How Equity Holders Can Protect Their Interests During Chapter 11
When a company files for Chapter 11 bankruptcy, its existing equity holders (such as shareholders) are typically at the bottom of the repayment hierarchy. In U.S. bankruptcy law, the order of claims is strictly observed: secured creditors are paid first, followed by unsecured creditors, and then, only if anything remains, equity holders receive payment. This low priority means that, in many bankruptcies, shareholders are wiped out entirely. However, there are circumstances in which equity holders can retain or even gain some value in the reorganized post-bankruptcy company.
One of the principal avenues for equity holders to preserve stake in the company is through a process known as “new value contribution” or “new capital contribution.” This exception to the absolute priority rule allows current owners to inject fresh capital into the debtor as part of the reorganization plan. For such an infusion of new capital to be effective, bankruptcy courts require that the contribution is both necessary for the successful reorganization of the company and provides a substantial, measurable benefit to the debtor and its creditors. The rationale is that, if the bankrupt company cannot attract external investment on better terms, the current equity holders’ new value can be justified. In exchange for providing this critical capital, shareholders may be granted new ownership stakes in the reorganized business, essentially allowing them to “buy” their way into the restructured entity.
A new value contribution is subject to strict judicial scrutiny. The value contributed equity holders must be reasonably equivalent to what their new equity interest is worth and must constitute more than just a token amount. Courts also require that no better deal is placed on the table by outside investors, ensuring fairness to creditors.
Apart from injecting new capital, equity holders have other forms of leverage to protect their interests during the bankruptcy process. For example, shareholders may argue that their continued involvement is essential for realizing the company’s growth potential, particularly if they possess unique industry knowledge, relationships, or leadership skills that cannot be easily replaced. They might negotiate for the right to retain a reduced, but meaningful, ownership stake in the reorganized company. In some cases, equity holders advocate for a hybrid compensation, such as a combination of cash payout and equity in the new entity, tied to their new capital contribution or ongoing involvement.
Equity holders may also seek to form alliances or negotiate directly with creditor groups to reach compromises that preserve their interests. One practical tool in this context is the use of Plan Support Agreements (PSAs). In a PSA, shareholders and certain creditor groups agree, in advance, to support specific terms of the proposed reorganization plan. These agreements commonly outline how new capital will be contributed, how ownership will be realigned, and under what circumstances the parties will vote for the plan. By committing to align their interests with those of the creditors, equity holders may strengthen their bargaining power and secure a more favorable position in the reorganized company compared to a scenario where they remain at odds with dominant creditors.
With the aid of skilled legal counsel, 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.
