CHAPTER 24—BANKRUPTCY, REORGANIZATION, AND LIQUIDATION
TRUE/FALSE
1. A central question that must be addressed in bankruptcy proceedings is whether the firm’s inability to
meet scheduled interest payments results from a temporary cash flow problem or from a potentially
permanent problem caused by falling asset values.
2. In the event of bankruptcy under the federal bankruptcy laws, debtholders have a prior claim to a
firm’s income and assets before both common and preferred stockholders. Moreover, in a bankruptcy
all debtholders are treated equally as a single class of claimants.
3. The basic doctrine of fairness under bankruptcy provisions states that claims must be recognized in the
order of their legal and contractual priority.
4. The primary test of feasibility in a reorganization is whether the firm’s fixed charges after
reorganization can be covered by its projected cash flows.
5. Bankruptcy plays no role in settling labor disputes and product liability suits. Such issues are outside
the bounds of bankruptcy law and are covered by other statutes.
6. Bankruptcy laws have been used to help reach settlements in major product liability lawsuits. By using
financial projections to show that contingent claims against the company jeopardize its existence,
agreements are reached, partially satisfying claimants, and allowing the firm to continue operating.
7. Even if a firm’s cash flow projections indicate that it will soon be unable to meet its interest payments,
a bankruptcy case cannot begin until the firm actually defaults on a scheduled payment.
8. One of the actions that can be taken in bankruptcy under the standard of feasibility is to replace
existing management with a new team if the quality of management is judged to have been
substandard.
MULTIPLE CHOICE
9. Chapter 7 of the Bankruptcy Act is designed to do which of the following?
a.
Establish the rules of reorganization for firms with projected cash flows that eventually
will be sufficient to meet debt payments.
b.
Ensure that the firm is viable after emerging from bankruptcy.
c.
Allow the firm to negotiate with each creditor individually.
d.
Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm
and allow insolvent debtors to discharge all of their obligations and to start over
unhampered by a burden of prior debt.
e.
Protect shareholders against creditors.
10. Which of the following statements is most CORRECT?
a.
Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal
bankruptcy are governed solely by state laws.
b.
All bankruptcy petitions are filed by creditors seeking to protect their claims against firms
in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the
perspective of the firm’s management.
c.
Chapters 11 and 7 are the most important bankruptcy chapters for financial management
purposes. If a reorganization plan cannot be worked out under Chapter 11, then the
company will be liquidated as prescribed in Chapter 7 of the Act.
d.
“Restructuring” a firm’s debt can involve forgiving a certain portion of the debt, but it
cannot call for changing the debt’s maturity or its contractual interest rate.
e.
Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained
unaltered since that time.
11. Which of the following statements is most CORRECT?
a.
The primary test of feasibility in a reorganization is whether every claimant agrees with
the reorganization plan.
b.
The basic doctrine of fairness states that all debtholders must be treated equally.
c.
Since the primary issue in bankruptcy is to determine the sharing of losses between
owners and creditors, the “public interest” is not a relevant concern.
d.
While a firm is in bankruptcy, the existing management is always allowed to retain
control, though the court will monitor its actions closely.
e.
To a large extent, the decision to dissolve a firm through liquidation versus keeping it
alive through reorganization depends on a determination of the value of the firm if it is
rehabilitated versus the value of its assets if they are sold off individually.
12. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter
7 of the Bankruptcy Act? 1 is the highest claim, 5 is the lowest.
(1)
Trustees’ costs to administer and operate the firm.
(2)
Common stockholders.
(3)
General, or unsecured, creditors.
(4)
Secured creditors, who have a claim to the proceeds from the sale of specific property
pledged to secure a loan.
(5)
Taxes due to federal and state governments.
a.
5, 4, 1, 3, 2
b.
4, 1, 5, 3, 2
c.
5, 1, 4, 2, 3
d.
1, 5, 4, 3, 2
e.
1, 4, 3, 5, 2