Chapter 11 bankruptcy

Chapter 11 bankruptcy is the section of the US Bankruptcy Code that allows a financially distressed company to continue operating while it restructures its debts and contracts under the supervision of a bankruptcy court. The goal is a confirmed plan of reorganization, not liquidation.

How it works

The company files a petition, usually with an 8-K under Item 1.03, and becomes a "debtor in possession" that keeps running the business. An automatic stay halts most creditor collection efforts. The debtor typically arranges debtor-in-possession (DIP) financing, which gets priority over existing debt. It can reject unprofitable leases and contracts, sell assets under Section 363, and negotiate a plan with creditor committees. Many cases are "prepackaged" or "prenegotiated," with key creditors already on board, which can shorten the process to weeks.

The plan must generally follow the absolute priority rule: secured creditors, then unsecured creditors, then equity. Existing shareholders recover only if creditors are paid in full or agree otherwise.

Why it matters for traders

For common stockholders, Chapter 11 usually means the equity is canceled and new shares go to creditors. Stocks of bankrupt companies often trade wildly anyway, driven by retail speculation, though prices rarely reflect a realistic recovery. Exchanges typically delist the stock, and on the OTC markets the ticker often gets a "Q" suffix. Watch for the plan of reorganization and disclosure statement, which spell out what, if anything, shareholders receive. Bonds and loans, not stock, are usually where the recovery value sits.

Example

Hypothetical retailer Northwind Stores (NWST) has $2 billion of debt and files a prepackaged Chapter 11 with $300 million in DIP financing. Under its plan, term lenders swap their debt for 100% of the new equity, unsecured creditors get a small cash pool and existing shares are canceled. The stock, delisted and trading as NWSTQ, still briefly doubles from $0.10 to $0.20 on speculation before the plan is confirmed and the shares are canceled.

FAQ

What happens to stock when a company files Chapter 11?

It usually keeps trading, often OTC, but in most cases existing shares are canceled under the plan and shareholders receive nothing.

What is the difference between Chapter 11 and Chapter 7?

Chapter 11 is a reorganization in which the business keeps operating. Chapter 7 is a liquidation run by a trustee.