Accountants’ Handbook Special Industries and Special Topics 10th Edition_18

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42.6 SOURCES AND SUGGESTED REFERENCES 42 27 • investors give little, if any, weight to book value in appraising the securities of companies with the high rates of earnings on capital that are characteristic of this industry. It should also be noted that we have not used a discounted future beneﬁts approach because ABC’s prospective growth rates are roughly comparable to those of the guideline companies. The adjusted valuation ratios are, therefore, a reﬂection of both the growth rate and the capitalization rate appropriate to ABC Snack Foods, Inc., on the valuation date. Dividing the preliminary value of $62,382,000 by the 100,000 shares outstanding results in a freely traded value (the price at which the stock would trade in an active market) of $624 per share. The fact that the ABC stock lacks ready marketability must be reﬂected by a discount for lack of marketability. We think that a discount of 30% is appropriate. This results in a value for the common stock of $437 per share. It is our conclusion that a block of 20,000 shares had a fair market value of $437 per share as of March 31, 2009, or $8,740,000 for the entire block. 42.6 SOURCES AND SUGGESTED REFERENCES Blackman, L., The Valuation of Privately-Held Businesses. Probus Publishing, Chicago, 1986. Brown, Ronald L., Valuing Professional Practices and Licenses: A Guide for the Matrimonial Practitioner. Pren- tice-Hall, Englewood Cliffs, NJ, 1987. Burke, Frank M., Jr., Valuation and Valuation Planning for Closely-Held Businesses. Prentice-Hall, Englewood Cliffs, NJ, 1981. Ibbotson, Roger A., Stocks, Bonds, Bills and Inﬂation. Ibbotson Associates, Chicago, 1989. Internal Revenue Service, IRS Valuation Guide for Income, Estate & Gift Taxes. Commerce Clearing House, Chicago, 1985. , Revenue Ruling No. 59-60. U.S. Treasury Dept., Washington, DC. Maher, J. Michael, “Discounts for Lack of Marketability for Closely-Held Business Interests,” Taxes—The Tax Magazine, September 1976, pp. 562–71. Moroney, Robert E., “Most Courts Overvalue Closely Held Stocks,” Taxes—The Tax Magazine, March 1973, pp. 144–154. Pratt, Shannon P., ed., Readings in Business Valuation. American Society of Appraisers Educational Foundation, 1986. , Valuing Small Businesses and Professional Practices. Dow Jones-Irwin, Homewood, IL, 1986. , Valuing a Business, 2nd ed. Dow Jones-Irwin, Homewood, IL, 1989. Schackelford, Aaron L., “Valuation of S Corporations,” Business Valuation Review, December 1988, pp. 159–162. Schnepper, J. A., The Professional Handbook of Business Valuation. Addison-Wesley, Reading, MA, 1982. Smith, Gordon V., Corporate Valuation. John Wiley & Sons, New York, 1988. Standard & Poor’s Corporation, Standard Corporation Records. Standard & Poor’s, New York, annual update.
43 CHAPTER BANKRUPTCY Grant W. Newton, PhD, CPA, CIRA Pepperdine University (i) Limitations on Executory 43.1 OVERVIEW 2 Contracts 11 (ii) Accounting Services— 43.2 ALTERNATIVES AVAILABLE TO Rejection of Executory TROUBLED COMPANIES 2 Contracts 11 (a) Out-of-Court Settlements 2 (f) Avoiding Power 12 (i) Appointment of Creditors’ (g) Preferences 12 Committee 3 (i) Exceptions to Preferential (ii) Plan of Settlement 3 Transfers 12 (b) Assignment for Beneﬁt of (ii) Accounting Services— Creditors 3 Search for Preferential (c) Bankruptcy Court Proceedings 3 Payments 13 (i) Title 11—Bankruptcy (h) Fraudulent Transfers 14 Code 4 (i) LBO as a Fraudulent (ii) Chapter 7—Liquidation 4 Transfer 14 (iii) Chapter 12—Adjustment (ii) Accounting Services— of Debt of a Family Search for Fraudulent Farmer with Regular Transfers 14 Annual Income 5 (i) Postpetition Transfers 14 (iv) Prepackaged Chapter 11 (i) Adequate Value Plans 6 Received 15 (d) The Accountant’s Services in (ii) Accounting Services— Proceedings 7 Preventing Unauthorized Transfers 15 (j) Setoffs 15 43.3 GENERAL PROVISIONS OF (i) Early Setoff Penalty 15 BANKRUPTCY CODE 7 (ii) Accounting Services— (a) Filing of Petition 7 Setoffs 15 (b) Timing of Petition—Tax (k) Reclamation 16 Considerations 8 (l) U.S. Trustee 16 (c) Accounting Services— Accounting Data Required in 43.4 HANDLING OF CLAIMS the Petition 8 UNDER CHAPTER 11 16 (d) Adequate Protection and Automatic Stay 9 (a) Proof of Claims 17 (i) Relief from the Stay 10 (b) Undersecured Claims 17 (ii) Accounting Services— (c) Administrative Determining Equity in Expenses 17 Property 10 (d) Priorities 18 (e) Executory Contracts and Leases 11 (e) Processing of Claims 18 43 1 •
43 2 BANKRUPTCY • (iv) Pro Forma Balance Sheet 31 43.5 OPERATING UNDER CHAPTER 11 19 (v) Reorganization Model 31 (a) Use of Property 19 (g) Accounting Services— (i) Cash Collateral 19 Assistance to Creditors’ (ii) Accounting Services— Committee 32 Assisting Debtor in (i) Assistance in the Providing Information to Bargaining Process 32 Secured Lender 20 (ii) Evaluation of Debtor’s (b) Obtaining Credit 20 Projections 32 (c) Appointment of Trustees 21 (iii) Reorganization Value 33 (d) Appointment of Examiner 21 (iv) Review of Plan and (i) Functions of Examiner 22 Disclosure Statement 33 (ii) Accountants as Examiners 22 (h) Accounting for the (e) Operating Statements 22 Reorganization 34 (f) Reporting in Chapter 11 22 (i) Requirements for Fresh (i) Balance Sheet 23 Start Reporting 34 (ii) Statement of Operations 24 (ii) Allocation of (iii) Statement of Cash Flows 25 Reorganization Value 34 (iii) Disclosure Requirements 35 43.6 CHAPTER 11 PLAN 26 (iv) Reporting by Debtors Not Qualifying for Fresh Start 35 (a) Classiﬁcation of Claims 26 (i) Accounting for the Impairment (b) Development of Plan 26 of Long-Lived Assets Under (c) Disclosure Statement 27 Chapter 11 36 (i) Deﬁnition of Adequate Information 27 43.7 REPORTING REQUIREMENTS (ii) Content 27 IN BANKRUPTCY CASES 37 (d) Conﬁrmation of Plan 29 (e) Conﬁrmation Requirements 29 (a) Litigation Services 37 (f) Accounting Services— (b) Disclosure Requirements 38 Assistance to Debtor 30 (c) Operating Reports 38 (i) Liquidation Value of (d) Investigative Services 39 Assets 30 (e) Financial Projections 40 (ii) Projections of Future 43.8 SOURCES AND SUGGESTED Operations 30 REFERENCES 41 (iii) Reorganization Value 31 43.1 OVERVIEW This chapter contains a brief description of the Bankruptcy Code, a discussion of the services that can be rendered by the accountant, and an introduction to the problems faced by accountants work- ing in the bankruptcy area. 43.2 ALTERNATIVES AVAILABLE TO TROUBLED COMPANIES The debtor’s ﬁrst alternatives are to locate new ﬁnancing, to merge with another company, or to ﬁnd some other basic solution to its situation that avoids the necessity of discussing its problems with rep- resentatives of creditors. If none of these alternatives is possible, the debtor may be required to seek a remedy from creditors, either informally (out of court) or with the help of judicial proceedings. (a) OUT-OF-COURT SETTLEMENTS. The informal settlement is an out-of-court agreement that usually consists of an extension of time (stretch-out), a pro rata cash payment for full settlement of claims (composition), an issue of stock for debt, or some combination. The debtor, through counsel or credit association, calls an informal meeting of the creditors for the purpose of discussing its ﬁ-
43.2 ALTERNATIVES AVAILABLE TO TROUBLED COMPANIES 43 3• nancial problems. In many cases, the credit association makes a signiﬁcant contribution to the out- of-court settlement by arranging a meeting of creditors, providing advice, and serving as secretary for the creditors’ committee. A credit association is composed of credit managers of various businesses in a given region. Its functions are to provide credit and other business information to member companies con- cerning their debtors, to help make commercial credit collections, to support legislation favor- able to business creditors, and to provide courses in credit management for members of the credit community. At the creditors’ meeting, the debtor describes the causes of failure, discusses the value of assets (especially those unpledged) and unsecured liabilities, and answers any questions the creditors may ask. The main objective of this meeting is to convince the creditors that they would receive more if the business were allowed to operate than if it were forced to liquidate and that all parties would ben- eﬁt from working out a settlement. (i) Appointment of Creditors’ Committee. To make it easier for the debtor to work with the creditors, a committee of creditors is normally appointed during the initial meeting of the debtor and its creditors, providing, of course, the case is judged to warrant some cooperation by the creditors. It should be realized that the creditors are often as interested in working out a settlement as is the debtor. The creditors’ committee serves as the bargaining agent for the creditors, supervises the operation of the debtor during the development of a plan, and solic- its acceptance of a plan once the committee has approved it. Generally, the creditors’ com- mittee meets immediately after appointment for the purpose of selecting a presiding ofﬁcer and counsel. (ii) Plan of Settlement. Provided there is enough time, it is often advisable that the accountant and the attorney assist the debtor in preparing a suggested plan of settlement for presentation and discussion at the ﬁrst meeting with creditors. Typically only the largest creditors and a few repre- sentatives of the smaller creditors are invited so that the group is a manageable size for accom- plishing its goals. There is no set pattern for the form that a plan of settlement proposed by the debtor must take. It may call for 100% payment over an extended period of time, payments on a pro rata basis in cash for full settlement of creditors’ claims, satisfaction of debt obligations with stock, or some combination. A carefully developed forecast of projected operations, based on realis- tic assumptions developed by the debtor with the aid of its accountant, can help creditors de- termine whether the debtor can perform under the terms of the plan and operate successfully in the future. (b) ASSIGNMENT FOR BENEFIT OF CREDITORS. A remedy available under state law to a corporation in serious ﬁnancial difﬁculties is an assignment for the beneﬁt of creditors. In this in- stance, the debtor voluntarily transfers title to its assets to an assignee, who then liquidates them and distributes the proceeds among the creditors. Assignment for the beneﬁt of creditors is an extreme remedy because it results in the cessation of the business. This informal liquidation device (although court-supervised in many states) is like the out-of-court settlement devised to rehabilitate the debtor, in that it requires the consent of all creditors or at least their agreement to refrain from taking action. The appointment of a custodian over the assets of the debtor gives creditors the right to ﬁle an invol- untary bankruptcy court petition. Proceedings brought in the federal courts are governed by the Bankruptcy Code. Normally it is necessary to resort to such formality when suits have been ﬁled against the debtor and its property is under garnishment or attachment or is threatened by foreclosure or eviction. (c) BANKRUPTCY COURT PROCEEDINGS. Bankruptcy court proceedings are generally the last resort for the debtor whose ﬁnancial condition has deteriorated to the point where it is impossi- ble to acquire additional funds. When the debtor ﬁnally agrees that bankruptcy court proceedings
43 4 BANKRUPTCY • are necessary, the liquidation value of the assets often represents only a small fraction of the debtor’s total liabilities. If the business is liquidated, the creditors get only a small percentage of their claims. The debtor is discharged of its debts and is free to start over; however, the business is lost and so are all the assets. Normally, liquidation proceedings result in large losses to the debtor, the creditors, and the business community in general. Chapter 7 of the Bankruptcy Code covers the proceedings related to liquidation. Another alternative under the Bankruptcy Code is to seek some type of relief so that the debtor, with the help of the bankruptcy court, can work out agreements with creditors and be able to continue operations. Chapters 11, 12, and 13 of the Bankruptcy Code pro- vide for this type of operation. (i) Title 11—Bankruptcy Code. Title 11 U.S. Code contains the bankruptcy law. The code is di- vided into eight chapters: Chapter 1 General Provisions Chapter 3 Case Administration Chapter 5 Creditors, the Debtor, and the Estate Chapter 7 Liquidation Chapter 9 Adjustment of Debts of a Municipality Chapter 11 Reorganization Chapter 12 Adjustment of Debts of a Family Farmer with Regular Income Chapter 13 Adjustment of Debts of an Individual with Regular Income Chapters 1, 3, and 5 apply to all proceedings under the code except chapter 9, where only speciﬁed sections of chapters 1, 3, and 5 apply. A case commenced under the Bankruptcy Code—chapter 7, 9, 11, 12, or 13—is referred to as a Title 11 case. Chapter 13, which covers the adjustment of debts of individuals with regular income, is beyond the scope of this presentation because it can be used only by individuals with unsecured claims of less than $290,525 and secured claims of less than $871,550. The dollar amount of the debt limits for a chapter 13 petition are to be increased to re- ﬂect the change in the Consumer Price Index for All Urban Consumers on April 1 every third year. The amounts are to be rounded to the nearest $25 multiple. The next three-year-period adjustment will be made on April 1, 2004. Provisions relating to Chapter 11 are discussed in detail in a sepa- rate section. (ii) Chapter 7—Liquidation. Chapter 7 is used only when the corporation sees no hope of being able to operate successfully or to obtain the necessary creditor agreement. Under this alternative, the corporation is liquidated and the remaining assets are distributed to creditors after administrative ex- penses have been paid. An individual debtor may be discharged from liabilities and entitled to a fresh start. A corporation’s debt is not discharged. The decision as to whether rehabilitation or liquidation is best also depends on the amount that can be realized from each alternative. The method resulting in the greatest return to the creditors and stockholders should be chosen. The amount received from liquidation depends on the resale value of the ﬁrm’s assets minus the costs of dismantling and legal expenses. The value of the ﬁrm after reha- bilitation must be determined (net of the costs of achieving the remedy). The alternative leading to the highest value should be followed. Financially troubled debtors often attempt an informal settlement or liquidation out of court; if it is unsuccessful, they will then initiate proceedings under the Bankruptcy Code. Other debtors, especially those with a large number of creditors, may ﬁle a petition for relief in the bankruptcy court as soon as they recognize that continuation of the business under existing con- ditions is impossible. As soon as the order for relief has been entered, the U.S. trustee appoints a disinterested party from a panel of private trustees to serve as the interim trustee. The functions and powers of the in-
43.2 ALTERNATIVES AVAILABLE TO TROUBLED COMPANIES 43 5• terim trustee are the same as those of an elected trustee. Once an interim trustee has been appointed, the creditors meet to elect a trustee that will be responsible for liquidating the business. If a trustee is not elected by the creditors, the interim trustee may continue to serve in the capacity of the trustee and carry through with an orderly liquidation of the business. The objective of the trustee is to liquidate the assets of the estate in an orderly manner. Once the property of the estate has been reduced to money and the security claims have been satis- ﬁed to the extent allowed, then the property of the estate is distributed to the holders of the claims in the order speciﬁed by the Bankruptcy Code. The ﬁrst order, of course, is priority claims; when they have been established, the balance goes to unsecured creditors. After all the funds have been distributed, the remaining debts of an individual are discharged. As mentioned earlier, if the debtor is a corporation, the debts are not discharged. Thus it is necessary for the corporation to cease existence. Any funds subsequently coming into the corporate shell would be subject to attachment. (iii) Chapter 12—Adjustment of Debt of a Family Farmer with Regular Annual Income. To help farmers resolve some of their ﬁnancial problems, Congress passed Chapter 12 of the Bank- ruptcy Code. It became effective November 26, 1986, and is scheduled to expire December 31, 2002. However, on previous occasions when the chapter 12 provisions were scheduled to end, Con- gress has extended the date and at times extended it after it expired. Because chapter 12 is new and relates to a speciﬁc class of debtors, Congress will evaluate whether the chapter is serving its pur- pose and whether there is a need to continue this special chapter for the family farmer. After Con- gress makes this evaluation, it will be able to determine whether to make this chapter permanent. If Congress does not act to either extend the date or make chapter 12 permanent, chapter 12 will ter- minate on October 1, 1998. Under current law, a family farmer in need of ﬁnancial rehabilitation may ﬁle either a Chapter 11 or 13 petition. Most family farmers, because they have too much debt to qualify, cannot ﬁle under chapter 13 and are limited to Chapter 11. Many farmers have found Chapter 11 needlessly compli- cated, unduly time-consuming, inordinately expensive, and, in too many cases, unworkable. Chapter 12 is designed to give family farmers an opportunity to reorganize their debts and keep their land. According to legislative history, chapter 12 gives debtors the protection from creditors that bank- ruptcy provides while, at the same time, it prevents abuse of the system and ensures that farm lenders receive a fair repayment. In order to ﬁle a petition, an individual or an individual and spouse engaged in farming opera- tions must have total debt that does not exceed $1,500,000, and at least 80% of noncontingent, liq- uidated debts (excluding debt from principal residence unless debt arose out of family operations) on the date the petition is ﬁled must have arisen out of farming. Additionally, more than 50% of the petitioner’s gross income for the taxable year prior to the ﬁling of the petition must be from farm- ing operations. A corporation or partnership may ﬁle if more than 50% of the outstanding stock or equity is owned by a family and: • More than 80% of the value of its assets consist of assets related to farming operations. • The total debts do not exceed $1,500,000 and at least 80% of its noncontingent, liquidated debts on the date the case is ﬁled arose out of farming operations. • The stock of a corporation is not publicly traded. Only the debtor can ﬁle a plan in a chapter 12 case. The requirements for a plan in chap- ter 12 are more ﬂexible and lenient than those in Chapter 11. In fact, only three requirements are set forth in Section 1205 of the Bankruptcy Code. First, the debtor must submit to the supervision and con- trol of the trustee all or such part of the debtor’s future income as is necessary for the execution of the plan. Second, the plan must provide for full payment, in deferred cash payments, of all priority claims unless the creditors agree to a different treatment. Third, where creditors are divided into classes, the
43 6 BANKRUPTCY • same treatment must apply to all claims in a particular class. The plan can alter the rights of secured creditors with an interest in real or personal property, but there are a few restrictions. To alter the right of the secured claim holder, the debtor must satisfy one of the following three requirements: 1. Obtain acceptance of the plan 2. Provide in the plan that the holder of such claim retain the lien and as of the effective date of the plan provide that the payment to be made or property to be transferred is not less than the amount of the claim 3. Surrender the property securing such claim If a holder of an allowed unsecured claim does not accept the plan, then the court may not ap- prove the plan unless the value of the property to be distributed is equal to at least the amount of the claim and the plan provides that all of the debtor’s projected disposable income to be received within three years, or longer if directed by the court, after the ﬁrst payment is made will be a part of the pay- ments under the plan. To facilitate the operation of the business and the development of a plan, Section 1206 of the Bankruptcy Code allows family farmers to sell assets not needed for the reorganization prior to con- ﬁrmation without the consent of the secured creditor, provided the court approves such a sale. (iv) Prepackaged Chapter 11 Plans. Before ﬁling a Chapter 11 plan, some debtors develop a plan and obtain approval of the plan by all impaired claims and interests. The court may accept the voting that was done prepetition provided that the solicitation of the acceptance (or rejection) was in compliance with applicable nonbankruptcy laws governing the adequacy of disclosure in connection with the solicitation. If no nonbankruptcy law is applicable, then the solicitation must have occurred after or at the time the holder received adequate information as required under Section 1125 of the Bankruptcy Code. It is often necessary for a Chapter 11 plan to be ﬁled for several reasons including the following three: 1. Income from debt discharge is taxed in an out-of-court workout to the extent that the debtor is or becomes solvent. While some tax attributes may be reduced in a bankruptcy case, the gain from debt discharged is not taxed. 2. A larger percent of the net operating loss may be preserved if a Chapter 11 petition is ﬁled. For example, the provisions of Sections 382(l)(5) and 382(l)(6) of the Internal Revenue Code (IRC) dealing with net operating losses only apply to bankruptcy cases. 3. A smaller percentage of creditor approval is needed in Chapter 11. Only two-thirds of the dollar amount of debt represented by those creditors voting and a majority in number in each class are necessary in Chapter 11. However, for any out-of-court workout to suc- ceed, the percentage accepting the plan must be much greater. For example, some bond indenture agreements provide that amendments cannot be made unless all holders of debt approve the modiﬁcations. Since it is difﬁcult, if not impossible, to obtain 100% ap- proval, it is necessary to ﬁle a bankruptcy plan to reduce interest or modify the principal of the bonds. Since the professional fees and other costs, including the cost of disrupting the business, of a prepackaged plan are generally much less than costs of a regular Chapter 11 bankruptcy, a prepack- aged bankruptcy may be the best alternative. The use of a prenegotiated plan is common among public companies today. A prenegotiated plan is a modiﬁcation of the prepackaged bankruptcy in that the voting is completed after the petition has been ﬁled rather than before the plan is ﬁled. In a prenegotiated plan, the debtor reaches an agreement with the major creditors and then ﬁles a plan either at the time or shortly after the Chapter 11 petition is ﬁled. For public companies, the ﬁling of the petition before vot-
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43 7 • ing allows all documents related to the plan to be ﬁled with the bankruptcy court and eliminates the need to follow the SEC requirements in the voting process. (d) THE ACCOUNTANT’S SERVICES IN PROCEEDINGS. One of the ﬁrst decisions that must be made at an early meeting of the debtor with bankruptcy counsel and accountants is whether it is best to liquidate (under provisions of state law or Bankruptcy Code), to attempt an out-of-court set- tlement, to seek an outside buyer, or to ﬁle a Chapter 11 petition. To decide which course of action to take, it is also important to ascertain what caused the debtor’s current problems, whether the com- pany will be able to overcome its difﬁculties, and, if so, what measures will be necessary. Accoun- tants may be asked to explain how the losses occurred and what can be done to avoid them in the future. To help with this determination, it may be necessary to project the operations after a 30-day period over at least the next three to six months, and to indicate the areas where steps will be neces- sary in order to earn a proﬁt. For existing clients, the information needed to make a decision about the course of action to make may be obtained with limited additional work; however, for a new client, it is necessary to perform a review of the client’s operations to determine the condition of the business. Once the re- view has been completed, the client must normally decide to liquidate the business, attempt an in- formal settlement with creditors, or ﬁle a Chapter 11 petition, unless additional funds can be obtained or a buyer for the business is located. For example, where the product is inferior, the de- mand for the product is declining, the distribution channels are inadequate, or other similar prob- lems exist that cannot be corrected, either because of the economic environment or management’s lack of ability, it is normally best to liquidate the company immediately. The decision whether a business should immediately ﬁle a Chapter 11 petition or attempt an out- of-court settlement depends on several factors. Among them are the following eight: 1. Size of company a. Public b. Private 2. Number of creditors a. Secured b. Unsecured c. Public d. Private 3. Complexity of matter a. Nature of debt b. Prior relationships with creditors 4. Pending lawsuits 5. Executory contracts, especially leases 6. The impact of alternatives selected 7. Nature of management a. Mismanagement b. Irregularities 8. Availability of interim ﬁnancing 43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE (a) FILING OF PETITION. A voluntary case is commanded by the debtor’s ﬁling of a bankruptcy petition under the appropriate chapter.
43 8 BANKRUPTCY • An involuntary petition can be ﬁled by three or more creditors (if 11 or fewer creditors, only one creditor is necessary) with unsecured claims of at least $10,000 and can be initiated only under chap- ter 7 or 11. An indenture trustee may be one of the petitioning creditors. The Court allows a case to proceed only if (1) the debtor generally fails to pay its debts as they become due, provided such debts are not the subject of a bona ﬁde dispute; or (2) within 120 days prior to the petition a custodian was appointed or took possession. The latter excludes the taking of possession of less than substantially all property to enforce a lien. (b) TIMING OF PETITION—TAX CONSIDERATIONS. The timing for ﬁling the petition is im- portant. For example, if the debtor delays ﬁling the petition until the creditors are about to force the debtor into bankruptcy, the debtor may not be in a position to effectively control its destiny. On the other hand, if the petition is ﬁled when the problems ﬁrst develop and while the creditors are reason- ably cooperative, the debtor is in a much better position to control the proceeding. If possible, it is best to ﬁle the petition near the end of the month or, even better, near the end of the quarter, to avoid a separate closing of the books. Tax factors should also be considered in deciding when to ﬁle the petition. For example, if a debtor corporation that has attempted an unsuccessful out-of-court settlement decides to ﬁle a peti- tion, the tax impact of the out-of-court action should be considered. If, in the out-of-court agreement, the debtor transferred property that resulted in a gain and a substantial tax liability, it would be best for the debtor to ﬁle the petition after the end of the current taxable year. By taking this action, the tax claim is a prepetition tax claim and not an administrative expense. If the tax claim is a prepetition claim, interest and penalties stop accruing on the day the petition is ﬁled and the debtor may provide in the plan for the deferral of the tax liability up to six years. If the tax claim is an administrative expense, penalties and interest on any unpaid balance will continue to accrue and the provision for deferred pay- ment of up to six years does not apply. (c) ACCOUNTING SERVICES—ACCOUNTING DATA REQUIRED IN THE PETITION. The accountant must supply the attorney with certain information necessary for ﬁling a Chapter 11 peti- tion. This would normally include the following: • List of Largest Creditors. A list containing the names and addresses of the 20 largest unsecured creditors, excluding insiders, must be ﬁled with the petition in a voluntary case. In an involun- tary situation, the list is to be ﬁled with the petition in a voluntary case. In an involuntary peti- tion, the list is to be ﬁled within two days after entry of the order for relief. See Bankruptcy Rule 1007 and Bankruptcy Form 4. • List of Creditors. The debtor must ﬁle with the court a list of the debtor’s creditors of each class, showing the amounts and character of any claims and securities and, so far as is known, the name and address or place of business of each creditor and a notation whether the claim is disputed, contingent, or unliquidated as to amount, when each claim was incurred and the con- sideration received, and related data. • List of Equity Security Holders. It is necessary to provide a list of the debtor’s security holders of each class showing the number and kind of interests registered in the name of each holder and the last known address or place of business of each holder. • Schedules of Assets and Liabilities. The schedules that must accompany the petition (or ﬁled within 15 days after the petition is ﬁled—unless the court extends the time period) are sworn statements of the debtor’s assets and liabilities as of the date the petition is ﬁled under Chap- ter 11. These schedules consist primarily of the debtor’s balance sheet broken down into de- tail, and the accountant is required to supply the information generated in the preparation of the normal balance sheet and its supporting schedules. The required information is supplied on Schedules A through C, which include a complete statement of assets, and Schedules D through F, which are a complete statement of liabilities. Schedule G requires the debtor to list all executory contracts and unexpired leases. It is crucial that this information be accurate and
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43 9 • complete because the omission or incorrect listing of a creditor might result in a failure to re- ceive notice of the proceedings, and consequently the creditor’s claim could be exempted from a discharge when the plan is later conﬁrmed. Also omission of material facts may be construed as a false statement or concealment. • Statement of Financial Affairs. The statement of affairs, not to be confused with an accoun- tant’s usual use of the term, is a series of detailed questions about the debtor’s property and conduct. The general purpose of the statement of affairs is to give both the creditors and the court an overall view of the debtor’ operations. It offers many avenues to begin investigations into the debtor’s conduct. The statement (Ofﬁcial Form No. 7) consists of 25 questions to be answered under oath concerning the following areas: 1. Income from employment or operation of business 2. Income other than from employment or operation of business 3. Payments to creditors 4. Suits, executions, garnishments, and attachments 5. Repossessions, foreclosures, and returns 6. Assignments and receiverships 7. Gifts 8. Losses 9. Payments related to debt counseling or bankruptcy 10. Other transfers 11. Closed ﬁnancial accounts 12. Safe deposit boxes 13. Setoffs 14. Property held for another person 15. Prior address of debtor 16. Spouses and former spouses 17. Environmental issues 18. Nature, location, and name of business 19. Books, records, and ﬁnancial statements 20. Inventories 21. Current partners, ofﬁcers, directors, and shareholders 22. Former partners, ofﬁcers, directors, and shareholders 23. Withdrawals from a partnership or distributions by a corporation 24. Tax consolidation group 25. Pension funds • Exhibit “A” to the Petition. This is a thumbnail sketch of the ﬁnancial condition of the busi- ness listing total assets, total liabilities, secured claims, unsecured claims, information relating to public trading of the debtor’s securities, and the identity of all insiders. The debtor must also ﬁle any additional reports or documents that may be required by local rules or by the U.S. trustee. (d) ADEQUATE PROTECTION AND AUTOMATIC STAY. A petition ﬁled under the Bank- ruptcy Code results in an automatic stay of the actions of creditors. The automatic stay is one of the fundamental protections provided the debtor by the Bankruptcy Code. In a chapter 7 case, it pro- vides for an orderly liquidation that treats all creditors equitably. For business reorganizations under Chapter 11, 12, or 13, it provides time for the debtor to examine the problems that forced it into
43 10 BANKRUPTCY • bankruptcy court and to develop a plan for reorganization. As a result of the stay, no party, with minor exceptions, having a security or adverse interest in the debtor’s property can take an action that will interfere with the debtor or his property, regardless of where the property is located, until the stay is modiﬁed or removed. Section 362(a) provides a list of eight kinds of acts and conduct subject to the automatic stay. Under Section 362 of the Bankruptcy Code, a tax audit, a demand for a tax return, or the issuance of a notice and demand for payment for such assessment are not considered a violation of the auto- matic stay. The stay of an act against the property of the estate continues, unless modiﬁed, until the property is no longer the property of the estate. The stay of any other act continues until the case is closed or dismissed, or the debtor is either granted or denied a discharge. The earliest occurrence of one of these events terminates the stay. (i) Relief from the Stay. The court may grant relief after notice and hearing, by terminating, an- nulling, modifying, or conditioning the stay. The court may grant relief for cause, including the lack of adequate protection of the interest of the secured creditor. With respect to an act against property, relief may be granted under Chapter 11 if the debtor does not have an equity in the property and the property is not necessary for an effective reorganization. Section 361 identiﬁes acceptable ways of providing adequate protection. First, the trustee or debtor may be required to make periodic cash payments to the entity entitled to relief as compensa- tion for the decrease in value of the entity’s interest in the property resulting from the stay. Second, the entity may be provided with an additional or replacement lien to the extent that the value of the interest declined as a result of the stay. Finally, the entity may receive the indubitable equivalent of its interest in the property. The granting of relief when the debtor does not have any equity in the property solves the prob- lem of real property mortgage foreclosures where the bankruptcy court petition is ﬁled just before the foreclosure takes place. It was not intended to apply if the debtor is managing or leasing real property, such as a hotel operation, even though the debtor has no equity, because the property is nec- essary for an effective reorganization of the debtor. The automatic stay prohibits a secured creditor from enforcing its rights in property owned by the debtor until the stay is removed. Without this right, a creditor could foreclose on the debtor’s property, collect the proceeds, invest them, and earn income from the investment, even though a bankruptcy petition has been ﬁled. Since the Bankruptcy Code does not allow this ac- tion to be taken, the creditor loses the opportunity to earn income on the proceeds that could have been received on the foreclosure. The courts refer to this as creditor’s opportunity costs. Four circuit courts have looked at this concept of opportunity cost. Two circuits (ninth and fourth) have ruled that the debtor is entitled to opportunity cost, the eighth circuit ruled that under certain conditions opportunity costs may be paid, and the ﬁfth circuit ruled that opportu- nity cost need not be paid. In January 1988, the Supreme Court held in In re Timbers of Inwood Forest Associates [484 U.S. 365 (1988)] that creditors having collateral with a value less than the amount of the debt are not entitled to interest during the period that their property is tied up in the bankruptcy proceeding. Because of the extended time period during which the creditors’ interest in the property is tied up in bankruptcy proceedings, this decision will most likely en- courage creditors to properly collateralize their claim and may in limited ways restrict the grant- ing of credit. If relief from the stay is granted, a creditor may foreclose on property on which a lien exists, may continue a state court suit, or may enforce any judgment that might have been obtained before the bankruptcy case. (ii) Accounting Services—Determining Equity in Property. The accountant may assist either the debtor or the creditor in determining the value of the collateral to help determine if there is any equity in the property. As a result of the Timbers decision, the court is more closely
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43 11 • considering the prospects for successful reorganization. In cases where there is considerable question about the ability of the debtor to reorganize, courts are now allowing the stay to be removed, providing there is no equity in the property. The debtor, creditors’ committee, or se- cured creditor(s) may ask accountants to provide evidences as to the ability of the debtor to reorganize. (e) EXECUTORY CONTRACTS AND LEASES. Section 365(a) provides that the debtor or trustee, subject to court approval, may assume, assign, or reject any executory contract or unexpired lease of the debtor. Executory contracts are contracts that are “so far unperformed that the failure of either [the bankrupt or nonbankrupt] to complete performance would constitute a material breach ex- cusing the performance of the other.”1 Countryman’s deﬁnition seems to have been adopted by Con- gress in the statement that “executory contracts include contracts under which performance remains due to some extent on both sides.”2 However, before a contract can be assumed, Section 361 indi- cates that the debtor or trustee must: • Cure the past defaults or provide assurance they will be promptly cured • Compensate the other party for actual pecuniary loss to such property or provide assurance that compensation will be made promptly • Provide adequate assurance of future performance under the contract or lease (i) Limitations on Executory Contracts. To be rejected, the contract must still be an ex- ecutory contract. For example, the delivery of goods to a carrier before the petition is ﬁled, under terms that provide that the seller’s performance is completed upon the delivery of the goods to the carrier, would not be an executory contract in Chapter 11. Furthermore, the seller’s claim would not be an administrative claim. On the other hand, if the terms provide that the goods are received on delivery to the buyer, the seller under Uniform Commercial Code (UCC) Section 2-705 would have the right to stop the goods in transit and the automatic stay would not preclude such action. If the goods are delivered, payment for such goods would be an administrative expense. The damages allowable to the landlord of a debtor from termination of a lease of real prop- erty are limited to the greater of onr year or 15% of the remaining portion of the lease’s rent due not to exceed three years after the date of ﬁling or surrender, whichever is earlier. This formula compensates the landlord while not allowing the claim to be so large as to hurt other creditors of the estate. The damages resulting from the breach of an employment contract are limited to one year following the date of the petition or the termination of employment, whichever is earlier. (ii) Accounting Services—Rejection of Executory Contracts. The accountant may render sev- eral services relating to the rejection of executory contracts, including these three: 1. Estimating the amount of the damages that resulted from the lease rejection for either the debtor or landlord. 2. Evaluating for the landlord the extent to which the debtor has the ability to make the payments required under the lease. 3. Assisting the debtor in determining (or evaluating for the creditor’s committee) the leases that should be rejected. To the extent possible, this assessment should be made at the beginning of the case to help reduce the expenses of administration during the Chapter 11 case. Amounts paid for rent for the period after ﬁling petition to the date of rejection are considered administrative expenses. Each lease needs to be analyzed to determine if there is equity in the lease or if the debtor needs it to successfully reorganize. 1 See Countryman, “Executory Contracts in Bankruptcy,” Minnesota Law Review, Vol. 57. (1973), pp. 439, 460. 2 See S. Rep. No. 95-989, 95th Cong., 2nd Sess. (1977).
43 12 BANKRUPTCY • (f) AVOIDING POWER. The Bankruptcy Code grants to the trustee or debtor in possession the right to avoid certain transfers and obligations incurred. For example, Section 544 allows the trustee to avoid unperfected security interest and other interests in the debtor’s property. Thus if the creditor fails to perfect a real estate mortgage, the trustee may be able to avoid that security interest and force the claim to be classiﬁed as unsecured rather than secured. The trustee needs these powers and rights to ensure that actions by the debtor or by creditors in the prepetition period do not interfere with the objective of the bankruptcy laws, to provide for a fair and equal distribution of the debtor’s assets through liquidation—or rehabilitation, if this would be better for other creditors involved. In addition the trustee has the power to avoid preferences, fraudulent transfers, and postpeti- tion transfers. (g) PREFERENCES. A preferential payment as deﬁned in Section 547 of the Bankruptcy Code is a transfer of any of the property of a debtor to or for the beneﬁt of a creditor, for or on account of an antecedent debt made or suffered by the debtor while insolvent and within 90 days before the ﬁling of a petition initiating bankruptcy proceedings, when such transfer enables the creditor to receive a greater percentage of payment than it would receive if the debtor were liquidated under chapter 7. In- solvency is presumed during the 90-day period. A transfer of property to an insider between 90 days and one year before the ﬁling of the petition is also considered a preferential payment. An ofﬁcer, di- rector, or person in control of the corporation would be considered an insider. Action to recover a preferential payment received by a third party that beneﬁted an ofﬁcer or other insider may only be taken against the ofﬁcer or other insider and not against the third party. For example, if a president paid off a loan that he personally guaranteed six months before the petition was ﬁled, the payment would be recoverable as a preference from the president, but not from the bank. Preferences include the payment of money, a transfer of property, assignment of receivables, or the giving of a mortgage on real or personal property. A preferential payment is not a fraud but rather a legitimate and proper payment of a valid an- tecedent debt. The voidability of preferences is created by law to effect equality of distribution among all the creditors. The 90-day period (one year for transactions with insiders) prior to ﬁling the bankruptcy petition has been arbitrarily selected by Congress as the time period during which distributions to the debtor’s creditors may be redistributed to all the creditors ratably. During this period, a creditor who accepts a payment is said to have been preferred and may be required to re- turn the amount received and later participate in the enlarged estate to the pro rata extent of its unre- duced claim. (i) Exceptions to Preferential Transfers. Section 547(c) contains eight exceptions to the power the trustee has to avoid preferential transfers. Five of the assumptions are discussed below. 1. Contemporaneous exchange. A transfer intended by the debtor and creditor to have a contem- poraneous exchange for new value given to the debtor and that is in fact a substantially con- temporaneous exchange is exempted. The purchase of goods or services with a check would not be a preferential payment, provided the check is presented for payment in the normal course of business. 2. Ordinary course of business and ordinary business terms. The second exemption protects payments of debts that were incurred in the ordinary course of business or ﬁnancial affairs of both the debtor and the transferee when the payment is made in the ordinary course of busi- ness according to ordinary business terms. 3. Purchase money security interest. The third exception exempts security interests granted in exchange for enabling loans when the proceeds are used to ﬁnance the purchase of spe- ciﬁc personal property. For example, a debtor borrowed $75,000 from a bank to ﬁnance a computer system and subsequently purchased the system. The “transfer” of this system as collateral to the bank would not be a preference provided the proceeds were given after
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43 13 • the signing of the security agreement, the proceeds were used to purchase the system, and the security interest was perfected within 20 days after the debtor received possession of the property. 4. New value. This exception provides that the creditor is allowed to insulate from prefer- ence attack a transfer received to the extent that the creditor replenishes the estate with new value. For example, if a creditor receives $10,000 in preferential payments and subse- quently sells to the debtor, on unsecured credit, goods with a value of $6,000, the prefer- ence would be only $4,000. The new credit extended must be unsecured and can be netted only against a previous preferential payment, not a subsequent payment. 5. Inventory and receivables. This exception allows a creditor to have a continuing security interest in inventory and receivables (or proceeds) unless the position of the creditor is im- proved during the 90 days before the petition. If the creditor is an insider, the time period is extended to one year. An improvement in position occurs when a transfer causes a re- duction in the amount by which the debt secured by the security interest exceeds the value of all security interest for such debt. A two-point test is to be used to determine if an improvement in position occurred: The position 90 days (one year for insiders) prior to the ﬁling of the petition is compared with the position as of the date of the petition. If the security interest is less than 90 days old, then the date on which new value was ﬁrst given is compared to the position as of the date of the petition. The extent of any improvement caused by transfers to the prejudice of un- secured creditors is considered a preference. To illustrate this rule, assume that on March 1, the bank made a loan of $700,000 to the debtor secured by a so-called ﬂoating lien on inventory. The inventory value was $800,000 at that date. On June 30, the date the debtor ﬁled a bankruptcy petition, the balance of the loan was $600,000 and the debtor had inventory valued at $500,000. It was determined that 90 days prior to June 30 (date petition was ﬁled), the inventory totaled $450,000 and the loan balance was $625,000. In this case there has been an improvement in position of $75,000 ($600,000 $500,000) ($625,000 $450,000), and any transfer of a security interest in inventory or proceeds could be revoked to that extent. (ii) Accounting Services—Search for Preferential Payments. The trustee or debtor-in- possession will attempt to recover preferential payments. Section 547(f) provides that the debtor is presumed to be insolvent during the 90-day period prior to bankruptcy. This pre- sumption does not apply to transfers to insiders between 91 days and one year prior to bank- ruptcy. This presumption requires the adverse party to come forth with some evidence to prove the presumption. The burden of proof, however, remains with the party in whose favor the presumption exists. Once this presumption is rebutted, insolvency at the time of payment is necessary, and only someone with the training of an accountant is in a position to prove in- solvency. The accountant often assists the debtor or trustee in presenting evidence showing whether the debtor was solvent or insolvent at the time payment was made. In cases where new management is in charge of the business or where a trustee has been appointed, the em- phasis is often on trying to show that the debtor was insolvent in order to recover the previous payments and increase the size of the estate. The creditors’ committee likewise wants to show that the debtor was insolvent at the time of payment to provide a larger basis for payment to unsecured creditors. Of course, the specific creditor recovering the payment looks for evi- dence to indicate that the debtor was solvent at the time payment was made. Any payments made within the 90 days preceding the bankruptcy court ﬁling and that are not in the ordinary course of business should be very carefully reviewed to see if the payments were pref- erences. Suspicious transactions would include anticipations of debt obligations, repayment of ofﬁ- cers’ loans, repayment of loans that have been personally guaranteed by ofﬁcers, repayment of loans made to personal friends and relatives, collateral given to lenders, and sales of merchandise made on a countraaccount basis.
43 14 BANKRUPTCY • In seeking to ﬁnd voidable preferences, the accountant has two crucial tasks: to determine the ear- liest date on which insolvency can be established within the 90-day period (one year for insiders), and to report to the trustee’s attorney questionable payments, transfers, or encumbrances that have been made by the debtor after that date. It is then the attorney’s responsibility to determine the void- able payments. However, the accountant’s role should not be minimized, for it is the accountant who initially determines the suspect payments. See Newton (2000) for a discussion of the procedures to follow in a search for preferences. (h) FRAUDULENT TRANSFERS. Fraudulent transfers and obligations are deﬁned in Section 548 and include transfers that are presumed fraudulent regardless of whether the debtor’s actual intent was to defraud creditors. A transfer may be avoided as fraudulent when made within one year prior to the ﬁling of the bankruptcy petition, if the debtor made such transfer or incurred such obligation with ac- tual intent to hinder, delay, or defraud existing or real or imagined future creditors. Also avoidable are constructively fraudulent transfers where the debtor received less than a reasonably equivalent value in exchange for such transfer or obligation and (1) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (2) was engaged in business, or was about to engage in business or a transaction, for which any prop- erty remaining with the debtor was an unreasonably small capital; or (3) intended to incur, or believed that the debtor would incur, debts that would burden the debtor’s ability to pay as such debts matured. Under Section 544 of the Bankruptcy Code, fraudulent transfers may also be recovered under state law for payments made between one and six years. Section 546 provides that any action to re- cover a preference or a fraudulent transfer under Section 548 through the Bankruptcy Code or under Section 544 through state law must commence the action within two years after the order for relief or if a trustee is appointed during the second year after the petition is ﬁled within one year after the trustee is appointed. In the determination of fraudulent transfers, insolvency is deﬁned by Section 101(32) as occurring when the present fair salable value of the debtor’s property is less than the amount required to pay its debts. The fair value of the debtor’s property is also reduced by any fraudulently transferred property, and for an individual, by the exempt property under Section 522. (i) LBO as a Fraudulent Transfer. A fraudulent transfer may occur in a leveraged buyout (LBO). For example, in a LBO transaction where the assets of the debtor were used to ﬁnance the purchase of the debtor’s stock and the debtor became insolvent, operated with an unreasonably small capital, or incurred debt beyond the ability to repay, a fraudulent transfer may have occurred. Note that the transfer may have been made without adequate consideration because the debtor corporation re- ceived no beneﬁt from the proceeds from the loan that were used to retire former stockholder’s stock. (ii) Accounting Services—Search for Fraudulent Transfers. It is important for the accountant to ascertain when a fraudulent transfer has in fact occurred because it represents a possible recovery that could increase the value of the estate. It can, under certain conditions, prevent the debtor from obtaining a discharge. To be barred from a discharge as the result of a fraudulent transfer, the debtor must be an individual and the proceedings must be under chapter 7 liquidation or the trustee must be liquidating the estate under a Chapter 11 proceeding. In ascertaining if the debtor has made any fraudulent transfers or incurred fraudulent obligations, the independent accountant would carefully examine transactions with related parties within the year prior to the petition or other required period, look for the sale of large amounts of ﬁxed assets, review liens granted to creditors, and examine all other transactions that appear to have arisen outside the or- dinary course of the business. (i) POSTPETITION TRANSFERS. Section 549 allows the trustee to avoid certain transfers made after the petition is ﬁled. To be avoidable, transfers must not be authorized either by the court or by an explicit provision of the Bankruptcy Code.
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43 15 • (i) Adequate Value Received. The trustee can avoid transfers made under Section 303(f) and 542(c) of the Bankruptcy Code even though authorized. Section 303(f) authorizes a debtor to con- tinue operating the business before the order for relief in an involuntary case. Section 549 does, however, provide that a transfer made prior to the order for relief is valid to the extent of value re- ceived. Thus, the provision of Section 549 cautions all persons dealing with a debtor before an order for relief has been granted to evaluate the transfers carefully. Section 542(c) explicitly au- thorizes certain postpetition transfers of real property of the estate made in good faith by an entity without actual knowledge or notice of the commencement of the case. (ii) Accounting Services—Preventing Unauthorized Transfers. To prevent unauthorized transfers, the procedures that the accountant should see are operative include the following three: 1. Establishing procedures to ensure that prepetition debt payments are made only with proper authorization 2. Designating an individual to handle all requests for prepetition debt payments 3. Acquainting accounting personnel with techniques that might be used to obtain unauthorized prepetition debt payments (j) SETOFFS. Setoff is that right existing between two parties to net their respective debts where each party, as a result of unrelated transactions, owes the other an ascertained amount. The right to setoff is an accepted practice in the business community today. When one of the two par- ties is insolvent and ﬁles a bankruptcy court petition, the right to setoff has special meaning. Once the petition is ﬁled, the debtor may compel the creditor to pay the debt owed and the credi- tor may in turn receive only a small percentage of the claim—unless the Bankruptcy Code per- mits the setoff. The Bankruptcy Code gives the creditor the right to offset a mutual debt, providing both the debt and the credit arose before the commencement of the case. Major restriction on the use of setoff prevents the creditor from unilaterally making the setoff after a petition is ﬁled. The right to setoff is subject to the automatic stay provisions of Section 362 and the use of property under Section 363. Thus, a debtor must obtain relief from the automatic stay before proceeding with the setoff. This automatic stay and the right to use the amount subject to setoff is possible only when the trustee or debtor in possession provides the creditor with adequate protection. If adequate protection—normally in the form of periodic cash payments, additional or replace- ment collateral, or other methods that will provide the creditor with the indubitable equivalent of its interest—is not provided, then the creditor may proceed with the offset as provided in Section 553. (i) Early Setoff Penalty. Section 553(b) contains a penalty for those creditors who, when they see the ﬁnancial problems of the debtor and threat of the automatic stay, elect to offset their claim prior to the petition. The Code precludes the setoff of any amount that is a betterment of the creditor’s position during the 90 days prior to the ﬁling of the petition. Any improvement in position may be recovered by the debtor in possession or trustee. The amount to be recovered is the amount by which the insufﬁciency on the date of offset is less than the insufﬁciency 90 days before the ﬁling of the petition. If no insufﬁciency exists 90 days before the ﬁling of the peti- tion, then the ﬁrst date within the 90-day period where there is an insufﬁciency should be used. Insufﬁciency is deﬁned as the amount by which a claim against the debtor exceeds a mutual debt owing to the debtor by the holder of such claim. The amount recovered is considered an unse- cured claim. (ii) Accounting Services—Setoffs. In addition to developing a schedule that helps deter- mine the amount of the penalty, the accountant may assist in determining the amount of debt outstanding.
43 16 BANKRUPTCY • (k) RECLAMATION. One area where the avoiding power of the trustee is limited is in a re- quest for reclamation. Section 546(c) provides that under certain conditions, the creditor has the right to reclaim goods if the debtor received the goods while insolvent. To reclaim these goods, the seller must demand in writing, within 10 days after their receipt by the debtor, that the goods be returned. The court can deny reclamation, assuming the right is established, only if the claim is considered an administrative expense or if the claim is secured by a lien. A creditor faces some problems in attempting to reclaim goods. One is that the request must be made within 10 days. If the 10-day period expires after the commencement of the case, the seller may reclaim the goods within 20 days after the receipt of the goods by the buyer. Requests made after this time period are denied. Another problem is that the right of reclamation under UCC Section 2-702 is basically a right to obtain the physical return of particular goods in the hands of the debtor. If the goods have been sold or used, the ability to obtain the goods may be limited. For example, it is doubtful that the seller could reclaim goods that were sold by the debtor to a purchaser in good faith that had no knowledge of the debtor’s ﬁnancial problems. Also, the reclamation rights of the seller are subject to any supe- rior right of other creditors, which most likely would include the good faith purchaser or buyer in the ordinary course of business. The court may deny reclamation to a seller that has the right to the reclamation only if the court either grants an administrative expense for the amount of the claim or secures such claim with a lien. (l) U.S. TRUSTEE. Chapter 30 of Title 28, U.S. Code, provides for the establishment of the U.S. trustee program. The Attorney General is responsible for appointing one U.S. trustee in each of the 21 regions, and one or more assistant U.S. trustees perform the supervisory and appointing func- tions formerly handled by bankruptcy judges. They are the principal administrative ofﬁcers of the bankruptcy system. The judicial districts of Alabama and North Carolina were not to be a part of the expansion of the U.S. Trustee program until 1992. The Judicial Improvements Act of 1990 (P.L. 101-650) extended the time period in which the six districts must be a part of the system to October 1, 2002. In these districts, some of the functions performed by the U.S. trustee in other districts are assigned to an administrator in the bankruptcy court. The U.S. trustee establishes, maintains, and supervises a panel of private trustees that are eligible and available to serve as trustee in cases under chapter 7 or 11. Also, the U.S. trustee supervises the administration of the estate and the trustees in cases under chapter 7, 11, 12, or 13. The intent is not for the U.S. trustee system to replace private trustees in chapters 7 and 11. Rather, the system should relieve the bankruptcy judges of certain administrative and supervisory tasks and thus help to elimi- nate any institutional bias or the appearance of any such bias that may have existed in the prior bank- ruptcy system. The U.S. trustees are responsible for the administration of cases. They appoint the committees of creditors with unsecured claims and also appoint any other committees of creditors or stockholders authorized by the court. If the court deems it necessary to appoint a trustee or examiner, a U.S. trustee makes this appointment (subject to court approval) and also petitions the court to authorize such an appointment. U.S. trustees monitor applications for compensation and reimbursement for ofﬁcers and accoun- tants and other professionals retained in the case, raising objections when deemed appropriate. Other responsibilities include monitoring plans and disclosure statements, creditors’ committees, and the progress of the case. 43.4 HANDLING OF CLAIMS UNDER CHAPTER 11 A claim antedating the ﬁling of the petition that is not a priority claim or that is not secured by the pledge of property is classiﬁed as an unsecured claim. Claims where the value of the security interest is less than the amount of the claims are divided into a secured and an unsecured part.
43.4 HANDLING OF CLAIMS UNDER CHAPTER 11 43 17 • (a) PROOF OF CLAIMS. A proof of claim or interest is deemed ﬁled in a Chapter 11 case pro- vided the claim or interest is listed in the schedules ﬁled by the debtor, unless the claim or inter- est is listed as disputed, contingent, or unliquidated. A creditor is thus not required to ﬁle a proof of claim if it agrees with the debt listed in the schedules. It is, however, advisable for creditors to ﬁle a proof of claim in most situations. Creditors who for any reason disagree with the amount admitted on the debtor’s schedules, such as allowable prepetition interest on their claims, or cred- itors desiring to give a power of attorney to a trade association or lawyer, should always prepare and ﬁle a complete proof of claim. Special attention must also be devoted to secured claims that are undersecured. (b) UNDERSECURED CLAIMS. Section 506 provides that if a creditor is undersecured, the claim will be divided into two parts. The ﬁrst part is secured to the extent of the value of the collateral or to the extent of the amount of funds subject to setoff. The balance of the claim is considered unsecured. The value to be used to determine the amount of the secured claim is, according to Section 506(a), to “be determined in light of the purpose of the valua- tion and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditors’ interest.” Bankruptcy Rule 3012 provides that any party in interest may petition the court to determine the value of a secured claim. Thus, the approach used to value property subject to a lien for a chapter 7 may be different from that for a Chapter 11 proceeding. Even within a Chapter 11 case, property may be valued differently. For example, ﬁxed assets that are going to be sold because of the discontinuance of operations may be assigned liquidation values, whereas assets that will continue to be used by the debtor may be as- signed going concern values. Although courts have to determine value on a case-by-case basis, it is clear that the value is to be determined in light of the purpose of the valuation and the proposed dis- position or use of the property. Section 1111(b) allows a secured claim to be treated as a claim with recourse against the debtor in Chapter 11 proceedings (that is, where the debtor is liable for any deﬁciency between the value of the collateral and the balance due on the debt) whether the claim is nonrecourse by agreement or by ap- plicable law. This preferred status terminates if the property securing the loan is sold under Section 363 or is to be sold under the terms of the plan, or if the class of which the secured claim is a part elects application of Section 1111(b)(2). Another available section under Section 1111(b) is that a class of undersecured creditors can elect to have its entire claim considered secured. A class of creditors will normally be only one creditor. For example, in Chapter 11 cases where most of the assets are pledged, very little may be available for unsecured creditors after paying administrative expenses. Thus, the creditor might ﬁnd it advisable to make the Section 1111(b)(2) election. On the other hand, if there will be a payment to unsecured creditors of approximately 75 cents per dollar of debt, the creditor may not want to make this election. The purpose of the election is to provide adequate protection to holders of secured claims where the holder is of the opinion that the collateral is undervalued. Also, if the treatment of the part of the debt that is accorded unsecured status is so unattractive, the holder may be willing to waive his unse- cured deﬁciency claims. The class of creditors making this election has the right to receive full pay- ment for its claims over time. If the members of the class do not approve the plan, the court may conﬁrm the plan as long as the plan provides that each member of the class receives deferred cash payments totaling at least the allowed amount of the claim. However, the present value of these pay- ments as of the effective date of the plan must be at least equal to the value of the creditors’ interest in the collateral. Thus, a creditor who makes the election under Section 1111(b)(2) has the right to re- ceive full payment over time, but the value of that payment is only required to equal the value of the creditor’s interest in the collateral. (c) ADMINISTRATIVE EXPENSES. The actual, necessary costs of preserving the estate, in- cluding wages, salaries, and commissions for services rendered after the commencement of the
43 18 BANKRUPTCY • case, are considered administrative expense. Any tax including ﬁnes or penalties is allowed un- less it relates to a tax-granted preference under Section 507(a)(8). Compensation awarded a professional person, including accountants, for postpetition services is an expense of adminis- tration. Expenses incurred in an involuntary case subsequent to the ﬁling of the petition but prior to the appointment of a trustee or the order for relief are not considered administrative ex- penses. They are, however, granted second priority under Section 507. Administrative ex- penses of a Chapter 11 case that is converted to chapter 7 are paid only after payment of chapter 7 administrative expenses. (d) PRIORITIES. Section 507 provides for the following nine priorities: 1. Administrative expenses 2. Unsecured claims in an involuntary case arising after commencement of the proceedings but before an order of relief is granted 3. Wages earned within 90 days prior to ﬁling the petition (or the cessation of the business) to the extent of $4,000 per individual 4. Unsecured claims to employee beneﬁt plans arising within 180 days prior to ﬁling petition limited to $4,000 times the number of employees covered by the plan less the amount paid in (3) above and the amount previously paid on behalf of such employees 5. Unsecured claims of grain producers against a grain storage facility or of ﬁshermen against a ﬁsh storage or processing facility to the extent of $4,000 6. Unsecured claims of individuals to the extent of $1,800 from deposits of money for purchase, lease, or rental of property or purchase of services not delivered or provided 7. Claims for debts to a spouse or former spouse or child for alimony, maintenance, or support payments 8. Unsecured tax claims of governmental units: a. Income or gross receipts tax, provided tax return was due (including extension) within three years prior to ﬁling petition, tax is assessable after commencement of the case; or tax was assessed within 240 days before petition was ﬁled b. Property tax last payable without penalty within one year prior to ﬁling petition c. Withholding taxes d. Employment tax on wages, and so forth, due within three years prior to the ﬁling of the petition e. Excise tax due within three years prior to the ﬁling of the petition f. Customs duty on merchandise imported within one year prior to the ﬁling of the petition g. Penalties related to a type of claim above in compensation for actual pecuniary loss 9. Allowed unsecured claims based on any commitment by the debtor to the Federal depository institutions regulatory agency (or predecessors to such agency), to maintain the capital of an insured depository institution Priority claims in a Chapter 11 case must be provided for in the plan. (e) PROCESSING OF CLAIMS. Several accounting ﬁrms and other businesses have developed models to handle the processing of claims of both small and large debtors. Some of their features in- clude these six: 1. Capture of all the various formats of claims needed by the bankruptcy court 2. Information needed for management to review and evaluate each claim 3. Mailing lists and labels