When a publicly listed companyceases operations and goes into liquidation, the company's shareholdersmay be entitled to a portion of the assets, depending on the type of shares they hold. However, the stock itself is usually worthless.
The owners of common stock shares are last in line for a share of the firm's liquidated assets, so the hope is a faint one.
Key Takeaways
- If a company declares Chapter 11 bankruptcy, it is asking for a chance to reorganize and recover. If the company survives, your shares may, too, or the company may cancel existing shares, making yours worthless.
- If the company declares Chapter 7, the company is dead, and so are your shares.
- Owners of common stock often get nothing when a company enters liquidation since they are last in line for payment.
What Bankruptcy Means
When it comes to businesses, there are two main types of bankruptcy recognized by U.S. law. The differences are crucial to shareholders. In either case, the company files for bankruptcy because it is in such deep financial trouble that it is unable to pay its immediate obligations.
- Chapter 11 bankruptcy signals that the company is asking the court to protect it from its creditors until it files a detailed plan for how it intends to recover financially. If the court accepts the plan, the company may renegotiate its debts, drastically cut its costs, and resume doing business. Over time, it may thrive and emerge from bankruptcy (or not).
- Chapter 7 bankruptcy means that the company has shut its doors for good. Its assets will be sold and the entire proceeds will be distributed to its creditors in a strict order of precedence.
What Bankruptcy Means to Shareholders
If it's a Chapter 11 bankruptcy, common stock shares will become practically worthless and will stop paying dividends. The stock may be delisted on the major stock exchanges, and a Q may be added to the stock symbol to indicate that the company has filed for bankruptcy.
It's possible that the shares may regain value as the company emerges from bankruptcy. Or, as part of the reorganization of debt, the company may cancel old shares and issue new ones, leaving little or nothing to the original shareholders.
If it's a Chapter 7 bankruptcy, the stock is defunct. The common shareholders may, at best, get a portion of their value back when the assets are distributed. They rarely get anything at all.
Once a company is in liquidation, bankruptcy law determines the order of the distribution of assets.
Notably, all of the above is true for preferred shares as well as common shares. But preferred shares are farther up in the line for repayment in case of liquidation. (The vast majority of shares are common stock. A preferred share is a hybrid of a stock and a bond that pays regular dividends.)
Who Gets Paid and When
Once a company is in liquidation, the law determines how the assets are distributed. There is a set waterfall in who gets paid first.
The first in line for payments is always secured creditors. Secured creditors assume the least amount of risk because they have collateral backing the money they have lent. After secured creditors come unsecured creditors. Within unsecured creditors, who has priority is listed in order legally.
The first in line for unsecured claims are related to domestic support. This would include obligations that are owed to a spouse, former spouse, or the child of the debtor, or the child's legal guardian. This would also include administrative expenses related to any trustee.
Second in line for where payments would be made would be administrative expenses related to unsecured claims by the Federal Reserve bank. This applies to loans made via programs under the Federal Reserve Act.
Third in line would include any unsecured claims under section 502(f), followed by unsecured claims of up to $10,000 earned by an individual or corporation within 180 days prior to the filing of the date of cessation. This can include wages, salaries, or commissions.
The list of unsecured claimants continues with a variety of situations. Unsecured claims include bondholders as well.
After secured and unsecured claims are paid, then stockholders receive payment. More often than not, stockholders will not be repaid.
Example of a Bankruptcy Payout
The amount of the payment a common shareholder will receive is based on the proportion of ownership they have in the bankrupt firm.
Moody's and Standard & Poor's provide company ratings that take into account the risk of bankruptcy. When buying stock, look at information such as a company's debt-to-equity ratio andbook value, whichcan give investors a sense of what they might receive in the event of bankruptcy. Watch for cash flow issues, and rising operating expenses at a time when revenue remains stagnant.
For example, suppose that a common stockholder owns 0.5% of the firm in question. If the firm has $100,000 to pay to its common shareholders after liquidation and other obligations, that owner would receive a cash payment of $500.
What Was the Biggest Bankruptcy?
The largest corporate bankruptcy in history was the 2008 collapse of Lehman Brothers, an investment bank with over $600 billion in assets. The collapse was caused by the firm's excessive exposure to mortgage-backed securities which crashed as a result of the 2008 housing crisis.
What Is the Downside of Filing for Bankruptcy?
Filing for personal bankruptcy can cause a large and immediate drop in your credit score, and it will stay on your credit report for seven to ten years. This will make it harder and more expensive to borrow money.
What Happens When a Corporation Files for Bankruptcy?
A bankruptcy is when a person or corporation says that they are unable to pay their debts and asks for those debts to be discharged. The court then liquidates the debtor's assets to repay some of their obligations. Certain types of property are protected in a personal bankruptcy, such as a person's car, personal property, and retirement accounts.
The Bottom Line
A corporate bankruptcy occurs when a company is unable to pay its debt obligations using existing assets or cash flows. This may occur due to mismanagement, bad investments, or unfavorable market conditions. Depending on the type of bankruptcy, the company may be able to continue doing business even after declaring bankruptcy.
