Companies that are in deep financial trouble are often described as either liquidating or trying to stave off liquidation. If it is liquidating, the company is out of business and its shareholders are almost certainly out of luck. If it is trying to stave off liquidation, it may possibly make a comeback and, if it does, its stock value could come back with it.

It depends on the legal process that the company undergoes. Most American companies that liquidate have followed the procedures of either Chapter 7 or Chapter 11 of the U.S. Bankruptcy Code.

Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy proceeding, the company immediately stops all business operations while a trustee is appointed to liquidate its assets, meaning sell off all of its remaining stock and other possessions for cash. The proceeds will be used to pay off its creditors and investors.

Key Takeaways

  • If a company files for Chapter 7 bankruptcy, it is out of business. The stock is almost certainly worthless.
  • If the company files for Chapter 11 bankruptcy, it's trying for a second chance. The stock shares may recover in time.
  • Historically, however, comebacks rarely succeed.

But when a company files under Chapter 7, it usually means that the company has few assets left to pay shareholders, and the stock is generally worthless. The company has gone out of business, and the trustee is appointed to wind down its affairs and sell off any assets.

The assets are used to pay administrative expenses first, followed by the claims of secured creditors. The trustee then distributes any remaining assets according to a hierarchy of interest holders. Bondholders and preferred shareholders are first in line for repayment if there are any remaining assets.

Common shareholders are last in line. It is highly unlikely that they will ever recoup any portion of their investments.

Chapter 11 Bankruptcy

Chapter 11 of the bankruptcy law is designed for companies that are in serious financial trouble but hope to emerge from it and rebuild.

To that end, the company submits a reorganization plan. For example, a troubled retailer may submit a plan to close half its stores, renegotiate some of its debts, and sell its headquarters building to raise money. The plan is usually aimed at satisfying the parties that have the greatest financial stake in the company. In a retailer's case, that might include unpaid suppliers and a bank that has extended large loans to the company.

The reorganization plan may be approved, or the company may be forced into Chapter 7 bankruptcy. If it's the latter, the company is finished and any stock shares are probably worthless. If the plan is approved, the company gets its second chance. If it succeeds, its stock shares may begin to rise again.

What Happens to the Stock During Chapter 11

If a company is in Chapter 11, it will continue its business operations and its stock shares could even continue trading.

By this point, those shares have almost certainly lost most of their value. Once it falls below $1 a share, the company will be de-listed from the major exchanges but could continue trading over the counter or on the pink sheets. Trading volume will be very low, and a stockholder would have trouble unloading them at any price.

Meanwhile, no dividends will be paid by the company while it is in the bankruptcy process.

General Motors made a historic comeback from bankruptcy but it took a massive infusion of government money.

In the best-case scenario, the company will emerge from bankruptcy stronger than before, and its shareholders may slowly recover value.

History is not on their side. Studies show the shares of companies that undergo Chapter 11 reorganization have a track record of performing poorly after reorganization.

If its fresh start fails, the company is back in bankruptcy court, this time to face liquidation.

A Post-Bankruptcy Success Story

One of the biggest shocks of the financial crisis of 2008-2009 was the bankruptcy filing of General Motors (GM), one of the bulwarks of American industry since 1908. At the time of its filing in 2009, GM had $82 billion in assets and $173 billion in liabilities.

It took five years and a massive infusion of government funding, but General Motors made a full comeback and repaid its debt to the taxpayers. Shareholders who hung on got their money back.