Commercial Finance
Proposed Regulations Remove Tax Obstacles to Secure U.S. Domestic Corporate Borrowings
By David H. Saltzman, Elaine B. Murphy, and Sara Clevering, Ropes & Gray
On October 31, 2018, the Treasury Department released proposed regulations under Section 956 of the Internal Revenue Code of 1986, as amended, that generally exempt U.S. domestic corporations from recognizing deemed dividends if a controlled foreign corporation (or CFC) invests in U.S. property or provides credit support for a U.S. domestic corporation’s borrowing. The broad application of these rules has kept domestic borrowers from pledging more than 66 2/3 percent of CFC voting stock or from providing lenders with upstream guarantees or asset pledges. Significantly, while the proposed regulations relax the rules for domestic corporations, they do not change the deemed dividend rules that apply to individuals and other non-corporate borrowers, such as domestic operating partnerships owned by private investment funds.
Going forward, while domestic corporations are likely to pledge 100 percent of CFC equity, it may not be commercially feasible for a borrower to provide other forms of credit support from a foreign corporation. In this regard, there can be considerable financial and administrative costs to perfecting foreign security arrangements. Moreover, local law restrictions, such as financial assistance rules, may prevent a subsidiary from supporting a parent borrowing. Borrowers should review their credit agreements, which, in some cases, require borrowers to provide security from CFCs if changes in tax rules, like the proposed regulations, eliminate potential tax costs.
The preamble to the proposed regulations indicates that the deemed dividend rules should be relaxed to provide parity with the tax treatment of a domestic corporation that receives an actual dividend from a CFC. The Tax Cuts and Jobs Act, which became law in December of 2017, can provide a 10 percent U.S. corporate shareholder of a CFC with a complete exemption from tax on dividends received from a CFC. Among other requirements to claim the exemption, the U.S. corporate shareholder must hold the shares for a one-year period that includes the dividend date, and the dividends paid to the domestic corporation must not afford the CFC a tax deduction or similar non-U.S. tax benefit under local law (hybrid dividends). These same rules are also conditions to the exemption for the deemed dividend rule. Before pledging 100 percent of the equity of a CFC (or providing other CFC credit support), a domestic corporate borrower should determine whether the CFC interests it holds produce hybrid dividends. Hybrid dividends may arise from profit-participating loans, convertible preferred equity certificates and similar instruments issued in many common holding company structures in Ireland and Luxembourg, among other jurisdictions.
Domestic corporate taxpayers can rely on the proposed regulations, even prior to promulgation in final form, for taxable years beginning after December 31, 2017.
Bankruptcy Law
Recent Cases on Guaranty Language Construction and Non-waivable Rights; Enforceability of Dispute Resolution Provisions
By Stephen L. Sepinuck, Frederick N. & Barbara T. Curley Professor & Director of the Commercial Law Center at Gonzaga University School of Law
Bowers v. Today’s Bank, 2018 WL 4998236 (Ga. Ct. App. 2018). A guarantor’s springing liability on a non-recourse loan agreement, which was to ripen if the collateral became subject to the debtor’s “voluntary bankruptcy or insolvency proceeding,” did not ripen when the debtor consented to the lender’s receivership proceeding. The court ruled that the term “voluntary” modified both the words “bankruptcy” and “insolvency proceeding.” Therefore, either such proceeding would have to be initiated by the debtor. Moreover, the debtor’s consent to the lender’s action in bringing a receivership proceeding did not satisfy the loan agreement’s requirement that such action be initiated by the debtor.
Harltey v. Hynes, 2018 WL 5093975 (Pa. Super. Ct. 2018). Guarantors who had waived any requirement that the creditor proceed first against the collateral and “any and all rights or defenses based on suretyship or impairment of collateral” could not assert a defense based on impairment of the collateral in the creditor’s possession. The duties imposed by UCC § 9-207(a) on a secured party in possession of collateral are not included in the list of non-waivable obligations in UCC § 9-602. Thus, the guarantors did waive their rights under UCC § 9-207. This conclusion is supported by UCC § 3-605(f), which expressly allows secondary obligors to waive an impairment of collateral defense.
Temsa Ulasim Araclari Sanayi Ve Ticaret A.S. v. CH Bus Sales, LLC, 2018 WL 4905593 (D. Del. 2018). Even though the security agreement between a manufacturer and its exclusive distributor contained no arbitration clause – instead, it expressly provided for judicial resolution of disputes between the parties – because an earlier distribution agreement contained an arbitration clause calling for arbitration pursuant to AAA rules, it was for an arbitrator to determine in the first instance whether the pending dispute was subject to arbitration. This case underscores the need to look at all documents in a transaction to determine the correct forum for dispute resolutions, and it also highlights the deference a court will give to arbitration provisions that appear in any in-force agreements between the parties.
Carve-Out in Cash Collateral Order Was Available Post-Conversion to Pay Professionals
By Michael Enright
The Sixth Circuit Court of Appeals recently construed the professional fee carve-out provisions of a cash collateral order to determine the carve-out remained available to pay professionals after a conversion of the case to Ch. 7. In re Licking River Mining, LLC, Case No. 17-6310 (6th Cir. Dec. 28, 2018). The secured creditors whose cash collateral was at issue argued that the carve-out was to apply only to their post-petition adequate protection liens and they never intended the funds to come from their prepetition liens. The issue was material for the professionals, because $2.5 million of professional fees remained unpaid and there was no other source for payment. The court construed the cash collateral order using ordinary contract construction principles considering the entire as a whole, rather than construing any single provision in isolation. Giving effect to that principle, the court found two places within the order where the carve-out language was construed to apply to prepetition collateral. The court also noted that the secured creditors had represented to the court that the use of cash collateral to pay fees could continue post-conversion from the carve-out on more than one occasion. Finally, the court considered the secured creditors’ argument that the Bankruptcy Code prohibited payment of the fees from the carve-out after conversion of the case, because the funds had become property of the estate at conversion. The creditors argued distributing those funds to the professionals would conflict with the Code’s priority of distribution. However, the court disagreed, upholding the bankruptcy court’s decision that the position espoused by the secured creditors would “yield an illusory and absurd result,” because under the proposed reading “how could there ever be a recovery for professionals from a carve-out?” The decision is a reminder that a good cash collateral order is the product of careful drafting to reflect the intent of the parties and the authority granted by the court, and that courts are likely to uphold a carve-out to provide the protection intended for professionals in bankruptcy cases.