Debt restructuring alternatives for the financially troubled corporation: possible risks and benefits

Tax Executive, The, May-June, 1992 by Ronald C. Maiorano, P. Lawrence Tunnell

Section 382 may restrict the use of NOL carryforwards in this type of exchange if there is a 50-percent ownership change among five-percent shareholders within a three-year period. If a significant portion of the stock of the company is issued in the exchange (which is very possible if the "nominal value" requirement is to be satisfied), the ability of the current shareholders to trade their shares without reducing the future value of the NOLS may be restricted.

The common stock altemative must not have the characteristics of disqualified stock or the exception to CODI recognition or TAC reduction will not apply. The Revenue Reconciliation Act of 1990 defined disqualified stock as stock with a stated redemption price that (a) has a fixed redemption date; (b) the issuer can redeem at one or more times; or (c) the holder of the stock can demand that it be redeemed at one or more times. Although the disqualified stock attributes are those normally associated with preferred stock, the statute does not restrict application of these provisions to preferred stock. Accordingly, common stock can be deemed to be disqualified stock for these purposes, and thus the issuance of common stock with some of the "disqualified stock" attributes could cause the stock to be disqualified. The result of disqualification in this situation is that any excess of the amount of the debt above the fair market value of the stock will result in CODI that either has to be recognized or causes the reduction of TACS to the extent of insolvency.

3. Common Stock with Warrants to Acquire Redeemable

Preferred for Reduction in Outstanding Debt

This option involves the issuance of common stock in exchange for a reduction in the debt outstanding. Under this alternative, however, a portion of the common stock will have warrants attached, allowing the conversion of the common stock into redeemable preferred stock with a stated redemption price. The common stock will not have a stated redemption price or redemption date and the issuer or holder of the stock will not have a right to redeem the stock or require redemption at any time in the future. The common stock may have a stated dividend rate subject to certain agreed-upon performance goals with a cumulative clause in the event that the annual dividend cannot be paid.

The advantages of this option are similar to the advantages of the exchange of straight common stock for debt. If certain requirements are met, there will be an unlimited ability to utilize any NOL carryforwards that exist. This option has the potential to improve significantly the debt equity position of the balance sheet since debt will be reduced and equity will be increased. This option will also reduce the amount of the fixed interest payments (and therefore the cash outflow) required of the financially troubled corporation. Finally, the creditors should prefer this option to a strict common stock-for-debt exchange because they can potentially substitute a preferred equity interest for at least part of their common interest if the company actually does succeed in their turnaround effort; this attribute provides the creditor with a more defined exit strategy than if a strict common-stock-for-debt exchange was consummated.