What Happens to Bondholders When a Company Goes Bankrupt?
Seniors and retirees like bond investments because they provide a steady income, diversify a stock portfolio, and are backed by the issuer's financial strength. But things don't always go as planned. Companies occasionally have financial problems and must file for bankruptcy as you well know.
Investors holding bonds in bankrupt companies can at least have the comfort in knowing that as unsecured creditors they are second in line for payment. Secured creditors, those with claims backed by collateral, such as equipment or real estate, are paid first. Stockholders come last and that is only if there is any money left after the creditors have been paid.
There are two general forms of bankruptcy: Chapter 7 and Chapter 11. With Chapter 7, the company is liquidated and bondholders should file a claim to receive a portion of the value of their bonds. In Chapter 11 proceedings, however, the process is quite different.
Chapter 11 allows the corporation to reorganize. Its bonds might continue to trade, but holders will not receive principal and interest payments. As a result, a default could occur, and the value of the bonds might decline significantly. Or the court may approve an exchange of the old bonds for new ones, which could have a lower value. The problem is that the fortunes of corporations change. The highly rated General Motors bond you may have purchased with an AA rating years ago may now be rated CCC as General Motors clings to financial life.
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How can you find out if a company that you lent money to by purchasing a bond has filed for bankruptcy or if the safety has declined? First, if you have a sizable portfolio and a good retirement consultant, he will keep you informed. Secondly, LOOK at your monthly brokerage statements when they arrive. The first hint of trouble is a decline in bond value from one month to the next. TV reports, newspapers, and financial magazines often give an account of companies that recently declared bankruptcy or have trouble. The company will also send you information on the reorganization plan and ask you to vote on it. And if a financial institution holds the bond for you, it should forward everything from the company.
If you would like a free credit report on bonds you currently own, here are two web sites to check
http://www.moodys.com/cust/default.asp. Register for a free account and you can return to this site periodically to check your bonds. Should your broker do this for you? One of the problems is that the broker gets paid a commission when you buy the bond. he has little if any incentive to keep you informed unless you continually do business with him.
Another site with information is http://www.fitchratings.com/
Unfortunately as with stock investing where you can get a lot of information on the common shares of public companies, the transparency and visibility of bond investing information is poor.
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Some of the bonds will convert to stock and you make money if stock goes back up after bankruptcy. Municipal bonds rarley fail they just raise taxes so they are a good bond and most are tax free income for federal and sometimes state taxes.
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If a company goes bankrupt, it still has to pay its debt. It may pay its debt with the assets. It has to pay all its debt until it has no assets at all. If you are a bondholders, the company owe you debt and you have the right to be paid.
Unlike bondholders, stockholders don't have the right to claim a refund of their money invested. Therefore, when a company goes bankrupt, stockholders will not get their money back.
I think remaining informed about the bonds is a good idea because these days times are tough and Investment companies are having tough time. People invest all their savings to one company is also a ludicrous idea. Don't go for all profits, it's a nice practice to invest half portion of your money into bonds and keep other for tough times. Or whatever you like but make better decisions where investments are concerned.
As Zag said, if you are a bondholders, the company owe you debt and you have the right to be paid. However, the reality is different. You might have a right to be paid but what is this right worth if the bunkrupt company does not have anything left to give to you? This is the case so often. Therefore, I'd say, you should not only trust in one asset of investment for your retirement but in various ones. Diversification is the thing to do.
When a company goes bankrupt, the company's bondholders depending on the type of bond they hold may be entitled to a portion of the liquidated assets, if there are any left over. The firm is required to sell all of it's assets and pay off all debts, in the order ..Government, financial institutions,other creditors, suppliers, and utility companies, bond holders, and preferred share holders.
As many learned in 2008, there can be a lot more risk associated with Bond Investing than previously thought. That particularly applies to municipal bonds because state, city and local budgets are in trouble due to the collapse in the real estate market and high unemployment. Some speculate that we will see a rash of bankruptcies in 2011.
I advised my clients and readers to move out of municipal bonds and funds in Nov 2010. Bonds have declined significantly since.