The chapters in this document are displayed in reversed order, with the last chapter
appearing first. This change ensures all chapters are included in the Solutions. Ch 1 to 20 ✅
Chapter 20 – Corporations in Financial Difficulty
CHAPTER 20
CORPORATIONS IN FINANCIAL DIFFICULTY
ANSWERS TO QUESTIONS
Q20-1 The nonjudicial actions available to a financially distressed company are debt
restructuring arrangements, creditor's committee management, and transferring
assets. The judicial actions available are corporate liquidation (Chapter 7) and
corporate reorganization (Chapter 11).
Q20-2 The major difference between a Chapter 7 action and a Chapter 11 action is that
the debtor continues as a business after a Chapter 11 reorganization whereas the
business does not survive a Chapter 7 liquidation.
Q20-3 Under two circumstances an involuntary petition for relief may be filed. The first
circumstance is that the debtor is generally not paying debts as they become due.
The second circumstance is that within the last 120 days a custodian has been
appointed by other creditors, by the debtor, or by some other agency to take
possession of the debtor's assets. If more than 12 creditors exist, then three or
more creditors must combine to file the petition. These three or more creditors
must have aggregate unsecured claims of at least $5,000.
Q20-4 The following items are usually included in the Plan of Reorganization filed as part
of a Chapter 11 reorganization:
All major actions to be taken during the reorganization:
1. Discontinuances of unprofitable operations
2. Restructuring of debt with specific creditors
3. Revaluation of assets and liabilities
4. Changes in the par value of outstanding stock, or realignment of stockholders'
equity with newly issued shares of voting common stock.
Q20-5 The account Reorganization Value in Excess of the Amount Assigned to
Identifiable Assets is established during a Chapter 11 fresh start accounting to
record the excess of the reorganization value that is not assigned to specific
assets. The account is an intangible asset and is accounted for in accordance with
ASC 350.
Q20-6 A company in Chapter 11 reorganization qualifies for fresh start accounting if both
of the following occur:
1. The reorganization value of the entity's assets of the emerging entity
immediately before the date of confirmation is less than the total of all post-
petition liabilities and allowed claims; and
2. Holders of existing voting shares immediately before confirmation receive less
than 50% of the voting shares of the emerging entity.
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,Chapter 20 – Corporations in Financial Difficulty
Companies using fresh start accounting revalue their assets to fair values, using
the procedures in ASC 805. An account called Reorganization Value in Excess of
the Amount Assigned to Identifiable Assets is used to record any excess in
reorganization value not assigned to specific assets.
Q20-7 The financial statements that must be filed by a company during a Chapter 11
reorganization include a complete set of audited financial statements. ASC 852
established specific guidelines for these statements, noting that amounts
associated with reorganization should be reported separately.
Q20-8 The rights of creditors with priority in a Chapter 7 liquidation are to receive any
assets available to unsecured creditors after the secured creditors have been
satisfied.
Q20-9 The statement of affairs is the basic accounting report made at the beginning of
the liquidation process to present the expected realizable amounts from disposal
of the assets, the order of creditors' claims, and the expected amount unsecured
creditors will receive as a result of the liquidation. In addition, the statement of
affairs presents the book values of the debtor company's balance sheet accounts,
the estimated fair market value of the assets, the order of claims, and the estimated
deficiency to the general unsecured creditors. As a final point, the statement of
affairs is not a going concern report.
Q20-10 A trustee who takes title to the debtor's assets in a liquidation must make a periodic
financial report to the bankruptcy court reporting on the progress of the liquidation
and on the fiduciary relationship held. When the trustee accepts the assets, a new
set of books is opened for the debtor and a new account is created to recognize
the debtor's interest in the net assets accepted by the trustee. A statement of
realization and liquidation is prepared on a monthly basis for the bankruptcy court
showing the results of the trustee's fiduciary actions’ beginning at the point the
trustee accepts the debtor's assets.
Q20-11 Sales of assets are reported in the statement of realization and liquidation as
assets realized in the assets section of the statement.
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,Chapter 20 – Corporations in Financial Difficulty
SOLUTIONS TO CASES
C20-1 Creditors' Alternatives
The options to the creditors are (1) form a creditors' committee, (2) a Chapter 11
reorganization, and (3) a Chapter 7 liquidation. The eventual decision must rest upon the
creditors' assessment of the viability of the rehabilitation of the debtor versus the
liquidation values of the debtor's assets.
Most creditors do not want to see the liquidation of a debtor because, as creditors, they
are in the business of loaning monies, not trying to manage a business or attempting to
obtain as much of a liquidation dividend as possible in a liquidation. Most creditors will
work with the debtor's management as long as possible. Secured creditors have greater
protection of their receivables than do unsecured creditors. However, even most secured
creditors prefer to see a debtor company be rehabilitated after a time of financial difficulty
rather than see the debtor liquidated. The timing of the cash flows is somewhat dependent
on the amount of reduction in debt the creditors are willing to absorb. If the creditors are
willing to work with the debtor, the creditors may eventually realize a greater percentage
of their debt, but it usually takes a longer time to receive the payments from the debtor.
The creditors' committee is a nonjudicial action that provides for flexibility to both the
creditors and the debtor. The creditors' committee typically works with the debtor company
to enact a plan of settlement of the debtor's indebtedness. In some cases, the creditors
may assume management control of the company, but most creditors are reluctant to do
this because of the added risk of legal action if the company does enter bankruptcy.
Creditors may eventually receive a substantial part, or possibly all, of their receivables as
the debtor is able to "work down" its debt over time.
Chapter 11 reorganization offers the creditors a chance to continue having a customer
once the customer solves its immediate financial problems. A reorganization is an
acceptable option if the creditors feel the company would have the basic operating and
financial foundations after the reorganization to become a going concern. Creditors often
accept reduced amounts as settlements of their receivables, or will modify the terms of
existing debt as part of the reorganization agreement.
Chapter 7 liquidations are the final step. The creditors must go through the judicial process
that may take a long time to complete. Liquidation should be used only if no other
alternative is viable. Creditors often receive a smaller portion of their receivables because
of the forced liquidation of the assets and the extensive legal and administrative costs
involved in a liquidation.
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, Chapter 20 – Corporations in Financial Difficulty
C20-2 Research Related to Bankruptcy
The website for the U.S. Bankruptcy Courts is:
http://www.uscourts.gov/FederalCourts/Bankruptcy.aspx
a. The Frequently Asked Questions (FAQs) for the U.S. Courts
(http://www.uscourts.gov/Common/FAQS.aspx) state that a U.S. bankruptcy judge is
a district court judicial officer who is appointed by the majority of judges of the U.S.
appeals court to have jurisdiction over bankruptcy matters. As bankruptcy cases come
before a district court, a bankruptcy judge is assigned to the case. Some courts assign
judges based on random assignment while other courts have a chief judge who seeks
to select a judge to assign based on a judge’s experience or special expertise relevant
to the case. Each court will have a written plan or system for assigning cases.
b. The U.S. Bankruptcy Court’s website has a link to Official Bankruptcy Forms to be
used in filings before the courts. The forms and instructions for a Voluntary Petition
are available in Part I of the Bankruptcy Forms Manual page. The official form is
FORM B1 for a voluntary petition.
A voluntary petition is initiated by the debtor and therefore the information required is
principally related to the debtor, such as name, address, and location of the principal
assets of the debtor. The debtor must declare such items as the number of creditors,
the estimated assets, the estimated debts, the type of petition (i.e., Chapter 7,
Chapter 11, etc.), if sufficient funds will be available to satisfy the unsecured
creditors. The debtor may also be required to file additional exhibits (Exhibit A for
publicly traded companies, Exhibit B is used in personal filings and Exhibit C to
describe any property that might pose a threat of identifiable harm to public health or
safety).
c. The United States Bankruptcy Courts Website presents a link to Bankruptcy
Statistics (http://www.uscourts.gov/Statistics/BankruptcyStatistics.aspx) that are
presented in .pdf format. Statistics are presented for various time periods such as
quarters, fiscal years and calendar years. Note that Case 20-3 asks for the most
recent calendar year ending on December 31.
(1) Total business filings are presented at the top of the form for business and
nonbusiness filings for the twelve month period ended for the most recent year.
Statistics for prior years are also available. Business filings are typically about
34,000 but do fluctuate slightly based on economic conditions. Approximately sixty
percent of these filings are under Chapter 7, about twenty-eight percent under
Chapter 11, and the remainder under various other chapters of the Bankruptcy
Code.
(2) Students should find the Federal judicial district in which their educational
institution is located. The larger states typically have several districts and students
may have to make an assumption for which district they are located. It is instructive
to see that the numbers of filings vary widely by district. The number of filings may
differ due to different economic factors for specific parts of the United States, the
nature of the industrial base in a specific district, the size of a district, and other
factors reflecting business factors across court districts. Students might reflect on
why the number of filings in their Federal court district are different from those in
other districts in other circuits.
20-4
©
appearing first. This change ensures all chapters are included in the Solutions. Ch 1 to 20 ✅
Chapter 20 – Corporations in Financial Difficulty
CHAPTER 20
CORPORATIONS IN FINANCIAL DIFFICULTY
ANSWERS TO QUESTIONS
Q20-1 The nonjudicial actions available to a financially distressed company are debt
restructuring arrangements, creditor's committee management, and transferring
assets. The judicial actions available are corporate liquidation (Chapter 7) and
corporate reorganization (Chapter 11).
Q20-2 The major difference between a Chapter 7 action and a Chapter 11 action is that
the debtor continues as a business after a Chapter 11 reorganization whereas the
business does not survive a Chapter 7 liquidation.
Q20-3 Under two circumstances an involuntary petition for relief may be filed. The first
circumstance is that the debtor is generally not paying debts as they become due.
The second circumstance is that within the last 120 days a custodian has been
appointed by other creditors, by the debtor, or by some other agency to take
possession of the debtor's assets. If more than 12 creditors exist, then three or
more creditors must combine to file the petition. These three or more creditors
must have aggregate unsecured claims of at least $5,000.
Q20-4 The following items are usually included in the Plan of Reorganization filed as part
of a Chapter 11 reorganization:
All major actions to be taken during the reorganization:
1. Discontinuances of unprofitable operations
2. Restructuring of debt with specific creditors
3. Revaluation of assets and liabilities
4. Changes in the par value of outstanding stock, or realignment of stockholders'
equity with newly issued shares of voting common stock.
Q20-5 The account Reorganization Value in Excess of the Amount Assigned to
Identifiable Assets is established during a Chapter 11 fresh start accounting to
record the excess of the reorganization value that is not assigned to specific
assets. The account is an intangible asset and is accounted for in accordance with
ASC 350.
Q20-6 A company in Chapter 11 reorganization qualifies for fresh start accounting if both
of the following occur:
1. The reorganization value of the entity's assets of the emerging entity
immediately before the date of confirmation is less than the total of all post-
petition liabilities and allowed claims; and
2. Holders of existing voting shares immediately before confirmation receive less
than 50% of the voting shares of the emerging entity.
20-1
©
,Chapter 20 – Corporations in Financial Difficulty
Companies using fresh start accounting revalue their assets to fair values, using
the procedures in ASC 805. An account called Reorganization Value in Excess of
the Amount Assigned to Identifiable Assets is used to record any excess in
reorganization value not assigned to specific assets.
Q20-7 The financial statements that must be filed by a company during a Chapter 11
reorganization include a complete set of audited financial statements. ASC 852
established specific guidelines for these statements, noting that amounts
associated with reorganization should be reported separately.
Q20-8 The rights of creditors with priority in a Chapter 7 liquidation are to receive any
assets available to unsecured creditors after the secured creditors have been
satisfied.
Q20-9 The statement of affairs is the basic accounting report made at the beginning of
the liquidation process to present the expected realizable amounts from disposal
of the assets, the order of creditors' claims, and the expected amount unsecured
creditors will receive as a result of the liquidation. In addition, the statement of
affairs presents the book values of the debtor company's balance sheet accounts,
the estimated fair market value of the assets, the order of claims, and the estimated
deficiency to the general unsecured creditors. As a final point, the statement of
affairs is not a going concern report.
Q20-10 A trustee who takes title to the debtor's assets in a liquidation must make a periodic
financial report to the bankruptcy court reporting on the progress of the liquidation
and on the fiduciary relationship held. When the trustee accepts the assets, a new
set of books is opened for the debtor and a new account is created to recognize
the debtor's interest in the net assets accepted by the trustee. A statement of
realization and liquidation is prepared on a monthly basis for the bankruptcy court
showing the results of the trustee's fiduciary actions’ beginning at the point the
trustee accepts the debtor's assets.
Q20-11 Sales of assets are reported in the statement of realization and liquidation as
assets realized in the assets section of the statement.
20-2
©
,Chapter 20 – Corporations in Financial Difficulty
SOLUTIONS TO CASES
C20-1 Creditors' Alternatives
The options to the creditors are (1) form a creditors' committee, (2) a Chapter 11
reorganization, and (3) a Chapter 7 liquidation. The eventual decision must rest upon the
creditors' assessment of the viability of the rehabilitation of the debtor versus the
liquidation values of the debtor's assets.
Most creditors do not want to see the liquidation of a debtor because, as creditors, they
are in the business of loaning monies, not trying to manage a business or attempting to
obtain as much of a liquidation dividend as possible in a liquidation. Most creditors will
work with the debtor's management as long as possible. Secured creditors have greater
protection of their receivables than do unsecured creditors. However, even most secured
creditors prefer to see a debtor company be rehabilitated after a time of financial difficulty
rather than see the debtor liquidated. The timing of the cash flows is somewhat dependent
on the amount of reduction in debt the creditors are willing to absorb. If the creditors are
willing to work with the debtor, the creditors may eventually realize a greater percentage
of their debt, but it usually takes a longer time to receive the payments from the debtor.
The creditors' committee is a nonjudicial action that provides for flexibility to both the
creditors and the debtor. The creditors' committee typically works with the debtor company
to enact a plan of settlement of the debtor's indebtedness. In some cases, the creditors
may assume management control of the company, but most creditors are reluctant to do
this because of the added risk of legal action if the company does enter bankruptcy.
Creditors may eventually receive a substantial part, or possibly all, of their receivables as
the debtor is able to "work down" its debt over time.
Chapter 11 reorganization offers the creditors a chance to continue having a customer
once the customer solves its immediate financial problems. A reorganization is an
acceptable option if the creditors feel the company would have the basic operating and
financial foundations after the reorganization to become a going concern. Creditors often
accept reduced amounts as settlements of their receivables, or will modify the terms of
existing debt as part of the reorganization agreement.
Chapter 7 liquidations are the final step. The creditors must go through the judicial process
that may take a long time to complete. Liquidation should be used only if no other
alternative is viable. Creditors often receive a smaller portion of their receivables because
of the forced liquidation of the assets and the extensive legal and administrative costs
involved in a liquidation.
20-3
©
, Chapter 20 – Corporations in Financial Difficulty
C20-2 Research Related to Bankruptcy
The website for the U.S. Bankruptcy Courts is:
http://www.uscourts.gov/FederalCourts/Bankruptcy.aspx
a. The Frequently Asked Questions (FAQs) for the U.S. Courts
(http://www.uscourts.gov/Common/FAQS.aspx) state that a U.S. bankruptcy judge is
a district court judicial officer who is appointed by the majority of judges of the U.S.
appeals court to have jurisdiction over bankruptcy matters. As bankruptcy cases come
before a district court, a bankruptcy judge is assigned to the case. Some courts assign
judges based on random assignment while other courts have a chief judge who seeks
to select a judge to assign based on a judge’s experience or special expertise relevant
to the case. Each court will have a written plan or system for assigning cases.
b. The U.S. Bankruptcy Court’s website has a link to Official Bankruptcy Forms to be
used in filings before the courts. The forms and instructions for a Voluntary Petition
are available in Part I of the Bankruptcy Forms Manual page. The official form is
FORM B1 for a voluntary petition.
A voluntary petition is initiated by the debtor and therefore the information required is
principally related to the debtor, such as name, address, and location of the principal
assets of the debtor. The debtor must declare such items as the number of creditors,
the estimated assets, the estimated debts, the type of petition (i.e., Chapter 7,
Chapter 11, etc.), if sufficient funds will be available to satisfy the unsecured
creditors. The debtor may also be required to file additional exhibits (Exhibit A for
publicly traded companies, Exhibit B is used in personal filings and Exhibit C to
describe any property that might pose a threat of identifiable harm to public health or
safety).
c. The United States Bankruptcy Courts Website presents a link to Bankruptcy
Statistics (http://www.uscourts.gov/Statistics/BankruptcyStatistics.aspx) that are
presented in .pdf format. Statistics are presented for various time periods such as
quarters, fiscal years and calendar years. Note that Case 20-3 asks for the most
recent calendar year ending on December 31.
(1) Total business filings are presented at the top of the form for business and
nonbusiness filings for the twelve month period ended for the most recent year.
Statistics for prior years are also available. Business filings are typically about
34,000 but do fluctuate slightly based on economic conditions. Approximately sixty
percent of these filings are under Chapter 7, about twenty-eight percent under
Chapter 11, and the remainder under various other chapters of the Bankruptcy
Code.
(2) Students should find the Federal judicial district in which their educational
institution is located. The larger states typically have several districts and students
may have to make an assumption for which district they are located. It is instructive
to see that the numbers of filings vary widely by district. The number of filings may
differ due to different economic factors for specific parts of the United States, the
nature of the industrial base in a specific district, the size of a district, and other
factors reflecting business factors across court districts. Students might reflect on
why the number of filings in their Federal court district are different from those in
other districts in other circuits.
20-4
©
