Spring 2011
Focus On Bankruptcy and Reorganization Financial Advisory Services
Editor for This Issue: Robert F. ReillyBankruptcy Valuation Insights
Best Practices:
Valuation of the Debtor Company Intellectual Property
Robert P. Schweihs and Patrick Schweihs, Esq.
There are many reasons why a valuation analyst may be asked to value
debtor company intellectual property within a bankruptcy context. Before the valuation
analyst is retained, the party-in-interest (and, typically, the legal counsel) should
carefully define the intellectual property valuation assignment. After being retained,
the valuation analyst will consider all of the generally accepted intellectual property
valuation approaches, methods, and procedures. This discussion explains and illustrates
those generally accepted valuation approaches and methods. And, this discussion describes
the intellectual property valuation synthesis and conclusion process. Most bankruptcy-
related valuations are subject to a rigorous contrarian review. Therefore, this
discussion concludes with suggestions related to (1)the attributes of an effective (i.e.,
persuasive) intellectual property valuation report and (2) what type of professional
should prepare the bankruptcy-related intellectual property valuation.
Valuation Analyst Guidelines Related to Bankruptcy Expert Reports and Expert Testimony
Robert F. Reilly, CPA
Valuation analysts are often called upon to value debtor corporation assets, properties,
and business interests during a bankruptcy proceeding. Valuation-related issues often
arise with respect to: (1) the solvency of the debtor corporation at various points in
time, (2) the value of creditors' security interests, (3) the protection of creditors and
other parties, (4) the fairness of proposed DIP sale or purchase transactions, (5) the
collateral for DIP financing, (6) the reasonableness of a proposed plan of
reorganization, and (7) many other reasons. In these instances, the valuation analyst is
typically asked to prepare an expert report and is often asked to offer expert testimony.
Now, the valuation analyst is not an attorney, of course. However, the valuation analyst
cannot serve the information interests of the client-or the judge or other finder of fact-
if his or her expert testimony is not admitted. Therefore, the valuation analyst who
practices in the bankruptcy discipline should have a basic understanding of the judicial
rules related to the admissibility of expert reports and expert witness testimony.
Bankruptcy Planning Insights
Income Tax Considerations Related to Debtor Company Debt Restructuring
Robert F. Reilly, CPA
Many debtor companies are organized as partnerships or limited liability companies
(taxed as partnerships) for income tax purposes. This statement is particularly true for
many commercial real estate property owners. In the current economic environment, many of
these companies have to renegotiate or restructure their commercial debt. This debt
restructuring presents unique income tax consequences (and tax planning opportunities) to
these debtor companies-and to their individual partners. This discussion summarizes these
income tax challenges-and opportunities. The debtor companies, the individual partners,
and their legal counsel and tax advisers should carefully consider these issues when
planning for any debt restructurings.
Income Tax Issues Related to S Corporation Debt Restructuring
Robert F. Reilly, CPA
In the current economic environment, a financially troubled S corporation may have to
restructure or renegotiate the terms of its corporate debt. Alternatively, the S
corporation may have to implement creative capital structure procedures (such as
converting debt to equity or subordinating equity to debt). In all capital restructuring
cases, careful planning should be considered by the S corporation, its shareholders, and
its professional advisers. This is because these restructuring procedures can have
undesirable income tax consequences to the corporation and/or the shareholders. This
discussion summarizes some of the income tax issues that the financially troubled S
corporation management and owners should consider with respect to the debt restructuring
or renegotiation.
Income Tax Planning for Commercial Real Estate Debt Restructuring
Robert F. Reilly, CPA
Many industry observers forecast a continued downturn in the commercial real estate
market over the next few years. In particular, many industry analysts forecast distress
in the commercial real estate market in 2011 as many short-term commercial loans come due-
while property values continue to decrease. Therefore, many commercial real estate
property owners may have to restructure or renegotiate the commercial mortgages related
to their property. These property owners (and their legal counsel and tax advisers)
should carefully plan for the income tax consequences related to such a debt
restructuring. These tax consequences are influenced both by the type of debt (i.e.,
recourse, nonrecourse, or partially recourse) and by the property owner's tax attributes.
Income Tax Planning Opportunities Related to COD Income and Debt Restructuring
Robert F. Reilly, CPA
Tax planning opportunities exist for debtor corporations that have to recognize COD income as a result of debt restructuring. Tax planning opportunities also exist for debtor corporations that have issued new debt (at a discount) in exchange for the outstanding old debt. This discussion summarizes some of the income tax planning considerations related to the debtor corporation restructuring of commercial debt.
Structuring the Debtor Company Purchase/Sale Transaction
Robert F. Reilly, CPA
The owner of a financially troubled debtor company may have to sell the company (1) to
pay the company creditors and (2) to achieve sufficient liquidity to nurture remaining
business opportunities. This liquidity event may be the only option available to either
the individual owner or the corporate parent of the debtor company. In all cases, the
structure of the debtor company sale and purchase will affect the income tax implications
of the transaction. And, the income tax implications will affect the valuation (i.e., the
pricing) of the proposed debtor company sale transaction. This discussion summarizes
several common transaction structuring issues that will affect the planning for the
debtor company sale and purchase transaction.
Kennedy v. Commissioner: Income Tax Consequence of Structuring the Company Purchase/Sale
Transaction
Robert F. Reilly, CPA
This review of a recent U.S. Tax Court decision is an addendum to the preceding
discussion, "Structuring the Debtor Company Purchase/Sale Transaction." The Kennedy v.
Commissioner decision relates to the sale of a closely held corporation, KCG
International, Inc. (KCG). KCG was not a debtor company in bankruptcy. In fact, KCG was a
financially sound company. However, this case relates to the negative income tax
consequences of the ineffective structuring of the sale of a closely held company. This
discussion provides a timely follow-up to the previous discussion. This is because the
Kennedy decision provides a clear road map on what the taxpayer did not do to minimize
the income tax consequences associated with the closely held business sale.
Like-Kind Exchange Safe Harbor Provisions When the QI Defaults Due to Bankruptcy or
Receivorship
Robert F. Reilly, CPA
The economic slowdown has negatively affected many Section 1031 like-kind exchange
transactions. This negative impact is often due to obligation defaults by the transaction
qualified intermediary (QI). In recent years, the QI's default on its obligation to
acquire and transfer the Section 1031 replacement property has often occurred because its
assets were frozen in bankruptcy or receivorship. Revenue Procedure 2010-14 provides a
safe harbor method for the taxpayer reporting of a gain or loss for the taxpayer that
initiated the like-kind exchange but failed to complete the exchange. This revenue
procedure relates to Section 1031 like-kind exchanges that failed because of a QI
obligation default when that default was due to the QI bankruptcy or receivorship.
Section 363 Sales of Debtor
Corporation Stock versus Assets
Robert F. Reilly, CPA
Bankruptcy Code Section 363 sales are a common occurrence in bankruptcy proceedings. In
these Section 363 sales, the court can approve either the sale of the debtor corporation
assets or the debtor corporation stock. The structuring of the Section 363 sale
transaction can have both income tax consequences and legal liability consequences to the
debtor/seller and to the buyer. This discussion summarizes the basic transaction
structuring considerations of both the debtor corporation and the buyer corporation. Both
transaction parties will assess these considerations so as to maximize the economic
benefit of the Section 363 sale.
Bankruptcy Clawbacks: The Ponzi Scheme Presumption and Valuation
John R. McDonald, Esq., and Marcus A. Ploeger, Esq.
The recent recession has contributed to the discovery and unraveling of numerous Ponzi
schemes. The bankruptcy cases of household names such as Madoff have spawned a tremendous
volume of "clawback" actions. In these actions, trustees have sought to recover payments
made to investors prior to the debtor bankruptcy filing on the grounds that such payments
were fraudulent transfers. A trustee can avoid the time, effort, and cost of establishing
actual or constructive fraud if he or she can convince the court to apply the Ponzi
scheme presumption. This discussion provides (1) an overview of the rationale behind the
Ponzi scheme presumption and (2) advice for defendants faced with a fraudulent transfer
claim and the assertion of the Ponzi scheme presumption.
Thought Leadership:
Director Liability to Creditors: The Changing Landscape
Shaw M. Riley, Esq. and Ann L. Zarick, Esq.
For an insolvent corporation or a corporation approaching the so-called "zone of
insolvency," the courts have considered the directors to have fiduciary duties to the
corporate creditors. Certain recent judicial decisions have been somewhat more director-
friendly with respect to director duties to corporate creditors. This discussion
summarizes directors' duties to the corporation (for the solvent corporation) and to the
creditors (for the insolvent corporations). This discussion considers the impact of
recent judicial precedent on corporate directors, on debtor corporations, and on
corporate creditors. And, this discussion provides insights to all parties involved in an
insolvency situation: the corporation officers and directors, the corporation
shareholders, the various creditors, and the financial advisers and valuation analysts.