PLR 1032009: Bankruptcy merger treated as a section 368(a)(1)(G) reorganization

Plain-English summary

A corporate holding company and its subsidiaries entered bankruptcy under title 11 with substantial secured and unsecured debt. Under an approved bankruptcy plan, the holding company would merge into a subsidiary, which would survive and issue new equity, warrants, loans, and limited cash to qualifying creditor classes, while the old common stock would be cancelled. The IRS ruled that the merger qualified as a section 368(a)(1)(G) reorganization and that the transfer of assets, assumption of liabilities, distribution of merger consideration, and specified tax-attribute succession would receive the stated treatment. Qualifying creditor claims treated as securities could receive nonrecognition, basis, and holding-period treatment, with gain possible for money or other property and ordinary income for accrued interest. The ruling also limited the treatment of cancellation-of-indebtedness income and did not address tax consequences outside the listed rulings.

Ruling snapshot

• Question: Will a title 11 downstream merger and creditor exchange qualify for the requested reorganization treatment?
• Outcome: Approved
• Key authorities: IRC §§ 108, 354, 356, 357, 361, 368, 381; Treas. Reg. §§ 1.1001-3, 1.368-1, 1.368-2, 1.381-1, 1.1502-28.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201032009 Third Party Communication: None
Release Date: 8/13/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 368.14-00 -----------------------, ID No. -------------
Telephone Number:
---------------------
------------------------------------------------- Refer Reply To:
-------------------------------------------- CC:CORP:B05
------------------------------------------------------ PLR-109110-10
----------------------------- Date:
May 12, 2010

LEGEND:

Taxpayer = ---------------------------------------------------

Business = ----------------------------------------------------------------

Sub1 = ------------------------------------------------

Sub2 = ------------------------------------------

StateA = ----------

StateB = -------------

Date1 = --------------------------

Date2 = -------------------

Date3 = ---------------------

a = -----------------

b = ----

c = ----
PLR-109110-10 2

d = --

e = -------------

f = ------

g = ------

i = -------------

j = ----------------

m = --------

n = -----------

o = ----

p = ------

Agency = -------

Exchange = ------------------------------------

Junior Debt = ---------------------------------------------------------------------------------
Obligations

JurisdictionA = ---------------------------------------

New Term Loans = ---------------------------------------------------------------------------------

Owner = ---------------------------------------------------------------------------------

Petition Date = --------------------------

Senior Secured = -------------------------------------------------------------
Obligations ---------------------------------------------------------------------------------

Term Loan = --------------------------------------------------------------------------------

PLR-109110-10 3

Dear --------------:

This letter responds to your February 26, 2010 request for rulings on certain federal
income tax consequences of the series of proposed transactions described below (the
“Proposed Transaction”). Additional information was submitted by letter dated May 11,
2010. The information provided in that request and in the subsequent correspondence
is summarized below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. This office has not verified any of the material submitted in
support of the request for rulings. Verification of the information, representations, and
other data may be required as part of the audit process.

                               Summary of Facts

Taxpayer is the common parent of an affiliated group of domestic corporations filing a
consolidated federal income tax return on the basis of a calendar year and whose
members each use an accrual method of accounting (the “Taxpayer Group”). Taxpayer
Group owns and operates Business. Taxpayer is a holding company and directly owns
all of the issued and outstanding stock of two domestic corporations, Sub1 and Sub2,
both of which are members of Taxpayer Group. In addition, Sub1 and Sub2 own
directly and indirectly interests in a variety of entities, including corporations (both
members and non-members of Taxpayer Group), limited liability companies, and joint
ventures.

As of Date1, Taxpayer had a shares of a single class of common stock outstanding,
which prior to Date2 were publicly traded on the Exchange. Taxpayer’s outstanding
shares are owned approximately b percent by unrelated third parties, approximately c
percent by Owner, and approximately d percent by Taxpayer’s directors and officers.
Taxpayer has no shares of preferred or preference stock outstanding.

On Petition Date, Taxpayer and its subsidiaries filed voluntary petitions in the United
States Bankruptcy Court for JurisdictionA (the “Bankruptcy Court”) seeking relief under
Title 11 of the United States Bankruptcy Code. On Petition Date, Taxpayer had
approximately $e in third party debt and other liabilities. Taxpayer’s third party debt is a
mixture of senior secured and unsecured subordinated instruments, including Senior
Secured Obligations and Junior Debt Obligations. Taxpayer and its subsidiaries jointly
and severally, unconditionally and irrevocably, guaranteed complete payment and
performance with respect to Term Loan. Substantially all of the assets of Taxpayer
Group are pledged as security for Term Loan. Taxpayer modified Term Loan on Date3,
PLR-109110-10 4

treating such modification as a deemed exchange for federal income tax purposes
pursuant to Treas. Reg. § 1.1001-3.

In addition to Senior Secured Obligations and Junior Debt Obligations, various
intercompany obligations exist between or among Taxpayer, Sub1, and Sub2 (the
“Intercompany Notes”). For all of the Intercompany Notes, the applicable creditor’s
basis is equal to the adjusted issue price of each obligation.

                                Summary of Plan

Pursuant an Agreement and Plan of Merger within the Approved Bankruptcy Plan,
Taxpayer will merge downstream with and into Sub1, with Sub1 surviving the merger.
Immediately after the effective date of such merger, Sub1 will own all the stock of Sub2,
and Taxpayer’s historic creditors will control Sub1. In connection with the merger, Sub1
will issue a combination of shares of Class A Common Stock, limited-vote Class B
Common Stock (together with the Class A Common Stock, the “New Common Stock”),
and/or Warrants to purchase shares of Class B Common Stock (together with the New
Common Stock, the “New Equity”).

Pursuant to the Approved Bankruptcy Plan, claims arising under the Senior Secured
Obligations are classified as Senior Claims. The Senior Claims will be exchanged on a
pro-rata basis for (i) the New Term Loans and (ii) a combination of New Common Stock
and Warrants together representing f percent of the New Equity. Claims arising under
the Junior Debt Obligations, and any other unsecured claims that are not an
administrative, priority tax, or other priority claim will be classified as General Unsecured
Claims. The General Unsecured Claims will be exchanged on a pro-rata basis for (i) a
combination of New Common Stock and Warrants together representing g percent of
the New Equity, and (ii) $i in cash. The New Equity will be allocated to Senior Claim
holders and General Unsecured Claim holders, respectively according to the “Equity
Allocation Mechanism” described in Taxpayer’s submission.

             Transactions Preceding the Proposed Transaction

Pursuant to the Approved Bankruptcy Plan, prior to the Proposed Transaction,

(A) Taxpayer and Sub1 will offset Sub1’s Intercompany Note to Taxpayer to the
extent of Taxpayer’s Intercompany Note to Sub1.

(B) Sub1 will contribute Agency licenses currently held by Sub1 to a newly formed
single member LLC wholly owned by Sub1.

(C) Taxpayer will contribute at least $j of Sub2’s Intercompany Note to Taxpayer to
the capital of Sub2.
PLR-109110-10 5

(D) Taxpayer will contribute the entire amount of Sub1’s Intercompany Note to
Taxpayer (as reduced by the offset in Step A) to the capital of Sub1.

(E) Sub1 will change the state of its incorporation from StateA to StateB (the “Sub1
Reincorporation”).
Proposed Transaction

Pursuant to the Approved Bankruptcy Plan,

Taxpayer will merge downstream with and into Sub1 and Sub1 will survive the merger
(the “Merger”). In the Merger, all of Taxpayer’s assets will be transferred to Sub1, and
Sub1 will assume any liabilities of Taxpayer that are not extinguished by order of the
Bankruptcy Court (the “Assumed Liabilities”).

As consideration in the Merger (the “Merger Consideration”):

(1) The Senior Claim holders will receive on a pro-rata basis, in respect of such
claims, (i) the New Term Loans and (ii) a combination of New Common Stock and
Warrants together representing f percent of the New Equity.

(2) The General Unsecured Claim holders will receive on a pro-rata basis, in respect
of such claims, (i) a combination of New Common Stock and Warrants together
representing g percent of the New Equity, and (ii) $i in cash.

(3) The holders of common shares of Taxpayer will receive no consideration in
respect of their shares, and such shares will be cancelled.

              Post-Transaction Corporate and Capital Structure

Following the Proposed Transaction, Sub1 will be the sole owner of Sub2. Sub1 and
Sub2 each will continue their respective historic operations. The structures of the Sub1
subgroup and the Sub2 subgroup will remain unchanged with the exception of the
creation of the new LLC intended to hold Agency licenses for Sub1.

Following the Proposed Transaction, Sub1 will have outstanding Class A Common
Stock, limited-vote Class B Common Stock, and Warrants to purchase Class B
Common Stock. The Class A Common Stock will be voting common stock. The Class
B Common Stock will possess the same economic rights as the Class A Common
Stock, but will be limited as to voting rights. Each share of Class B Common Stock will
be convertible into shares of Class A Common Stock upon the satisfaction of certain
Agency restrictions. The Warrants to purchase Class B Common Stock will have an
exercise price of $m per share and a term of n. The Warrants will not have voting
rights, but will be freely transferable and will have equivalent distribution, tender, and
consideration rights to the Class A and Class B Common Stock.
PLR-109110-10 6

                           Equity Incentive Program

Not less than o percent and no greater than p percent (on a fully diluted basis) of the
issued and outstanding New Common Stock and New Common Stock issuable upon
exercise of the Warrants will be reserved for issuance as options in connection with
Sub1’s equity incentive program.

                                 Agency Trust

In order to expedite the emergence of Sub1 from bankruptcy in the event Agency
approval has not been granted, the Approved Bankruptcy Plan contemplates that Sub1
may emerge from bankruptcy upon the transfer of control from the debtors to a trust
subject to continuing jurisdiction and oversight of the Bankruptcy Court pending Agency
approval (the “Agency Trust”).

                                Representations

In connection with this ruling request, Taxpayer makes the following representations:

  a. Taxpayer will be under the jurisdiction of the Bankruptcy Court in a case
     under Title 11 of the Bankruptcy Code at the time of the Proposed
     Transaction.

  b. The Agreement and Plan of Merger that will be approved by the Bankruptcy
     Court as part of the Approved Bankruptcy Plan will constitute a plan of
     reorganization for purposes of section 368.

  c. In the Proposed Transaction, Sub1 will acquire more than 50 percent of the
     fair market value of the gross assets held by Taxpayer (including the stock of
     and intercompany interests in affiliates) as of the Petition Date and more than
     70 percent of the fair market value of the operating assets held by Taxpayer
     (including the stock of and interests in affiliates) as of the Petition Date. For
     purposes of this representation, operating assets include stock in Sub2, stock
     in Sub1, the Sub2 Intercompany Note to Parent, and the Sub1 Intercompany
     Note to Parent and exclude cash, other accounts receivable, or investment
     assets, provided that Taxpayer will have previously transferred the Sub2
     Intercompany Note to Parent and the Sub1 Intercompany Note to Parent as
     discussed herein.

  d. The Senior Claim holders, in their capacity as creditors, will be the most
     senior class of Taxpayer creditors to receive an equity interest in Sub1 in the
     Proposed Transaction, in the form of New Common Stock or Warrants.

  e. Taking into account (i) the value of the New Equity and New Term Loans to
     be received by the Senior Claim holders in respect of their Senior Claims, and
     (ii) the value of all consideration to be received by creditors of Taxpayer with

PLR-109110-10 7

      claims that are equal and junior to that of the Senior Claim holders (the
      portion of the Senior Claims to which the New Common Stock and Warrants
      are allocable, together with claims junior to such Senior Claims, the
      “proprietary interests” of Taxpayer), at least 40 percent of the fair market
      value of the total consideration received by all such holders in respect of such
      proprietary interests of Taxpayer will consist of New Common Stock and
      Warrants.

 f. There is no plan or intention for Sub1, or for any party related to Sub1 (within
    the meaning of Treas. Reg. § 1.368-1(e)(4)), to redeem or acquire any New
    Common Stock or Warrants issued in the Proposed Transaction, either
    directly or through any transaction, agreement, or other arrangement with any
    other person.

 g. The fair market value of the New Common Stock and Warrants and any other
    consideration to be received in the Proposed Transaction by the Senior Claim
    holders and the General Unsecured Claim holders will be approximately
    equal to the fair market value (at the time of the exchange) of such creditors’
    claims constructively surrendered in exchange therefor.

 h. The fair market value of the assets to be acquired by Sub1 in the Proposed
    Transaction will be approximately equal to the value of the consideration
    issued by Sub1 in exchange therefor.

 i.   Sub1 has no plan or intention to sell or otherwise dispose of any of the assets
      of Taxpayer acquired in the transaction, except for dispositions made in the
      ordinary course of business or in transfers described in section 368(a)(2)(C)
      or Treas. Reg. § 1.368-2(k).

 j.   Sub1 (or members of Sub1’s “qualified group,” within the meaning of Treas.
      Reg. § 1.368-1(d)) will continue the historic business of Taxpayer or use a
      significant portion of Taxpayer’s historic business assets in a business.

 k. Sub1 has no plan or intention to liquidate or merge with or into another
    corporation subsequent to the Proposed Transaction.

 l.   The liabilities of Taxpayer to be assumed by Sub1 (within the meaning of
      section 357(d)) were incurred by Taxpayer in the ordinary course of its
      business.

 m. Except for the Sub1 Intercompany Note to Parent, there is no inter-corporate
    indebtedness existing between Sub1 and Taxpayer that was acquired at a
    discount or was discounted. Except for the Transactions Preceding the
    Proposed Transaction, no intercompany indebtedness existing between
    Taxpayer and Sub1 will be settled (at a discount or otherwise).

PLR-109110-10 8

  n. No two parties to the transaction are non-diversified “investment companies”
     as defined in section 368(a)(2)(F)(iii) and (iv).

  o. After taking into account the discharge and Transactions Preceding the
     Proposed Transaction, the total fair market value of the assets transferred by
     Taxpayer to Sub1 will exceed the sum of: (a) the amount of liabilities
     assumed (as determined under section 357(d)) by Sub1 in connection with
     the exchange; (b) the amount of liabilities owed to Sub1 by Taxpayer that
     were constructively discharged or extinguished in connection with the
     exchange; and (c) the amount of any money and the fair market value of any
     other property (other than stock permitted to be received under section 361
     without the recognition of gain) received by Taxpayer in consideration for the
     transfer of assets to Sub1. The fair market value of the assets of Sub1 will
     exceed the amount of its liabilities immediately after the Proposed
     Transaction.

  p. Taxpayer and Sub1 will each pay its own expenses, if any, in connection with
     the Proposed Transaction.

  q. In the event the Agency Trust becomes effective, the Agency Trust will qualify
     as a liquidating trust within the meaning of Treas. Reg. § 301.7701-4(d).

  r. Taxpayer will treat the Sub1 Reincorporation as a tax-free reorganization
     under section 368(a)(1)(F) for all U.S. federal income tax purposes.

  s. Pursuant to the Proposed Transaction, Taxpayer will distribute all Merger
     Consideration received from Sub1 in the Merger to the Senior Claim holders
     and General Unsecured Claim holders.

                                    Rulings

Based solely on the information submitted and the representations set forth above, we
rule as follows:

  1. The Proposed Transaction will constitute a reorganization within the meaning
     of section 368(a)(1)(G). Taxpayer and Sub1 will each be “a party to a
     reorganization” within the meaning of section 368(b).

  2. No gain or loss will be recognized by Taxpayer on the transfer of all its assets
     to Sub1 in exchange for the Merger Consideration and the assumption of
     Assumed Liabilities (sections 361(a), 361(b)(1)(A), 361(b)(3), and 357(a)).

  3. No gain or loss will be recognized by Sub1 upon the receipt of all of
     Taxpayer’s assets in exchange for the Merger Consideration (section
     1032(a)).

PLR-109110-10 9

 4. The adjusted basis of Sub1’s assets received from Taxpayer in the Proposed
    Transaction in the hands of Sub1 will be, in each instance, the same as the
    adjusted basis of such assets in the hands of Taxpayer immediately prior to
    the exchange (section 362(b)).

 5. Sub1’s holding period for the assets received from Taxpayer in the Proposed
    Transaction will include, in each instance, the holding period of those assets
    in the hands of Taxpayer immediately prior to the exchange (section 1223(2)).

 6. No gain or loss will be recognized by Taxpayer upon the distribution of the
    Merger Consideration to the Senior Claim holders and General Unsecured
    Claim holders (section 361(c)).

 7. Pursuant to section 381(a) and Treas. Reg. § 1.381(a)-1, Sub1 will succeed
    to and take into account the items described in section 381(c), subject to
    reduction with respect to excluded cancellation of indebtedness income of
    Taxpayer as required by section 108, section 1017, and Treas. Reg. §§
    1.1502-28 and 1.108-7(c). These items will be taken into account by Sub1
    subject to applicable provisions and limitations, including the limitations
    specified in sections 381, 382, 383, 384, 904, 1502, and the regulations
    thereunder (Treas. Reg. § 1.381(b)-1(b)(1); Rev. Rul. 70-27, 1970-1 C.B. 83;
    and Rev. Rul. 80-144, 1980-1 C.B. 80).

 8. With respect to the cancellation of indebtedness income that is treated as
    realized directly by Sub1 as a result of the Proposed Transaction and that is
    excluded from gross income under section 108(a), the liability floor of section
    1017(b)(2) will be determined at Sub1 taking into account the bases of Sub1’s
    assets and the amount of Sub1’s liabilities immediately after all of the steps of
    the Proposed Transaction. Treas. Reg. § 1.1502-28(b)(9).

 9. To the extent that a claim of any Taxpayer claimholder qualifies as a security
    (within the meaning of sections 354 and 356), no gain or loss will be
    recognized by such claimholder upon the receipt of New Common Stock,
    Warrants, or Sub1 securities in exchange for the claimholder’s Taxpayer
    security, except that the claimholder may recognize ordinary income to the
    extent that the consideration is treated as received in satisfaction of accrued
    but unpaid interest (section 354(a)). If a Taxpayer claimholder also receives
    money or other property in exchange for his or her Taxpayer security
    (including Sub1 securities to the extent their principal amount exceeds that of
    the Taxpayer securities surrendered by the claimholder in the exchange), the
    claimholder will recognize gain in an amount not in excess of the fair market
    value of such money or other property (section 356(a)(1), section 356(d)). No
    loss will be recognized by such Taxpayer security holder (section 356(c)).

 10. To the extent that a claim of any Taxpayer claimholder qualifies as a security
     (within the meaning of sections 354 and 356), the adjusted basis of the New

PLR-109110-10 10

      Common Stock, Warrants, and Sub1 securities received by a Taxpayer
      claimholder in exchange therefor will equal the adjusted basis of the Taxpayer
      security in the hands of the claimholder immediately before the distribution,
      less the fair market value of any money or other property distributed to the
      claimholder, plus any gain recognized by the claimholder (section 358(a)(1)).
      The basis of money or other property received by a Taxpayer claimholder will
      be the fair market value of such money or other property (section 358(a)(2)).

   11. To the extent that a claim of any Taxpayer claimholder qualifies as a security
       (within the meaning of sections 354 and 356), the holding period of New
       Common Stock, Warrants, and Sub1 securities received by a claimholder in
       exchange for his or her Taxpayer security will include the period during which
       the claimholder has held the Taxpayer security exchanged therefor, provided
       such Taxpayer security was a capital asset in the hands of the holder (section
       1223(1)).

                                      Caveats

No opinion is expressed about the federal income tax treatment of the Proposed
Transaction under other provisions of the Code or regulations or about the federal
income tax treatment of any conditions existing at the time of, or effects resulting from,
the Proposed Transaction not specifically covered by the above rulings.

                                Procedural Matters

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

                                   Sincerely,

                                   _Douglas C. Bates__________
                                   Douglas C. Bates
                                   Assistant to the Branch Chief, Branch 5
                                   Office of Associate Chief Counsel
                                   (Corporate)

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