If a company you've funded files for bankruptcy, wish you luck for getting any money back, the alarmist says–or if you do, chances are you'll get back pennies on the Rupees. But is it true? The solution depends upon a variety of parts, together with the variability of Corporate bankruptcy and also the style of investments you hold.
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Companies can file for either Chapter 7 or Chapter 11 bankruptcy if they're impotent to pay their debts.
Chapter 7 simply liquidates (sell off) the company's assets, while Chapter 11 allows the business to continue to function under a reorganization plan.
If a company you've funded declares bankruptcy, how much you're likely to get back will depend on the type of bankruptcy and the types of investment, such as stocks versus bonds.
The kind of bankruptcy proceedings—Chapter 7 or Chapter 11— in general produce some clue as to whether the average investor will get back all, a portion, or none of their financial stake. But even that will differ on a case-by-case basis. There is also a chain of command of creditors and investors, which dictates who gets paid back first, second, third, and last (if at all).
Under Chapter 7 of U.S. Bankruptcy Code, "the company stops all operations or working and goes entirely out of business. A trustee is arranged to liquidate (sell) the company's assets, and the money is used to pay off debt," the U.S. Securities and Exchange Commission notes.
But not all debts are treated the same. Not surprisingly, the investors or creditors who signed up for the least risk are paid first. For example, investors who hold the bankrupt concern's corporate bonds have a relatively reduced exposure to loss: They had already forgone the potential of participating in any excess profits from the company (as they would have had they bought its stock), in return for the safety of regular, specified interest payments on their bonds.
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.
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 in 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.
From an investor's point of view, there isn't much good to say about bankruptcy. No matter what type of investment you made in a company, once it goes bankrupt you are probably going to get less for your investment than you expected.
In general, Chapter 11 is better for investors than Chapter 7. But in either case, don't expect much. Relatively few companies undergoing Chapter 11 proceedings become profitable again after a reorganization; even if they do, it is rarely a quick process. As an investor, you should react to a company's bankruptcy the same way you would if its shares took an unexpected dive for other reasons: Recognize the dramatically reduced prospects of the company and ask yourself whether you still want to be committed.
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