Primary Objective: The objective of this project is to provide accounting and financial reporting guidance for governments that have been granted protection from creditors under Chapter 9 of the United States Bankruptcy Code. The project includes an analysis of the financial reporting consequences for governments that have been granted protection under Chapter 9. “Protection” may include modifications to the terms and conditions of certain of the government’s debt issuances and relief from burdensome provisions of certain executory contracts and unexpired lease commitments.
Status: The Board reviewed the ballot draft of the Statement on Accounting and Financial Reporting for Chapter 9 Bankruptcies at the December 2009 teleconference. The Board approved the release of the Statement.
Chapter 9 Bankruptcy—Project Plan
Background: The first municipal bankruptcy legislation was enacted in 1934 during the Great Depression. In the seventy-plus years since then, there have been fewer than 600 Chapter 9 filings. To put that statistic into perspective, it is said to be less than the number of Chapter 11 (reorganization) filings during an average two-week period in 2006. Nevertheless, recent high-profile filings (or potential filings) have brought the process to the public’s attention, and the current economic environment maintains the possibility of additional Chapter 9 filings and raises questions about the accounting implications that result from such filings.
Chapter 9 of the Bankruptcy code is directed specifically to “municipalities”—defined in the code as a “political subdivision or public agency or instrumentality of a State.” That definition would encompass cities, counties, townships, school districts, and other special districts—but not the states themselves. Its scope also includes business-type activities that provide services generally financed by user charges rather than by taxes or other general revenues.
The purpose of Chapter 9 is to provide a financially distressed government protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the government’s debt is typically accomplished by (1) extending debt maturities, (2) reducing the amount of principal or interest, or (3) refinancing the debt with new borrowing.
Although similar to other chapters in the Bankruptcy Code in some respects, Chapter 9 is significantly different in that it contains no provision for liquidation of the government’s assets and distribution of the proceeds to creditors.
If a petitioning government satisfies the eligibility criteria under Chapter 9, the case is assigned to a bankruptcy judge. In general, it remains “business as usual” for the Chapter 9 government. Under the automatic stay provisions of the code only some of the government’s debt will be adjusted (“special revenue” debt will not be affected, for example). In addition, under the “avoiding” powers provisions, the government (or through an appointed trustee) has the power to reject and renegotiate unexpired leases and executory contracts (included within the definition of executory contracts are collective bargaining agreements between the government and its employees). Retiree benefit plans also are subject to rejection and renegotiation.
The most specific financial reporting guidance applicable to entities that have filed for bankruptcy is provided by American Institute of Certified Public Accountants’ Statement of Position (SOP) 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. It applies to entities that have filed for protection under Chapter 11 and those that have emerged from Chapter 11 under confirmed reorganization plans. The SOP specifically states that it does not apply to governmental organizations.
Financial Accounting Standards Board (FASB) Technical Bulletin No. 81-6, Applicability of Statement 15 to Debtors in Bankruptcy Situations, indicates that FASB Statement No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, does not apply to troubled debt restructurings in which debtors restate their liabilities generally under the purview of the Bankruptcy Court. Thus, the provisions of FASB Statement 15 would generally not apply to entities that have petitioned the court under Chapter 11 because the general restructuring of debts of the petitioner is the usual outcome.
One of the chief differences between Chapter 11 and Chapter 9 in the bankruptcy code is that under Chapter 9, only some of a government’s debts are subject to adjustment. Consequently, the reason given for the inapplicability of FASB Statement 15 to entities under Chapter 11 does not apply to governments filing under Chapter 9. Thus, one could argue that within the current hierarchy of generally accepted accounting principles, FASB Statement 15 (specifically paragraphs 16 through 18, Modification of Terms) constitutes the most appropriate guidance for governments whose debts are adjusted in a confirmed plan under Chapter 9. FASB Statement 15 is included among the pronouncements to be codified into the GASB’s authoritative literature via the Codification of Pre-November 30, 1989, FASB Pronouncements project, which currently is on the GASB’s research agenda. Statement 15, however, does not contemplate other financial reporting implications for additional areas of relief that may be provided to governments under Chapter 9.
Other pronouncements that may provide relevant guidance or indicate precedents with regard to accounting for and reporting changes to debt arrangements include Accounting Principles Board (APB) Opinion 26, Early Extinguishment of Debt, and GASB Statements No. 23, Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary Activities, and No. 7, Advance Refundings Resulting in Defeasance of Debt. Under Chapter 9, debts may be extinguished or refinanced with new debt, thus guidance from those pronouncements may be appropriate.
Accounting and Financial Reporting Issue: The primary accounting and financial reporting issue would be to determine whether and how recognition and measurement in financial statements should be affected for governments that are granted protection from creditors under Chapter 9. One approach would include incorporating the existing guidance for debt restructuring, early extinguishment, and refunding from FASB Statement 15, APB 26, and GASB Statements 7 and 23, respectively. In addition, a government’s ability to reject and renegotiate unexpired leases and executory contracts may have financial statement consequences for employee benefit obligations such as OPEB and compensated absences. Possible modifications to lease arrangements also may impact pre-petition amounts recognized in financial statements.
It is unlikely that valuation of other assets and liabilities of a government emerging from Chapter 9 will be affected because the reasoning underlying the requirement in SOP 90-7 for fresh-start reporting using reorganization value would not apply. Fresh-start reporting using reorganization value is based on the notion that a new controlling interest is established through reorganization—that is, the emerging entity is different from the entity that petitioned the court for reorganization.Chapter 9 Bankruptcy—Recent Developments
Minutes of Teleconference, December 8, 2009
The Board reviewed and provided comments on a ballot draft of Statement No. 58, Accounting and Financial Reporting for Chapter 9 Bankruptcies. The Board members suggested changes to further clarify the draft material. After discussion, the Board voted unanimously to issue the final Statement.
Minutes of Meeting, November 18-20, 2009
The Board reviewed the preballot draft of the proposed Statement and made tentative editorial changes.
A ballot draft of a final Statement will be prepared and will be discussed at the December 2009 teleconference.
Minutes of Teleconference, October 27, 2009
The Board continued redeliberations of the measurement approaches presented in paragraphs 6 and 7 of the Exposure Draft as well as the alternative views. The Board tentatively decided to retain the measurement provisions as proposed in the Exposure Draft.
The Board also discussed the interest rate to be applied if paragraph 7 is used. The Board tentatively decided to leave the interest rate provisions as proposed in the Exposure Draft.
Minutes of Meeting, October 6-8, 2009
The Board discussed comment letters received in response to the Exposure Draft for Chapter 9 bankruptcies. The Board began redeliberations by discussing the measurement approaches presented in paragraphs 6 and 7 of the Exposure Draft as well as alternative views. The Board also considered the appropriateness of having consistent measurement approaches in paragraphs 6 and 7. No tentative decisions were reached. The Board will further consider the issues at the next teleconference.
Next, the Board discussed amending the disclosure provisions set forth in paragraph 15 of the Exposure Draft. The Board requested that the disclosures refer to “levels of service” rather than “service levels.” The Board tentatively decided to retain the remaining disclosure requirements as proposed in the Exposure Draft.
Finally, the Board discussed the pension provisions in paragraph 9 and tentatively decided to retain the requirements essentially as proposed in the Exposure Draft.
Minutes of Teleconference, June 23, 2009
The Board approved for issuance an Exposure Draft of the proposed Statement, Accounting and Financial Reporting for Chapter 9 Bankruptcies. The Board balloted the document out of session; however, Mr. Attmore, Mr. Williams, and Ms. Taylor noted that they would provide alternative views to the Exposure Draft.
Minutes of Meeting, June 2-4, 2009
The Board reviewed the preballot draft of the proposed Statement and made editorial changes, including adding a clarification that unamortized bond issuance costs should be expensed when debt is adjusted in bankruptcy. The Board is scheduled to discuss a ballot draft of the proposed Statement and vote on the issuance of this Exposure Draft at the teleconference on June 23, 2009.
Minutes of Teleconference, May 12, 2009
The Board continued discussing the measurement approach for bonds, notes, accounts payable, and similar liabilities. The Board tentatively decided that measurement should be based on whether or not the terms are specified in a confirmed Plan of Adjustment. That is, if the Plan of Adjustment indicates that only interest rates have been reduced, no gain would be recognized. If the Plan of Adjustment indicates that the carrying amount has been reduced, a gain would be recognized for the amount of the reduction. If the Plan of Adjustment reduces future debt payments but does not indicate whether the reductions relate to the carrying amount or to interest, a gain would be recognized based on discounting the new payments at the original interest rate. This is similar to remeasurement of leases. All other measurement guidance tentatively agreed to by the Board at previous meetings was retained.
Three Board members indicated that they would submit alternative views on measurement in the proposed Exposure Draft. A preballot draft of the proposed Statement will be discussed at the June meeting.
Minutes of Meeting, April 21-23, 2009
The Board continued debilerations of issues regarding accounting for Chapter 9 bankruptcy and reviewed a draft of the standards section of the proposed Exposure Draft.
The Board began deliberations by tentatively deciding to use the term government throughout the proposed Statement rather than the term municipality, which is used in bankruptcy law.
The Board revisited the recognition and measurement approach tentatively adopted at the previous meeting. No tentative decisions were reached, and the Board requested that the issues be further discussed at the next meeting.
Next, the Board discussed whether gains or losses from asset remeasurement should be presented separately from gains from debt adjustment. The Board tentatively determined not to include guidance on this issue in the proposed Statement.
Next, the Board discussed the possible inclusion of guidance about the frequency of asset remeasurements for entities that do not plan on continuing as going concerns. The Board tentatively agreed not to include specific guidance on this issue.
The Board then deliberated reporting changes in benefit obligations. The Board tentatively determined that, if a benefit plan is rejected in bankruptcy and, therefore, becomes general unsecured debt, any pre-petition net benefit liabilities or assets should be removed, and any payments of that debt agreed to in the confirmed Plan of Adjustment should be recognized as a judgment.
Then the Board discussed the effective date for the proposed Statement. The Board tentatively determined that the standard should apply to all reporting periods beginning after June 15, 2009.
The Board also requested various clarifying edits to the draft of the standards section of the proposed Statement.
Minutes of Meeting, March 10-12, 2009
The Board continued its discussion of the accounting and financial reporting issues associated with Chapter 9 bankruptcy by comparing guidance in FASB Statement No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, and AICPA Statement of Position (SOP) 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. The Board tentatively decided that the proposed guidance should include a provision for the recognition of a reduction of liabilities as of the date a Plan of Adjustment is confirmed by the court or as of a later date when all material conditions precedent to the plan’s becoming binding are resolved.
Next, the Board discussed the accounting treatment for legal and other direct costs associated with bankruptcy. The Board tentatively decided that the proposal should include a provison that these costs be expensed as incurred.
The Board then discussed methods to measure any gains on restructuring of liabilities, including the approaches in FASB Statement 15 and SOP 90-7. The Board tentatively determined that the proposed measurement approach should generally be consistent with FASB Statement 15, which measures a liability at “the total future cash payments specified by the new terms,” if those payments are less than the carrying amount of the liability. However, the Board also tentatively decided that an appropriate discount rate, consistent with Accounting Principles Board Opinion No. 21, Interest on Receivables and Payables, should be proposed to apply to those future cash payments.
The Board then discussed measurement of liabilities that are not within the scope of FASB Statement 15 and tentatively determined that the current guidance for modifications to lease arrangements, pensions and OPEB obligations, and pollution remediation obligations should be proposed to be carried forward.
Next, the Board deliberated the classification of gains associated with restructuring of liabilities in Chapter 9. After discussing the approaches used in FASB Statement 15, SOP 90-7, and GASB Statement No. 34, Basic Financial Statements—and Management's Discussion and Analysis—for State and Local Governments, the Board tentatively decided to propose that all gains resulting from debt restructuring in Chapter 9 be classified as an extraordinary gain.
The Board then discussed the display of liabilities subject to compromise in Chapter 9, and tentatively agreed that the proposal should contain a provision that these liabilities need not be separately displayed.
The Board also discussed reporting issues for entities that are not expected to emerge from Chapter 9 Bankruptcy. The Board tentatively concluded that the proposal should contain a provision that the entity’s assets be reported at a remeasured value that represents the amount expected to be received.
The Board also looked at potential disclosures based on those required by FASB Statement 15 and SOP 90-7, and those required for going concern issues. The Board requested that the staff further develop the disclosures to make them more specific to Chapter 9 bankruptcies.
Finally, the Board tentatively determined that the reporting provisions should cease to apply for periods following the period in which the municipality is discharged from bankruptcy or has its petition dismissed.
Minutes of Meeting, January 27-29, 2009
The meeting began with a presentation to the Board by James Spiotto, a partner with the law firm Chapman & Cutler LLP. Mr. Spiotto discussed issues related to Chapter 9 Bankruptcy and answered questions from the Board. Next, the Board deliberated the scope of the standard. The Board tentatively concluded that the proposed standard should not contemplate changing or including guidance for going concern assessments but that the proposed standard should not be disconsonant with that guidance. Next, the Board tentatively decided that troubled debt restructurings that occur outside the scope of bankruptcy should not be addressed as part of this project. The Board then tentatively concluded that this project should provide guidance for both governments that have formally petitioned for relief under Chapter 9 and for those governments that have been granted relief under the provisions of Chapter 9.
Chapter 9 Bankruptcy—Major Tentative DecisionsStatement No. 58 , Accounting and Financial Reporting for Chapter 9 Bankruptcies, was approved in December 2009.