When a company is unable to pay its debts as they become due, this is known as bankruptcy. Under federal bankruptcy laws, public companies can file for protection when their debts or liabilities exceed their assets, or if they simply cannot pay their bills. Filing bankruptcy leaves a company with two options:

		Reorganizing its business with an eye towards regaining profitability
		Shutting down operations completely and selling off assets to pay debts (liquidation)

Chapter 11 and Chapter 7

Under either Chapter 11 or Chapter 7 of the federal bankruptcy laws, public companies have the ability to file for bankruptcy protection.

Under Chapter 11

		A company will make an effort to reorganize and continue operating
		Management oversees the day-to-day business but a bankruptcy court retains final approval of any important business decisions
		The U.S. Trustee Program, a division of the Department of Justice, supervises the administration of bankruptcy cases. It sets up different committees to represent the interests of creditors and stockholders and to work with the company to create a plan for reorganization
		The plan for reorganization has to be approved by creditors and stockholders, and confirmed by the bankruptcy court. If any group votes to disallow the plan, the bankruptcy court allows it if it is deemed fair

Under Chapter 7

		Federal courts decide that reorganizing the company is of no use
		Court-appointed trustees liquidate any company assets and hand out the proceeds to satisfy claims

Order of Claim Settlement

		Secured creditors: Claims protected by specified collateral or assets (like property) are paid first
		Unsecured creditors: Bank lenders, suppliers, and bondholders are paid second and hand out the proceeds.
		Stockholders: Those who own a piece of the company are the last to be paid, assuming there is money left over after all of the creditors’ claims (secured and unsecured) have been settled

If You are a Bondholder

Bonds are debt that a company has arranged to pay back with interest. So when a company files for bankruptcy, the likelihood is that bondholders will be repaid ahead of stockholders. Under a Chapter 7 bankruptcy, bondholders might be able to obtain some of their bond value. After notification of a bankruptcy filing, bondholders need to file a claim for payment.

Under a Chapter 11 bankruptcy, bonds might still be traded. But bondholders will not get principal or interest payments—the result is a default. And the securities’ value could depreciate rapidly while trading may be severely limited. Sometimes, as part of the plan for reorganization, bondholders can receive new stock, new bonds, or a mix of new stock and bonds in exchange for the bonds that they are holding. There is a strong possibility that the new bonds might be valued lower than the old ones.

How to Find Out That a Company has Filed for Bankruptcy

Many times, media reports are investors’ first source of information about a company’s bankruptcy filing. If you own bonds through a brokerage, though, your broker should get in touch with you and pass on any information from the company. If the bonds are in your name, the company should pass on information straight to you.

You might receive a request to vote on the company’s plan for reorganization. Before voting you should be sent a copy of the plan, along with a ballot and a court-approved disclosure statement, plus details about court hearings regarding confirmation of the plan and deadlines for filing objections.

Your Taxes

You might be able to take an income tax deduction for securities that have lost their value. Check with your tax advisor or the Internal Revenue Service (IRS).

More Sources of Information

		U.S. Bankruptcy Courts
		Administrative Office of the U.S. Courts
		Securities and Exchange Commission
		U.S. Trustee Program
		Securities/Bankruptcy Attorneys