Avoiding Traps for the Unwary in Drafting a Secured Creditor's Plan of Reorganization

AVOIDING TRAPS FOR THE UNWARY IN DRAFTING A SECURED CREDITOR'S PLAN OF REORGANIZATION

Lenders battling recalcitrant bankrupt borrowers may resort to filing plans of reorganization to recover commercial real estate. A lender’s plan is often the best weapon to recover real estate and gain control over its cash flow. In addition, a lender may avoid transfer taxes by disposing of real property through a plan or reorganization. Lenders, however, must carefully draft a plan so that they do not become the sword of Damocles.

This paper addresses drafting lender’s plans to avoid (i) incurring or shifting capital gains tax liability (in partnership bankruptcies), (ii) taking the real property subject to subordinate liens, (iii) losing the transfer tax exemption available to transfers in a plan, and (iv) the Hobson's choice of either assuming insider contracts or paying rejection damages to insiders.

The longer that a partnership debtor has owned and depreciated real property the more likely it is that large capital gains taxes will be due upon the disposition of such real property. The danger of incurring liability for capital gains taxes is a dangerous trap awaiting a lender proposing its own plan of reorganization.