The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to educate investors about what happens when a publicly traded company declares bankruptcy.
What happens in bankruptcy?
A company may decide to declare bankruptcy when it suffers from crippling debt. Federal bankruptcy laws govern how the assets and business of a company will be used to clear its debts. There are two types of bankruptcy available to companies. If the company is going out of business, then the company files for Chapter 7 bankruptcy. Under Chapter 7 bankruptcy, a trustee is appointed to liquidate the company’s assets and use the money to pay off its debts.
Under Chapter 11 bankruptcy, the company seeks to reorganize its business and, in particular, restructure its debt obligations. Management often continues to run the day-to-day business operations but all significant business decisions must be approved by the bankruptcy court. If it’s successful in the bankruptcy process, the company will emerge from bankruptcy with more manageable debt obligations.
Regardless of the type of bankruptcy a company files under, any common stock in a bankrupt company is likely to be worthless. That is because the common stock (that is, “equity”) is the last in line to receive what’s available to be distributed in a bankruptcy proceeding. Creditors, including bondholders, suppliers and employees, all come before holders of the company’s common stock. And, even if a company successfully reorganizes, its plan of reorganization often cancels the existing shares of common stock.
Can I still trade the stock after bankruptcy?
A company’s common stock may continue to trade even after the company has filed for bankruptcy. Companies that file for bankruptcy, however, are generally unable to meet the listing standards to continue to trade on the NYSE or NASDAQ. But, even when a company is delisted from one of these stock exchanges, its shares may continue to trade on over-the-counter securities markets, such as OTCBB or the OTC Markets. There is no federal law that prohibits trading of securities of a company solely because it is in bankruptcy.
|Note: “Q” is for Caution. Once a company files for bankruptcy, a “Q” may be added to its stock symbol to indicate the company’s bankrupt status. If the company issues new stock as a part of its reorganization plan, the new shares will be traded without the “Q” and the “old” shares (if still traded) will retain the “Q.” Investors are often confused by the fact that, despite the likelihood that the common stock of a bankrupt company will be cancelled, the company’s securities may continue to trade after the company has filed for bankruptcy protection and before it emerges as a newly reorganized company. This confusion may be aggravated by the lengthy bankruptcy process—which may take months, if not years.|
What are the risks of investing in a bankrupt company?
When a company files for reorganization under the federal bankruptcy laws, investors may be tempted to buy or hold the company’s common stock in anticipation that the company that emerges from bankruptcy will be profitable. The reality is that when companies emerge from bankruptcy, the “old” common stock of the company is usually worthless. In most instances, the company’s plan of reorganization will cancel the existing shares of common stock.
While a typical bankruptcy reorganization plan allows the reorganized company to issue new shares, holders of the “old” common stock generally do not receive any of these shares. A company must settle existing debt before it emerges from bankruptcy—and creditors, including bondholders, are the ones that usually receive these new shares as settlement.
This leaves little or nothing of value for holders of the “old” common stock. It may seem unfair, but it reflects the established priority scheme under federal bankruptcy laws and the fact that, in contrast to bondholders, holders of common stock take greater risk, but have the potential for the greater gain.
|How can I invest in the “new” company? If you are interested in investing in a newly reorganized company, you can do so by purchasing shares of “new” common stock after the company emerges from bankruptcy. Investing in the shares of companies that are in the middle of bankruptcy proceedings is extremely risky and can lead to financial loss.|
How will I know what’s going on?
If you hold stocks or bonds in street name with a broker, your broker should forward information from the company to you. If you hold a stock or bond in your own name, you should receive information directly from the company. In addition, a public company is required to file Forms 8-K with the SEC that provide information regarding the bankruptcy proceedings. You can search for these Form 8-K filings on the SEC’s EDGAR website.
As an investor in either the common stock or a bond of the company, you may be asked to vote on the plan of reorganization. Before you vote, you should receive from the company:
- a copy of the plan of reorganization or a summary;
- a court-approved disclosure statement which includes information to help you make an informed decision about the plan;
- a ballot to vote on the plan; and
- notice of the date, if any, for a hearing on the court’s confirmation of the plan, including the deadline for filing objections.
Even if you are not afforded an opportunity to vote, you should get a summary of the disclosure statement and a notice on how to file an objection to the plan.
You may also receive other notices unrelated to the plan of reorganization, such as a notice of a hearing on the proposed sale of assets, or notice of a hearing if the company converts to a Chapter 7 bankruptcy.
For information on how to search for company documents, such as Forms 8-K, in the SEC’s EDGAR database, see Using EDGAR - Researching Public Companies.
For another resource for using EDGAR, see Researching Public Companies Through EDGAR: A Guide for Investors.
For additional investor educational information, see the SEC’s website for individual investors, investor.gov.
The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.