Creditor COI in Insolvency Explained
The diagram walks through an insolvency reorganization in three panels. In the Initial Structure, Corp T is insolvent: its assets have a fair market value of $150x while its liabilities total $200x. T owes two senior creditors with claims of $25x each and one junior creditor with a claim of $150x.
In the Reorganization, Corp T transfers all of its assets to Corp P in exchange for $95x of cash and P stock with a fair market value of $55x. That consideration is then distributed to the creditors in exchange for their claims: each senior creditor receives $20x of cash and $5x of P stock, and the junior creditor receives $55x of cash and $45x of P stock. The T shareholders receive nothing.
At the Ending Point, the creditors hold the P stock (a $55x aggregate proprietary interest): each senior creditor owns 9.1% ($5x of $55x) and the junior creditor owns 81.8% ($45x of $55x), with Corp P now holding T’s former assets.
Under Treas. Reg. § 1.368-1(e)(6), because the amount of T’s liabilities exceeds the fair market value of its assets immediately before the transaction, the claims of T’s creditors may be proprietary interests in T. Applying the paragraph (e)(6)(ii) valuation rules, the creditors received $55x of P stock in the aggregate; because P acquired 50 percent of the value of the proprietary interests in T in exchange for P stock, a substantial part of that value is preserved and the continuity-of-interest requirement is satisfied.
