Bankruptcy: Chapter 11 vs Chapter 7, and the Hierarchy That Decides Who Gets Paid

Usually it doesn't. Under US law — this article's primary frame, per the pillar's standing rule, with the note that insolvency regimes differ substantially by jurisdiction — most large corporate bankruptcies are Chapter 11 reorganisations, in which the business keeps operating while a court supervises the restructuring of its debts; Chapter 7 liquidation, the shut-it-down-and-sell-the-assets chapter, is the smaller-company and end-of-the-road case. What bankruptcy reliably does destroy is the old capital structure — and the order of that destruction is written in advance, in the creditor hierarchy every investor holding stocks or bonds implicitly signed up to. This article covers both chapters, the priority ladder and where common shareholders stand on it (last), the mechanical experience of holding stock or bonds through a filing, and the documented modern phenomenon of bankrupt-company shares trading actively anyway. Mechanics and history; nothing here is guidance on distressed situations.

The two chapters, and the machinery of Chapter 11

Chapter 7 is conceptually simple: operations cease, a trustee is appointed, assets are sold, and proceeds flow down the priority ladder until the money runs out — for a company worth more dead than alive, or with no plausible path back. Chapter 11 is the interesting machine: the company files, an automatic stay instantly freezes creditor collection (the breathing space that is the chapter's entire point), and existing management typically continues running the business as a debtor in possession under court oversight. New DIP financing — loans made after the filing, granted super-senior priority precisely so someone will lend to a bankrupt company — funds operations while the parties negotiate a plan of reorganisation: which debts are paid, compromised, or converted to equity in the reorganised company, voted on by creditor classes and confirmed by the court, including — under conditions — over a dissenting class's objection (the "cramdown", noted as vocabulary). Timelines run from months (prepackaged filings, where creditors agreed the plan before the filing) to years; the company that emerges is legally continuous but financially rebuilt — less debt, new owners, and, critically for this pillar's readers, usually new shares. Alongside the myths, one more distinction worth precision: filing for Chapter 11 is not an admission the business is worthless — it is an admission the balance sheet is unsustainable, and the entire proceeding is an argument about how much value exists and who owns it.

The hierarchy — and where shareholders stand

The absolute priority rule orders the queue: secured creditors first, to the value of their collateral; then administrative claims (the bankruptcy's own costs, DIP lenders' super-priority); then priority unsecured claims (categories set by statute, including certain employee wages and taxes); then general unsecured creditors — the bondholders, suppliers, and landlords who form the main negotiating mass; then any subordinated debt; then preferred shareholders; and last, common shareholders — residual claimants in the fullest sense, paid only if every class above is paid in full. The practical consequence, stated without cushioning: in most Chapter 11 cases, existing common stock is cancelled and receives nothing — the reorganised company's new equity goes to creditors whose claims were converted, and the old shares expire worthless on the plan's effective date. The documented exceptions exist and matter for honesty: where the estate proves solvent enough to pay creditors in full, old equity can receive recovery — cash, new shares, or warrants — and a handful of famous cases have done exactly that; they are exceptions, statistically rare, and the hierarchy is why. Bondholders' experience is graded by the same ladder: secured and senior classes recover more, junior classes less, with recoveries paid in cash, new debt, or — very commonly — the new equity, which is how distressed-debt investors come to own reorganised companies: buying the fulcrum debt cheap and receiving the keys is the documented specialist strategy, described here as market structure. Credit ratings map onto this ladder in advance — seniority is half of what a rating prices — and the capital-structure reading skill this section teaches is exactly the one that page's vocabulary serves.

Trading through it — the documented modern spectacle

Here is the part that confuses more retail investors than any other in this pillar. A bankrupt company's shares usually keep trading — typically delisted to OTC markets, where they change hands daily, often for cents, sometimes in furious volume — while the plan making them worthless is being negotiated in public filings. Regulators publish standing investor warnings about precisely this, and the pillar's documented-history slot belongs to the era that made it famous: in 2020, Hertz filed for Chapter 11 and its shares, instead of fading, rallied so hard on retail enthusiasm that the company sought — briefly, with court permission — to sell new shares into the demand, an offering it withdrew after regulatory scrutiny; the case then delivered the rarest ending, an estate solvent enough in 2021's recovery that old shareholders actually received meaningful value at emergence. Both halves of that story are documented fact, and the honest telling holds them together: the exception happened, it was visible in the filings as asset values recovered, and it is the exception — the same years saw bankrupt retailers and rental names whose rallying shares expired at zero exactly as the hierarchy dictated, and the base rate, not the famous outlier, is the statistic. The mechanical literacy that survives the spectacle: the plan documents state each class's treatment in writing; "old" and "new" shares are different securities (old tickers often carry a distinguishing suffix while in bankruptcy); and a price above zero on a claim the plan cancels is a documented market phenomenon with its own research literature — reported here, per house rule, as something to understand rather than something to trade.