Filing Chapter 11 bankruptcy means that the 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. Although the Chapter 11 reorganization process is complex and expensive, most companies, given the choice, prefer Chapter 11 to other bankruptcy Provisions such as Chapter 7 and Chapter 13, which will cease operations of the company and lead to a complete liquidation of assets to creditors. Filing for Chapter 11 gives companies the opportunity to be successful.
Understanding Chapter 11 Bankruptcy
Chapter 11 can spare a company from declaring total bankruptcy, the bondholders and the shareholders of the company, as a rule, very bumpy ride. When a company files for Chapter 11 protection, its share value typically drops significantly as investors sell their positions. In addition, filing for bankruptcy protection means that the company is in such rough shape that it should be excluded from listing on the largest exchanges such as Nasdaq or new York stock exchange and transferred to the pink sheets or OTC Bulletin Board (OTCBB).
When the company is going through bankruptcy proceedings is listed on the pink sheets or otcbb, the letter “M” is added at the end the Ticker of the company, to distinguish it from other companies. For example, if a company with Ticker ABC was placed on the OTCBB because of Chapter 11, its new symbol will be ABCQ.
In accordance with Chapter 11, corporations can continue doing business, but the court of bankruptcy retains control over significant business decisions. Corporations may also continue to trade in company debt and equity throughout the bankruptcy process, but are required to report to the US securities and exchange Commission within 15 days. As soon as Chapter 11 of the bankruptcy code served in the Federal court appoints one or more committees that are mandated to represent and work with the creditors and shareholders of the Corporation to develop a fair restructuring. The Corporation, along with members of the Committee, creates a reorganization plan, which needs to be confirmed in bankruptcy court and agreed to by all lenders, bondholders and shareholders.
Sometimes, after the reorganization, the company will issue new shares that is different from the pre reorganization stock. If this happens, investors need to know whether the company has given its shareholders the possibility of exchanging old shares for new shares, as old stock, generally will be deemed useless when new shares are issued.
During the period of reorganization, the bondholders receive coupon payments and/or principal payments. In addition, the company’s bonds will also be downgraded to speculative grade bonds, otherwise known as junk bonds. Since most investors are afraid to buy junk bonds, investors who want to sell their bonds, you will need to do it at a significant discount.
After the completion of the restructuring process, depending on the terms dictated by the debt restructuring plan, the company may require the investors to exchange their old bonds for shares and/or bonds. These new issues of stocks and bonds, represent an attempt to create more manageable level of debt.
(For more on this, see what is a credit rating? and junk bonds: everything you need to know.)
If the reorganization plan fails and the company’s liabilities start to exceed its assets, then bankruptcy becomes a Chapter 7 bankruptcy.
As the division of property varies in accordance with Chapter 7 bankruptcy
Under Chapter 7 bankruptcy, all assets are sold for cash. That cash is then used to repay the judicial and administrative expenses, which were incurred in the bankruptcy proceedings. After this money is distributed first to holders of senior debt, and then unsecured debtholders, including the holders of the Bonds. In extremely rare cases, there is still cash left, the rest is divided among the shareholders.
On the other hand, if the reorganization plan were successful and the company returns to profitability, several things can happen prior to the reorganization of the investor bonds or the shares. In the case of the issuance of bonds, investors may be required to exchange the old bonds for new bonds or stock, depending on conditions required in accordance with the debt restructuring plan. In addition, the coupon and principal payments on the new debt instruments will be resumed.
Shareholders, however, usually not so lucky. After the restructuring, the company usually issues new shares, making the pre-reorganization shares depreciated. In some cases, the owners of the old stock is not allowed to exchange their securities for a reduced amount of a new promotion that dictates the reorganization plan.
For further reading on this topic, see an Overview of corporate bankruptcy.