How Corporate Bankruptcy Works

The Bankruptcy Process and Aftermath

For creditors and investors, the bankruptcy process all boils down to one important question: "When will I get paid?" The answer depends largely on the type of debt or investment.

In both Chapter 7 and Chapter 11 cases, the settling of debts is overseen by a trustee. This person's role varies based on the type of bankruptcy, but generally includes seeing that the business's assets – buildings, equipment, supplies, products – are sold off in a timely fashion and that creditors and investors are paid, to the extent possible. In Chapter 7 cases, for example, the trustee will sell all of the company's assets and keep paying creditors until that money runs dry. In Chapter 11 cases, the business gets to keep some of its assets. All debts are wiped away at the end of the process under either chapter, regardless of whether a creditor actually gets paid [source: SEC].

Federal bankruptcy law provides a general hierarchy of debt holders that serves as a road map of sorts for determining order of payment. Secured creditors – those whose loans are backed by collateral, such as a house or building – get paid first. That is, after money is put aside for legal fees and other costs related to the bankruptcy proceeding, of course. A bank that holds the mortgage on a bankrupt company's business headquarters, for example, will likely take the property. If that's not enough to cover what's owed, the bank gets the first shot at any other money generated when other assets are liquidated [source: Fullerton].

Unsecured creditors are next to be paid, if there's any money left. This group includes people and businesses that hold debts that aren't secured by property. That means credit card companies as well as suppliers and service providers who haven't been paid for their work, among others [sources: SEC, Fullerton].

Investors in a bankrupt company reside at the bottom of the totem pole for payment purposes. As those who lost money in the stock market during the recent recession might already know, investors take on quite a bit of risk when they buy a piece of ownership in a business. Bondholders, who are offered a specific rate of return in exchange for investing in a company, are paid ahead of other investors. Shareholders are last in line, where they're generally unlikely to get much of their money back [sources: SEC, Fullerton].