Bankruptcy: Shareholders likely to be left in the lurch


July 28, 2002|By EILEEN AMBROSE

YOU'RE WAITING for one of your laggard stocks to recover, but instead the company files for bankruptcy.

Now what?

Unfortunately, shareholders don't have much leverage. The claims of banks, bondholders, bankruptcy lawyers, vendors that supply the company during the filing and other creditors override those of common shareholders.

"Stockholders are at the very bottom of the priority barrel," said Nancy Alquist, president of the Bankruptcy Bar Association for the District of Maryland.

Big companies always choose to file under Chapter 11 of the bankruptcy code, said Lynn M. LoPucki, a law professor at the University of California, Los Angeles. This allows them to hold creditors at bay, reorganize their debt while continuing to operate and, if all goes well, emerge with a sound business and financial structure, he said.

The recent major bankruptcy filings of WorldCom Inc., Enron Corp., Kmart Corp. and Global Crossing Ltd. are Chapter 11.

Most commonly in Chapter 11 filings, the company's debts exceed its assets. The old stock is canceled, and the shareholders are left with worthless paper, LoPucki said. The business then issues new shares in the reorganized company and gives them to bondholders, he said. In exchange, the company's debt to bondholders is reduced.

There are times, though, when shareholders don't go away empty-handed.

For instance, a company's assets might outweigh liabilities and shareholders could get cash or retain stock.

Shareholders also might get something if the company becomes a competitor's target for merger or acquisition. "They could acquire all or some of the assets. That could create value for stockholders," Alquist said.

Even if debts exceed assets, shareholders might not take a total loss. They could organize and fight, prompting the company and creditors to throw some crumbs their way.

"They can cause a lot of trouble for the company, and the company will want to get rid of them," LoPucki said. "The main thing they can do is unearth ugly facts. You have one more committee, one more lawyer in the case, who is trying to find the embarrassing points and bring them out. And that's why you pay off shareholders."

Not all Chapter 11 filings are successful. Sometimes companies convert to a Chapter 7, in which any company assets are liquidated and shareholders get money only if there is anything left after everybody else is paid.

About 90 percent of companies trying to reorganize emerge from bankruptcy, and within five years 20 percent to 30 percent are in enough financial hot water that they file again for bankruptcy or merge with a healthier company, LoPucki said.

Huge bankruptcy cases can take a year or more. Meanwhile, investors have three options: buy, hold or sell.

Buy. Purchasing shares of a company under Chapter 11 or headed that way is a gamble, but it's a gamble investors are tempted to take because the shares are so cheap, said Mark Sellers, editor of the newsletter Morningstar Stock Investor in Chicago.

Buy the shares, suggest Sellers, only "if it's more fun to you than taking a trip to Vegas or to a riverboat casino."

Some are doing just that.

David Berman, a Timonium financial planner, said that after WorldCom filed for bankruptcy last week, some of his clients bought tens of thousands of shares of the company for a dime a share. They sold the stock shortly thereafter when it went up to 17 cents.

"Most of my clients maintain a play account in which they can do a lot of transactions, short-term things and act on hunches," he said.

This should never be a strategy for serious money for retirement or other goals, but having a play account can keep investors from making mistakes with cash they can't afford to lose, Berman said.

Despite these warnings, if investors still want to dabble in troubled companies, Sellers suggests investing in Third Avenue Value Fund, which has a good record of buying at a discount some debt of businesses in distress. The fund bought debt in Kmart and WorldCom before they filed for bankruptcy.

Hold. If an investor owns so few shares that the commission would eat up nearly all of the proceeds if he sold, he should consider holding the stock, said Saxon Birdsong, director of investments for Baltimore-Washington Financial Advisors in Ellicott City.

Investors can always sell the shares later and deduct the losses on their tax returns, he said.

Birdsong is in a holding pattern. The money manager acquired Global Crossing for clients' portfolios about 18 months ago because he was impressed with the company's ability to build a global network and save customers money. The company filed under Chapter 11 in January, and the shares Birdsong bought are down about $400,000.

"It's still on our books just because there is no point in doing anything with it, no real market for it," Birdsong said.

Still, he said, there's a small chance that the shares will yield some value. "They're trying to sell off pieces of the company now," he said.

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