Spring 2011


Focus On Bankruptcy and Reorganization Financial Advisory Services

Editor for This Issue: Robert F. Reilly

Bankruptcy 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 and Insolvency Litigation Insights

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.