Flouting logic by buying Chapter 11 stocks

Retail traders bet on insolvent companies despite bankruptcy rules that often wipe out shareholders.

Investors are piling into stocks of companies in bankruptcy, wagering against a court process that routinely wipes out shareholders.

Car renter Hertz Global Holdings Inc., oil driller Whiting Petroleum Corp. and retailer J.C. Penney Co. are among companies that have seen their shares more than double recently despite being in Chapter 11 bankruptcy, a process that allows companies to keep operating while working out a plan to repay creditors.

“I have always thought people have a psychological urge to buy stocks at a low price,” said Kirk Ruddy, a former bankruptcy claims trader. Retail investors may be buying big names they recognize without realizing how rare it is for shareholders to get anything back in bankruptcy, he said.

“If you look at the markets in general, people don’t know where to put their money. They are like, ‘Hey, I’m going to try that $1 stock,’ ” Ruddy added.

On Tuesday, J.C. Penney shareholders will press a federal judge to appoint a court-approved committee to represent them in the bankruptcy case. Getting official status would mean forcing the retailer to pay for lawyers and financial advisors who would work on behalf of shareholders. Judges rarely grant such requests for two reasons: The legal fees can be high, and under the so-called absolute priority rule, all the debt of a company must be paid before shareholders can collect anything.

Some of the rally in insolvent companies’ shares might be attributable to short covering, when traders who have bet against a company close their positions by re-buying shares, lifting prices. But the rally could also be fueled by amateur traders, bored in lockdown and looking for a quick buck, using platforms such as Robinhood. The number of Robinhood users holding both Hertz and Whiting Petroleum shares surged after the companies filed for bankruptcy, according to Robintrack, a website that uses data to show trends.

“No one ever loses equity in a bankruptcy case,” U.S. Bankruptcy Judge David Jones said during a status conference in the J.C. Penney case. “Equity gets lost long before the case is filed.”

Under U.S. bankruptcy law, shareholders are last in line for any kind of payout — behind the lawyers, lenders and vendors — making a recovery for shares unusual. The size and scope of payouts are usually determined by a so-called Chapter 11 plan, which creditors vote on and send to a federal judge for approval. Those plans often leave even high-ranking creditors getting less than they’re owed.

The price gains among the insolvent include:

Hertz, which climbed 95% since it filed for bankruptcy protection May 22.

J.C. Penney, up 167% since May 15.

Whiting Petroleum, up 835% since April 1.

Pier 1 Imports Inc., which more than doubled in the last two trading sessions, though it’s still down 97% since filing for bankruptcy Feb. 17.

Companies that have begun planning for bankruptcy also saw their shares surge Monday, including:

Chesapeake Energy Corp., up 181%.

GNC Holdings Inc., up 106%.