Corporate Bonds and Bankruptcy

Sometimes even large corporations are forced to file for bankruptcy.

Corporate bonds are a type of investment that offer both lower risk and lower reward than investing in the stock market. However, like stockholders, bondholders stand to lose money in bankruptcy from the bonds losing value, becoming worthless, or being replaced with stocks and bonds of lesser value. In general, however, a bondholder stands to lose less in a bankruptcy than an equity holder.

Notification of a Bankruptcy

Often, the first time a bondholder learns about a bankruptcy is through reading about it or hearing it in the news. Additionally, bondholders might learn of a bankruptcy through their brokers or from the company if they purchased the bonds directly.

Types of Bankruptcy

Corporations that file for bankruptcy will generally be filing under Chapter 11 or Chapter 7. In a Chapter 11 bankruptcy, a business attempts to reorganize but continues to operate with creditors being paid back according to a bankruptcy plan. In a Chapter 7 bankruptcy, the business ceases operation and liquidates its assets. In the case of public companies, companies will often (at least initially) attempt to file under Chapter 11.

The Reorganization Plan

In a Chapter 11 bankruptcy, a reorganization plan is developed. The plan is voted on by interested parties such as creditors, bondholders and stockholders. Bondholders might be given the opportunity to vote on a reorganization plan. After the reorganization plan is approved, the corporate bonds that existing bondholders have may be replaced by bonds and stocks.

Proof of Claim

In bankruptcy, a proof of claim is a document that creditors file that says that the company owes them money. Bondholders may be given the opportunity to file a proof of claim in both Chapter 11 and Chapter 7 cases.

Bond Trading in Bankruptcy

Bonds continue to trade during bankruptcy, but they may lose value if a default occurs. A default is when the company fails to make principal and interest payments.

Tax Deductions

If the bonds lose all of their value and become worthless, there's the potential for investors to take tax deductions. Tax issues should always be discussed with a knowledgeable accountant or tax attorney.

References

• SIFMA: About Corporate Bonds
• Investopedia: An Overview of Corporate Bankruptcy
• U.S. Courts: Chapter 11 Reorganization Under the Bankruptcy Code