Corporate Bankruptcy
There are two main forms of corporate bankruptcy which includes chapter 7 and chapter 11 bankruptcies. If the court finds out that the company is not worth reorganizing then it goes for bankruptcy under chapter 7 which is known as liquidation bankruptcy. In this type of bankruptcy the company ceases all of its operations and goes out of business completely. All the assets of the company are liquidated to payoff its debts to the creditors. A trustee is appointed to sell the equity of company, liquidate it to pay the debts to investors and creditors. These debts are paid off in the order of claim.
The order of claim means that investors and creditors with least risk are paid first. Creditors are of different types including; secured creditors, unsecured creditors and stockholders. The creditors and bondholders who lend money to the company and whose claims are protected by specific assets or collateral, such as real estate, are the secured creditors and are paid before the company’s stockholders; those who have purchased an ownership stake include bank lenders, bondholders and suppliers. Moreover, after legal and administrative costs have been covered the creditors who have purchased a portion of the company are then paid.
If the court finds that the company can reorganize then the company can file for bankruptcy under chapter 11. Under chapter 11 the company will attempt to reorganize and continue its operations. In such a case a bankruptcy court must approve all major business decisions however the management continues to run the day-to-day operations.
After filing for bankruptcy under chapter 11 a company’s securities can continue to trade as there are no federal laws that forbid the companies to trade their securities after filing for bankruptcy. But mostly the companies become unable to trade their securities after filing for bankruptcy under chapter 11 and if they continue to trade their securities then it is done at extremely low prices. Moreover, in such a case its investors can take an income tax deduction for worthless securities
A public company will want to stay in business and reorganize its financial framework and become profitable again by paying off its debts so it will go for bankruptcy under chapter 11.
When a company files for bankruptcy the investors become cautious and usually avoid investing in such a company to prevent themselves from losses. This is because a bankrupt company has a greater risk of loss. From investor’s point of view bankruptcy is not good at all as they know that when the company they have invested in goes bankrupt they will get fewer profits as they had expected. However, chapter 11 bankruptcy is better than chapter 7 as in chapter 11 the business continues to run instead of ceasing when a company files for bankruptcy.
When a company files for bankruptcy the bondholders have a greater chance than stockholders’ to get repaid payment. Bonds represent debt which a company has agreed to repay with interest. But in case of bankruptcy the bondholder stops receiving interest payments and principle. Bonds may also continue to trade after bankruptcy under Chapter 11 but trading can be limited after bankruptcy as the value of securities decline sharply. Bondholders may receive new stock, new bonds, or a combination of new stock and bonds in exchange (of lower worth than the old ones) for their bonds as a result of the court-approved reorganization plan.