Abankruptcy is the inability of a company to pay its debts when they become due. When company's liabilities or debts exceed its assets, it files for a protection under the federal bankruptcy law. During bankruptcy, the company stops all operations and goes out of business. A trustee is appointed by the court to sell off all the company's assets and the money is used to pay off debts. The creditors or the investors are paid first, since they take the least risk. Among creditors, the secured creditors are given priority as they are more risk-averse and accept very low interest rates. Shareholders are the last ones to be paid, since they take more risk than the investors, as there are chances that the values of shares they purchase may come down.
When a company goes bankrupt, bondholders or creditors stop receiving interest and principal payments, and stockholders stop receiving dividends. Opportunities and rights as an investor change to reflect the bankrupt status of the company. Even though the company makes a successful comeback in business after implementing the restructuring, chances are that the risk and return may change from the previous one. Although secured creditors, bondholders and holders of other senior debt issues may receive some distribution of corporate assets, it is rare that they will get whole of total investment. The bankruptcy results in trading the bonds of companies at very low prices, if they trade at all, and liquidity may disappear. According to the court-approved reorganization plan, bondholders may receive new stock, new bonds, or a combination of new stock and bonds in exchange for their bonds. |
