Why don't you still own stock when a company emerges from Chapter Eleven Bankruptcy?

Factual Questions
1

I knew several people that owned stock in Conseco when it entered bankruptcy. They were apalled to learn that when the company emerged from bankruptcy that they no longer owned stock in the company. I thought owning stock was like owning a “piece” of the company. Thus, if you acquired fifty one percent of a company’s stock you would “control” the corporation. So, if I staged a “hostile takeover” of Disney by buying fifty one percent of their stock, would my ownership/control be nullified if the company entered Chapter 11? I am aware of the differences between common and preferred stock, however I thought this distinction had mainly to do with who got paid first in the event the company went bankrupt and didn’t emerge (thus those with preferred stock get paid before those with common stock). Is there a more fundamental difference between common and preferred stock ownership? Also, isn’t most stock sold on the NYSE and NASDAC common, rather than preferred?

I’m not sure that your average investor is aware of this “loophole” if it indeed exists. Of course we all know that there is a chance that a company we have stock in will go down the drain, it’s just that many of us assume that if it should crawl back out, that our stock would still be intact.

2

IANAFW (I am not a financial whiz), but…

I’d imagine that the stockholders forfeit equity in a company much as a sole proprieter forfeits equity when his/her business goes belly up. After all, anything of value would go to pay bills, and this would include owners equity.

3

I’ll take a stab at this until someone more qualified comes along.

When a company goes bankrupt, it’s essentially saying that its liabilities exceed its assets. The same thing goes for personal bankruptcies. When you buy stock in a company yes, you “own” part of the company. But if the company is worthless, so is your stock.

As an example, let’s say you issue 1,000 shares of “Roland Deschain, Inc”. It’s going to trade on the NASDAQ under the symbol “RDIQ” and the IPO has it priced at $10/share. This price is based on the fact that RDIQ has $2,000 in the checking account, a car worth $5,000, a stereo and some other stuff generously valued at $2,000 and an income stream (job) capable of paying the rent and the bills, which are about $1,000/month. (Note: Gross generalizations used for illustrative purposes only. I have no idea what RDIQ would actually be worth :wink: ). The shareholders now own 100% of the equity in RDIQ.

People buy the stock, and it stays stable at $10/share. In June RDIQ gets a pay raise which results in $1,000/month more income. The stock rises to $12 based on the future accumulated earnings in the checking account.

With the stock at $12, the Board of RDIQ pats themselves on the back and decides it’s time to expand the company. They trade in the car (worth $5K free and clear) and buy a $10K car, borrowing $5K in the process. Assets increase by $5K, but so do liabilities. Also, the new car starts to depreciate. But wait! It’s also time to upgrade the executive suite! The old stereo is donated to charity and a new stereo, plasma TV and surround-sound system are purchased for $10K. New clothes, a few expensive dinners and a vacation to Maui add another $5K to the debt load.

When the July numbers come out, RDIQ has $15K in assets and $15K in liabilities. Worse, the new pay raise has been eaten up and then some. Instead of adding $1K/month to the checking account, the debt payments are now draining $400/month out of the checking account. The spending binge was too big, too fast. The stock rapidly sinks to $4/share.

After a few months of this, the checking account is down to $800 with no reprieve in sight. With the stock at $4, the company tires to float another stock issuance to raise some capital. This time, no one will back the offering. The company tries to borrow money but is denied by every bank they apply to. Bonds are out of the question with the debt load.

Next month the checking account is down to $400, and that will be eaten up by next months bills. With no increase in income available, no loans and no stock available, the company decalres bankruptcy.

Here’s where the shareholders get punished for believing in RDIQ. First, the creditor that owns the car comes and reclaims it. Then the creditor that owns the stereo, TV and speakers comes and reclaims those. The bank that floated the loan for the Maui trip files a lawsuit to reclaim whatever cash is on hand to recoup its debt.

When all is said and done, there is $50 left in RDIQ’s checking account. The lawyers squabble over these scraps, declaring that it must be divided among them for services rendered. The common stock is declared worthless, and the scraps of RDIQ (clothes, change from under the couch cushions, etc) is sold off and divided among the legal claimees.

Granted this is more of a Chapter 7 (liquidation) than a Chapter 11 (reorginization), but you get the picture. I hope (assuming anyone actually paid attention to this long, rambling post!) that this helped.

4

I understand what you are saying, but the Conseco example is different in that the company emerged back out of Chapter Eleven. Here’s my basic problem/question with this issue: I was under the impression that stock holders were company owners rather than creditors (that’s one reason they call it the equity market I think). Your example makes perfect sense with bonds.

Here’s a similar example to illustrate my point: Roland Deschaine INC, is a lawful corporation organized under the laws of Nevada (with our headquarters located on a boat off the shore of Nevis where we display the the flag of the Cayman Islands) where all the stock is privately held by the Deschaine Family. After many years of retail success, Roland’s World suffers financial set backs due to China passing a fifty cents per hour minimum wage law which impacts the cost of our products. We enter chapter eleven to achieve a respite from our creditors, and secure alternative production in Burma (where the government understands the value to their economy of ten cents per hour labor) and emerge from our bankruptcy after about four months. No one would question, but that the Deschaine family still controls Roland Deschaine INC.

My Conseco example is no different except that we are talking about a publicly held company where the “owners” are spread out accross America (this case also irks me in particular because I know that the former CEO Stephen Hilbert paid himself a salary often over fifty million per year with options even as the company was marching towards bankruptcy largely in part to his unwise acquisition of Green Tree Financial). That is unless “stocks” are really just a “debt instrument” which can be erased in bankruptcy proceeedings rather than a piece of coorporate ownership. If this is the case then I would submit that the vast majority of small to medium size investors are not aware of this fact.

5

This whole post is RDIQlous :smiley:

6

Jeez, how many times is my novel-length post going to get quoted? :smack:

Anyone want to start trading RDIQ futures?

And for the CEO of RDIQ, I say this:

When companies are in trouble, lots of desperate/strange things happen.

I am unfamiliar with the Conseco example, so I can’t comment directly on it.

However, as to the owners/creditors thing, read my first post again. People buy stock in the company based on their impresssion that the company can earn money in the future. A company’s stock price is not only it’s current value, but also its anticipated value.

Once again: if you are shareholder, you own part of the company. If the company is worthless (ie liabilities are greater than assets) then you own part of nothing. A creditor that loaned the company a specific asset (ie a machine shop) can reclaim the asset when the company can’t pay for it. This reduces the value of the company, which reduces the value of your stock.

This is correct. If you were a creditor you would have some asset that you could claim against your interest in the company. If you are an owner, you can only claim the value of the company itself.

P.S. I’ve got some RDIQ futures that are burning up the floor! :smiley:

7

Here’s what your post doesn’t address. Pilot141 buys a thousand shares of Conseco when it is selling for ten dollars a share, thus your investment is worth ten thousand dollars. Conseco goes into chapter eleven and it’s stock is worthless, everyone agrees that your investment isn’t worth much at this point.

Conseco, emerges from bankruptcy, and once again trades on the NYSE (or some other exchange) and now trades for five dollars per share. You are told that you no longer have an ownership interest in Conseco because your stock was “extinguished” in the bankruptcy. At no time did you sell your stock. How can this happen. Maybe, I missed it, but I didn’t see where your post addressed this issue.

8

lots of useful information here. http://www.sec.gov/investor/pubs/bankrupt.htm

Essentially there is no automatic loss of share rights. This will depend on the exact plan drawn up at bankruptcy, and may even involve a shareholder vote. However, if the existing assets are negative in value, then it is much more likely that the debt owners (bank etc) will get to take control of the entire company and retrieve what they can. If this was done in an underhand way so that existing shareholders got stiffed wrongly, then one could always go to court.

9

Bankrupt companies can get out of certain obligations. Leases, for example. When K-Mart entered Chapter 11, they were still paying rent on several stores that had closed. As part of the bankrupcy proceedings, these leases were terminated early. Perhaps shareholder obligations can be nullified in a similar manner.

10

I’ll bet there are loads of shareholders who have no idea that their investment can be lost completely, and the company can then still be selling more shares to other unsuspecting fools.

I literally pissed away money a few years ago, when I bought several shares of a toilet-cleaning company (called SWISHER) that went belly-up, but I discovered (while urinating in California this winter) that the company was still around, still cleaning toilets, and still trading on the market (I made the last discovery after flushing and zipping). They had reorganized, my broker explained to me, which kind of sounded to me like, “Yeah, you invested your money, the company went broke, and now they’re not broke anymore, and you lost all your cash. You got a problem with that?”

11

Here’s a link to an article that I read in Newsweek that discusses some of these issues.

One point in the article is that:

So, pseudotriton ruber ruber, the company you invested in no longer exists. :frowning:

12

Many Chapter 11 reorganization plans, as approved by bankruptcy courts, include transfer of ownership to the creditors. Existing shares are voided. The companies announce this, and people still don’t get out. Check out this article on Conseco: http://www.businessweek.com/magazine/content/03_35/b3847084_mz020.htm

13

In my paper yesterday, a headline said that KMart recorded its first quarterly profit since bankruptcy. But the article itself refers to KMH: the KMart holding company. The original KMart company is gone. If you had stock in it, tough. If you want to invest in KMH, you have to buy shares in that.

Note that one reason that shareholders are last in line, is that it protects shareholders of bankrupt companies. If you owned KMart stock and the company’s net value is less than zero, nobody comes after you to pay the difference. You can’t have your cake and eat it too.

14

One point that Roland Deschain is trying to make is that people are not generally aware that their stock can be nullified in a Chapter 11 reorganization bankruptcy.

I bought a small amount of stock in a biotec company, Organogenesis. They have a very promising product, Apligraf, and had several other promising products in research. They seemed to be doing okay, and the occasional report I received from them was quite glowing about the company’s prospects. Eventually the company failed to file a required financial statement, and quite rapidly the stock dropped to the point where it was no longer being traded on AMEX. I hung onto my stock because I believed that at worst the company would be bought out and that my stock would be exchanged for stock in the new owner company. Instead, Organogenesis filed Chapter 11 and was reorganized as a private company – same name, same major players, same address, same product. 6.2 million shares of stock were nullified in the reorganization.
Stockholders were never notified of the bankruptcy or the stock nullification. I learned of it through a Google search. Today I Googled the company and learned that there is a class action suit against them for defrauding the stockholders. Even if I follow this up, I doubt that I will get much benefit from it.

Had I been aware that my stock could be nullified, I would have behaved differently. I would have sold at a loss, rather than hanging on with the hope that things would get better in the long term. They did get better, just not for the common stockholders.

15

Get out how? “Hey, I just found out that these RDIQ shares will be worth nothing in a few weeks. Anyone want to buy them real cheap? A nickel? A penny? Um … some buttons that came off your shirts in the dryer? Lint? … Crud.”

16

This is the first thing I thought about when I read the OP. If I as a stockholder in RDIQ maintain continuity of “ownership” (as the OP is using the term) from the beginning of the bankruptcy throughout the proceeding, then I may be at risk of having my car and other possessions seized and sold to pay off the debts RDIQ has accumulated. Seems a much better idea to cancel the stock and not hold the stockholders liable for any further losses.

17

What protects you from personal liability is the fact that it is a corporation not the fact that your “ownership” is nullified. Generally, unless the “corporate veil is pierced” by comingleing of funds ect. the owner is not liable for the debts of a corporation (unless as is often the case with smaller companies he has personally signed for the debt as well)

Okay, this thread begs the following question: If as a stockholder you are not the “real owner” of the company (as demonstrated by the fact that the company can enter Chapter 11, re-emerge and you are no longer involved) then WHO is? Someone, was with K-Mart, Conseco and the other examples cited both before and after they filed Chapter Eleven. What was the nature of their ownership which allowed them to maintain their involvement with the coorporations in question? Is it a matter of common verses preferred stock or is there some other not yet mentioned modality of ownership that “insiders” have?

18

Also IIRC prefered stock is not ownership of the CO, and better thought of as a bond.

19

That’s pretty much how it works. If your stock gets delisted from the major indexes, you have to go out and find a buyer yourself.

20

I read your link and while I understood the overall picture some of the details are still fuzzy:

  1. When a company goes into Chapter 11, the article talks about how it can be transferred to creditors. Now, I understood that creditors could take the non exempt “assets” of company (equipment, buildings ect) in order to satisfy debts, but I didn’t think that this extended to the actual “on going concern of the business itself”. This implies that in at least in a bankruptcy setting that the real “equity” investors are the bond/debt holders since they are the ones who might end up with the company after it emerges (if it does, understanding of course that most companies who enter Chapter 11 never again do business).

  2. Why don’t the stockholders automatically get to vote on these issues during a Chapter Eleven? After all if I owned 100% of the stock in a Corp. and we filed Chapter Eleven, I would be on all of the meetings and presumably have a say in whoat course of action (within the context of Chapter 11 rules) that we took.

  3. Several posters have referenced examples where “most of the same players” are involved in a company after a Chapter Eleven, BUT that the previous stockholders are wiped out. How does this happen? How could the creditors take over a company disenfranchise the previous stockholders, and leave old management, and or employees in place? As a previous stockholder/owner couldn’t I assume that they shouldn’t be able to use “my” old companies name or benefit from “my” investments without my being compensated?

  4. Again, and this is of primary importance I don’t think that your average, individual investor realizes that a company could enter, and then emerge from Chapter Eleven as an on going business concern, all the while eliminating his ownership (as represented by stock) in the company. What would keep a privately held company from going public and then raising a bunch of money (in the form of sold, stock, shares) then entering Chapter Eleven to “wipe out” those shares? The original owners (before it went public) could ensure that they retained control when the company re-emerged by making sure that they held the primary debt positions to the company (thus they could lend the company money or otherwise grant themselves liens). Thus, they would have received some of the benefits of going public (such as raising the funds to expand nationally or regionally), and then “regained” the benefits of being a privately held corporation by “gaming” the system (and it would probably be legal unless intent could be proven which with the attorneys these guys use just isn’t going to happen very often).