Bankruptcy and restructuring professionals usually do not need to be political junkies. Amendments to the Bankruptcy Code, and the accompanying machinations of the Congressional legislative process, typically occur at a glacial pace, and such changes nearly always affect future rather than current chapter 11 cases. However, the federal tax and spending bill approved by Congress earlier this month, passed in the usual whirlwind of year-end activity and horse trading, nearly derailed the pending reorganizations of two of the largest chapter 11 cases ever filed, Energy Future Holdings Corp. (“EFH”) and Caesars Entertainment Operating Company (“Caesars”). (Kelley Drye & Warren LLP represents creditors of both EFH and Caesars, but has had no involvement in the matters discussed here.)
The bill initially contained language intended to eliminate certain tax advantages of real estate investment trusts (“REITs”). Such structures are central components of the chapter 11 plans for both enterprises. Had the bill passed with the language unmodified, it could have been devastating for both companies. The blow would have been particularly keen for EFH, which only a few days earlier had succeeded in getting its plan of reorganization confirmed, following months of work by an army of bankruptcy professionals and a multi-day hearing. The proposed REIT limitation language could have prevented the plan from ever becoming effective.
REITs are entities designed to hold real estate assets and provide investors with numerous tax breaks. The EFH plan is centered around an unusual strategy of permitting certain creditors to invest in a new REIT structure to take control of EFH’s public utility assets, an approach projected to attract enough new capital to pay most of EFH’s remaining creditors in full immediately upon the effectiveness of the Plan. Although the Caesars case remains mired in contentiousness and is at best several months away from having a plan confirmed, all plans proposed to date in Caesars have similarly been centered on transferring various hotel and casino properties to a REIT structure.
In recent years, a number of companies with substantial real estate assets, such as Sears and Darden Restaurants (owner of the Olive Garden chain), have transferred those assets into REITs and then leased them back, moves that have resulted in aggregate tax savings of over $21 billion. Certain members of Congress view these types of transactions as an abuse of the REIT structure, and inserted provisions in the tax and spending bill designed to curb them.
The REIT limitation language was contained in the initial version of the tax and spending bill that was released on December 7. It is unlikely that more than a handful, if any, of the bankruptcy professionals in the EFH and Caesars cases were aware of the threat posed by the tax and spending bill (and a review of bankruptcy-related news services turns up no mention of the REIT limitation proposal), but business persons at both EFH and Caesars spotted the danger. Lobbyists for both companies immediately began pressing the case that any changes to the tax benefits of REITs should be prospective only, as it would have a huge negative impact on several companies to disrupt deals that had already been announced. A crucial ally was found in Sen. Harry Reid of Nevada, a state heavily reliant on the strength of the gaming industry and therefore the continued viability of Caesars.
Sen. Reid also sought unsuccessfully to help Caesars by adding language to the tax and spending bill which would have amended another federal statute, the Trust Indenture Act (“TIA”). The proposed TIA change was intended to defuse a litigation threat to Caesars, but it drew significant opposition from numerous financial institutions, hedge funds and academics, and was removed. Withdrawing the proposed TIA amendment language may have given Sen. Reid a bargaining chip to push through the necessary protective fix with respect to the REIT proposal. In any event, by the time the bill made it to President Obama’s desk for signature on December 18, an additional fifty-four words that insulated EFH and Caesars had been inserted to the language governing the REIT changes:
The amendments made by this section shall apply to distributions on or after December 7, 2015, but shall not apply to any distribution pursuant to a transaction described in a ruling request initially submitted to the Internal Revenue Service on or before such date, which request has not been withdrawn and with respect to which a ruling has not been issued or denied in its entirety as of such date.
The threat to the REIT transactions for EFH and Caesars was averted and, for EFH creditors especially, it remained a merry Christmas.