When companies run into financial difficulties, they can seek out protection via the bankruptcy process, the same way individuals can file for bankruptcy when their debts spiral out of control. Filing for bankruptcy does not automatically mean a company is winding down operations and ceasing to exist. In some situations, that is the case, but often, a bankruptcy filing involves reorganizing a company's debts to allow business operations to continue.
But no matter what type of bankruptcy a given company files for, it can be bad news for investors who own shares of its stock. So if you have stocks in your brokerage account whose companies seem to be in trouble, you may want to unload them before those businesses file for bankruptcy.
Your stocks could become worthless
When a company files for bankruptcy, its stock gets delisted. At that point, it will only trade privately in what's known as the over-the-counter market. And any dividends that would normally be paid out to shareholders will cease.
Generally, when you add shares of stock to your brokerage account or IRA, you're buying common stock. But you should know that once a company files for bankruptcy, a trustee is appointed to make sure its assets are distributed as equitably as possible to creditors. And you should also know that as a holder of common stocks, you're basically last in line to get paid. Bondholders and investors with preferred stock will get paid before you do.
Does this mean that if a company files for bankruptcy, you'll get nothing from your shares? Not necessarily. But they may end up only being worth pennies on the dollar. And much will depend on how the bankruptcy itself shakes out.
If a company files for Chapter 7 bankruptcy, it means it's liquidating its assets and shutting down operations. In a situation like this, your chances of getting paid anything for your shares of stock are pretty slim.
But if a company files for Chapter 11 bankruptcy, it means it's reorganizing its debt with the intent to keep operating and move forward with a cleaner financial slate. In a Chapter 11, it's possible for new shares of stock to be issued to stockholders, so in a situation like that, you may not end up losing much or even any money.
Keep tabs on your investments
Generally speaking, if you own shares of a company that you think may be on the verge of bankruptcy, you're better off getting out and selling your stock before that filing becomes official. You might end up taking a loss on those shares, but it'll be a smaller loss than what you'd be looking at after a bankruptcy filing.
Along these lines, it's important to keep tabs on the companies you have money invested in. Once you start to see signs of financial decline, it should serve as a wake-up call to consider cashing out your shares before their value falls even more, or before a bankruptcy filing renders your shares worthless.
The good news is that losses you take in your investment portfolio can be used to offset gains. So if you have reason to believe a company you're invested in is about to file for bankruptcy and you sell your shares while they're worth a little bit of money, you might lose, say, $2,000 in the process. But if you have a $2,000 gain in your account, your loss will cancel it out. And if you don't have any gains, you can use your loss to offset some of your ordinary income.
Taking losses in your portfolio may not be ideal. But at least there's a silver lining from a tax perspective.
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FAQs
When you file for bankruptcy, any stock you own is often considered non-exempt property. This is because stock is not placed in a category of property that is exempt from creditors in your bankruptcy case. Exempt property includes retirement accounts, social security funds, and homesteads.
What happens to stock options in bankruptcy? ›
Essentially, the company becomes illiquid. In this case, stock options are either suspended or lose all of their value. Thus, you'll be unable to sell off your shares. As an employee with stock options, understanding the difference between a Chapter 11 bankruptcy versus a Chapter 7 bankruptcy is important.
What happens to investors when a company files Chapter 11? ›
Key Takeaways
During Chapter 11, a company's bonds will be significantly downgraded by the ratings agencies. The company may require investors to exchange their bonds for new bonds or stock as this helps them to rebalance their debt. The company's stock might be reissued to investors.
What does it mean when shareholders are wiped out? ›
For investors who own shares in a company that goes bankrupt, the equity is wiped out, rendering their investment worthless. Big stock exchanges set limits on how low a stock can go before they take it off their platform.
Can creditors take your stocks? ›
In most cases, stocks and brokerage accounts can be garnished by a creditor with a money judgment. However, sometimes a brokerage account may be exempt from garnishment due to federal or state law.
What happens to my stock if a company is bought out? ›
If the transaction is being paid in all cash, the shares should disappear from your account on the date of closing, and be replaced with cash. If the transaction is cash and stock, you'll see the cash and the new shares show up in your account. It's pretty much that simple.
What does bankruptcy mean in stock market? ›
Definition: When an organisation is unable to honour its financial obligations or make payment to its creditors, it files for bankruptcy. A petition is filed in the court for the same where all the outstanding debts of the company are measured and paid out if not in full from the company's assets.
What is probability of bankruptcy stocks? ›
A score below 1.8 signals the company is likely headed for bankruptcy, while companies with scores above 3 are not likely to go bankrupt. Investors may consider purchasing a stock if its Altman Z-Score value is closer to 3 and selling, or shorting, a stock if the value is closer to 1.8.
Do shareholders get wiped out in Chapter 11? ›
The Chapter 11 Debtor in Possession
A corporation exists separate and apart from its owners, the stockholders. The chapter 11 bankruptcy case of a corporation (corporation as debtor) does not put the personal assets of the stockholders at risk other than the value of their investment in the company's stock.
Should I sell my stock if company files Chapter 11? ›
When a company declares bankruptcy, its stock can end up being worth nothing. It's important to keep tabs on the companies you're invested in and consider selling your stock if you think a bankruptcy filing is imminent.
After filing for Chapter 11, the company's stock will be delisted from the major exchanges. Common stock shareholders are last in line to recover their investments, behind bondholders and preferred shareholders. As a result, shareholders may receive pennies on the dollar, if anything at all.
Do I lose my money if a stock is delisted? ›
Though delisting does not affect your ownership, shares may not hold any value post-delisting. Thus, if any of the stocks that you own get delisted, it is better to sell your shares. You can either exit the market or sell it to the company when it announces buyback.
What happens to investors if a company fails? ›
Generally, investors will lose all of their money, unless a small portion of their investment is redeemed through the sale of any company assets.
What does a shareholder lose if a corporation fails? ›
In case a corporation fails, its shareholders can lose the amount of money equal to or less than the amount initially invested. Therefore, they are not at risk of losing more money than their investment amount.
Will I lose my stocks if I file Chapter 7? ›
Stocks, bonds, and money contained in brokerage accounts can be liquidated as part of a Chapter 7 bankruptcy case but are protected just as your cash is protected. Your retirement accounts are safe from liquidation.
Should you sell stock before bankruptcy? ›
Generally speaking, if you own shares of a company that you think may be on the verge of bankruptcy, you're better off getting out and selling your stock before that filing becomes official.
