THE COLOR OF MONEY
Bargain hunters beware: After Chapter 11, company stock may be worthless
By Michelle Singletary
Susan Ferris Wyderko, director of the Office of Investor Education and Assistance for the Securities and Exchange Commission, recently joined me online for a discussion of investing in companies that have filed for bankruptcy protection. Many investors bet that these stocks will rise again. In fact, the opposite is likely to happen. Often companies that have regained solvency through Chapter 11 reorganization cancel their old stock, making it worthless.
Reader: What theory of business law allows a company to cancel its stockholders' investment in their company when it emerges from Chapter 11 and becomes solvent again to pay its just debts? Why can a company cancel its investors' interests?
Susan Ferris Wyderko: During the bankruptcy process, the company's assets must be divided up to satisfy the claims of the creditors. The investors who take the least risk are paid first.
For example, secured creditors take less risk because the credit that they extend is usually backed by collateral, such as a mortgage or other assets of the company. They know they will get paid first if the company declares bankruptcy.
Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal.
Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly.
The owners are last in line to be repaid if the company fails.
Bankruptcy laws determine the order of payment. If no assets are left over after satisfying the claims of creditors who stand in priority to the shareholders, common stock holders will receive nothing. Because the stock has zero dollar value, the company will cancel it and issue new stock in the newly organized entity.
Michelle Singletary: Why it is necessary to cancel the stock?
S.F.W.: In short, because there are no corporate assets left over after satisfying the claims of creditors who stand before the common stockholders in priority.
M.S.: In the Kmart case, is it possible that many of the stock sellers were aware the stock would be canceled and were in fact guilty of victimizing unsuspecting investors?
S.F.W.: I just can't speculate.
All I can say is that if any investor plans to invest in a bankrupt company, he or she should not assume that the stock will have any value — let alone rise in price — after the company emerges from bankruptcy.
M.S.: Do you feel that many investors just don't understand what they are doing when they buy stock? I mean do you feel they just don't understand the true risk?
S.F.W.: The e-mails and phone calls that we've gotten suggest that some people simply do not understand that stock in a bankrupt company may be canceled when the company emerges from bankruptcy.
M.S.: Where can investors go to find the information they need to make investment decisions on companies in bankruptcy?
S.F.W.: Unless it cancels its common stock or withdraws its registration when it files for bankruptcy protection, a company in bankruptcy will file reports with the bankruptcy courts and the SEC.
At some point, the company will file a "plan of reorganization" with the bankruptcy court, which outlines how assets will be allocated among creditors.
When a company files its proposed plan of reorganization with the court, it will also file that plan with the SEC, attached to a "Form 8-K." A Form 8-K is the "current report" that companies use to disclose material events or corporate changes. The SEC requires companies to file these forms promptly whenever an important event occurs. You can find Forms 8-K on our Web site by going to www.sec.gov and clicking on "Search for Company Filings." Click on "Companies & Other Filers" to initiate a search.
