Distressed Debt Buybacks and Restructurings - It's Easy, Unless It's Not

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Distressed Debt Buybacks and Restructurings - It's Easy, Unless It's Not

General

The credit crisis continues to take its toll on virtually all

economic activity. As it sweeps the globe, it has left many

companies financially weakened, if not crippled. In some

situations, the fair market value of corporate debt has fallen

significantly below face amount. As a result, some companies may be

forced to restructure their debt and others may wish to take

advantage of this "opportunity" to repurchase their debt

at a discount. Interesting tax issues arise in this context.

A corporation is generally subject to tax on cancellation of

indebtedness ("COD") income. COD income may arise in

several situations, including forgiveness of debt by the

debtholder, the repurchase of debt by the issuer at a discount, the

exchange of one debt instrument of the issuer for another,

significant modification of debt, the exchange of debt for equity

of the issuer, and the acquisition of debt by a person related to

the issuer. COD income, however, generally is not included in gross

income with respect to a taxpayer that is insolvent or in a title

11 bankruptcy proceeding. However, tax attributes of such a

taxpayer (e.g., its net operating losses, tax credits or

adjusted tax basis in property) are reduced by the amount of COD

income that is excluded from gross income. In addition, and as

described below under "The Stimulus Bill – An

Executive Summary," the American Recovery and Reinvestment Act

of 2009 ("ARRA") provides some relief for taxpayers that

are not insolvent or in a title 11 bankruptcy proceeding. Pursuant

to ARRA the recognition of COD income in connection with certain

repurchases, modifications and exchanges of debt instruments can be

deferred for a period of four or five years upon election by the

taxpayer. With respect to financial institutions, an added benefit

is that COD income, less an amount in respect of deferred tax

liability, increases such institutions' Tier 1 Ratio.

Contingent Convertible Debt Instruments

U.S. corporations have raised billions of dollars of funding by

issuing so-called contingent convertible debt instruments

("CoCos"). CoCos are debt instruments convertible into

stock of the issuer that provide for the payment of

"contingent interest." For example, a typical CoCo may

provide that the amount of interest...

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