Bankruptcy - S Corporate Tax Loophole
Bankruptcy - S Corporate Tax Loophole
2014
Recommended Citation
Diane Lourdes Dick, Bankruptcy’s Corporate Tax Loophole, 82 Fordham L. Rev. 2273 (2014).
Available at: http://ir.lawnet.fordham.edu/flr/vol82/iss5/12
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BANKRUPTCY’S CORPORATE
TAX LOOPHOLE
Diane Lourdes Dick*
TABLE OF CONTENTS
INTRODUCTION ........................................................................................ 2274
I. BACKGROUND: THE INTERSECTION OF CHAPTER 11
BANKRUPTCY AND TAX LAW....................................................... 2282
A. Bankruptcy-Related Tax Provisions ....................................... 2285
* Assistant Professor of Law, Seattle University School of Law; LL.M. in Taxation, 2011,
University of Florida Levin College of Law. Earlier versions of this Article were presented
at the 2013 National Business Law Scholars Conference at The Ohio State University
Michael E. Moritz College of Law, the 2013 annual meeting of the Southeastern Association
of Law Schools, and the 2013 Pacific West Business Law Scholars Colloquium at the
University of Oregon School of Law. Special thanks to Yariv Brauner, Kara Bruce,
Michelle Arnopol Cecil, Brooke Coleman, Wendy Couture, Steven Davidoff, Eric Franklin,
Charlotte Garden, Andrew Hayashi, Julie Hill, John Hunt, Lily Kahng, Stephen Lubben,
Charlene Luke, Mohsen Manesh, Colin Marks, Shu-Yi Oei, Elizabeth Pollman, Karena
Rahall, Anna Roberts, and Julie Shapiro for thoughtful comments on previous drafts.
2273
2274 FORDHAM LAW REVIEW [Vol. 82
INTRODUCTION
In September 2011, the financially troubled solar cell manufacturing
company Solyndra LLC and its parent, 360 Degree Solar Holdings, Inc.,
filed voluntary petitions for bankruptcy protection in U.S. Bankruptcy
Court for the District of Delaware.1 By generally accepted financial and
accounting conventions, Solyndra2 was insolvent.3 In preliminary
disclosures made to the court, the privately held company reported assets of
$854 million and liabilities of $863 million.4
Solyndra’s difficulties were not merely financial. By most accounts, the
company failed because of fundamental deficiencies in its business model.5
The company produced solar panels made from innovative materials that
became increasingly difficult to market as commodity price shifts and
6. Id.
7. Eric Morath, Lawmaker Seeks Solyndra Examiner, WALL ST. J., Sept. 20, 2011, at
A2.
8. Thomas Catan & Deborah Solomon, FBI Raids Solar-Panel Maker, WALL ST. J.,
Sept. 9, 2011, at B1.
9. See, e.g., Michael Bradley & Michael Rosenzweig, The Untenable Case for Chapter
11, 101 YALE L.J. 1043, 1050–51 (1992).
10. 11 U.S.C. §§ 701–784 (2012) (providing for liquidations of bankrupt persons).
11. All references herein to the Bankruptcy Code are to the Bankruptcy Reform Act of
1978, Pub. L. No. 95-598, 92 Stat. 2549 (codified as amended at 11 U.S.C.).
12. 11 U.S.C. §§ 1101–1174 (providing for reorganizations and liquidations of bankrupt
persons).
13. This purpose of Chapter 11 was articulated at the time of its adoption in 1978:
“Chapter 11 deals with the reorganization of a financially distressed business enterprise,
providing for its rehabilitation by adjustment of its debt obligations and equity interests.” S.
REP. NO. 95-989, at 9 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5795. “The purpose of
a business reorganization case, unlike a liquidation case, is to restructure a business’s
finances so that it may continue to operate, provide its employees with jobs, pay its creditors,
and produce a return for its stockholders.” H.R. REP. NO. 95-595, at 220, reprinted in 1978
U.S.C.C.A.N. 5963, 6179.
14. In re Maxim Indus., Inc., 22 B.R. 611, 613 (Bankr. D. Mass. 1985).
15. Liquidation can be accomplished by selling all or substantially all of the company’s
assets in a sale conducted during the pendency of the case or pursuant to a confirmed
Chapter 11 plan. Asset sales may be conducted under 11 U.S.C. § 363(b)(1), which provides
that, in the course of a Chapter 11 case, a debtor in possession, “after notice and a hearing,
may . . . sell . . . other than in the ordinary course of business, property of the estate . . . .”
Moreover, 11 U.S.C. § 1123(b)(4) permits the sale of all of the property of the estate and the
distribution of the proceeds to creditors pursuant to a liquidation plan. See 11 U.S.C.
§ 1123(b)(4).
16. See infra notes 17–18.
2276 FORDHAM LAW REVIEW [Vol. 82
17. Motion of Solyndra LLC Pursuant to Sections 105(a) and 363 of the Bankruptcy
Code for Authority to (A) Conduct an Auction for Core Assets, and (B) Sell Assets to the
Successful Bidders at an Auction Free and Clear of all Encumbrances at 1, In re Solyndra
LLC, No. 11-12799 (Bankr. D. Del. Nov. 22, 2011).
18. Id. at 17. Solyndra’s stakeholders sought to sell the company’s assets to a turnkey
buyer. Id. at 3. However, they also solicited court approval to sell the assets separately if
necessary. Id. at 17.
19. See, e.g., H. Jason Gold & Dylan G. Trache, Liquidation of Troubled Businesses:
Chapter 11 Liquidations Increasing, METROPOLITAN CORP. COUNS., Apr. 2009, at 10;
Michael Cooley, How To Succeed at Chapter 11 Without Really Reorganizing, J. CORP.
RENEWAL (Aug. 27, 2008), http://www.turnaround.org/Publications/Articles.aspx?
objectID=9654.
20. The debtor in possession “generally has the authority to exercise the same powers as
a trustee.” Weingarten Nostat, Inc. v. Serv. Merch. Co., 396 F.3d 737, 742 n.4 (6th Cir.
2005) (discussing and citing 11 U.S.C. §§ 1107(a), 1108).
21. 11 U.S.C. §§ 701–702.
22. See, e.g., Arturo Bris et al., The Costs of Bankruptcy: Chapter 7 Liquidation Versus
Chapter 11 Reorganization, 61 J. FIN. 1253, 1301 (2006); Stephen J. Lubben, Business
Liquidation, 81 AM. BANKR. L.J. 65, 81 (2007); see also 9C AM. JUR. 2D Bankruptcy § 2818
(2006); BEN BRANCH ET AL., LAST RIGHTS: LIQUIDATING A COMPANY (2007). Not all
bankruptcy scholars, however, agree that Chapter 11 offers a more efficient method of
achieving any outcome. See generally Diane Lourdes Dick, The Chapter 11 Efficiency
Fallacy, 2013 BYU L. REV. 759 (highlighting Chapter 11’s inherent structural
inefficiencies).
23. Consider, for instance, the recent Chapter 11 liquidation of the beleaguered
bookseller Borders. The debtor in possession proposed and sought court approval of a
“Chapter 11 Plan of Liquidation,” which contemplated that the debtor would sell its assets
and then dissolve. See First Amended Joint Plan of Liquidation Pursuant to Chapter 11 of the
Bankruptcy Code Proposed by the Debtors and the Official Committee of Unsecured
Creditors at 15, In re Borders Grp., Inc., No. 11-10614 (Bankr. S.D.N.Y. Nov. 2, 2011).
24. Debtors’ Amended Joint Chapter 11 Plan at 1, In re Solyndra LLC, No. 11-12799
(Bankr. D. Del. Sept. 7, 2012).
25. Id. at sec. I.
26. Id.
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2277
series of sales to liquidate the assets of the subsidiary,27 the parent bore
little resemblance to its previous incarnation as the holding company to a
solar cell manufacturer. With no operating subsidiary, no manufacturing
assets, no significant employee base and no active business,28 the
“reorganized” parent was arguably a mere shell. The Solyndra Plan’s
preservation of the parent was especially perplexing given that the company
adopted a parent-subsidiary structure just seven months prior to the
bankruptcy filing.29
In terms of economic substance, the Solyndra Plan clearly contemplated
liquidation of Solyndra’s historic business enterprise of manufacturing solar
panels. But in terms of legal form, the Solyndra Plan also devised a
reorganization of the parent. The company’s shareholders, led by two
private equity firms,30 exploited the disconnect between substance and form
to extract a noteworthy economic privilege: the future ability to use nearly
$1 billion of Solyndra’s tax losses and credits.31 These valuable tax
attributes came to rest on the books of the corporate parent because the
operating subsidiary was an unincorporated flow-through entity with only
one corporate member, and therefore disregarded for tax purposes.32 While
not disclosed as assets at the time of the company’s bankruptcy filing,33
these losses and credits have substantial value because they can be used to
reduce federal income tax liabilities on future earnings.34
27. See Michael Kanellos, Failed Solar Company’s Auction Draws Bargain Hunters,
N.Y. TIMES, Nov. 1, 2011, at B1; Michael Bathon, Solyndra Wins Court Approval To Sell
Manufacturing Plant, BLOOMBERG.COM (Sept. 24, 2012, 1:05 PM), http://www.bloomberg.
com/news/2012-09-24/solyndra-wins-court-approval-of-manufacturing-facility-auction.html.
28. The company terminated operations and laid off virtually all of its employees prior
to its bankruptcy filing. Declaration of W.G. Stover, Jr., Senior Vice President and Chief
Financial Officer, in Support of First Day Motions at 13, In re Solyndra, No. 11-12799
(Sept. 6, 2011).
29. Stakeholders reorganized the company in February 2011. Id. at 6–11.
30. See Solyndra, Inc., Amendment 1 to Form S-1 (Form S-1), at 2, 98 (Mar. 16, 2010)
(noting that Argonaut Ventures I, LLC, and its affiliates (Argonaut) beneficially owned
approximately 35.7 percent of the company’s outstanding common stock, and Madrone
Partners, L.P., (Madrone) beneficially owned 11 percent of the company’s outstanding
common stock). The remaining investors were other equity funds, officers, and directors of
the company. See id. However, pursuant to the February 2011 restructuring, the company
issued equity warrants that would revert ownership of 99.9 percent of the company’s
outstanding common stock to Argonaut and Madrone. See The Solyndra Memorial Tax
Break, WALL ST. J. (Oct. 17, 2012, 12:01 AM), http://online.wsj.com/news/articles/SB10000
872396390444799904578050803545600588; see also Solyndra, Inc., Notice of Exempt
Offering of Securities (Form D) (Mar. 10, 2011).
31. See Michael Bathon, Solyndra Lenders Ahead of Government Won’t Recover Fully,
BLOOMBERG.COM (Oct. 17, 2012, 5:53 PM), http://www.bloomberg.com/news/2012-10-
17/solyndra-lenders-ahead-of-government-won-t-recover-fully.html.
32. Treas. Reg. § 301.7701-3(a) (2006).
33. The tax attributes are not disclosed on the company’s schedules of assets and
liabilities filed with the court. See Schedules of Assets & Liabilities 360 Degree Solar
Holdings (Amended), In re Solyndra LLC, No. 11-12799 (Bankr. D. Del. Jan. 19, 2012);
Schedules of Assets & Liabilities Solyndra LLC (Second Amended), In re Solyndra, No. 11-
12799 (Feb. 7, 2012).
34. See infra Part I.B.
2278 FORDHAM LAW REVIEW [Vol. 82
35. These figures assume a 35 percent federal income tax rate on corporate income. The
corporate income tax is imposed pursuant to I.R.C. § 11(B)(1)(D), based upon the statutory
rates set forth in that section.
36. See The Solyndra Memorial Tax Break, supra note 30.
37. See Debtors’ Amended Joint Chapter 11 Plan, supra note 24, at 18, 38.
38. Under I.R.C. § 1501, an affiliated group of corporations may file a consolidated
return. Consolidated enterprises are subject to extensive regulations promulgated under
§ 1501. See I.R.C. § 1501 (2012).
39. There are, of course, some highly specific exceptions. See, e.g., Alvin C. Warren, Jr.
& Alan J. Auerbach, Transferability of Tax Incentives and the Fiction of Safe Harbor
Leasing, 95 HARV. L. REV. 1752, 1768 (1982) (providing an early critique of the continuing
practice of “safe harbor leasing,” whereby taxpayers lease the tax benefits of ownership of
an asset to another party who can use them). Similarly, to the extent we think of tradable
pollution credits as tax attributes, then these would also exemplify a departure from the
general rule. See Richard F. Kosobud et al., Tradable Environmental Pollution Credits: A
New Financial Asset, 1 REV. ACCT. & FIN. 69 (2002).
40. Unless the context indicates otherwise, the term “corporation” refers to entities taxed
under Subchapter C of the Tax Code and not to corporations governed by Subchapter S of
the Tax Code. The former are taxpaying entities while the latter are generally treated as
“pass through” entities, with shareholders responsible for paying taxes on income. See
sources cited infra note 149.
41. See infra Part I.B.3.
42. Unlike individual debtors, business debtors are not entitled to discharge debts in a
Chapter 7 bankruptcy. 11 U.S.C. § 727(a)(1). Instead, Chapter 7 debtors must distribute all
property in full or partial satisfaction of claims against the estate. Id. § 726. Debtors who are
not individuals are then dissolved. See infra note 43 and accompanying text.
43. H.R. REP. NO. 95-595, at 384–85 (1977); S. REP. NO. 95-989, at 98–99 (1978),
reprinted in 1978 U.S.C.C.A.N. 5787.
44. Chapter 11 liquidating plans typically contemplate that the debtor will sell its assets
and remit the proceeds to a liquidating trust. Under federal income tax regulations,
liquidating trusts are permitted to exist solely for the purpose of satisfying claims and
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2279
cases, any excess tax benefits would have expired with the then defunct
parent and subsidiary entities.45
Although Chapter 11 offered Solyndra’s stakeholders the best
opportunity to keep the company intact and therefore preserve its valuable
tax attributes, Chapter 11 carries its own restrictions. Most notably, debtors
are not permitted to discharge debts and exit bankruptcy pursuant to a plan
that essentially achieves liquidation rather than reorganization.46 For these
reasons, Chapter 11 bankruptcy only became economically attractive to
Solyndra following its February 2011 adoption of a parent-subsidiary
structure. Then, the company could enter Chapter 11 as two separate
debtors and creatively sidestep these confirmation requirements.
Predictably, the evidence presented by the Solyndra Plan’s opponents
strongly suggests that the company’s path through Chapter 11 was tax
driven. The Solyndra Plan was designed to take advantage of an ambiguity
in the law that allows a company to liquidate its business under Chapter 11
and preserve valuable tax attributes for future use by reorganizing only the
corporate parent.47 Solyndra has not been the only company to employ this
strategy in recent years. Among others,48 Washington Mutual followed a
similar path through Chapter 11, liquidating its business assets and
reorganizing the parent to preserve nearly $18 billion in valuable tax
attributes.49
Nonetheless, the bankruptcy court endorsed the Solyndra Plan in October
201250 over the objections of the Internal Revenue Service51 (IRS) and the
otherwise effectuating the plan of liquidation. Treas. Reg. § 301.7701-4(d) (as amended in
1997).
45. See supra notes 43–44.
46. Section 1141(d)(3) expressly proscribes the granting of a discharge if “(A) the plan
provides for the liquidation of all or substantially all of the property of the estate; (B) the
debtor does not engage in business after consummation of the plan; and (C) the debtor would
be denied a discharge . . . if the case were a case under chapter 7.” See 11 U.S.C.
§ 1141(d)(3); Borsdorf v. Fairchild Aircraft Corp. (In re Fairchild Aircraft Corp.), 128 B.R.
976, 982 (Bankr. W.D. Tex. 1991) (describing the purpose of this provision). What is more,
a Chapter 11 plan may not be confirmed unless it complies with the provisions of 11 U.S.C.
§ 1129(a). A plan must be feasible, demonstrating that the debtor will generate profits from
future business operations. See Fin. Sec. Assurance v. T-H New Orleans Ltd. P’Ship (In re
T-H New Orleans Ltd. P’ship), 116 F.3d 790, 801–02 (5th Cir. 1997). The proponent of a
Chapter 11 plan bears the burden of proof with respect to each element of 11 U.S.C.
§ 1129(a). See In re Genesis Health Ventures, Inc., 266 B.R. 591, 610 (Bankr. D. Del. 2001).
47. See sources cited infra notes 51–52.
48. See Order Confirming First Amended Plan of Reorganization, In re PMI Grp., Inc.,
No. 11-13730 (Bankr. D. Del. July 25, 2013), ECF No. 1015 (confirming a Chapter 11 plan
pursuant to which a corporate parent reorganized to preserve valuable tax attributes).
49. Peg Brickley & Mike Spector, WaMu Gets Closer to Bankruptcy Exit, WALL ST. J.
(May 25, 2011, 12:01 AM), http://online.wsj.com/news/articles/SB10001424052702303654
804576343803438618670. The tax attributes are discussed in greater detail in In re Wash.
Mut., Inc., 461 B.R. 200, 225–26 (Bankr. D. Del. 2011), vacated in part, No. 08-12229
(MFW), 2012 WL 1563880 (Bankr. D. Del. Feb. 24, 2012).
50. Order Confirming Debtors’ Amended Joint Chapter 11 Plan, In re Solyndra LLC,
No. 11-12799 (Bankr. D. Del. Oct. 22, 2012).
51. Objection of the United States of America, on Behalf of the IRS, to Confirmation of
Debtors’ Amended Joint Chapter 11 Plan, In re Solyndra, No. 11-12799 (Oct. 10, 2012).
2280 FORDHAM LAW REVIEW [Vol. 82
U.S. Trustee.52 The government argued that the principal purpose of the
Solyndra Plan was tax avoidance, as evidenced by the fact that the parent
would emerge from bankruptcy with valuable tax attributes and no active
business.53 In approving the Solyndra Plan, the court reasoned that the
parent’s business purpose was merely to serve as a holding company and
that the valuable tax attributes would motivate the parent to continue its
historical line of business of investing in companies.54
Yet this “pseudo-reorganization” tax avoidance strategy, as I call it in this
Article, arguably cannot withstand a closer reading of tax and commercial
law.55 But it would miss the mark to focus only on the dubious merits of
this particular deal structure. The pseudo-reorganization is just one of
many recent and high-profile attempts to circumvent Chapter 11’s
distributional norms by exploiting ambiguity in the corporate tax and
bankruptcy laws. Thus, whether one agrees or disagrees with the Solyndra
court’s reasoning, the case invites one to explore the relatively uncharted
junction between these two areas of the law,56 and to give deeper theoretical
consideration to various provisions of the U.S. Tax Code57 that benefit
bankrupt companies.
A central claim of this Article is that bankruptcy-specific exceptions in
the tax laws transform the debtor’s valuable tax attributes into marketable
property that, in many cases, gives the estate its intrinsic value. Yet the
bankruptcy laws leave these tax assets vulnerable to siphoning by dominant
stakeholders who are in a position to extract excess returns.58 The problem
arises because one of the Bankruptcy Code’s most important safeguards
instructs courts to evaluate the fairness of nonconsensual Chapter 11 plans
against a hypothetical Chapter 7 liquidation.59 But because under the tax
52. U.S. Trustee’s Objection to Confirmation of the Debtors’ Amended Joint Chapter 11
Plan, In re Solyndra, No. 11-12799 (Oct. 10, 2012).
53. See id. at 5–6.
54. See supra note 50 and accompanying text. A similar decision was more recently
rendered in the PMI Group, Inc.’s Chapter 11 case. See Order Confirming First Amended
Plan of Reorganization at 10, In re PMI Grp., Inc., No. 11-13730 (Bankr. D. Del. Jul. 25,
2013), ECF No. 1015.
55. See infra Part III.C.
56. There is a relative dearth of legal scholarship at the confluence of tax and
bankruptcy. There are, however, some recent exceptions. See, e.g., Michelle Arnopol Cecil,
Abandonments in Bankruptcy: Unifying Competing Tax and Bankruptcy Policies, 88 MINN.
L. REV. 723 (2004); Frances R. Hill, Toward a Theory of Bankruptcy Tax: A Statutory
Coordination Approach, 50 TAX LAW. 103 (1996); Shu-Yi Oei, Taxing Bankrupts, 55 B.C.
L. REV. 375 (2014); Katherine Pratt, Shifting Biases: Troubled Company Debt
Restructurings After the 1993 Tax Act, 68 AM. BANKR. L.J. 23 (1994); Jack F. Williams,
Bifurcation for Claim Filing Purposes of a Corporate Tax Year That Straddles the Petition
Date, 9 AM. BANKR. INST. L. REV. 463 (2001).
57. All references herein to the Tax Code are to the Internal Revenue Code of 1986
(codified as amended at 26 U.S.C.).
58. Such excess returns are the very essence of economic rents. See LUCIAN BEBCHUK &
JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE
COMPENSATION 62 (2004) (referring to economic rents as “extra returns that firms or
individuals obtain due to their positional advantages”). See generally GORDON TULLOCK,
THE RENT SEEKING SOCIETY (2005).
59. 11 U.S.C. § 1129(a)(7) (2012).
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2281
laws, the debtor’s valuable tax attributes do not survive liquidation, they are
overlooked.60 The problem is exacerbated by the fact that these tax
attributes are often omitted from the debtor’s asset disclosures.61 This
amounts to a perfect storm, where some of bankruptcy’s most vital
protective devices neglect to take into account what is often the debtor’s
most valuable asset. As I argue in this Article, this extraordinary ambiguity
at the intersection of federal tax and bankruptcy law not only facilitates
inequitable allocations of economic benefits and burdens in Chapter 11 but
also causes a much broader, systematic misallocation of resources. In
particular, it contributes to an overall reduction in social welfare, as parties
in a position to exploit the information asymmetry and control the
restructuring are able to monetize the tax assets as excess returns and then
use them to shelter income from unrelated assets.62
This ambiguity and its negative collateral consequences should be
addressed now because both the Tax Code and the Bankruptcy Code are the
subject of major reform efforts. President Obama has expressed interest in
corporate tax reforms, with policymakers in both political parties studying
proposals.63 At the same time, the American Bankruptcy Institute recently
convened the Commission to Study the Reform of Chapter 11, laying the
groundwork for a comprehensive rewriting of Chapter 11.64 As
policymakers work to reshape the corporate tax system and the commercial
bankruptcy framework, special attention must be given to the areas of
overlap.
This Article proceeds as follows. Part I offers those new to the literature
a short overview of commercial bankruptcy under Chapter 11. Part I also
contains a discussion of various bankruptcy-specific provisions of the Tax
Code. Part II revisits the Solyndra case and others to understand the role of
valuable tax attributes in large commercial bankruptcies. This Part reveals
how these tax attributes not only give the bankruptcy estate its intrinsic
value, but also become a source of excess returns for persons in a position
to exploit the restructuring. Part III proposes a new legal framework for the
65. See, e.g., 5 COLLIER ON BANKRUPTCY ¶ 541.01 (Alan N. Resnick & Henry J.
Sommer eds., 16th ed. 2013) (noting as a “fundamental purpose[] of the Bankruptcy Code”
the “breathing room given to a debtor that attempts to make a fresh start”); Local Loan Co.
v. Hunt, 292 U.S. 234, 244 (1934) (“[Bankruptcy] gives to the honest but unfortunate debtor
. . . a new opportunity in life and a clear field for future effort, unhampered by the pressure
and discouragement of preexisting debt.”).
66. 11 U.S.C. § 541(a) (2012). As this expansive language suggests, Congress intended
a wide range of property to be included in the bankruptcy estate. See United States v.
Whiting Pools, Inc., 462 U.S. 198, 203 (1983).
67. “The scope of [§ 541(a)(1)] is broad. It includes all kinds of property, including
tangible or intangible property, causes of action . . . and all other forms of property currently
specified in section 70a of the Bankruptcy Act.” H.R. REP. NO. 95-595, at 367 (1977); S.
REP. NO. 95-989, at 82 (1978), reprinted in 1978 U.S.C.C.A.N. 5868, 6323.
68. 11 U.S.C. §§ 1107(a), 1108.
69. See id. § 362. The court can grant relief from the automatic stay only under certain
specified conditions or for cause. See id.; see also FED. R. BANKR. P. 4001.
70. 11 U.S.C. § 1141.
71. Id. § 1123.
72. See supra note 13.
73. For instance, in the General Motors bankruptcy, creditors received equity security
interests in a newly formed company. Parker v. Motors Liquidation Co. (In re Motors
Liquidation Co.), 430 B.R. 65, 72 (S.D.N.Y. 2010).
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2283
creditors in satisfaction of their claims, and then dissolve.74 While the latter
plan achieves substantially the same outcome as a Chapter 7 bankruptcy,
the debtor is able to manage the sale of its assets under Chapter 11.75
Broadly speaking, the Chapter 11 plan is a distributional exercise,
detailing how and to what extent economic benefits and burdens will be
borne by various constituents. Acknowledging the significance of the plan
to the bankrupt company, the Bankruptcy Code gives the debtor the
exclusive right to file a Chapter 11 plan for a period of 120 days.76 In
addition to its draft plan, the debtor must also prepare adequate financial
and nonfinancial disclosures.77
Once proposed, the Chapter 11 plan is subject to a vote by classes of the
bankrupt company’s creditors and equity security holders.78 In some cases,
the debtor and its creditors are able to negotiate a Chapter 11 plan that all
classes either affirmatively accept or are deemed to accept because they will
be paid in full, such that their interests are not impaired.79 In cases of this
sort, the bankruptcy court must confirm the plan unless the plan proponent
is unable to meet its burden of proving certain additional requirements.80
For instance, the plan must be feasible, proposed in good faith, and not
violate any applicable laws.81
Typically, however, a Chapter 11 plan faces opposition from one or more
classes. In these cases, at least one class of impaired claims must vote in
favor of the plan.82 Additionally, with respect to each impaired class of
claims or interests, under the plan each holder must receive property equal
to or greater than the amount that such holder would so receive if the debtor
were liquidated under Chapter 7.83 In other words, the claimants should be
74. See supra note 44. For an example of a plan of liquidation, see supra note 23.
75. See supra note 20.
76. 11 U.S.C. § 1121(b).
77. With respect to plans of reorganization, the debtor must also provide an estimate of
the value of the debtor as a going concern. See id. § 1125. Reorganization value, or
“enterprise value,” is used to determine value received or retained in the form of equity
security interests in the debtor. Under GAAP, enterprise value is the “fair value” of the
company before liabilities. Fair value refers to “the price that would be received to sell [an]
asset . . . in an orderly transaction between market participants . . . at the measurement date.”
FIN. ACCOUNTING STANDARDS BD., STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO.
157 (2006) (effective Nov. 15, 2007), available at http://www.fasb.org/summary/
stsum157.shtml.
78. 11 U.S.C. § 1126. Consent thresholds are explored in greater detail in David Arthur
Skeel, Jr., The Nature and Effect of Corporate Voting in Chapter 11 Reorganization Cases,
78 VA. L. REV. 461, 467 (1992).
79. For a discussion of a recent uncontested Chapter 11 plan, see Peg Brickley,
GateHouse Media Wins Confirmation of Chapter 11 Restructuring, WALL ST. J. (Nov. 6,
2013, 3:36 PM), http://online.wsj.com/article/BT-CO-20131106-713150.html.
80. 11 U.S.C. § 1129(a).
81. See id. (setting forth the remaining elements of plan approval).
82. Id. § 1129(a)(10). “Insiders” are not taken into account for the purposes of
satisfying this requirement. Id. In bankruptcy law, the term “insider” includes a person in
control of the debtor, as well as any person so closely related to the debtor as to suggest that
any transactions were not conducted at arm’s length. Id. § 101(31)(B)(iii).
83. Id. § 1129(a)(7).
2284 FORDHAM LAW REVIEW [Vol. 82
given at least what they would receive if the debtor were liquidated.84
Finally, the bankruptcy court may “cramdown”85 the plan over the
objections of a dissenting class only if certain additional statutory
requirements are satisfied.86 Chief among these is the condition that a plan
be “fair and equitable” with respect to dissenting classes.87 A plan is fair
and equitable if members of the dissenting class receive property equal in
value to their permitted claims or, to the extent the class receives less than
this amount, no creditor of lesser priority (or any equity security holder)88
receives any distribution under the plan.89 This requirement, which is a
core tenet of bankruptcy law, is known as the “absolute priority rule.”90 It
serves as an important safeguard for creditors by ensuring that, unless their
claims are paid in full or they agree otherwise, the Chapter 11 plan will—
with limited exceptions91—respect the relative collection rights of creditors
under state law.92
As this brief overview reveals, Chapter 11 principally functions to
preserve all potential sources of economic value that can be used to satisfy
the debtor’s obligations, while setting legal parameters on the distribution
of such wealth. By imposing these protective distributional norms, Chapter
11 allows debtors to continue their business operations while negotiating
with creditors to restructure their financial obligations. Against this
backdrop, the following sections consider how the tax laws not only
facilitate a firm’s use of federal bankruptcy process to resolve financial
84. Id. This test is commonly known as the “best interests of creditors” test. See
generally Jonathan Hicks, Note, Foxes Guarding the Henhouse: The Modern Best Interests
of Creditors Test in Chapter 11 Reorganizations, 5 NEV. L.J. 820 (2005).
85. This term does not appear in the Bankruptcy Code, but is used to refer to judicial
confirmation of a plan notwithstanding the objections of dissenting impaired classes. See
generally Charles D. Booth, The Cramdown on Secured Creditors: An Impetus Toward
Settlement, 60 AM. BANKR. L.J. 69, 69 (1986).
86. 11 U.S.C. § 1129(b).
87. Id.
88. Id. But see infra note 91 (discussing the “new value exception” to the absolute
priority rule).
89. See Booth, supra note 85.
90. The doctrine, presently codified at § 1129(b)(2)(B)(ii), originated in judicial
opinions. See, e.g., Case v. L.A. Lumber Prods. Co., 308 U.S. 106 (1939); N. Pac. Ry. Co. v.
Boyd, 228 U.S. 482 (1913); see also Douglas G. Baird & Thomas H. Jackson, Bargaining
After the Fall and the Contours of the Absolute Priority Rule, 55 U. CHI. L. REV. 738 (1988);
Walter J. Blum & Stanley A. Kaplan, The Absolute Priority Doctrine in Corporate
Reorganizations, 41 U. CHI. L. REV. 651 (1974); Ralph Brubaker & Charles Tabb,
Bankruptcy Reorganizations and the Troubling Legacy of Chrysler and GM, 2010 U. ILL. L.
REV. 1375, 1391 (referring to the absolute priority rule as “one of the most central,
fundamental distribution-value protections of a chapter 11 plan”).
91. See infra notes 210–12 and accompanying text.
92. The rights of secured and unsecured creditors are determined under state law, in
statutes and case law governing contracts, debtor-creditor relations, as well as liens in real
and personal property. For instance, the relative priority of secured creditors and other lien
holders are set forth in the Uniform Commercial Code as adopted in each state. See, e.g.,
U.C.C. § 9-317 (2000) (setting forth the basic rule governing priority between lien creditors
and secured parties); id. § 9-322(a)(1) (setting forth the basic rule governing priority among
conflicting security interests).
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2285
distress, but also unexpectedly generate additional value for the bankruptcy
estate.
97. As the staff of the Joint Committee on Taxation explains, the distinction is not
always clear: “The determination of whether a provision is a tax expenditure is made on the
basis of a broad concept of income that is larger in scope than ‘income’ as defined under
general U.S. income tax principles. The Joint Committee staff uses its judgment in
distinguishing between those income tax provisions (and regulations) that can be viewed as
part of normal income tax law and those special provisions that result in tax expenditures.”
JOINT COMM. ON TAXATION, ESTIMATES OF FEDERAL TAX EXPENDITURES FOR FISCAL YEARS
2012–2017, at 2 (2013).
98. I.R.C. § 368(a)(1)(G) (2012). The acquisition of a debtor’s assets will be a
nonrecognition event if the stock or securities of the acquiring corporation are distributed in
a transaction that qualifies under §§ 354, 355, or 356 of the Internal Revenue Code. Id.
99. Id.
100. See Id. § 368(a)(3)(B)(ii). For instance, a debtor’s equity security holders would not
recognize gain or loss if they exchanged their equity interests for stock or securities of either
the corporation acquiring the debtor’s assets or a corporation controlled by the acquiring
corporation. Id. §§ 354, 355. However, gain must be recognized to the extent of any money
or other property received. Id. § 356.
101. See supra note 95. Under normal income tax law, dispositions of property are
taxable pursuant to the calculation described in I.R.C. § 1001.
102. To receive nonrecognition treatment for reorganizations described in I.R.C. § 368,
transactions must also satisfy nonstatutory requirements set forth in accompanying
regulations. The principal tests are the continuity of interest and continuity of business
enterprise requirements, which are described in Treasury Regulations § 1.368-1 (2011) and
§ 1.368-2 (2010).
103. See Treas. Reg. § 1.368-1(d) (2011).
104. I.R.C. § 61(a)(12); United States v. Kirby Lumber Co., 284 U.S. 1, 2 (1931); Treas.
Reg. § 1.61-12 (as amended in 1997).
105. See Treas. Reg. § 1.61-12.
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2287
115. See, e.g., Marie Beaudette & Jacqueline Palank, Kodak Files Plan To Exit
Bankruptcy Protection, WALL ST. J. (May 1, 2013, 5:00 PM), http://online.wsj.com/news/
articles/SB10001424127887324266904578457030412008730 (noting sizable NOLs in
Kodak’s bankruptcy estate); Erik Holm & Eric Morath, Ambac Files for Chapter 11, WALL
ST. J. (Nov. 9, 2010, 12:01 AM), http://online.wsj.com/news/articles/SB1000142405274870
3514904575602911478916800 (noting substantial NOLs in Ambac’s bankruptcy estate).
116. I.R.C. § 1398.
117. Id. § 1398(g)(6).
118. Companies accrue NOLs when deductions exceed gross income during the tax year.
Id. § 172. Once accrued, NOLs can be used to offset income in a different tax year. Id.
§ 172(b)(1)(A). Specifically, NOLs may be carried back and applied against income in
previous years, or carried forward and applied against income in subsequent years. Id.
§ 172(b)(2).
119. Individual taxpayers are permitted to deduct a maximum of $3,000 of net capital
losses (total capital losses less total capital gains) in any given tax year. Id. § 1211(b). Net
capital losses in excess of $3,000 may be carried forward to subsequent tax years, subject to
the same limitation of being deductible only to the extent of capital gains plus a maximum
additional deduction of $3,000. See id. § 1212(b). Corporate taxpayers do not have the
benefit of the additional $3,000 and have greater restrictions on the number of years
carryforwards are permitted. However, corporate taxpayers are permitted a limited
carryback, which is not available to noncorporate taxpayers. Id. § 1212(a).
120. For instance, certain unused business and investment credits may be carried forward
to subsequent years. See, e.g., id. § 39 (allowing for the carryforward of unused general
business credits); id. § 904(c) (allowing for the carryforward of unused foreign tax credits).
121. See id. § 1398(g).
122. Conflicting approaches to the appraisal of tax attributes are considered in In re
Washington Mutual, Inc., 461 B.R. 200, 231–32 (Bankr. D. Del. 2011), vacated in part, No.
08-12229 (MFW), 2012 WL 1563880 (Bankr. D. Del. Feb. 24, 2012).
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2289
123. GAAP are uniform standards of, and guidelines to, financial accounting and
reporting. See Frequently Asked Questions, AM. INST. CPAS, http://www.aicpa.org/About/
FAQs/Pages/FAQs.aspx (last visited Mar. 25, 2014). The Financial Accounting Standards
Board and the Governmental Accounting Standards Board are authorized by the Securities
and Exchange Commission to establish these principles. See id.
124. FIN. ACCOUNTING STANDARDS BD., STATEMENT OF FINANCIAL ACCOUNTING
CONCEPTS NO. 6: ELEMENTS OF FINANCIAL STATEMENTS 16 (1985).
125. Under GAAP, deferred tax assets represent the increase in taxes refundable (or
saved) in future years as a result of deductible temporary differences existing at the end of
the current year. FIN. ACCOUNTING STANDARDS BD., FASB INTERPRETATION NO. 48:
ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES 2 (2006).
126. FIN. ACCOUNTING STANDARDS BD., STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 109, at 5 (1992).
127. I.R.C. § 172(b)(1)(A) (2012).
128. See, e.g., Bill Rochelle, Harrisburg, Madoff, Ambac, Old GM, Friendly:
Bankruptcy, BLOOMBERG BUSINESSWEEK (Oct. 14, 2011), http://www.businessweek.com/
news/2011-10-14/harrisburg-madoff-ambac-old-gm-friendly-bankruptcy.html (noting that a
commercial debtor declared that its NOLs were its most valuable asset); Robert Willens, CIT
Moves To Protect Its NOLs, CFO.COM (Dec. 28, 2009), http://ww2.cfo.com/accounting-
tax/2009/12/cit-moves-to-protect-its-nols/ (describing the steps taken by CIT Group Inc. to
protect its NOLs as a vitally important asset).
129. Such was the case in Selectica, Inc. v. Versata Enterprises, Inc., No. 4241-VCN,
2010 WL 703062 (Del. Ch. Feb. 26, 2010), discussed infra notes 260–66 and accompanying
text.
130. Outside of bankruptcy, the “poison pill” is becoming an increasingly common
planning device to protect NOLs. This strategy has been given scholarly attention recently.
See, e.g., Michael R. Patrone, Case Note, Is the “Tax Poison Pill” the Last Stand for
Protecting NOLs After Health Care Reform?, 1 HARV. BUS. L. REV. ONLINE 11 (2010).
131. For instance, Judge Posner notes that although NOLs were the only asset of Chapter
11 debtor South Beach Securities, Inc., they were not disclosed as assets in the company’s
initial asset disclosures. In re S. Beach Sec., Inc., 606 F.3d 366, 373 (7th Cir. 2010); see also
supra note 33; infra note 133.
132. See B 6B (Official Form 6B), Schedule B—Personal Property, available at
http://www.uscourts.gov/uscourts/RulesAndPolicies/rules/BK_Forms_1207/B_006B_1207f.
pdf. The debtor’s valuable tax attributes could potentially come under item 18, “Other
liquidated debts owed to debtor including tax refunds.” Id. However, most debtors do not
2290 FORDHAM LAW REVIEW [Vol. 82
fully disclose valuable tax attributes here or elsewhere in their disclosures; this is likely a
function of the valuation principles discussed infra Part I.B.2.
133. See, e.g., Schedule of Assets and Liabilities for Eastman Kodak Co. at 5, Eastman
Kodak Co. v. Apple Inc. (In re Eastman Kodak Co.), No. 12-10202 (ALG) (Bankr. S.D.N.Y.
Apr. 18, 2012) (noting as a disclaimer that the asset disclosures exclude tax accruals).
134. Bankruptcy law is unique in that statutory interpretation and policymaking resides
almost entirely with the courts rather than with administrative agencies. See Rafael I. Pardo
& Kathryn A. Watts, The Structural Exceptionalism of Bankruptcy Administration, 60
UCLA L. REV. 384, 391 (2012).
135. For a more detailed discussion of the distinction between an asset and its valuation,
see infra note 146 and accompanying text.
136. See FIN. ACCOUNTING STANDARDS BD., supra note 126, at 5–6.
137. See id.
138. Id. at 6.
139. See id.
140. For instance, the struggling oil and gas company Ultra Petroleum took a full
valuation allowance against its deferred tax assets in 2012. Ultra Petroleum Corp., Annual
Report (Form 10-K), at 42–43 (Dec. 31, 2012); see also Zoltek Cos., Quarterly Report (Form
10-Q), at 13 (June 30, 2012) (“The Company has recorded a full valuation allowance against
its deferred tax assets in Hungary, the United States and Mexico because it is more likely
than not that the value of the deferred tax assets will not be realized.”); The Spectranetics
Corp., Quarterly Report (Form 10-Q), at 12 (Mar. 31, 2012) (“Due to the Company’s history
of losses and the lack of sufficient certainty of generating future taxable income, the
Company has recorded a full valuation allowance against its deferred tax assets.”).
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2291
generate profits in the near future. When a company takes a full valuation
allowance, its deferred tax assets are reflected with zero value on financial
statements.141
Of course, companies that are suffering economic difficulties are often
the very companies that eventually file for bankruptcy. For instance,
Solyndra’s financial statements leading up to its bankruptcy filing reflect
zero value for its deferred tax assets, accompanied by the following
notation: “Due to its history of operating losses, the Company has recorded
a full valuation allowance against its deferred tax assets.”142 Because of
this, the company’s initial asset disclosures to the bankruptcy court—which
do not contain any reference to tax attributes—are facially consistent with
financial statements that recorded zero value for deferred tax assets.143
Thus, it seems that the interaction of accounting rules and federal
bankruptcy procedure yields a peculiar result: one of the debtor’s most
important assets is not disclosed at the outset of the bankruptcy case. But
there is another possible explanation for the lack of disclosure: although
tax attributes are “assets,” they may not be consistently thought of as
“property” of the estate. The following section considers this theoretical
question in the context of tax and bankruptcy law.
3. Transferability of Tax Attributes: General Rules
Tax attributes are undeniably an important source of value to most
bankruptcy estates, even after taking into account any reductions caused by
anticipated cancellation of indebtedness.144 Thus it is not surprising that, as
the previous section articulates, they are recognized as assets under modern
accounting principles. But with respect to their treatment in bankruptcy
law, a wider question remains: Are valuable tax attributes property of the
estate? Or are they merely legal entitlements, reflecting the debtor’s future
and highly contingent ability to receive value by operation of the tax laws?
The question implicates a principal distinction in property law: “not only is
there valueless property, but there is also propertyless value . . . . [I]n short,
property is not wealth.”145 Thus, what amounts to an “asset” under modern
accounting principles may not be “property” in a legal sense.146
157. The Joint Committee staff explains that “normal income tax law would provide for
the carryback and carryforward of net operating losses . . . . [T]he general limits on the
number of years that such losses may be carried back or forward were chosen for reasons of
administrative convenience and compliance concerns and may be assumed to represent
normal income tax law.” JOINT COMM. ON TAXATION, supra note 97, at 8. Theoretical
justifications for NOLs have been discussed in the academic literature. See Michelle M.
Arnopol, Why Have Chapter 11 Bankruptcies Failed So Miserably? A Reappraisal of
Congressional Attempts To Protect a Corporation’s Net Operating Losses After Bankruptcy,
68 NOTRE DAME L. REV. 133, 138 (1992); Daniel L. Simmons, Net Operating Losses and
Section 382: Searching for a Limitation on Loss Carryovers, 63 TUL. L. REV. 1045, 1057
(1989); J. Henry Wilkinson, Jr., The Net Operating Loss Deduction and Related Income Tax
Devices, 45 TEX. L. REV. 809, 855 (1967).
158. Some of the legislative concerns are highlighted in H.R. REP. NO. 83-1337 (1954).
159. I.R.C. § 269(a)(1) (2012).
160. Section 269(a)(1) is so rarely used to defeat transactions because, for the principal
purpose of a transaction to be tax avoidance, the purpose of tax evasion has to clearly
overshadow any other purpose. See U.S. Shelter Corp. v. United States, 13 Cl. Ct. 606, 621
(1987) (discussing evidentiary challenges).
161. I.R.C. § 382 was initially enacted over fifty years ago. The section was substantially
overhauled in the Tax Reform Act of 1986. See BORIS I. BITTKER & LAWRENCE LOKKEN,
FEDERAL TAXATION OF INCOME, ESTATES AND GIFTS § 95.5.1 (2003).
162. I.R.C. § 382(g). A “5 percent stockholder” is a shareholder who held at least 5
percent of the company’s shares during the test period. Id. All shareholders who do not own
at least 5 percent of the company’s shares are aggregated and treated as a single 5 percent
stockholder. Id. Transfers between such stockholders are disregarded for purposes of
determining whether an ownership change has occurred. Id. Thus, so long as 50 percent or
more of the shares is owned by less than 5 percent equity holders throughout the three-year
testing period, there will be no change in control. Id. § 382(g)(4)(A). These limitations are
also triggered by certain tax-free reorganizations. See id. §§ 368(a)(1), 382(g)(1).
2294 FORDHAM LAW REVIEW [Vol. 82
The restrictions on use of these tax assets are quite severe. Generally
speaking, where a change of ownership has occurred, the corporation’s
ability to use its NOLs to reduce future income is capped at an annual rate
equal to the value of the corporation immediately before the ownership
change163 multiplied by the highest adjusted long-term tax exempt bond
rate for that month and the two prior months.164 For example, if a company
has $1,000 of NOLs and the fair market value of the company on the date
of the change of ownership is only $500, then the available NOLs are
reduced to $500. Assuming a 3 percent bond rate at the time of the change
of ownership, the annual usable value of the NOLs would be reduced to a
meager $15. If the corporation does not continue its historic business, its
available NOLs generally are reduced to zero.165 These rules apply to the
corporate merger, acquisition, and recapitalization context and were
designed to neutralize the tax consequences of corporate investments.166
With respect to other forms of valuable tax attributes, the same statute
limits a corporation’s recognition of built-in losses during the five-year
period following a change of ownership,167 while a successive statute limits
indirect transfers of certain tax credit or capital loss carryovers.168
Taken together, these rules effectively proscribe direct and indirect
transfers of a corporation’s valuable tax attributes. Thus, at least outside of
bankruptcy,169 tax attributes are reminiscent of the “propertyless value” that
courts must occasionally grapple with in cases under Article 9 of the
Uniform Commercial Code.170 Like liquor licenses,171 Federal
Communications Commission (FCC) licenses,172 and other governmental
permits that figure prominently in such cases, tax attributes are generally
treated as creatures of statutory law, subject to direct and indirect transfer
restrictions.173 Similarly, their future economic benefits are theoretically
revocable by the government at any time, through revisions to federal tax
laws, regulations, or interpretations thereof.174 Accordingly, while they
163. In determining the value of the corporation, I.R.C. § 382(l)(1) generally disregards
any capital infusions received within two years of the ownership change. Id. § 382(l)(1).
164. Id. The rate is published monthly by the U.S. Treasury. See, e.g., Rev. Rul. 2014-1,
2014-2 I.R.B. 263 (providing the adjusted long term rates for January 2014).
165. I.R.C. § 382(c)(1); Treas. Reg. § 1.368-1(d) (2012).
166. BITTKER & LOKKEN, supra note 161, § 95.5.1 (“Congress sought a limitation that
would make NOL carryovers a relatively neutral factor in acquisitions.”).
167. I.R.C. § 382(h).
168. Id. § 383.
169. See infra Part I.B.4.
170. See, e.g., Jackson v. Miller (In re Jackson), 93 B.R. 421, 423 (Bankr. W.D. Pa. 1988)
(stating that a purported security interest in a liquor license was void and of no effect
because the license was classified as nonproperty under state law). The issue of whether an
asset constitutes “property” is important in cases of this sort, because Article 9 applies only
to transactions “intended to create a security interest in personal property.” U.C.C. § 9-110
(2010).
171. In re Jackson, 93 B.R. at 424.
172. See Thacker v. FCC (In re Magnacom Wireless, LLC), 503 F.3d 984, 990 (9th Cir.
2007); Kidd Commc’n v. FCC, 427 F.3d 1, 5 (D.C. Cir. 2005).
173. See supra notes 148–62 and accompanying text.
174. See, e.g., In re Jartran, Inc., 44 B.R. 331, 380 (Bankr. N.D. Ill. 1984) (“[T]he
realization of the tax savings [from use of NOLs] is subject to a number of contingencies,
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2295
including continuation in effect of relevant tax provisions . . . .”). Likewise, the government
can take steps to enhance the economic benefits associated with tax attributes. See, e.g., J.
Mark Ramseyer & Eric B. Rasmusen, Can the Treasury Exempt Its Own Companies from
Tax? The $45 Billion GM NOL Carryforward, 1 CATO PAPERS PUB. POL’Y 1, 3–5 (2011)
(describing the government’s issuance of a series of notices permitting General Motors to
engage in a § 363 sale in Chapter 11 without subsequently running afoul of the Tax Code’s
§ 382 NOL limitations).
175. This principle is reflected in Revenue Ruling 74-175, wherein the Internal Revenue
Service declined to allow a decedent’s estate to deduct his losses, on the grounds that “only
the taxpayer who sustains a loss is entitled to take the deduction.” Rev. Rul. 74-175, 1974-1
C.B. 52.
176. Of course, this valuation would typically not assign value to the debtor’s tax
attributes. See supra Part I.B.2.
177. This perverse outcome is noted in Kelly Kogan, Solyndra: Now It’s IRS’s Turn, 217
DAILY TAX REP. 1, 3 (2012).
178. I.R.C. § 382(l)(5) (2012).
179. See Treas. Reg. § 1.382-9(m)(1) (as amended in 1994) (“If section 382(l)(5) applies
to an ownership change of a loss corporation, section 382(c) and the regulations thereunder
do not apply with respect to the ownership change.”). However, there is a limited continuity
of business enterprise requirement under the more broadly applicable § 269. See Treas. Reg.
§ 1.269-3(d) (as amended in 1992) (“Absent strong evidence to the contrary, a requisite
acquisition of control or property in connection with an ownership change to which section
382(l)(5) applies is considered to be made for the principal purpose of evasion or avoidance
of Federal income tax unless the corporation carries on more than an insignificant amount of
an active trade or business . . . .”).
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180. The 50 percent threshold must be satisfied by “old and cold” holdings, meaning that
relevant stakeholders have kept their interests for at least eighteen months. See I.R.C.
§ 382(l)(5)(E)(i).
181. However, recall that NOLs (and certain other valuable tax attributes) are subject to
reduction in an amount equal to any cancellation of indebtedness income excluded by the
debtor from taxable income. See supra note 111 and accompanying text. The reduction is
made after calculating the tax for the year in which the cancellation of indebtedness occurs.
I.R.C. § 382(l)(5)(B). Additionally, NOLs must be reduced for certain interest payments
made within the past three years to creditors that receive equity interests in the debtor under
the Chapter 11 plan. Id. Finally, if an “ownership change” occurs in the two years following
the debtor’s emergence from bankruptcy, the NOLs must be reduced to zero. See id.
§ 382(l)(5)(D).
182. See supra note 73 and accompanying text.
183. See I.R.C. § 382(l)(5)(D).
184. Strategic planning opportunities are described by Mark Gelfeld & Karen Lobl, Tax
Planning Opportunities for Debtor Corporations in Title 11 Proceedings, 91 COM. L.J. 417,
429 (1986).
185. Rules that allow taxpayers to retain valuable tax attributes, such as NOLs, have been
characterized as tax incentives elsewhere. For example, the Joint Committee on Taxation
notes that any extensions in the time limits for carrybacks and carryforwards constitute tax
expenditures. JOINT COMM. ON TAXATION, supra note 97, at 3; see also Ramseyer &
Rasmusen, supra note 174, at 8–9 (using the term “tax breaks” to describe the government’s
issuance of notices exempting the § 363 sale of General Motors from § 382 restrictions);
Julie Tennyson, Tax Incentives for the Biotechnology Industry: Should Tennessee Offer
Sales Tax Exemptions and Net Operating Loss Extensions?, 70 TENN. L. REV. 567, 578
(2003) (analyzing extensions in the time limits for NOL carryovers as tax expenditures).
186. See supra note 96.
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2297
former creditors and/or shareholders), the tax laws allow these assets to be
monetized by corporate stakeholders in a way that makes Chapter 11
bankruptcy especially appealing.
estate and that substantial equity trades would violate the automatic stay); Revised Final
Order Pursuant to 11 U.S.C. §§ 105(a) and 362 Establishing Notification Procedures for
Substantial Claimholders and Equity Security Holders and Approving Restrictions on
Certain Transfers of Interests in the Debtors’ Estates at 2, In re AMR Corp., No. 11-15463
(Bankr. S.D.N.Y. Apr. 11, 2013), ECF No. 7591 (stating that NOL carryforwards were
property of the debtors’ estates and approving notification procedures and restrictions on
transfers of claims against and interests in the debtors to protect tax credits).
194. H.R. REP. NO. 95-595, at 176 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6136.
195. Nisselson v. Drew Indus., Inc. (In re White Metal Rolling & Stamping Corp.), 222
B.R. 417, 424 (Bankr. S.D.N.Y. 1998).
196. Gibson v. United States (In re Russell), 927 F.2d 413, 417–18 (8th Cir. 1991).
While courts do not classify NOLs as any particular type of property, these assets would
presumably qualify as general intangibles as the term is defined in the Uniform Commercial
Code. Under U.C.C. § 9-102(42), “general intangibles” is a catch-all term, referring to “any
personal property, including things in action, other than accounts, chattel paper, commercial
tort claims, deposit accounts, documents, goods, instruments, investment property, letter-of-
credit rights, letters of credit, money, and oil, gas, or other minerals before extraction. The
term includes payment intangibles and software.” See U.C.C. § 9-102(42) (2001).
197. See supra Part I.A.
198. See supra Part I.B.
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2299
other words, while the tax laws may function to bolster the value of the
bankruptcy estate, it ought to be squarely within the domain of bankruptcy
law to account for and distribute this value to satisfy claims against the
estate. The very purpose of bankruptcy is to provide for the fair and orderly
distribution of the debtor’s property in accordance with established legal
and equitable principles.199
An expectation that bankruptcy law provides a distributional framework
may explain why legal scholars were not troubled by the initial adoption of
the tax laws that allow debtors to indirectly transfer valuable tax attributes
through Chapter 11.200 Scholars, much like the judges tasked with
construing these provisions, largely assumed that Chapter 11 would
function to efficiently and fairly reallocate the value of these newly
monetized assets to the company’s true residual owners.201 Reflecting this
view, Professor Michelle Arnopol Cecil noted in a 1992 article that the
bankruptcy-specific rules on transferability of tax attributes rest upon the
“sound assumption that historic creditors of a loss corporation are its true
owners and should be treated as equity holders for tax purposes.”202
According to Professor Arnopol, this would “effectuat[e] the policy of tax
neutrality by allowing only the owners of the loss corporation to have
unfettered use of its net operating losses.”203
Of course, implicit within this reasoning is an expectation that
Chapter 11 in fact functions to allow the true residual owners of a
corporation to succeed to its remaining assets, including its valuable tax
attributes. In other words, the argument rests upon an assumption that tax
attributes, like all other potential sources of value, are accounted for in
bankruptcy. Further, the logic assumes that any indirect transfers of
valuable tax attributes that take place pursuant to a confirmed Chapter 11
plan merely vest the future economic benefits in the persons who have
borne the corresponding economic losses, such that they would be entitled
to distributions from the debtor’s estate in the first place. But, as we shall
see, this reasoning assumes too much about the manner in which valuable
tax attributes are disclosed, appraised, accounted for, and indirectly
transferred in Chapter 11.
199. See, e.g., Rine & Rine Auctioneers, Inc. v. Douglas Cnty. Bank & Trust Co. (In re
Rine & Rine Auctioneers, Inc.), 74 F.3d 854, 860 (8th Cir. 1996).
200. See, e.g., Martin M. Van Brauman, The Carryforward of Net Operating Losses and
Other Tax Attributes After Bankruptcy Reorganizations, 23 ST. MARY’S L.J. 461, 489 (1991)
(“[T]he ability to currently structure an acquisition solely for the carryover of tax attributes
from a non-affiliated corporation is somewhat comparable to Sir Galahad’s quest for the
Holy Grail.”); see also William M. Davidow, Jr., Limitations Imposed by the Tax Reform Act
of 1986 on a Corporation’s Use of Net Operating Loss Carryovers After an Ownership
Change, 17 U. BALT. L. REV. 331, 353–59 (1988) (thoroughly critiquing § 382 and the
regulations promulgated thereunder, but expressing no concerns about the bankruptcy-
specific exceptions).
201. Judge Posner identifies this expectation regarding § 382’s bankruptcy-specific
exception in In re South Beach Securities, Inc., 606 F.3d 366, 374–75 (7th Cir. 2010).
202. Arnopol, supra note 157, at 195.
203. Id.
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204. See supra notes 38–41 and accompanying text. Judge Posner notes this
impossibility in In re South Beach Securities, Inc., 606 F.3d at 376.
205. See supra Part I.B.4.
206. See infra notes 207–13 and accompanying text.
207. See First Amended Plan of Reorganization of the PMI Group, Inc. Pursuant to
Chapter 11 of the U.S. Bankruptcy Code at 11, In re PMI Grp., Inc., No. 11-13730 (Bankr.
D. Del. June 3, 2013), ECF No. 882. An earlier example includes In re Celotex Corp., 204
B.R. 586, 614 (Bankr. M.D. Fla. 1996) (allocating 50 percent or more of the stock of the
reorganized company to asbestos claimants, as creditors of the debtor).
208. In this way, Solyndra’s plan did not turn on application of I.R.C. § 382(l)(5), as any
changes in equity ownership pursuant to the warrants would take place outside of the
Chapter 11 plan. See generally Amy S. Elliott, Setting the Record Straight on Solyndra’s
NOLs Post-bankruptcy, 136 TAX NOTES 1493 (2012).
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only three cents on the dollar for their claims.209 Solyndra’s shareholders
relied upon a limited, judicially created210 exception to the absolute priority
rule where shareholders are permitted to invest new capital in the
reorganized debtor in exchange for the right to retain their equity security
interests, even though creditors are not paid in full.211 To meet this “new
value exception,” investors must contribute new and substantial money or
money’s worth that is necessary for a successful reorganization and is
reasonably equivalent to the interest received.212 Finally, creditors must
either have a right to bid for the equity interests or the bankruptcy court
must determine the market value of the new equity interests.213 In the
Solyndra case, the court found that an $810,000 capital contribution,214
coupled with a commitment to make secured financing available to the
reorganized debtor,215 was sufficient to allow shareholders to retain their
equity security interests, thereby preserving their rights to nearly $1 billion
of the company’s tax attributes. As these numbers suggest, restructurings
of this sort pose a more obvious threat to the absolute priority rule.
But both types of restructurings have the potential to yield inequitable
and inefficient allocations of value. This is because, astonishingly, whether
the Chapter 11 plan vests beneficial ownership of a debtor’s valuable tax
attributes in creditors or shareholders, bankruptcy’s most vital safeguards
do not apply to the transfer. Indeed, the law fails to provide an efficient
mechanism for both recognizing the value enhancements that these tax
attributes bring to the debtor’s corporate stock and ensuring that such value
is subjected to Chapter 11’s distributional norms.
The disconnect is caused by an ambiguity at the junction of tax and
bankruptcy law. Recall that under bankruptcy law, a court must confirm a
Chapter 11 plan before a debtor can exit bankruptcy.216 Where there is
controversy, such as where the debtor is attempting to obtain judicial
confirmation over the objections of dissenting impaired classes, the court
must ensure that the plan is “fair and equitable.”217 As noted above, this
analysis requires, in pertinent part, that the court evaluate whether the plan
provides each impaired and dissenting creditor with at least as much as it
violation of the absolute priority rule, in the form of equity security interests
in the debtor that either exceed the value of the holders’ claims, or that
exceed the value of any new money they intend to contribute to the
reorganized debtor.
But these disputes are extremely costly and time consuming, often
requiring expert testimony to consider how various tax attributes should be
appraised under complex financial valuation models.225 And even the most
comprehensive valuation models are ultimately based on multiple
assumptions and subjective determinations.226 For instance, in the highly
contested In re Washington Mutual, Inc. case, the consolidated debtors’
expert applied a financial model that declined to take into consideration the
likelihood that the reorganized company would receive new capital or debt
infusions to acquire profitable businesses; accordingly, the plan’s estimated
reorganization value was quite conservative.227 Meanwhile, the expert for
the plan’s opponents speculated that the reorganized debtor could raise
billions of dollars to realize more of the tax benefits.228 The court
ultimately adopted a conservative valuation estimate, noting that “the
Reorganized Debtor should be able to raise additional capital and debt over
the next twenty years equal to twice the value of its current assets,”229
which the court found to be approximately $140 million.230 Within months
of exiting bankruptcy, the reorganized debtor had already executed debt
instruments allowing it to borrow over $250 million to acquire profitable
businesses and utilize the tax benefits, thereby rapidly outpacing the court’s
ballpark figure.231
Thus, while challenges to the debtor’s reorganization value may provide
a last resort for impaired dissenting classes, they do not offer meaningful
safeguards. Moreover, much has changed in the decades following the
initial adoption of Chapter 11 in 1978 and the revamping of the Tax Code
in 1986.232 As I have argued elsewhere, modern corporate restructurings
are highly political processes, in which insiders, traditional bank lenders,
hedge funds, distressed-debt investors, and other powerful stakeholders are
able to engage in strategic conduct to acquire control of the process.233 In
this environment, Chapter 11 enables parties with existing market power in
the securities and capital markets to extract excess returns at the expense of
other constituents.234 Negotiations often focus on the distribution of
economic burdens, on one hand, and the exploitation of rent-seeking
to file a Chapter 11 plan during the first 120 days,238 those stakeholders
who are in the best position to know the nature and extent of the debtor’s
tax attributes are also most likely to be tasked with preparation and
advancement of the debtor’s Chapter 11 plan. The resultant power
imbalance infects the restructuring with strategic, rather than transparent
and competitive, bargaining. And, ironically, because Chapter 11 relies on
consensus- and market-based processes to reach case outcomes,239 these
information asymmetries have the potential to thwart the efficient resolution
of corporate financial distress.
This ambiguity in the law also manifests in a more subtle—yet equally
troublesome—way: it weakens the negotiating power of certain parties
from the outset of the case by obscuring the true enterprise value of the
debtor. For instance, the debtor’s failure to disclose the nature and extent of
its valuable tax attributes early in the case can prevent common
shareholders from gaining a seat at the negotiation table. The U.S.
Trustee’s power to appoint an official committee to represent equity
security holders is discretionary, rather than mandatory, and the U.S.
Trustee will only appoint a committee where shareholders prove that they
are not already adequately represented.240 Courts reiterate that the
appointment of an equity committee is extraordinary relief, and their
formation “should be the rare exception.”241 Under the strictest standard,
shareholders bear the burden of demonstrating “a substantial likelihood that
they will receive a meaningful distribution in the case under a strict
application of the absolute priority rule.”242
Without early and meaningful disclosure of the debtor’s assets, including
its tax attributes, shareholders cannot meet this burden. In that event, the
U.S. Trustee is likely to determine that the equity security holders have no
reasonable expectation of a recovery and thus do not require the
appointment of an equity committee.243 For precisely these reasons,
shareholders in the recent In re Eastman Kodak Co. bankruptcy case had to
“take matters into their own hands . . . [and were] forced to represent
[themselves].”244 This creates both a substantial barrier to entry and a
collective action obstacle in Chapter 11 negotiations.245
Along similar lines, the market for the debtor’s tax benefits is further
insulated from competition by legal barriers, such as the exclusivity rule,246
as well as strategic barriers, such as Chapter 11–plan proponents’ frequent
and deliberate creation of impaired classes to vote in favor of a
controversial plan.247 Indeed, the enormous transaction costs associated
with a plan-confirmation battle also serve as a legal barrier of sorts,
particularly where only certain parties enjoy reimbursement of attorney’s
fees from the debtor’s estate.248
These inefficiencies, in turn, lead to principal-agent problems.
Chapter 11 relies on formal and informal grouping mechanisms, whereby
persons designated as agents represent an aggregated grouping of similarly
situated claimants. For instance, in a Chapter 11 case, similarly situated
claimants may be recognized collectively in official committees comprising
persons holding the largest claims.249 Yet within these agency structures,
certain dominant stakeholders with superior information, as well as market
power in the capital and securities markets, such as insiders, traditional
bank lenders, hedge funds, and distressed debt investors, are able to lobby
the agent to steer the case towards an outcome that allows them to extract
excess returns.250 For instance, in the Solyndra case, dominant
shareholders arguably took control of the case long before the company
filed for bankruptcy by advancing the February 2011 restructuring and
securing warrants to obtain additional equity in the debtor.251 These same
dominant shareholders also served as proponents of the company’s Chapter
11 plan, advancing a plan that would enable them to use the tax attributes to
privilege their future, unrelated investments.252
For these reasons, Chapter 11 creates an anticompetitive environment, in
which the debtor’s valuable tax attributes become economic rents for
dominant stakeholders. In this manner, the muddled overlap of tax and
bankruptcy law facilitates a bewildering result. Valuable tax attributes,
which are routinely recognized by bankruptcy courts as “property” of the
estate253 and are often a debtor’s most substantial asset, are permitted to
269. This framework assumes that the reorganized debtor will take steps to maximize its
economic interests vis-à-vis the valuable tax attributes. This assumption is consistent with
broader corporate jurisprudence. See, e.g., Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio
Corp., 475 U.S. 574, 588–89 (1986) (assuming that firms behave in an economically rational
manner).
270. See supra notes 111, 181 and accompanying text.
271. The proposed modification would be made to 11 U.S.C. § 1129(a)(7).
272. The Supreme Court has explained that the preponderance-of-the-evidence standard
is appropriate for deciding most bankruptcy claims. See Grogan v. Garner, 498 U.S. 279, 286
(1991) (“Because the preponderance-of-the-evidence standard results in a roughly equal
allocation of the risk of error between litigants, we presume that this standard is applicable in
civil actions between private litigants unless ‘particularly important individual interests or
rights are at stake.’” (quoting Herman & MacLean v. Huddleston, 459 U.S. 375, 389–90
(1983))).
273. A discounted cash flows analysis would estimate the tax attributes’ value by using
forecasted future cash flows, and by applying an appropriate discount rate. See DAVID T.
LARABEE & JASON A. VOSS, VALUATION TECHNIQUES: DISCOUNTED CASH FLOW, EARNINGS
EQUALITY, MEASURES OF VALUE ADDED, AND REAL OPTIONS 108 (2013). Factors that would
be relevant to the forecast include: (1) proposed or otherwise anticipated changes to the
reorganized company’s business enterprise, (2) forecasted revenue growth rates for such
industry, and (3) estimated future expenses. Id.
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2311
would further advance the congressional intent to prevent the use of the
bankruptcy process to traffic in corporate shells.274
was a sham, and that the Chapter 11 plan used the legal form of a
reorganization to achieve the economic substance of a liquidation. To this
end, the step transaction doctrine could have been used to collapse
Solyndra’s February 2011 adoption of a parent-subsidiary structure and the
later Chapter 11 plan. Doing so may have demonstrated that the purported
business purpose motivating the February 2011 restructuring was
insufficient to disguise the true tax-driven character of the transaction, that
the reorganization elements of the Chapter 11 plan lacked economic
substance, and that the Solyndra Plan in substance contemplated only a
liquidation of the business and a preservation of the future tax benefits to
benefit future, unrelated investments. The U.S. Trustee, in its role as a
“watchdog in bankruptcy proceedings,”292 should be more proactively
examining Chapter 11 cases for abuses of this sort, drawing upon
bankruptcy and tax statutory law, as well as doctrinal principles.
Of course, sound application of these judicial doctrines to complex
questions at the confluence of bankruptcy and tax law requires greater
coordination from the bench. As modern commercial bankruptcies feature
increasingly nuanced tax issues, presiding judges must be well versed in the
tax laws. Thus, while bankruptcy jurisdiction may continue to reside in the
bankruptcy judge,293 judges should be required—or at least strongly
encouraged—to refer cases and proceedings to the U.S. tax court for
guidance on the tax implications of decisions rendered in the bankruptcy
case. Indeed, Congress should reconsider providing U.S. bankruptcy courts
jurisdiction to resolve tax matters that arise in bankruptcy cases.294 A full
discussion of the proper jurisdictional balance for tax and bankruptcy
matters is outside the scope of this Article, but on the surface it seems that
the traditional efficiency arguments that favor more streamlined case
management cannot justify failures of the sort identified here.
Finally, while also beyond the scope of this Article, there is a deeper
question that deserves thoughtful scholarly attention: should bankruptcy
law continue to defer to GAAP as the primary way for parties to disclose
their economic condition? Skeptics exist in the legal and accounting
scholarly communities.295 Although modern accounting principles allow
for the systematic reporting of assets and liabilities, the rules were designed
to serve a different purpose and do not necessarily give the truest picture of
a person’s overall economic condition. Indeed, just as tax law strays from
GAAP in computing a corporation’s earnings and profits for the purposes of
292. In re S. Beach Sec., Inc., 606 F.3d 366, 370 (7th Cir. 2010) (discussing the duties
assigned to the U.S. Trustee under 28 U.S.C. § 586(a)(3) (2006)); see also 28 U.S.C.
§ 586(a)(3)(B) (authorizing the U.S. Trustee to monitor Chapter 11 plans and disclosure
statements); Morgenstern v. Revco D.S., Inc., 898 F.2d 498, 500 (6th Cir. 1990) (referring to
the U.S. Trustee as a “watchdog”).
293. See generally 28 U.S.C. § 1334.
294. Questions of this sort are raised in Steve R. Johnson, The Phoenix and the Perils of
the Second Best: Why Heightened Appellate Deference to Tax Court Decisions Is
Undesirable, 77 OR. L. REV. 235, 239–42 (1998).
295. See generally Mark J. Cowan, A GAAP Critic’s Guide to Corporate Income Taxes,
66 TAX LAW. 209 (2012).
2014] BANKRUPTCY’S CORPORATE TAX LOOPHOLE 2315
CONCLUSION
Between tax law and bankruptcy law lies fertile ground for companies in
financial distress to design abusive, tax-motivated restructuring
transactions. For example, Solyndra’s pseudo-reorganization takes
advantage of Chapter 11’s historic role as a rehabilitative device to cloak a
corporate liquidation with some semblance of reorganization and exploit
valuable tax attributes as excess returns. When troublesome ambiguities of
this sort are exploited, taxpayers are left subsidizing economically irrational
restructurings, while providing built-in investment returns for future,
unrelated investments. Because these tax benefits manage to escape
bankruptcy’s distributional norms, the benefits largely accrue to insiders,
traditional bank lenders, hedge funds, distressed-debt investors, and other
powerful stakeholders. Meanwhile, the distressed company’s other
constituents—employees, unsecured creditors, or common shareholders, as
the case may be—bear a disproportionate share of the company’s losses
without any of the accompanying tax benefits. Not only is this outcome
inequitable and inefficient, but it fails to satisfy basic elements of sound tax
and bankruptcy policy. Working together to advance meaningful legal
reforms, tax and bankruptcy experts can eradicate abuses of this sort and
help to restore the functionality of the commercial restructuring process.
296. The method of calculating a corporation’s earnings and profits is set forth in
regulations promulgated under 26 I.R.C. § 312. See, e.g., Treas. Reg. § 1.312-6 (2012).