What if the company gets broke? What about my shares, will they breathe their last too? These are the common nightmares of panicked investors which they seek answers to.
Market volatility and the ongoing pandemic has seen burgeoning queries about their shares and the expected conditions if the company goes bankrupt.
You see, when a firm stops operating and enters into liquidation it is ending the business and allocates the assets to its plaintiffs, like creditors and shareholders.
The stocks though are returned but no longer hold any value.
Let us first grasp the concept of bankruptcy, which is usually confused with insolvency.
What is meant by Bankruptcy?
Bankruptcy is defined as a state where a firm finds itself impotent to reimburse its financial liabilities and thus files a case in the court wherein it further declares the bankruptcy.
It is a legal way that an afflicted company adopts to liberate itself from debts and other dues.
And then the debts not paid to claimants are absolved. The filing procedures for bankruptcy vary from country to country.
For instance, the United States processes involve adherence to three chapters which are: Chapter 7, 11, and 13.
Here, if an individual files for bankruptcy Chapter 7, it allows them to liquidate their assets and repay their monetary dues.
It means your shares are dead as well along with the company.
Chapter 11 under US laws for bankruptcy means that a company beseeches a chance to recover their obligations.
In case the company survives here, it may obliterate all the existing shares.
Chapter 13 here asserts that individuals may try to restructure their resources to recompense the debts.
This Chapter only serves self-employed or sole proprietors and not organizations or partnership companies.
However, in India filing for bankruptcy debilitates your credit ratings which further makes it difficult for a person to get loans.
So, you might have to look out for some other investor, if you want to start up all over again.
How is Bankruptcy different from Insolvency?
Often taken synonymous to bankruptcy, a company is said to be insolvent if it is not able to repay its debts and monetary obligations.
Just like bankruptcy, it can be transient too.
Insolvency generally arises due to bigger expenses, drop in cash arrival, or due to some unpredictable reasons, just as we have this pandemic as an example before our eyes.
When the company declares bankruptcy, it proposes for the following:
Plea the government to reorganize or restructure their debts and dues. It demands relaxation in reimbursement terms and condition to pay off the arrears easily.
The second alternate which a bankrupt company may opt is to ask the government to allow them the liquidation and then recompense the liabilities from its resources.
Also Read: Difference Between Growth Stock & Value Stock
How does Bankruptcy impact its shareholders?
As we just discussed, that bankruptcy case filing gives relaxation to the company in two ways: either by reorganizing of debt terms and recover from the broke state or by liquidation.
In case of restructuring of dues, the pertinent court assigns a resolution expert who will determine the laws and rules concerning creditors and lenders and those of reorganization.
The firm is rendered 6 months period, which can be further extended owing to a valid reason, during which it cannot channelize its resources and assets or raise funds on its own.
Furthermore, no lender or creditor can issue legal trials or execution against the firm.
The restructuring process of debts due to insolvency impacts the stock prices of company, and it may lessen the worth of shareholder’s portion.
The stock would be no more appreciative after imposing the restructuring terms during reorganizing procedure of debts.
Nevertheless, in case the firm proffers a solid scheme after restructuring, then investors and financiers may get the similar or more worth in long-standing.
Now, if the firm goes for liquidation, the professional appointed by the court will ready the liquidation terms and orders for payback preference.
Here, the common shareholders get paid at last for their investments, and may be even not recompensed with anything for their stocks as well in some cases.
Under liquidation, the allocation of company’s resources and assets is decided by the lawmakers, as to who is to be paid and when.
The priority here are the secured creditors who possess collateral supporting the lent money.
Next, to them, are unsecure creditors who shall be reimbursed. While the maximum perils are associated with domestic monetary backings such as from father, brother, spouse, legal guardian of a child, grandparents and so forth.
It also counts managerial expenditures associated with any trustee.
The second priority for repayment of investments are unsecured claims by the Federal Reserve Bank.
Further, other unsecured claims of up to $10000 are considered as next urgency.
And after all the secured and unsecured claims are fulfilled, the shareholders get the sum and may quite often even not get repaid either.
Since you are a part owner of the company as well, so it means the debt will also affect you.
However, there are many companies that can show up back well after bankruptcy.
To give you an example, General Motors, Marvel Entertainment, converse and so on are some of the companies that had the fortune of successful comeback indeed.
Now, to cut a long story short, in this write-up we discussed bankruptcy and how it can affect your shares in the company.
If a company is unable to pay off its debts and obligations for a long time, it can file for bankruptcy in court.
Therein, it can go for liquidation, which involves selling of its assets to satiate the creditors, or it may choose restructuring and reorganization of debts.
The latter allows the company to relax the credits terms and pay them back to the financiers.
If the company goes for liquidation, it is law which decides whom to pay first and when.
Here, secured creditors are topmost priority while common stockholders may or may not get back their revenues.