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What Happens to Stock When a Company Goes Bankrupt?

I f you’re wondering what happens to stock when a company goes bankrupt, you’re not alone. Bankruptcy filings from big-name companies often make front page news. Bankruptcies tend to be long, complex processes, and the financial issues of the company involved will almost certainly affect the company’s shareholders.

Key Takeaways:

  • The existing shares of a company that goes bankrupt usually end up being worthless, or worth only a tiny portion of their original value.
  • Businesses that file for Chapter 11 bankruptcy have the chance to reorganize, while businesses that file for Chapter 7 bankruptcy will cease operations and liquidate assets.
  • If a company survives Chapter 11 bankruptcy, your shares may still be worth something — but the company can also cancel existing shares.
  • Common stock owners are last in line for payment and generally get nothing when a company enters liquidation.

What Is Bankruptcy?

Image via Unsplash by jsnbrsc

What happens to stock when a company goes bankrupt depends on many factors, including what type of bankruptcy a company files for. First, it’s important to understand what bankruptcy means. Bankruptcy is the legal procedure for dealing with extreme financial problems. This isn’t usually good for anyone involved, from the company to its debt holders to its shareholders.

What Happens to a Company in Bankruptcy?

What bankruptcy means for a company depends on the type of bankruptcy proceedings they follow.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is often considered the ‘good kind’ of bankruptcy for public companies. When a company files for bankruptcy in this way, it asks for protection from creditors while reorganizing the business and restructuring debt.

The goal with this type of bankruptcy is reorganization. This can involve:

  • Reducing expenses.
  • Restructuring debt.
  • Turning around cash flow.

Chapter 11 bankruptcy is available to:

  • Corporations.
  • Partnerships.
  • Sole proprietors.

When a company obtains Chapter 11 bankruptcy protection, it means they’re on the brink of needing to cease operations but believe they can become successful again if given the opportunity to reorganize assets, business affairs, and debts. The firm’s management will oversee daily operations under Chapter 11, but the company will direct significant business decision to a bankruptcy court for approval. Significant decisions can include things like decisions about debts or debt securities.

In ideal circumstances, a company will continue to operate after filing Chapter 11 bankruptcy. For example, the retailer Sears filed for bankruptcy in 2018, and while it has significantly fewer stores now (and share prices have significantly decreased), the company is still in business.

Chapter 11 stocks come with a warning. The SEC cautions investors against buying shares of a company that’s in Chapter 11 bankruptcy, even saying that it’s ‘likely to lead to financial loss.’

Chapter 7 Bankruptcy

This is the ‘bad’ type of bankruptcy. A company filing Chapter 7 bankruptcy means it’s going out of business. The company will cease operations and liquidate its assets completely, selling all assets for cash that will be used to pay off administrative and legal costs incurred during the bankruptcy process.

What Happens to Stockholders When a Company Goes Bankrupt in This Way?

When a company files for Chapter 7 bankruptcy, a trustee sells off company assets and pays off debts. If there’s any money left at that point, the shareholders get to split those leftovers. However, many times, shareholders don’t receive anything after a company goes through Chapter 7 bankruptcy.

What Happens to Shareholders If a Company Goes Bankrupt?

Shareholders are the last people to receive payment when a company goes out of business. Unfortunately, people who own stock don’t get anything back at all in many cases.

What Happens to My Stock if a Company Goes Bankrupt?

What happens to stock in bankruptcy depends on the type of bankruptcy proceedings a company goes through. If a company goes through a reorganization, your stock will at best go way down in value. It’s also possible that things will get so bad that the stock gets delisted from major stock exchanges.

Many times, stock becomes totally worthless. Stock price is likely to at least stay low during and immediately after bankruptcy. However, there’s always the possibility that a company emerges from bankruptcy stronger than before, and stock prices rise again.

Let’s look at what the different types of bankruptcies can mean for stock and stockholders:

  • Chapter 11: Common stock shares become practically worthless and stop paying dividends. In addition to being delisted, the stock may get a Q added to its stock symbol to show that the company filed for bankruptcy. Shares could regain value as a company emerges from bankruptcy. On the other hand, the company may cancel old shares and issue new ones as part of their debt reorganization. This would leave little to nothing for the original shareholders.
  • Chapter 7: The stock is defunct if a company goes for Chapter 7 bankruptcy. At best, common shareholders can get a portion of their value back when assets are distributed. In most cases, though, common shareholders don’t get anything. Keep in mind that bankruptcy law will determine the order of asset distribution once a company is in liquidation. Preferred shares (a combination of a stock and a bond paying regular dividends) are higher up in line than common shares for repayment during liquidation. That being said, common stock makes up the vast majority of shares.

What Can Shareholders Do?

The unfortunate reality is that shareholders don’t usually have good options if a company goes bankrupt. Once you see news of the bankruptcy filings, stock prices have most likely already plummeted due to the company’s financial reality.

If stock is still listed on an exchange, you may be able to sell shares at this point, or you can sell shares over-the-counter (known as OTC). You may have to take a loss — if you can even sell at all. If you can’t sell, you’ll need to just wait out the bankruptcy and hope to get some kind of financial relief down the road.

It’s also not unlikely that the company will cancel all their existing stock, which will make your shares worthless. If you have faith in the business model and management, you can hang on and see if the company recovers with stock prices following. This can be a risk, as there’s a high probability the company will simply cancel your shares.

If a company makes it out of bankruptcy, they may offer pre-bankruptcy stock in the OTC market. Then, they’ll offer new stock to be traded publicly on the stock market. If you want to buy back in, the OTC stock will have that ‘Q’ symbol at the end of the ticket name; this old stock is more volatile (and possibly worth very little). The new stock may have a ‘V’ at the ticker name end, or it just won’t have additional letters.

Who Gets Paid…and When?

Once a company is in liquidation, the law will determine the order in which assets are distributed:

  1. Secured creditors: Banks and other lenders holding mortgage, equipment, or other secured debt agreements get paid for outstanding debts first. Secured creditors take on the least risk as they have collateral that backs the money they lend.
  2. Unsecured creditors: Second in line for payment are unsecured creditors, which may include banks, bondholders, suppliers, and more. There is also a legally determined priority for unsecured claims:
    1. Unsecured claims related to domestic support go first. This includes obligations owed to a child (or the child’s legal guardian) or a spouse or former spouse. Administrative expenses related to any trustee go here as well.
    2. Next are payments for administrative expenses related to loans made under programs of the Federal Reserve Act and any unsecured claims by the Federal Reserve Bank.
    3. Unsecured claims under section 502(f) go next.
    4. Then, unsecured claims up to $10,000 earned by a corporation or individual within 180 days prior to the filing of the date of cessation go. This may include things like salaries, commissions, or wages.
    5. Depending on the situation, the list of unsecured creditors can continue as well.
  3. Shareholders: Unfortunately, shareholders are the last ones in line to receive any payment. Stockholders only receive payment after all secured and unsecured claims are paid. More often than not, this means stockholders aren’t repaid at all.

Investing in Bankruptcy-Declared Stock

Investors who like to take risks might consider buying stock of a company that has declared bankruptcy. The logic is that you can get very inexpensive stock prices compared to what the stock was worth previously, and that the value of stock after reorganization will exceed the current low share price. However, this strategy comes with a big probability of failure. Even if a company does manage to reorganize and continue operations, creditors and lenders will often become the new owners. Their plan for reorganization will likely cancel existing shares, again rendering those shares worthless.

W hat happens to stock when a company bankrupts depends on whether a company filed for Chapter 11 or Chapter 7 bankruptcy. Still, in most bankruptcy proceedings, the results are usually bad news for shareholders.