How Does Chapter 11 Bankruptcy Affect Common Stock?

When a company has liabilities exceeding its assets, it may declare bankruptcy, just as individuals do. However, in a corporate bankruptcy, the individual shareholders are often left with no assets, even if the company reorganizes and emerges as a continuing entity. Before bankruptcy proceedings are closed, the stock of a company filing Chapter 11 is often quite volatile.

When a company files Chapter 11 bankruptcy, the stock usually falls dramatically and immediately. Stock is nothing more than a representation of ownership in the financial fortunes of a company. If a company declares bankruptcy, those shares will usually end up being worthless, so most investors try to sell the stock for whatever price they can get soon after a bankruptcy announcement.

One of the reasons stock shares generally fall to just pennies a share after a bankruptcy announcement is due to the hierarchy of payments in the corporate structure. Even if a company changed their filing to a Chapter 7 liquidation, or otherwise had available assets to pay investors, the first payments would go to bondholders, who are considered senior creditors in a bankruptcy. If any assets remained after the bondholders were satisfied, remaining assets would be distributed to preferred stockholders. Common stockholders are last in line in terms of receiving assets, meaning that in any type of bankruptcy proceeding, there is usually nothing to distribute to common shareholders.

After a company declares bankruptcy, it usually no longer fulfills the financial requirements for listing its shares on an exchange such as the New York Stock Exchange. However, the SEC doesn't prohibit the trading of any company's shares, so after being delisted from the major exchanges, a bankrupt company's stock usually trades on an over-the-counter bulletin board market, also known as the "pink sheets." Buying stock in this market is generally considered speculative and quite risky, as many of these stocks will ultimately trade to zero.

Many companies filing Chapter 11 ultimately emerge from bankruptcy under the terms of a reorganization plan filed with the courts. Reorganization for a company invariably means the cancellation of existing common stock and issuance of new stock. At this point, the pre-bankruptcy stock will officially be rendered worthless and will have no valid claim on any corporate assets.

Once a reorganization plan has been announced, but before it is officially put into effect, the pre-bankruptcy shares will trade with a five-letter stock symbol ending in "Q," to prevent investor confusion as to the nature of the shares. The post-bankruptcy shares will trade with a stock symbol ending in "V" and will be referred to as "when-issued" shares, meaning that they will be the valid trading shares once the company officially emerges from bankruptcy. Ultimately, the "Q" shares will be rendered worthless.