A company's bondholders may lose much or all their money if the company goes bankrupt. Under the laws of many countries (including the United States and Canada), bondholders are in line to receive the proceeds of the sale of the assets of a liquidated company ahead of some other creditors.
Bank lenders, deposit holders (in the case of a deposit-taking institution such as a bank) and trade creditors may take precedence. However, compared to equity holders, bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount), whereas the company's equity stock often ends up valueless.
When a business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11 of the Bankruptcy code. In Chapter 7, the business ceases operations, a trustee sells all of its assets, and then distributes the proceeds to its creditors. Any residual amount is returned to the owners of the company. In Chapter 11, in most instances, the debtor remains in control of its business operations as a debtor in possession, and is subject to the oversight and jurisdiction of the court. (Figure 1)
There is no guarantee of how much money will remain to repay bondholders, therefore, the value of the bond is uncertain. As an example, after an accounting scandal and a chapter 11 bankruptcy at the giant telecommunications company Worldcom in 2004, its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly-issued bonds.