NOL Poison Pills Designed to Prevent an Ownership Change Under Section 382? Now That’s Something to Think About

Section 382's Limitation on Use of a Target's Net Operating (and Built-in) Losses

Section 382 provides a limitation on change of control transactions involving loss corporations, i.e., target corporations with net operating loss carryovers or certain built-in losses. In general, a net operating loss may be carried back 2 years and forward 20. Section 172(b)(1)(A). Alternatively, an election may be made to carryforward the net operating loss for the 20 year period. States corporate income tax statutes also have their own NOL provisions.

Where there has been an "ownership change" as defined, Section 382 limits the amount of the post-acquisition use of the net operating losses on an annual basis by multiplying the loss corporation's value at the time of the ownership change by the long term tax-exempt rate published by the Service. Using the vernacular of Section 382, Section 382(a) provides that a "new loss corporation" is not permitted to deduct "pre-change losses" in an amount greater than the "Section 382 limitation". An ownership change occurs where the shareholders who own 5% or more of the loss corporation, as a result of the change in control event, tested over a statutory measuring or "testing" period of 3 years, increase their ownership in a loss corporation by more than 50 percentage points. While the testing rules for ownership changes (as well as equity structure shifts where applicable under the facts such as in a recapitalization) are quite complex, many acquisitions of a target corporation will be easily identified as resulting in an ownership change and therefore trigger application of Section 382. Where a loss corporation has a substantial net operating loss, then the deferred tax asset associated with the timely utilization of such loss can have substantial value. See FASB ASC 740. However, where Section 382 applies, and the loss corporation's value has declined, full absorption of the net operating losses (and built-in losses) after the acquisition is consummated may be in doubt. This results in a partial write down of the deferred tax asset.

Corporate Anti-Takeover Defense: The Poison Pill

A poison pill plan refers to a plan used by the board of directors of a corporation to make it more difficult or costly, and therefore less attractive, to acquire the target corporation. The poison pill plan is one strategy corporations, whose stock is publicly traded, employ to prevent hostile takeover attempts and invariably involves the adoption of shareholder rights agreements. The traditional poison pill plan's goal was protection of the shareholder control premium. See Moran v. Household International, Inc., Del. Supr., 500 A.2d 1346 (1985); Revlon, Inc., et al, v. Forbes Holdings, Inc., 506 A.2d 173 (1986); Unocal Corporation v. Mesa Petroleum Co., 483 A.2d 946 (1985). Poison pill plans issue rights are in essence the issuance of options to purchase shares by the existing target shareholders, thereby diluting the purchased ownership of the hostile acquirer. The issuance of such rights generally does not require shareholder approval. See Air Products & Chemicals, Inc. v. Airgas, Inc., 16 A.3d 48 (Del. Ch., 2011).

There are two general forms of poison pill plans, the so-called "flip-in plan" and a...