Bankruptcy

Stock trading dictionary: meaning, example and how traders use it.

Last updated: October 17, 2026

Definition: Bankruptcy is a legal process in which a company that cannot pay its debts either reorganizes under court protection or liquidates its assets to repay creditors. In the US, corporate cases are typically filed under Chapter 11 or Chapter 7.

How corporate bankruptcy works

When a company's liabilities become unmanageable, it can file a petition in federal bankruptcy court. Filing triggers an automatic stay that halts most collection efforts, giving the company and its creditors time to resolve claims in an orderly way. The court then oversees how the company's assets and future cash flows are divided.

The two main paths for businesses are:

  • Chapter 11 (reorganization): the company keeps operating, renegotiates debts and contracts, and proposes a plan that creditors vote on and the court confirms.
  • Chapter 7 (liquidation): a trustee sells the company's assets and distributes the proceeds to creditors; the business stops operating.

What happens to shareholders

Bankruptcy follows a priority order. Secured creditors are paid first from their collateral, followed by administrative claims and unsecured creditors such as bondholders and suppliers. Preferred shareholders come next, and common shareholders are last.

Because claims usually exceed what is available, common stock is often canceled under a reorganization plan, and creditors receive the new equity. The exchange may delist the shares, after which they may trade as OTC stocks at very low prices. Recovery for shareholders is possible but uncommon.

Trading in a bankrupt company's shares often continues during the case, sometimes with heavy speculative volume. Prices at this stage reflect hopes for a recovery rather than a likely payout, and they can collapse once a reorganization plan confirms that the old equity will be canceled. Investors who own shares of a company that files should read the court filings and the company's announcements carefully, since the plan's treatment of shareholders is usually spelled out there.

Example: a Chapter 11 reorganization

Suppose a hypothetical company has $800 million in secured loans, $600 million in unsecured bonds, and an estimated enterprise value of $1 billion when it files for Chapter 11. Secured lenders are covered in full at $800 million. The remaining $200 million of value goes to unsecured bondholders, who recover about one-third of their $600 million claim, perhaps in the form of new shares.

Common shareholders, ranked last, receive nothing because creditors were not repaid in full. Even if the reorganized company later succeeds, the old shares have been canceled.

Warning signs and investor lessons

Signs of financial distress often appear in the balance sheet and cash flow statement well before a filing: persistent negative operating cash flow, debt coming due without refinancing, breached loan covenants, and auditor going-concern warnings in the annual report. Distressed stocks can be extremely volatile and may attract speculators, but buying shares of a bankrupt company is a high-risk bet that often ends in a total loss.

Frequently asked questions

What happens to my stock if a company goes bankrupt?

Common shareholders are paid last, after all creditors. In many cases the existing stock is canceled, and shareholders receive little or nothing.

Can a stock recover after Chapter 11?

The company may emerge and do well, but the old common shares are often canceled and replaced with new shares issued to creditors, so existing holders frequently do not benefit.

What is the difference between Chapter 7 and Chapter 11?

Chapter 11 lets a company keep operating while it restructures its debts. Chapter 7 ends the business, and a trustee sells its assets to pay creditors.

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For information only, not investment advice. See the disclaimer.