Revisiting Bankruptcy Rules and Reorganization Plans

By Lombard, Dori | Review of Business, Winter 2002 | Go to article overview
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Revisiting Bankruptcy Rules and Reorganization Plans


Lombard, Dori, Review of Business


The September 11 terrorist attack on the World Trade Center and Pentagon left us with more than sorrow and fear: It caused many companies in a wide range of industries to go bankrupt. In these frying economic times, we thought it would be appropriate to revisit bankruptcy reporting rules.

Introduction

In the aftermath of the September 11, 2001 terrorist attack on the World Trade Center and the Pentagon, our country is experiencing a multitude of bankruptcies. This paper will revisit and summarize bankruptcy reporting rules. Specifically, we'll talk about Statement of Position (SOP) 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" -- issued November 1990 by an Accounting Standards Executive Committee task force by the same name. As its name suggests, the purpose of this document is to provide guidance for organizations that have filed petitions with the Bankruptcy Court and plan to reorganize under Chapter 11 of Title 11 of the United States Code or, simply, "Chapter 11."

Within this framework, we'll look at two distinct periods:

1) Financial Reporting During Reorganization Proceedings: During this time, financial statement users' needs change. The reporting practices they previously followed should change accordingly.

2) Financial Reporting when Entities Emerge from Chapter 11: Separate reporting rules apply for entities that meet the criteria for "fresh-start reporting" and those that don't, as you'll see.

What Is Chapter 11?

Chapter 11 is a reorganization action that's initiated -- voluntarily or involuntarily -- under the Bankruptcy Code (a federal statute, enacted October 1,1979 as Title 11 of the United States Code by the Bankruptcy Reform Act of 1978). It provides for the reorganization of a business' debt and equity structure, allowing that business to continue its operations. A debtor may also file a plan of liquidation under Chapter 11.

Chapter 7 is a liquidation action (also initiated voluntarily or involuntarily under the Bankruptcy Code) that provides for liquidation of the business or the debtor's estate.

The Process...

The First Step: Filing a Petition. An entity enters reorganization under Chapter 11 by filing a petition with the Bankruptcy Court (an adjunct of the U.S. District Courts). A petition is, simply, a document filed in a Bankruptcy Court, initiating proceedings under the Bankruptcy Code.

The goal of the proceeding is to maximize recovery by creditors and shareholders by preserving the entity as viable -- preserving its ongoing value.

The Chapter 11 reorganization typically takes a year or the business' operating cycle, whichever is longer. Organizations filing for bankruptcy benefit because: 1) There's an automatic "stay" provision, halting creditors from collecting on pre-petition debts; and 2) It gives them time to develop their reorganization plan. Under the stay provision, no party having a security or adverse interest in the debtor's property can take any action that will interfere with the debtor or its property -- regardless of where the property is located or who has possession -- until the stay is modified or removed. One of the only exceptions would be in the case of fraud.

Coming Up with the Reorganization Plan. A plan of reorganization is an agreement (confirmed by the Bankruptcy Court) enabling the debtor to continue in business. The provisions of this plan specify the treatment of all creditors and equity holders. The plan also provides for treatment of all of the debtor's assets and liabilities, shapes the entity's emerging financial structure and sometimes even results in forgiveness of indebtedness.

The debtor has the exclusive right to file a plan within the first 120 days of the case (or a longer or shorter time as the Bankruptcy Court decrees, for cause). If a plan is filed within the exclusive period, the debtor is given additional time to gain acceptance of its plan, as explained below.

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