US: Corporate Liquidations and Reorganizations

Corporate Liquidations and Reorganizations

1. What is the distinction between equity insolvency and bankruptcy insolvency?

Equity insolvency occurs when a debtor is unable to pay its debts as they come due. Bankruptcy insolvency occurs when a debtor’s liabilities exceed the fair value of all assets.

2. Bankruptcy proceedings may be designated as voluntary or involuntary. Distinguish between the two types, including the requirements for filing of an involuntary petition.

A bankruptcy proceeding is designated voluntary if the debtor corporation files the petition to place itself under the protection of the bankruptcy court and involuntary if creditors file the petition to bring the debtor into bankruptcy court. An involuntary petition may be filed by a single creditor with an unsecured claim of $14,425 or more if there are fewer than twelve unsecured creditors. Otherwise, three or more entities with unsecured claims totaling at least $14,425 must file in order to commence an involuntary case. The requirements are the same for Chapter 7 and Chapter 11 cases.

3. What are the duties of the U.S. trustee under BAPCPA? Do U.S. trustees supervise the administration of all bankruptcy cases?

The duties of the U.S. trustee are to maintain and supervise a panel of private trustees eligible to serve in Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the administration of bankruptcy cases, and to preside over creditor meetings. Bankruptcy judges still supervise cases in districts without U.S. trustees.

4. What obligations does a debtor corporation have in a bankruptcy case?

The debtor corporation in a bankruptcy case has the following duties: (1) to file a list of creditors, a schedule of assets and liabilities, and a statement of the debtor’s financial affairs; (2) to cooperate with the trustee so that the trustee may perform his duties; (3) To surrender all property, including books, documents, records, and so on, to the trustee; and (4) to appear at hearings of the bankruptcy court as required.

5. Is a trustee appointed in Title 11 cases? Is a trustee appointed in all Chapter 7 cases? In all Chapter 11 cases? Discuss.

A trustee is not appointed in all Title 11 cases. In Chapter 7 cases, a trustee will be elected by unsecured creditors if a majority of creditors vote for the trustee, and those creditors hold at least 20 percent of the claims. Otherwise, an appointed interim trustee serves as trustee. In Chapter 11 cases a trustee is appointed only if deemed necessary by the court, but otherwise, the debtor remains in possession of the estate and performs the duties of a trustee. Within 30 days from the time the court orders the appointment of a trustee in a Chapter 11 case, a party in interest may request the election of a trustee.

6. Describe the duties of a trustee in a liquidation case under the BAPCPA 1978.

The trustee in a liquidation case takes possession of the debtor’s estate, converts estate assets into cash, and distributes the proceeds as directed by the court. They also performs other duties such as investigating the financial affairs of the debtor, providing information about the estate to parties of interest, examining creditor claims and objecting to those that appear improper, operating the debtor’s business if authorized to do so by the court, providing financial reports and summaries about the estate to the court, and filing reports on trusteeship as directed by the court.

7. Which unsecured claims have priority in a Chapter 7 liquidation case? Discuss in terms of priority ranks.

The priority rankings in a Chapter 7 liquidation case are summarized in Exhibit 18–2 of the text. The priorities recognized for unsecured claims (Rank II) are: (1) administrative expenses, (2) claims incurred between an involuntary filing and appointment of a trustee, (3) salary claims up to $11,725 per individual earned within 180 days of filing, (4) employee benefit plan contribution claims up to $11,725 per individual earned within 180 days of filing, (5) individual claims up to $2,600 for goods and services purchased from, but not provided by the debtor, and (6) claims of governmental units for taxes owed by the debtor (subject to time restrictions), including taxes collected and withheld for which the debtor is liable.

8. Does the BAPCPA establish priorities for holders of unsecured nonpriority claims (i.e., general unsecured claims)?

Four ranks within the unsecured nonpriority claim category (general unsecured claims) are: (1) claims allowed that were timely filed, (2) claims allowed where proof was filed late, (3) claims allowed for fines, penalties or forfeitures, or damages, and arising before the court order for relief or appointment of a trustee, and (4) claims for interest on unsecured claims.

9. What is the purpose of a statement of affairs, and how are assets valued in this statement?

The accountant’s statement of affairs is a financial statement that is designed to provide information about liquidation values and priority rankings for use by the trustee, the court, creditors, and other interested parties in the debtor’s estate. Assets are measured at expected net realizable values in the statement, but book values are also included for reference purposes.

10. Does filing a case under Chapter 11 of the bankruptcy act mean that the company will not be liquidated? Discuss.

A debtor corporation’s estate may be liquidated even though the filing is under Chapter 11. This can occur when the case is transferred to Chapter 7 for liquidation. It can also be carried out in accordance with an approved Chapter 11 plan of reorganization that calls for sale and distribution of the proceeds from the debtor corporation’s estate.

11. What is a debtor-in-possession reorganization case?

A debtor in possession reorganization case is a Chapter 11 case in which the bankruptcy court does not appoint a trustee, but instead, allows the debtor corporation to carry out the duties that otherwise would be performed by a trustee.

12. When can a creditors’ committee file a plan of reorganization under a Chapter 11 case?

A creditor committee can file a plan of reorganization under a Chapter 11 case after 120 days from the date the court order for relief is granted. The order for relief occurs when the debtor or creditor’s filing petition is approved by the court.

13. Discuss the requirements for approval of a plan of reorganization.

The approval of a plan of reorganization requires acceptance of the plan by at least two-thirds in dollar amount of claim holders and over half in number of claims in each class of claims. Further, each class of claims must accept the plan or not be impaired under it. A class of claims that would receive nothing if the corporation were liquidated is not impaired if it receives nothing under a plan and, accordingly, acceptance by that class of claims is not required.

14. Describe prepetition liabilities subject to compromise on the balance sheet of a company operating under Chapter 11 of the bankruptcy act.

Prepetition liabilities are the liabilities of an enterprise that were incurred prior to a Chapter 11 filing. They are reported at the amounts allowed by the bankruptcy court. Prepetition liabilities subject to compromise are those liabilities that may be impaired by a plan and that are eligible for compromise because they are either unsecured or undersecured.

15. The reorganization value of a firm emerging from Chapter 11 bankruptcy is used to determine the accounting of the reorganized company. Explain reorganization value as used in FASB ASC 852.

Reorganization value is an estimate of the value of the reconstituted entity that will emerge from reorganization. It is also described as the fair value of the entity before considering liabilities. Reorganization value approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.

16. FASB ASC 852 provides two conditions that must be met for an emerging firm to use fresh-start reporting. What are these two conditions?

Fresh start reporting should be used by a company emerging from Chapter 11 if the following two conditions are met: (1) the reorganization value of the assets of the emerging entity immediately before the date of confirmation of the reorganization plan is less than the total of all postpetition liabilities and allowed claims and (2) holders of existing voting shares immediately before confirmation of the reorganization plan receive less than 50 percent of the voting shares of the emerging entity.

17. A firm emerging from Chapter 11 bankruptcy that does not qualify for fresh-start reporting must still report the effect of the reorganization plan on its financial position and results of operations. How is debt forgiveness reported in the reorganized company’s financial statements?

Entities not qualifying for fresh start reporting report liabilities compromised by a confirmed reorganization plan in a manner similar to that of a note issued in a noncash transaction under FASB ASC 835. Forgiveness of debt should be reported as an extraordinary item.