A market order that protects the trading of securities of bankrupt companies is taking shape and should be finalized within the next few weeks. The order is a response to recent efforts by companies that filed for bankruptcy and tried to restrict trading of their securities to protect the use of net operating loss tax benefits.
The new order was drafted by the Loan Syndications and Trading Association and the Bond Market Association after Mirant, United Airlines and Delphi tried to restrict trading in their loans and bonds when they filed for bankruptcy. "We think it is terrible," Elliot Ganz, executive v.p. and general counsel for the LSTA, said of the companies' efforts to restrict trading. "We want a free, unrestricted trading market. We don't want trading restricted through the company." The LSTA and the BMA got together with representatives of the creditors and market makers, as well as representatives of both the debtor and creditors side of the bankruptcy bar to draft a resolution.
Micah Bloomfield, partner at law firm Strook & Strook & Lavin, said bankrupt companies trying to restrict trading of securities has been a big problem for some clients. "Our bankruptcy people are constantly having to deal with these limitations. It makes it difficult for those who want to accumulate enough debt in a company to influence the bankruptcy," said Bloomfield.
The bankrupt companies argued that the trading of securities would damage their ability to benefit from so-called net operating loss carryovers. These are tax benefits that allow a company to carry forward net operating losses (NOLs) of prior years to reduce tax liability in later years. Lawyers on behalf of Delphi, for example, argued that the trading of the securities might have stopped them from using the NOL tax benefits because certain sections of the tax code restrict the use of NOLs if a company undergoes an ownership change. This is defined as more than a 50% shift in the ownership of the company's stock over three years. The trading of securities could lead to investors buying large chunks of debt, which when converted into equity in post-reorganization could mean a change of ownership.
The new order strikes a balance between a bankrupt company's ability to use NOLs and investors' ability to buy and sell securities in these companies. In the case of Delphi, the court approved the trading of securities based on the LSTA-BMA model order. It is hoped that the final NOL order, which is due out in a couple of weeks, will act as a standard bearer in future bankruptcy cases, Ganz said. The new order is slightly different from the LSTA-BMA model, but is similar on many important points, he added. "We are hoping that it will set standards for courts to follow," he said.
The most important aspect of the new order is that it does not restrict investors from buying securities in bankrupt companies. But it protects companies' ability to use NOLs if it chooses to reorganize under Section 382 (1) (5) of the bankruptcy code. The order permits trading of securities provided that the debtors can require debt holders that have accumulated large chunks of debt to sell down their securities so that they do not own more than 5% of equity when the company emerges from bankruptcy. Despite this restriction, Ganz said debt holders will be not be discouraged from buying debt in bankrupt companies because it is uncommon for them to reorganize under Section 382 (1) (5) of the bankruptcy code. He said most companies choose to restructure under another section Section 382 (1) (6), which does not restrict the use of NOLs in the event of an ownership change.