Companies may file for bankruptcy protection under one of the federal bankruptcy laws. Chapter 11 allows the company to reorganize its business and try to be profitable again. Under Chapter 7, the company stops all business operations and liquidates its assets to pay off debt to creditors and investors.

The amount of money investors receive depends upon the type of bankruptcy filed and the company's solvency (the difference between the value of assets versus liabilities). Bankruptcy laws determine order of payment, but in both types, the secured creditors are paid first since their loans were backed by collateral. Unsecured creditors - such as bondholders - are paid next, since bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders are the last to be repaid, and only if there is money left.

During a Chapter 11 bankruptcy, which you can read more about on the U.S. Courts Web site, the company's stock will continue to trade. During bankruptcy, stockholders will not receive dividends. As a part of reorganization, stockholders may be asked to exchange old shares for new ones that may be worth less per share. The bankruptcy court may determine that stockholders get nothing if the company's liabilities are greater than its assets, thus deeming the stock worthless.

During a Chapter 7 bankruptcy, a company is likely to liquidate and sell its assets for cash. As with Chapter 11, secured creditors are paid first, with the remainder going to unsecured creditors. The company is not required to notify stockholders. Most stockholders will lose their entire investment and their only recourse is to file a claim in case the creditors are paid in full. If this occurs, an investor may want to contact a tax advisor or the Internal Revenue Service (IRS) for information on how to report worthless securities as a loss on your income tax return.

For more information, visit the Securities and Exchange Commission (SEC) Web site.