What Chapter 11 Bankruptcy Filings Mean For Investors

Tuesday Morning Corporation TUES is taking the Chapter 11 route, in a retail sector beset by online competition and caution among consumers due to economic uncertainty.

A slew of publicly listed companies have filed for Chapter 11 of late, including:  

• Hertz Global Holdings Inc HTZ
• J C Penney Company Inc JCPNQ
• LATAM Airlines Group SA LTM
• Intelsat SA INTEQ
• Akorn, Inc. AKRX
• Stage Stores Inc SSINQ
• Windstream Holdings Inc WINMQ

What Chapter 11 Means

Chapter 11, or reorganization bankruptcy, is relief sought by a corporation or partnership wherein a plan of reorganization is proposed by the company to allow it to pay creditors over time in a bid to keep its business alive.

It takes its name after U.S. bankruptcy code 11, which governs the process. 

As opposed to Chapter 11, a Chapter 7 bankruptcy filing does not involve the filing of a repayment plan, but rather allows straight liquidation and settlement of debtors.

The Steps Involved In Chapter 11

• The filing of a petition with the bankruptcy court where the company is incorporated.
• Chapter 11 can be a voluntary filing, where companies seeking relief take the initiative for filing, or involuntary, where creditors can join hands to file against a defaulting company.
• The defaulting company that has filed for Chapter 11 can run its business as the debtor-in-possession, or DIP, and usually no trustee is appointed. However, if fraud or incompetency is involved, the court usually appoints a trustee to run the company through the proceedings.
• All significant decisions taken during the period should be approved by the bankruptcy court.
• Stakeholders such as creditors and shareholders have the right to accept or oppose decisions that require the court's approval. The court hears their argument before making its decision in this regard.
• The company is usually notified regarding the period within which it has to file the reorganization plan. This period usually ranges from four months to up to 18 months.
• If the company fails to do, committees of creditors, stockholders or other stakeholders can table their reorganization plan.
• The court confirms the plan, taking into account various criteria such as feasibility, good faith and determination that it is in the best interest of creditors.

What Happens To The Securities Of Chapter 11 Filers

The shares and bonds of companies that have filed for Chapter 11 continue to trade on exchanges, as the companies continue to do business. Therefore, the companies are liable to report any significant changes within 15 days on the SEC's Form 8-K.

There's always the risk of the shares losing much of their value due to the negative sentiment generated by the inability of the company to handle its finances. In most cases, they plummet hard so that they become ineligible to trade on main exchanges and are delisted. These companies will then trade over the counter on the OTC Markets.

When listed over the counter, the ticker of a company going through bankruptcy proceedings will be suffixed with "Q." Shareholders are the least protected in the eventuality of a bankruptcy filing and will cease to receive dividends.

See Also: What Happens When A Stock Gets Delisted And How It Impacts Investors

The trustee appointed to run the operations may require the shareholders to surrender their shares in order to be issued shares in the reorganized company. Investment value often sees an erosion.

Bond holders will stop receiving interest or repayments during the proceedings. Since bonds of a company reorganizing its debts will be downgraded to junk status, even if the bond holders choose to sell, it will be at a substantial discount.

After a company emerges from Chapter 11, it usually requires bond holders to exchange their bonds for either stock or bond or a combination of both, depending on what is allowed under the reorganization plan.

In the eventuality of a company being unable to put its financial house in order even with the Chapter 11 process, it may have to file for Chapter 7 or eventual liquidation.