Accountants’ Handbook Special Industries and Special Topics 10th Edition_18 pdf

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.
42.6 SOURCES AND SUGGESTED REFERENCES 42
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27
CHAPTER
43
BANKRUPTCY
Grant W. Newton, PhD, CPA, CIRA
Pepperdine University
43.1 OVERVIEW 2
43.2 ALTERNATIVES AVAILABLE TO
TROUBLED COMPANIES 2
(a) Out-of-Court Settlements 2
(i) Appointment of Creditors’
Committee 3
(ii) Plan of Settlement 3
(b) Assignment for Benefit of
Creditors 3
(c) Bankruptcy Court Proceedings 3
(i) Title 11—Bankruptcy
Code 4
(ii) Chapter 7—Liquidation 4
(iii) Chapter 12—Adjustment
of Debt of a Family
Farmer with Regular

Annual Income 5
(iv) Prepackaged Chapter 11
Plans 6
(d) The Accountant’s Services in
Proceedings 7
43.3 GENERAL PROVISIONS OF
BANKRUPTCY CODE 7
(a) Filing of Petition 7
(b) Timing of Petition—Tax
Considerations 8
(c) Accounting Services—
Accounting Data Required in
the Petition 8
(d) Adequate Protection and
Automatic Stay 9
(i) Relief from the Stay 10
(ii) Accounting Services—
Determining Equity in
Property 10
(e)
Executory Contracts and Leases
11
(i) Limitations on Executory
Contracts 11
(ii) Accounting Services—
Rejection of Executory
Contracts 11
(f) Avoiding Power 12
(g) Preferences 12
(i) Exceptions to Preferential

Transfers 12
(ii) Accounting Services—
Search for Preferential
Payments 13
(h) Fraudulent Transfers 14
(i) LBO as a Fraudulent
Transfer 14
(ii) Accounting Services—
Search for Fraudulent
Transfers 14
(i) Postpetition Transfers 14
(i) Adequate Value
Received 15
(ii) Accounting Services—
Preventing
Unauthorized Transfers 15
(j) Setoffs 15
(i) Early Setoff Penalty 15
(ii) Accounting Services—
Setoffs 15
(k) Reclamation 16
(l) U.S. Trustee 16
43.4 HANDLING OF CLAIMS
UNDER CHAPTER 11 16
(a) Proof of Claims 17
(b) Undersecured Claims 17
(c) Administrative
Expenses 17
(d) Priorities 18
(e) Processing of Claims 18

43
•
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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-
43.5 OPERATING UNDER CHAPTER 11 19
(a) Use of Property 19
(i) Cash Collateral 19
(ii) Accounting Services—
Assisting Debtor in
Providing Information to
Secured Lender 20
(b) Obtaining Credit 20
(c) Appointment of Trustees 21
(d) Appointment of Examiner 21
(i) Functions of Examiner 22
(ii) Accountants as Examiners 22
(e) Operating Statements 22
(f) Reporting in Chapter 11 22

(i) Balance Sheet 23
(ii) Statement of Operations 24
(iii) Statement of Cash Flows 25
43.6 CHAPTER 11 PLAN 26
(a) Classification of Claims 26
(b) Development of Plan 26
(c) Disclosure Statement 27
(i) Definition of Adequate
Information 27
(ii) Content 27
(d) Confirmation of Plan 29
(e) Confirmation Requirements 29
(f) Accounting Services—
Assistance to Debtor 30
(i) Liquidation Value of
Assets 30
(ii) Projections of Future
Operations 30
(iii) Reorganization Value 31
(iv) Pro Forma Balance Sheet 31
(v) Reorganization Model 31
(g) Accounting Services—
Assistance to Creditors’
Committee 32
(i) Assistance in the
Bargaining Process 32
(ii) Evaluation of Debtor’s
Projections 32
(iii) Reorganization Value 33
(iv) Review of Plan and

Disclosure Statement 33
(h) Accounting for the
Reorganization 34
(i) Requirements for Fresh
Start Reporting 34
(ii) Allocation of
Reorganization Value 34
(iii) Disclosure Requirements 35
(iv) Reporting by Debtors Not
Qualifying for Fresh Start 35
(i) Accounting for the Impairment
of Long-Lived Assets Under
Chapter 11 36
43.7 REPORTING REQUIREMENTS
IN BANKRUPTCY CASES 37
(a) Litigation Services 37
(b) Disclosure Requirements 38
(c) Operating Reports 38
(d) Investigative Services 39
(e) Financial Projections 40
43.8 SOURCES AND SUGGESTED
REFERENCES 41
43
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BANKRUPTCY
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
43.2 ALTERNATIVES AVAILABLE TO TROUBLED COMPANIES 43
•
3
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
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BANKRUPTCY
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
43.2 ALTERNATIVES AVAILABLE TO TROUBLED COMPANIES 43
•
5
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
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BANKRUPTCY
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.
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43
•
7
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 liabilit
y, 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
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BANKRUPTCY
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
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43

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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
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BANKRUPTCY
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.
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43
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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).
(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
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BANKRUPTCY
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 Ϫ $500,000) Ϫ ($625,000 Ϫ $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.
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43
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13
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.

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BANKRUPTCY
(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 ex
tent 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.
43.3 GENERAL PROVISIONS OF BANKRUPTCY CODE 43
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(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.
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BANKRUPTCY
(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
43.4 HANDLING OF CLAIMS UNDER CHAPTER 11 43
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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
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BANKRUPTCY
4. Creditor statements
5. Online update and inquiry capability
6. Modeling and decision analysis capability that enables management to evaluate settlement al-
ternatives efficiently
One system uses a multifield data base to help debtors deal with the complexities of a bank-
ruptcy. Creditors’ files can be sorted in terms of classes of creditors, priorities of claims, and so on,
and then alphabetically within these categories. Notices sent to creditors include all the necessary
information, such as the amount of a claim and its current status. Ongoing information that changes
over time is constantly updated. This could include the extent to which proofs of claim differ from
the recorded debt, the assessment of market values of collateral pledged as security, other assets
that are not pledged as security, distributions made during the course of a Chapter 11 case, and
changes to or withdrawals of claims. Automatically prepared and mailed notices keep creditors cur-
rent on the proceedings of a case. The system, through automatic mailings, answers telephone in-
quiries as they are entered.
43.5 OPERATING UNDER CHAPTER 11
No order is necessary under the Bankruptcy Code for the debtor to operate the business in Chapter
11. Sections 1107(a) and 1108 grant the debtor all the rights, powers, and duties of a trustee, except
the right to compensation under Section 330, and provide that the trustee may operate the business
unless the court directs otherwise. Thus, the debtor will continue to operate the business unless a
party in interest requests that the court appoint a trustee. Until action is taken by management to cor-
rect the problems that caused the adverse financial condition, the business will most likely continue
to operate at a loss. If the creditors believe new management is necessary to correct the problem, they
will press for a change in management or the appointment of a trustee. In most large bankruptcies as
well as in many smaller cases, the management is replaced, often by turnaround specialists, who
have particular expertise in taking over troubled companies. They often eliminate the unprofitable
aspects of the company’s operations, reduce overhead, and find additional financing as part of the
turnaround process. Once the plan has been confirmed, turnaround specialists frequently move on to
other troubled companies. In small cases where management is also the stockholders, creditors are
apt to be uncomfortable with existing management, which may have created the problems.

(a) USE OF PROPERTY. The debtor or trustee must be able to use a secured party’s collateral, or
in most situations there would be no alternative but to liquidate the business. Section 363(c) gives the
trustee or debtor the right to use, sell, or lease property of the estate in the ordinary course of business
without a notice and a hearing. As a result of this provision, the debtor may continue to sell inventory
and receivables and use raw materials in production without notice to secured creditors and without
court approval. The use, sale, or lease of the estate’s property other than in the ordinary course of
business is allowed only after notice and an opportunity for a hearing. Under Section 363 of the
Bankruptcy Code, companies, with court approval, may sell all of a large percent of the assets of
the company. As noted below, the sale of all or a large percentage of the debtor’s assets is
viewed as a very viable option to the development of a plan.
(i) Cash Collateral.
One restriction on the use of the property of the bankruptcy estate is placed
on the trustee or debtor where cash collateral is involved. Cash collateral is cash, negotiable instru-
ments, documents of title, securities, deposit accounts, or other cash equivalents where the estate
and someone else have an interest in the property. Also included would be the proceeds of noncash
collateral, such as inventory and accounts receivable and proceeds, products, offspring, and rents,
profits, or property subject to a security interest, if converted to proceeds of the type defined as cash
collateral, provided the proceeds are subject to the prepetition security interest.
43.5 OPERATING UNDER CHAPTER 11 43
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To use cash collateral, the creditor with the interest must consent to its use, or the court, after no-
tice and hearing, must authorize its use. The court may authorize the use, sale, or lease of cash col-
lateral at a preliminary hearing if there is a reasonable likelihood that the debtor in possession will
prevail at the final hearing. The Bankruptcy Code also provides that the court is to act promptly for a
request to use cash collateral.
(ii) Accounting Services—Assisting Debtor in Providing Information to Secured Lender. In
many cases, a company cannot operate unless it can obtain use of its cash collateral. For example,
cash in bank accounts subject to setoff or collections from pledged receivables and inventory prior to
the filing of the petition are not available for use until the company obtains the consent of the appro-

priate secured creditor or of the court.
Thus, an immediate concern of many companies that need to file a Chapter 11 petition is how
to procure enough cash to operate for the first week or so after filing the petition. Often the best
way to obtain the use of the cash is to get approval from the secured creditor prior to the filing of
the petition. Accountants can work with the debtor in putting together information for the secured
lender that may result in the pledge of additional property or an extension of a receivable or in-
ventory financing agreement for the release of cash to allow operation of the business once the pe-
tition is filed.
(b) OBTAINING CREDIT. I
n most Chapter 11 proceedings, the debtor must obtain additional fi-
nancing in order to continue the business. Although the debtor was allowed to obtain credit under prior
law, the power granted to the debtor under the Bankruptcy Code is broader. Section 364(a) allows the
debtor to obtain unsecured debt and to incur unsecured obligations in the ordinary course while oper-
ating the business. This right is automatic unless the court orders otherwise. Also the holder of these
claims is entitled to first priority as administrative expenses.
If the debtor is unable to obtain the necessary unsecured debt under Section 364(a), the court may
authorize the obtaining of credit and the incurring of debt by granting special priority for claims.
These priorities may include the following:
•
Giving priority over any or all administrative expenses
•
Securing the debt with a lien on unencumbered property
•
Securing the debt with a junior lien on encumbered property
Debtor-in-possession (DIP) financing may be obtained from the existing lender or from a new
lender. Most all major banks are involved in DIP financing as well as several other financial entities,
including funds that are established to make loans to companies in Chapter 11 and on emergence
from Chapter 11. At times existing creditors will lend to the Chapter 11 debtor in order to prevent
other lenders from obtaining a position that may be superior to that of the existing lender. The bank-
ruptcy court may allow the debtor to prime

3
the position of the existing lender. However, for the
court to authorize the obtaining of credit with a lien on encumbered property that is senior or equal
to the existing lien, the debtor must not be able to obtain credit by other means and the existing lien
holder must be adequately protected.
Credit obtained other than in the ordinary course of business must be authorized by the court after
notice and a hearing. Where there is some question whether the credit is related to the ordinary
course of business, the lender should require court approval.
The number of 363 sales has recently increased compared to the number of plans approved.
Banks and other financial institutions are less willing to lend funds for the time period necessary
for businesses to reorganize, but may be willing to provide funds for a shorter period while the
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BANKRUPTCY
3
Priming allows a new lender to obtain a lien in all or some of the property of the debtor that is above that
of the existing lender for the new funds lent to the debtor.
debtor implements a 363 sale. Additionally, creditors appear to be less patient today than they
were in the 1980s and early 1990s, asking debtors to sell the business or in some cases filing a
motion asking the court to provide for a 363 sale.
Asset sales are not restricted to the middle market or smaller cases. For example, companies
like Polaroid (received $56.5 million cash for assets of its Identification Systems Business Divi-
sion), Fruit of the Loom (business operations purchased by Berkshire Hathaway, Inc.), and LTV
Corporation (sold its integrated steel assets to WL Ross & Co.) completed significant asset sales
as a part of their Chapter 11 filing.
(c) APPOINTMENT OF TRUSTEES. The Bankruptcy Code provides that a trustee can be ap-
pointed in certain situations based on facts in the case and not related to the size of the company
or the amount of unsecured debt outstanding. The trustee is appointed only at the request of a
party in interest after a notice and hearing. A party in interest includes the debtor, the trustee (in

other contexts), creditors’ or stockholders’ committees, creditors, stockholders, or indenture
trustees. Also, a U.S. trustee, while not a party in interest, may petition the court for an appoint-
ment of a trustee.
Section 1104(a) states that a trustee be appointed:
1. For cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of
the debtor by current management, either before or after the commencement of the case, or sim-
ilar cause, but not including the number of holders of securities of the debtor or the amount of
assets or liabilities of the debtor; or
2. If such appointment is in the interest of creditors, any equity security holders, and other interests
of the estate, without regard to the number of holders of securities of the debtor or the amount of
assets or liabilities of the debtor.
The U.S. trustee is responsible for the appointment of the trustee from a panel of quali-
fied trustees, once the appointment has been authorized by the court. It also appears that
the U.S. trustee would have the right to replace trustees who fail to perform their functions
properly.
The Bankruptcy Code, as originally enacted, provided that in a Chapter 7 case, the interim
trustee appointed by the U.S. trustee would serve as the trustee unless a trustee is elected by a ma-
jority of at least 20% of the unsecured creditors voting in an election at a meeting of creditors under
Section 341 of the Bankruptcy Code. In most Chapter 7 cases, the interim trustee serves as the
trustee. The Bankruptcy Reform Act of 1994 modified Section 1104 of the Bankruptcy Code to pro-
vide that on request of a party in interest (made within 30 days after the court authorized the ap-
pointment of a trustee), the U.S. trustee must call a meeting of unsecured creditors for the purpose
of electing a Chapter 11 trustee. This change might encourage more creditors to petition the court
for the appointment of a trustee in a Chapter 11 case because the creditors now have some impact as
to who is appointed.
(d)
APPOINTMENT OF EXAMINER. Under the Bankruptcy Code, the trustee’s major func-
tions are to (1) operate the business and (2) conduct an investigation of the debtor’s affairs.
Under certain conditions, it may be best to leave the current management in charge of the busi-
ness, without resolving the need for the investigation of the debtor. The Code provides for the

appointment of an examiner to perform this function. Section 1104(b) states that if a trustee is
not appointed:
. . . [O]n request of a party in interest, and after notice and hearing, the court shall order the ap-
pointment of an examiner to conduct such an investigation of the debtor as is appropriate, including
an investigation of any allegations of fraud, dishonesty, incompetence, misconduct, mismanage-
ment, or irregularity in the management of the affairs of the debtor of or by current or former man-
agement of the debtor, if
43.5 OPERATING UNDER CHAPTER 11 43
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1. Such appointment is in the interest of creditors, any equity security holders, and other interests
of the estates; or
2. The debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or
owing to an insider, exceed $5 million.
(i) Functions of Examiner. The function of the examiner is to conduct an investigation into
the actions of the debtor, including fraud, dishonesty, mismanagement of the financial condition
of the debtor and the operation of the business, and the desirability of the continuation of such
business. The report is to be filed with the court and given to any creditors’ committee, stock-
holders’ committees, or other entities designated by the court. In addition to these two provisions,
Section 1106(b) also states that an examiner may perform other functions as directed by the
court. In some cases, the court has expanded the role of the examiner. For example, the bank-
ruptcy judges may prefer to see additional controls exercised over the management of the debtor,
but may not see the need to incur the costs of the appointment of a trustee. These functions are as-
signed to the examiner.
(ii) Accountants as Examiners. Accountants may serve as examiners, and in some regions U.S.
trustees have expressed a preference for appointing accountants in certain situations. Where a fi-
nancial investigation is needed, an accountant may be the most qualified person to perform as an
examiner. In many cases where the role of the examiner has been expanded, accountants were serv-
ing as examiners.
(e) OPERATING STATEMENTS. Several different types of reports are required while the debtor is

operating the business in a Chapter 11 reorganization proceeding. The nature of the reports and the
time period in which they are issued depend to some extent on local rules and on the type of internal
controls of the debtor and the extent to which large losses are anticipated.
Districts establish local bankruptcy rules that generally apply to all cases filed in that particu-
lar district. These rules cover some of the procedural matters that relate to the handling of a
bankruptcy case, including appearance before the court, forms of papers filed with the court,
assignment of case, administration of case, employment of professionals, and operating state-
ments. The rules for the filing of operating statements have become primarily the responsibility
of the U.S. trustee and, as a result, the specific procedures for these statements are those of the
U.S. trustee.
O
ne statement required by all regions is an operating statement—profit and loss statement.
This statement may include, in addition to the revenue and expense accounts needed to deter-
mine net income on the accrual basis, an aging of accounts payable (excluding prepetition
debts) and accounts receivable, status of payments to secured creditors, analysis of tax pay-
ments, analysis of insurance payments and coverage, and summary of bankruptcy fees that
have been paid or are due.
The U.S. trustee also requires cash receipts and disbursement statements. In some cases, it may
be necessary to prepare this statement for each bank account of the debtor. For example, the U.S.
trustee for the central district of California requires that the debtor, in addition to the regular account,
establish separate accounts for payroll and taxes. Separate cash receipts and disbursement statements
are also required for each account.
An independent accountant may assist the debtor in the preparation of these monthly operating
reports. See Section 43.7(c) of this chapter.
(f)
REPORTING IN CHAPTER 11. In November 1990, the American Institute of Certi-
fied Public Accountants (AICPA) issued Statement of Position (SOP) 90-7, Financial Re-
porting by Entities in Reorganization Under the Bankruptcy Code, which represents the
first major pronouncement to be issued on financial reporting by companies in bankruptcy.
The SOP applies to any company that files a Chapter 11 petition after December 31, 1990.

In addition, the provisions regarding fresh start reporting apply to any entity that has its
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BANKRUPTCY
plan confirmed after June 30, 1991, even though the Chapter 11 petition was filed before
January 1, 1991. Earlier use of the provisions of the SOP is encouraged for companies still
in Chapter 11.
The SOP was designed to eliminate some of the significant divergences in accounting for
bankruptcies and to increase the relevance of financial information provided to debtors, cred-
itors, stockholders, and other interested parties who make decisions regarding the reorganiza-
tion, especially the reorganization plan, of the debtor. The SOP applies to financial reporting
by companies that have filed Chapter 11 petitions and expect to reorganize as going concerns,
and to companies that emerge from Chapter 11 under confirmed plans. It does not apply to
companies that are restructuring their debt outside of Chapter 11 or to those that adopt Chap-
ter 11 plans of liquidation. It deals with how to report the activities of the Chapter 11 company
during the reorganization proceeding and how to report the emergence of the company from
Chapter 11.
A major objective of financial statements issued by the debtor in Chapter 11 should be to reflect
the financial evolution of the debtor during the proceeding. Thus, for financial statements issued in
the year the petition is filed and in subsequent years, a distinction should be made between transac-
tions and events directly associated with the reorganization, as opposed to those related to the on-
going operations of the business. This principle is reflected in several significant areas of the
financial statements.
(i) Balance Sheet. Paragraphs 23 to 26 of the SOP provide specific guidance for the preparation
of the balance sheet during the reorganization.
Liabilities subject to compromise should be separated from those that are not and from post-
petition liabilities. Liabilities that are subject to compromise include unsecured claims, under-
secured claims, and fully secured claims that may be impaired under a plan. Paragraph 23
indicates that if there is some uncertainty as to whether a secured claim is undersecured or will

be impaired under the plan, the entire amount should be included with prepetition claims subject
to compromise.
In view of this, it is expected that most prebankruptcy claims will be reported initially as liabil-
ities subject to compromise. There are a number of reasons for this. For example, at the time the
balance sheet is prepared, the collateral may not have been appraised. Also, it might be determined
as the case progresses that estimated cash flows from property are less than anticipated. All security
interests may not have been fully perfected. Due to these and other factors, it is not unusual for
claims that appeared fully secured at the onset of a case to be found to be compromised during the
proceedings.
Paragraph 26 also indicates that circumstances arising during the reorganization may require a
change in the classification of liabilities between those subject to compromise and those not subject
to compromise.
The principal categories (such as priority claims, trade debt, debentures, institutional claims, etc.)
of the claims subject to compromise should be disclosed in the notes to the financial statements. Note
that the focus of the reporting requirement is on providing information about the nature of the claims
rather than whether the claims are current or noncurrent.
Liabilities that are not subject to compromise consist of postpetition liabilities and liabili-
ties not expected to be impaired under the plan. They are reported in the normal manner and
thus should be segregated into current and noncurrent categories if a classified balance sheet
is presented.
Liabilities that may be affected by the plan should be reported at the amount expected to be al-
lowed even though they may be settled for a lesser amount. For example, once the allowed amount
of an existing claim is determined or can be estimated, the carrying value of the debt should be ad-
justed to reflect that amount. Paragraph 25 provides that debt discounts or premiums as well as
debt issue costs should be viewed as valuations of the related debt. When the allowed claim differs
from the net carrying amount of the debt, the discount or premium and deferred issue costs should
be adjusted to the extent necessary to report the debt at the allowed amount of the claim. If these
43.5 OPERATING UNDER CHAPTER 11 43
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