Does a shareholder lose all of their equity once a Chapter 11 bankruptcy is filed by the company?

By Chizoba Morah AAA
A:

When a company files for Chapter 11 bankruptcy, the management of the company is still in charge of the daily operations. That said, significant business decisions, especially those pertaining to debt or debt securities, are sent to the bankruptcy court for approval. While the firm is in Chapter 11, its stock will still have value, but there is a temporary trading freeze. Although the stock will be delisted, over the counter (OTC) trading may still occur. In other words, the equity a broker has invested in the firm is not valued at zero, but their true value cannot be easily determined since the shares are no longer publicly traded.

If the company proceeds to file for Chapter 7 bankruptcy, the company's creditors are paid in a specific order. Generally, investors or creditors are paid in the following order:

1) Secured creditors
2) Unsecured creditors
3) Shareholders

Usually, little to nothing is leftover for shareholders after the more senior creditors are paid. However, if the company restructures and emerges from Chapter 11 as an improved organization, its share price may rise to higher levels than previously witnessed.

When a corporation is on the verge of bankruptcy, its stock value will reflect the risk that a Chapter 11 may become a Chapter 7. For example, a company traded at $50 may trade at $2 per share due to bankruptcy speculation. If Chapter 11 is actually filed, the stock price may fall to 10 cents. This value is composed of the potential income that shareholders may receive after liquidation and a premium based on the possibility that the firm may restructure and begin to operate successfully in the future. Private investors can buy and sell these 10-cent shares in the OTC market. The actual value does not reach zero unless the probability of restructuring is so low that a Chapter 7 filing is sure to follow.

For more, check out What are the differences between Chapter 7 and Chapter 11 bankruptcy?

This question was answered by Chizoba Morah.

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