Investors who own a piece of Borders or the old General Motors Co. know all about the devastating effects of bankruptcy on stock values. Borders, a national bookstore chain, and Motors Liquidation Company, which holds pre-bankruptcy GM stocks, are worth pennies a share.
Motors Liquidation Co. expects the shares to eventually become worthless as the company wends its way through Chapter 11 bankruptcy proceedings, which protect the company from creditors as it reorganizes in attempts to survive. As part-owners of the bankrupt company, stock holders stand behind creditors in a long line of investors hoping to recoup losses. It’s possible for a company to emerge from Chapter 11 with a stock that’s held some of its value, but that’s not likely for investors holding old GM shares.
“Management continues to remind investors of its strong belief that there will be no value for the common stockholders in the bankruptcy liquidation process, even under the most optimistic of scenarios,” the MLC website advises. “Stockholders of a company in chapter 11 generally receive value only if all claims of the company’s secured and unsecured creditors are fully satisfied. In this case, management strongly believes all such claims will not be fully satisfied, leading to its conclusion that the common stock will have no value.”
A company reaches bankruptcy when its debts exceed its value, and there is no longer any realistic hope the company can pay its bills. Chapter 11 can give a company a second life, while Chapter 7 provides for the orderly sale of company assets.
Historic bankruptcies such as Lehman Brothers and General Motors dominate the news, but during the recession hundreds of companies quietly filed for protection. According to Forbes.com, 207 publicly traded companies entered bankruptcy last year.
Shareholders of companies in Chapter 11 bankruptcy may have the option of selling their shares, unless the company is so shaky that it is banned from trading. Shares of pre-bankruptcy GM were delisted to avoid confusion with the reformed company, which is a separate entity. Investors can also hold onto to their shares. This approach tends to pay off only when the company can make a speedy return to profitability. Chapter 7 bankruptcy proceedings offer shareholders little hope since there’s usually nothing leftover once all other creditors are paid.
Bankruptcy typically offers shareholders one consolation - the possibility of claiming losses as a tax deduction and using the loss to offset capital gains. Losses from stocks held in an IRA cannot be deducted at all.
Tax benefits rarely outweigh losses for shareholders in bankrupt companies. Investors are usually better off avoiding the situation by carefully evaluating the financial health of companies before purchasing stocks and by continuing to monitor the debt ratios and profit margins of the companies they own.
Investors are often surprised to hear that a company has gone bankrupt, but publicly traded companies usually issue warnings well in advance. The website smarterspend.com tracks at-risk companies and has identified eight in its 2011 list of large companies facing bankruptcy:
• They describe Radio Shack as the epitome of a company facing bankruptcy.
• Say RiteAid is being pushed out of a competitive pharmacy market by Walgreen’s and CVS.
• Note Zale’s Jewelry has already begun closing stores and laying off employees.
• Say gourmet gifts retailer Harry & David won’t make it without a larger takeover.
• Point to American Apparel’s large debt and declining revenue.
• Say Sears is facing a losing battle against Target and Walmart.
• Note Jamba Juice over expanded during its early boom years.
• Predict that Perfumania’s mounting losses will drive down the company