Businesses filing bankruptcy affect more than just the company and its employees; it can also affect any shareholders who have invested in that business, too.
Luckily, Chapter 11 is not a liquidation. Therefore, the management of that business remains in charge of its daily operations, and it can still generate profits. However, all decisions for the company are made by a court-appointed trustee, including debt securities, payments of debts, and more.
To understand how Chapter 11 affects shareholders, one must first understand how it affects the business.
Why Chapter 11 Bankruptcy Is Used
A company filing for Chapter 11 is requesting court-approved protections from their debts. They will still operate, and while they are on the verge of insolvency, they are requesting protection so that they can become successful after reorganizing debts owed, assets, and all business management affairs.
Chapter 11 works as an official reorganization. It is expensive, complicated, and most businesses will choose Chapter 11 because it ensures that they can remain open. If a company were to file for Chapter 7 bankruptcy, then they must cease operations – which negatively impacts the business, employees, and shareholders.
Chapter 11 spares the business from full bankruptcy. However shareholders are still affected even with the company operating as it should.
How Chapter 11 Affects Shareholders
Chapter 11 affects shareholders in different ways, including:
Share Value Drops
Usually, when a company files for Chapter 11, shareholders sell off their positions quickly. This sell-off will then create a share value decrease – a rather significant one. Therefore, anyone who maintains ownership of their shares will have a decreased value, and the longer they hold, the less they may receive in return when they do sell.
Company Is Removed from Major Exchanges
Any time a company files for Chapter 11 bankruptcy, the chances of them being delisted from the major exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq, is high. Exchanges do not want to offer shares on companies under bankruptcy because these carry a high risk of failure. Once removed, companies filing Chapter 11 are then re-listed on the pink sheets, known as the Over-the-Counter Bulletin Board (OTCBB).
Once on the pink sheets with the “Q” added to their ticker symbol, the company will stand out from others. You know which companies are currently in Chapter 11 because they have the Q symbol after their exchange symbol. For example, if company XYZ files for Chapter 11 and they are listed on the pink sheet, they will now have XYZQ as their ticker.
Bankruptcy Court Maintains Control
The company is allowed to operate as usual, but only with normal business operations. The court has control over all business decisions for the company. A company can still trade bonds and stocks while in Chapter 11, but they must report all of these to the Securities and Exchange Commission within 15 days of the transaction.
The Court Does Protect Shareholders (Sort Of)
Under Chapter 11, the court also creates a committee that is in charge of representing all shareholders and creditors of the company to ensure a fair reorganization. The company, alongside this committee, must then create a reorganization plan that the court approves. Also, creditors, bondholders, and shareholders can have a say in the reorganization plan – especially contesting it if they feel it does not address them equally.
Bondholders of a company in reorganization will not receive coupon payments or repayments. The company’s bonds are also downgraded under Chapter 11 to speculative-grade bonds. Most investors will not purchase these bonds, and if they are willing to take the risk, they will only do so after a substantial discount is applied.
Shares May Require Exchange Post-Bankruptcy
Also, once the reorganization and debt restructuring plan completes, all old shares usually are exchanged for new ones. The newly issued shares are part of the company’s chance to manage their debts and assets correctly.
What If the Company Fails to Finish Their Debt Restructuring Plan?
A company must follow its debt restructuring plan, which allocates specific payment amounts to creditors. The company is following a court-ordered repayment plan. And when they fail to comply with that reorganization or their liabilities exceed their assets, they may opt to convert into Chapter 7 bankruptcy.
What Happens to Shareholders If a Chapter 7 Bankruptcy Conversion Occurs?
If a company moves into Chapter 7, shareholders do not fair well. The reorganized stock is already somewhat worthless in value after the Chapter 11 process begins. And while shareholders can exchange their securities for a discounted version, they are under the control of the bankruptcy court’s reorganization plan.
If the company moves into Chapter 7, all assets are liquidated and the proceeds are used to pay down debt. First, legal and administrative expenses are paid. Second comes senior debts and unsecured debts, which can include bonds. Any cash left after selling those assets goes to the shareholders – and rarely is cash left after the liquidation. Therefore, shareholders may receive little to nothing.
Are You a Company Filing for Chapter 11? Take the Necessary Steps to Protect Your Business and Your Shareholders
If you are a company with shareholders and you are considering Chapter 11, you need a law firm that understands how important it is to protect your shareholders and investors. After all, a critical part of your business succeeding after the reorganization is having investors back your company. If you do not create a restructuring plan you can follow, your investors may become weary and sell their shares, even at a discount, to avoid falling into a Chapter 7 trap.
The attorneys at Hames, Anderson, Whitlow & O’Leary understand how difficult it can be for a business to file for bankruptcy. We also know how critical it is to keep your investors. Therefore, we work alongside business owners to find the best solution for their business, employees, and shareholders alike.
To get started on your bankruptcy plan, contact our firm for an initial consultation. We will help you decide whether Chapter 11 works best for your business’s future. Contact us now at 509-586-7797 or request more information online.