 Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at the topic of bankruptcy. This topic is covered in advanced accounting, as well as the CPA exam, the regulation section, as well as the FAR section. As always, I would like to remind you, my viewers, to connect with me only then. I would like to also remind you to subscribe to my YouTube. YouTube is where I list all my lectures, all my 1,500 plus accounting, auditing and tax lectures. If you like my lectures, please like them. Put them in playlists, share them, let the world know about them and please visit my website. I often have CPA offers for CPA students. This is my Instagram account and this is my Facebook account. So we're going to start by looking at the introduction and law. This topic is covered much, much more detailed than a business law course, but this is just an overview. So you are good enough for an advanced accounting course. You have a good enough knowledge. So first thing you want to know is Congress. Congress has the authority to enact uniform bankruptcy law and constitution of the Congress that right. There has been bankruptcy law since the 1800s. So it's something that's common and it's old. Then there was the major bankruptcy reform act of 1978, which was amended several times, 84, 88, 1990 and 1984. And there was always new rules and amendment to the bankruptcy law. But basically what we're going to be covering in this course is Chapter 7 or in this chapter and Chapter 11, which is Chapter 7 is liquidation and Chapter 11 is reorganization. Now notice, for example, Chapter 13 is adjustment of that to individuals with regular income. For example, Chapter 9 is adjustment of that of a municipality when a municipality goes out of business. So law applies to individuals, corporation and partnership, all of which are persons referred to as debtors. We have debtors and we have creditors. So the bankruptcy petition is an official form that initiate the bankruptcy proceeding. Now you could initiate this voluntarily. It means the business can start it itself or the creditors are in voluntary. The debtor must file a form listing all property at current market value and it's that. So they have to show their assets at current market value and they have to show their liabilities at current market value. This form is called statement of asset and liabilities. And here's a schedule of the statement of assets and liabilities. Let's take a look at it just to kind of show you what we mean by this. For example, here we have statement of all liabilities. Creditors have a priority, creditors holding security, creditors have an unsecured claim. So they list A1, A2, A3, then schedule B, real property. Again, with fair market value listed, personal property with fair market value, property not otherwise scheduled, property discovered later. So those are the schedule and B4, property claimed as exempt. Basically as exempt it means they belong to the individual. The individual can claim it. There are certain property that the individual can keep by law. Again, to learn more in details about this topic, you will learn in your business law class. Also in addition to this form, the debtor will have to complete a questionnaire called a statement of fair containing questions concerning all aspects of its financial condition and operation. Because the numbers may not capture everything. The court, they want to learn a little bit more, as well as the creditors about the person, about the debtor. So again, the bankruptcy can either start voluntarily or involuntarily. Basically, voluntarily is pretty straightforward. The debtor might file a voluntary petition for liquidation, which is chapter 7, or reorganization chapter 11. So there is no requirement. If you decide to file, you can file. Filing petition constitute an order for relief and prohibit legal action against the debtor by the creditor. Once you file, basically it's called an order of relief and the creditors can no longer take action. Now they're going to have to both submit to the court. It establishes in a state of the debtor's asset all property at current value and all liabilities at current value. So once you file, there is an estate, basically a new entity. Think of it as a corporation or as a trust. And in that trust, you'll list all the assets and all the liabilities. Who cannot file for a voluntary petition for bankruptcies? Banks, savings and loans, insurance companies, those they may not file for petition. Why? Because they're for the common good. They could be involuntary file against them, but they cannot voluntarily file. Involuntary petition, a little bit different. It's what someone comes after you. When the creditor comes after you. Creditor initiate action by filing a petition for liquidation, which is chapter seven or reorganization, which is chapter 11. So not anyone and you have to have a specific requirement. If you have 12 or more creditors, three have to sign them. And those three, they have to have a debt. Unsecured debt for more than 15,575. Now these figures, they change year after year. That's why I have underlined because you might be listening to this lecture in 2023, 2022. And you might say, this number is incorrect. Yeah, it does change. So the debt has to be greater than equal to than the value of any liens on the property. So basically this debt has to be unsecured. If they have a secured debt, then they cannot file the claim. Okay, because your debt is secured. Secured means you have a property. You have something that you can take over to satisfy your obligation. If you have less than 12 creditors, you have to sign it by one or more. One or more will be good enough. And the debt has to be greater than 1575, more than the value of any liens on the debtor property. So you have to have unsecured debt by that much. Okay, the court will accept the petition. If it sees evidence, the debtor is not paying its bill on time. Now you'll try, maybe the debtor will try to say, well, I'm paying my bills, but the court, if they say you're not paying your bills, they will accept the petition. And now you went into an involuntary petition. Basically you did not want to go into a bankruptcy, but your creditors, as long as they meet the requirements, they were able to put you into bankruptcy. We also have, we have a lot of differentiated between secured, fully secured, that's called partially secured and unsecured. Basically a lot secured and unsecured, but really we're going to have fully secured, the group that's called fully secured, partially secured and unsecured, but really it's secured and unsecured. So the creditors are classified at either secured or unsecured, although we're going to break them into three components, you will see why in a moment. So who are the fully secured or the secured, or the secured creditors? Those are those whose claims are secured by a lien or pledge of a specific asset, and the lien cover 100% of the debt. So the fair market value of the lien covers your debt, then you are fully secured. Okay, so if the proceeds from the sale of a pledged asset exceed the secured, the access proceeds are available to the unsecured. So if you have a loan, if you lend $100,000 to a company and they have a warehouse, and that warehouse is worth 120, they sold the warehouse, you are fully secured, okay, and they have $20,000 left. That $20,000 left, now it goes to the unsecured, unsecured group. If the secured claim exceeds the proceeds, okay, from the sale of a pledged asset, the remaining claim constitute an unsecured claim. Basically you lend $100,000 worth of money to this company and the warehouse is only worth 70,000. Now guess what? Now you are short $30,000. Now you are short $30,000, you become part of the unsecured claim, or you become partially secured. Partially secured claim are those who would lien against the asset who a realizable value is less than the amount claimed. So you have a million, 100,000, but the warehouse is only worth 70,000. So now you are partially secured, 70,000 and 30,000 unsecured. And we have the unsecured creditors. Well, who are the unsecured creditors? They really don't have a lien. They paid from whatever total money remains after the secured. The secured creditor has been satisfied. So you want to be fully secured. That means you have an asset against the debt and that asset is worth equal to the debt or more than the debt. If not, then it's partially secured and you could be unsecured. Now, for the unsecured, so let's assume we have money left for the unsecured. How do we distribute this money? There's a priority. So the priority for the unsecured creditors specified by the reform act. And it assigns priority to certain claims and each rank must be satisfied before the next rank is paid. So here are the, here's the rank. Now this rank may not be 100% in detail completely, but it gives you an idea. The first that's going to be paid are the people who is handling the bankruptcy. Basically the lawyers, the accountant, the CPA, the judges, the administration expenses, fees, the charges incurred and administering the bankruptcy estate. So those are the people that get paid first because they're going to be doing the work. Okay? Because those are the people in charge of the bankruptcy. Then you're going to pay the unsecured claim for wages, salaries commissioned by employees within 90 days before the date of filing the petition. So what's going to happen? The employees, they come after. The employees that work for the company. And you have to pay them, whatever you owe them for the past 90 days, but you cannot pay more than 4650 per employee. Once again, those figures will change every once in a while. Then once those are satisfied, unsecured claim for contribution to employee benefit plan from services rendered within 180 days before the date of the filing of the petition. But subject to certain limitation, we're not going to go into details. Simply put, if you have to fund your 401k for those employees, if you owe them anything for the past 180 days, you have to do the funding after you pay them. Then unsecured claims of individuals to the extent of 2100 for each individual arising from the deposit of money in connection with the purchase lease, rental of property or services that were not delivered or performed. Let's assume you went to this place and you rented something from them and you made a deposit. Okay, now you returned the item. Guess what? They have to give you your money back. You do have priority after the employees are paid and after the employees get their 401k funded. It's called unsecured claim to individuals. Then the last is unsecured claims of governmental unit for unpaid taxes. Then there's any unpaid taxes, those comes next, any unsecured claims. Now, bear in mind in a business law class you'd learn much, much more in details. This list is much more in details, but this again gives you an idea. Now, after all these people, all these parties has been satisfied, any remaining unsecured claim participate in a pro rata of any remaining real legalization proceeds. So after they have been satisfied that there's any money, we'll see if there's anything and we'll have to distribute it. The distribution to unsecured creditor is termed a dividend. So don't confuse the dividend with a stock dividend. And it generally expressed in terms of a percentage of the total unsecured claims that will be paid. So let's take a look to show you how it works. For example, if 100,000 of proceeds remain, so we still have 100,000, after all secured claim and claims have the priority have been paid, and total unsecured claims is 400,000, while each one will get 100,000 divided by 400,000, that's 25%. So each individual, each individual, each unsecured creditor will receive a 25% dividend. And how do you find a 25% dividend? It's this amount, amount of the proceeds remaining divided by the total unsecured creditor pro rata amount. Just to give you an idea about the actual bankruptcy in the real world, I remember when Enron filed for a bankruptcy in 2001, Enron, and it was $65 billion. That was, wow, that was huge. That was the largest bankruptcy. Then a year later, Wartcom, a year later in 2002, Wartcom filed another bankruptcy and it's 103. And we thought that's like, like this is huge. I mean, this is 103 billion dollars. Okay, those are the largest 10 bankruptcies. Then 2000, here comes 2008, with a financial crash, Washington Mutual, $327 billion. So Washington Mutual alone, accounted for almost, not almost, but almost for the last four largest bankruptcies. Okay, then here comes Lehman. Again, the financial crisis, $691 billion. So if you really think about it, Lehman and Washington Mutual, almost $1 trillion, it's more than the eight prior bankruptcies. What does that mean? Why am I saying this? If you notice, as time goes by, as time goes by, bankruptcies are getting larger and larger because companies are getting larger and larger. And I could assure you if the government did not intervene during the financial crisis, we would have had trillions of dollars and bankruptcies from different banks. Okay, but obviously the government stepped in and saved the day. This is just to give you an idea about bankruptcies. For example, GM, when they fell for their bankruptcy, Chapter 11 reorganization, it was $91 billion. Now GM, get out of it. Now, if you don't know what Chapter 11 is, we're going to be working with Chapter 11 shortly. The next thing, we're going to do Chapter 7 then Chapter 11. Just to give you an idea about bankruptcies in the real world. If you have any questions, any comments about this topic, please email me. If you happen to visit my website for additional lectures, please consider donating. If you are studying for your CPA exam, by all means study hard, it's worth it. And see you on the other side of success.