Morning Zoo Radio and Cash Flow Relief for Issuers: Part 1
Monday, August 24, 2020

The pandemic is forcing even the most frugal issuers to seek to reduce or postpone their debt repayment requirements. There are many ways to do this. Each approach has pros and cons from a business perspective. Not surprisingly, each approach also has tax consequences that are often not intuitive and sometimes downright devilish. We will tackle them one at a time in a series of bite-size (relatively speaking) posts. First up: It’s America’s #1 Morning Zoo Tag-Team Radio Show: SCOOP AND CHUCK! 

Like “Cinderella Bonds” and “total return swaps,” the term “Scoop and Chuck” can mean several things. To your stir-crazy author, it conjures images of  two zany morning radio hosts bantering and giving incessant weather reports (“It’s 99 degrees and miserable in Houston, 99 degrees and miserable in Galveston, 99 degrees and miserable in Katy, 99 degrees and miserable in the Woodlands. . .” ), while their dopey sidekick hosts a 2-for-1 giveaway from a dunk tank at a local discount mattress store. (Maybe that’s just me.)

(Also, because the term involves the word “scoop,” I bet you thought we were going to go with yet another ice cream metaphor, didn’t you? Such range we have!)

The basic idea of the “Scoop and Chuck” is that an issuer sticks its metaphorical shovel into the ground, “scoops” up its scheduled debt service payments, and “chucks” them into the future. The issuer accomplishes this not by a literal deferment[1] of the scheduled payments, but rather by issuing refunding bonds that have a repayment schedule that is more spread out in time than the repayment schedule of the refunded bonds. This affords the issuer time to build cash from revenues and other sources (instead of using them to pay debt service on the refunded bonds) so that the issuer can make the later debt service payments on the refunding bonds while also tackling other pressing needs in the meantime.

As we said above, there are several iterations of the scoop and chuck model. We’ll take what’s maybe the simplest iteration first: The only principal and interest on the issue that is being scooped and chucked is interest (no principal) that will accrue on the refunded bonds in the upcoming months and years.

For tax purposes, two questions are critical to consider in all scoop and chuck structures. This one is no different. First, when does the principal and interest to be scooped and chucked come due? Second, how much principal and how much interest is the issuer scooping and chucking?

On the first question: The scoop and chuck issue will, in general, be treated as a “refunding issue.” This is because the issuer will use the proceeds of the scoop and chuck issue “to pay principal, interest, or redemption price on another issue,” under Reg. 1.150-1(d)(1). Thus, in general, the issuer must not use the proceeds of the scoop and chuck issue to pay debt service on the prior issue more than 90 days after the issuance date of the new issue, or else the scoop and chuck issue will be an advance refunding issue, the interest on which will be taxable in almost all cases.

However, there’s an exception. (There’s always an exception.) The scoop and chuck issue is not a refunding issue if the only principal or interest that the scoop and chuck issue will be paying is:

  • interest (i.e., the issuer isn’t scooping and chucking any principal)
  • on another issue
  • which either:
    • accrues on the other issue during a one-year period including the issue date of the scoop and chuck issue, or
    • is a capital expenditure (i.e., accrues on the prior issue and is allocable to a prior project that is still, or
    • is a working capital expenditure that qualifies for an exception to the dreaded proceeds-spent-last rule, under Reg. 1.148-6(d)(3)(ii)(A).

So, if the only principal and interest to be scooped and chucked is interest that fits into one of the above three categories, the scoop and chuck issue isn’t a refunding issue, so it by definition can’t be an advance refunding issue. Under our facts, we’re doing the classic “interest-only” scoop and chuck, so as long we keep our interest to one of those three categories, and don’t scoop and chuck any principal that means we get to use the world’s biggest shovel and scoop and chuck years and years of interest, right? Head on down to the MATTRESS MADNESS EVENT at Acme Mattress and see if you can dunk Cletus. Then, if you know the Phrase that Pays (TM), he’ll give you the answer.

[1] We’ll deal with that situation, too, in a future post.

 

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