PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MEMORANDUM
December 12, 2022
FROM: Sylvia Hartwell, Specialist Partner, Tax — Calderwood & Harkness LLP
TO: Nathaniel Bower, Responsible Partner, Bankruptcy & Restructuring Amy Chesterton, Lead Associate, Bankruptcy & Restructuring
RE: Cancellation of Debt Income and §108 Exclusion Analysis — Thalassa Americas Inc. / Thalassa Shipping & Logistics SA
MATTER NO.: 1044-00003
This memorandum is a privileged and confidential attorney-client communication and attorney work product prepared by Calderwood & Harkness LLP in connection with the above-referenced matter. It is intended solely for the use of the attorneys and professionals identified above and should not be disclosed to any third party without the prior written consent of the undersigned. Disclosure to any third party may waive applicable privileges.
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I. Executive Summary
The purpose of this memorandum is to analyze the federal income tax consequences under Internal Revenue Code ("IRC" or "Code") §61(a)(12) arising from cancellation-of-debt income ("CODI") that may be triggered by the potential restructuring of the outstanding indebtedness of Thalassa Shipping & Logistics SA ("TSL") and Thalassa Americas Inc. ("TAI"), and to evaluate the available exclusions from gross income under Code §108. This analysis is prepared at the request of the Bankruptcy & Restructuring practice group in connection with the ongoing dual-track restructuring advisory engagement for TSL and TAI.
The focus entities for this analysis are as follows:
• Thalassa Americas Inc. ("TAI"): A Delaware C-corporation (EIN 84-3291057), wholly owned by TSL, which serves as the U.S. operating platform for TSL's Americas business segment. TAI is the relevant U.S. federal income taxpayer for purposes of this analysis.
• Thalassa Shipping & Logistics SA ("TSL"): A Greek société anonyme organized under the laws of Greece (Greek Tax ID/AFM 998214763), headquartered in Piraeus, Greece, which serves as the foreign parent company and primary borrower under the corporate credit structure.
The debt instruments under consideration in this analysis include the following:
(a) Mezzanine Notes — $112.3 million in aggregate principal amount outstanding, held by Dralvecen Mezzanine Capital LLC ("BMC"), consisting of $100 million in original principal plus $12.3 million in payment-in-kind ("PIK") interest capitalized through September 30, 2022. The notes bear interest at 11.5% on a PIK toggle basis, are secured by a second-priority lien, and mature on December 15, 2024.
(b) Senior Secured Credit Facility — $540 million in aggregate principal amount outstanding across three tranches: Term Loan A ("TLA") of $270 million, a revolving credit facility (the "Revolver") drawn at $185 million against a $200 million commitment, and Term Loan B ("TLB") of $85 million (non-amortizing bullet). The facility bears interest at SOFR plus 375 basis points (with a default rate of SOFR plus 575 basis points), matures on June 15, 2024, and is administered by Nordbank International AG as administrative and collateral agent.
(c) Subordinated Intercompany Note — $76.4 million from TAI payable to TSL, bearing interest at 5.0% per annum.
This memorandum analyzes two restructuring scenarios currently under discussion: (a) an out-of-court exchange and modification of the mezzanine notes, together with an amendment of the senior secured credit facility and modification of the intercompany note (the "Out-of-Court Path" or "RSA Path"); and (b) a Chapter 11 filing by TAI in the United States Bankruptcy Court for the Southern District of Texas, Houston Division (the "Chapter 11 Path").
Key conclusions are as follows:
First, significant CODI is likely to arise from the proposed mezzanine note exchange. Under the contemplated terms, BMC would exchange $112.3 million in mezzanine notes for $60 million in new second-lien notes plus 15% equity in TSL. The potential haircut on the debt component is approximately 46.6%, resulting in estimated CODI in the range of $41.8 million to $52.3 million, depending on the fair market value ascribed to the equity component.
Second, available exclusions under §108 — specifically, the bankruptcy exclusion under §108(a)(1)(A) and the insolvency exclusion under §108(a)(1)(B) — may eliminate or substantially reduce the tax impact of CODI, depending on the restructuring path chosen. The bankruptcy exclusion, available only in a Title 11 case, provides an unlimited exclusion for all CODI realized by a debtor under the jurisdiction of the bankruptcy court. The insolvency exclusion, available without a bankruptcy filing, is limited to the amount by which the taxpayer is insolvent immediately before the discharge.
Third, regardless of which exclusion is invoked, §108(b) mandates a reduction of the taxpayer's tax attributes (including net operating losses, credit carryforwards, and tax basis of property) in a prescribed order, which effectively defers rather than permanently eliminates the tax cost of the discharge.
Fourth, the choice between the Out-of-Court Path and the Chapter 11 Path has material tax implications. The Chapter 11 Path provides the broadest protection against CODI recognition but entails approximately $18.5 million in estimated administrative costs, operational disruption, and reputational risk. The Out-of-Court Path avoids those costs but may leave a portion of CODI taxable if TAI's insolvency amount is insufficient to cover the full CODI exposure.
Important limitation: This memorandum addresses U.S. federal income tax consequences only. It does not address state or local income tax implications, value-added tax, or other non-income-based taxes. Cross-border tax implications — including the Greek tax treatment of TSL's debt restructuring, withholding tax issues, and the interaction of the U.S.-Greece income tax treaty — are addressed in a separate memorandum currently in preparation, which is expected to be circulated on December 20, 2022.
II. Factual Background
A. Corporate Structure and Relevant Entities
Thalassa Shipping & Logistics SA ("TSL") is a société anonyme organized under the laws of the Hellenic Republic, with its principal executive offices located at 42 Akti Miaouli, Piraeus 18538, Greece. TSL was founded in 1987 by the Kostandinos family and has grown to become one of the leading mid-market international shipping and logistics operators, with a fleet of 50 vessels (38 dry-bulk carriers and 12 container vessels) and supporting logistics infrastructure. TSL is the ultimate parent company of the Thalassa corporate group and serves as the primary borrower under the senior secured credit facility and the mezzanine note issuance.
Thalassa Americas Inc. ("TAI") is a Delaware C-corporation, wholly owned by TSL, with its principal office located at 1400 McKinney Street, Suite 2200, Houston, Texas 77010. TAI's registered agent is Capitol Registered Agents LLC, located at 1209 Orange Street, Wilmington, Delaware 19801. TAI serves as the U.S. operating entity for TSL's Americas business, which includes domestic freight brokerage operations, the Houston terminal operations, and certain U.S.-based chartering activities. TAI is the relevant U.S. federal income taxpayer for purposes of this analysis.
KFO Holdings SA ("KFO") is a Greek société anonyme that functions as the Kostandinos family holding company. Through KFO, Dimitrios Kostandinos holds 62% of the equity interest in TSL and Elena Kostandinos-Pavlou holds 18% of the equity interest in TSL, for a combined family interest of 80% in TSL. The remaining 20% of TSL equity is held by non-family investors, principally certain Greek institutional shareholders.
The corporate structure is straightforward for purposes of this analysis: KFO holds 80% of TSL; TSL holds 100% of TAI. There is no U.S. affiliated group that files a consolidated federal income tax return. TAI is a standalone U.S. corporate taxpayer.
TAI is a co-borrower under the U.S. Tranche (TLB, $85 million) of the senior secured credit facility and is the maker of the $76.4 million subordinated intercompany note payable to TSL. TAI's co-borrower and guarantee obligations under other tranches of the senior secured facility and the mezzanine notes are discussed in further detail below.
B. Outstanding Indebtedness
The debt capital structure of the TSL/TAI group, as of September 30, 2022, consists of the following instruments:
1. Senior Secured Credit Facility
The senior secured credit facility was originally entered into on June 15, 2019, pursuant to a credit agreement among TSL (as borrower), TAI (as co-borrower with respect to the TLB tranche), Nordbank International AG (as administrative agent and collateral agent), and a syndicate of nine institutional lenders. The total original commitment was $685 million. As of September 30, 2022, the aggregate principal amount outstanding under the facility is $540 million, allocated as follows:
The facility bears interest at the Secured Overnight Financing Rate ("SOFR") plus 375 basis points, with a default rate of SOFR plus 575 basis points (i.e., an additional 200 basis points upon an event of default). The facility is secured by first-priority liens on substantially all of the assets of the TSL group, including 38 dry-bulk carriers, 12 container vessels, the Houston terminal lease, all accounts receivable, and the equity interests in TAI and 14 vessel-owning special purpose vehicles ("SPVs").
The lender syndicate and their respective commitments are as follows:
2. Mezzanine Notes
The mezzanine notes were issued on June 15, 2019, and are held by Dralvecen Mezzanine Capital LLC ("BMC"), located at 600 Lexington Avenue, 22nd Floor, New York, New York 10022 (Rebecca Quimby, Senior Partner). The aggregate principal amount outstanding as of September 30, 2022 is $112.3 million, consisting of $100 million in original principal and $12.3 million in PIK interest that has been capitalized to principal. The notes bear interest at 11.5% per annum on a PIK toggle basis. Since the second quarter of 2022, all interest payments have been made in PIK form. The mezzanine notes are secured by a second-priority lien on the same collateral pool as the senior secured credit facility, subject to an intercreditor agreement dated June 15, 2019, between Nordbank International AG (as first-lien agent) and BMC (as second-lien holder). The maturity date of the mezzanine notes is December 15, 2024.
3. Unsecured Notes
TSL also has outstanding $50 million in unsecured notes, bearing interest at 8.25% per annum, payable semi-annually in cash. The notes were issued on March 1, 2020, and mature on March 1, 2025. The indenture trustee is Garrison Trust Company, located at 100 Wall Street, 16th Floor, New York, New York 10005. The notes bear CUSIP number 87265BAB5. TSL missed the December 1, 2022 interest payment of $2,062,500 (calculated as $50 million × 8.25% ÷ 2). Pursuant to the terms of the indenture, TSL has a 30-day cure period, which expires on January 1, 2023. If the missed payment is not cured, an event of default under the indenture will be triggered, potentially resulting in acceleration of the full $50 million principal amount at the option of the requisite holders or the trustee.
4. Intercompany Note
TAI is the maker of a $76.4 million subordinated intercompany note payable to TSL. The note bears interest at 5.0% per annum and is subordinated to all external indebtedness of TAI. This note represents a key component of the intercompany financing arrangement through which TSL funded TAI's U.S. operations and capital expenditures.
5. Total Debt Summary
The largest trade creditor is Olympian Fuel & Supply SA, with an outstanding balance of approximately $9.2 million as of September 30, 2022.
C. Financial Condition and Valuation
The TSL group has experienced a significant deterioration in financial performance and asset values over the course of 2022, driven by a combination of declining freight rates in the dry-bulk and container shipping segments, rising fuel costs, and increased competition from larger integrated logistics platforms.
Revenue Performance:
• TSL consolidated revenue for fiscal year 2021 was €1.42 billion. Revenue for fiscal year 2022 is estimated at approximately €987 million, representing a decline of approximately 30.5% year-over-year.
• TAI revenue for fiscal year 2021 was $312 million. Revenue for fiscal year 2022 is estimated at approximately $198 million, reflecting the broader downturn in the Americas segment.
Earnings and Leverage:
• Last twelve months ("LTM") EBITDA as of September 30, 2022 was $98.6 million.
• LTM interest expense as of September 30, 2022 was $56.7 million.
• The net leverage ratio as of September 30, 2022 was 7.82x, calculated as $770.9 million in net debt divided by $98.6 million in LTM EBITDA. This ratio significantly exceeds the 5.50x maximum leverage covenant under the senior secured credit facility.
Fleet and Enterprise Valuation:
• An independent fleet appraisal conducted by Drakos Maritime Valuations Ltd., dated November 1, 2022, valued the TSL fleet at $623 million. This represents a decline of $268 million, or 30.1%, from the January 2022 appraised value of $891 million, reflecting the deterioration in secondhand vessel prices across the dry-bulk and container sectors.
• A preliminary enterprise valuation conducted by Kensington Veltrian Partners LLC ("KHP"), the financial advisor engaged by TSL, in November 2022 estimated the enterprise value of TSL at $580 million to $640 million, with a midpoint of $610 million.
Covenant Breaches and Forbearance:
• TSL breached the minimum liquidity covenant on September 15, 2022, with actual liquidity of $27.3 million versus a minimum requirement of $40.0 million (a shortfall of $12.7 million).
• As of September 30, 2022, TSL was also in breach of the leverage ratio covenant (7.82x actual vs. 5.50x maximum permitted) and the interest coverage ratio covenant.
• In response to these defaults, TSL, TAI, Nordbank (as administrative agent), and the required lenders entered into a Forbearance Agreement dated October 10, 2022, pursuant to which the lenders agreed to forbear from exercising remedies for a period of 90 days (through January 8, 2023) to permit the parties to negotiate a consensual restructuring.
D. Restructuring Alternatives Under Discussion
Two restructuring paths are currently under active discussion by the TSL/TAI board, management, and financial and legal advisors. The dual-track approach is being pursued in parallel, with the objective of reaching a consensual out-of-court restructuring if possible, while preserving the option of a Chapter 11 filing as a backstop.
1. Out-of-Court Path (RSA)
The out-of-court path would be implemented through a restructuring support agreement ("RSA") and would involve the following principal transactions:
(a) Mezzanine Exchange: BMC would exchange its $112.3 million in mezzanine notes for (i) $60 million in new second-lien notes bearing interest at 10.0% PIK, with a maturity date of June 2028, and (ii) 15% of the equity in TSL.
(b) Senior Secured Facility Amendment: The senior secured credit facility would be amended to extend the maturity date from June 15, 2024 to June 15, 2027; convert $75 million of TLA principal to PIK status; reduce the revolving credit commitment from $200 million to $150 million; reset financial covenants to levels consistent with the revised business plan; add a 1.00% amendment fee of $5.4 million (payable in PIK); and waive all accrued default interest.
(c) Intercompany Note Modification: The maturity of the $76.4 million intercompany note from TAI to TSL would be extended to December 2028, and the interest rate would be reduced from 5.0% to 2.0%.
(d) KFO Equity Contribution: KFO Holdings SA would make a new equity contribution to TSL of €35 million (approximately $38.2 million at the then-prevailing exchange rate of €1 = $1.0914).
2. Chapter 11 Path
If the out-of-court path proves unachievable — whether due to holdout creditors, valuation disputes, or other impediments — TAI would file a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of Texas, Houston Division. The Chapter 11 filing would involve the following elements:
(a) DIP Facility: A $75 million debtor-in-possession ("DIP") financing facility to be provided by Nordbank International AG and Triton Credit Partners LP, bearing interest at SOFR plus 600 basis points, with a 0.50% commitment fee and a 12-month maturity.
(b) Administrative Costs: Estimated total administrative costs of approximately $18.5 million for professional fees and expenses incurred during the Chapter 11 case.
(c) Chief Restructuring Officer: Alderney Management Advisors LLC (Richard Thornberg) has been identified as the CRO designee.
(d) Plan Confirmation Timeline: The anticipated timeline from filing to plan confirmation is approximately 270 days.
III. Legal Framework: CODI Under §61(a)(12)
A. General Rule
Section 61(a)(12) of the Internal Revenue Code provides that gross income includes "income from the discharge of indebtedness." This principle is one of the most fundamental tenets of the federal income tax system and reflects the longstanding judicial and statutory recognition that a taxpayer who is relieved of an obligation to repay borrowed funds has realized an accession to wealth.
A "discharge of indebtedness" occurs when a debtor is released from all or a portion of its outstanding obligations for less than the amount owed, whether through outright forgiveness, the exchange of old debt for new instruments of lesser value, a modification of existing debt terms, a negotiated settlement, or a discharge pursuant to a plan of reorganization in bankruptcy. The fundamental economic rationale is that the discharge improves the debtor's net financial position by the amount of the cancelled obligation — the debtor retains the benefit of the originally borrowed funds without a corresponding repayment obligation.
The amount of CODI equals the excess of the adjusted issue price of the discharged debt over the amount paid by the debtor to satisfy or exchange the obligation, including the fair market value of any property transferred or the issue price of any new debt instrument issued in exchange. The "adjusted issue price" of a debt instrument is generally its original issue price plus any accrued original issue discount ("OID") and minus any payments of principal that have been made.
The seminal authority for the inclusion of CODI in gross income is United States v. Kirby Lumber Co., 284 U.S. 1 (1931), in which the Supreme Court held that a corporation that repurchased its own bonds at a price below face value realized taxable income equal to the difference. The Kirby Lumber principle has been codified in §61(a)(12) and extensively elaborated upon in subsequent statutory provisions, Treasury Regulations, and case law.
In the context of the TSL/TAI restructuring, CODI may arise from multiple sources: the physical exchange of the mezzanine notes for new instruments and equity; any deemed exchange resulting from a significant modification of the senior secured credit facility; and the modification of the intercompany note. Each of these potential CODI-generating events is analyzed separately below.
B. Debt-for-Debt Exchanges and Significant Modifications Under Treas. Reg. §1.1001-3
Under general tax principles, a realization event occurs when property (including a debt instrument) is exchanged for other property that is materially different. See Code §1001(a); Cottage Savings Ass'n v. Commissioner, 499 U.S. 554 (1991). In the context of debt instruments, Treasury Regulation §1.1001-3 provides a comprehensive framework for determining when a modification of an existing debt instrument is so significant as to be treated as an exchange of the old instrument for a new instrument for U.S. federal income tax purposes.
Under Treas. Reg. §1.1001-3(b), a "modification" of a debt instrument includes any alteration in the legal rights and obligations of the parties, whether the alteration is evidenced by an express agreement, a course of dealing, or a unilateral action by the issuer. A modification is "significant" — and thus triggers a deemed exchange — if it falls within one or more of the categories enumerated in Treas. Reg. §1.1001-3(e). The principal categories of significant modifications relevant to this analysis include:
(i) Change in yield: A modification that changes the yield of a debt instrument is a significant modification if the yield on the modified instrument varies from the yield on the unmodified instrument by more than the greater of (a) 25 basis points or (b) five percent of the annual yield of the unmodified instrument. See Treas. Reg. §1.1001-3(e)(2)(ii).
(ii) Change in timing of payments: A modification that results in a material deferral of scheduled payments is a significant modification. A deferral is material if it exceeds certain safe harbor thresholds based on the yield and term of the instrument. See Treas. Reg. §1.1001-3(e)(3).
(iii) Change in obligor or collateral: A modification that substitutes a new obligor or releases a substantial portion of collateral may be a significant modification under certain circumstances. See Treas. Reg. §1.1001-3(e)(4), (e)(5).
Application to the proposed senior secured credit facility amendment: The proposed amendment would extend the maturity date from June 15, 2024 to June 15, 2027 (a three-year extension), convert $75 million of TLA principal from cash-pay to PIK status (materially deferring principal and interest payments), reduce the revolving credit commitment from $200 million to $150 million, reset financial covenants, impose a 1.00% amendment fee of $5.4 million in PIK, and waive all accrued default interest. Each of these modifications must be tested independently and in combination to determine whether the aggregate effect constitutes a significant modification. We address this analysis in greater detail in Section IV.B below. Our preliminary conclusion is that the proposed amendments, taken together, likely constitute a significant modification, particularly given the maturity extension and the PIK conversion, which together substantially change both the yield and the timing of payments.
Application to the proposed mezzanine note exchange: The proposed transaction with BMC involves a physical exchange of the existing $112.3 million mezzanine notes for two distinct forms of consideration: $60 million in new second-lien notes and 15% equity in TSL. Because this is a physical exchange of instruments — not merely a modification of existing terms — it clearly constitutes a realization event under §1001(a) and Treas. Reg. §1.1001-1(a), and the analysis under Treas. Reg. §1.1001-3 regarding significant modifications is not required (though the result would be the same).
C. Debt-for-Equity Exchanges
When a debtor issues equity to a creditor in partial or complete satisfaction of a debt obligation, CODI arises to the extent the adjusted issue price of the old debt exceeds the sum of (i) the issue price of any new debt instrument issued in the exchange and (ii) the fair market value of the equity received by the creditor. This rule is codified in §108(e)(8), which provides that if a debtor corporation transfers stock to a creditor in satisfaction of its indebtedness, the debtor is treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the stock.
In the context of the proposed BMC mezzanine exchange, BMC would receive 15% of the equity in TSL in addition to the new $60 million second-lien notes. The equity component must be valued at fair market value as of the date of the exchange. If the fair market value of the 15% equity interest is $X, then CODI equals $112.3 million minus ($60 million + $X).
Critically, TSL (not TAI) is the primary obligor on the mezzanine notes, and TAI's role is as co-obligor or guarantor. The allocation of CODI between TSL and TAI depends on the precise terms of the credit documents and the nature of TAI's obligation. To the extent TAI's co-obligation or guarantee liability is discharged, CODI is realized by TAI as a U.S. taxpayer. To the extent TSL's obligation is discharged, the CODI is realized by TSL as a Greek entity, and the U.S. federal income tax consequences to TSL would depend on whether the CODI constitutes income effectively connected with a U.S. trade or business. This obligor-tracing analysis requires further review of the credit documentation, which we have requested from the Bankruptcy & Restructuring team.
D. Purchase-Price Reduction Exception Under §108(e)(5)
For completeness, we briefly note that §108(e)(5) provides an exception to CODI treatment where a purchaser's debt to a seller is reduced. Under this provision, if a buyer of property incurs a debt to the seller in connection with the purchase, and the seller subsequently reduces the debt, the reduction is treated as a purchase-price adjustment rather than CODI, provided that the debtor is not insolvent and the reduction does not arise in a Title 11 case.
This exception is inapplicable to the present facts. The indebtedness at issue — the senior secured credit facility, the mezzanine notes, and the intercompany note — was incurred in lending transactions for general corporate and acquisition purposes, not in connection with the purchase of goods or services from the lenders. Accordingly, §108(e)(5) provides no relief here.
E. Related-Party Acquisitions Under §108(e)(4)
Section 108(e)(4) of the Code provides that if a person related to the debtor acquires the debt of the debtor from a third party, the debtor is treated as having satisfied the debt for the acquisition price. This provision is designed to prevent related parties from acquiring distressed debt at a discount and then forgiving it without CODI recognition. The implementing regulations are found at Treas. Reg. §1.108-2.
We have analyzed whether any related party — including the Kostandinos family, KFO Holdings, or any entity controlled by them — is acquiring TSL/TAI debt at a discount in connection with the proposed restructuring. Based on the facts currently available to us, KFO's participation in the restructuring is limited to a new equity contribution of €35 million (approximately $38.2 million). KFO is not acquiring any third-party debt of TSL or TAI at a discount. Accordingly, §108(e)(4) does not appear to be triggered by the proposed transactions.
However, the intercompany note ($76.4 million from TAI to TSL) warrants additional analysis. The proposed modification of this note — reducing the interest rate from 5.0% to 2.0% and extending the maturity to December 2028 — involves a modification between related parties (TAI as debtor and TSL as creditor/parent). We do not believe that §108(e)(4) applies to this modification, because TSL is not acquiring a debt owed by TAI from a third party; rather, TSL is modifying its own receivable. Nevertheless, the modification may constitute a significant modification under Treas. Reg. §1.1001-3, resulting in a deemed exchange and potential CODI to TAI, as discussed in Section IV.C below.
Because TAI and TSL do not file a U.S. consolidated federal income tax return — TSL being a Greek corporation not subject to U.S. consolidated return rules — any CODI realized by TAI on the intercompany note modification is recognized by TAI as a standalone U.S. taxpayer.
IV. Quantification of Potential CODI
A. Mezzanine Note Exchange
The mezzanine note exchange is the most significant potential source of CODI in the proposed restructuring. The relevant parameters for the CODI calculation are as follows:
Adjusted Issue Price of Old Mezzanine Notes: The adjusted issue price of the existing mezzanine notes is $112.3 million, consisting of $100 million in original issue price plus $12.3 million in PIK interest that has been capitalized to the principal balance through September 30, 2022. Assuming no original issue discount was present at issuance (the notes were issued at par with adequate stated interest at 11.5%), the adjusted issue price equals the outstanding principal balance. Any additional PIK interest accrued between October 1, 2022 and the closing of the exchange will need to be added to this amount, but for purposes of this preliminary analysis we use the September 30, 2022 balance.
Consideration Received by BMC:
(i) New Second-Lien Notes: $60 million face value, 10.0% PIK, maturing June 2028. The issue price of the new notes must be determined under §§1273 and 1274 of the Code. If the new notes are issued for property (as opposed to money), the issue price is determined under §1274 based on the stated principal amount, provided the notes bear "adequate stated interest" — that is, stated interest at a rate equal to or exceeding the applicable federal rate ("AFR") for instruments of comparable term. As discussed further in Section VII.C below, the current long-term AFR (December 2022) is approximately 4.5%–5.0% for instruments with a term of approximately 5.5 years. Because the 10.0% PIK rate on the new notes significantly exceeds the AFR, the notes bear adequate stated interest, and the issue price equals the stated principal amount of $60 million. No OID analysis is necessary.
(ii) 15% Equity in TSL: The fair market value of the 15% equity interest in TSL must be determined as of the exchange date. Based on the KHP enterprise value estimate of $580 million to $640 million (midpoint $610 million), the implied equity value of TSL can be calculated by subtracting the face value of all outstanding debt from the enterprise value:
Enterprise value (midpoint): $610M Less: Senior secured facility: ($540M) Less: Mezzanine notes (pre-exchange): ($112.3M) Less: Unsecured notes: ($50M) Implied equity value: negative ($92.3M)
On a strict balance-sheet basis, the equity of TSL has no positive value; indeed, it is deeply out of the money. However, equity in a restructured company may carry positive value on a going-concern or option-value basis, reflecting the potential for recovery beyond the face amount of claims in a favorable scenario. For conservatism, we present a range of equity value assumptions:
CODI Calculation — Illustrative Range:
As reflected in the table above, the estimated CODI from the mezzanine note exchange ranges from $41.8 million to $52.3 million. The midpoint estimate of approximately $47.1 million represents a haircut of approximately 41.9% on the total consideration received relative to the adjusted issue price of the old notes. This is a substantial CODI exposure that warrants careful attention to the available §108 exclusions.
Obligor Allocation: An important caveat is warranted. TSL is the primary obligor on the mezzanine notes, and TAI's role under the credit documents must be examined to determine whether TAI is a co-obligor (jointly and severally liable for the full $112.3 million) or a guarantor (secondarily liable). If TAI is only a guarantor, CODI may be realized primarily by TSL rather than TAI, with TAI's CODI limited to the extent of the guarantee liability discharged. This distinction is critical because TSL, as a Greek entity, may not be subject to U.S. federal income tax on the CODI unless it constitutes income effectively connected with a U.S. trade or business. We have requested copies of the relevant credit documents and expect to refine this analysis once the obligor structure is confirmed.
B. Senior Secured Credit Facility Amendment
The proposed amendment of the senior secured credit facility raises the threshold question of whether the changes constitute a "significant modification" under Treas. Reg. §1.1001-3, which would treat the amendment as a deemed exchange of the existing $540 million obligation for a new obligation with the modified terms.
Significant Modification Analysis:
(i) Maturity Extension (June 15, 2024 → June 15, 2027): The extension of the maturity date by three years constitutes a change in the timing of payments under Treas. Reg. §1.1001-3(e)(3). A deferral of payments is a significant modification if the deferred payments exceed certain thresholds based on the yield and the original term. The safe harbor for non-significance under Treas. Reg. §1.1001-3(e)(3)(ii) generally applies only to deferrals that are not material, measured against the lesser of five years or 50% of the original term. Given that the original maturity was approximately five years from inception (June 2019 to June 2024) and the proposed extension adds three years (60% of the original term), this change alone is likely significant.
(ii) PIK Conversion of $75M TLA: Converting $75 million of TLA principal from cash-pay to PIK status materially defers the cash payments associated with that portion of the debt. This change also affects the yield of the instrument. The combined effect of the PIK conversion and maturity extension almost certainly satisfies the yield-change threshold under Treas. Reg. §1.1001-3(e)(2), as the effective yield of the modified instrument (reflecting deferred payments and PIK accrual) will differ materially from the yield of the unmodified instrument.
(iii) Revolving Credit Commitment Reduction ($200M → $150M): The reduction of the revolving credit commitment, standing alone, may not constitute a significant modification if no drawn amounts are forgiven. The reduction from $200 million to $150 million may simply reduce the availability of future draws. However, if any portion of the currently drawn $185 million is required to be repaid as a result of the commitment reduction (i.e., $35 million in excess of the new $150 million commitment), this prepayment may interact with the other modifications in the overall analysis.
(iv) Amendment Fee of $5.4M PIK: The PIK amendment fee increases the effective yield of the modified instrument, which must be factored into the yield-change analysis.
(v) Default Interest Waiver: The retroactive waiver of default interest (an additional 200 basis points on $540 million accruing from the date of default) reduces the total amount owed by the borrower. To the extent this default interest has accrued as a fixed obligation, the waiver may itself give rise to CODI.
Preliminary Conclusion: Based on the foregoing, we believe that the proposed amendments, taken in the aggregate, constitute a significant modification under Treas. Reg. §1.1001-3. The maturity extension, PIK conversion, and amendment fee collectively change both the timing and yield of the instrument beyond the applicable thresholds.
CODI Calculation: If the modification is treated as a deemed exchange, the CODI analysis requires a comparison of the adjusted issue price of the "old" debt ($540 million outstanding) with the issue price of the "new" deemed-exchanged debt. Critically, if the total principal amount remains $540 million (no face amount is being forgiven), CODI arises only if the issue price of the new instrument is less than $540 million. This could occur if the modified instrument does not bear adequate stated interest, resulting in OID and an issue price less than the face amount.
We note, however, that the modified instrument will bear interest at SOFR plus 375 basis points on the cash-pay portion and at least an equivalent rate on the PIK portion (with the additional $5.4 million PIK fee). Given current SOFR levels of approximately 3.8%–4.0%, the all-in rate on the modified instrument is approximately 7.5%–8.0% or higher. This rate exceeds the applicable federal rate for instruments of comparable term. Accordingly, the modified instrument likely bears adequate stated interest, and the issue price equals the stated principal amount. Under this analysis, no CODI arises from the deemed exchange of the principal amount.
The primary source of CODI from the senior secured facility amendment is therefore the waiver of accrued default interest. Default interest at a rate of SOFR plus 575 basis points (approximately 9.5%–10.0% all-in) has been accruing on $540 million since approximately October 10, 2022, the effective date of the covenant default. From October 10, 2022 through the anticipated waiver date (estimated January–February 2023), the incremental default interest (the additional 200 basis points above the contract rate) is estimated at:
$540M × 2.00% × (90–120 days ÷ 360 days) ≈ $2.7M–$3.6M
To the extent this default interest had accrued as an obligation of TSL/TAI and is subsequently waived, the waiver generates CODI in a corresponding amount. The precise figure will depend on (i) the date of the waiver, (ii) the applicable daily accrual calculation under the credit agreement, and (iii) whether the default interest is characterized as a fixed obligation or a contingent penalty under the terms of the credit documents. We estimate the CODI from the default interest waiver in the range of $2 million to $5 million, pending confirmation of the specific amounts from Nordbank's counsel at Whitfield, Crane & Burgess LLP (Graham Whitfield III) or from KHP.
C. Intercompany Note Modification
The proposed modification of the $76.4 million subordinated intercompany note from TAI to TSL raises significant modification concerns under Treas. Reg. §1.1001-3.
Current Terms: $76.4 million principal, 5.0% interest rate, subordinated.
Proposed Terms: Maturity extended to December 2028, interest rate reduced from 5.0% to 2.0%.
Significant Modification Analysis: The reduction of the interest rate from 5.0% to 2.0% represents a 300 basis point decline, which far exceeds the greater of (a) 25 basis points or (b) 5% of the annual yield of the unmodified instrument (5% × 5.0% = 25 basis points). Under Treas. Reg. §1.1001-3(e)(2), a change in yield exceeding this threshold is a significant modification. Additionally, the extension of the maturity date further changes the timing of payments. Accordingly, the proposed modification almost certainly constitutes a significant modification, triggering a deemed exchange of the old intercompany note for a new note with the modified terms.
CODI Calculation: Under the deemed exchange, the CODI realized by TAI (as the debtor/maker of the note) equals the excess of the adjusted issue price of the old note over the issue price of the new note. The adjusted issue price of the old note is $76.4 million (assuming no OID at issuance). The issue price of the new note depends on whether the new note bears adequate stated interest.
The new note will bear interest at 2.0% per annum. As of December 2022, the applicable federal rates are approximately as follows:
The intercompany note, as modified, would have a remaining term of approximately six years (to December 2028), placing it in the mid-term AFR category. The stated rate of 2.0% is below the mid-term AFR of approximately 4.1%. Accordingly, the new note does not bear adequate stated interest, and the issue price must be determined by discounting the future payments at the AFR.
Illustrative Calculation (assuming annual interest payments and bullet maturity at December 2028):
Annual interest payment: $76.4M × 2.0% = $1.528M Principal payment at maturity: $76.4M Discount rate (mid-term AFR): 4.1%
Present value of interest payments: $1.528M × [PV annuity factor, 6 years, 4.1%] ≈ $1.528M × 5.186 ≈ $7.92M Present value of principal: $76.4M × [PV factor, 6 years, 4.1%] ≈ $76.4M × 0.787 ≈ $60.14M
Issue price of new note ≈ $7.92M + $60.14M ≈ $68.06M
CODI = $76.4M – $68.06M ≈ $8.34M
We note that this calculation is illustrative and sensitive to assumptions regarding the precise AFR applicable on the exchange date, the payment frequency, and the compounding convention. The actual CODI could range from approximately $5 million to $12 million depending on these variables. A more precise calculation will be performed once the final terms of the intercompany note modification are agreed upon and the AFR for the applicable month is confirmed.
Additionally, the difference between the face amount of the new note ($76.4 million) and its issue price (approximately $68.06 million) constitutes original issue discount on the new note. TAI, as the issuer, would be entitled to deduct the OID as it accrues over the life of the new note. TSL, as the holder, would be required to include the OID in income as it accrues. Because these are related parties that do not file a consolidated U.S. return (TSL is foreign), the timing and character of these inclusions and deductions must be analyzed further, including under the matching and acceleration rules of Treas. Reg. §1.163-12 and §267(a)(2).
D. Summary of Estimated CODI Exposure
The following table summarizes the estimated CODI exposure by instrument and by restructuring scenario:
Entity Allocation: As noted above, the critical question of which entity — TSL or TAI — realizes the CODI from the mezzanine note exchange depends on the obligor structure under the credit documents. If TSL is the primary obligor and TAI is only a guarantor, the bulk of the mezzanine CODI would be attributable to TSL, reducing TAI's direct CODI exposure. TAI-specific CODI would then consist primarily of the intercompany note modification CODI ($5M–$12M), any allocated portion of the senior secured facility CODI attributable to TAI's co-borrower obligation on the TLB ($85 million), and any guarantee-discharge CODI. We will refine this analysis once the credit documents have been reviewed and the obligor-tracing analysis is complete.
V. Section 108 Exclusions from CODI
A. Overview of §108(a) Exclusions
Section 108(a)(1) of the Code provides that gross income does not include any amount that would otherwise be includible in income by reason of the discharge of indebtedness of the taxpayer if the discharge occurs under one of the following specified circumstances:
(A) Title 11 case — the discharge occurs in a case under Title 11 of the United States Code (the Bankruptcy Code), and the taxpayer is under the jurisdiction of the court in such case, and the discharge is granted by the court or pursuant to a plan approved by the court (the "bankruptcy exclusion");
(B) Insolvency — the discharge occurs when the taxpayer is insolvent, to the extent the taxpayer is insolvent (the "insolvency exclusion");
(C) Qualified farm indebtedness — not applicable to the present facts;
(D) Qualified real property business indebtedness — not applicable to the present facts; and
(E) Qualified principal residence indebtedness — not applicable to the present facts (TAI is a corporation, and this exclusion applies only to individuals).
Both the bankruptcy exclusion under §108(a)(1)(A) and the insolvency exclusion under §108(a)(1)(B) are potentially available in the present case, depending on the restructuring path chosen. The analysis of each exclusion follows.
Importantly, §108(a)(2) establishes a priority ordering among the exclusions. The bankruptcy exclusion takes precedence: if the discharge occurs in a Title 11 case, subparagraphs (B), (C), and (D) do not apply. In other words, the insolvency exclusion is applied only to the extent the taxpayer is not in a Title 11 case. This priority rule is relevant to the dual-track analysis because, in the Chapter 11 scenario, the bankruptcy exclusion would apply in lieu of the insolvency exclusion, and the two exclusions cannot be combined.
B. Bankruptcy Exclusion — §108(a)(1)(A)
The bankruptcy exclusion is the most powerful of the §108 exclusions because it provides an unlimited exclusion for all CODI realized by a debtor in a Title 11 case. There is no dollar cap; the exclusion covers the full amount of CODI, regardless of the taxpayer's degree of insolvency or the magnitude of the discharge.
The requirements for the bankruptcy exclusion are as follows:
(i) The discharge must occur in a "Title 11 case," which is defined under §108(d)(2) as a case under Title 11 of the United States Code (the Bankruptcy Code);
(ii) The taxpayer must be "under the jurisdiction of the court" in such Title 11 case; and
(iii) The discharge must be "granted by the court or is pursuant to a plan approved by the court."
Application to TAI — Chapter 11 Scenario: If TAI files a voluntary petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas, Houston Division, and the restructuring of the mezzanine notes, senior secured credit facility, and intercompany note is effectuated pursuant to a confirmed plan of reorganization, then all CODI realized by TAI would be fully excludable from gross income under the bankruptcy exclusion. There is no limitation based on insolvency amount or any other metric. The full estimated CODI exposure of $48.8 million to $69.3 million (to the extent attributable to TAI) would be excluded.
Application to TSL: TSL is a Greek corporation organized under Greek law. If TSL does not itself file a petition under Title 11 of the U.S. Bankruptcy Code — and instead proceeds under a Greek insolvency or restructuring regime (such as Greek Law 4738/2020 on debt regulation and second chance) or does not file at all — the bankruptcy exclusion under §108(a)(1)(A) is not available to TSL for U.S. federal income tax purposes. A foreign insolvency proceeding does not constitute a "Title 11 case" within the meaning of §108(d)(2). However, TSL's liability for U.S. federal income tax on CODI depends on whether the CODI constitutes income effectively connected with a U.S. trade or business under §§871 and 882. If TSL's CODI is not effectively connected income, it may not be subject to U.S. tax in the first instance, rendering the §108 exclusion analysis moot for TSL. This issue is addressed further in the forthcoming December 20, 2022 cross-border tax memorandum.
Key Implication for Dual-Track Strategy: The bankruptcy exclusion provides the broadest and most certain tax protection for TAI's CODI. The availability of this unlimited exclusion is one of the significant tax advantages of the Chapter 11 contingency path. If the out-of-court RSA is executed without a Chapter 11 filing, the bankruptcy exclusion is unavailable, and TAI must rely on the more limited insolvency exclusion.
C. Insolvency Exclusion — §108(a)(1)(B)
The insolvency exclusion provides that CODI is excluded from gross income to the extent the taxpayer is "insolvent" immediately before the discharge. Unlike the bankruptcy exclusion, the insolvency exclusion is subject to a dollar limitation: it excludes CODI only up to the amount of the taxpayer's insolvency. Any CODI in excess of the insolvency amount is included in gross income and subject to tax.
"Insolvency" is defined under §108(d)(3) as the excess of liabilities over the fair market value of assets. This determination is made on a taxpayer-by-taxpayer basis, immediately before the discharge. The Supreme Court confirmed in Gitlitz v. Commissioner, 531 U.S. 206 (2001) (addressing the analogous S corporation context), that insolvency is measured at the entity level using fair market values.
Insolvency Analysis for TAI (Standalone):
Because TAI does not file a consolidated U.S. return with TSL (which is foreign), the insolvency analysis must be performed on TAI's standalone balance sheet, examining TAI's own liabilities and the fair market value of TAI's own assets as of the date immediately before the discharge.
TAI Liabilities:
• TLB co-borrower obligation: $85.0 million (TAI is a co-borrower on the TLB tranche)
• Intercompany note payable to TSL: $76.4 million
• Accrued interest on intercompany note: to be determined
• Portion of trade payables allocable to TAI: to be determined from TAI's standalone books
• Guarantee liability on parent's senior secured and mezzanine obligations: this is a critical variable — if TAI has guaranteed all or a portion of TSL's obligations under the senior secured facility and the mezzanine notes, the guarantee liability could be substantial; the treatment of contingent liabilities for insolvency purposes under §108(d)(3) requires analysis of whether the guarantee constitutes a "liability" for this purpose; see Merkel v. Commissioner, 109 T.C. 463 (1997) (contingent liabilities included if more likely than not to be paid)
• Other liabilities (accrued compensation, lease obligations, etc.): to be determined
TAI Assets (Fair Market Value):
• Houston terminal lease and improvements
• Domestic freight brokerage business (customer contracts, goodwill, workforce)
• Accounts receivable
• Intercompany receivables from TSL or affiliated entities (if any)
• Cash and cash equivalents
• Other tangible and intangible assets
TAI's revenue for fiscal year 2022 is estimated at $198 million. A separate standalone valuation from KHP is necessary to determine the fair market value of TAI's assets. Preliminarily, we note that the insolvency analysis for TAI is uncertain. TAI may or may not be insolvent on a standalone basis, depending critically on (a) the fair market value assigned to its Houston terminal operations and brokerage business, (b) the treatment of contingent guarantee liabilities, and (c) the treatment of intercompany payables and receivables.
If, for example, TAI's total liabilities (including the $85 million TLB obligation and $76.4 million intercompany note) are approximately $180 million–$220 million, and its assets are valued at $100 million–$160 million, the insolvency amount would be approximately $20 million–$120 million. The available insolvency exclusion would be capped at that amount. Any CODI exceeding the insolvency amount would be taxable.
Insolvency Analysis for TSL (Consolidated/Group Level):
Although the insolvency analysis applies on a taxpayer-by-taxpayer basis (and TSL's U.S. tax obligations depend on ECI analysis), we note for informational purposes that TSL appears insolvent on a group-wide balance-sheet basis:
• Total liabilities: approximately $847.3 million
• Fleet appraised value: $623 million
• Other assets (including TAI, cash, receivables): estimated $50M–$100M
• Total asset FMV: approximately $673M–$723M
• Degree of insolvency: approximately $124M–$174M
On this basis, TSL's insolvency amount significantly exceeds any CODI that might be attributable to TSL. However, as noted, TSL's U.S. tax obligation on CODI requires ECI analysis, and the insolvency exclusion under U.S. law applies only to U.S. taxable income.
Recommendation: We strongly recommend that the team obtain a detailed standalone balance sheet for TAI from Diana Restrepo (VP Finance, TAI), reflecting fair market values as of the most recent practicable date, and that KHP (James Calloway) be engaged to prepare a standalone insolvency analysis for TAI. Without this data, we cannot quantify the precise capacity of the insolvency exclusion, which is critical to evaluating the tax consequences of the out-of-court path.
D. Comparison: Bankruptcy Exclusion vs. Insolvency Exclusion in Context
The following table summarizes the key differences between the two available exclusions in the context of the TSL/TAI restructuring:
Out-of-Court RSA Scenario: Under the out-of-court path, only the insolvency exclusion is available. If TAI's insolvency amount (as determined under a standalone balance-sheet analysis) is less than the total CODI attributable to TAI, the excess CODI is taxable income. For example, if TAI's insolvency amount is $30 million and TAI's total CODI is $50 million, TAI would exclude $30 million and recognize $20 million of taxable CODI.
Chapter 11 Scenario: Under the Chapter 11 path, the bankruptcy exclusion fully excludes all CODI realized by TAI without dollar limitation. TAI would recognize zero taxable CODI regardless of its solvency status.