Bar, read this, but the way I see it, he can cancel all shares and issues new ones and still use NOL.
Bankruptcy Exception
The most important portion of section 382 in the bankruptcy context is section 382(l)(5). Under this provision, the section 382 limits on the use of NOLs following an ownership change will not apply if:
1. The corporation is under the jurisdiction of the court in a bankruptcy case before the ownership change; and
2. The corporation's pre-change shareholders and qualified creditors (determined immediately before the ownership change) own at least 50 percent of the value and voting power of the loss corporation's stock immediately after the ownership change and as a result of being pre-change shareholders or qualified creditors immediately before the ownership change.
This second requirement actually encompasses a whole list of requirements, including some important definitions. Before we get to those all-important definitions, though, note what the bankruptcy NOL exception means in the event it applies. Instead of being limited in using NOL's post bankruptcy (and post ownership change) by the long-term tax exempt rate, the NOLs will be available in a unrestricted fashion. The only price tag for using the NOL's in this way is that they will be reduced to the extent of interest deducted during the three year period that precedes the tax year in which the ownership change occurs, and during the portion of the year of the ownership change (but before that change occurs). See I.R.C. §382(l)(5)(B).
More Definitions
One of the key aspects of qualifying for NOL relief is determining just who the "qualified creditors" are. After all, it is simple to determine the identity of the pre-change shareholders. These pre-change shareholders, together with the "qualified creditors," must own at least 50 percent of both the value and voting power of the loss corporation's stock when the smoke clears. Comparing the shareholders before and after the ownership change is fairly straightforward.
Significantly, it is not even important what the percentage is between the portion of the company owned by the pre-change shareholders and the ownership interests held by the qualified creditors. Thus, it may be that the qualified shareholders will own all of the corporation after the smoke clears, and that the common shareholders will be frozen out entirely. That actually occurs with some frequency. This is still okay under section 382(l)(5). NOL relief will still be available.
To be a qualified creditor, a creditor must meet one of two tests. The creditor must have been a creditor at least 18 months before the date of the filing of the bankruptcy case. Alternatively, the debt must have arisen in the ordinary course of the business of the debtor, and be held by the person who at all times held the beneficial interest in that indebtedness.
This second wing of the "qualified creditor" definition focuses on trade debt, debt that is acquired by the debtor in the ordinary course of the debtor's business (not in the ordinary course of the creditor's business). Thus, lenders who may acquire claims in the ordinary course of their own lending business would not constitute qualified creditors for this purpose, unless they held their debt for at least 18 months prior to the bankruptcy filing date.
Interestingly, there is no statutory continuity of interest requirement before the section 382(l)(5) exception is available. This means that the business of the old debtor corporation need not be continued insofar as the preservation of the NOLs is concerned.
Advantages of Section 382(l)(5)
The advantages of these rules set forth in section 382(l)(5) are fairly obvious: a corporation can maintain its NOLs (and maintain them in unrestricted fashion) notwithstanding the fact that the company's stock might otherwise be deemed to have been the subject of an ownership change and therefore be limited in the subsequent use of its NOLs. Although the section 382(l)(5) provision is available only in a bankruptcy case (or similar proceeding), this provision allows the corporation to exchange outstanding debt for new stock without falling subject to the dreaded 382 limitations. (It's always been puzzling what a proceeding "similar" to a bankruptcy case might be, but it doesn't appear to expand the availability of the provision in any substantial way.)
In evaluation whether the ability to extinguish debt with stock (without triggering section 382 limits) is significant in a particular case, other factors should be considered. Predominately non-tax considerations will likely govern the appropriateness of the bankruptcy filing. Moreover, the importance of avoiding the section 382 limits can only be thoroughly evaluated by calculating the 382 limits in a particular case.
