The Disclosure Statement

The disclosure statement is a legal document which every company undergoing bankruptcy in the United States is expected to create and share with its stakeholders. The disclosure statement is often considered to be a fundamental document. It is often compared to the prospectus, which is issued by companies before they solicit investors during an initial public offering process. Just like the prospectus, the objective of the disclosure statement is to provide the creditors with useful information about the current financial position of the company as well as the reorganization plan.

In this article, we will learn more about what the disclosure statement is as well as what procedure needs to be followed in order to file one.

What does a Disclosure Statement Contain?

A disclosure statement is meant to provide all the necessary information to the stakeholders. Now, there is a big debate about what can be considered to be necessary. Many courts have tried to create a checklist of information which must be present in the disclosure statement. However, over the years, courts have realized that there is no particular structure to information which may be relevant to creditors of a company facing bankruptcy. Hence, expecting a checklist to be exhaustive is wishful thinking, to say the least!

As a result, courts have prescribed some basic guidelines about what a disclosure statement must include. However, they have left the rest of the process to the company and its creditors. Some of the commonly included information is as follows:

  1. The financial causes which have led the company to a position of bankruptcy

  2. The present financial condition of the debtor. This includes a list of the market values of the assets owned by the company as well as the cash flow which is likely to accrue to the company in the near future

  3. A schedule depicting the liquidation value of the firm. This is often used by the creditors to decide whether liquidating the firm is in their best interests or whether allowing it to continue as a going concern is better

  4. A brief description of the expected outcome of the reorganization plan. This should include projected cash flows and should also take into account professional fees which will be incurred during the reorganization plan

  5. The risks of fraud should also be mentioned in the plan.

  6. The possibility of a tax liability which would reduce the worth of the creditors' assets should also be mentioned in the document

  7. Any conflict of interest on the part of the management or any other decision-making body must be disclosed before the beginning of the reorganization plan in this disclosure statement

Financial Values in a Disclosure Statement

The disclosure statement is a court-mandated document. As a result, it is prepared using extreme caution and conservatism. The values listed on the document are often an under-representation of the true value of the company.

  • For instance, the liquidation value of the firm listed in the disclosure statement is mentioned at the fire-sale price. This means that the value listed is what would be realized if all the assets of the company were sold immediately at distressed prices in order to return money to the stakeholders. It does not take into account the going concern value of the firm.

  • Many times future operations are considered to be a part of the source of funding. The revenue from these operations is considered to be at the bare minimum level. This is done to ensure that the management is not misleading the creditors by providing incorrect values which cannot be realized.

The Approval Process

The disclosure statement prepared by the debtor company is not considered to be final. It has to be approved by the courts. The process is that the statement is filed with the courts. The courts then send this statement to other stakeholders. The other stakeholders are then given time to object to these statements. The time limit set by the court is usually 25 days. However, this time limit is negotiable, meaning that if all parties agree, this time limit could be shortened.

It also needs to be understood that the creditors can only object to the completeness of information in the plan. They cannot object to the contents of the plan. For instance, a creditor may not think that taking more debt is a good strategy. However, they cannot object to that during the disclosure statement process. Their objections can be taken into account at a later stage.

It needs to be understood that the disclosure statement is not the final agreement. Instead, it is just the opening offer given by the debtor firm to other stakeholders.

The bottom line is that the disclosure statement provides basic information to enable any investor to make informed decisions about their stake in a particular firm. These disclosure statements are seldom met by resistance and do not tend to be long drawn affairs. However, it also a fundamental document. The proceedings of the bankruptcy court are halted until approval is received for the disclosure statement.

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