Grant W. Newton, CPA, CIRA, CMA, is Professor of Accounting at the Graziadio School of Business and Management at Pepperdine University and is Executive Director of the Association of Insolvency and Restructuring Advisors. He is the author of Corporate Bankruptcy: Tools, Strategies, and Alternatives (2003) and Bankruptcy and Insolvency Taxation (2005), both from Wiley. His articles have appeared in a large number of professional periodicals. He received his PhD from New York University, Master's from the University of Alabama, and BS from the University of North Alabama.

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• Preface xxxvAcknowledgments xxxixAbout the Author xliPART ONE BANKRUPTCY AND INSOLVENCY ENVIRONMENT 11 Accountant’s and Financial Advisor’s Role in Perspective, 31.1 Introduction, 31.2 Scope of Coverage, 4Accounting Services, 51.3 Need for Financial Advisor’s Services, 51.4 Financial Advisor Defined, 6Topical Overview, 71.5 Economic Causes of Business Failure, 71.6 Business Turnaround, 71.7 Alternatives Available to a Financially Troubled Business, 71.8 Comparison of Title 11 of the United States Code with the Bankruptcy Act, 111.9 Retention of the Financial Advisor and Fees, 131.10 Accounting Services, 141.11 Special Investigation and Financial Reporting, 141.12 Tax Awareness, 14Responsibilities of Independent Accountant, 151.13 Responsibilities in General, 151.14 Observation of Business Decline, 151.15 Responsibility to Client, 161.16 Advice on Selection of Attorneys, 171.17 Other Steps to “Manage” the Proceedings, 18Professional Certification, 181.18 Certified Insolvency and Restructuring Advisors, 181.19 Certification in Distressed Business Valuation, 202 Economic Causes of Business Failures, 212.1 Introduction, 21Definition of Successful and Unsuccessful Business, 212.2 Failure Defined, 212.3 Business Failure Statistics, 23Causes of Financial Difficulty, 242.4 Introduction, 242.5 Size of Business Failures, 262.6 Geographic Distribution of Business Failures, 292.7 Age of Business Failures, 302.8 Business Failures and Economic Conditions, 302.9 Characteristics of the Economic System, 332.10 Casualties, 342.11 Inside Underlying Causes, 342.12 Dishonesty and Fraud: Planned Bankruptcies, Sham, 422.13 Other External Causes, 42Stages of Financial Failure, 432.14 Introduction, 432.15 Period of Incubation, 442.16 Cash Shortage, 452.17 Financial or Commercial Insolvency (Equity Definition), 452.18 Total Insolvency (Bankruptcy Definition), 452.19 Bankruptcy or Out-of-Court Workout, 45Detection of Failure Tendencies, 462.20 Introduction, 462.21 Trend Analysis, 462.22 Analysis of Accounting Measures, 482.23 Analysis of Management, 642.24 Importance of Forecasts, 642.25 Other Factors, 65PART TWO LEGAL ASPECTS OF BANKRUPTCY AND INSOLVENCY PROCEEDINGS 673 Turnaround Process, 693.1 Objectives, 69Stages of Turnaround Process, 693.2 Introduction, 693.3 Stage 1: Management Change, 713.4 Stage 2: Situation Analysis, 72 Competitive Ability, 773.5 Stage 3: Design and Selection of Turnaround Strategy, 783.6 Stage 4: Emergency Action Stage, 813.7 Stage 5: Business Restructuring Stage, 873.8 Stage 6: Return-to-Normal Stage, 89Characteristics of Effective Turnaround Managers, 903.9 Introduction, 903.10 Organizational Leader, 913.11 Ability to Develop and Implement Strategy, 913.12 Entrepreneurial Instincts, 913.13 “Hands-On” Operating Experience, 913.14 Effective Negotiating Skills, 923.15 Good Interviewing Skills, 923.16 Action Orientation, 923.17 Trustworthiness and Fairness, 93Techniques Used in Business Turnarounds, 943.18 Introduction, 943.19 Lean Manufacturing, 943.20 Activity-Based Costing, 983.21 Retail Store “Four-Wall” Analysis, 1023.22 Business Process Reengineering, 108Summary and Recommendations, 1093.23 Summary, 1094 Nonbankruptcy Proceedings, 1114.1 Introduction, 111Out-of-Court Settlements, 1114.2 Nature of Proceedings, 1114.3 Importance of an Early Meeting Date, 1134.4 Preparation for the Creditors’ Meeting, 1134.5 Appointment of Creditors’ Committee, 1144.6 Duties and Functions of Creditors’ Committee, 1154.7 Interim Management, 1164.8 Committee Management, 116Preparation of a Plan of Settlement, 1184.9 Introduction, 1184.10 Conditions of Agreement, 1194.11 Out-of-Court Agreement Prior to Chapter 11 (Prepackaged Bankruptcy), 120Advantages and Disadvantages, 1214.12 Advantages, 1214.13 Disadvantages, 121Assignment for the Benefit of Creditors (State Court), 1224.14 Introduction, 1234.15 Duties, Functions, and Procedures of Assignee, 1224.16 Discharge of Debts, 1234.17 Advantages, 1244.18 Disadvantages, 1255 Nature of Bankruptcy and Insolvency Proceedings, 127 Origin, 1275.1 Introduction, 1275.2 United States, 1285.3 Insolvency and Bankruptcy Laws Today, 1305.4 Current Bankruptcy Statistics, 132Nature of Insolvency, 1345.5 Types of Insolvency, 1345.6 Equity versus Bankruptcy Meanings of Insolvency, 1355.7 Determination of Assets and Liabilities, 1355.8 Valuation of Assets, 1365.9 Insolvency and the Bankruptcy Code, 1365.10 Should There Be a Threshold Test?, 1375.11 Alternatives Available to a Financially Troubled Business, 139Assignment for the Benefit of Creditors (State Court), 1405.12 Introduction, 1405.13 Duties, Functions, and Procedures of Assignee, 1405.14 Discharge of Debts, 1415.15 Advantages, 1425.16 Disadvantages, 142Provisions Common to all Proceedings, 1435.17 Introduction, 1435.18 Bankruptcy Courts, 1445.19 U.S. Trustee, 1465.20 Sovereign Immunity, 1495.21 Commencement of Cases, 1545.22 Filing and Quarterly Fees, 1565.23 Partnership, 1575.24 Meeting of Creditors, 1585.25 Meeting of Equity Security Holders, 1595.26 Adequate Protection, 1595.27 Automatic Stay, 1645.28 Use of the Estate’s Property, 1745.29 Executory Contracts and Leases, 1755.30 Utility Service, 1935.31 Allowance of Claims or Interests, 1965.32 Expense of Administration, 2025.33 Priorities, 2055.34 Exemptions, 2075.35 Discharge of Debts, 2115.36 Property of the Estate, 2135.37 Avoiding Power of Trustee, 2205.38 Reclamation and 503(b)(9) Claim, 2225.39 Preferences, 2265.40 Fraudulent Transfers, 2495.41 Postpetition Transfers, 2585.42 Postpetition Effect of Security Interest, 2595.43 Setoffs, 260Chapter 7 Liquidation, 2635.44 Filing the Petition, 2635.45 Trustee, 2645.46 Creditors’ Committee, 2665.47 Partnerships, 2675.48 Treatment of Tax Liens, 2695.49 Liquidation of Assets, 2695.50 Discharge, 2715.51 Discharge of Environmental Claims, 278SIPC Liquidation, 2785.52 Introduction, 2785.53 Determination of Need of Protection, 2795.54 Appointment of Trustee, 2805.55 Court Jurisdiction, 2805.56 Powers and Duties of Trustee, 2835.57 Satisfaction of Claims, 2845.58 Prohibited Acts, 2865.59 Role of Securities and Exchange Commission, 2875.60 Compensation in an SIPA Action, 2886 Rehabilitation Proceedings Under the Bankruptcy Code, 2896.1 Introduction, 2896.2 Purpose of Chapter 11, 289Operating Under Chapter 11, 2906.3 Role of the Court and U.S. Trustee, 2906.4 KERPs, 2926.5 Consolidation of Chapter 11 Petitions, 2966.6 Creditors’ and Equity Holders’ Committees, 3026.7 Appointment or Election of Trustee, 3096.8 Appointment of Examiner, 3146.9 Operation of the Business, 3186.10 Automatic Stay, 3196.11 Impact of Timbers, 3196.12 Use of Collateral, 3206.13 Use of Cash Collateral, 3206.14 Obtaining Credit, 3226.15 Claims and Interests, 3306.16 Special Provisions for Partially Secured Creditors, 340Developing the Plan, 3426.17 Negotiating a Chapter 11 Plan, 3436.18 Exclusivity Period, 3446.21 Secured Claim Classification, 3566.22 Interest Classification, 3576.23 Content of the Plan, 3576.24 Permissible Provisions, 3596.25 Impairment of Claims, 3616.26 Disclosure Statement, 3646.27 Modification of the Plan, 373Confirmation of the Plan, 3756.28 Acceptance of the Plan, 3756.29 Confirmation Hearing, 3756.30 Confirmation Requirements, 3766.31 Best Interest of Creditors, 3786.32 Priority Treatment, 3796.33 Feasibility, 3816.34 Cramdown, 3856.35 Chapter 11 Cases Filed by Individuals, 394Postconfirmation, 3976.36 Impact, 3976.37 Distribution, 4006.38 Discharge of Debts, 4016.39 Postconfirmation Recovery, 4016.40 Securities Law Exemption, 4026.41 Final Decree, 4046.42 Conversion to Chapter 7 or Dismissal, 4056.43 Advantages and Disadvantages of Chapter 11, 407Chapter 12: Adjustment of Debts of a Family Farmer with Regular Annual Income, 4076.44 Purpose, 4076.45 Requirements for Use, 4086.46 Operation of Farm, 4086.47 Chapter 12 Plan, 409Chapter 13: Adjustment of Debts of an Individual with Regular Income, 4116.48 Nature, 4116.49 Filing of Petition, 4116.50 Operation of Business, 4136.51 The Plan, 4136.52 Discharge of Debts, 4176.53 Use of Chapter 13 by Business, 4186.54 Chapter 15: Ancillary and Other Cross Border Cases, 4197 Retention of the Financial Advisor and Fees, 4277.1 Introduction, 427Retention of the Financial Advisor, 4287.2 The Accountant or Financial Advisor’s Role in the Proceedings, 4287.3 Obtaining the Engagement, 4287.4 Retention Procedure, 4297.5 Creditors’ Committee, 4327.6 Source of Payment, 4337.7 Affidavit of Proposed Financial Advisor, 4347.8 Survey of Work to Be Performed, 4407.9 Application for Retention, 4417.10 Retention Order, 4447.11 Retention on a Retainer Basis, 4447.12 Deviations from Retention Order, 4457.13 Accountants as Consultants or Financial Advisors, 4457.14 Prepetition Retention, 4467.15 Retention Procedure—Informal, 4467.16 Accountants as Quasi-Officers of the Court, 447Determination of Financial Advisor’s Fees, 4477.17 Introduction, 4477.18 SEC May Object to Fees, 4487.19 Compensation Reviewed by U.S. Trustee, 4497.20 Compensation Must Be Approved by the Court, 4497.21 Factors to Consider When Estimating Fees, 4537.22 Compensation Based on Comparable Services, 4587.23 Prepetition Fees, 460Time Records, 4617.24 Requirements, 461Petition for Fee Allowance, 4627.25 Court Discretion in Ruling on Fees, 4627.26 Procedure for Filing the Petition, 4657.27 Payment for Services Rendered, 4668 Accounting and Financial Services for Debtors-in-Possession or Trustee, 469Nature of Accounting Services, 4698.1 Introduction, 4698.2 Parties Retaining Accountants and Financial Advisors, 4698.3 Summary of Services, 471Prefiling Stage of Chapter Proceedings, 4728.4 Importance of Early Meetings, 4728.5 Advice on Selection of Counsel, 4738.6 Conference with Attorney, 4738.7 Determine Alternatives, 4748.8 Prebankruptcy Planning, 475Accounting/Financial Reporting Requirements, 4818.9 Introduction, 4818.10 Affidavits in Support of Petition, 4838.11 Supporting Schedules, 4848.12 Statement of Financial Affairs, 4878.13 Monthly Reporting, 4888.14 U.S. Trustee’s Requirements, 4898.15 Operating Statements, 4908.16 SEC Reporting in Chapter 11, 4928.17 Bankruptcy Claims Management Process, 495Formulation of a Plan of Reorganization, 4998.18 Introduction, 4998.19 Liquidation Value of Assets, 5008.20 Projection of Future Operations, 5018.21 Reorganization Value, 5018.22 Pro Forma Balance Sheet, 5028.23 Formulating an Amended Plan, 5038.24 Disclosure Statement, 503Accountant and Financial Advisor as Examiner, 5048.25 Nature of Service, 504Additional or Other Accounting Services, 5058.26 Introduction, 5058.27 Normal Accounting Services, 5058.28 Special Investigation, 5058.29 Accounting Services and the Granting of New Credit, 507Professional Conduct of Accountants and Financial Advisors, 5088.30 Introduction, 5088.31 Personal Liability: Preparation of Financial Statements, 5088.32 Professional Conduct of Debtor’s Accountant— Toward Client, 5098.33 Professional Conduct of Debtor’s Accountant— Toward Creditors’ Accountant/Advisors, 5108.34 Direct Liability to Third Parties, 5118.35 Other Professional Ethical Factors, 5119 Other Financial Advisory Services for Debtors-in-Possession or Trustee, 5139.1 Introduction, 513Management Advisory Services, 5139.2 Introduction, 5139.3 Long-Range Business Plan, 5149.4 Financial Projections, 516Interim Management Services, 5169.5 Introduction, 5169.6 Retention, 5179.7 Billing, 517Balloting and Noticing Agent Services, 5179.8 Noticing Overview, 5179.9 Solicitation Overview, 5189.10 Pre-Balloting Services, 5199.11 Plan Classes, 5199.12 Solicitation Process, 5209.13 Plan Information and Ballots, 520Chapter 7 and Chapter 11 Liquidations, 5219.14 Introduction, 5219.15 Items Requiring Immediate Attention, 5219.16 Performance of Audits and Other Special Investigations, 5229.17 SIPC Liquidation, 522Postconfirmation Services, 5239.18 Overview, 5239.19 Litigation Trusts, 5239.20 Tort Trusts, 52310 Accounting and Financial Services for the Creditors’ Committee, 525Nature of Creditors’ Committee, 52510.1 Introduction, 52510.2 Creditors’ Committees, 52610.3 Directing Committee Activities, 53410.4 Data, 53510.5 Bargaining Process, 53510.6 Role of Creditors’ Financial Advisor in the Bargaining Process, 53610.7 Form of Consideration, 537Monitoring Debtor’s Activities, 53710.8 Introduction, 53710.9 Areas Requiring Immediate Attention, 53710.10 Importance of Speed, 53810.11 Establishment of Proper Controls, 53910.12 Investigation of Causes of Failure and Development of Controls to Limit Further Impairment of Assets, 54010.13 Review of Receipts and Disbursements Control, 54010.14 Review of Debtor’s Accounting System, 54110.15 “Insider” Problem, 54210.16 Review of Weekly/Monthly Reporting, 544Special Investigations and Reviews, 54510.17 Investigation of Debtor’s Books and Records, 54510.18 Review of Debtor’s Transactions, 54610.19 Evaluation of Debtor’s Projections, 54610.20 Review of Plan of Reorganization and Disclosure Statement, 547Other Accounting Services, 55010.21 Introduction, 55010.22 Secured Creditor, 55010.23 Major Stockholder or Equity Committee, 55010.24 Responsibilities of Creditors’ Financial Advisor, 55111 Valuation of a Business in Bankruptcy Proceedings, 553 Importance of Valuation, 55311.1 Introduction, 55311.2 Adequate Protection under Section 361, 55411.3 Claims Determination, 55811.4 Recovery Action, 56111.5 Chapter 13 Secured Claims, 56711.6 Determining Best Interest of Creditors and Stockholders under Chapter 11, 56811.7 Determining Whether a Plan Is Fair and Equitable to a Dissenting Class in Chapter 11, 56911.8 Determining Feasibility, 57311.9 Codification of Value, 573Liquidation Values, 57511.10 Introduction, 57511.11 Approaches, 577Going-Concern (Reorganization) Valuation, 57811.12 Introduction, 57811.13 Cost of Capital, 57911.14 Appraisal Value or Replacement Cost, 58811.15 Market Value of Securities, 58811.16 Income Approach (Discounted Cash Flows), 58911.17 Market Approach, 59611.18 Asset-Based (Cost) Approach, 60711.19 Discounts and Premiums, 61211.20 Synthesizing Results, 61811.21 Determining Liabilities, 622PART THREE INVESTIGATION AND REPORTS12 Special Areas of Inquiry, 627Nature of Investigation, 62712.1 Introduction, 62712.2 Objectives, 62812.3 Balance Sheet Emphasis, 62912.4 Modifications of Investigation, 629Introduction to the Special Areas of Inquiry, 63112.5 Irregularities, 63112.6 Fraud, 63312.7 Proof of Fraud, 63412.8 Auditor’s Responsibility for the Detection of Irregularities, 63412.9 Methods of Discovering Irregularities and Fraud, 640Availability of Books and Records, 64112.10 Locating and Obtaining Possession of the Records, 64112.11 Scheduling the Books; Procedure Followed for Missing Records, 642Fraudulent Transfers, 64212.12 Transfer of Assets without Fair Consideration, 64212.13 Sales of Assets Below Market Values, 64312.14 Transfer of Assets to Insiders, Officers, Employees, Relatives, and Others, 643Concealment of Assets, 64812.15 Merchandise, 64812.16 Cash Surrender Value of Officers’ Life Insurance Policies, 65012.17 Deposits and Security, 65112.18 Investments and Real Estate, 65112.19 Machinery and Equipment, 652False Entries and Statements, 65212.20 Mutilation and Alteration of Records, 65212.21 Concealment and Destruction of Records, 65312.22 Forgery, 65312.23 Issuance of False Statements, 653Financing Irregularities, 65712.24 Receivables, 65712.25 Inventory, 659Preferential Payments, 66012.26 Introduction, 66012.27 Recovery of Preferential Payments, 66112.28 Search for Preferential Payments, 66212.29 Inflated Claims, 663Applicability of Generally Accepted Auditing Standards, 66412.30 Auditing Standards, 66412.31 Auditing Procedures, 66512.32 Audit Program Guide, 66613 Financial Reporting During Bankruptcy, 66713.1 Introduction, 667Form and Substance of Financial Statements, 66813.2 Financial Data Required at the Date of Filing of Petition in Chapter 11, 66813.3 Balance Sheet, 66813.4 Rejected Leases, 67713.5 Warranty Reserves and Similar Liabilities, 67813.6 Pension Liability, 67913.7 Pro Forma Statement of Financial Position, 68113.8 Notes to Statements, 68113.9 Statement of Operations, 68213.10 Statement of Cash Flows, 68713.11 Statement of Capital Deficiency, 68913.12 Statement of Affairs, 68913.13 Special-Purpose Statements, 693Accounting for a Chapter 11 Filing, 69413.14 Use of New Accounts, 69413.15 Illustration of Entries, 69613.16 Accrued Interest, 69714 Reporting Results of the Plan, 69914.1 Introduction, 699Chapter 11, 69914.2 Requirements for Fresh-Start Reporting, 69914.3 Allocation of Reorganization Value, 70114.4 Disclosures, 70414.5 Recording the Adoption of Fresh-Start Reporting, 70514.6 Deferred Taxes, 70814.7 Disclosure Statement, 71014.8 Subsequent Events and Preconfirmation Contingencies, 71114.9 Reporting by Entities Not Qualifying for Fresh Start, 71414.10 Comparison with Prior Periods, 714Out-of-Court Workouts, 71514.11 Introduction, 71514.12 Debt Discharge under FASB Statement No. 15, 71514.13 Reporting of Income from Debt Discharge When FASB Statement No. 15 Is Not Applicable, 72314.14 Determining the Amount of Income from Debt Discharge When FASB Statement No. 15 Is Not Applicable, 724Quasi-Reorganization, 72414.15 Introduction, 72414.16 Adjustment of Equity Section Only (“Mini Quasi”), 72514.17 Adjustment of All Accounts, 72614.18 Conditions Necessary for Quasi-Reorganization, 72914.19 Quasi-Reorganization and the SEC, 72915 Reporting on an Insolvent Company, 73115.1 Introduction, 731Litigation Services, 73415.2 Application of Litigation Services to Bankruptcy, 73415.3 Disclosure Requirements, 73615.4 Operating Reports, 73615.5 Investigative Services, 73715.6 Financial Projections, 738Accountant’s Report: Nonlitigation Services, 73915.7 Introduction, 73915.8 Limitations on Scope, 74015.9 Unique Disclosures in Report, 74115.10 Full Disclosure, 74215.11 Accountant’s Responsibility for Disclosure, 743Going-Concern Concept, 74315.12 Introduction, 74315.13 Going-Concern Concept Defined, 74415.14 Absence of Evidence to the Contrary, 74515.15 Auditor’s Responsibility for Evaluation, 74615.16 Audit Procedures, 74615.17 Consideration of Management’s Plans, 747Types of Opinions, 74815.18 Unqualified Opinion, 74815.19 Qualified Opinion, 74915.20 Disclaimer of Opinion, 75015.21 Adverse Opinion, 75015.22 Reports Relating to the Results of Applying Agreed-On Procedures, 751Unaudited Financial Statements, 75315.23 Introduction, 75315.24 Public Entity Report, 75315.25 Nonpublic Entity Reports, 756Reporting on a Liquidation of the Debtor, 76215.26 Introduction, 76215.27 Single-Year Report, 76315.28 Comparative Financial Statements, 76415.29 Solvency Letters, 76415.30 Reports on Prospective Financial Statements, 76515.31 Liquidation Analysis, 76516 Tax Awareness, 76716.1 Introduction, 767Notification of Proceedings and Filing of Returns, 76716.2 Notice to Governmental Agencies, 76716.3 Responsibility for Filing Income Tax Returns: Corporations, 76816.4 Responsibility for Filing Income Tax Returns and Other Information Required by the Bankruptcy Court: Individual and Partnership, 769Special Rules for Individuals, 77416.5 Introduction, 77416.6 Income and Deductions, 77416.7 Transfers between Debtor and Estate, 77516.8 Attribute Carryover to Estate, 77816.9 Attribute Carryover to Debtor, 77816.10 Carryback of Net Operating Losses and Other Credits Incurred Subsequent to Commencement of Case, 77916.11 Administrative Expenses, 77916.12 Change in Accounting Period, 782Minimization of Tax and Related Payments, 78216.13 Estimated Taxes, 78216.14 Prior Year Taxes, 78216.15 Pension Funding Requirements, 782Treatment of Income During Bankruptcy Period, 78216.16 Income Required to Be Reported, 78216.17 Deductions Allowed, 78316.18 Discharge of Debts, 78416.19 Debt Discharge by Farmers, 78816.20 Cancellation of Real Property Business Indebtedness, 78916.21 Basis Adjustment, 79016.22 Debt Discharge by Partnerships, 79316.23 Debt Discharge by S Corporations, 79316.24 Exchange of Stock for Debt, 79316.25 Purchase-Money Debt Reduction, 79416.26 Tax Planning, 794Corporate Reorganizations, 79416.27 Introduction, 79416.28 Tax-Free G Reorganization, 79516.29 Personal Holding Company, 797Availability of New Operating Losses, 79716.30 Introduction, 79716.31 Section 382 Limitation, 79816.32 Special Rules for Corporations in Bankruptcy, 79916.33 Other Provisions, 800Effects on Earnings and Profits, 80116.34 Introduction, 80116.35 Account Adjustment, 80116.36 Earnings and Profits Carryover, 801Administrative Aspects of Taxes, 80216.37 Tax Priorities, 80216.38 Tax Penalty, 80916.39 Interest, 81016.40 Erroneous Refunds or Credits, 81016.41 Chapter 11 Reorganization, 81016.42 Chapters 12 and 13 Adjustments, 81116.43 Tax Discharge, 81116.44 Tax Preferences, 81316.45 Tax Procedures, 81316.46 State and Local Tax Provisions, 814Appendix: Statement of Position 815Statutes Citations 849Case Index 855Name Index 865Subject Index 867

Grant W. Newton, CPA, CIRA, CMA, is Professor of Accounting at the Graziadio School of Business and Management at Pepperdine University and is Executive Director of the Association of Insolvency and Restructuring Advisors. He is the author of Corporate Bankruptcy: Tools, Strategies, and Alternatives (2003) and Bankruptcy and Insolvency Taxation (2005), both from Wiley. His articles have appeared in a large number of professional periodicals. He received his PhD from New York University, Master's from the University of Alabama, and BS from the University of North Alabama.

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• Preface xxxvAcknowledgments xxxixAbout the Author xliPART ONE BANKRUPTCY AND INSOLVENCY ENVIRONMENT 11 Accountant’s and Financial Advisor’s Role in Perspective, 31.1 Introduction, 31.2 Scope of Coverage, 4Accounting Services, 51.3 Need for Financial Advisor’s Services, 51.4 Financial Advisor Defined, 6Topical Overview, 71.5 Economic Causes of Business Failure, 71.6 Business Turnaround, 71.7 Alternatives Available to a Financially Troubled Business, 71.8 Comparison of Title 11 of the United States Code with the Bankruptcy Act, 111.9 Retention of the Financial Advisor and Fees, 131.10 Accounting Services, 141.11 Special Investigation and Financial Reporting, 141.12 Tax Awareness, 14Responsibilities of Independent Accountant, 151.13 Responsibilities in General, 151.14 Observation of Business Decline, 151.15 Responsibility to Client, 161.16 Advice on Selection of Attorneys, 171.17 Other Steps to “Manage” the Proceedings, 18Professional Certification, 181.18 Certified Insolvency and Restructuring Advisors, 181.19 Certification in Distressed Business Valuation, 202 Economic Causes of Business Failures, 212.1 Introduction, 21Definition of Successful and Unsuccessful Business, 212.2 Failure Defined, 212.3 Business Failure Statistics, 23Causes of Financial Difficulty, 242.4 Introduction, 242.5 Size of Business Failures, 262.6 Geographic Distribution of Business Failures, 292.7 Age of Business Failures, 302.8 Business Failures and Economic Conditions, 302.9 Characteristics of the Economic System, 332.10 Casualties, 342.11 Inside Underlying Causes, 342.12 Dishonesty and Fraud: Planned Bankruptcies, Sham, 422.13 Other External Causes, 42Stages of Financial Failure, 432.14 Introduction, 432.15 Period of Incubation, 442.16 Cash Shortage, 452.17 Financial or Commercial Insolvency (Equity Definition), 452.18 Total Insolvency (Bankruptcy Definition), 452.19 Bankruptcy or Out-of-Court Workout, 45Detection of Failure Tendencies, 462.20 Introduction, 462.21 Trend Analysis, 462.22 Analysis of Accounting Measures, 482.23 Analysis of Management, 642.24 Importance of Forecasts, 642.25 Other Factors, 65PART TWO LEGAL ASPECTS OF BANKRUPTCY AND INSOLVENCY PROCEEDINGS 673 Turnaround Process, 693.1 Objectives, 69Stages of Turnaround Process, 693.2 Introduction, 693.3 Stage 1: Management Change, 713.4 Stage 2: Situation Analysis, 72 Competitive Ability, 773.5 Stage 3: Design and Selection of Turnaround Strategy, 783.6 Stage 4: Emergency Action Stage, 813.7 Stage 5: Business Restructuring Stage, 873.8 Stage 6: Return-to-Normal Stage, 89Characteristics of Effective Turnaround Managers, 903.9 Introduction, 903.10 Organizational Leader, 913.11 Ability to Develop and Implement Strategy, 913.12 Entrepreneurial Instincts, 913.13 “Hands-On” Operating Experience, 913.14 Effective Negotiating Skills, 923.15 Good Interviewing Skills, 923.16 Action Orientation, 923.17 Trustworthiness and Fairness, 93Techniques Used in Business Turnarounds, 943.18 Introduction, 943.19 Lean Manufacturing, 943.20 Activity-Based Costing, 983.21 Retail Store “Four-Wall” Analysis, 1023.22 Business Process Reengineering, 108Summary and Recommendations, 1093.23 Summary, 1094 Nonbankruptcy Proceedings, 1114.1 Introduction, 111Out-of-Court Settlements, 1114.2 Nature of Proceedings, 1114.3 Importance of an Early Meeting Date, 1134.4 Preparation for the Creditors’ Meeting, 1134.5 Appointment of Creditors’ Committee, 1144.6 Duties and Functions of Creditors’ Committee, 1154.7 Interim Management, 1164.8 Committee Management, 116Preparation of a Plan of Settlement, 1184.9 Introduction, 1184.10 Conditions of Agreement, 1194.11 Out-of-Court Agreement Prior to Chapter 11 (Prepackaged Bankruptcy), 120Advantages and Disadvantages, 1214.12 Advantages, 1214.13 Disadvantages, 121Assignment for the Benefit of Creditors (State Court), 1224.14 Introduction, 1234.15 Duties, Functions, and Procedures of Assignee, 1224.16 Discharge of Debts, 1234.17 Advantages, 1244.18 Disadvantages, 1255 Nature of Bankruptcy and Insolvency Proceedings, 127 Origin, 1275.1 Introduction, 1275.2 United States, 1285.3 Insolvency and Bankruptcy Laws Today, 1305.4 Current Bankruptcy Statistics, 132Nature of Insolvency, 1345.5 Types of Insolvency, 1345.6 Equity versus Bankruptcy Meanings of Insolvency, 1355.7 Determination of Assets and Liabilities, 1355.8 Valuation of Assets, 1365.9 Insolvency and the Bankruptcy Code, 1365.10 Should There Be a Threshold Test?, 1375.11 Alternatives Available to a Financially Troubled Business, 139Assignment for the Benefit of Creditors (State Court), 1405.12 Introduction, 1405.13 Duties, Functions, and Procedures of Assignee, 1405.14 Discharge of Debts, 1415.15 Advantages, 1425.16 Disadvantages, 142Provisions Common to all Proceedings, 1435.17 Introduction, 1435.18 Bankruptcy Courts, 1445.19 U.S. Trustee, 1465.20 Sovereign Immunity, 1495.21 Commencement of Cases, 1545.22 Filing and Quarterly Fees, 1565.23 Partnership, 1575.24 Meeting of Creditors, 1585.25 Meeting of Equity Security Holders, 1595.26 Adequate Protection, 1595.27 Automatic Stay, 1645.28 Use of the Estate’s Property, 1745.29 Executory Contracts and Leases, 1755.30 Utility Service, 1935.31 Allowance of Claims or Interests, 1965.32 Expense of Administration, 2025.33 Priorities, 2055.34 Exemptions, 2075.35 Discharge of Debts, 2115.36 Property of the Estate, 2135.37 Avoiding Power of Trustee, 2205.38 Reclamation and 503(b)(9) Claim, 2225.39 Preferences, 2265.40 Fraudulent Transfers, 2495.41 Postpetition Transfers, 2585.42 Postpetition Effect of Security Interest, 2595.43 Setoffs, 260Chapter 7 Liquidation, 2635.44 Filing the Petition, 2635.45 Trustee, 2645.46 Creditors’ Committee, 2665.47 Partnerships, 2675.48 Treatment of Tax Liens, 2695.49 Liquidation of Assets, 2695.50 Discharge, 2715.51 Discharge of Environmental Claims, 278SIPC Liquidation, 2785.52 Introduction, 2785.53 Determination of Need of Protection, 2795.54 Appointment of Trustee, 2805.55 Court Jurisdiction, 2805.56 Powers and Duties of Trustee, 2835.57 Satisfaction of Claims, 2845.58 Prohibited Acts, 2865.59 Role of Securities and Exchange Commission, 2875.60 Compensation in an SIPA Action, 2886 Rehabilitation Proceedings Under the Bankruptcy Code, 2896.1 Introduction, 2896.2 Purpose of Chapter 11, 289Operating Under Chapter 11, 2906.3 Role of the Court and U.S. Trustee, 2906.4 KERPs, 2926.5 Consolidation of Chapter 11 Petitions, 2966.6 Creditors’ and Equity Holders’ Committees, 3026.7 Appointment or Election of Trustee, 3096.8 Appointment of Examiner, 3146.9 Operation of the Business, 3186.10 Automatic Stay, 3196.11 Impact of Timbers, 3196.12 Use of Collateral, 3206.13 Use of Cash Collateral, 3206.14 Obtaining Credit, 3226.15 Claims and Interests, 3306.16 Special Provisions for Partially Secured Creditors, 340Developing the Plan, 3426.17 Negotiating a Chapter 11 Plan, 3436.18 Exclusivity Period, 3446.21 Secured Claim Classification, 3566.22 Interest Classification, 3576.23 Content of the Plan, 3576.24 Permissible Provisions, 3596.25 Impairment of Claims, 3616.26 Disclosure Statement, 3646.27 Modification of the Plan, 373Confirmation of the Plan, 3756.28 Acceptance of the Plan, 3756.29 Confirmation Hearing, 3756.30 Confirmation Requirements, 3766.31 Best Interest of Creditors, 3786.32 Priority Treatment, 3796.33 Feasibility, 3816.34 Cramdown, 3856.35 Chapter 11 Cases Filed by Individuals, 394Postconfirmation, 3976.36 Impact, 3976.37 Distribution, 4006.38 Discharge of Debts, 4016.39 Postconfirmation Recovery, 4016.40 Securities Law Exemption, 4026.41 Final Decree, 4046.42 Conversion to Chapter 7 or Dismissal, 4056.43 Advantages and Disadvantages of Chapter 11, 407Chapter 12: Adjustment of Debts of a Family Farmer with Regular Annual Income, 4076.44 Purpose, 4076.45 Requirements for Use, 4086.46 Operation of Farm, 4086.47 Chapter 12 Plan, 409Chapter 13: Adjustment of Debts of an Individual with Regular Income, 4116.48 Nature, 4116.49 Filing of Petition, 4116.50 Operation of Business, 4136.51 The Plan, 4136.52 Discharge of Debts, 4176.53 Use of Chapter 13 by Business, 4186.54 Chapter 15: Ancillary and Other Cross Border Cases, 4197 Retention of the Financial Advisor and Fees, 4277.1 Introduction, 427Retention of the Financial Advisor, 4287.2 The Accountant or Financial Advisor’s Role in the Proceedings, 4287.3 Obtaining the Engagement, 4287.4 Retention Procedure, 4297.5 Creditors’ Committee, 4327.6 Source of Payment, 4337.7 Affidavit of Proposed Financial Advisor, 4347.8 Survey of Work to Be Performed, 4407.9 Application for Retention, 4417.10 Retention Order, 4447.11 Retention on a Retainer Basis, 4447.12 Deviations from Retention Order, 4457.13 Accountants as Consultants or Financial Advisors, 4457.14 Prepetition Retention, 4467.15 Retention Procedure—Informal, 4467.16 Accountants as Quasi-Officers of the Court, 447Determination of Financial Advisor’s Fees, 4477.17 Introduction, 4477.18 SEC May Object to Fees, 4487.19 Compensation Reviewed by U.S. Trustee, 4497.20 Compensation Must Be Approved by the Court, 4497.21 Factors to Consider When Estimating Fees, 4537.22 Compensation Based on Comparable Services, 4587.23 Prepetition Fees, 460Time Records, 4617.24 Requirements, 461Petition for Fee Allowance, 4627.25 Court Discretion in Ruling on Fees, 4627.26 Procedure for Filing the Petition, 4657.27 Payment for Services Rendered, 4668 Accounting and Financial Services for Debtors-in-Possession or Trustee, 469Nature of Accounting Services, 4698.1 Introduction, 4698.2 Parties Retaining Accountants and Financial Advisors, 4698.3 Summary of Services, 471Prefiling Stage of Chapter Proceedings, 4728.4 Importance of Early Meetings, 4728.5 Advice on Selection of Counsel, 4738.6 Conference with Attorney, 4738.7 Determine Alternatives, 4748.8 Prebankruptcy Planning, 475Accounting/Financial Reporting Requirements, 4818.9 Introduction, 4818.10 Affidavits in Support of Petition, 4838.11 Supporting Schedules, 4848.12 Statement of Financial Affairs, 4878.13 Monthly Reporting, 4888.14 U.S. Trustee’s Requirements, 4898.15 Operating Statements, 4908.16 SEC Reporting in Chapter 11, 4928.17 Bankruptcy Claims Management Process, 495Formulation of a Plan of Reorganization, 4998.18 Introduction, 4998.19 Liquidation Value of Assets, 5008.20 Projection of Future Operations, 5018.21 Reorganization Value, 5018.22 Pro Forma Balance Sheet, 5028.23 Formulating an Amended Plan, 5038.24 Disclosure Statement, 503Accountant and Financial Advisor as Examiner, 5048.25 Nature of Service, 504Additional or Other Accounting Services, 5058.26 Introduction, 5058.27 Normal Accounting Services, 5058.28 Special Investigation, 5058.29 Accounting Services and the Granting of New Credit, 507Professional Conduct of Accountants and Financial Advisors, 5088.30 Introduction, 5088.31 Personal Liability: Preparation of Financial Statements, 5088.32 Professional Conduct of Debtor’s Accountant— Toward Client, 5098.33 Professional Conduct of Debtor’s Accountant— Toward Creditors’ Accountant/Advisors, 5108.34 Direct Liability to Third Parties, 5118.35 Other Professional Ethical Factors, 5119 Other Financial Advisory Services for Debtors-in-Possession or Trustee, 5139.1 Introduction, 513Management Advisory Services, 5139.2 Introduction, 5139.3 Long-Range Business Plan, 5149.4 Financial Projections, 516Interim Management Services, 5169.5 Introduction, 5169.6 Retention, 5179.7 Billing, 517Balloting and Noticing Agent Services, 5179.8 Noticing Overview, 5179.9 Solicitation Overview, 5189.10 Pre-Balloting Services, 5199.11 Plan Classes, 5199.12 Solicitation Process, 5209.13 Plan Information and Ballots, 520Chapter 7 and Chapter 11 Liquidations, 5219.14 Introduction, 5219.15 Items Requiring Immediate Attention, 5219.16 Performance of Audits and Other Special Investigations, 5229.17 SIPC Liquidation, 522Postconfirmation Services, 5239.18 Overview, 5239.19 Litigation Trusts, 5239.20 Tort Trusts, 52310 Accounting and Financial Services for the Creditors’ Committee, 525Nature of Creditors’ Committee, 52510.1 Introduction, 52510.2 Creditors’ Committees, 52610.3 Directing Committee Activities, 53410.4 Data, 53510.5 Bargaining Process, 53510.6 Role of Creditors’ Financial Advisor in the Bargaining Process, 53610.7 Form of Consideration, 537Monitoring Debtor’s Activities, 53710.8 Introduction, 53710.9 Areas Requiring Immediate Attention, 53710.10 Importance of Speed, 53810.11 Establishment of Proper Controls, 53910.12 Investigation of Causes of Failure and Development of Controls to Limit Further Impairment of Assets, 54010.13 Review of Receipts and Disbursements Control, 54010.14 Review of Debtor’s Accounting System, 54110.15 “Insider” Problem, 54210.16 Review of Weekly/Monthly Reporting, 544Special Investigations and Reviews, 54510.17 Investigation of Debtor’s Books and Records, 54510.18 Review of Debtor’s Transactions, 54610.19 Evaluation of Debtor’s Projections, 54610.20 Review of Plan of Reorganization and Disclosure Statement, 547Other Accounting Services, 55010.21 Introduction, 55010.22 Secured Creditor, 55010.23 Major Stockholder or Equity Committee, 55010.24 Responsibilities of Creditors’ Financial Advisor, 55111 Valuation of a Business in Bankruptcy Proceedings, 553 Importance of Valuation, 55311.1 Introduction, 55311.2 Adequate Protection under Section 361, 55411.3 Claims Determination, 55811.4 Recovery Action, 56111.5 Chapter 13 Secured Claims, 56711.6 Determining Best Interest of Creditors and Stockholders under Chapter 11, 56811.7 Determining Whether a Plan Is Fair and Equitable to a Dissenting Class in Chapter 11, 56911.8 Determining Feasibility, 57311.9 Codification of Value, 573Liquidation Values, 57511.10 Introduction, 57511.11 Approaches, 577Going-Concern (Reorganization) Valuation, 57811.12 Introduction, 57811.13 Cost of Capital, 57911.14 Appraisal Value or Replacement Cost, 58811.15 Market Value of Securities, 58811.16 Income Approach (Discounted Cash Flows), 58911.17 Market Approach, 59611.18 Asset-Based (Cost) Approach, 60711.19 Discounts and Premiums, 61211.20 Synthesizing Results, 61811.21 Determining Liabilities, 622PART THREE INVESTIGATION AND REPORTS12 Special Areas of Inquiry, 627Nature of Investigation, 62712.1 Introduction, 62712.2 Objectives, 62812.3 Balance Sheet Emphasis, 62912.4 Modifications of Investigation, 629Introduction to the Special Areas of Inquiry, 63112.5 Irregularities, 63112.6 Fraud, 63312.7 Proof of Fraud, 63412.8 Auditor’s Responsibility for the Detection of Irregularities, 63412.9 Methods of Discovering Irregularities and Fraud, 640Availability of Books and Records, 64112.10 Locating and Obtaining Possession of the Records, 64112.11 Scheduling the Books; Procedure Followed for Missing Records, 642Fraudulent Transfers, 64212.12 Transfer of Assets without Fair Consideration, 64212.13 Sales of Assets Below Market Values, 64312.14 Transfer of Assets to Insiders, Officers, Employees, Relatives, and Others, 643Concealment of Assets, 64812.15 Merchandise, 64812.16 Cash Surrender Value of Officers’ Life Insurance Policies, 65012.17 Deposits and Security, 65112.18 Investments and Real Estate, 65112.19 Machinery and Equipment, 652False Entries and Statements, 65212.20 Mutilation and Alteration of Records, 65212.21 Concealment and Destruction of Records, 65312.22 Forgery, 65312.23 Issuance of False Statements, 653Financing Irregularities, 65712.24 Receivables, 65712.25 Inventory, 659Preferential Payments, 66012.26 Introduction, 66012.27 Recovery of Preferential Payments, 66112.28 Search for Preferential Payments, 66212.29 Inflated Claims, 663Applicability of Generally Accepted Auditing Standards, 66412.30 Auditing Standards, 66412.31 Auditing Procedures, 66512.32 Audit Program Guide, 66613 Financial Reporting During Bankruptcy, 66713.1 Introduction, 667Form and Substance of Financial Statements, 66813.2 Financial Data Required at the Date of Filing of Petition in Chapter 11, 66813.3 Balance Sheet, 66813.4 Rejected Leases, 67713.5 Warranty Reserves and Similar Liabilities, 67813.6 Pension Liability, 67913.7 Pro Forma Statement of Financial Position, 68113.8 Notes to Statements, 68113.9 Statement of Operations, 68213.10 Statement of Cash Flows, 68713.11 Statement of Capital Deficiency, 68913.12 Statement of Affairs, 68913.13 Special-Purpose Statements, 693Accounting for a Chapter 11 Filing, 69413.14 Use of New Accounts, 69413.15 Illustration of Entries, 69613.16 Accrued Interest, 69714 Reporting Results of the Plan, 69914.1 Introduction, 699Chapter 11, 69914.2 Requirements for Fresh-Start Reporting, 69914.3 Allocation of Reorganization Value, 70114.4 Disclosures, 70414.5 Recording the Adoption of Fresh-Start Reporting, 70514.6 Deferred Taxes, 70814.7 Disclosure Statement, 71014.8 Subsequent Events and Preconfirmation Contingencies, 71114.9 Reporting by Entities Not Qualifying for Fresh Start, 71414.10 Comparison with Prior Periods, 714Out-of-Court Workouts, 71514.11 Introduction, 71514.12 Debt Discharge under FASB Statement No. 15, 71514.13 Reporting of Income from Debt Discharge When FASB Statement No. 15 Is Not Applicable, 72314.14 Determining the Amount of Income from Debt Discharge When FASB Statement No. 15 Is Not Applicable, 724Quasi-Reorganization, 72414.15 Introduction, 72414.16 Adjustment of Equity Section Only (“Mini Quasi”), 72514.17 Adjustment of All Accounts, 72614.18 Conditions Necessary for Quasi-Reorganization, 72914.19 Quasi-Reorganization and the SEC, 72915 Reporting on an Insolvent Company, 73115.1 Introduction, 731Litigation Services, 73415.2 Application of Litigation Services to Bankruptcy, 73415.3 Disclosure Requirements, 73615.4 Operating Reports, 73615.5 Investigative Services, 73715.6 Financial Projections, 738Accountant’s Report: Nonlitigation Services, 73915.7 Introduction, 73915.8 Limitations on Scope, 74015.9 Unique Disclosures in Report, 74115.10 Full Disclosure, 74215.11 Accountant’s Responsibility for Disclosure, 743Going-Concern Concept, 74315.12 Introduction, 74315.13 Going-Concern Concept Defined, 74415.14 Absence of Evidence to the Contrary, 74515.15 Auditor’s Responsibility for Evaluation, 74615.16 Audit Procedures, 74615.17 Consideration of Management’s Plans, 747Types of Opinions, 74815.18 Unqualified Opinion, 74815.19 Qualified Opinion, 74915.20 Disclaimer of Opinion, 75015.21 Adverse Opinion, 75015.22 Reports Relating to the Results of Applying Agreed-On Procedures, 751Unaudited Financial Statements, 75315.23 Introduction, 75315.24 Public Entity Report, 75315.25 Nonpublic Entity Reports, 756Reporting on a Liquidation of the Debtor, 76215.26 Introduction, 76215.27 Single-Year Report, 76315.28 Comparative Financial Statements, 76415.29 Solvency Letters, 76415.30 Reports on Prospective Financial Statements, 76515.31 Liquidation Analysis, 76516 Tax Awareness, 76716.1 Introduction, 767Notification of Proceedings and Filing of Returns, 76716.2 Notice to Governmental Agencies, 76716.3 Responsibility for Filing Income Tax Returns: Corporations, 76816.4 Responsibility for Filing Income Tax Returns and Other Information Required by the Bankruptcy Court: Individual and Partnership, 769Special Rules for Individuals, 77416.5 Introduction, 77416.6 Income and Deductions, 77416.7 Transfers between Debtor and Estate, 77516.8 Attribute Carryover to Estate, 77816.9 Attribute Carryover to Debtor, 77816.10 Carryback of Net Operating Losses and Other Credits Incurred Subsequent to Commencement of Case, 77916.11 Administrative Expenses, 77916.12 Change in Accounting Period, 782Minimization of Tax and Related Payments, 78216.13 Estimated Taxes, 78216.14 Prior Year Taxes, 78216.15 Pension Funding Requirements, 782Treatment of Income During Bankruptcy Period, 78216.16 Income Required to Be Reported, 78216.17 Deductions Allowed, 78316.18 Discharge of Debts, 78416.19 Debt Discharge by Farmers, 78816.20 Cancellation of Real Property Business Indebtedness, 78916.21 Basis Adjustment, 79016.22 Debt Discharge by Partnerships, 79316.23 Debt Discharge by S Corporations, 79316.24 Exchange of Stock for Debt, 79316.25 Purchase-Money Debt Reduction, 79416.26 Tax Planning, 794Corporate Reorganizations, 79416.27 Introduction, 79416.28 Tax-Free G Reorganization, 79516.29 Personal Holding Company, 797Availability of New Operating Losses, 79716.30 Introduction, 79716.31 Section 382 Limitation, 79816.32 Special Rules for Corporations in Bankruptcy, 79916.33 Other Provisions, 800Effects on Earnings and Profits, 80116.34 Introduction, 80116.35 Account Adjustment, 80116.36 Earnings and Profits Carryover, 801Administrative Aspects of Taxes, 80216.37 Tax Priorities, 80216.38 Tax Penalty, 80916.39 Interest, 81016.40 Erroneous Refunds or Credits, 81016.41 Chapter 11 Reorganization, 81016.42 Chapters 12 and 13 Adjustments, 81116.43 Tax Discharge, 81116.44 Tax Preferences, 81316.45 Tax Procedures, 81316.46 State and Local Tax Provisions, 814Appendix: Statement of Position 815Statutes Citations 849Case Index 855Name Index 865Subject Index 867