The Portland Press Herald reports that the bankruptcy trustee for Great Northern Paper has said there is sufficient evidence to pursue claims against the Company’s owners, officers and directors for breach of their fiduciary duties and breach of the duty of loyalty arising from the structuring and execution of a Maine new markets tax credit transaction. The trustee hopes to settle the matter – and has proposed to sell the asset in question and reserve a portion of the sales proceeds for the company’s unsecured creditors – rather than litigating the claims because litigation would likely be time consuming and expensive given the complexity of the transaction and the issues involved. The issues arising from the NMTC transaction will sound familiar to tax credit professionals.
One of the issues described by the trustee’s counsel reflects some discomfort with the leveraged structure or debt QLICIs or both. The trustee’s attorney describes a leveraged NMTC investment in which “insiders” invested funds to capitalize CDEs that, in turn, loaned the proceeds of those investments to the project. According to the Press Herald, the trustee’s attorney stated that the investors “put in the money that otherwise would have been put in as equity … and put it in as debt.” In a typical “self-leveraged” NMTC financing, QALICB affiliates, like the insiders in the Great Northern transaction, provide loans to the investor, which the investor combines with its equity investment and uses to capitalize CDEs providing NMTC allocation to the transaction. Often, the leverage debt provided by a QALICB’s affiliates is on terms and conditions far more favorable than a loan that could be obtained at arms’ length from conventional sources of capital. Without more information on the structure of the Great Northern transaction, it is impossible to evaluate the terms of the leverage debt provided by the Great Northern insiders, or the terms of the QLICIs, but under appropriate circumstances it must be possible for insiders to use debt as well as equity to capitalize an affiliate without violating bankruptcy law or breaching fiduciary duties or duties of loyalty – particularly if the debt is equity-equivalent or otherwise on terms that are substantially more favorable than market rate debt.
Two other, related issues concern the use of QLICI proceeds. First, the application submitted by the trustee’s attorney states that immediately after the closing of the NMTC financing, the borrower was “insolvent.” Second, and more specifically, the filing states that the borrower acquired personal property assets from an affiliate for $28.5 million in QLICI proceeds, but the true value of these assets was “substantially less.” It is not uncommon in NMTC transactions for QALICBs to incur indebtedness that initially exceeds the appraised value of its assets. The trustee’s argument underscores the importance of conducting a careful, searching review of such transactions in order for the participants to be comfortable that the QALICB is a going concern and that the debt can be repaid in accordance with its terms. With respect to the value of the assets acquired with QLICI proceeds, the Press Herald report states that the current, preliminary bid for all QALICB assets is $2.6 million. There is no discussion in press accounts or the trustee’s application of the nature or scope of valuation analyses conducted in connection with the QALICB’s asset purchase, but the plight of Great Northern demonstrates the importance of obtaining well-supported, third-party appraisals or other valuation analyses of assets to be acquired with QLICI proceeds.