Corporate Liquidations and Reorganization

Puji Rahayu
Copyright © 2018 Pearson Education, Ltd. All Rights Reserved .
Type of Bankruptcy
Equity insolvency
● Inability to pay debts on time
- May avoid bankruptcy proceedings
- Negotiate directly with creditors
Bankruptcy insolvency
● Having total debts in excess of the fair value of
assets
- May be liquidated, or
- Reorganized
Characteristics of Bankruptcy

Voluntary bankruptcy proceedings

● Filed by debtor
Involuntary bankruptcy proceedings
● Filed by creditor or group of creditors
Court action
● Dismiss a case
● Accept the petition
● Change form
Duties of Debtor Corporation
In both liquidation and reorganization cases, the
debtor corporation must
● File a list of creditors, a schedule of assets and
liabilities, and a statement of financial affairs
● Cooperate with trustee
● Surrender property to the trustee, including
records
● Appear at court hearings
Duties of Trustee
Trustee serves in liquidation cases
● Investigate debtor's financial affairs
● Provide information
● Examine, perhaps object to, creditor claims
● File report on trusteeship
● If authorized to operate debtor's business, other
period reports are required.
In reorganization cases, in addition to above
● File reorganization plan or statement why one
cannot be filed
 Ranking of Claims: Liquidation
I Secured Claims
Claims secured by valid liens.
II Unsecured Priority Claims
1. Administrative expenses incurred in preserving and liquidating the estate, including trustee’s fees and
legal and accounting fees.
2. Claims incurred between the date of filing an involuntary petition and the date an interim trustee is
appointed.
3. Claims for wages, salaries, and commissions earned within 180 days of filing the petition and not
exceeding $12,475 per individual.
4. Claims for contributions to employee benefit plans arising from services rendered within 180 days of filing
the petition and limited to $12,475 per employee.
5. Claims of governmental units for income or gross receipts taxes, property taxes, employment taxes,
excise taxes, and customs duties that originated within one to four years before filing (periods vary for
different claims). Taxes collected or withheld for which the debtor is liable and penalties related to the
foregoing are also included.
III Unsecured Nonpriority Claims
1. Allowed claims that were timely filed.
2. Allowed claims whose proof of claim was filed late.
3. Allowed claims (secured and unsecured) for any fine, penalty, or forfeiture, or for multiple, exemplary, or
punitive charges arising to the order to relief or appointment of trustee.
4. Claims for interest on the unsecured priority claims or the unsecured nonpriority claims.
IV Stockholders’ Claims
Remaining assets are returned to the debtor corporation or its stockholders.
Statement of Affairs
Legal document prepared for bankruptcy court
– Assets at expected net realizable values
– Classified on basis of availability for classes of
creditors
– Liabilities are classified
● Priority, fully secured, partially secured,
unsecured
– Historical values included for reference
 CAM Corporation Statement of Affairs on
August 1, 2017
Assets
Estimated Estimated
Realizable Realizable
Value Less Value
Book Value
Secured Available for
Creditor Unsecured
Liabilities Creditors
Pledged for Fully Secured Creditors
$55,000 Land and buildings – net $60,000
Less: Mortgage payable $50,000
Interest payable 5,000 55,000 $5,000
Pledged for Partially Secured Creditors
25,000 Accounts receivable $22,000
Less: Note payable to bank $25,000
Interest payable 2,000 27,000 0
 CAM Corporation Statement of Affairs on
August 1, 2017 (continued)
Assets

Estimated Estimated
Realizable Realizable
Book
Value Less Value
Value
Secured Available for
Creditor Unsecured
Liabilities Creditors
Available for Priority and Unsecured
Creditors
3,000 Cash 3,000
7,000 Marketable securities 7,000
50,000 Inventories 55,000
4,000 Prepaid expenses 0
30,000 Equipment – net 12,000
6,000 Intangible assets 0
Total available for priority and
unsecured creditors 82,000
Less: Priority liabilities 15,000
Total available for unsecured creditors 67,000
Estimated deficiency 8,000
$180,000 $75,000
Liabilities and Stockholders’ Equity
Secured and Unsecured
Book Value Priority Claims Nonpriority Claims

Fully Secured Creditors

$50,000 Mortgage payable $50,000
5,000 Interest payable 5,000
$55,000
Partially Secured Creditors
25,000 Not payable – bank $25,000
2,000 Interest payable 2,000
27,000
Less: Accounts receivable pledged 22,000 $5,000
Priority Liabilities
$13,000 Wages payable $13,000
2,000 Property taxes payable 2,000
$15,000
Unsecured Creditors
65,000 Accounts payable 65,000
5,000 Notes payable to suppliers 5,000
Stockholders’ Equity
200,000 Capital stock
(187,000) Retained earnings _______
$180,000 $75,000
Trustee Accounting

At start of case, trustee creates a new set of books.

During the case,
● Records transactions
● Statement of cash receipts and disbursements
● Statement of changes in estate equity
● Balance sheet
● Statement of realization and liquidation
At close of case,
● Final settlement of claims
● Trustee is dismissed
Debtor in Possession

Unless there is a reason to appoint a trustee, the

debtor corporation’s management is permitted to
continue to run the company while in bankruptcy.

The debtor in possession has the same

responsibilities as a trustee in a reorganization
case.
Creditors’ Committee

The creditors’ committee is elected in a liquidation

case and appointed in a reorganization case from
the largest unsecured creditors.
● Makes decisions on behalf of all creditors
● Reviews ongoing transactions of the debtor in
possession and can object
● Handles negotiations with any creditor regarding
settlement or continued business
Benefits of Being the Debtor
Benefits of being the Debtor in Possession include:
● Rejecting executory contracts
● Cancelling unexpired leases
● Legal protection from creditor action, such as
lawsuits or repossession of property

However, day-to-day operations may become more

difficult as lenders, suppliers, customers, and
employees are aware of the bankruptcy filing.
Reorganization Plan

A plan may be filed at the time of the bankruptcy

filing (“prepackaged bankruptcy”) or by the debtor
corporation within 120 days of filing. Other
interested parties may file proposed plans after 120
days.
● Identify classes of claims
● Specify the expected payout of each class
● Claims within a given class must be treated alike
● Define the expected requirements for execution of
the plan
● Must be fair and equitable
Financial Reporting During Reorganization
Corporate Liquidations and Reorganizations
Balance Sheet

Prepetition liabilities subject to compromise are

reported as a separate line item in liabilities
● Arose before filing
● Include unsecured and under-secured liabilities
● Likely to be paid at an amount less than face
value
Prepetition secured liabilities and post petition
liabilities reported in normal fashion
Prepetition claims discovered after filing
● Included at court-allowed amounts
Other Statements
Reorganization costs shown separately

Interest to be paid or probable amount

● Differences from contractual amounts should
be noted
Expected stock or stock equivalent issuances should
be disclosed.
Cash flow items related to reorganization are shown
separately.
Combined Financial Statements

Condensed combined financial statements are

prepared for all entities in reorganization
proceedings as supplementary information.
– Intercompany receivables and payables
– Write-down if necessary
Emerging from Reorganization
Reorganization Value
Approximates fair value of entity without
considering liabilities
– Discounted future cash flows of reorganized
business
– Consider business and financial risk
Reorganization value determines how much
creditors recover.
Emerging business will either use
1. Fresh start reporting or
2. Report liabilities at present value and
forgiveness of debt as extraordinary item
Fresh-Start Reporting
Fresh-start Reporting recognizes that the emerging
company is a new entity.

To qualify,

1. Revaluation value immediately before the

reorganization plan is confirmed must be less
than post-petition liabilities and allowed
claims, and
2. Holders of existing voting shares receive less
than 50% of emerging entity
Apply Fresh-Start Reporting
Allocated reorganization value to identifiable assets
● Unallocated amount is an intangible called
“Reorganization value in excess of amounts
allocated to identifiable assets”
Liabilities at current value at confirmation date
● Deferred tax benefits are first applied to
reduce any intangible asset recorded
Prepare final reports of old entity
● The effects of adjustments to asset and liability
accounts are shown, so that ending balance
sheet of old entity = beginning balance sheet
of new entity.
Continued Reporting of Old
Company
If a company does not qualify for Fresh-Start
Reporting, then

● Report liabilities at the appropriate interest rate

under GAAP
● Report debt forgiveness as an extraordinary item
Reorganization Example

Tig files for protection on January 5, 2016.

Accordingly, it
● reclassifies prepetition liabilities
● obtains short-term financing
● acquires additional equipment
● continues operations through June 30, 2017
when the plan is approved, with a
reorganization value of $2,200
First, we'll look at the statements pre- and post-
reorganization. Then we'll go through the entries
and adjustments that occurred.
Balance Sheet Assets
Filed FYE Before Fair value AFTER
1/5/16 12/31/16 6/30/17 Re-valuation 6/30/17 6/30/17

Cash 50 150 300 0 300 300

Accounts receivable 500 350 335 0 335 335

Inventory 300 370 350 25 375 375

Other current assets 50 50 30 0 30 30

Land 200 200 200 100 300 300

Building, net 500 450 425 (75) 350 350

Equipment, net 300 330 290 (30) 260 260

Patent 200 150 125 (125) 0 0

Reorganization value in
excess of identifiable assets 250

2,100 2,050 2,055 (105) 1,950 2,200

Changes to Assets
Fair values and revaluation amounts are shown on
6/30/17 for comparison.
Tig continues operations, records depreciation, and
even acquires equipment from filing on 1/5/16 to
reorganization on 6/30/17.
The reorganization revalues the assets to their fair
value on that date. Patents are completely written
off.
Tig records an intangible "Reorganization value in
excess of identifiable assets" of $250. Not all
reorganizations result in this intangible.
Balance Sheet – Liability & Equity
Filed FYE Before AFTER
1/5/16 12/31/16 6/30/17 6/30/17
Short-term borrowing (post) 150 75 75
Accounts payable (pre/post) 600 100 125 125
Wages payable (post) 50 55 55
Taxes payable (pre) 150 150
Accrued bond interest (pre) 90
Note payable (pre) 260
Subordinated debt (post) 395
12% bonds payable – current (post) 100
12% bonds payable (post) 500
15% bonds payable (pre) 1,200
Liabilities subject to compromise 2,300 2,300
Capital stock (old) 500 500 500
Capital stock (new) 800
Deficit (700) (1,050) (1,000) 0
2,100 2,050 2,055 2,200
Changes to Liabilities
Upon filing on 1/5/16, Tig reclassifies the unsecured
and partially secured liabilities at that point as Pre-
petition Liabilities Subject to Compromise.
Pre-petition Liabilities Subject to Compromise are
then reclassified or settled according to the plan.
Accounts payable on 12/31/16 does not include any
of the $600 due prior to filing.
Taxes payable are still to be paid, and eventually
recorded again in full.
Changes to Equity
Some of the creditors receive stock in the
reorganized firm. The old shareholders also receive
stock, but now own only $100 of $800 of the stock
at book value.
Although some APIC was recorded in reorganizing,
it was subsequently eliminated. If it had been
sufficient to wipe out the deficit, no intangible
"reorganization value in excess of identifiable
assets" would be recorded.
The Deficit is removed!
Can Tig Use Fresh Start?

Post-petition liabilities $255

Allowed claims 2,300
Total liabilities $2,555
Less reorganization value (2,200)
Excess liabilities $355

On 6/30/17 there were $255 in post-petition

liabilities. All $2,300 pre-petition liabilities were
allowed by the courts. Firm value is $2,200.
1. Liabilities exceed reorganization value
2. Old shareholders retain less than 50%
Yes, fresh start is appropriate.
 Reorganization Plan: 6/30/17
Pre-petition
Liabilities and Equity New Agreements Debt Discharge

15% partially secured $500 new stock, $500 senior

bonds, $1200 12% bonds, and another $100
bonds due 12/31/17 $100
To be paid cash once
Priority tax claims $150 confirmed $0
Remaining unsecured
claims, $950
$275 subordinated debt and
$600 accounts payable $140 new stock $185

$90 accrued interest Forgiven $90

$120 subordinated debt and
$260 note $60 new stock $80

Total debt discharged $455

Old stock $100 new stock Equity

Record New Debt Agreements
Liabilities subject to compromise (pre) 2,300
Taxes payable 150
12% senior debt 500
12% senior debt - current 100
Subordinated debt 395
Common stock (new) 700
Gain on debt discharge 455
settlement of prepetition claims

This entry reclassifies the pre-petition debt according

to the reorganization plan.
Give Shareholders New Shares

Common stock (old) 500  

Common stock (new) 100

Additional paid in capital 400
exchange of stock with owners

They will lose control since creditors have $700 of

common stock.
Revalue Assets
Inventory 25
Land 100
Loss on asset revaluation 105
Buildings, net 75
Equipment, net 30
Patent 125
revalue assets to fair value

A loss is recorded in revaluing the assets. Refer

back to the Asset side of the balance sheet.
Calculate Balance in Retained
Earnings (Deficit)
Deficit, 6/30/17 (1,000)
Gain on debt discharge 455
Loss on asset revaluation (105)
Final measure of deficit, 6/30/17 ($650)
Write-off Additional paid in capital 400
Reorganization value in excess of
identifiable assets (intangible asset) ($250)
If sufficient APIC had existed, there would be no intangible
asset, and excess APIC would remain on the balance sheet.
Eliminate Deficit in Equity
Reorganization value in excess of
identifiable assets 250
Gain on debt discharge 455
Additional paid in capital 400
Loss on asset revaluation 105
Deficit 1,000

The $1,000 deficit on 6/30/17 is adjusted for the

gain on debt discharge and loss on asset
revaluation. The net $650 deficit eliminates all of
the APIC and creates a $250 intangible.
Simplifying Assumptions
● All transactions are recorded on 6/30/17.
● Generally this takes some time.
● Creditors may have interest between submission
and approval of plan.
● All pre-petition debt is approved.
● The $2,200 reorganization value of the firm
probably used a discounted cash flow firm
valuation model.
Disclosures

Adjustments to historical values

● Assets
● Liabilities
Debt forgiveness
Prior retained earnings or deficit eliminated
Significant factors in determining the reorganization
value
Thank You