Michael Price of Mutual Series Fund, Inc., speaks of three stages of bankruptcy. The first stage, immediately after the Chapter 11 filing, is the time of greatest uncertainty but perhaps also of greatest opportunity for investors. The debtor's financial situation is in turmoil, financial statements may be late or unavailable, off-balance-sheet liabilities are not immediately evident, and the underlying business may not have stabilized. In addition the market for the debtor's securities is in disarray, with many holders forced to sell their holdings regardless of price.
The second stage of bankruptcy, involving the negotiation of a plan of reorganization, begins anywhere from a few months to several years after filing. By then analysts will have pored over the debtor's business and financial situation. Much more is known about the debtor, and security prices will incorporate the available information. Considerable uncertainty remains, however, about the eventual plan of reorganization. The treatment of various classes of creditors is still to be resolved.
The third and final stage of bankruptcy occurs between the finalization of a reorganization plan and the debtor's emergence from bankruptcy. Unless the plan is contested, is rejected by one or more classes of creditors, or falls through because a key condition is not met, this stage usually takes three months to one year. Although the time frame and legal process are less certain, the last stage most closely resembles a risk-arbitrage investment.
Each stage of bankruptcy affords different opportunities to the investor. The best bargains appear amidst the uncertainty and high risk of the first stage. The lowest but most predictable returns are available in the third stage, after the reorganization plan becomes publicly available.
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