Case: Alpha Manufacturing Corporation, bankruptcy, governance and priority of claims
Alpha Manufacturing Corporation is in extreme financial difficulty and is considering bankruptcy. Its shareholders are almost equally divided: one outspoken faction wants bankruptcy and the other strongly opposes it. Alpha has $50 million in debt, all in bonds, and the bondholders are united in wanting the firm to declare bankruptcy.
- The CEO says he is leaning against bankruptcy. Can the unhappy faction of shareholders team up with the bondholders to vote out the CEO? Explain using the background readings.
- Alpha declares bankruptcy. It has no cash but owns $60 million of real estate and has only common shareholders. If it sells the real estate, how much do bondholders and shareholders receive?
- Now Alpha has common and preferred shareholders, and preferred shareholders are owed $20 million in unpaid dividends from the past two years. If Alpha sells its $60 million of real estate, how much do bondholders, preferred shareholders and common shareholders each receive?
Secured, then unsecured debt, including bondholders
Paid only after all debt is satisfied
Residual claimants, last in line
Model answers
Original example for study purposes (about 800 words). Replace or add citations from your module’s background readings.
A. Can Unhappy Shareholders and Bondholders Vote Out the CEO?
No, at least not together and not directly. The answer depends on who holds voting rights in a corporation and who controls the CEO.
- Bondholders have no vote. Bondholders are creditors, not owners. Their relationship with Alpha is governed by the bond contract (the indenture), which promises interest and repayment of principal. Unlike shareholders, they do not elect directors or vote on corporate matters. Their protection comes from contract terms (covenants), from their priority in bankruptcy and from legal remedies if Alpha defaults.
- Shareholders do not fire the CEO directly either. In the U.S. corporate governance model, shareholders elect the board of directors, and the board hires, oversees and removes the CEO. The unhappy faction could therefore try to change the CEO’s direction indirectly by persuading the board, nominating directors and soliciting proxies at the next annual meeting (a proxy contest), or calling a special meeting to remove directors if the company’s charter, bylaws and state law allow it.
- The numbers are against the dissidents. Because shareholders are almost evenly split, the pro-bankruptcy faction would need to win over some undecided or opposing shareholders to elect a new board majority. Adding the bondholders does not help, because bondholders hold no shares and have no votes to contribute.
The two groups could still coordinate their influence. Bondholders can refuse to renegotiate or refinance debt, enforce covenants and, if Alpha stops paying, file an involuntary bankruptcy petition. Once a company is insolvent, Delaware law also allows creditors to bring derivative claims for breaches of directors’ fiduciary duties, because creditors become the main residual claimants of an insolvent firm (North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 2007). These pressures might push the board to reconsider, but they are not a vote to remove the CEO.
This situation also illustrates an agency conflict. Shareholders of a nearly insolvent firm may prefer to avoid bankruptcy and “gamble for resurrection,” since they lose little if risky strategies fail but gain if they succeed, while bondholders prefer an orderly bankruptcy that protects what is left of the assets. The CEO’s position may reflect his own interest in keeping his job, which is why board oversight matters.
B. One Class of Stock: Who Gets the $60 Million?
Distribution in bankruptcy follows the absolute priority rule: each class of claimants must be paid in full before the next, more junior class receives anything. Creditors, including bondholders, come before stockholders, and common stock is last in line (U.S. Securities and Exchange Commission [SEC], 2015).
| Claimant (in order) | Claim | Amount received | Remaining proceeds |
|---|---|---|---|
| Bondholders | $50 million | $50 million (paid in full) | $10 million |
| Common shareholders | Residual | $10 million | $0 |
Bondholders recover 100% of their $50 million claim, and the common shareholders share the remaining $10 million in proportion to their shares. This assumes the real estate sells for the full $60 million and ignores bankruptcy costs, such as legal fees and trustee costs, and any other creditors such as employees, suppliers or tax authorities. In real cases, administrative expenses and priority claims would be paid first, reducing what is left for shareholders, which is one reason the SEC (2015) warns that stock in a bankrupt company is often worthless.
C. Preferred and Common Stock: Who Gets the $60 Million?
Preferred stock ranks below all debt but above common stock (Financial Industry Regulatory Authority [FINRA], n.d.). The $20 million in unpaid dividends suggests the preferred shares are cumulative, so the missed dividends accumulate as part of the preferred holders’ claim. However, unpaid dividends are not debt; preferred shareholders remain equity holders and cannot be paid until bondholders are paid in full.
| Claimant (in order) | Claim | Amount received | Remaining proceeds |
|---|---|---|---|
| Bondholders | $50 million | $50 million (paid in full) | $10 million |
| Preferred shareholders | $20 million in dividend arrears (plus any liquidation preference) | $10 million (50% recovery of arrears) | $0 |
| Common shareholders | Residual | $0 | $0 |
Bondholders again receive their full $50 million. The remaining $10 million goes to the preferred shareholders, which covers only half of the $20 million they are owed, and common shareholders receive nothing. If the preferred stock also carries a liquidation preference, such as its par value, the preferred holders’ total claim would be even larger, but they still could not receive more than the $10 million available. Comparing Parts B and C shows how adding a senior class of equity wipes out common shareholders when asset values are limited.
Conclusion
Alpha’s case shows the difference between control rights and cash flow rights. Shareholders control the firm through their votes for the board, while bondholders hold contractual claims with priority in bankruptcy. When a firm fails, the absolute priority rule ensures that bondholders are paid before preferred shareholders, who in turn are paid before common shareholders, which is why common stockholders often recover little or nothing.
References
Financial Industry Regulatory Authority. (n.d.). What a corporate bankruptcy means for shareholders. https://www.finra.org/investors/insights/what-corporate-bankruptcy-means-shareholders
North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007).
U.S. Securities and Exchange Commission. (2015, March 31). Investor bulletin: Bankruptcy for a public company. Investor.gov. https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-84
[Your module’s background readings, in APA format.]
Before you submit: the assignment asks you to explain your reasoning using the background readings, so add at least one citation from your module for each part, especially on shareholder voting rights and the order of payment in bankruptcy.
Frequently asked questions
What is the absolute priority rule?
It is the principle that senior claimants must be paid in full before junior claimants receive anything: creditors first, then preferred stockholders, then common stockholders.
Do bondholders ever get voting rights?
Not as bondholders. In a Chapter 11 reorganization, however, creditor classes vote on the reorganization plan, and bondholders often receive new shares, and therefore votes, in the reorganized company.
Related reading: bond, stock and DCF valuation case solutions.
More model assignments posted today
- Bond, stock and DCF valuation solutions
- Overfishing crisis: how would you vote?
- DMDD and PMH-APRN prevention roles
- Reflection on the four domains of teaching
- Clinical judgment and BSN presentation
- Pyelonephritis concept map
- NUR 1141 pharmacology questions
- Mark Ilescu captopril case study
- Five pharmacology case scenarios