In Search of the Holy Grail

In our article that appeared in last month's Bankruptcy Strategist, we discussed the special rule contained in Section 382(l)(5) with respect to the use of net operating losses by a company that has restructured under the protection of the bankruptcy court. See “In Search of the Holy Grail, Musings on Section 382(l)(5)“, 22 The Bankruptcy Strategist Number 2, 1. As discussed in that article, Section 382(l)(5) requires a bankrupt corporation to meet special stock ownership rules which forces the bankrupt company to track the ownership of its stock and its “qualified indebtedness” (“old and cold” and “ordinary course” debt) in the hopes of preventing dispositions which might render Section 382(l)(5) inapplicable. Internal Revenue Service regulations ameliorate the harsh holding period rules with respect to “qualified indebtedness” by permitting some trading of such indebtedness, so long as a person who acquires debt that would otherwise qualify as “qualified indebtedness” does not wind up being a 5% shareholder under the plan of reorganization. Where the stock, debt and claims against a bankrupt company are traded, companies execute lock up agreements with their stockholders or request orders from the bankruptcy court to restrict trading in the stock, debt or claims so as to protect its net operating loss carry forwards. Often, out of an excess of caution, the orders requested have been overly broad and have disrupted trading in such debt and claims.