| |||||||||||||||||||||||
| |||||||||||||||||||||||
 In the Daily Deal Robert Willens, president of Robert Willens LLC, examines the Calpine Corp./NRG Energy Inc. deal.NRG Energy, Inc. recently proposed a business combination with Calpine Corp. in which NRG would acquire each of Calpine's outstanding shares in exchange for 0.534 of a share of NRG. Calpine recently emerged from bankruptcy. Its Plan of Reorganization became effective on January 31, 2008. Calpine emerged from bankruptcy with substantial tax "attributes". It is reporting net operating losses (NOLs) and other credits totaling $5.1 billion. At issue is whether a business combination with NRG would impair Calpine's ability to utilize such tax attributes.
As a result of the issuance of its stock to its creditors in satisfaction of their claims, Calpine experienced an ownership change. Where a loss corporation is under the jurisdiction of a court in a "Title 11 or similar case", and its old shareholders and "qualified creditors" own, after the ownership change, at least 50 percent of the voting power and value of the loss corporation's stock, the ownership change can qualify under Sec. 382(l)(5). If it does, the "Sec. 382 limitation" will not apply to the corporation's NOLs.
In general, the Sec. 382 limitation measures the annual amount of taxable income that the pre-change NOLs can offset. Thus, if the ownership change qualifies under Sec. 382(l)(5), the loss corporation's NOLs are more valuable because there is no annual limit imposed on the amount of taxable income (for any taxable year ending after the date of the ownership change) that its pre-change NOLs can offset. However, if an ownership change qualifies under Sec. 382(l)(5), certain penalties are exacted. Thus, the amount of the NOLs is reduced by certain interest paid or accrued during a specified period on debt converted into stock in the course of the bankruptcy case (the period referred to commences on the first day of the third taxable year preceding the taxable year in which the ownership change occurs and ends on the date of the ownership change) and, under Sec. 382(l)(5)(D), if a second ownership change occurs within two years of the ownership change that occurred in bankruptcy, the NOLs are, effectively, lost. For these reasons, a loss corporation, even if it is eligible for the "benefits" of Sec. 382(l)(5), may elect not to have Sec. 382(l)(5) apply. If so, its NOLs will be subject to the Sec. 382 limitation. Such limitation is calculated by multiplying the fair market value of the loss corporation's stock, immediately before the ownership change, by the "long-term tax-exempt rate". In the case of a bankrupt corporation, however, its "equity value", immediately before the ownership change, is likely to be close to zero. Accordingly, if the general rule applied, the bankrupt corporation's Sec. 382 limitation would be close to zero and, therefore, the NOL would be, as a practical matter, valueless. Fortunately, in these cases where the loss corporation elects out of Sec. 382(l)(5), Sec. 382(l)(6) provides that the value of the loss corporation's stock "shall reflect the increase in value resulting from the cancellation of creditors' claims in the transaction." In short, in these cases, the value of the loss corporation's stock, for purposes of calculating the Sec. 382 limitation, is determined immediately after (and not immediately before) the ownership change. Calpine, based on the tenor of its disclosures, seems clearly to be opting into Sec. 382(l)(6). This is made apparent by the following statement in Calpine's 10-K "...we do not expect the annual limitation from this ownership change to result in elimination of the NOL carryforward..." Thus, Calpine is acknowledging that an ownership change--with respect to which the Sec. 382 limitation is applicable--has taken place. Calpine's filing then goes on to say that if a second ownership change were to occur as a result of future transactions in Calpine's stock, and this second ownership change was accompanied by a substantial reduction in the market value of Calpine immediately prior to the ownership change, Calpine's ability to use its NOL carryforwards might be limited. This is so because, under Reg. Sec. 1.382-5(d), the I.R.S. takes a "heads I win, tales you lose" approach to second ownership changes. Thus, the regulation provides that if a loss corporation experiences two (or more) ownership changes, any losses attributable to the period preceding the earlier ownership change (the one that occurred in bankruptcy) are treated as pre-change losses with respect to both ownership changes. Accordingly, the regulation goes to say, the later ownership change may result in a lesser (but never in a greater) Sec. 382 limitation with respect to such losses (arising before the earlier ownership change). The business combination with NRG certainly has the potential to cause such a second ownership change with respect to Calpine. An ownership change occurs when one or more the loss corporation's "five percent shareholders" increase their percentage ownership of its stock by more than 50 percentage points relative to the lowest percentage of stock owned by such shareholders at any time during the "testing period". Here, the testing period begins on the day following the day on which the earlier ownership change transpired. Where, as here, a public loss corporation (L) is combined with a public profit corporation (P), the post-combination shareholder group is segregated into two separate five percent shareholders, the L group and the P group, and if P's shareholders wind up with more than 50 percent of the surviving entity's stock, an ownership change will have occurred. It is unclear which group of shareholders, here, will emerge with a majority of the combined entity's stock. If, however, an ownership change occurs with respect to Calpine the impact should not be particularly damaging. If such a change occurred, Calpine would be forced to calculate a new Sec. 382 limitation. If the new limitation is higher than the Sec. 382 limitation Calpine emerged from bankruptcy with, the NOLs arising prior to the date of the first ownership change will be subject to the initial Sec. 382 limitation and the ones, if any, arising after the date of the first ownership change will be subject to the limitation calculated with respect to the second ownership change. On the other hand, and this is what Calpine warned about in its disclosures, if the second Sec. 382 limitation is smaller than the first such limitation, all of Calpine's losses, including those which arose prior to the date of the first ownership change, will be subject to this reduced limitation. However, unlike the case in which a loss corporation avails itself of the benefits of Sec. 382(l)(5), where a second ownership change has disastrous consequences, a second ownership change in the case of a taxpayer governed by Sec. 382(l)(6) will, at worst, extend the period over which the NOLs can be deployed. Robert Willens is president of Robert Willens LLC. He is also an adjunct professor of finance at Columbia Business School. Categories Deal Video
    Community
 Elsewhere on The Deal.comDealwatchThe Deal MagazineCorporate Dealmaker
The Deal VideoCategories
Blog roll
Archives
| |||||||||||||||||||||||
|
|
|
|
|
©Copyright 2009, The Deal, LLC. All rights reserved. Please send all technical questions, comments or concerns to the Webmaster.
