The losses that drove Sears Holdings Corp. into bankruptcy could end up being a valuable multibillion-dollar asset because of tax breaks — especially for Eddie Lampert, its chairman and most notable creditor.
When a company has accumulated net operating losses, it can use them to offset future taxable income. The rule that allows that accounting move is meant to give struggling companies more breathing room. For example, Sears saved $1.7 billion in deferred taxes in 2017, according to its most recent quarterly filing.
As of Oct. 15, when Sears filed for Chapter 11 protection,, the retailer estimated it had net operating losses large enough to offset $5 billion of future income, and separate tax credits of around $900 million.
These are the most valuable assets Sears has, but under U.S. tax law, they could disappear in bankruptcy if another company or investor takes control of the business.
While a sale in bankruptcy would often amount to a change in control, Lampert’s stock and debt stakes would help him avoid that if he wanted to take control. The chairman and his hedge fund, ESL Investments Inc., together own about 49% of Sears shares and are among Sears’s biggest creditors, having extended it $2.66 billion in debt through various loans.
Creditors who have held debt for 18 months before the filing and whose debt rose in the ordinary course of Sears’ business are "qualified creditors" who can thus avoid losing the tax assets even if there’s a shift in control. ESL “consistently has provided financing" when Sears was short on cash, according to the company’s bankruptcy filing.
In fact, says Roy Haya, head derivatives trader for Twenty-First Securities, a firm that specializes in structuring tax-efficient hedging transactions, it appears Lampert is now in a situation in which he can’t lose control of the company because of the assets, which only he appears able to take advantage of.
"By buying up almost half the stock while lending the company more money, he effectively created a situation such that no one could force a change in ownership, even in Chapter 11," Haya said.
Lampert’s potential purchase offer for Sears stores would be a "stalking horse bid," which would be tested at an auction for higher offers, according to court papers.
But other creditors might not decide to even bid, since they wouldn’t have the benefit of the tax advantages. In either case, avoiding liquidation is crucial, since the net operating losses could disappear in such a scenario, Haya said.
Robert Willens, a New-York based tax consultant, agrees Lampert has an edge in the bankruptcy — but it goes beyond even that.
Essentially, if Sears reorganizes and some of its debt converts to stock in a new company, Lampert could take more than half of the new stock without losing the tax asset. Should that happen, Sears would have to turn a profit to deploy the assets, but one way to do that is simply by buying companies, he said.
“Ironically, or perversely, Sears might become an acquirer of profitable companies, wielding its net operating losses as a weapon that allows it to pay more for those companies than other buyers because of the promise of avoiding taxes on the profits that they bring to the table,” Willens said.
ESL declined to comment. Sears didn’t return calls for comment, but its bankruptcy lawyers said in court filings that the assets could help its "efforts towards a successful reorganization."
The fate of Sears has yet to be decided, with the company trying to reorganize but admitting it could be forced to liquidate.
In its bankruptcy filing, it listed assets of $6.94 billion — not that much more than the tax losses. A big factor in whether the company survives will be whether Lampert extends a $300-million loan and offers to buy up a group of around 400 stores.
Sears has already used net operating losses, also known as NOLs, to offset a taxable gain of about $2.2 billion when it sold more than 200 Sears and Kmart stores to real estate company Seritage Growth Properties in 2015, according to a company filing. Lampert’s hedge fund has a stake in Seritage.
"They’ve been using NOLs to avoid paying taxes on the capital gains they’ve been realizing by selling off pieces of the company," Willens said.