A:

Filing for chapter 11 bankruptcy protection simply means that a company is on the verge of bankruptcy but believes that it can once again become successful if it is given an opportunity to reorganize its assets, debts and business affairs. Although the chapter 11 reorganization process is complex and expensive, most companies, if given the choice, prefer chapter 11 to other bankruptcy provisions such as chapter 7 and chapter 13, which cease company operations and lead to the total liquidation of assets to creditors. Filing for chapter 11 gives companies one last opportunity to be successful.

Understanding Chapter 11 Bankruptcy

While chapter 11 can spare a company from declaring total bankruptcy, the company's bondholders and shareholders are usually in for a rough ride. When a company files for chapter 11 protection, its share value typically drops significantly as investors sell their positions. Furthermore, filing for bankruptcy protection means that the company is in such rough shape that it would probably be de-listed from the major exchanges such as the Nasdaq or the New York Stock Exchange and relisted on the pink sheets or the Over-The-Counter Bulletin Board (OTCBB).

When a company going through bankruptcy proceedings is listed on the pink sheets or OTCBB, the letter "Q" is added to the end of the company's ticker symbol to differentiate it from other companies. For example, if a company with the ticker symbol ABC was placed on the OTCBB due to chapter 11, its new ticker symbol would be ABCQ.

Under Chapter 11, corporations are allowed to continue business operations, but the bankruptcy court retains control over significant business decisions. Corporations may also continue to trade company bonds and stocks throughout the bankruptcy process but are required to report the filing with the Securities and Exchange Commission within 15 days. Once Chapter 11 bankruptcy is filed, the federal court appoints one or more committees that are tasked with representing and working with creditors and shareholders of the corporation to develop a fair reorganization. The corporation, along with committee members, creates a reorganization plan that must be confirmed by the bankruptcy court and agreed upon by all creditors, bondholders and stockholders.

Sometimes after a reorganization, a company will issue new stock that is considered different from the pre-reorganization stock. If this occurs, investors will need to know whether the company has given its shareholders the opportunity to exchange the old stock for new stock, because the old stock will usually be considered useless when the new stock is issued.

Throughout the duration of the reorganization, bondholders will stop receiving coupon payments and/or principal repayments. Furthermore, the company's bonds will also be downgraded to speculative-grade bonds, otherwise known as junk bonds. Since most investors are wary of buying junk bonds, investors that want to sell their bonds will need to do so at a substantial discount.

After the reorganization process and depending on the terms dictated by the debt restructuring plan, the company may require investors to exchange their old bonds for shares and/or new bonds. These new issues of stocks and bonds represent the company's attempt to create a more manageable level of debt. (For more on this, see What Is A Corporate Credit Rating? and Junk Bonds: Everything You Need To Know.)

If the plan for reorganization fails and the company’s liabilities start to exceed its assets, then the bankruptcy is converted into a chapter 7 bankruptcy.

How Division of Assets Differs Under Chapter 7 Bankruptcy

Under a chapter 7 bankruptcy, all assets are sold for cash. That cash is then used to pay off legal and administrative expenses that were incurred during the bankruptcy process. After that, the cash is distributed first to senior debt-holders and then unsecured debtholders, including owners of bonds. In the extremely rare event that there is still cash left over, the rest is divided among the shareholders.

On the other hand, if the reorganization plan ends up being successful and the company returns to a state of profitability, then multiple things could happen to investors’ pre-reorganization bonds or stock. In the case of bonds, investors may be obligated to exchange their old bonds for a combination of new bonds or stock, depending on the conditions required by the debt restructuring plan. In addition, the coupon and principal repayments on the new debt instruments would resume.

Stockholders, however, tend not to be so lucky. After restructuring, the company usually issues new stock, making the pre-reorganization stock worthless. In some cases, holders of the old stock are allowed to exchange their securities for a discounted amount of the new stock, which is dictated by the plan of reorganization.

For further reading on this topic, see An Overview of Corporate Bankruptcy.

RELATED FAQS
  1. Do shareholders lose all their equity once Chapter 11 bankruptcy is filed?

    Learn what happens to an investor's equity when a company files for Chapter 11 bankruptcy. Find out what happens if a company ... Read Answer >>
  2. What are the differences between Chapter 7 and Chapter 13 bankruptcy?

    Read about some of the primary differences between a Chapter 7 and Chapter 13 bankruptcy, including who may be ineligible ... Read Answer >>
Related Articles
  1. Personal Finance

    The Other Personal Bankruptcy Option: Chapter 13

    In a Chapter 13 bankruptcy, filers develop a plan to repay all or part of their "past due" debt. Any allowable debt left afterward is discharged.
  2. Personal Finance

    What You Need To Know About Bankruptcy

    Don't choose this last-resort option until you learn how it will affect your future.
  3. Taxes

    How To Survive Bankruptcy

    Bankruptcy is not the end of the world. You can survive it and come out on the other side more financially solid.
  4. Personal Finance

    Should You File for Bankruptcy?

    Find out how to determine whether bankruptcy will help or hurt your financial situation.
  5. Investing

    Don't Go Broke Buying Bankrupt Stocks

    Don't be tricked by bankrupt companies' low stock prices; they're low for a reason.
  6. Managing Wealth

    Benefit Issues When Your Employer Goes Bankrupt

    There are some safeguards in place to ensure that health benefits don't just disappear when a plan is canceled.
  7. Personal Finance

    Life After Bankruptcy

    Find out what you have to look forward to after filing for Chapter 7 or 13.
  8. Taxes

    How Long Bankruptcy Will Affect You

    How long will the sad chapter of bankruptcy impact the rest of your life?
  9. Insurance

    Personal Bankruptcies Cut Almost in Half After Obamacare

    Access to health insurance many have saved many Americans from going broke.
  10. Financial Advisor

    Bankruptcy Protection For Your Accounts

    Will the plan assets you've worked hard for be safe if you experience a personal financial crisis?
RELATED TERMS
  1. Chapter 10

    Chapter 10 was a type of corporate bankruptcy filing that was ...
  2. Wage Earner Plan (Chapter 13 Bankruptcy)

    A wage earner plan (Chapter 13 Bankruptcy) enables individuals ...
  3. Reorganization

    Reorganization is a process designed to revive a financially ...
  4. Means Test

    A means test is a method for determining whether someone qualifies ...
  5. 341 Meeting

    The meeting of creditors that occurs when an individual files ...
  6. Bankruptcy Financing

    Financing arranged by a company while under the chapter 11 bankruptcy ...
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center