7.5 Joint-and-Several Liability Arrangements

In a joint-and-several liability arrangement, two or more entities are co-obligors with respect to the same obligation. Because each co-obligor is a primary obligor, the creditor can demand repayment of the full amount of the obligation from any of the co-obligors. A co-obligor cannot refuse to pay the full amount even if it did not borrow that amount. Depending on what the co-obligors have agreed to among themselves and under any applicable laws, however, a co-obligor that has paid amounts to the creditor on behalf of other co-obligors might be able to seek repayment of such amounts from its co-obligors.

ASC 405-40 applies to all entities that have obligations resulting from joint-and-several liability arrangements regardless of the relationship among the parties involved in the agreement. Examples of obligations that may be subject to joint-and-several liability include debt obligations, line-of-credit arrangements, settled litigation, and judicial rulings. However, ASC 405-40 does not apply to obligations within the scope of other Codification topics (including ASC 410, ASC 450, ASC 460, ASC 715, and ASC 740). For example, if an entity is a guarantor or co-guarantor of a debt arrangement and the creditor can seek repayment from the entity only if the creditor has been unable to collect amounts due from the debtor, the entity would apply the guidance on guarantees in ASC 460, not ASC 405-40. A significant difference between a joint-and-several liability arrangement and a guarantee obligation is that an entity is a primary obligor under the former and a secondary obligor under the latter.

The scope of ASC 405-40 is limited to arrangements for which the total amount is fixed as of the reporting date. For the total amount to be considered fixed, it cannot be subject to measurement uncertainty (such as uncertainty associated with ongoing litigation). Liabilities that are subject to measurement uncertainty are accounted for under ASC 450 or other GAAP. If the measurement uncertainty is resolved after the inception of the arrangement (e.g., settled litigation), ASC 405-40 applies when the total amount becomes fixed. The total amount would be considered fixed as of the reporting date even if (1) the portion the entity expects to pay among its co-obligors is subject to measurement uncertainty or (2) the total amount varies over time because of factors unrelated to measurement uncertainty (e.g., an additional amount was borrowed or the interest rate changed).

Upon initial recognition and on each subsequent measurement date, obligations within the scope of ASC 405-40 are measured as the sum of (1) the amount the entity has agreed to pay under the arrangement among the co-obligors (i.e., the amount the entity has agreed to be ultimately liable for; not the full amount) and (2) any additional amount the entity expects to pay on behalf of its co-obligors (e.g., because a co-obligor is expected to be unable to pay some or all of the amount it has agreed to be liable for among its co-obligors).

In determining how much it has agreed to pay under the arrangement among the co-obligors, the entity should consider any written agreements among the co-obligors as well as other facts and circumstances. In the absence of a written agreement between the parties, factors that could result in a conclusion that there is an implicit agreement include information about how the parties have acted in the past, which party received the proceeds, and which party has made principal repayments or interest settlements.

In determining any additional amount it expects to pay on behalf of its co-obligors, the entity applies a measurement approach similar to that for loss contingencies in ASC 450-20 (see Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees). That is, if a best estimate of the additional amount is available, the entity should record that amount. If there is a range of potential estimates and some amount within the range is a better estimate than any other amount within the range, the best estimate should be recorded. If no amount within the range is a better estimate than any other amount, the minimum amount within the range should be recorded.

ASC 405-40 does not prescribe the specific offsetting entry or entries an entity should make when recognizing or remeasuring the liability in a joint-and-several liability arrangement. Accordingly, an entity must use judgment and consider the facts and circumstances.

To the extent that an entity has received cash for amounts it has borrowed under a joint-and-several liability arrangement, the appropriate offsetting entry would be to cash. If the entity expects to pay amounts on behalf of co-obligors, the offsetting entry for such amounts depends on whether the entity has a contractual right to recover those amounts from its co-obligors (e.g., under a side agreement). If it has such a right, it should record a receivable and evaluate it for impairment under ASC 310 or ASC 326 (see Deloitte’s Roadmap Current Expected Credit Losses), as applicable. If the entity has no such right, the appropriate offsetting entry might be an expense. Any expected recoveries (e.g., if the entity sues its co-obligors) would be evaluated as a contingency under ASC 450-20 and ASC 450-30 (see Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees).

If the co-obligors are related parties, an entity should consider the reasons for, and substance of, the arrangement among the co-obligors in determining the corresponding entry or entries for any amounts that it has agreed or expects to pay on behalf of its co-obligors. For an amount owed from a shareholder or related party (such as a sister company) to be classified as an asset (a receivable), the terms of the transaction generally should be comparable to the terms that would be expected to be available from external sources (e.g., interest rates, payment terms and maturities, evidence of the ability and intent of repayment, and nature and sufficiency of collateral). If an entity has agreed or expects to pay an amount on behalf of a co-obligor that is a related party and receivable classification is not appropriate, the appropriate corresponding entry might be to equity. For example, if a subsidiary expects to pay an amount on behalf of its parent, the substance of the subsidiary’s payment might be that of an equity distribution from the subsidiary to the parent.

An entity must disclose information about the nature and amount of each obligation (or each group of similar obligations) within the scope of ASC 405-40, including how the liability arose, the relationship with other co-obligors, and any other relevant terms and conditions of the explicit or implicit agreement between them.