In a 27 page opinion released October 23, 2014 in the Conex Holdings case (Bank. D. Del. 11-10501), Judge Sontchi of the Delaware Bankruptcy Court provided his analysis of the ability of a debtor to recover the value of NOLs used by its parent within consolidated tax returns. This ruling has implications for any debtor whose parent company uses its NOLs in a consolidated filing. Judge Sontchi’s opinion is available here (the “Opinion”).
CopperCom (the “Defendant”) included the Debtor’s tax returns in its consolidated tax returns. As the Debtor had a net loss, the Defendant included $7.79 million of net operating losses (or NOLs) in its tax return. This created a net benefit to the Defendant of $2.64 million. Conex Holdings’ chapter 7 trustee (the “Trustee” or “Plaintiff”) sued CopperCom to recover what he claimed was a preferential transfer of the net tax benefit. The Defendant eventually filed a motion to dismiss. In deciding the motion to dismiss, Judge Sontchi issued this Opinion.
This case was very fact intensive and the Opinion’s discussion includes numerous references to the Internal Revenue Code and the tax treatment of single member LLCs. A full discussion of the implications would take numerous pages of detail. Given that the order was 27 pages, one can easily imagine the hundreds of pages that the parties’ briefs and legal argument span. In that vein, I’d encourage anyone with an interest in the intersection of tax and bankruptcy to read the Opinion.
NOLs are lost when a company liquidates and closes shop following a chapter 7 bankruptcy. As the Opinion makes clear on page 23, when you have no future business, it is impossible to have any future income that can be offset. This was one of the factors that appears to be dispositive. If a debtor (or the chapter 7 trustee) could never use the NOL, then it has no value which can be recovered by a debtor in preference litigation.
Additionally, following the requirements of the Internal Revenue Code, as the Defendant did, will generally shield you from preference liability. As demonstrated in pages 25-26 of the Opinion, the policy behind avoidance actions is not implicated when a party has no discretion in how it complies with federal regulation. When the policy underlying the preferential transfer statutes is not implicated, it is unlikely that a party will be required to repay a transfer.
For both of these reasons, Judge Sontchi granted the Defendant’s summary judgment motion, allowing it to retain the tax relief it received by using NOLs created by the Debtor. I wouldn’t feel too bad for the Debtor though. Remember, as a single member LLC, every dollar the Debtor lost was a dollar received from its parent company — in this case, the Defendant.