9.2 Other Reconsideration Event Considerations
9.2.1 Entering Into or Emerging From Bankruptcy
Generally, the act of filing for bankruptcy is a reconsideration event. This is because entering into bankruptcy will often result in the loss of the equity investors’ ability to direct the activities of the legal entity that most significantly affect the legal entity’s economic performance (generally, this ability would reside with the bankruptcy court) which is a reconsideration event (see Section 9.1.5).
Emerging from bankruptcy is also a reconsideration event. In a majority of cases, when a legal entity emerges from bankruptcy, its governing documents generally establish new equity and other contractual arrangements that change the characteristics of the legal entity’s equity investment at risk (see Section 9.1.1). In this situation, a reporting entity that holds a variable interest in the legal entity must reconsider its original conclusion related to that legal entity’s VIE status.
9.2.2 Valuation of Equity Investment at Risk When a Reconsideration Event Occurs
If it is determined that a reconsideration event has occurred, a reporting entity should measure equity investment at risk in determining its sufficiency. In a manner consistent with the analysis in Section 5.2.3, a reporting entity should use the fair value of the equity investment at risk as of the reconsideration date, not the carrying value of the equity investment at risk, in determining the sufficiency of equity investment at risk.
9.2.3 Operating Losses
ASC 810-10-35-4 indicates that operating losses incurred by a legal entity that
are in excess of its expected losses that result in a reduction of the equity
investment at risk generally do not cause a legal entity to be subject to the
VIE guidance. Said differently, if the amount of the equity investment at risk
at the legal entity’s inception (or when a reporting entity first became
involved with the legal entity) was determined to be sufficient, losses later
incurred by that legal entity do not by themselves result in the requirement for
a reporting entity to reconsider whether the legal entity has sufficient equity
investment at risk. However, there may be situations in which significant losses
may call into question whether the power to direct the most significant
activities of the legal entity still rest with the holders of the equity
investment at risk. This may occur, for example, when significant losses result
in a violation of a covenant that allows the debt holder or a guarantor to
obtain a controlling financial interest in
the legal entity. This would be deemed a reconsideration event under ASC
810-10-35-4(e) (see Section
9.1.5). In addition, a legal entity may initiate other changes to
the governing documents or contractual arrangements, issue additional equity
interests, or change its activities, which could be reconsideration events.
Example 9-12
Company X was formed on January 15, 20X5. As of that date, all variable interest holders determined that X had sufficient equity investment at risk (i.e., X is not a VIE). Company X incurred significant operating losses for its first two years of operations. On January 15, 20X7, X had insufficient equity investment at risk. However, no event causing reconsideration under ASC 810-10-35-4 has occurred.
On January 16, 20X7, the governing documents of X were changed. The variable interest holders determined that the change in the governing documents did not cause a change in the amount of the equity investment at risk. Even though X has insufficient equity investment at risk on January 16, 20X7, the insufficiency was caused by operating losses, not by the change in governing documents. Therefore, a reconsideration event has not occurred.