Question

If a firm files for Chapter 11 bankruptcy, why would its creditors allow the firm's management to receive some of the new equity? Please provide some input beyond "as an incentive for management to improve the company"

Answer 1

• Chapter 11 bankruptcy allows businesses and some individuals to reorganize while receiving protection from creditors.
• Stock values are adversely affected by bankruptcy speculation, and even more so by the actual filing.
• After filing for Chapter 11, trading of the company's stock will cease temporarily.

• Understanding Chapter 11 Bankruptcy

  Obtaining Chapter 11 bankruptcy protection means that a company is on the verge of bankruptcy but believes that it can once again become successful if given an opportunity to reorganize its assets, debts, and business affairs. Although the Chapter 11 reorganization process is complex and expensive, most companies prefer Chapter 11 to other bankruptcy provisions, such as Chapter 7 and Chapter 13, which cease company operations and lead to the total liquidation of assets to creditors. Filing for Chapter 11 gives companies another chance at success.

  While the firm is in Chapter 11, its stock will still have value, but there is a temporary trading freeze. Although the stock will be delisted, over-the-counter (OTC) trading may still occur. In other words, the equity a broker invested in the firm is not valued at zero, but their true value cannot be easily determined since the shares are no longer publicly traded. When a company is listed on the pink sheets or Over-the-Counter Bulletin Board (OTCBB), the letter "Q" is added to the end of the company's ticker symbol to differentiate it from other companies.

Most publicly-held companies will file under Chapter 11 rather than Chapter 7 because they can still run their business and control the bankruptcy process. Chapter 11 provides a process for rehabilitating the company's faltering business. Sometimes the company successfully works out a plan to return to profitability; sometimes, in the end, it liquidates. Under a Chapter 11 reorganization, a company usually keeps doing business and its stock and bonds may continue to trade in our securities markets. Since they still trade, the company must continue to file SEC reports with information about significant developments. For example, when a company declares bankruptcy, or has other significant corporate changes, they must report it within 15 days on the SEC's Form 8-K.