Bankruptcy court rules OID generated in fair market value debt exchange should be allowed

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On 15 November 2013, judge Martin Glenn of the Bankruptcy Court for the Southern District of New York held that original issue discount (OID) created in a prepetition ‘fair market value’ debt exchange is not disallowable in bankruptcy. This ruling provides important and long-awaited guidance for the investing community on the question left open by the Second Circuit’s 1992 ruling in LTV Corp v Valley Fidelity Bank & Trust Co (In re Chateaugay Corp).

OID is a form of ‘deferred interest’ that is generated when a bond is issued for less than its face value. The discount is the difference between the face value of a bond and the price paid to the issuer. For instance, if a company issues a zero coupon bond with a face value of $100 (£62) at an issue price of $80, the OID for the bond is $20.

Although OID is only payable at maturity, for tax and accounting purposes, OID is amortised over the life of the bond. In a debt exchange, the issue price of the new debt is generally determined by reference to its market value at the time of issuance…

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