Lesson 3
Corporate Liquidation
CORPORATE LIQUIDATION LECTURE NOTES
Business failures take many forms, common one is the inability to settle financial
obligations as they become due. If the distressed company liquidates, it enters into
bankruptcy procedures that are court administered because of legal ramifications.
The process of corporate liquidation would include realization of assets and the
distribution of the cash proceeds, first to the different creditors, then the balance to
stockholders, if any. Generally, the cash provided would be less than the amount of all
the liabilities so a payment deficiency to creditors would occur. These activities are done
by a court-appointed trustee under accountability techniques.
Actual liquidation, however, is preceded by a court-petition for bankruptcy, voluntary, if
filed by the distressed company itself; involuntary if initiated by its creditors. The
voluntary petition is submitted to the courts for resolution and a statement exhibiting the
petitioner’s debts and assets (at fair values) accompanies the petition. This statement is
commonly called the Statement of Affairs.
The Statement of Affairs.
It is prepared under a quitting-concern assumption and makes the following
classifications as to assets and liabilities:
Assets:
(1) Pledged with Fully Secured Creditors – estimated cash proceeds is equal to or
more than the amount of the secured claim.
(2) Pledged with Partially Secured Creditors – estimated cash proceeds is less than
the amount of the secured claim.
(3) Free Asset – any asset of the entity that has not been used to secure the
payment of any of the company’s liabilities and therefore any cash proceeds therefrom
is available to unsecured creditors.
Liabilities
(1) Secured Liabilities – that which is covered by a collateral asset
(a) Fully-secured – the realizable value of the pledged asset is at least equal to the
amount of the claim.
(b) Partially-secured liabilities – the realizable value of the pledged asset is less than
the amount of the claim. Every partially secured claim has a secured portion, which is
covered by the realizable value of the collateral and an unsecured portion, that which is
not covered.
(2) Unsecured Liabilities – that which is not covered by a pledged asset.
(a) Unsecured liabilities with priority – those that are specified under the Bankruptcy
Law that must be paid in full ahead of any other type of unsecured liabilities.
(b) Unsecured liabilities without priority – is any other type of unsecured liability.
Unrecorded assets with market values are included in the statement of affairs under
free assets category and are called contingent assets; unrecorded administrative and
liquidation expenses are categorized as unsecured with priority, and are called
contingent liabilities. The statement of affairs measures in estimated terms what
payments are to be received by the different types of creditors in the event of
liquidation.
Accounting and Reporting by the Trustee.
Accounting would be by simple financial records and reports detailing accountability for
the custody of assets and temporary assumption of liabilities. Assets and liabilities taken
over are recorded in the trustee’s books at carrying values in the books of the
distressed company upon the transfer. Since the stockholders’ equity items are not
transferred, a reciprocal account, Estate Equity, is established in the books of the
trustee to balance the accounts. In turn, a reciprocal Trustee Account is established in
the books of the distressed company in representation of the net assets transferred out
to the responsibility of the trustee.
1. The trustee is required to prepare the following periodic statements and reports:
(a) Cash receipts and disbursements statement, (b) a Statement of Estate Equity; and
(c) supporting exhibits of assets still undisposed and liabilities not yet liquidated as at
the end of the reporting period (balance sheet). The Statement of Realization and
Liquidation which is actual-transaction based has lost utility value, and popularity, and
thus will be il lustrated only briefly.
