By Ken Little. Stocks Expert
Part 1 of 3
When a company goes bankrupt, what happens to investors holding its stock or bonds?
Is buying the stock of a bankrupt company a good idea?
The bottom line is bankruptcy is seldom good for stockholders or bond owners.
However, many firms have emerged from one form of bankruptcy stronger and able to continue operations.
Bankruptcy is a form of reorganization or liquidation under the guidance of federal law.
The bankruptcy laws cover both companies and individuals, although there are major differences.
There are two major types of corporate bankruptcy: Chapter 11 and Chapter 7.
In both cases, companies are in a financial pickle and can no longer continue as a viable business.
Simply stated, they owe more money than they are worth. In most cases, the
companies are not able to pay for day-to-day expenses such as payroll, utilities, supplies and so on.
Some companies are allowed to declare a form of bankruptcy before they are completely destitute.
Companies may choose this action or may be forced into it by a creditor that is demanding a payment the company can’t make.
Bankruptcy laws offer an orderly way for the company to attempt to get back on its feet (Chapter 11).
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When that is not possible or fails, Chapter 7 bankruptcy structures a liquidation that pays creditors in the fairest distribution possible.
Stockholders are owners of the company and are last in line to receive any proceeds from liquidation. In addition, bond owners may only receive pennies on the dollar.
Other articles in this series cover forms of bankruptcy and what happens to stockholders and bond owners.