Lehman Brothers Financial SA (LEHNQ)

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Bankruptcy Exceptions for Loss Corporations

While the Code Section 382 NOL limitations could have a significant impact on a Loss Corporation, there are exceptions to the application of these rules. A principal exception is extended to Loss Corporations that are subject to bankruptcy proceedings. Specifically, Code Section 382 contains two separate exceptions for bankruptcy restructuring transactions.

First, there is no cap on the utilization of NOLs following a restructuring through a bankruptcy case of the Loss Corporation if the shareholders and qualified creditors of the Loss Corporation (as determined prior to bankruptcy restructuring), own 50% of the stock of the corporation (i.e., retain 50% of the voting power and 50% of the economic value), after the restructuring.[2] As suggested, two primary requirements must be satisfied for this so-called “bankruptcy exception” to apply:

First, the Loss Corporation must have been under the jurisdiction of a court immediately before the ownership change in a Title 11 or similar case.
Second, the former shareholders and qualified creditors of the bankrupt corporation must retain “control” after the ownership change.[3]
With respect to the second requirement, stock transferred to a creditor only counts towards the 50% threshold if the stock was transferred in satisfaction of indebtedness held by the creditor for at least 18 months prior to the filing of the bankruptcy case, or if the indebtedness arose in the ordinary course of business of the Loss Corporation and continued to be held by the original creditor.[4] To the extent these requirements are satisfied, this allows the NOLs to be used going forward without the limitations imposed by the general Code Section 382 rules.

While valuable, this exception will be lost (and the cap will be set to zero) if there is a second ownership change within two years after the bankruptcy restructuring transaction.[5] Additionally, while this bankruptcy exception contained within Code Section 382 eliminates the cap on the utilization of post-restructuring NOLs, the NOLs that can be utilized going forward will be reduced by the amount of any deductions that the Loss Corporation took within the prior three years with respect to interest payments made to creditors that received stock in the restructuring transaction.[6] These are some of the considerations that must be taken into account when evaluating the viability of the “bankruptcy exception” to Code Section 382.

Additionally, to the extent that the Loss Corporation does not qualify for the bankruptcy exception (or elects not to utilize the exception), then under Code Section 382(l)(6), following a bankruptcy restructuring, the Code Section 382 cap is calculated to account for any increase in value of the corporation resulting from any surrender or cancellation of creditor’s claims in the restructuring. The valuation of a business could be increased substantially as a result of such claims being mitigated, which could have a corresponding positive impact on the cap for calculating the NOLs going forward.[7]

These specialized NOLs rules related to bankruptcy proceedings provide potentially valuable planning considerations. For example, a corporation with a large NOL may find bankruptcy as an attractive avenue for obtaining an equity infusion. Under the bankruptcy exception to the NOL limitations, a new investor could potentially obtain up to 50% of the Loss Corporation’s equity, without effecting the value of the NOL, provided that the Loss Corporation’s existing shareholders and qualified creditors retain the remaining 50% equity.


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