Page 108 - Bankruptcy and Reorganization Services

In its discussion of tax affecting, the court noted that, "A Subchapter S corporation does not pay taxes.
Some potential buyers do. But how much a buyer will pay for a revenue stream does not tell us whether
a firm is insolvent, except indirectly: If a buyer will pay a positive price for the firm’s stock, then it is
very likely to be solvent." fn 71 Commenting on an illiquidity discount, the court discussed differences
between selling stock traded in a liquid market and that of a closely held firm; the court found that even
though appraisals were usually lower than the present value of the firm’s income stream ("the hypothet-
ical price"), "this had nothing to do with whether the firm is insolvent. The thing being adjusted is the
anticipated selling price per share, not the asset side of a balance sheet." fn 72

The practitioner needs to be aware of the relevant case law in their venue. A complete discussion of tax-
affecting issues is beyond the scope of this practice aid. The reader is referred to numerous sources
available on this topic.

Balance Sheet Test Rejected for Start-up Companies

Some bankruptcy courts have rejected the balance sheet test in favor of cash flow and other tests in re-
gard to start-up companies. For instance, in the Teleglobe Communications Corp. case, the bankruptcy
court ignored one expert’s balance sheet test for a start-up company that was a U.S. subsidiary of a Ca-
nadian parent company, noting that "[t]he balance sheet test was not a good measure of the insolvency
of a start-up company, because it ignored non-balance sheet factors such as shareholder support and the
market when calculating value." fn 73 In this case, the evidence indicated that the parent company of the
debtor subsidiaries was able and willing to provide financial support to the debtors. The court also cited
the Delaware Chancery case of Francotyp-Postaliea AG & Co., noting that it dismissed the balance
sheet test in favor of the more reliable cash flow test regarding a start-up company because it "is all too
common, especially in the world of start-up companies...[for a company] to operate with liabilities in
excess of its assets for that condition to be the sole indicia of insolvency." fn 74

Does the Ability to Borrow Money Provide a Reasonable Prospect for Continuing?

In Production Resources Group, LLC v. NCT Group, Inc., the Delaware Court of Chancery denied a re-
quest for a motion to dismiss and allowed discovery to continue, in part to test the solvency of NCT, a
public company. In its findings, the court noted that although NCT conceded that its liabilities exceeded
its assets, it [NCT] believed that its ability to continue to borrow money to pay its debts did not render it
insolvent. In response, the court found that plaintiff PRG had alleged sufficient facts to support a rea-
sonable inference of insolvency, and the court questioned NCT’s viability, noting

That NCT has staved off collapse by pleading billions of unauthorized and unregistered shares
(of its penny stock), fails to negate the inference that the company has no reasonable prospect to
salvage its finances and continue as a viable going concern that meets its legal obligations.
NCT’s drastic circumstances differ materially from cases where the relevant corporation’s assets

fn 71 Id. at 695.

fn 72 Id.

fn 73 In re Teleglobe Communications Corp., 2008 WL 3819727 (Bankr. D. Del., Aug 7, 2008).

fn 74 Francotyp-Postalia AG & Co. v. On Target Tech., Inc, No. 16330, 1998 WL 928382, at *5 (Del. Ch. Dec 24, 1998).

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