Lehman Brothers Financial SA (LEHNQ)

[jwnoble3]

That $31B of claims against itself does protect against an ownership change


However, the absolute priority rule, 11 U.S.C. §1129(b)(2)(B)(ii), often mandates the issuance of stock in satisfaction of creditors' claims. In these circumstances, the reorganization plan will almost always create an ownership change. The Internal Revenue Code provides two types of relief to the debtor that undergoes an ownership change in a bankruptcy case: the "bankruptcy exception" set forth in §382(l)(5) and the "special valuation" rule set forth in §382(l)(6).

The "bankruptcy exception" provides that the general rule of §382 does not apply if, in a bankruptcy case, the shareholders and certain qualified creditors own at least 50 percent of the stock of the reorganized debtor.3 A qualified creditor is a creditor who receives stock in the reorganized debtor in satisfaction of debt (a) held at least 18 months prior to commencement of the bankruptcy case or (b) that arose in the ordinary course of the debtor's business and that has been held by the same creditor at all times. See 26 U.S.C. §382(l)(5)(E). Additionally, a creditor may be presumed to be a qualified creditor—even if the creditor's claim was purchased after the commencement of the case—if that creditor does not become, as a result of the ownership change, a 5 percent shareholder. See 26 C.F.R. §1.382-9(d)(3).

Unrestricted claims trading can limit the debtor's ability to confirm a plan that distributes at least 50 percent of the stock to qualified creditors, particularly if large claims are traded. To preserve the ability to fit within the §382(l)(5) bankruptcy exception, debtors typically structure anti-trading injunctions to apply to claims that could be expected to entitle the holder, under a plan, to receive approximately 5 percent of the stock in the reorganized debtor. See, e.g., Williams Communications Group Inc., Case No. 02-11957 (BRL) (Bankr. S.D.N.Y. July 24, 2002) (subjecting transfers of claims equal to or greater than $200 million to the transfer-approval procedures; $200 million was the smallest claim that could be reasonably anticipated to lead to a distribution of 5 percent of the stock in a reorganized entity); In re Service Merchandise Co. Inc., Case No. 02-11957 (GCP) (Bankr. M.D. Tenn. April 6, 2000) (subjecting holders of unsecured claims equal to or greater than 4 percent of the total estimated unsecured claims to the notification and waiting periods). If creditors who each receive less than 5 percent of the stock in the reorganized debtor own, in the aggregate, less than 50 percent of that stock, then the debtor can use the presumption created by Treasury Regulation §1.382-9(d)(3) to fit within the "bankruptcy exception," thereby sheltering NOLs from the general limitation imposed by §382.

Debtors who anticipate utilizing the "bankruptcy exception" to §382 also seek to restrict trading in equity securities prior to confirmation of a plan. Anti-trading injunctions are usually structured to prevent any 5 percent shareholder from increasing its ownership or to prevent any person from becoming a 5 percent shareholder prior to confirmation of a plan. See, e.g., In re Conseco Inc., Case No. 02-49671 (Bankr. N.D. Ill. Dec. 18, 2002); Metrocall Inc., Case No. 02-11579 (RB) (Bankr. D. Del. July 8, 2002).

If the "bankruptcy exception" does not apply (either because the requisite amount of stock was not distributed to qualified creditors or because the debtor made an election to opt-out of the bankruptcy exception, which is permitted by §382(l) (5)(H)), then §382(l)(6) provides a special valuation rule. Specifically, the value of the reorganized debtor is the lesser of (a) the value of the stock in the reorganized debtor immediately after the ownership change or (b) the value of the debtor's pre-confirmation assets. See 26 C.F.R. 1.382-9(j). As noted above, the §382(b) annual limitation is determined by applying a long-term tax-exempt rate to the value of the pre-confirmation debtor, a valuation that is typically tested immediately before the ownership change. See 382(b), (e)(1). Thus, the special valuation rule gives effect to the increase in value resulting from any surrender or cancellation of creditors' claims under a plan. This increase can alleviate the burden of an ownership change on a debtor. Creditors opposing the entry of an anti-trading injunction can argue that the special valuation rule is available to the debtor even if the safe harbor of the bankruptcy exception is not. Therefore, the argument goes, the debtor's NOLs would not be destroyed by unrestricted claims trading (as they would have been in Prudential Lines by the worthless stock deduction), but only reduced.

In addition, the special valuation rule of §382(l)(6) does not require the payment of a "toll charge," which the debtor must pay if it uses the "bankruptcy exception." Therefore, the effect of unrestricted claims trading may not be as deleterious as the debtor contends.

https://www.abi.org/abi-journal/claims-trading-injunctions-and-preservation-of-nols