Chapters 7 and 11 Can Negatively Affect Creditors and Shareholders, Daniel Kamensky Says
Although business bankruptcies have declined in the United States since 2009, more than 13,000 businesses filed for bankruptcy in 2022, according to Statista. Bankruptcy filings occur as the result of business insolvencies. These bankruptcies significantly impact the corporation’s stakeholders, says Daniel Kamensky, a member of the advisory board of The Creditor Rights Coalition and founder and managing partner of Kingston Valley Enterprises.
The impact varies depending on whether the company files for bankruptcy under Chapter 7 or Chapter 11 of the federal bankruptcy code.
Under Chapter 7, the business stops operating, and a court-appointed trustee sells its assets. The trustee then divides the proceeds among shareholders based on precedence rules. Once the proceeds deplete, payments stop, and the remaining stakeholders receive nothing.
Bondholders take precedence, with those who secured their investment with collateral receiving payment before unsecured bondholders. Other debt holders, such as suppliers, follow. Shareholders are next, with preferred stockholders receiving payment before common stockholders.
Shareholders have little say in whether a business files Chapter 7. Businesses file Chapter 7 because their debts exceed their ability to pay. The value of their assets is often too little to cover all the debts, leaving nothing for shareholders, says Kamensky.
Chapter 11 is a petition to reorganize while still operating. The court will appoint a committee of creditors and shareholders to work with the company on restructuring its debt. Bondholders, creditors, and shareholders can approve the plan with court confirmation. However, if creditors and shareholders reject the plan, the court may still approve it if the court believes it is fair. Once the company complies with the terms of the restructuring, the court will discharge the rest of its debt.
Although shareholders typically fare a little better under Chapter 11 than Chapter 7, Daniel Kamensky says the impact may still be negative. Shares typically lose considerable value when the company announces a Chapter 11 filing. The company also is unlikely to pay a dividend until the company complies with the restructuring plan. Sometimes shareholders receive shares of stock in the newly reorganized company, but not always.
Creditors are impacted because they often make concessions such as lowering interest rates, agreeing to longer payment terms, or forgiving part of the debt.
Also, filing for Chapter 11 protection may sometimes result in a sale of a company under Section 363 of the Bankruptcy Code. Creditors, especially those who secured their loans with an asset, have more input in a Section 363 sale than they do under a Chapter 7 sale. They can also bid the amount of debt the company owes them when the asset comes up for auction, allowing them to obtain it without providing cash. However, a sale doesn’t guarantee creditors will receive all they are owed and generally leaves shareholders with nothing, Kamensky says.