Introduction

When we talk about insolvencies in connection with shares, we are of course referring to the underlying company, which obviously has financial problems and is now (possibly) facing the end. Of course, no investor wants to experience such an event, but unfortunately it does happen from time to time. Who would have thought, for example, that a former global corporation such as Weatherford plc (ticker; WFT), which is active in commodity trading, would file for insolvency in May 2019? Or that former giants such as GE (General Electric, ticker: GE) or US Steel (ticker: X), which are also among the oldest companies in the USA, would now be struggling to survive.

In this article, we would like to look at the various aspects that could be of valuable help to you if the worst comes to the worst. But first things first: don’t panic!
This may be easier said than done, but if an insolvency becomes public, you can expect the price to plummet within minutes before you can react. If you have not set a stop-loss limit, you are now sitting on a share that is almost worthless. But unlike in the movie “All is lost” by the lone sailor (played by R. Redford), all may not be lost, even if you own shares in this company. There is still hope. The most important thing now is not to lose your nerve and sell in panic (if that is still possible at all due to the possible trading halt of the respective share).

The different types

In principle, there are three different types of insolvency applications (known as “chapter filing”). Chapters 7 and 13 are intended for individuals (i.e. persons), while Chapter 11 can be used primarily by companies. There is also a Chapter 12 for farmers and fishermen, which takes into account their seasonal characteristics.

Chapter 13

This is only possible for people with a fixed income and is therefore only considered briefly. It is only possible for debts up to a certain amount and has the advantage that the debts can be repaid in an orderly manner according to a fixed plan. This protects people from having their home repossessed, even if the mortgage installments have to be repaid properly (with a delay, usually up to 5 years).

Chapter 7

Chapter 7 can be applied for by both private individuals and companies. The big difference to Chapter 13 is that the assets are liquidated here, so there is no reorganization of debts. It allows a much quicker restart, but assets such as a home or car are of course lost. There are exceptions such as pension accounts, jewelry and other cash. In the case of companies, all assets are recorded and sold by an authorized representative (the so-called trustee) in order to obtain as much money as possible for the liquidation.

In the case of companies with Chapter 7 insolvency, the lenders are of course paid first. Only when they have been satisfied do the bondholders come next, followed by the shareholders, who usually go away empty-handed. In the case of bonds and shares, there is usually a distinction between different classifications (such as preferred shares). As an owner of regular shares, you naturally come last and your chances of seeing any money are probably rather slim. But don’t give up yet, sometimes miracles happen, and there are companies with considerable liquidation value (e.g. large pieces of land, real estate, enormously expensive production facilities or machines, licenses, copyrights, etc.). So don’t throw in the towel and keep yourself informed.

However, your chances are much better than with Chapter 7 if a company demands protection under Chapter 11. This is because you could actually get off lightly, and with a lot of luck you won’t even get a black eye.

Note
Chapter 7 is usually applied to small companies or sole proprietorships where there are little or no funds left to continue a business. In this case, it is often only a matter of averting even greater financial damage for all parties involved and drawing a line under the business. In the case of small companies or sole proprietorships, however, private liability may remain.

Chapter 11 (the last hope)

While in Chapter 7 bankruptcies a company is actually dissolved and its assets distributed (preferably to banks and other lenders), a Chapter 11 bankruptcy takes a different approach and allows you as a shareholder to at least avoid a total loss of your money.

The aim is to continue to run the company under supervision and to reach agreements with the lenders, etc. The aim is to reach agreements with lenders etc. if you are no longer able to meet your obligations on time. To this end, credit or loan interest rates can be renegotiated, deadlines reset or other agreements made that give the company time (and therefore breathing space). In many cases, this can make perfect sense if the company still has a good order backlog, a flourishing business or other resources that have come into difficulties due to adverse circumstances. If the company’s solid foundation gives it hope of continuing to exist, a period under Chapter 11 (usually in the range of 1 to 3 years) is a solution.

A court must accept the liquidation plan submitted by the company, and sometimes an appointee (“trustee”) is appointed. This may be the case in cases of fraud or incompetence of the management. This plan must contain concrete, balanced and fair steps that enable the company to continue as a going concern and have a real chance of success. Otherwise, the arbitral tribunal will reject the plan. For share owners, it could mean that they are paid a certain percentage of the shareholding. But don’t expect too much. The plan must normally be submitted by the company within 120 days, but the court can extend this period in exceptional cases (up to a maximum of 18 months).

Once the restructuring plan has been accepted, the courts have supervision over certain significant financial transactions such as the sale of assets or the termination of business activities, but otherwise the company continues to operate as usual. It must submit monthly reports to the court on its current status. But during this time, the company enjoys creditor protection.

It is assumed that up to 20% of Chapter 11 insolvencies end well and the business continues to exist. If this is not the case, Chapter 7 insolvency will follow with the resulting final liquidation.

Note
Chapter 11 can also be applied for by private individuals. This is the case if the requirements for the other chapters are not met. This may be the case, for example, in the event of very high financial debts (see limits for Chapter 13).

How does this affect me?

As I said, if it has happened and you actually hold shares in such a company, then you hardly have any time to react and you have to ride it out and hope for the best. There is a small chance, and panic selling usually doesn’t help, as the share price is already at rock bottom anyway. There are certainly cases where the share price has shot up again after the statutory lock-up period (a recent example is the oil drilling company Seadrill (ticker: SDRL).

However, it is of course best not to own such shares in the first place. The usual precautionary measures apply here:

• Is the balance sheet healthy? Is there sufficient cash/reserves?
• What is the current/quick ratio?
• What is the financial flow (cash flow)?
• How are sales/earnings looking? Are they falling? Are they increasing?
• Have there been a noticeable number of insider sales recently?
• How is the short float (short interest)? Is it rising continuously? A high proportion of short interest can mean investor distrust.
• What do the annual reports say?
  Does management address difficulties? Does it have solutions ready? Or do they beat around the bush and talk about a turnaround every quarter?
• Are new debts constantly being incurred? New bonds issued? New shares issued?
• How has the credit rating developed? Hands off companies with junk ratings!!!
• How do analysts view the company? If almost all analysts and banks have listed the company as “sell”, then stay away!
  Also stay away from insider tips in forums or chats! They only want to push you into a share, usually out of self-interest. Be warned against good advice that this or that share is now particularly cheap or a bargain. There are no bargains, only junk!