Why would a company file for bankruptcy protection

As such, in the case of a Chapter 7 bankruptcy, stockholders may not be fully compensated for the value of their shares. In light of this risk-return tradeoff , it seems fair and logical that shareholders are second in line to bondholders when a bankruptcy takes place. Secured creditors assume even less risk than bondholders. They accept very low interest rates in exchange for the added safety of corporate assets being pledged against corporate obligations.

Therefore, when a company goes under, its secured creditors are paid back before any regular bondholders begin to see their share of what's left. This principle is referred to as absolute priority. In a Chapter 11 bankruptcy, the company doesn't go out of business but is allowed to reorganize. A company filing Chapter 11 hopes to return to normal business operations and sound financial health in the future.

This type of bankruptcy is generally filed by corporations that need time to restructure debt that has become unmanageable. On Sept. The settlement dissolves Purdue Pharma and creates a new public benefit company charged with funding opioid-addiction treatment and prevention. Purdue also agreed to release 30 million documents related to the case. On Dec. Chapter 11 allows the company a fresh start, but it must still fulfill its obligations under the reorganization plan.

A Chapter 11 reorganization is the most complex and, generally, the most expensive of all bankruptcy proceedings. It is therefore undertaken only after a company has carefully considered all the alternatives.

Public companies tend to file under Chapter 11 rather than Chapter 7 because it allows them to continue to run their businesses and participate the bankruptcy process. Rather than simply turning over its assets to a trustee for liquidation, as it would have to in Chapter 7, a company entering Chapter 11 has the opportunity to retool its financial framework and, ideally, return to profitability.

If the process fails, all of the company's assets are liquidated and stakeholders are paid off according to absolute priority, as described above. When a company files for Chapter 11, it is assigned a committee that represents the interests of creditors and stockholders. This committee works with the company to develop a plan to reorganize the business and get it out of debt, reshaping it into a profitable entity.

Shareholders may be given a vote on the plan, but that is never guaranteed. If no suitable reorganization plan can be devised by the committee and confirmed by the courts, shareholders may not be able to stop the company's assets from being sold off to pay creditors. When a company files for Chapter 11 bankruptcy, investors have basically two choices: ride it out to the end, hoping the company will revive, or just bail out and take the loss.

Clearly, nobody invests money in a company, whether through its stock or its debt instruments , expecting it to declare bankruptcy. However, when you venture outside of the risk-free realm of government-issued securities, you are accepting this added risk. When a company begins bankruptcy proceedings, its stocks and bonds usually continue trading, albeit at extremely low prices. Generally, if you are a shareholder, you will usually see a substantial decline in the value of your shares in the time leading up to the company's bankruptcy declaration.

Bonds for near-bankrupt companies are usually rated as junk. Once the company goes bankrupt, there is a very good chance you will not get back the full value of your investment. In fact, there is a strong possibility that you won't get anything back at all. During Chapter 11 bankruptcy, as the SEC summarizes, "bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends.

If you are a bondholder, you may receive new stock in exchange for your bonds, new bonds, or a combination of stock and bonds. If you are a stockholder, the trustee may ask you to send back your old stock in exchange for new shares in the reorganized company. The new shares may be fewer in number and may be worth less than your old shares.

The reorganization plan will spell out your rights as an investor, and what you can expect to receive, if anything, from the company. Basically, once a company files under any type of bankruptcy protection, your rights as an investor change to reflect the bankrupt status of the company. While some companies do indeed make successful comebacks after undergoing restructuring, many others don't. And if your stake in the pre-Chapter 11 company ends up being worth anything in the restructured firm, chances are it won't be as much as it used to be.

During a Chapter 7 bankruptcy, investors are even lower on the ladder. Usually, the stock of a company undergoing Chapter 7 proceedings becomes worthless and investors just lose their money. If you hold a bond, you might receive a fraction of its face value. What you'll receive depends on the amount of assets available for distribution and where your investment ranks on the priority list.

Secured creditors have the best chance of recouping the value of their initial investments. The moment a debtor files its petition, an automatic stay is imposed on creditors, which operates like a pause button on any collection efforts, litigation or similar actions.

Creditors can ask the court to lift the stay under certain circumstances, but the standard for doing so is often difficult to meet. The debtor may ask the court to pause other lawsuits outside of the bankruptcy case if they affect the estate. While the stay is in place, debtors use the bankruptcy process to evaluate their problems and make the necessary changes to succeed after reorganizing.

This includes deciding which contracts they want to carry forward and which to abandon. What many people misunderstand, however, is that this power is balanced by strong creditor protections. The Bankruptcy Code requires debtors to disclose significant information about their operations and imposes strict checks on debtor actions.

Under Chapter 11, the debtor is allowed to remain in possession of its estate and continue operating. Creditors may even move to dismiss the case if they believe the debtor is abusing the bankruptcy process.

The Bankruptcy Code creates a committee of unsecured creditors — those without assets backing their claims — to advocate on behalf of claimants who are likely not involved in the case. Arlington Heights: Chicago: Crystal Lake: Subscribe via RSS.

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