Chapter 20 - Corporations in Finanacial 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 and creditor's committee management. 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 FASB 142.
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.
Companies using fresh start accounting revalue their assets to fair values, using the
procedures in FASB 141. 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.
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,Chapter 20 - Corporations in Finanacial Difficulty
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. SOP 90-7
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 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 Finanacial 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 Finanacial Difficulty
C20-2 Research Related to Bankruptcy
The website for the U.S. Bankruptcy Courts is:
www.uscourts.gov/bankruptcycourts.html
a. The Frequently Asked Questions (FAQs) for the U.S. Bankruptcy Courts 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
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
CHAPTER 20
CORPORATIONS IN FINANCIAL DIFFICULTY
ANSWERS TO QUESTIONS
Q20-1 The nonjudicial actions available to a financially distressed company are debt
restructuring arrangements and creditor's committee management. 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 FASB 142.
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.
Companies using fresh start accounting revalue their assets to fair values, using the
procedures in FASB 141. 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.
20-1
,Chapter 20 - Corporations in Finanacial Difficulty
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. SOP 90-7
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 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 Finanacial 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 Finanacial Difficulty
C20-2 Research Related to Bankruptcy
The website for the U.S. Bankruptcy Courts is:
www.uscourts.gov/bankruptcycourts.html
a. The Frequently Asked Questions (FAQs) for the U.S. Bankruptcy Courts 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
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
