Updated from 9:45 a.m. EDTCHARLOTTE, N.C. -- The Obama administration appears ready to disregard years of precedent in bankruptcy and taxation law as it remakes the U.S. auto industry. The latest example is the General Motors ( GMGMQ) bankruptcy, where the intent is to have a newly created GM assume the benefit of tax losses at the old GM. The problem, says Jeffrey Coyne, senior lecturing fellow at the Duke University School of Law and a management consultant who specializes in reorganizing troubled companies, is that tax losses can be passed on only to companies whose owners controlled at least 50% of the predecessor company. Since the start of 2005, General Motors has reported losses of about $87 billion. "You can't form new GM, which has never transacted business before, and sell the assets (of existing GM) and then sell the net tax benefit to the new company," Coyne says. "And as far as I can tell, the NOL is not a saleable asset." An NOL, or net operating loss, can be used as a tax loss carry forward, an accounting technique that allows it to be applied to future profits to reduce tax liability. The administration does not share Coyne's view. On a briefing with reporters on May 31, the night before GM filed for bankruptcy protection, a senior administration official declared: "The NOL would be transferred to the new company." The administration's position is laid out in a paragraph buried in the bankruptcy filing. "The outstanding balance of deferred tax assets and NOL carry forwards at NewCo reflect the effects of restructuring and subsequent 363 Sale, including the expected cancellation of debt income," the filing says, adding "This analysis assumes that utilization of NewCo's non-U.S. tax attributes will not be limited in any way by the Company's reorganization or other restructuring events."
GM, which named a new chairman Tuesday, is slated to gain new owners in its bankruptcy, filed under section 363 of the bankruptcy code. A 363 filing enables t a company to get expeditious treatment and to largely bypass creditors, who do not have the same rights to force consensus as they do in a Chapter 11 bankruptcy. A Chapter 11 reorganization "requires the approval of the creditor body," says New York bankruptcy attorney John Jerome. "You wrap everything into a plan and have the creditors vote on it. That way, you won't have people who are bound by the plan making trouble later on," which is happening in the Chrysler bankruptcy.
In a series of airline bankruptcies during the past three decades, Coyne says, 363s were never attempted because carriers anticipated that judges would not approve filings so favorable to the debtor at the expense of the creditors, and because the net operating loss would be lost to the new company. The rules are different in the GM and Chrysler bankruptcies because the government is the major financier and a major shareholder. The owners of the new GM would be the U.S. government, with 60%; the governments of Canada and Ontario with 12%, a retiree health care trust fund administered by the UAW, with 12.5%, and bondholders with 10%. The bondholder's share, filings indicate, will initially be issued to the company. "What's going to happen in the GM bankruptcy is whatever its major shareholder says is going to happen," says Elmer Dean Martin, an attorney in Diamond Bar, Calif., in Los Angeles County, whose practice includes cases involving tax loss carry forwards.
"They are going to treat it as not a change of ownership, and how they get there is going to be very creative, but you can probably assume that something good will happen to the tax loss carry forward (because) the IRS has the administrative ability to characterize it favorably," Martin said, adding that no other party would have any reason to object. The Internal Revenue Service declined to comment. The administration is also overriding precedent in the Chrysler bankruptcy, where the historic rights of secured creditors have been subjugated to unsecured claims. Typically, higher priority, secured claims are paid in full before unsecured, lower priority claims are paid. A group of three Indiana pension and construction funds, which hold $42 million of the $6.9 billion in secured loans to the company, appealed that ruling to the Supreme Court, which on Monday issued a stay in the bankruptcy court's approval of the Chrysler sale to Fiat. It was not clear how quickly the Supreme Court would rule. In the Chrysler case, "the secureds are taking a massive crushing," Coyne said. "It puts a new corollary to bankruptcy law, which is: 'The law is the law unless the government is a creditor.' " The Chrysler reorganization also favors the retiree health care trust fund administered by the UAW, which would own 55% of the company. Fiat would own 20%, which could grow to 35%, while the U.S. and Canadian governments would hold the remainder. During the May 31 briefing, a senior administration official said that secured banks in the GM bankruptcy "will receive a full recovery because they are amply secured, as distinct from the banks in Chrysler which were not fully secured." The argument is that the secured claims in the Chrysler case are not worth their full value without government intervention, Coyne says. In trading shortly before noon, GM shares were up 32 cents to $1.53, while shares in Ford ( F) were down 6 cents to $6.32.