Structuring a Section 363 Sale as a “G” Reorganization

© 2021, Stuart J. Goldring. All rights reserved. Published by and reprinted with permission from Wolters Kluwer.¹

Sales of businesses of a distressed corporation are often structured to occur as a sale under section 363 of the Bankruptcy Code (generally referred to as a “Section 363 sale”), rather than occurring outside bankruptcy and rather than pursuant to a confirmed bankruptcy plan. This is due in significant part to the general ability of a debtor to sell assets pursuant to a bankruptcy court approved Section 363 sale “free and clear of any interest in such property….” over the objection of any creditor or shareholder and much faster than confirming a bankruptcy plan (which generally involves the resolution or handling of all claims against the company).² Upon notice and a hearing, the bankruptcy court generally will approve a Section 363 sale so long as there is a valid business reason for the sale and the debtor satisfies the business judgment test from a fiduciary duty perspective.³ Where the desired sale entails a sale of all or substantially all of the debtor’s business, care must also be taken to ensure that the terms of sale do not constitute a sub rosa or de facto bankruptcy plan. This generally means that the transaction should avoid dictating the terms of a subsequent plan (particularly the distribution waterfall) or constraining parties in interest in exercise of their rights with respect to confirmation of a plan.⁴

Most Section 363 sales are taxable transactions. However, in appropriate circumstances, a Section 363 sale can be structured to qualify as a tax reorganization under IRC Section 368(a)(1)(G),⁵ a so-called “G” reorganization (or other asset-based tax reorganization, such as a “C” or “D” reorganization). In such instance, an acquiring corporation would essentially step into the shoes of the debtor corporation, succeeding to the debtor’s tax attributes (subject to reduction due to any ultimate excluded cancellation of debt income in the debtor’s bankruptcy case,⁶ and any resulting applicable limitations on the use of the acquired tax attributes, such as under IRC Section 382 in the event of a proscribed 50% change in ownership). The Section 363 sale by General Motors Corporation in its 2009 bankruptcy case is one such example.⁷

To qualify as an acquisitive “G” reorganization requires that, pursuant to a plan of reorganization approved by the court in a title 11 or similar case,⁸ the transferor corporation – in the case of a Section 363 sale, the debtor corporation – (i) transfer substantially all of its assets to an acquiring corporation for consideration that includes, in whole or in part, stock in such corporation (or a direct parent corporation) and (ii) then liquidate – i.e., distribute the stock and other consideration received, as well as its other properties, to its creditors and/or shareholders – with at least one security holder or shareholder receiving stock or securities of the acquiring corporation.⁹ The need to receive and distribute a sufficient amount of stock (in value) is often the result of having to satisfy the continuity-of-interest test. In addition, the business purpose and continuity-of-business-enterprise tests for tax reorganization treatment must be satisfied.

Where, though, in the case of a Section 363 sale of a debtor corporation’s assets, is the necessary “plan of reorganization” or the required liquidation pursuant to such plan? It is clear that the court approved Section 363 sale cannot itself constitute a plan of reorganization in the bankruptcy sense (although it sometimes can be combined with one). However, IRC Section 368(a)(3)(B) does not speak of a formal bankruptcy plan but simply “a plan of reorganization approved by the court.¹⁰” Thus, all that is needed is a plan of reorganization in the tax sense that is approved by the bankruptcy court. As such, the sales agreement can constitute the necessary plan of reorganization for tax purposes, as the court in the General Motors bankruptcy case so recognized.¹¹

Since a sale of assets is normally considered the antithesis of a reorganization, the sales agreement should make clear that it is the intent of the parties that the agreement constitute a plan of reorganization of the debtor for tax purposes. It is also important that the distribution of the sales consideration and the debtor’s other assets to the debtor’s creditors and/or shareholders be pursuant to the tax plan. Thus, in the sales agreement the debtor should commit to liquidate (as determined for tax purposes) within a specified time. However, it might not be possible to dictate the specifics of such a distribution, such as how the stock consideration should be distributed among the creditors, without the risk of being considered a de facto bankruptcy plan. As a result, a potential impediment to a good “G” reorganization in certain cases may be the inability to be sure that the continuity-of-interest test will be satisfied. In fact, just having stock being part of the sales consideration may be a practical threshold issue, since in a Section 363 sale the debtor and its creditors are generally seeking to maximize distributable cash.

One potential work-around for the need to issue stock consideration is the use of a “credit bid.” In the bankruptcy context, a credit bid is where a secured creditor in connection with a Section 363 sale uses (or “bids”) all or a portion of its secured debt as full or partial consideration for the debtor’s assets. IRS Letter Ruling 201025018 illustrates how a credit bid can be structured to qualify as a “G” reorganization.¹² In basic terms, the ruling involved a credit bid of certain secured debt and other consideration (including some stock, although not essential to the tax outcome) for substantially all of the debtor’s assets where the secured debt and other consideration would be contributed by the lenders for stock in a new corporation (Newco) formed by one of the lenders for the sole purpose of effectuating the acquisition (termed the Newco Reorganization). Pursuant to the acquisition agreement approved by the bankruptcy court (referred to in the ruling as the Reorganization Agreement), the debtor would be obligated to liquidate (possibly through use of a liquidating trust) no later than a specified date. In the ruling, the IRS concluded that the described transaction would be recast for tax purposes and qualify as a good “G” reorganization. More specifically, the IRS treated the debtor as transferring substantially all of its assets to Newco for the stock received by the lenders upon formation of Newco (instead of the credit bid debt) and the other sale consideration, and then distributing such stock in satisfaction of the credit bid debt and, except to the extent any of the other consideration is sold by the debtor during its liquidation, distributing the remaining consideration and the debtor’s remaining assets in satisfaction of other creditor claims. The debtor represented to the IRS that the stock received by lenders was sufficient in amount to satisfy the continuity-of-interest requirement, and although not stated in the ruling, presumably at least some portion of the credit bid debt constituted a “security” for reorganization purposes.¹³

In support of the recast, the ruling cites without discussion Helvering v. Alabama Asphaltic Limestone Co.¹⁴ The Supreme Court’s decision in Alabama Asphaltic is well known for establishing the principle that the creditors of a corporation in bankruptcy that receive stock can be treated as equity owners for purposes of satisfying the continuity-of-interest test.¹⁵ In addition, as relevant to the present discussion, the structure of the reorganization transaction at issue involved a credit bid:

The bankruptcy trustee offered the assets for sale at public auction. They were bid in by the creditors’ committee for $150,000. The price was paid by $15,000 in cash, by agreements of creditors to accept stock of a new corporation [respondent] in full discharge of their claims, and by an offer of the committee to meet the various costs of administration, etc. Thereafter respondent was formed and acquired all the assets of the bankrupt corporation. It does not appear whether the acquisition was directly from the old corporation on assignment of the bid or from the committee. Pursuant to the plan respondent issued its stock to the creditors of the old corporation—over 95% to the noteholders and the balance to small creditors.

Rejecting the contention that the form of the transaction precluded reorganization treatment, the Court held that the separate steps were integrated parts of a single scheme “utilized to enable the new corporation to acquire all the assets of the old one pursuant to a single reorganization plan.”

Accordingly, the acquisition of a debtor corporation pursuant to a confirmed bankruptcy plan is not the only way to acquire a debtor corporation’s tax attributes. A Section 363 sale also offers the opportunity in the context of a sale of substantially all of a debtor corporation’s assets for the debtor corporation to “sell” its tax attributes for the benefit of its stakeholders and for a purchaser (whether a third party or a creditor) to obtain the benefit of such tax attributes. This is not always easily done, but in appropriate circumstances can be achieved.