Answer By law4u team
When a company files for bankruptcy or enters insolvency, the impact on shareholders can be significant, as their investments may lose value or even become worthless. Shareholders are the owners of the company, but their position in the hierarchy of creditors is at the bottom. Understanding how bankruptcy affects shareholders and their role in insolvency proceedings is important for assessing potential risks and outcomes.
How Bankruptcy Affects Shareholders
Position of Shareholders in the Bankruptcy Hierarchy
Shareholders are considered the owners of the company, but they are at the bottom of the priority list during insolvency proceedings. In the event of liquidation, secured creditors and unsecured creditors are paid first, and only if there are remaining assets will shareholders be entitled to anything.
Equity Holders (shareholders) usually receive nothing or very little in a liquidation scenario because creditors have priority. If the company has substantial debts, shareholders typically do not receive a payout.
Impact During Corporate Insolvency Resolution Process (CIRP)
During the Corporate Insolvency Resolution Process (CIRP), shareholders’ rights may be affected in several ways. The Resolution Professional (RP) takes control of the company's affairs, and a Committee of Creditors (CoC) is formed, primarily comprising financial creditors.
Shareholders are usually not part of the CoC, which means they have limited influence over the company’s restructuring or resolution process. However, they may still be able to voice their concerns at meetings or influence the Resolution Plan through voting if allowed.
If the company is successfully restructured and a Resolution Plan is approved, shareholders may receive some value if the company is able to continue operating, but this depends on the terms of the plan and the company's financial recovery.
Possible Outcomes for Shareholders in Insolvency
Equity Dilution: In many cases, as part of a restructured resolution, existing shareholders may see their equity stake diluted or wiped out. The Resolution Plan might involve issuing new equity to creditors in exchange for their claims, thus leaving existing shareholders with little or no ownership.
Share Value Depreciation: The market value of the company's shares typically declines sharply during insolvency or bankruptcy proceedings due to the company's uncertain future. In liquidation, shares often become worthless.
Sale or Transfer of Ownership: In some cases, the company may be sold to a third party or a strategic investor as part of the resolution process. Shareholders may receive some payout if the sale price exceeds the liabilities owed to creditors, but this is rare.
In Liquidation
If the company is liquidated, its assets are sold off, and the proceeds are used to pay off the creditors. Shareholders only receive any remaining funds after all other debts are paid. In most cases, there is little or no money left for shareholders, as creditors’ claims take precedence.
Shareholders can file claims for any remaining funds in liquidation, but as unsecured creditors, they are unlikely to recover anything unless the liquidation proceeds exceed expectations and there are leftover funds.
Impact on Voting Rights
In the CIRP process, shareholders retain their voting rights, but they have a limited role compared to creditors. Voting on the Resolution Plan is typically handled by the Committee of Creditors, where financial creditors hold the majority of the votes. Shareholders do not have a significant role in influencing the decision-making unless their equity stakes are substantial.
Legal Protection for Shareholders
Shareholders have some legal protection under the Insolvency and Bankruptcy Code (IBC), especially during the resolution process, but their rights are often secondary to those of creditors. Shareholders may challenge certain actions or Resolution Plans in court if they believe their rights are being violated, but such challenges are typically limited in scope and success.
Shareholders are also protected under the Securities and Exchange Board of India (SEBI) regulations, but these protections are more related to market integrity and investor rights rather than providing direct benefits during insolvency.
Reorganization vs. Liquidation
Reorganization may offer a better outcome for shareholders, as it could lead to the company continuing operations, thus potentially restoring the value of shares over time. However, this depends heavily on the company’s financial situation and the Resolution Plan.
In contrast, liquidation almost always results in shareholders losing their investment, as the company's assets are sold to pay creditors, and there is typically no remaining value for equity holders.
Example
Suppose a tech startup enters insolvency and goes through the Corporate Insolvency Resolution Process (CIRP). The company's creditors, including banks and vendors, are owed large amounts of money. The Resolution Professional (RP) works on finding a potential buyer or restructuring the company's debts.
If the company is restructured and a Resolution Plan is approved, existing shareholders might see their equity diluted, with creditors receiving a portion of the company in exchange for their debts.
If the company is liquidated, the shareholders will likely receive nothing because the company’s debts outweigh the assets, and creditors take precedence in receiving the liquidation proceeds.
Conclusion
In the event of bankruptcy or insolvency, shareholders are typically the most affected group. They are at the bottom of the creditor hierarchy, and in cases of liquidation, they are unlikely to receive any returns from the company’s assets. During Corporate Insolvency Resolution Process (CIRP), shareholders may retain limited rights, but their influence is usually minimal compared to creditors. The outcome for shareholders largely depends on the resolution plan, with reorganization offering a chance for recovery, whereas liquidation usually results in the loss of their investment.
