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What Happens to Shareholders if J.C. Penney Files for Bankruptcy?

By Daniel B. Kline - Apr 16, 2020 at 8:15AM

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If you own shares of J.C. Penney, you're probably not going to like what the SEC has to say.

The coronavirus pandemic appears to have pushed already damaged J.C. Penney (JCPN.Q) to potentially seek Chapter 11 bankruptcy protection. If that happens, the company would attempt to restructure its debt and keep some of its stores open (perhaps even most).

These reports aren't surprising because the retailer was struggling before the coronavirus pandemic gained speed. It reported a small surprise profit in the fourth quarter, but sales dropped by 7.7%. Profitability was achieved largely by cutting inventory by 11.1% to $2.17 billion.

It's fair to say that CEO Jill Soltau might have had a chance to continue her chain's slow turnaround. But that seems less and less likely now as the coronavirus pandemic has forced the closure of all of its stores for the foreseeable future.

That makes a Chapter 11 bankruptcy filing a real possibility. For the company, that might help it stay afloat and get back on track. For shareholders, that's probably really bad news.

The J.C. Penney concept store

J.C. Penney has a concept store where it's trying out new ideas. Image source: J.C. Penney.

What would a J.C. Penney bankruptcy look like for shareholders?

The department store chain closed out 2019 with about $1.8 billion in liquidity, and it had $386 million in cash. It's hard to estimate the company's expenses at the moment because it has furloughed workers, cut some executive salaries, and pushed back or canceled orders for new inventory.

If it has to declare bankruptcy, it's likely to opt for Chapter 11. The Securities and Exchange Commission (SEC) defines that on its website:

A bankrupt company, the "debtor," might use Chapter 11 of the Bankruptcy Code to "reorganize" its business and try to become profitable again. Management continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court.

The more serious alternative -- Chapter 7 -- would involve a liquidation. It's possible that in that case another operator purchases the assets and keeps stores running, but that's not very likely.

In bankruptcy, stockholders fall behind secured creditors in terms of priority and "bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal," according to the SEC.

People who own shares generally end up at the end of the line. Shares, of course, can still legally trade, but equity for the original shareholders may be greatly reduced (if it's not eliminated). The SEC spells it out pretty bluntly:

Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment.

That's as bad as it sounds. If J.C. Penney (or really any company or retailer) files for Chapter 11, shareholders will likely suffer and may get wiped out.

Is there a silver lining?

In most cases, there's no silver lining. Buying stock comes with risks and the SEC hammers that point home:

In most instances, the company's plan of reorganization will cancel the existing equity shares. This happens in bankruptcy cases because secured and unsecured creditors are paid from the company's assets before common stockholders. And in situations where shareholders do participate in the plan, their shares are usually subject to substantial dilution.

What's right for J.C. Penney may not mirror what's best for shareholders. That's almost certainly going to be the case in the event of a bankruptcy.

Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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