Businesses are under unprecedented stress due to the global COVID-19 pandemic. Many of these businesses need some form of relief on their debt obligations in order to avoid triggering defaults, foreclosures and collection activity during this extraordinary period of economic inactivity. There is no one way to structure a workout. The workout structure can be influenced by the U.S. federal income tax considerations for the parties. For the distressed debtor, often the principal goal is often to avoid cancellation of indebtedness income or loss of valuable tax attributes. That goal may have greater or lesser significance depending on whether the debtor is insolvent or in bankruptcy, the extent of the debtor’s net operating losses, and the value of those net operating losses beyond their availability to offset cancellation of indebtedness income. For the lender, often the principal goal is to avoid creating original issue discount on the restructured debt or otherwise incurring taxable income without receiving cash. Whether cancellation of indebtedness income and original issue discount are generated from the workout generally requires that, first, the debt undergo a “significant modification” and, second, the debt be “publicly traded.”
For a more detailed discussion, read our Legal Update here.