What to do when chapter 11 threatens.

Just as the 1980s was the decade of business euphoria, so the 1990s as become the decade of retrenchment, as the economic misreadings of a more optimistic time are documented in chapter 11 filings. For many CPAs the painful road to bankruptcy -- for their employers, customers or clients - is not well traveled.

his article provides practical advice for CPAs involved in chapter 11 proceedings. It examines the steps to take before and after the bankruptcy papers are filed.

PREPARING FOR A FILING The work a CPA does in advance of a court filing often is as important as anything done afterward. If a business expects to enter chapter 11, its accountant should be working with other managers of the enterprise, often with major creditors or suppliers, to develop a strategic plan that ensures a flow of cash and raw materials to the company after the petition is filed so it can continue to function.

Developing such a plan is the single most, important prefiling task because it determines whether the business will emerge whole from chapter 11. The plan must document how the troubled business intends to turn itself around. It must examine the options, which include tactics such as using the bankruptcy laws to Prune operations and sell surplus assets or to discount or stretch out existing debt.

Although the need for a long-term Plan may seem obvious to most professionals, many debtors actually file for chapter 11 without one. Such a failure imposes even more risk on the debtor than it already faces. Creditors likely will pressure the Bankruptcy Court to force the debtor to sell properties to meet its obligations. If the debtor lacks a turnaround plan, the court must make decisions on the creditors' petitions without the benefit of the debtor's alternative proposals. As a result, there is a greater likelihood the debtor will get involved in extended legal battles will creditors that lack faith the debtor ever pay its debts.

A QUESTION OF CREDIBILITY A debtor without a plan also jeopardizes its credibility before the bankruptcy judge. Although most judges support the idea of reorganization, they are hesitant to use their power to protect a debtor from creditors if they do not see good-faith evidence that a way is being worked out to repay debts. Telling a bankruptcy judge that creditors should wait for their money without presenting a credible plan and timetable is a ticket to a foreclosure sale.

Of equal importance is a short-range action plan providing a timetable for the interim steps that must be taken before the long-range plan can be implemented. A short-term plan enhances the debtor's credibility with the bankruptcy judge, who typically attempts to give a company time to emerge from bankruptcy. A good short-range plan also provides the court with the ammunition it needs to block the official creditors' committee from implementing its own reorganization plan, which usually is not favorable to the debtor.

In preparing the short-term plan, the debtor's CPA usually is asked to work with other members of management to prepare a cash-flow analysis to ensure the company will be able to fund both the retainers for attorneys and accountants before the filing and the debtor's business operations after the filing. The analysis also identifies key assets or contract rights the debtor will have to defend if it is going to maintain the core of its business.

On many occasions, the debtor's CPA is asked to undertake prefiling negotiations with its bank to work out the terms and conditions of a postfiling financing. The accountant also may be asked to negotiate with its key suppliers the terms and conditions for providing critical materials or inventory after the filing.

The CPA is responsible for preparing most of the documents the bankruptcy lawyers need to file with the petition. While the petition itself is less complicated than a short form 1040, the other initiating documents are complicated and time-consuming. For starters, the lawyers need the names and addresses of the creditors. They also need cash flow analyses to support motions, for permission to use the bank's collateral or motions for authority to borrow more money from the bank, even if the bank already is on board. If the debtor intends to sell surplus assets immediately after the filing, the accounting staff must help the lawyers prepare the motion explaining why the sale is in the interests of both the debtor and the creditors and how the debtor plans to use the sale proceeds.

AFTER THE FILING When the filing has been completed, the debtor's accountant continues to perform the classic tasks - preparing and analyzing financial reports - while attempting build confidence in the debtor. However, simple matters like financial reporting take on new importance in chapter 11 filings. The petition and address lists have to be followed in very short order by a statement of financial affairs providing basic information about the debtor's operations over the previous year and a schedule of assets and liabilities that lists every claim against it and every asset on its books. The logistics of assembling and distributing the schedules can be overwhelming; in some cases the schedules can be thousands of pageslong.

Carelessly structuring the project - presenting the claims in descending dollar amounts rather than in alphabetical order, for example - may result in a final product that meets the formal requirements of the bankruptcy laws but is useless for any other purpose.

If the debtor owns real estate, a number, of courts require special reports, including deeds-of-title reports and insurance information. A medium-sized portfolio of apartment or office buildings can beget another couple of thousand pages of filings. All of this information is due within the first few weeks of the filing.

Reporting and analyzing does not stop with this first wave of documents. Every bankruptcy court requires monthly operating reports, including cash flow and profit-and-loss statements and monthly balance sheets. To complete these reports, the accountant may have to convert accrual-basis records to cash-basis statements. To avoid confusion or recriminations once the reports are filed, the CPA must be able to explain to the creditors the variations between, the two different sets of accounts. Some bankruptcy Courts have their own rules calling for other kinds of reports, and some lenders require still more reports on the status of their collateral, even though this information can be gleaned from existing reports.

After these special reports have been completed for the courts and creditors, the CPA still has to worry about generating the reports that regularly were done before this chapter 11 case was launched - tax returns, financials for management or filings for the Securities and Exchange Commission.

FROM THE CREDITORS' VIEWPOINT For the CPA representing the creditors in a chapter 11 filing, the main goal is to obtain as much of the money owed as possible. The first order of business is to review the credit file to determine whether the debtor has goods on order that can be delayed until after the filing and whether the creditor holds liens on goods that have not yet been perfected. The creditor's staff must consider whether the potential chapter 11 debtor has its own claims against the creditor that could lead to Bankruptcy Court litigation. Finally, the creditor's CPA should prepare an answer to the debtor's likely request for new credit.

Reporting work does not stop when the reports go out the door. Both the debtor's and the creditor's CPAs' responsibility for analyzing the information in the reports is more important than it was before the filing because the company is -- or should be -- taking steps to restructure its business operations fundamentally. The company's creditors also rely on the reports as they debate with management about the company's programs and prospects and make their own fundamental decisions about the company's business plans.

If the debtor is to remain on top of the chapter 11 case, the CPA must stay ahead of the creditors, anticipate their questions and concerns and force them to respond to the debtor's initiatives. Those initiatives should flow from the CPA'S assessment of the company's operating numbers.

Before a filing, the debtor's chief executive officer is the company's principal representative to the outside world. If creditors have questions about finances or operations, they generally look to the CEO for answers. After the filing, the chief financial officer's role expands, as once - complacent creditors insist on understanding exactly where the company is and where it is going. The details of the company's performance and its projections become more important, given the company's failure to meet its projections in the days leading up to the filing.

Accordingly, the CFO should anticipate skepticism, cross-examination and even hostility from creditors. The CEO should be prepared to explain how creditors may have been misled in the past and why they should trust the numbers they are receiving in this round.

The scale of the tasks in a chapter 11 case may seem daunting -- compounded by the possibility that the CPA'S own job hangs in the balance -- but a CPA should recognize that accounting in a chapter 11 case can be the most challenging professional work he or she is ever likely to face. It puts all of an accountant's formal education, experience and street smarts to work. Viewed in this light, chapter 11 filings provide CPAs with an opportunity for career advancement.

EXECUTIVE SUMMARY

* THE WORK CPAs DO in advance of a court filing often is as important as anything done afterward. The key task is to develop a strategic plan that ensures a flow of cash and raw materials to the company after a chapter 11 petition is filed so it can continue to function.

* THE PLAN MUST document how the troubled business intends to turn itself around. It must examine the options, which include tactics such as using the bankruptcy laws to prune its operations and sell surplus assets or to discount or stretch out its existing debt.

* A DEBTOR WITHOUT a plan jeopardizes its credibility before the bankruptcy judge and may lose the opportunity to be protected from creditors.

* ON MANY OCCASIONS the debtor's CPA is asked to undertake prefiling negotiations with its bank to work out the terms and conditions of a postfiling financing. The accountant also may negotiate with key suppliers the terms and conditions for providing critical materials or inventory after the filing.

* FOR CPAs REPRESENTING creditors, the main goal is to obtain as much of the money owed as possible. The first order of business is to review the credit file to determine whether the debtor has goods on order that can be delayed until after the filing and whether the creditor holds liens on goods that have not yet been perfected.

* AFTER CHAPTER 11 filing, the debtor's accountant continues to perform his or her classic tasks -- preparing and analyzing financial reports -- while building confidence in the debtor.

BANKRUPTCY:

OPPORTUNITIES

AND CAVEATS

Companies in financial trouble provide opportunities for bargain hunters. A squeezed business is likely to offer assets for sale to raise cash, and some of them may be real bargains.

However, buyers should exercise caution because the seller is likely to be

the subject of a bankruptcy filing. The buyer's CPA should advise delaying a deal until after the sale. Without such protection, the buyer may face claims of a fraudulent transfer or successor liability.

By the same token, if a company is considering a loan or an investment to a distressed company, it should consider getting the Bankruptcy Court's blessing, which would confirm rights to collateral or rights vis-a-vis other investors in the enterprise.