Company Equity Holders’ Rights and Remedies in Chapter 11
In a Chapter 11 bankruptcy, company equity holders (shareholders) occupy a precarious position in the hierarchy of claims. They are typically last in line to receive payment due to their subordinate position in the capital structure. However, through negotiations and the infusion of new capital, they can sometimes retain a portion of their equity or secure other forms of value in the reorganized company.
A Chapter 11 bankruptcy is governed by the “absolute priority rule,” codified in 11 U.S.C. § 1129(b)(1). This rule mandates that creditors be paid in full before equity holders receive any distribution. The priority of payment follows a strict order as follows.
- Secured creditors — These creditors have a lien on specific assets of the company. In a Chapter 11 proceeding, they are first in line to be paid. Their claims are usually settled through the sale of the collateral securing the debt or by receiving replacement collateral.
- Unsecured creditors — These include suppliers, bondholders and employees who are owed wages. They are paid after secured creditors, but still before any equity holders. They may receive a portion of the company’s reorganized stock or a percentage of the debt’s value.
- Equity holders — The absolute priority rule means that if the claims of secured and unsecured creditors are not fully satisfied, equity holders may be wiped out entirely.
However, equity holders can sometimes negotiate to retain some value in the reorganized company. This typically occurs through a process known as “new value contribution” or “new capital contribution.” This means injecting fresh capital into the reorganized business. This infusion of new capital must be necessary for the reorganization plan and must provide a substantial benefit to the company and its creditors. In exchange for this contribution, equity holders may be granted ownership in the reorganized entity.
Shareholders can also use other forms of leverage during the negotiation process. For example, if the company has significant future growth potential, shareholders might argue that their continued involvement is essential to realizing that potential. They could negotiate for a reduced but retained stake in the reorganized company, or they might push for a combination of cash and equity in exchange for their new capital contribution.
In some cases, equity holders may enter into plan support agreements (PSAs) with creditors. These agreements outline the terms under which shareholders will support a proposed reorganization plan, often including provisions for new capital contributions. By aligning their interests with those of the creditors, shareholders may secure a more favorable position in the reorganization.
With the aid of skilled legal counsel, proactive equity holders can emerge from Chapter 11 with a continued stake in the business.
The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced Chapter 11 bankruptcy law firms, with 12 locations across the region. If you are an equity holder in a company with overwhelming debt, contact us online or call 310-271-6223 to schedule a consultation.
