Debt Restructuring, Corporate Reorganizations, and Liquidations

1. Chapter 21 Debt Restructuring, Corporate Reorganizations, and Liquidations

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 100,000 Accrued Interest 8,000 Assets 70,000 Gain on Assets 10,000 Restructuring 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. Troubled debt restructuring: Granting an equity interest, continued Example: Loan Payable 100,000 Accrued Interest 8,000 Common Stock at par 50,000 Paid-in-Capital in Excess of par 30,000 Restructuring Gain 28,000 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. Troubled debt restructuring: Modification of terms, continued Example: Year-end payments of $25,639 are made for the next five years. Loan Payable 100,000 Accrued Interest 8,000 Restructuring Loan Payable 108,000 Restructuring Loan Payable 19,159 Interest 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 Example: Beginning deficit in retained earnings is $60,000. Retained Earnings 50,000 Net Assets 50,000 Common Stock 120,000 Common Stock 10,000 Paid-in-Capital 110,000 Paid-in-Capital 110,000 Retained Earnings 110,000 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 C21