Download What Happens to Bondholders When a Company Files for Bankruptcy

What Happens to Bondholders When a Company Files for Bankruptcy?
When a public company files for bankruptcy, everyone with a stake in the company, from
employees to creditors to bondholders, is concerned about the future of the company and the
outcome of the bankruptcy proceeding.
For bondholders, here's some general information to help understand what could happen to your
investment.
What is
bankruptcy?
Generally, bankruptcy is the inability of a company to pay its debts as they
become due. Public companies file for protection under the federal bankruptcy
laws when their liabilities or debts exceed the value of their assets, or they are
unable to pay their bills. A bankruptcy filing gives a company an opportunity to
reorganize its business in hopes of returning to profitability or completely closing
down operations and selling off assets, then using the money to pay off its debts
in a process known as liquidation.
What happens when a company
files for bankruptcy?
Public companies can file for bankruptcy protection under either Chapter 7 or
Chapter 11 of the federal bankruptcy laws.
In order of their priority...
In a bankruptcy, assets and proceeds are distributed to satisfy claims in order of
the claims' priority. Investors who take the least amount of risk are paid first. As
a result, creditors and bondholders who lend a company money will be paid
before its stockholders, who have purchased an ownership stake. Creditors are
paid after legal and administrative costs have been covered.
1. Secured creditors, whose claims are protected by specific assets or
collateral, such as real estate, are paid first.
2. Then unsecured creditors, which often include bank lenders, bondholders
and suppliers, are next in line.
3. Stockholders, who have purchased a portion of the company, are paid last, if
there is money available after the secured and unsecured creditors' claims have
been paid.
Under Chapter 7, the corporation is liquidated after the federal courts have
determined that a reorganization is not worthwhile. A court-appointed trustee will
liquidate all of the company's assets and distribute the proceeds in order to
satisfy claims. Claims are considered in order of their priority.
Under Chapter 11, a company will attempt to reorganize and continue
operations. Management continues to run the day-to-day operations, but a
bankruptcy court must approve all major business decisions.
The U.S. Trustee Program, a component of the Department of Justice
responsible for overseeing the administration of bankruptcy cases, will establish
and oversee several committees to represent the interest of parties including
creditors, such as banks and bondholders, and stockholders. The committees
work with the company to develop a reorganization plan.
The reorganization plan must be approved by creditors, and stockholders and
confirmed by the bankruptcy court. However, even if some of the groups vote to
reject the plan, the court can approve it if it believes the plan treats creditors and
stockholders fairly.
What will happen
to my bonds?
Bonds represent debt which a company has agreed to repay with interest. As
such, when a company files for federal bankruptcy protection, bondholders have
a better chance of getting repaid than stockholders. While bankruptcy laws
determine the order of repayment, stockholders, considered owners of the
company, have the last claim on assets.
In a Chapter 7 bankruptcy, bondholders may receive a portion of the value of
their bonds. After being notified of the bankruptcy filing, bondholders should file a
claim so they can receive a payment if cash is available after other expenses
have been paid. Proof of claim forms are available on the Administrative Office
U.S. Courts Web site.
default
When a company fails to pay principal and interest when due, a default occurs.
In a corporate bankruptcy or liquidation, although secured creditors,
bondholders and holders of other senior debt issues may receive some
distribution of corporate assets, it is rarely enough to "make whole" their total
investment. Bonds of companies in default may trade at very low prices, if they
trade at all, and liquidity may disappear.
Bonds may continue to trade once a company has filed for bankruptcy under
Chapter 11. However, bondholders will stop receiving principal and interest
payments, causing a default to occur. Also the value of the securities could
decline sharply and trading could be extremely limited.
In addition, as a part of the court-approved reorganization plan, bondholders may
receive new stock, new bonds, or a combination of new stock and bonds in
exchange for their bonds. The new securities may also be worth less than the old
ones.
How will I know if a company
has filed for bankruptcy?
Often, news reports provide investors with their first information about a
company's bankruptcy filing. However, if you hold bonds through a broker, your
broker should contact you, forwarding information from the company. If the bonds
are held in your name, then you should receive information directly from the
company. Investors should also contact their brokers or investment advisor if
they do not receive any information from the company.
Investors may be asked to vote on a company's reorganization plan. Before you
do, you should receive a copy of the plan and a ballot, as well as a courtapproved disclosure statement and information on any court hearings on the
plan's confirmation and deadlines for filing objections to the plan.
Important tax issues
If securities lose their value as the result of a bankruptcy filing, investors may be
able to take an income tax deduction for worthless securities.
An accountant, tax or bankruptcy attorney or investment advisor can provide
additional information, or contact the Internal Revenue Service for information
and publications to find out if your securities meet the IRS criteria.
Visit www.irs.gov for information and forms on worthless securities, frequently
asked questions regarding worthless securities, and the Gain/Loss Publication.
How can I find out
more information?
The U.S. Bankruptcy Courts can be a source of information. The Administrative
Office of the United States Courts provides a listing of the bankruptcy courts in
each region, as well as links to their Web sites.
The Administrative Office of the U.S. Courts' Web site also provides information
on bankruptcy procedures as well as official bankruptcy forms, including a
creditor's proof of claim form.
At the company, the investor relations officer can be a contact for information.
Search the company Web site for information on how to contact the investor
relations office. In addition, companies operating under Chapter 11 are still
required to file financial reports with the Securities and Exchange Commission
disclosing material financial information and business developments. Companies
are required to file reports through the SEC's EDGAR database.
The United States Trustee Program's Web site contains information about the
program and the federal bankruptcy system. Regional trustees often have Web
sites offering updates on important cases.
Also, a securities or bankruptcy attorney may be able to provide additional
information about bankruptcy proceedings.
For more information about corporate bonds see An Investor's Guide to
Corporate Bonds and An Investor's Guide to High Yield Bonds.
© 2003. Terms and Conditions