Stocks and bonds are prioritized behind secured and unsecured creditors in Chapter 11 filings. Whether holders of stocks and bonds will have an interest in the restructured organization depends on what types of stocks they hold. It also depends on the value of the corporation's assets and the amount owed to the primary creditors.
Types of Stocks and Bonds
There are two types of stocks involved in a corporate structure: preferred and common. Preferred stocks are also known as preferred shares and are a hybrid between a special equity security and a debt instrument. They are superior to common stocks but are subordinate to bonds. Preferred stocks offer no voting rights but may carry dividends that must be paid out before common stock dividends. The structure of the preferred payouts is outlined in a document called a "Certificate of Designation."
Unlike preferred stocks, common stocks carry the right to vote, but this right is basically a vote for or against a block of directors. Depending on the their structure, common stocks may or may not pay out dividends and unless otherwise stipulated, a company is not contractually obligated to pay out common stock dividends.
Similar to preferred stocks, bonds are also debt securities that obligate authorized issuers to pay interests to the holders and/or repay the principals once the bonds mature.
In a bankruptcy, preferred stocks are superior to common stocks but are subordinate to bonds. Additionally, the trustee usually appoints an equity committee to represent the common stockholders' rights during the reorganization.
Priority in a Chapter 11 Bankruptcy
In a Chapter 11 reorganization, creditors precede stockholders in priority. The hierarchy puts creditors of secured debt first. Secured debt is debt backed by specific collateral that reduces a loan's risk. Next in line are holders of unsecured debt which may include corporate bonds and certain types of credit.
Once the debts to the secured and unsecured creditors are satisfied, preferred stockholders may then be allotted ownership interest in the restructured organization. Because common stockholders have the lowest priority, they may not recover anything in a Chapter 11 bankruptcy.
Procedure
Once a company files for Chapter 11, the debtor has to submit a reorganization plan to the bankruptcy court that outlines the reorganization. Both creditors and shareholders must approve the plan. If the creditors and shareholders do not approve the plan, the court can still authorize the plan if it deems the plan fair and equitable.
If the plan is approved, the stock may continue to trade. However, dividend distribution to shareholders is suspended. In some cases, creditors are issued a new class of stock to repay the debts. In any case, usually the value of the company stocks substantially decreases. Holders of decreased value stocks may deduct the loss to offset up to $3,000 in capital gains.
Find an Attorney
If you hold stocks and/or bonds in a company that is restructuring under Chapter 11, your stock may suffer a substantial decrease in value. If you are a common stockholder, the creditor hierarchy may put you at the losing end. Consult with a bankruptcy and/or tax attorney to discuss your particular situation.
