What Happens to Shareholders in a Prepackaged Bankruptcy?

• A prepackaged bankruptcy plan involves the reorganization of a company's financial structure, which is implemented with the full knowledge, cooperation and votes of the company's owners, who are the existing shareholders. The law requires that two-thirds of shareholders who vote must agree, and those remaining have to accede. This process greatly simplifies the required steps and can result in substantial cost savings in accounting and legal fees. It also allows the company to put the taint of bankruptcy quickly behind it and return focus to core operations.

Immediate Consequences

• A prepackaged bankruptcy plan is generally a smoother process than one carried out without shareholder and creditor approval, but existing shareholders should expect the value of their holdings to decline significantly before such a plan is even announced, as a public company's financial condition is openly reported. According to the U.S. Securities and Exchange Commission, "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." Even after filing under the federal Chapter 11 bankruptcy code, a company's shares may continue to trade on the open market, as no federal law exists to ban trading in such securities. However, those shares typically no longer meet the listing requirements of the major stock exchanges and are de-listed and relegated to either the Over-the-Counter Bulletin Board (OTCBB) or what are known as the Pink Sheets. Private companies have no such option, and their shareholders will also see the value of their holdings plummet.

Substantial Dilution

• A prepackaged bankruptcy will often leave at least some value for existing shareholders in order to secure their cooperation. Still, even if the company is viable going forward, its bondholders and creditors will own most of the shares, which significantly dilutes their value. Typically, the process will cancel the previous common stock in favor of new shares, some of which may go to existing shareholders. As creditors hold a priority claim on a company's assets, shareholders receive what's left -- an amount usually worth far less.

Post-Bankruptcy Effects

• Given the streamlined nature of prepackaged bankruptcies, companies can return to their operations in tangibly better financial shape. Without the burden of crippling debt, they often become profitable enterprises. This can lead to long-tern value for owners of the new shares, one of the key incentives for creditors and shareholders to agree initially. While owners of the previous shares are left with far less value, those who purchase stock post-bankruptcy can experience significant gains.