Bankruptcy and Insolvency Accounting, Volume 1

Practice and Procedure

Grant W. Newton

• Publisher: Wiley
• Year: 2009
• ISBN:
  9780470524824
• Edition: 7
• Topic: Business
• Subtopic: Managerial Accounting
• Index: Business

Accountants and financial managers are often the first professionals to realize that a financial problem exists within a corporation but must be familiar with the various alternatives available to clients before they can offer solutions. Completely updated, Bankruptcy and Insolvency Accounting, Seventh Edition, Volume 1 provides detailed information on SOP 90-7 and FASB statements 141, 142, and 144 and revisions made in CSSR 93-1 by CSSR 03-1. The process of corporate restructuring is thoroughly described for controllers, CEOs, CFOs and CPAs with small businesses as clients.

PART ONE

Bankruptcy and Insolvency Environment

1

Accountant’s and Financial Advisor’s Role in Perspective

§ 1.1 Introduction

Thousands of businesses fail each year in the United States, with periods of marked increases in failures in the 1980s, early 1990s, early 2000s, and 2008 and 2009. The liabilities associated with these failures escalated in the first part of the 1990s, but declined in the late 1990s. In 1998, over 1.4 million bankruptcy petitions were filed. Almost 97 percent of these filings were by consumers, representing the largest number of petitions ever filed in a 12-month period. This increase in filings took place during a period of more than eight straight years of economic growth. In 1998, business filings of 44,367 decreased by 18 percent over the filings in 1997. The number of business filings for the year ending June 30, 1999, was only 39,934. For the first time in five years, the number of total filings declined in 1999. For the year ending June 30, 1999, 1,391,964 petitions were filed. However, the number of filings began to increase again in the early 2000s to around 1.6 million filings. In 2005, the number of filings had increased to over 2 million, due partly to the large number of filings just prior to the effective date of the 2005 amendments to the Bankruptcy Code. In 2006 only 617,660 petitions were filed; however, by 2008 the number of filings increased to over 1.1 million. The number of public filings increased during the first quarter of 2009 to 65 with declared assets of $101 billion.

It was estimated in 1970 that one out of every five Americans had been involved in bankruptcy proceedings as a bankrupt or a creditor, or was acquainted with someone who had become bankrupt.¹ The number involved today is much higher.

On April 20, 2005, President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005² (2005 Act). In many ways, the 2005 Act represents the most significant change in the bankruptcy laws since the Bankruptcy Code replaced the Bankruptcy Act in 1979. Although the primary focus of the 2005 Act was on eliminating abuses of the law by consumers, there are provisions in the bill affecting almost all participants in the bankruptcy process—businesses, creditors, landlords, and professionals involved in this field.

There was a desire, driven to a large extent by credit card companies, to make it harder for consumers to walk away from their debts. The motive underlying the 2005 Act is clear from its title, “Bankruptcy Abuse Prevention.” Some of the underlying objectives driving the changes in the law were to:

• Use a means test as a method to reduce perceived abuses of the current system by requiring some individuals to either have their petition dismissed or agree to transfer to chapter 11 or 13 and make at least some debt payments with future income.

• Eliminate perceived abuses by consumers in addition to limiting the extent to which individuals can walk away from their debts, by adjusting amounts available for homestead exemptions, for example, and increasing amounts that may be recovered from fraud.

• Reduce the amount of time a business is in bankruptcy as evidenced by, among other things, limits on the time a debtor has to decide whether to assume or reject a lease and on the time a debtor has the exclusive right to develop a plan.

• Provide a source of tax revenue, especially for state and local governments, by changing the tax law to provide fewer tax benefits to individuals and businesses in bankruptcy. With a significant amount of influence from state attorneys general, the drafters of the law were convinced that state and local governments were at a disadvantage when it came to the collection of taxes.

• Provide additional opportunities for creditors of businesses under certain conditions to recover all or a large percent of their prepetition claims by, for example, increasing the reclamation period and providing that goods shipped within 20 days of bankruptcy are administrative expenses.

• Reinstate chapter 12 on a permanent basis and make other changes perceived as necessary to the Bankruptcy Code.

• Provide protection to certain creditors including, for example, those owed amounts for domestic support obligations and secured creditors in chapter 13.

The 2005 Act consists of over 16 different titles. The provisions of the Bankruptcy Code are described throughout this volume, including those changes made by the 2005 Act.

§ 1.2 Scope of Coverage

The scope of these volumes is, deliberately, fairly broad. The various accounting procedures to be followed under each alternative remedy for business failure are analyzed in detail. To provide a complete and realistic description of the environment within which the financial advisor must work, the discussion incorporates the economics and the legal aspects of business liquidations and rehabilitations.

The economics of bankruptcy and insolvency proceedings is most important when considering the various causes of financial difficulties. Once the causes have been ascertained, the most appropriate remedy may then be determined. Economic considerations are also important when analyzing what remedies have proven most successful in particular circumstances.

The legal aspects of bankruptcy permeate the entire work, for the Federal Bankruptcy Code (title 11) establishes the framework within which anyone concerned with insolvency must work. As a result, the Bankruptcy Code is explicitly cited in the descriptions of the petitions, forms, and schedules that must be filed; the alternatives and rights available to all parties involved, including creditors; the requirements of the debtor; and the treatment of the various transactions and property of the debtor, both before and after the proceedings. Bankruptcy and insolvency proceedings cannot be correctly handled unless everyone involved has a thorough understanding of the legal aspects of the case.

Only a small percent of bankruptcy court petitions are filed by businesses (for example, in 2008 approximately 4 percent were business filings); the majority are filed by wage earners. However, it is primarily business bankruptcy and insolvency proceedings that require the services of a financial advisor. The two volumes of this work are therefore directed toward business bankruptcies. Although the emphasis is on incorporated businesses, the material covered is applicable to partnerships and proprietaries because the remedies available are basically the same.

ACCOUNTING SERVICES

§ 1.3 Need for Financial Advisor’s Services

The financial advisor provides a range of services that can be effective in helping the debtor overcome financial problems and operate profitably again, which can assist the creditors and their committees in deciding which actions to take. An accountant or financial advisor may become a party to insolvency and bankruptcy proceedings while serving a client who is having financial problems. Before resorting to judicial proceedings, the debtor may attempt to negotiate a moratorium or settlement of its debt with unsecured creditors. Financial advisors may be retained by the debtor and/or creditors’ committee to perform accounting and other financial services.

Reorganization of a corporation under chapter 11 of the Bankruptcy Code involves many parties who may need the assistance of financial advisors. First, the debtor, who remains in possession, has the right to retain a financial advisor to perform necessary accounting functions, to develop a business plan that will help turn the business around, and to develop and negotiate the terms of a plan of reorganization. Others include attorneys, trustee, examiner, creditors, security holders, and stockholders.

In liquidation proceedings under chapter 7 of the Bankruptcy Code, the financial advisor often assists in accounting for the distribution of the debtor’s assets. If the liquidation proceedings are initiated involuntarily, the petitioning creditors will need the assistance of a financial advisor in establishing a case of insolvency, and the debtor will need a financial advisor’s assistance in trying to prove a defense of solvency. An investigation may be required for specific purposes, such as by the debtor to defend a turnover proceeding or by a third party to defend a suit by the trustee alleging a preferential transfer.³

The trustee as the appointed or elected representative of the creditors in a bankruptcy court proceeding most frequently finds it necessary to employ a financial advisor to examine the debtor’s books and records and to investigate any unusual or questionable transactions. A corporation’s past transactions may need investigation to determine whether any assets have been concealed or removed or any preferences, fraudulent conveyances, or other voidable transactions committed. Often, the debtor may have kept inadequate books and records, further complicating the situation. The financial advisor may help the trustee develop a business plan, and may negotiate the terms of a plan of reorganization.

Under section 1103 of the Bankruptcy Code, the creditors’ committee is permitted to employ such agents, attorneys, and financial advisors as may be necessary to assist in the performance of its functions. The financial advisor can provide valuable assistance to the committee by reviewing the business plan and the plan of reorganization of the debtor. At times, the financial advisor may help the committee develop a plan. The committee may also retain its own financial advisor to examine the debtor’s books and records and to investigate the activities of the debtor. The creditors’ committee is expected to render an opinion on the plan of reorganization, and to do so it must have knowledge of the debtor’s acts and property. It must know the value of the debtor’s assets in liquidation and the nature of the transactions entered into by the debtor before proceedings began. Because financial advisors are most qualified to establish these facts, they are often engaged to perform an investigation of the debtor’s operations so that the committee will be able to give an informed opinion on the actions to take, such as a search for preferences or fraudulent transfers.

The debtor’s internal accounting staff is also actively involved in the proceedings. Staff members often provide information or advice that assists the debtor in selecting the appropriate remedy. They also provide the debtor’s attorneys with the accounting information needed to file the bankruptcy court petition.

Accounting and financial advising services are needed by a large number of participants in both out-of-court and bankruptcy proceedings. See §1.1 of Volume 2, Bankruptcy and Insolvency Accounting, for a list of these parties.

§ 1.4 Financial Advisor Defined

It is not unusual to see several accountants or financial advisors involved in the same bankruptcy court proceeding. There may be independent accountants for the debtor, financial advisors for the debtor, internal accountants of a debtor company, financial advisors for the trustee, and financial advisors representing the creditors’ committee or individual holder of claims. Many of the accounting functions may be performed by more than one firm. For example, each of the financial advisors retained will want to determine the underlying causes of failure. The term financial advisors is used here to refer to any financial advisor involved in the proceedings; where the service must be rendered by a particular financial advisor, the type of financial advisor is identified either in the text or at the beginning of the ch...

Table of contents

• Update Service
• Title Page
• Copyright Page
• Dedication
• Preface
• Acknowledgements
• About the Author
• PART ONE - Bankruptcy and Insolvency Environment
• PART TWO - Legal Aspects of Bankruptcy and Insolvency Proceedings
• PART THREE - Investigation and Reports
• APPENDIX - Statement of Position
• GLOSSARY
• Statutes Citations
• Case Index
• Name Index
• Subject Index