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2.9 Joint and several liability
Publication date: 31 Dec 2021
us Financing guide 2.9
A joint and several liability is an obligation shared by several parties that is enforceable, for the full amount of the obligation, against any one of the parties. For example, in a joint and several debt obligation, the lender can demand payment in accordance with the terms of the debt for the total amount of the obligation from any one, or a combination, of the obligors. An obligor cannot refuse to pay the total obligation on the basis that they individually only borrowed a portion of the total proceeds; however, they may be able to pursue the other obligors for repayment, depending on the agreement among the co-obligors and the laws covering the arrangement.
Joint and several liabilities can exist between entities that are under common control or between unrelated parties. Entities under common control may participate in a financing arrangement in which each entity borrows a specified amount but are jointly and severally liable for repayment of the total debt incurred by the group. An example of joint and several liability among unrelated parties is a legal dispute when the courts hold all of the defendants jointly and severally liable for the damages awarded.
ASC 405-40, Obligations Resulting from Joint and Several Liability Arrangements, provides guidance on accounting for joint and several liabilities.
2.9.1 Joint and several obligations within ASC 405-40
The guidance in this Subtopic applies to obligations resulting from joint and several liability arrangements for which the total amount under the arrangement is fixed at the reporting date, except for obligations otherwise accounted for under the following Topics:
a. Asset Retirement and Environmental Obligations, see Topic 410
b. Contingencies, see Topic 450
c. Guarantees, see Topic 460
d. Compensation—Retirement Benefits, see Topic 715
e. Income Taxes, see Topic 740.
For the total amount of an obligation under an arrangement to be considered fixed at the reporting date there can be no measurement uncertainty at the reporting date relating to the total amount of the obligation within the scope of this Subtopic. However, the total amount of the obligation may change subsequently because of factors that are unrelated to measurement uncertainty. For example, the amount may be fixed at the reporting date but change in future periods because an additional amount was borrowed under a line of credit for which an entity is jointly and severally liable or because the interest rate on a joint and several liability arrangement changed.
Although the total amount of the obligation of the entity and its co-obligors must be fixed at the reporting date to be within the scope of this Subtopic, the amount that the entity expects to pay on behalf of its co-obligors may be uncertain at the reporting date.
A reporting entity should consider its agreements to determine whether a contract creates a joint and several liability arrangement or is a guarantee. For example, a joint venture between two unrelated parties may obtain financing from a bank. If the bank is required to demand repayment from the joint venture first, and only upon nonperformance by the joint venture can the bank demand repayment from the two reporting entities that formed the joint venture, then the reporting entities may not have joint and several liability. The reporting entities may instead have a guarantee that should be accounted for under ASC 460.
2.9.2 Measurement and recognition of joint and several liabilities
ASC 405-40-30-1 provides guidance on measuring obligations under joint and several liability arrangements, both initially and in subsequent periods. The guidance in ASC 405-40-30-1 requires a reporting entity to record, at a minimum, its portion of the joint and several liabilities. A reporting entity cannot avoid recording a liability simply because it does not believe it will pay.
Obligations resulting from joint and several liability arrangements included in the scope of this Subtopic initially shall be measured as the sum of the following:
- The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors.
- Any additional amount the reporting entity expects to pay on behalf of its co-obligors. If some amount within a range of the additional amount the reporting entity expects to pay is a better estimate than any other amount within the range, that amount shall be the additional amount included in the measurement of the obligation. If no amount within the range is a better estimate than any other amount, then the minimum amount in the range shall be the additional amount included in the measurement of the obligation.
When applying the guidance above, a reporting entity should not apply a probability weighted threshold to determine the amount it expects to pay on behalf of its co-obligors (e.g., a reporting entity should not follow a more-likely-than-not threshold).
The offsetting entry or entries (e.g., cash, an expense, a receivable, an equity transaction) will depend on the specific facts and circumstances of the transaction to which the joint and several liability arrangement relates.
Example FG 2-7 illustrates the application of the scope guidance for obligations related to joint and several liability arrangements. Example FG 2-8 illustrates the application of the scope guidance for obligations related to joint and several liability arrangements upon the issuance of a judicial ruling.
EXAMPLE FG 2-7
Joint and several litigation liability arrangements
Joint and several litigation liability arrangements
LCD Corp and FG Corp jointly marketed a product. A lawsuit is brought against both LCD Corp and FG Corp claiming that the product posed a threat to the public. Under government laws and regulations for the product, LCD Corp and FG Corp are jointly and severally liable. The litigation is still ongoing; however, both reporting entities believe that a loss is probable and can be reasonably estimated.
Should LCD Corp and FG Corp record an obligation under ASC 405-40 as a result of their joint and several liability arrangement?
Analysis
No. The litigation is ongoing and therefore the obligation is not fixed at the reporting date. Since there is no fixed obligation at the reporting date, LCD Corp and FG Corp should not record a joint and several obligation. They should each record a contingency using the guidance in ASC 450.
EXAMPLE FG 2-8
Judicial ruling
Judicial ruling
LCD Corp and FG Corp jointly marketed a product. A lawsuit is brought against both LCD Corp and FG Corp claiming that the product posed a threat to the public. Under government laws and regulations for the product, LCD Corp and FG Corp are jointly and severally liable.
When the case is completed and a judicial ruling has been given, the total judgment is $10 million. Under the terms of their joint and several liability arrangement LCD Corp and FG Corp are each required to pay $5 million but are jointly and severally liable for the total judgment amount of $10 million. In addition, the parties must also pay interest on the award through the settlement date.
Should LCD Corp and FG Corp record a liability using the guidance in ASC 405-40?
Analysis
Yes. The amount is now considered fixed at the reporting date and LCD Corp and FG Corp have an obligation under a joint and several liability arrangement; therefore, they are within the scope of ASC 405-40. The fact that the award accrues interest until it is settled does not affect the conclusion that the amount of the liability has been fixed at the reporting date.
2.9.2.1 Recoveries from co-obligors
If a reporting entity pays an amount in excess of its share of a joint and several liability, it may be able to demand repayment from its co-obligors. ASC 405-40 does not provide guidance on recording recoveries under a joint and several liability arrangement. Depending on the facts and circumstances, a reporting entity may determine that some of the payment can be recovered and would either record a receivable or treat the recovery as a gain contingency.
If a reporting entity has a contractual right to demand repayment from its co-obligors, then it may be appropriate to record a receivable. The receivable should be continually assessed for impairment. If the reporting entity does not have a contractual right to demand repayment, then the recovery should be treated as a gain contingency. For example, if a reporting entity does not have a contractual right to demand repayment, but intends to sue its co-obligors, then the recovery should be accounted for as a gain contingency. A reporting entity should also consider the relationship between the co-obligors to determine the appropriate accounting for the recovery. When co-obligors are related parties, a recovery may need to be accounted for as an equity or capital transaction.
Once the guidance in ASC 326 is effective, impairment of receivables will be assessed using the current expected credit loss model. See LI 7 and LI 13 for more information on the application and effective dates of ASC 326.
Example FG 2-9 and Example FG 2-10 illustrate the considerations when accounting for a recovery.
EXAMPLE FG 2-9
Recording a joint and several liability recovery as a receivable
Recording a joint and several liability recovery as a receivable
Subsidiary Inc and Branch Inc are wholly owned subsidiaries of FG Corp. Subsidiary Inc and Branch Inc collectively borrow $50 million and are both identified as being jointly and severally obligated for the full amount of the debt in the borrowing arrangement. Subsidiary Inc uses $20 million for its corporate purposes and Branch Inc uses $30 million for its corporate purposes. Subsidiary Inc and Branch Inc have entered into a supplemental written agreement which enables each to obtain a recovery from the other should they pay an amount in excess of the amount of proceeds received.
The bank demands repayment in full on the debt from Subsidiary Inc because Branch Inc is experiencing financial difficulty. Subsidiary Inc repays the full $50 million obligation.
How should Subsidiary Inc account for the amount it is owed from Branch Inc?
Analysis
Subsidiary Inc should record a receivable for $30 million because Subsidiary Inc and Branch Inc have a legally enforceable arrangement under which each party is responsible for repaying the amount it borrowed. Subsidiary Inc should assess the receivable for impairment and record an allowance for the amount considered uncollectible.
EXAMPLE FG 2-10
Recording a joint and several liability recovery as an equity transaction
Recording a joint and several liability recovery as an equity transaction
Subsidiary Inc and Branch Inc are wholly owned subsidiaries of FG Corp. Subsidiary Inc and Branch Inc collectively borrow $50 million and are both identified as being jointly and severally obligated for the full amount of the debt in the borrowing arrangement. Subsidiary Inc uses $20 million for its corporate purposes and Branch Inc uses $30 million for its corporate purposes. Subsidiary Inc and Branch Inc have entered into a supplemental written agreement which enables each to obtain a recovery from the other should they pay an amount in excess of the amount of proceeds received.
FG Corp, the parent, directs Subsidiary Inc to write-off the amount otherwise recoverable from Branch Inc under the supplemental agreement.
How should the nonpayment by Branch Inc be recognized by Subsidiary Inc and Branch Inc?
Analysis
FG Corp's decision to override the terms of the agreement, which requires Branch Inc to repay Subsidiary Inc, is effectively an equity transaction between entities that are under common control. Accordingly, Subsidiary Inc should record the transaction as a dividend or a return of capital, as applicable, and not as a charge to the income statement as an uncollectible receivable. Branch Inc should similarly recognize a contribution of capital for its share of the original loan that it will not have to repay.
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