A.              Cancellation of Debt

B.              Asset Transfers

C.              Net Operating Losses and Other Considerations  

CHAPTER 1  

INTRODUCTION  

     These materials provide simple operating guidelines for businesspersons contemplating filing a debtor-in-possession, corporate, business bankruptcy ("chapter 11").  (In this type of bankruptcy case the company's present management and board continue to operate the company.)  They are also intended to be an introduction to the strengths and formalities of a business bankruptcy for non-bankruptcy attorneys, creditors, and businesspersons.  The specific duties, powers and complications of each chapter 11 case are individually determined. Partnership, limited liability corporation and personal bankruptcy issue differences are not specifically discussed.

     Filing a business bankruptcy is complicated by the cost, unexpected financial and legal powers and complex controls of the bankruptcy court ("court").  Among these complications is that the fees and costs incurred by all of the interested parties is borne by the business in bankruptcy ("debtor-in-possession" or "debtor").  Additional issues include the negative response of customers, trade suppliers and family members.  Effectively functioning during a chapter 11 requires: (i) special management skills, (ii) constant contact with both business and bankruptcy attorneys, and (iii) personality traits, including, but not limited to, optimism, a strong will and a sense of humor.

     In order to be eligible to file a business bankruptcy the debtor’s debts exceed its assets and it cannot make current payments on its debts.  If you, or one of your clients satisfy this “equity insolvency test” this article may prove helpful.

CHAPTER 2

PRE-FILING CONSIDERATIONS

     Most business bankruptcies are filed at a crisis time.  However, businesspersons contemplating a chapter 11 ("pre-petition") should plan ahead for particularly critical issues.   

THE AUTOMATIC STAY AND GUARANTORS

     Immediately after filing of the chapter 11 petition ("post-petition" or "administrative period") all creditors are prohibited from performing any action to collect pre-petition debts or improve their pre-petition legal position relative to the debtor ("automatic stay").  This typically means the cessation of law suits, collection efforts of any kind, set-offs, foreclosures, seizures and withholding deliveries until pre-petition debts are paid.  However, the automatic stay typically does not stop creditors from demanding payment from any non-debtor guarantors ("guarantors").

     The court may enjoin creditors from pursuing guarantors if such collection efforts would seriously and adversely affect: (i) management actively involved in the debtor's operations, (ii) essential operating property of the debtor, or (iii) the debtor's ability to effectively utilize people and property essential to achieving a successful business reorganization ("confirmation of a plan of reorganization" or "reorganization").  If it is only inconvenient to the debtor or creates a hardship on the guarantors, it is unlikely that the court will enjoin creditors from pursuing guarantors.  

OPERATING CAPITAL

     Secured lenders, such as banks, factors, bond holders, etc. ("secured lenders") have created a lien on the proceeds from a business' collection of accounts receivable or sale of inventory and equipment ("cash collateral proceeds").  However, the secured lender has actually authorized the business to use its cash collateral proceeds to pay its daily operating expenses. 

     The debtor must obtain new administrative period authority to use cash collateral ("cash collateral agreement" or "cash collateral stipulation”) on an expedited basis, or it will quickly run out of operating capital.  The secured lender is given an opportunity to negotiate for a better legal position during the administrative period.  Often they will demand a waiver of all of the debtor's prior claims against the secured lender.  They may require the debtor to renew the cash collateral agreement every ninety days. 

     The debtor's unsecured creditors, ("unsecured creditors"), generally merchandise and inventory suppliers ("trade suppliers" or "the trade"), receive increased protection during the administrative period.  Trade suppliers and others, typically represented by an executive committee of 5-7 unsecured creditors ("unsecured creditors committee" or “committee”), and other interested parties, will carefully scrutinize any cash collateral agreement between the debtor and the secured lender. 

     The debtor's management should attempt to limit the concessions granted to the secured lender to avoid a court battle with the other interested parties.  It is usually helpful to quickly involve the unsecured creditors committee, if it has been formed, and other powerful interested parties in the cash collateral agreement negotiations.  The court must approve the cash collateral stipulation.

     The debtor may request court approval for use of cash collateral without the agreement of the secured lender.  The courts are generally interested in allowing the debtor a chance to reorganize and recognize its urgent need for operating capital.  However, the secured lender has powerful rights and strategic position.  It is extremely difficult to win a cash collateral battle.  The debtor must demonstrate that the lender's collateral will not be diminished ("impaired") during the administrative period, by utilizing proforma financial statements and business and equipment valuations. 

     Any motion to obtain court approval for the use of cash collateral will require notice to all creditors.  The debtor may request this notice period be upon shortened time ("emergency motion shortening time").   

ATTORNEY AND PROFESSIONAL FEES

     Bankruptcy attorneys will require a substantial retainer prior to becoming the debtor's chapter 11 counsel ("debtor's counsel").  Initial retainers may range from $15,000 to $350,000 depending on the scope of the debtor's operations.  Pre-petition it is advisable for businesspersons to create a "war chest" of funds to pay the retainer and provide operating capital until court approval of the cash collateral agreement.  If possible, the debtor's counsel's retainer should be paid from funds that are not subject to a secured lender's lien.

     The court must pre-approve the employment and payment of all administrative period professionals with the other interested parties given an opportunity to object.  "Professionals" include: (i) bankruptcy counsel, (ii) non-bankruptcy legal counsel, (iii) accountants, (iv) consultants, (v) real estate, business or machinery and equipment brokers, and (vi) business valuators or real estate appraisers.  

PUBLIC DISCLOSURE AND NOTIFICATION

     Immediately upon filing the chapter 11 petition, and periodically during the administrative period, both private and public company debtors should issue press releases and send explanatory letters to their entire mailing list ("public statements").  Public statements should additionally be issued for all significant events.  

     An initial public statement should include: (i) the events leading up to the filing, (ii) any recent improvements in operations or personnel, (iii) the anticipated continuation of the debtor's operations, (iv) the anticipated ability to recover and strengthen operations (to "reorganize"), (v) that a chapter 11 ("operating case") was filed rather than a chapter 7 ("liquidating case"), (vi) the anticipated effects on the employees, customers, trade creditors and the local community, and (vii) management, shareholders, customers and any secured or trade creditor's statements of support for the debtor.

     It is beneficial, but risky, to personally provide carefully structured advance notice of a chapter 11 filing to certain secured lenders, trade suppliers, shareholders, affiliates and senior employees.  However, public companies must time this advance notification carefully to avoid insider information concerns.  Both private and public companies must be aware of the possibility of a pre-emptive action by interested parties with advance notice of an intended bankruptcy filing.  

EMPLOYEE ISSUES

     Employees usually know that a business is in trouble before management officially tells them.  After the bankruptcy petition has been filed and the company becomes a debtor-in-possession employees will be even more concerned about their future.  The debtor should immediately inform its employees of: (i) the reasons for the filing, (ii) its benefits and problems, (iii) that the company pragmatically has become stronger by not being allowed or required to pay prior debts, and (iv) that the debtor must stay current in all of its post-petition (“administrative period”) payments, including employee wages.   

CHAPTER 3  
OPERATING DURING THE ADMINISTRATIVE PERIOD
ORDINARY COURSE OF BUSINESS
     During a chapter 11 the debtor's management does not have to seek bankruptcy court approval to operate its business in the customary manner ("ordinary course of business").  Although operations are subjected to enhanced scrutiny and reporting requirements, bankruptcy court approval is only required for those activities "outside" the ordinary course of business.  Some examples are: (i) settling any substantial claim or litigation, (ii) obtaining new credit, (iii) purchasing or selling equipment, old inventory and product lines, (iv) changes in senior management, or (v) leasing property or terminating leases.  It is advisable to conservatively categorize changes as outside the ordinary course of business.  

THE UNSECURED CREDITORS COMMITTEE

     The United States Trustee ("U.S. Trustee") is different from the trustee-in-bankruptcy ("trustee").  The U.S. Trustee is a part of the United States Department of Justice (“Department of Justice”) and is an interested party in every bankruptcy.  The Office of the United States Trustee ("OUST") is the operating staff of the U.S. Trustee.  They will determine the size and members of the unsecured creditors committee, typically, from the twenty largest unsecured creditors.  Each group of creditors with similar interests will be placed into a group ("class") for the purpose of the bankruptcy.  Examples of typical classes are: (i) secured lenders, (ii) equipment lessors, (iii) landlords, (iv) trade suppliers/unsecured creditors, (v) employees, (vi) bondholders, and (vii) equity holders. 
     The unsecured creditors committee has a fiduciary obligation to all of the unsecured creditors and may have almost as much power as a secured creditor.  The committee is also specifically given a great deal of oversight responsibility, including the authority to: (i) investigate and audit the financial condition, operations and acts of the debtor, (ii) request the appointment of a trustee, (iii) request the appointment of a bankruptcy examiner ("examiner") who will be given power over, and the right to audit, the debtor, and (iv) help create the plan of reorganization.  The debtor's management should maintain a cooperative relationship with the unsecured creditors committee and its counsel.

BANK ACCOUNTS

     Immediately upon filing the chapter 11 petition the debtor must close all of its old bank accounts and open new ones denominating itself as a debtor-in-possession and listing the case number.  Separate general, payroll and tax accounts will be required, but other types of customary accounts are allowed (postage, trust, commission, license, fees, etc.).  Immediate notice and explanation should be given to the holders of checks written on the closed accounts since they will bounce and cannot be replaced.  

EXECUTORY CONTRACTS

     An "executory contract" is generally defined as one where both parties must substantially perform in the future.  Leases, collective bargaining agreements, employment contracts and supplier contracts are typical executory contracts.  The debtor may "assume, assume and assign, or reject" executory contracts. 

     If an executory contract is “assumed” during the administrative period then the other party to the contract becomes an administrative period creditor granted priority payments over most pre-petition creditors ("administrative priority"). 

     Executory contract creditors would prefer to quickly know whether the debtor will assume, assume and assign or reject their contract.  Generally, the debtor can wait until confirmation of a plan of reorganization to assume, assume and assign or reject executory contracts, unless they are for non-residential real estate.

     A non-residential real property lease must be assumed or rejected within sixty days of filing the petition ("assumption period").  The bankruptcy court usually will extend the assumption period for good cause, over the objection of the lessor.  However, any extension must be obtained prior to the end of the initial sixty days, or any extended, assumption period.  

INSIDER PAYMENTS

     Senior managers, shareholders, or any of their family members, ("insiders") cannot be compensated as employees without filing and serving a "request for insider compensation" and individually obtaining bankruptcy court approval.  Insider wages may be accrued, but not paid, during the approximately twenty-one day "notice and objection" period.  The insider must disclose its name, social security number, relationship to the debtor, duties and responsibilities, prior compensation, future compensation and where the company will obtain the funds to pay their wages (typically operating funds).  Creditors may object to these wage payments.  Insiders owed payments for other reasons (loans, leases, or acting as a trade supplier) should also be disclosed. Any payment to an insider will be the subject of careful scrutiny (and resentment) by other interested parties.  

INSURANCE AND UTILITIES

     Utilities (electricity, gas, water, telephone, internet, paging, etc.) providers will typically demand a deposit to provide administrative period utility services.  Often the deposit required is equal to twice the highest previous monthly bill.  Although it is impractical, the debtor may seek court approval for a lower utility deposit.

     The debtor must convert, or obtain, insurance coverage in the name of the debtor-in-possession.  This may include: all risk property and casualty, automobile, director and officer liability, errors and omissions, and products liability, etc.  All of the debtor's assets, employees and potential liabilities must be insured in a customary manner.  

CHAPTER 4  

REPORTING AND DISCLOSURE REQUIREMENTS  

THE OFFICE OF THE UNITED STATES TRUSTEE

     Initially, OUST must decide whether the debtor has any prospects for reorganization, in order for the chapter 11 to continue.  OUST will require information about all of the property and activities of the Debtor, including: (i) each parcel of real estate owned, (ii) machinery and equipment, (iii) inventory, (iv) insider transactions, employment and compensation, (v) insurance coverage, (vi) certificates and licenses, (vii) bank statements, (viii) recent financial statements and projections, (ix) recent state and federal payroll, income and sales tax returns, and (x) lists of creditors and employees.     

INTERIM STATEMENTS

          Monthly operating reports ("interim statements"), prepared on a cash basis, must be submitted monthly to the bankruptcy court and OUST.  The debtor's interim statements must include: (i) a description of the bank accounts, (ii) receipts and disbursements, (iii) profit and loss, (iv) accounts receivable and payable, (v) insurance coverage, (vi) executory contract payments, (vii) secured creditor payments, and (viii) perceived progress towards reorganization.  

THE INITIAL DEBTOR INTERVIEW

THE 341(A) HEARING

     OUST will schedule an initial public meeting of creditors called the "341(a) hearing".  All of the creditors will receive notice of the 341(a) hearing.  The debtor's senior management, chief financial officer, counsel and consultant/advisor must attend and answer questions under penalty of perjury from any attendee.  Typical questions include: (i) the location, description and value of all assets, (ii) the extent and type of debts, (iii) what lead to the financial difficulties and the filing, (iv) what improvements have already been done or will be initiated, (v) creditor, customer and employee responses to the filing, (vi) any intended management, personnel and responsibility changes, (vii) prospects for recovery of assets removed from the company in an inappropriate manner, and (viii) prospects and timing for filing a "plan of reorganization" or "plan".  

2004 EXAMINATIONS

     Any interested party can depose the debtor's: (i) employees, (ii) shareholders, (iii) insiders, (iv) affiliates, (v) lenders, and (vi) entities holding the debtor's property.  During these periodically allowed depositions called "2004 examinations", interested parties may ask questions about any matter relevant to the case or to the progress toward a plan of reorganization.  

OTHER INFORMATIONAL DISCLOSURES

     Interested parties may request additional information from the debtor.  It is advisable for the debtor's management to cooperatively present any non-privileged information that is requested.  Trade secrets, customer lists and other "competitive" information should be withheld, or provided only to the OUST, or, as a last resort, to bankruptcy counsel for the unsecured creditors committee.  The debtor cannot rely on the unsecured creditors committee's confidentiality, and often not even the confidentiality of creditor's committee bankruptcy counsel, because they are responsible to report to their client.  This will require delicate negotiations.  

CHAPTER 5  

DEBTOR-IN-POSSESSION FIDUCIARY DUTIES

     The debtor has the same responsibilities and powers as a chapter 11 trustee.  Therefore, the debtor, by its management, has a fiduciary duty to the creditors, employees, shareholders, company and court.    This fiduciary duty extends to all of the debtor's controlling management, shareholders, officers and directors.  Although a difficult concept to implement practically, the debtor has a legal responsibility to act in the best interests of its creditors, and not in its own best interest.

     The debtor is obligated to: (i) maximize the value of the estate for the benefit of all creditors, (ii) protect and conserve its property, (iii) appropriately pay expenses of operations and the costs of maintenance, (iv) be cooperative and honest in its disclosure of the company's condition, (v) properly maintain books and records of all transactions, (vi) investigate prior acts, conduct and the financial condition of the debtor, (vii) investigate the desirability of continuing operations, (viii) refrain from performing acts which could damage the estate or hinder a successful reorganization, (ix) institute suits to recover "avoidable preferences" (where one creditor has received an advantage over other similar creditors, generally within 90 days of the bankruptcy filing unless it is an "insider preference" which period extends for one year prior to the bankruptcy filing.), (x) disclose potential adversary proceedings or claims against creditors before asking them to vote on a plan of reorganization, (xi) negotiate in good faith and cooperate with creditors who may vote to accept or reject a plan of reorganization, and (xii) propose a plan of reorganization that satisfies all bankruptcy requirements.

     In many respects, the post-petition debtor becomes a new company and is obligated to pursue any claims created by the pre-petition company and its management.  This may create the odd circumstance that the debtor's administrative period management must sue pre-petition management or shareholders.  Separate counsel must be utilized to represent the debtor when suing pre-petition management or shareholders. 

     The debtor's bankruptcy counsel represents only the company, acting by its management, but not the individual managers or shareholders.  Often the primary shareholder is also the debtor's chairperson and chief executive officer.  It is advisable for the primary shareholder and senior management to engage their own bankruptcy counsel to defend their personal interests.  

CHAPTER 6  

BANKRUPTCY RULES AND CRIMES

     During the administrative period the debtor's management may not allow any funds to be used for: (i) payment of pre-petition debts, (ii) loans to insiders or affiliates, (iii) payment of debts guaranteed by insiders if other creditors are not receiving pro-rata amounts, (iv) gaming or highly risky endeavors, and (v) unreported or deceptively reported purposes.  Additionally the debtor may not: (i) write a check unless there are sufficient funds in the account at the time, (ii) bounce checks, (iii) fail to pay any administrative period debts as agreed, (iv) operate at a loss, and (v) fail to pay: (a) employees salaries, (b) withholding taxes "trust funds", and (c) sales taxes, etc., in a timely manner. 

     The consequence for violating these procedures is generally dismissal of the bankruptcy, or conversion to a chapter 7 liquidation.  However, OUST, and the bankruptcy court, have increasingly been referring individuals performing deliberate and significant bankruptcy code violations for "bankruptcy crime" investigations.  Conduct that may have been a minor problem Pre-petition can become a bankruptcy crime during the administrative period.  

CHAPTER 7  

ATTORNEY-CLIENT RELATIONSHIP

     The attorney-client relationship confidentiality privilege ("confidentiality") protects individuals and the management of businesses.  In solvent companies, management has the power to waive confidentiality, typically with the approval of its board of directors.  However, any new management can waive confidentiality regarding former officers or directors.  It is unsettled whether becoming a debtor automatically creates new corporate management.

     The United States Supreme Court held that a chapter 11 trustee of a corporation may waive the corporation's confidentiality regarding pre-petition and administrative period communications.  Some courts have held that a chapter 11 trustee may similarly waive confidentiality for a partnership.  The United States Court of Appeals, Ninth Circuit, for the States of California, Nevada, Arizona, Utah, Washington, Oregon and Hawaii has held that a bankruptcy examiner may waive confidentiality of a debtor corporation, over the objections of its then current management and directors.   

     If the debtor's bankruptcy counsel discovers management committing violations of bankruptcy rules, they may resign, but may not reveal these violations.  Upon debtor's bankruptcy counsel's resignation, the interested parties suspect a bankruptcy code violation.  They may request a trustee to assume responsibility for operations and a referral to the Department of Justice for a bankruptcy crime investigation.  

CHAPTER 8

APPOINTMENT OF A TRUSTEE IN BANKRUPTCY

     The administrative period management and board of directors of the debtor will be replaced by a chapter 11 (or 7) trustee for: (i) lying, (ii) stealing, (iii) favoring certain creditors or insiders, (iv) failing to actually reorganize operations and personnel, (v) failing to file timely interim statements or other reports, (vi) increasing debt or bouncing checks, or (vii) violating bankruptcy code rules or committing bankruptcy crimes.

     Any interested party may request appointment of a chapter 11 (or 7) trustee.  The OUST selects the trustee subject to the approval of the court.  Although interested parties have the right to vote to select a particular trustee, OUST generally selects an individual who is serving in this capacity on a continuing basis and has been pre-approved ("panel trustee").

     Once a trustee has been appointed, the debtor's management and director's role is limited to turning over company property and providing full information.  The trustee has all powers to: (i) operate the business, (ii) employ personnel, (iii) represent the debtor, and (iv) sell the business.  The trustee often employs its own personnel to supervise the debtor's operations, prepare financial statements, and secure all of the debtor's assets.  The trustee assumes the obligation of filing all necessary interim statements and reports, tax returns and certificates.  However, the trustee has unusual immunity from employee and municipal "police power" claims that arise from its operational activities (similar to many state court appointed "receivers").

CHAPTER 9

PLAN OF REORGANIZATION

     The plan of reorganization is the successful conclusion of the chapter 11 business reorganization.  The plan must specify how the debtor intends to pay the creditors.  It will typically specify: (i) which assets will be kept or sold, (ii) whether there will be new investors or a merger, and (iii) which contracts, liens and debts will be satisfied, canceled or modified.

     The debtor is given the sole power to file the plan during the approximately 120-180 day post-petition "exclusivity period." Once the exclusivity period has expired other interested parties may also file a "competing" plan.

     The plan will describe the payments to be made to each class.  Creditors in the same class must be treated equally, unless they individually agree to be treated differently. 

     Accompanying the plan is a separate description of the economic terms in the plan, referred to as the "disclosure statement."  It is similar to an investment prospectus utilized by solvent companies, and contains simple explanations, many caveats and warnings.  There is a securities law exemption for companies "going public" by virtue of a chapter 11 plan.  Therefore, utilizing a standard form disclosure statement can become a relatively inexpensive form of investment prospectus.

     The disclosure statement must contain adequate information for the creditors to appropriately vote on the plan.  The plan and disclosure statement must be approved by the court.  The plan must be approved by the creditors.   

     The plan and disclosure statement are filed and served on the creditors before the noticed court hearing to approve ("confirm") the plan.  A class of creditors "accepts" the plan, if two-thirds in amount, and more than one-half in number, vote to accept the payments they will receive under the plan.  If these voting requirements are not met the class has "rejected" the plan.  However, creditors whose interests are not altered by the plan ("unimpaired") are deemed to have accepted the plan without separately voting.

     The plan takes effect on a specified date ("effective date") after it has been approved by a sufficient amount of classes, and the court ("confirmed").  The "post confirmation" "reorganized" debtor must make the payments required under the plan.  Payments to different classes may be made over various time periods under the plan.  Interest rates, payment periods and principal amounts of secured loans may be altered by the plan ("cram down").

     There are many technical requirements for plan approval, including:

     When the plan becomes effective, the debtor usually receives a “discharge” from the prior debts except for payments required by the plan.  

CHAPTER 10

TAX IMPLICATIONS

Chapter 11 cases usually raise tax issues.  Bankruptcy inherently involves modification or cancellation of debt and transferring of assets.  These actions frequently cause tax  consequences for the debtor.  

CANCELLATION OF INDEBTEDNESS

     Major tax planning issues in bankruptcy are: (i) to minimize recognition of income from cancellation of indebtedness, and (ii) to maximize the use of tax attributes, such as net operating losses ("NOLs") and basis, after the bankruptcy.  Cancellation or modification of indebtedness usually produces income equal to the amount of the debt cancelled or forgiven (“COD income”).  The timing of the debt discharge and COD income is usually the effective date of the plan.  COD income may also be realized even if the debt is not actually cancelled.  The following events may cause COD income:

     (a)  If a debtor replaces an existing debt with new debt;

     (b)  If the terms of an existing debt are materially modified in kind or extent (perhaps by a cram down);

     (c)  If a person related to the debtor acquires the debt at a discount from a person unrelated to the debtor; or

     (d)  If a debtor that is a corporation issues stock in exchange for the debt (perhaps by a “creditors plan”).

     COD income of taxpayers is excluded from income under Internal Revenue Code ("IRC") §108 (“bankruptcy exception”).  Bankrupt taxpayers are those entities or individuals under the jurisdiction of the court where the discharge of indebtedness is either granted by the Court or pursuant to a plan approved by the court.  A taxpayer who excludes COD income from currently taxable gross income due to the bankruptcy exception is required to reduce tax attributes by the amount of the excluded income.  This reduction is done in the following order of priority:
net operating losses and net operating loss carryovers;
general business credits under section 38;
alternative minimum tax credits;
net capital losses and capital loss carryovers;
the basis of depreciable property (to the extent the basis exceeds remaining liabilities);
passive activity losses and credit carryovers; and
foreign tax credits and carryovers.

     A taxpayer may instead elect to first reduce the basis of depreciable property.  This reduction in basis is limited to the taxpayer's adjusted basis of depreciable property held at the beginning of the taxable year following the taxable year in which the debt is cancelled (effective date of the plan).    

Asset Transfers

     Often assets are sold or transferred as part of the plan.  These transfers may cause the debtor to recognize gain or loss on the disposition under IRC §1001 unless some other IRC provision (bankruptcy exception) excuses the recognition of the gain or loss.  The gain is measured by the difference between the amount paid by the purchaser and the basis the debtor has for tax purposes in the property. 

     Sometimes the property may be transferred back to a secured creditor by allowing the secured creditor to retake possession of the property in partial satisfaction of that creditor's debt.  The transfer is treated as a sale of the property even though the debtor does not receive any cash.  The purchase price for tax purposes will depend upon whether the debt securing the property is recourse or nonrecourse. 

     If the debt is nonrecourse, the purchase price will be the total debt securing the property at the time of the transfer.   Thus, if property subject to a nonrecourse debt is transferred to the secured creditor, the debtor will recognize gain or loss equal to the difference between the amount of the debt discharged and the debtor's adjusted tax basis in the property immediately before the transfer.  However, no portion of the debtor's gain is treated as COD income and the property's fair market value is irrelevant to the transaction. 

     If the debt is recourse the transaction is split into two parts consisting of: (i) a taxable disposition of the property, and (ii) to the extent the value of the property is less than the recourse liability, either a continuing debt obligation to the creditor or a discharge of the remainder of the liability.  Under this approach, the taxpayer recognizes gain or loss equal to the difference between the fair market value of the property and the taxpayer's adjusted tax basis therein immediately prior to the transfer.  If the remainder of the debt is forgiven, the amount forgiven will constitute COD income that, unless excepted under the bankruptcy exception, will be included in the taxpayer's ordinary taxable gross income.  

     There are numerous other tax considerations that may arise in a chapter 11.  These issues are too numerous and specific for this article.  However, as a general rule, anytime a corporation has a NOL carry forward, any transfer of the corporation's stock may endanger whether the NOL may still be used.  A sale of the assets, only, will not allow the purchaser to use any portion of the seller’s NOL.  These same rules are applicable to debtor corporations sale of stock or assets. 

     Any transfer of assets into or out of the debtor must be scrutinized under the general partnership and corporate tax laws to determine the tax effect of the transfer.  Any payments to insiders, owners, or employees must also be scrutinized to determine the tax consequence to the debtor.

CHAPTER 11

AUTHORS' BACKGROUND