Winning Losses: Trading Injunctions and the Treatment of Net Operating Loss Carryovers in Chapter 11

Bankruptcy judges routinely enjoin debt and equity trading during Chapter 11 proceedings in order to protect bankrupt corporations’ net operating loss (NOL) tax credits. These credits disappear if a corporation changes ownership. Firms and judges reason that Chapter 11’s automatic stay prohibits any trading that would imperil NOL credits by causing a change in ownership. The automatic stay protects a debtor corporation’s assets, and firms and judges argue that tax credits are assets protected by the stay. At first glance, this argument makes sense. However, a deeper analysis reveals serious legal and policy concerns with trading injunctions in Chapter 11. Prohibiting trading is an extreme step that lacks a clear foundation in previous legislative and judicial treatment of the automatic stay. In addition to imposing costs on shareholders and debtholders in a bankrupt corporation, trading injunctions provide a debtor corporation’s management with a powerful — and potentially coercive — tool to entrench its position. Furthermore, NOL credits for reorganized corporations make little sense from a tax policy perspective: NOL credits are meant to offset profits from the project that created the losses, but reorganized corporations use NOL credits to offset gains from reorganization. This Note critiques the treatment of NOLs during Chapter 11 from both bankruptcy and tax angles. Thus far, there has been almost no policy conversation surrounding NOLs in bankruptcy. After illustrating the problems with the current policy, this Note suggests several original solutions and evaluates these alternate policies.