Corporate Liquidation and Reorganization PRESENTATION

Corporate Liquidations and
Reorganizations
18-1
P R O F. J R R
Corporate Liquidations and

Reorganizations: Objectives
1. Understand differences among types
of bankruptcy filing.
2. Comprehend trustee responsibilities
and accounting during liquidation.
3. Understand financial reporting during
reorganization.
4. Understand financial reporting after
emerging from reorganization,
including fresh-start accounting.
Copyright 2012 Pearson Education,
Inc. Publishing as Prentice Hall
18-2
Corporate Liquidations and Reorganizations
1: TYPES OF BANKRUPTCIES

18-3
Insolvency
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
18-4
Characteristics
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
18-5
2: TRUSTEE
RESPONSIBILITIES AND
ACCOUNTING

18-6
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
18-7
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
Filing reorganization plan or statement why
one cannot be filed
18-8
Ranking of Claims: Liquidation

18-9
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
18-10

18-11

18-12
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
18-13
Debtor in Possession
Unless there is a reason to appoint a
trustee, the debtor corporations
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.
18-14
Creditors Committee
The Creditors Committee is elected in a
liquidation case, and is 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.
18-15
Benefits of Chapter
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.
18-16
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
18-17
3: FINANCIAL REPORTING
DURING REORGANIZATION

18-18
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
18-19
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
shown separately
18-20
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

18-21
4: EMERGING FROM
REORGANIZATION

18-22
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
2. Report liabilities at present value and
forgiveness of debt as extraordinary item
18-23
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
18-24
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 entityCopyright
= beginning
sheet of new entity
2012 Pearsonbalance
Education,
18-25
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

18-26
Reorganization Example
Tig files for protection under Chapter 11 on
January 5, 2011. Accordingly, it
reclassifies prepetition liabilities
obtains short-term financing
acquires additional equipment
continues operations through June 30, 2012
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.
18-27
Balance Sheet Assets

Fair
Filed
FYE Before
Revalue
1/5/11 12/31/11 6/30/12 valuation 6/30/12
Cash
50
150
300
0
300
Accountsreceivable
500
350
335
0
335
Inventory
300
370
350
25
375
Othercurrentassets
50
50
30
0
30
Land
200
200
200
100
300
Building,net
500
450
425
(75)
350
Equipment,net
300
330
290
(30)
260
Patent
200
150
125 (125)
0
Reorganization value in excess of identifiable assets

Hall
2,100Inc. Publishing
2,050as Prentice
2,055
(105) 1,950
AFTER
6/30/12
300
335
375
30
300
350
260
0
250
18-28
2,200
Changes to Assets
Fair values and revaluation amounts are shown on 6/30/12 for
comparison.
Tig continues operations, records depreciation, and

even acquires equipment from filing on 1/5/11 to
reorganization on 6/30/12.
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.
18-29
Balance Sheet - Liability & Equity
Short-termborrowing(post)
Accountspayable(pre/post)
Filed
1/5/11
FYE
12/31/11
600
150
100
75
125
75
125
50
55
55
Wagespayable(post)
Taxespayable(pre)
Accruedbondinterest(pre)
Notepayable(pre)
Subordinateddebt(post)
12%bondspayablecurrent(post)
12%bondspayable(post)
15%bondspayable(pre)
150
90
260
1,200
Liabilities subject to compromise

Capitalstock(old)
Before AFTER
6/30/12 6/30/12
500

150
395
100
500

2,300
2,300
500
500
18-30
Changes to Liabilities
Upon filing on 1/5/11, 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 12/31/11 does not include
any of the $600 due prior to filing.
Taxes payable are still to be paid, and eventually
recorded again inCopyright
full.2012 Pearson Education,
18-31
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!
18-32
Can Tig Use Fresh Start?

Post-petitionliabilities
Allowedclaims
Totalliabilities
Lessreorganizationvalue
Excessliabilities
$255
2,300
$2,555
(2,200)
$355
On 6/30/12 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.
18-33
Reorganization Plan: 6/30/12

Pre-petition
Liabilities and Equity
15%partiallysecured
bonds,$1200
Prioritytaxclaims$150
New Agreements
$500newstock,$500
senior12%bonds,and
another$100bondsdue
12/31/12
Tobepaidcashonce
confirmed
Debt Discharge
$100
$0
Remaining unsecured claims, $950:
$600accountspayable
$275subordinateddebt
and$140newstock
$90accruedinterest
Forgiven
$260note
$120subordinateddebt
and$60newstock
Total debt discharged
Oldstock
$100newstock
$185
$90
$80
$455
18-34
Equity
Record New Debt Agreements

Liabilitiessubjecttocompromise(pre)
Taxespayable
12%seniordebt
12%seniordebt-current
Subordinateddebt
Commonstock(new)
Gainondebtdischarge
settlement of prepetition claims
2,300
150
500
100
395
700
455
This entry reclassifies the pre-petition debt

according to the reorganization plan.
18-35
Give Shareholders New Shares

Commonstock(old)
Commonstock(new)
Additionalpaidincapital
exchange of stock with owners
500
100
400
They will lose control since creditors have

$700 of common stock.

18-36
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.
18-37
Calculate Balance in Retained

Earnings (Deficit)
Deficit,6/30/12
Gainondebtdischarge
Lossonassetrevaluation
Finalmeasureofdeficit,6/30/12
Write-offAdditionalpaidincapital
Reorganization value in excess of
identifiable assets (intangible asset)
(1,000)
455
(105)
($650)
400
($250)
If sufficient APIC had existed, there would be

no intangible asset, and excess APIC would
remain on the balance sheet.
18-38
Eliminate Deficit in Equity

Reorganization value in excess of
identifiable assets
Gainondebtdischarge
Additionalpaidincapital
Lossonassetrevaluation
Deficit
250
455
400
105
1,000
The $1,000 deficit on 6/30/12 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.
18-39
Simplifying Assumptions
All transactions are recorded on
6/30/12.
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.
18-40
Disclosures
Adjustments to historical values
Assets
Liabilities
Debt forgiveness
Prior retained earnings or deficit eliminated
Significant factors in determining the
reorganization value
18-41
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18-42

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Corporate Liquidations and

Corporate Liquidations and

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Duties of Debtor Corporation

Ranking of Claims: Liquidation

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Combined Financial Statements

Copyright 2012 Pearson Education,

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Apply Fresh Start Reporting

Continued Reporting of Old Company

Copyright 2012 Pearson Education,

Balance Sheet Assets

Copyright 2012 Pearson Education,

Tig continues operations, records depreciation, and

Balance Sheet - Liability & Equity

Liabilities subject to compromise

Copyright 2012 Pearson Education,

Can Tig Use Fresh Start?

On 6/30/12 there were $255 in post-petition

Reorganization Plan: 6/30/12

Remaining unsecured claims, $950:

Record New Debt Agreements

This entry reclassifies the pre-petition debt

Give Shareholders New Shares

They will lose control since creditors have

Copyright 2012 Pearson Education,

Loss on asset revaluation

revalue assets to fair value

A loss is recorded in revaluing the assets. Refer

Calculate Balance in Retained

If sufficient APIC had existed, there would be

Eliminate Deficit in Equity

The $1,000 deficit on 6/30/12 is adjusted for

This work is protected by United States copyright laws

form or by any means, electronic, mechanical, photocopying,

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