8. Liquidations in bankruptcy

When a business is worth more if its assets are sold than if it continues to operate, then the business is liquidated, and the proceeds from the sale are used to satisfy any outstanding debt.

Liquidation occurs when businesses file for bankruptcy under Chapter 7 of the Federal Bankruptcy Reform Act. This act provides for an equitable distribution of the debtors assets among the creditors. The distribution of assets is governed by a certain priority of claims.

Which of the following claimants has the highest priority according to Chapter 7?

A. Unfunded pension plan liabilities

B. Preferred stockholders

C. Unsecured claims for customer deposits

D. Common stockholders

Fuzzy Badger Transport has been in financial distress for the past three years. The companys reorganization plans were rejected, and the bankruptcy court is forcing Fuzzy Badger Transport to liquidate its assets and settle creditor claims.

The court appointed the trustee with an estimated expense budget of $421,875. Subordinated debentures are subordinated only to the notes payable.

Fuzzy Badger Transport

Balance Sheet

(Thousands of dollars)

Current assets	$2,813	Accounts payable	$563
Net fixed assets	2,813	Notes payable	1,125
		Subordinated debentures	1,125
		Total debt	2,813
		Common equity	2,813
Total assets	$5,626	Total liabilities and equity	$5,626

The trustee has arranged the sale of Fuzzy Badger Transports assets and estimates to receive $3.75 million in proceeds from the liquidation.

Proceeds from the liquidation will be used to settle Fuzzy Badger Transports liabilities. Based on your understanding of distribution of assets to various claimants, how much will common stockholders receive (if they receive anything at all) when Fuzzy Badger Transport is liquidated?

A. $937,000

B. $1,078,125

C. $566,638

D. $515,125

The bankruptcy courts and the company have discretion in how they elect to handle a failing firm. Just as the decision to reorganize or liquidate the firm depends on the relationship between its going concern and its liquidation values, the significance and competitiveness of the industry in which the failing firm operates also affects the courts decision. If Fuzzy Badger Transport were a public utility company or a railroad service company instead of an industrial corporation, the bankruptcy courts would likely push for:

A. Reorganization

B. Liquidation