As businesses across the country continue to experience the current recession’s economic shockwaves, bankruptcy news is quickly becoming more common. But what happens to stock when a company goes bankrupt? Most of the time, the stock will become worthless and the investor won’t get any compensation. For investors, and employees with stock options, this can come as a shock. Understanding what happens when a company files for bankruptcy can save you from undue stress.
What Happens to Stock When a Company Goes Bankrupt?
Bankruptcy is a legal proceeding intended to free a business or individual from debt. It also allows creditors to receive potential repayment. When a company files for bankruptcy, shareholders may be entitled to some of the assets. Yet filing for bankruptcy doesn’t necessarily mean a company ceases operations. In fact, it can take years for the process to be completed. Additionally, federal courts determine how the liquidated assets are distributed. More often than not, shareholders are last in line to receive dividends.
Factor in the Type of Bankruptcy
What happens to stocks when a company goes bankrupt depends on what kind of bankruptcy they declare. Chapter 11 bankruptcy allows the company to reorganize and propose a recovery plan. This can save the company, and your shares, too. In most cases, however, the recovery plan will cancel existing shares. And even if it doesn’t, these shares will be worthless or near-worthless. If the Chapter 11 recovery plan is not approved by the court, it then moves on to Chapter 7 bankruptcy. This means there is no way to save the company or its shares.
Can the Stock be Traded After Bankruptcy?
The US Securities and Exchange Commission (SEC) says investing in companies that have filed for Chapter 11 bankruptcy is “likely to lead to financial loss.” Keep in mind that doing so is “extremely risky” and is not a thoughtful investing approach. Unfortunately, this has not stopped risk-takers who have sent bankrupt stocks soaring recently. They are not long-time investors, but instead speculators who are creating a higher demand for the stocks of companies like Hertz, JCPenney, and Diamond Offshore. These investors are attempting to time the market, an approach Zoe never recommends.
If you’re looking to understand which stocks indicate bankruptcy when looking at market summaries, “Q” is usually added to a stock symbol once a company files for Chapter 11. While a bankrupt company’s stock may continue to trade after the bankruptcy filing, the value of its stock is most likely worthless.
What Happens to My Stock as an Employee With Stock Options?
Once a company files for bankruptcy, they are no longer “good for” the agreed-upon value, and the potential for Chapter 7 bankruptcy increases. Essentially, the company becomes illiquid. In this case, stock options are either suspended or lose all of their value. Thus, you’ll be unable to sell off your shares.
As an employee with stock options, understanding the difference between a Chapter 11 bankruptcy versus a Chapter 7 bankruptcy is important. If your company files for a Chapter 11 bankruptcy, there is still a small chance that your shares will continue having value. In that case, there may be a difference in payout based on if you are a preferred shareholder or a common shareholder. While rare, your shares may survive or even be paid out to you. Whereas with a Chapter 7 bankruptcy, your company no longer has any value, nor do your shares. In some cases, there may be a bankruptcy payout to shareholders.
The Value of Staying Informed
When buying stocks at a company, it is essential to stay informed about the company’s activities and operating status. You don’t want to be caught by surprise when hearing about bankruptcy in the news. The company is responsible for sending you information if you hold a stock in your own name. If a stock is held through a financial planner, they should forward this information to you. If the company, indeed, files for bankruptcy, you may or may not be asked to vote on the recovery plan. As mentioned, shareholders are the last in line to receive any payout.
Whatever type of bankruptcy a company files, stocks are likely to be worthless, says the SEC. This is because liquidated assets are divided first between secured creditors (banks), then unsecured creditors (suppliers and bondholders), and lastly, between stockholders. These liquidated assets will only be divided if the shares are not canceled as part of the reorganization plan. Having a financial planner by your side when making investments will ensure your money is best managed by someone who understands your unique financial situation.
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