Oh, that Hertz: Protecting Unsophisticated Investors from Buying Stock in Bankrupt Companies

Abstract

In United States bankruptcies, the absolute priority rule dictates that shareholders recover no value unless creditors are paid in full. Because unsecured creditors are typically not paid in full, shareholders lose their ownership interest and recover little-to-nothing in bankruptcy. Despite the minuscule chances that debtors’ shareholders will recover their investment in bankruptcy, debtors’ stock continues to trade in large volume during bankruptcy. Amateur investors, who know little about the small chance of shareholder recovery, buy bankrupt company stock, especially that of well-known public companies trading at low prices from sophisticated, institutional investors. Consequently, amateur investors can see huge losses during the bankruptcy process, while institutional investors are able to hedge some of their losses from the now insolvent company. The current public and private regulatory regimes do not have the authority or desire to protect amateur investors trading bankrupt company stock. This Note proposes that Congress adopt an amendment to the Bankruptcy Code that grants bankruptcy courts a limited power to suspend trading in a company’s stock after it files for bankruptcy. In order to trigger this measure, the courts must determine that shareholders are likely to receive little-to-no value in bankruptcy and that amateur investors will ignorantly purchase such bankrupt company stock. This Note then discusses the proposed amendment and its potential consequences, and responds to expected criticisms of the amendment.