What happens when a public company files for protection under the federal bankruptcy laws? Who protects the interests of investors? Do the old securities have any value when, and if, the company is reorganized?
Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. A bankrupt company might use Chapter 11 of the Bankruptcy Code to reorganize its business and try to become profitable again. Management continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court.
Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to "liquidate" (sell) the company's assets and the money is used to pay off the debt, which may include debts to creditors and investors.
Most public companies will file under Chapter 11 rather than Chapter 7 because they can still run their business and control the bankruptcy process.
In most bankruptcy cases, the role of the SEC is limited. The SEC will review the disclosure document to determine if the company is telling investors and creditors the important information they need to know, and to ensure that stockholders are represented by an official committee if appropriate.
Although the SEC does not negotiate the economic terms of reorganization plans, we may take a position on important legal issues that will affect the rights of investors in other bankruptcy cases as well. For example, the SEC may step in if we believe that the company's officers and directors are using the bankruptcy laws to shield themselves from lawsuits for securities fraud.