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What Stockholders Must Know About Bankruptcy

Don't delude yourself about the fate of common shares in a Chapter 11 filing.

Editor's note: This is the first article in a new series called "Ask the Expert," in which our reporters talk to the experts in their field for answers to questions on a variety of sectors, companies and issues affecting the market. Got a question you'd like us to track down? Email us at

Question: What happens to my common shares when a company goes into bankruptcy?

If you own shares in a company that goes bankrupt, there's an excellent chance your stock will end up worthless. While there are exceptions to this rule, it's something that investors often misunderstand, in part because companies themselves many times emerge from Chapter 11. It's the common stock that almost never survives.

A company declares bankruptcy because it owes more than it can pay. To extricate itself from this, it works with banks and other creditors to create what can be thought of as a new company that doesn't owe as much money. Almost always, that company is one that current shareholders won't own shares in.

"Our experience is that you get very little return on equity after bankruptcy," said Chris Stuttard, editor of

, a clearinghouse for corporate bankruptcy information. "Look at it like this. It was one company going in and becomes a brand-new company when it comes out. And more often than not, the company will decide to cancel the old common stock."

This is because when it comes to getting paid back, equity stakeholders are last in line, trailing banks and debt holders. This makes trading in potential bankruptcy cases -- an airline, for instance -- a particularly risky proposition, since the downside could very possibly be everything.

Consider the case of

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US Airways

, which entered bankruptcy last year and re-emerged as a new entity at the end of March.

A year ago, US Air shares were trading on the

New York Stock Exchange

as the company teetered into bankruptcy. After the company declared Chapter 11, the shares moved below $1 and were delisted, but still traded as over-the-counter shares as recently as March. Once the company left the protection of bankruptcy, whatever stake you owned instantly became worthless -- the company's old stock price is $0 and it isn't listed anywhere.

Because it had so many subsidiaries and moving parts, US Air's plan of reorganization is rather complex, but one thing is clear: Stock investors got nothing.

"All of the common stock was reinstated, but those common shares are worthless," said Stuttard. "They might have reinstated that stock for tax purposes, but investors got nothing."

In rare instances, investors can hope to get next to nothing, perhaps one share for every 10,000 they own.

"Institutional investors understand it, but more often than not individuals look at a company a year ago and it goes to a penny, and for some reason they look at it and think it's going to go back up," said Stuttard. "They don't understand

what it means when a company is attempting to reorganize its balance sheet."