When companies run into financial difficulties, they can seek out protection via the bankruptcy process, the same way individuals can file for bankruptcy when their debts spiral out of control. Filing for bankruptcy does not automatically mean a company is winding down operations and ceasing to exist. In some situations, that is the case, but often, a bankruptcy filing involves reorganizing a company's debts to allow business operations to continue.
But no matter what type of bankruptcy a given company files for, it can be bad news for investors who own shares of its stock. So if you have stocks in your brokerage account whose companies seem to be in trouble, you may want to unload them before those businesses file for bankruptcy.
Your stocks could become worthless
When a company files for bankruptcy, its stock gets delisted. At that point, it will only trade privately in what's known as the over-the-counter market. And any dividends that would normally be paid out to shareholders will cease.
Generally, when you add shares of stock to your brokerage account or IRA, you're buying common stock. But you should know that once a company files for bankruptcy, a trustee is appointed to make sure its assets are distributed as equitably as possible to creditors. And you should also know that as a holder of common stocks, you're basically last in line to get paid. Bondholders and investors with preferred stock will get paid before you do.
Does this mean that if a company files for bankruptcy, you'll get nothing from your shares? Not necessarily. But they may end up only being worth pennies on the dollar. And much will depend on how the bankruptcy itself shakes out.
If a company files for Chapter 7 bankruptcy, it means it's liquidating its assets and shutting down operations. In a situation like this, your chances of getting paid anything for your shares of stock are pretty slim.
But if a company files for Chapter 11 bankruptcy, it means it's reorganizing its debt with the intent to keep operating and move forward with a cleaner financial slate. In a Chapter 11, it's possible for new shares of stock to be issued to stockholders, so in a situation like that, you may not end up losing much or even any money.
Keep tabs on your investments
Generally speaking, if you own shares of a company that you think may be on the verge of bankruptcy, you're better off getting out and selling your stock before that filing becomes official. You might end up taking a loss on those shares, but it'll be a smaller loss than what you'd be looking at after a bankruptcy filing.
Along these lines, it's important to keep tabs on the companies you have money invested in. Once you start to see signs of financial decline, it should serve as a wake-up call to consider cashing out your shares before their value falls even more, or before a bankruptcy filing renders your shares worthless.
The good news is that losses you take in your investment portfolio can be used to offset gains. So if you have reason to believe a company you're invested in is about to file for bankruptcy and you sell your shares while they're worth a little bit of money, you might lose, say, $2,000 in the process. But if you have a $2,000 gain in your account, your loss will cancel it out. And if you don't have any gains, you can use your loss to offset some of your ordinary income.
Taking losses in your portfolio may not be ideal. But at least there's a silver lining from a tax perspective.
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FAQs
In the event you own stock of a company that files Chapter 7 bankruptcy, it will likely become worthless and it is unlikely you will recover any of your investment (see Banks and bondholders first sidebar).
What happens to stock options when a company declares bankruptcy? ›
Do the options keep trading until expiration date? If a company files for bankruptcy and the shares still trade or are halted from trading but continue to exist, the options will settle for the underlying shares. If trading in the underlying stock has been halted, trading on the options will be halted as well.
Do I lose my stock if a company files Chapter 11? ›
Practically speaking, companies usually take a significant hit to their stock value after a bankruptcy filing. Investors should understand that existing shares of common stock in a company filing for Chapter 11 usually are canceled, even if the company emerges and returns to profitability.
What happens to my stocks if I file Chapter 7? ›
Sometimes, the stock is protected explicitly if the business is a family-owned entity with a nominal number of shareholders. But if no exemptions protect the shares of stock from creditors, the bankruptcy trustee in Chapter 7 can SELL the shares and distribute the proceeds to creditors pro-rata.
What happens to shares when a company goes into administration? ›
What happens to shares when a company goes into administration? When a company enters administration, the shares held by the shareholders usually become worthless. Shareholders are often left with no claim to the company's assets or future profits.
Can a company take away your stock options? ›
Key Points. Your company cannot terminate vested options, unless the plan allows it to cancel all outstanding options (both unvested and vested) upon a change in control. In this situation, your company may repurchase the vested options.
What happens to stock options when company fails? ›
If the company fails, or gets acquired as part of a fire sale, common shareholders (i.e. the employees) either lose their investment entirely, or have to queue up behind preferred shareholders, who get paid out first.
What does Chapter 11 mean for stock holders? ›
The Chapter 11 Debtor in Possession
A corporation exists separate and apart from its owners, the stockholders. The chapter 11 bankruptcy case of a corporation (corporation as debtor) does not put the personal assets of the stockholders at risk other than the value of their investment in the company's stock.
Who gets paid first in Chapter 11? ›
Secured creditors like banks are going to get paid first. This is because their credit is secured by assets—typically ones that your business controls. Your plan and the courts may consider how integral the assets are that secure your loans to determine which secured creditors get paid first though.
Will I lose my job if my company files Chapter 11? ›
Chapter 11
Many employees may remain at work and continue to be paid and receive benefits. However, some may be laid off.
Chapter 7 bankruptcy is a type of bankruptcy filing commonly referred to as liquidation because it involves selling the debtor's assets in bankruptcy. Assets, like real estate, vehicles, and business-related property, are included in a Chapter 7 filing.
Can I keep my savings in Chapter 7? ›
Filing for Chapter 7 Bankruptcy: The Process
If an item of property, an investment, or cash is "exempt" or protected under the bankruptcy exemption laws, you can keep it.
Do you get a tax return after filing Chapter 7? ›
Your tax refund will be part of your bankruptcy estate. A tax refund based on the income you earned before filing for bankruptcy goes to the estate. Note: Most trustees are concerned about tax refunds owed to the filer after the tax year ends, not before. You keep the full refund.
Do I lose my money if a stock is delisted? ›
Though delisting does not affect your ownership, shares may not hold any value post-delisting. Thus, if any of the stocks that you own get delisted, it is better to sell your shares. You can either exit the market or sell it to the company when it announces buyback.
Should I sell my stock if company files Chapter 11? ›
When a company declares bankruptcy, its stock can end up being worth nothing. It's important to keep tabs on the companies you're invested in and consider selling your stock if you think a bankruptcy filing is imminent.
What happens to my shares if a company is dissolved? ›
While shares of liquidated companies are deemed worthless immediately, the same is not necessarily true for companies entering administration. Although it often acts as a step towards liquidation, administration does not have such a devastating impact on the value of shares and the portfolio of shareholders.
What happens to put options when a company is delisted? ›
When a stock is delisted, options trading on that stock typically ceases. This means that options holders are no longer able to buy or sell their options on the open market. However, they still have the right to exercise their options if they choose to do so.
What happens to options in liquidation? ›
If the underlying stock for an options contract you own liquidates and stops trading in the market, the shares that make up the contract will turn into the cash-per-share amount the company allocates. This means that the contract will be worth 100 times the amount per share the company decides to pay out.
What happens to stock options if the company never goes public? ›
If a startup never goes public what happens to the stock options that employees have? Nothing in particular happens to employee stock options if the issuer fails to go public, they simply persist as stock options according to the terms of the option plan and option grant.
What happens to options when a company splits? ›
For example, if you buy a call option that controls 100 shares of XYZ with a strike price of $75. If XYZ announces a 2:1 stock split, the contract would now control 200 shares with a strike price of $37.50. On the other hand, if the stock split is 3 for 2, the option would control 150 shares with a strike price of $50.
