Debt Restructuring Corporate Reorganization and Liquidations FISCHER TAYLOR

Debt Restructuring, Corporate Reorganization, and Liquidations FISCHER | TAYLOR | CHENG

Relief Procedures Not Requiring Court Action • Troubled debt restructuring – – Transfer of assets in full settlement Granting an equity interest Modification of terms Combination restructuring • Quasi-reorganizations • Corporate liquidations COPYRIGHT © 2012 South-Western/Cengage Learning 2

Troubled Debt Restructurings Transfer of Assets in Full Settlement • Debtor transfers assets to creditors in order to settle debt • Debtor records gain as measured by the difference between the carrying basis of the debt and the fair market value (FMV) of the assets transferred • The difference between the FMV of the assets transferred and their book value is recorded by the debtor as a gain or loss separate from the restructuring gain COPYRIGHT © 2012 South-Western/Cengage Learning 3

Troubled Debt Restructurings Granting an Equity Interest • Debtor transfers an equity interest (stock) in order to settle debt • Debtor records gain as measured by the difference between the carrying basis of the debt and the FMV of the equity interest COPYRIGHT © 2012 South-Western/Cengage Learning 4

Troubled Debt Restructurings Modification of Terms • Principal and/or interest on debt may be modified • Future cash payments < carrying basis of debt – restructuring gain is recognized – no subsequent interest expense is recognized • Future cash payments > carrying basis of debt – no restructuring gain is recognized – subsequent interest expense (at an effective rate) is recognized COPYRIGHT © 2012 South-Western/Cengage Learning 5

Quasi-Reorganization • Goal is to eliminate a large deficit in retained earnings in order to possibly permit future dividend distributions • Assets should be written down as necessary • Par value of common stock is reduced to produce additional paid-in-capital • The deficit balance in Retained Earnings is eliminated (credit additional paid-in capital) COPYRIGHT © 2012 South-Western/Cengage Learning 6

Solutions Available Through the Bankruptcy Code • Chapter 7 Liquidation – The business liquidates and ceases operations (some exclusions by nature of business) • Chapter 11 Reorganization – Allows a company to pay a portion of its debts, discharge remaining debts, and continue in business • Chapter 13 Adjustment of Debts – Limited exclusively to individuals, including sole proprietors; allows the debtor to retain assets and propose a plan by which creditors can be repaid COPYRIGHT © 2012 South-Western/Cengage Learning 7

Restructuring Debt Under a Chapter 11 Reorganization • The accounting for the restructuring differs from a restructuring which is not covered by the Bankruptcy Act • The gain on restructuring is measured as the difference between the FMV of the restructured consideration (the net present value of future payments discounted at imputed market rates) and the carrying basis of the debt being restructured …continued… COPYRIGHT © 2012 South-Western/Cengage Learning 8

Restructuring Debt Under a Chapter 11 Reorganization • The gain on restructuring is recognized as either income or additional paid-in-capital • Subsequent to the restructuring, interest is recognized on the restructured debt at the imputed market rate COPYRIGHT © 2012 South-Western/Cengage Learning 9

Chapter 7 Corporate Liquidations • A trustee in liquidation is appointed • The liquidating entity files an inventory of property and debts/claims • Assets are liquidated and the debts/claims of the entity are settled …continued… COPYRIGHT © 2012 South-Western/Cengage Learning 10

Chapter 7 Corporate Liquidations • Claims against the entity may be – – Fully secured Partially secured Unsecured with priority Unsecured without priority …continued… COPYRIGHT © 2012 South-Western/Cengage Learning 11

Chapter 7 Corporate Liquidations • A reorganization plan will not be confirmed unless creditors will receive as much as they would under a Chapter 7 Liquidation • Certain debts/claims are not dischargeable COPYRIGHT © 2012 South-Western/Cengage Learning 12

Statement of Affairs • Used in a liquidation to approximate the estimated amounts available to each class of claims • The estimated realizable value of assets are categorized as: – Assets pledged with fully secured creditors – Assets pledged with partially secured creditors – Free assets (estimated amounts available for unsecured creditors) COPYRIGHT © 2012 South-Western/Cengage Learning 13

Statement of Affairs • Liabilities are classified – – Fully secured creditors Partially secured creditors Unsecured creditors with priority Unsecured creditors without priority • The statement provides an estimate of to what extent claims will be satisfied COPYRIGHT © 2012 South-Western/Cengage Learning 14

Preparation of Other Accounting Reports • The bankruptcy court will generally require the trustee to report – Unrealized assets assigned to the trustee including those subsequently discovered – Assets that have been realized or liquidated – Liabilities to be liquidated that have been assigned to the trustee – Liabilities that have been liquidated COPYRIGHT © 2012 South-Western/Cengage Learning 15

Statement of Realization and Liquidation • Reports the actual liquidation results • Provides an on-going report of the trustee’s activities – Updated throughout the liquidation process. COPYRIGHT © 2012 South-Western/Cengage Learning 16