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What Happens to Stock in Chapter 11 Bankruptcy?
According to the U.S. Bankruptcy Court for the Eastern District of California, more than 30 companies filed for Chapter 11 bankruptcy in the Sacramento Division during 2016 alone. In 2015, the total was slightly higher at 40 companies filing for Chapter 11 in the Sacramento Division.
If you’re a California business owner who is thinking about filing Chapter 11, you are not alone. With care and diligence, filing Chapter 11 could be the action that transforms your failing business into a successful franchise or establishment. However, before you make such an impactful decision, it is necessary to educate yourself about how your company will be affected, such as effects on your shareholders and stocks.
Unlike Chapter 7, which involves liquidation of the business’ assets, Chapter 11 allows the company to continue operating because the Chapter 11 process centers around a debt restructuring (“reorganization”) plan. This plan must be negotiated with a committee of creditors.
The purpose of the plan is to delineate when, how, and to what extent various debts will be repaid, potentially including provisions for shareholders to receive financial compensation. In most instances, however, shareholders receive only a small amount of compensation, if any. For example, one study, which culled bankruptcy data from 2009 and 2010, revealed that less than 10% of the Chapter 11 cases analyzed resulted in “substantial” compensation for equity holders, including shareholders. Typically, shareholders receive little or nothing unless the company’s creditors are paid in full. Rather than being paid simultaneously, some creditors receive higher priority than others, starting with secured creditors, followed by unsecured or general creditors, followed – where possible – by shareholders. The Chapter 11 trustee may ask shareholders to return stocks, which can then be replaced with shares – though not necessarily as many – in the reorganized business.
Be advised that the Chapter 11 committee may reject your initial proposal for a reorganization plan. However, even in such a scenario, the bankruptcy court may nonetheless decide to approve your proposed plan.
You should also be prepared for stock trading – and, crucially, the value of your stocks – to be affected by the bankruptcy. Even though your company will continue to operate during the bankruptcy (though approval on major financial decisions, particularly those that would result in the company taking on more debt, may require approval from the bankruptcy court), the stock will be “delisted,” or taken off the pertinent stock exchange, such as the New York Stock Exchange or the Nasdaq. However, over-the-counter trading may proceed after the stock is delisted. A letter “Q” designation, which indicates bankruptcy, will appear at the end of the ticker symbol that identifies your business.
As to the bankruptcy’s impact upon stock value, there is both good news and bad news. The good news is that the stock will retain some of its value, but the bad news is that the value is likely to decline significantly. The bottom line is that, while Chapter 11 bankruptcy generally results in financial losses for stockholders, the process can be of immense benefit to struggling businesses. If Chapter 11 bankruptcy is executed with thoughtful planning and meticulous attention to detail, it can save an unprofitable company from collapse.
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