Investing in the stock market is not the easiest thing in the world to do... far from it! Make a few wrong moves and you can lose your shirt before you know what's happened. Hopefully that will never happen to you, but what happens if it does?
In this article today I'm going to discuss what you should do, and what you shouldn't do, if a company you have invested in suddenly goes bankrupt.
I'm not going to lie to you... I have owned shares of stock in a company that has gone bankrupt in the past. If you want to know the name of the company I'll even tell you; it was WorldCom and I owned 1,000 shares. I was just sure that the company would not declare bankruptcy and so I held on till the very end. But the company did go bankrupt.
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For the most part you will usually have two choices when a company goes into bankruptcy. You can either hold on to the stock and hope against hope that the company will somehow recover, or you can sell the stock and take the loss immediately.
Most of the time a bankrupt company will do either one of two things. First, it may reorganize itself under what is called a Chapter 11 bankruptcy during which time it continues as a viable entity and has the chance to pay back its creditors and reverse most of its losses.
On the other hand a company can be completely dissolved in what we call Chapter 7 or Chapter 13 bankruptcy. When this happens the assets of the company are usually completely liquidated and used to pay back its creditors. It's good to note that a shareholder is not a creditor which means you will not see a penny of that money yourself. Chapter 7 or 13 bankruptcies are usually decided by a court, called a bankruptcy court.
You may be able to get your money back as a shareholder under Chapter 7 or 13 but only if absolutely everybody else gets paid back first, including any creditor the company may have, any taxes the company may owe, and any bondholders the company may have. That's right bonds get paid back before shares in a bankruptcy. It is highly highly unlikely that there will be any money left after all of these people get paid off, but if there is it will go to the shareholders... but I'm not aware of a single instance when that has actually happened in the real world.
If a company is likely to be reorganize under Chapter 11 bankruptcy then it is possible, several years down the line, the shares of the stock in the company will rebound. But realize even under the best case scenario it's going to take years for this to happen, if it happens at all. So you have to ask yourself whether or not you can afford to wait and whether or not you can afford to take the risk that the company won't ever actually turn itself around.
Most of the time the best thing to do is simply sell your stock and take a loss. After all, in certain circumstances you can even use the loss as a tax write off. Consult your accountant or tax attorney to be sure before hand.
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