Chapter 11 Bankruptcy can Reduce Obligations to Shareholders

Dunlap Law Insights

Companies have financial obligations to many different parties. When a business hires people to work, they have an obligation to fulfill the promises made regarding that employment, including the payment of wages. Companies also have financial obligations to local and federal government agencies because they must collect and pay taxes.

Businesses can also incur additional financial obligations to creditors that help them fund expansions, suppliers who do not demand payment up front, and shareholders or investors that use their own money to fund the business. Even a well-organized business can experience some lean seasons that leave it struggling to meet all major financial obligations.

If you believe that your business can recover from its current downturn in the future, Chapter 11 bankruptcy could be an opportunity to restructure your debt and eliminate some of the financial obligations that are preventing your company from remaining stable and solvent.

Restructuring through Chapter 11 can involve liquidating equity shares

Becoming a publicly-traded company can be a great way for a business to capitalize on an established reputation, its existing infrastructure and public interest in the business. Selling stock can increase the amount of revenue your business has to operate.

Unfortunately, it also incurs new financial obligations, as investors and shareholders expect to earn dividends on what they have invested with your company. Turning an adequate profit to compensate stock and shareholders may prove more difficult than anticipated at the time of your company’s IPO. During Chapter 11 bankruptcy, your company can dilute the existing stock by offering stock to those who hold higher priority debts with the company. They may also cancel the existing equity shares.

Stockholders do not have a priority claim on assets

During Chapter 11 proceedings, a business will attempt to restructure and reduce its debt to make it more solvent in the future. Typically, there will be a repayment plan, the liquidation of certain assets and an obligation to use some of the proceeds from those sales to repay priority creditors.

Banks and financial institutions that provided funding for the business or for the purchase of its most significant assets typically have the top priority for repayment in Chapter 11 proceedings. Bondholders and other unsecured creditors are next when it comes to the payment of debts during Chapter 11 proceedings. Stockholders are technically partial owners of the company, so they will only receive compensation in Chapter 11 proceedings once all the other creditors have been paid.

The restructuring process may include eliminating or buying out some of the stock the company initially issued in order to reduce its future obligations to stockholders. These kinds of losses are unfortunate for investors, but that is why there is risk involved in buying stock in a company. If your business can no longer meet the expectations of its stockholders and creditors, Chapter 11 bankruptcy may be an opportunity to save the business and reduce financial obligations.