A Foreclosure Sale

A Foreclosure Sale

January 01, 2007

A foreclosure sale of the Great Plains coal gasification project triggered more than $1 billion in income and some recapture of tax credits for the owners.

The owners were five interstate gas pipelines. The project was built in the early 1980’s in North Dakota to turn lignite into gas of high enough quality that the gas can be put into interstate pipelines. It has been operating since 1984. A partnership of the pipeline companies built the plant using $550 million in equity contributed by the pipelines and another $1.45 billion borrowed from a US government entity called the Federal Financing Bank. The US Department of Energy guaranteed repayment of the loan.

Gas prices dropped precipitously just as the project was nearing completion. By August 1985, the project had defaulted on the loan, and the Department of Energy ended up two months later having to repay the Federal Financing Bank $1.57 billion in principal and unpaid interest. The Department of Energy bought the project in June 1986 in a foreclosure sale by exchanging $1 billion of its debt claim against the project partnership. It later wrote off the remaining debt in exchange for the shares of a separate company that managed the project. In 1988, the government resold the project to an electric cooperative in North Dakota called Basin Electric.

The pipeline companies argued that they made a sale of the project to the government for only $1 billion and not the full $1.57 billion in outstanding debt. The US Tax Court disagreed. The rule is that when a “recourse” debt is involved, the borrower realizes only the market value of his assets in a foreclosure sale. (A debt is recourse if the lender can pursue the partners personally for repayment of the loan.) However, with a “nonrecourse” debt — or debt where the lender is limited to foreclosing on specific collateral — the borrower realizes the full amount of the debt in the foreclosure sale. The debt in this case was not explicitly labeled.However, the court said it was nonrecourse in substance because the government was unable to pursue the partners individually for repayment.

The court sided with the pipeline companies on the question of when the plant was sold to the government. The pipelines claimed both a 10% investment tax credit and separate 10% energy tax credit in 1984 when the plant went into service. Such tax credits vest ratably over five years. Thus, for example,if the plant was sold one year after it went into service, then 80% of the tax credits would have been recaptured. The pipelines argued that the foreclosure sale was not completed until November 1987 when the US Supreme Court declined to hear an appeal of the foreclosure. A sale is not final while it is still being appealed (and the sale date does not relate back once the appeals are exhausted). The IRS argued that the appeal was a sham with no purpose other than to delay when tax credits would be recaptured.The court declined to be drawn into a debate over motives.

The case is Great Plains Gasification Associates v.Commissioner.The court released its decision on December 27.


Keith Martin