liquidation.
It is unlikely that bondholders will see their original principal returned.
Should you buy the stock of a company in bankruptcy?
This may seem like an unusual question, but some investors look for companies in Chapter 11 that have a good chance of emerging intact from bankruptcy.
If a company comes through Chapter 11 with its original stock intact, it might be an investment worth considering.
You should make a determination that the company has a good chance of continuing as a viable entity.
Buying stock in a company in bankruptcy usually means you are getting the stock at rock-bottom prices.
If the company has a successful turn around, you may be sitting on very low-priced stock that could register an impressive rise.
Company Could TankOf course, the company could ultimately tank even after Chapter 11.
Buying stock in a bankrupt company or one that is about to file bankruptcy is a risky proposition. You may lose your entire investment.
If you believe the company will emerge “leaner and meaner” and be in a position to make impressive gains, it makes sense to consider such an investment.
However, this investment should be with money you can afford to lose.
In most cases, a company in Chapter 11 bankruptcy has a very good chance of slipping into Chapter 7 when things don’t work out.
Part 1: What is corporate bankruptcy?
Part 2: The two major forms of corporate bankruptcy.
Part 3: What happens to stockholders and bond owners?