TAX INDEMNITIES in lease transactions are not always enforced by the courts as written

TAX INDEMNITIES in lease transactions are not always enforced by the courts as written

August 01, 2001
TAX INDEMNITIES in lease transactions are not always enforced by the courts as written.

A federal bankruptcy court in New York refused recently to enforce a tax indemnity claim tied to a safe harbor lease of aircraft to Eastern Air Lines.  Eastern entered into safe harbor leases of its aircraft during the early 1980’s.  A “safe harbor” lease was basically a sale of tax depreciation and tax credits on the aircraft.  Congress allowed such transactions in 1981 and 1982 as long as they were structured in form to look like leases.

Eastern later went bankrupt and sold the planes, causing a loss of tax benefits to the lessors.  Eastern had agreed to idemnify the lessors against any loss of tax benefits on the planes.  The indemnity assumed a value for the tax benefits based on the corporate tax rate at the time of 46%.  Congress reduced the corporate tax rate to 35% in 1986.  The lessors suffered the tax loss after 1986.  Nevertheless, the indemnity let them claim compensation based on a 46% tax rate.

The bankruptcy court called the valuation using the 46% rate an “unenforceable penalty” and refused to enforce it on grounds that it would lead to a windfall for the lessors at the expense of the airline’s creditors.

Keith Martin