This question may sound trivial, but in our opinion it is certainly justified. Since we are not afraid of international stocks either, let us look at the case of insolvency of a European and an American stock corporation.
Back out or wait?
If you have a share in your portfolio that has unexpectedly filed for insolvency, you have to react. But your reaction should neither be to buy nor to sell!
Have a look at the latest balance sheet, analyse the value of the assets and check the structure of your assets. The stock will probably be listed close to zero or at liquidation value – which means you cannot lose a lot – a hasty sale would therefore be of little use.
Usually, there is a comparably large amount of information coming from the media in an insolvency case. You should prefer business media to tabloids.
A European insolvency
Even if there is a difference between the individual insolvency laws of the European countries, one can generally distinguish between insolvency (settlement) and bankruptcy (liquidation), even if the legal term is usually different.
If the company is continued, in Austria (and presumably in Germany as well) one speaks of a compensation. The creditors receive a – comparatively high – quota and the equity investors, i.e. the shareholders, stay with the company.
That sounds too good to be true? Well, the equity capital is already used up, actually even negative, otherwise the company would not be insolvent. If it could “only” not pay its bills, the company would be classified as illiquid and the company could stay afloat with an injection of liquidity.
If it is not enough for this certain quota – which in Austria is 20 % within 2 years – bankruptcy proceedings are opened against the company’s assets. Creditors file claims, the receiver sets a quota, which is usually in the single-digit range, and the company dies.
The advantage of compensation is obvious. The shareholders still have the chance of future profits. Depending on the probability with which this case can be expected, the share price is quoted more or less close to zero.
An American insolvency
Before 2007, it was relatively easy to predict American bankruptcies. The insolvency law has become famous through its name, “Chapter 11”. US federal law is simply divided into chapters, and insolvency law is in 11th position in the United States Code. Criminal law would then be called “Chapter 18”, which however nobody does.
What is important in this Chapter 11 are two further sections or actually sub-sections:
- Chapter 7: Liquidation
- Chapter 11: Reorganisation
The American liquidation is hardly different from the “European” liquidation. All assets are sold – individually or in larger packages -, the creditors are satisfied and if there is anything left over, which is rather unlikely, the rest is paid back to the equity providers. First to the preference shareholders, then to the common shareholders.
Chapter 11 is more interesting and could also be described as a debt-equity swap. The old equity investors usually disappear and the old debt investors become the new equity investors. For the executive committee, which usually decides which Chapter should be “chosen” in the case of insolvency, this has the obvious advantage that the committee could remain in office afterwards – but it must still be approved by the new shareholders.
As a shareholder of a company placed under Chapter 11, however, things look rather bad – the share price usually quickly reaches zero.