DebtRestructuring,

CorporateReorganizations, and Liquidations

Chapter 21

C21 2

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

C21 3

Troubled debt restructuring: Transfer of assets in full settlement Debtor transfers assets to creditors in order to

settle debt Debtor records gain, as an extraordinary item

if material, as measured by the difference between the carrying basis of the debt and the fair market value (FMV) of the assets transferred

C21 4

Troubled debt restructuring: Transfer of assets in full settlement, continued 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

C21 5

Troubled debt restructuring: Transfer of assets in full settlement, continued

Example:Loan Payable 100,000Accrued Interest 8,000

Assets 70,000Gain on Assets 10,000Restructuring Gain 28,000

C21 6

Troubled debt restructuring: Granting an equity interest Debtor transfers an equity interest (stock) in

order to settle debt Debtor records gain, as an extraordinary item

if material, as measured by the difference between the carrying basis of the debt and the FMV of the equity interest

C21 7

Example:Loan Payable 100,000Accrued Interest 8,000

Common Stock at par 50,000Paid-in-Capital in Excess of par 30,000Restructuring Gain 28,000

Troubled debt restructuring: Granting an equity interest, continued

C21 8

Troubled debt restructuring: Modification of terms Principal and/or interest on debt may be

modified If total future cash payments called for by

restructuring are less than carrying basis of debt, a restructuring gain is recognized and no subsequent interest expense is recognized

C21 9

Troubled debt restructuring: Modification of terms, continued If total future cash payments called for by

restructuring are greater than carrying basis of debt, no restructuring gain is recognized and subsequent interest expense (at an effective rate) is recognized

C21 10

Example: Year-end payments of $25,639 are made for the next five years.

Troubled debt restructuring: Modification of terms, continued

Loan Payable 100,000Accrued Interest 8,000

Restructuring Loan Payable 108,000

Restructuring Loan Payable 19,159Interest Expense (6%) 6,480

Cash 25,639

C21 11

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

additional paid-in-capital

C21 12

Quasi-Reorganization, continued

Retained Earnings 50,000Net Assets 50,000

Common Stock 120,000Common Stock 10,000Paid-in-Capital 110,000

Paid-in-Capital 110,000Retained Earnings 110,000

Example: Beginning deficit in retained earnings is $60,000.

C21 13

Corporate relief procedures under the Bankruptcy Act Chapter 7: liquidation - the troubled corporation is liquidated Chapter 11: reorganization - the corporation remains in

business through a restructuring of its debt and/or equity Filings under either act may be voluntary or involuntary

C21 14

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

C21 15

Chapter 11 reorganization, continued The gain on restructuring is recognized as either an

extraordinary item or additional paid-in-capital Subsequent to the restructuring, interest is recognized

on the restructured debt at the imputed market rate

C21 16

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

C21 17

Chapter 7: corporate liquidations, continued Claims against the entity may be

– fully secured– partially secured– unsecured with priority– unsecured without priority

C21 18

Corporate Liquidations, continued

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

C21 19

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, and free assets (estimated amounts available for unsecured creditors)

C21 20

Statement of Affairs, continued 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

C21 21

Statement of Realization and Liquidation 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

C21 22

Statement of Realization and Liquidation, continued The Statement of Realization and Liquidation

provides much of the above information in that it reports the actual (versus estimated) results of the liquidation process