Preferred Stock Shouldn't Be Recharacterized As Debt

[2] Your position, as well as that of the Examiner here, is that the preferred stock issued by * * * (hereafter "S") should be recharacterized as debt. The consequence of this recharacterization is that the shareholders would not be entitled to a dividends received deduction within the meaning of I.R.C. section 243. In view of the low risk nature of S's permitted investments, you believe the preferred stockholders are virtually guaranteed a right to dividends and repayment of the principal and therefore should be treated as bondholders.

[3] In Rev. Rul. 90-27, the Service concluded that the terms of the described issue of dutch-auction rate preferred stock issued by X, a publicly held domestic corporation, did not cause the stock to be equity for federal income tax purposes. The fact that the required investments in the revenue ruling were composed of high quality assets was not, in and of itself, determinative of the debt/equity question. It was observed that although, from an investor's perspective, the stock resembled an investment alternative to short-term debt, there were critical differences in legal rights. In light of these legal rights, it was held that the Service would not seek to recharacterize that stock as debt. Based upon inferences that may be drawn from this revenue ruling and for the reasons stated below, we disagree with your conclusion concerning the preferred stock in this case.

[4] Several years prior to * * * tens of billions of dollars of preferred stock, similar to those here, were issued. See Schler, Money Market Preferred Stock: Making the Punishment fit the Crime, 46 Tax Notes 935 (Feb. 19, 1990); Frost & Conlon, Adjustable Rate Preferred Stock Still Provides Many Tax Benefits, 73 J. Taxation 244 (Oct. 1990); and Jassy, Issuances of Floating Rate Preferred Stock by Special Purpose Subsidiaries of Loss Corporations, 39 Tax Lawyer 519 (Spring 1986). Generally, the reason for the popularity of this type of financing arrangement was that it permitted the parent corporation to take advantage of expiring net operating losses in its consolidated return.

[5] * * *-auction rate preferred stock is often issued by special purpose subsidiaries that have an asset base consisting principally of highly rated debt obligations (frequently a Standard and Poor's rating of AAA or better). Typically, a corporation with large net operating losses sets up a subsidiary, referred to as a special purpose corporation, and either transfers high grade securities to it (generally government securities or government backed mortgage obligations), or has the entity invest in these securities from the proceeds of the preferred stock underwriting. Usually the special purpose corporation will, in the year in which the dividends are paid, be unable to use deductions for interest which would have been paid had the special purpose corporation issued commercial paper. This is because the special purpose corporation ordinarily files a consolidated return with its parent organization.

[6] The dividend rate can be offered at a lower rate than the interest rate on commercial paper because, in the hands of a corporate holder, only 30 percent (20 percent prior to 1988) of the dividends are subject to tax as a result of the dividends received deduction. The tax rate on such dividends for a corporation in the 34 percent bracket is only 10.2 percent (30 percent times 34 percent). Thus, for example, the after tax yield on commercial paper paying 9 percent interest to a corporation in the 34 percent bracket is 5.94 percent (i.e. 9 percent less a 34 percent tax) while the after tax yield on the above described preferred stock paying a rate of 7 percent is 6.29 percent (i.e. 7 percent less a 10.2 percent tax).

[7] In the Revenue Reconciliation Act of 1989 Congress promulgated I.R.C. section 1503(f) to deal with the above method of utilizing expiring net operating losses. The new provision states, in brief, that if a consolidated subsidiary issues preferred stock described in I.R.C. section 1504(a)(4), tax losses of other group members may not be used to reduce the separately computed taxable income of the issuer to a level below the amount of dividends paid on that stock. The provision was specifically made prospective for stock issued after November 17, 1989. You now wish to attack the above financing mechanism under the debt/equity rules. If the stock is reclassified as debt, the dividends received deduction would not be applicable and this would decrease the after tax yield.

[10] S may invest in government obligations, mortgage backed securities, corporate and municipal securities with a Standard & Poors rating of "AAA," commercial paper with a Standard & Poors rating of at least "A-1+," demand and time deposits, certificates of deposit, bankers acceptances, and certain other high quality securities. S may freely substitute the assets in its portfolio and, subject to certain limitations, incur direct borrowings of up to $ * * * and additional borrowings in the form of reverse repurchase agreements. At the time of the issuance of the preferred stock, S's assets, which were contributed by P, consisted of FNMA and FHLMC mortgage pass-through certificates evidencing interest in pools of residential mortgage loans with stated maturities ranging from the year 2009 through 2026. S sold * * * shares of preferred stock for $ * * * collateralized by the mortgage backed securities, and transferred the net proceeds to P, as a return of capital. ¹

[11] The terms of the preferred stock are set forth in the Certificate of Incorporation. The preferred stock had a fixed dividend rate of * * * percent per annum until * * * and thereafter has an adjustable dividend rate equal to * * * percent plus the highest of the One-Year, Ten-Year, or Twenty-Year Treasury Obligation Rate. The dividend payment dates are set quarterly, starting on January 1. The Certificate is to be amended to provide for additional payments to holders of the stock in the event the preferred stock is treated as "debt" for federal income tax purposes. The stock is subject to optional redemption by S, in whole or in part, on any dividend payment date on or after * * *. A provision exists for mandatory redemption if the required asset coverage (an unspecified figure in excess of $ * * *) is not maintained. In addition, S is required to redeem any share upon demand out of funds legally available therefore at a redemption price of $ * * * per share on any dividend payment date on or after * * *. In the event S fails to maintain the required asset coverage or fails to redeem the stock as required by the terms of the agreement, the preferred shareholders shall be given voting rights sufficient to elect a majority of the board of directors.

[12] The liquidation preference of the shares is set at $ * * * per share, plus an amount equal to accrued and unpaid dividends. The liquidation preference is stated as subordinate to other creditors. There is no obligation by any entity to make capital contributions to S.

[13] For accounting purposes, the preferred stockholders here are required to treat the preferred stock as debt since it is a collateralized mortgage obligation (CMO). See FASB Technical Bulletin 85-2, effective for CMOs issued after March 31, 1985, and FASB Issue Summary Number 89-4, Supplement Number 6. Since 1973, the Financial Accounting Standards Board has been the designated authoritative organization for establishing standards of financial accounting. Any deviation from a FASB accounting pronouncement requires an auditor to qualify the opinion or explain in the body of the report the reasons for the departure. The Office of the Comptroller of currency has ruled that the foregoing pronouncement is the proper treatment of accounting for bank regulatory purposes. See 1987 OCC QJ 43.

[15] Courts have not established any comprehensive rule for determining the proper classification of an instrument. Nevertheless, courts have identified various factors to look at in resolving the question. See Roth Steel Tube Co., 800 F.2d 625, 630 (6th Cir. 1986); Stinnett's Pontiac Service, Inc. v. Commissioner, 730 F.2d 634, 638 (11th Cir. 1984); Texas Farm Bureau v. United States, 725 F.2d 307 (5th Cir. 1984); In re Indiana Lake Estate, Inc. v. Stewart, 448 F.2d 574 (5th Cir. 1971); and Fin Hay Realty Co. v. United States, 398 F.2d 694 (3d Cir. 1968). Among the factors that have been identified to determine whether a transaction is debt or equity are the following:

1. The names given to the instruments evidencing the indebtedness,

2. The presence or absence of a fixed maturity date and schedule of payment,

3. The presence or absence of a fixed rate of interest and interest payments,

4. Whether the advances were carried on the books of the lender and debtor as loans,

5. The source of repayments,

6. The adequacy or inadequacy of capitalization (the debt/equity ratio),

7. The identity of the interest between the creditors and the stockholders,

8. The security, if any, for the advances,

9. The corporation's ability to obtain financing from outside lending institutions,

10. The extent to which the advances were subordinated to the claims of other creditors,

11. The extent to which the advances were used to acquire capital assets, and

12. The presence or absence of a sinking fund to provide repayments.

See generally Plumb, The Federal Income Tax Significance of Debt: A Critical Analysis and a Proposal, 26 Tax L. Rev. 369 (1971); and Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders, Para 4.02 (5th ed. 1987).

[16] "The various factors which have been identified in the cases are only aids in answering the ultimate question whether the investment, analyzed in terms of its economic reality, constitutes risk capital entirely subject to the fortunes of the corporate venture or represents a strict debtor-creditor relationship." Fin Hay Realty Co., 398 F.2d at 697. Therefore, "[w]hether an instrument represents indebtedness or an equity investment for federal income tax purposes depends on the facts and circumstances of each case. No particular fact is conclusive in making such a determination." Rev. Rul. 83-98, 1983-2 C.B. 40, 41. See also John Kelley Co. v. Commissioner, 326 U.S. 521 (1946).

[17] The object of these factors is not to count them but to evaluate them. See In re Indian Lake Estates, Inc., 448 F.2d at 579. Furthermore, "[i]t still remains true that neither any single criterion nor any series of criteria can provide a conclusive answer in the kaleidoscopic circumstances which individual cases present." Fin Hay Realty Co., 398 F.2d at 696-697. In any event, the goal of the analysis is to determine whether there was "a genuine intention to create a debt, with a reasonable expectation of repayment, and did that intention comport with economic reality of creating a debtor- creditor relationship." Litton Business Systems, Inc. v. Commissioner, 61 T.C. 367, 377 (1973), acq,. 1974-2 C.B. 3.

[18] Numerous cases have dealt with the debt/equity problem in great detail. The following analysis will explore those cases and analyze those situations as they relate to the present case.

1. Fixed Maturity Date

[19] It has been held that the unconditional right of the holder of an instrument to receive the payment of its principal investment by a fixed (or ascertainable) maturity date is the most important factor supporting debt characterization. Racal Electronics v. Commissioner, 60 T.C. Memo. 1990-494; Development Credit Corp. v. Commissioner, T.C. Memo. 1988-127; Federal Express Corp. v. United States, 645 F. Supp. 1281 (W.D. Tenn. 1986); and Lansall Co. v. United States, 512 F. Supp. 1178 (S.D.N.Y. 1981). In some cases, it may be clear from the surrounding circumstances that there is, in effect, a fixed maturity date even in the absence of such a contractual provision. Comtel Corp. v. Commissioner, 376 F.2d 791 (2d Cir. 1967), cert. denied, 389 U.S. 929 (1967).

[20] According to the representatives of F, the preferred stock does not provide for fixed, unconditional payments of principal. The stock is redeemable on or after * * *, at the election of a purchaser, but only to the extent of legally available funds for a redemption of stock under * * * law. Under * * * law, a redemption is prohibited when the corporation is insolvent or would be rendered insolvent. * * *

[21] You argue that the redemption provisions here evidence the purchaser's right to receive an unqualified right to repayment on a date certain. If S fails to redeem the shares of preferred stock when requested, the shareholders, voting together as a class, are entitled to elect a majority of the board of directors and presumably force a redemption. The same is true if the required asset coverage is not maintained. Furthermore, you argue that the risk of insolvency upon redemption is so remote as to be illusory.

[22] In Zilkha & Sons v. Commissioner, 52 T.C. 607, 614 (1969), acq. 1970-1 C.B. xvi, considered in AOD 16784 (1970), the Service argued that the risks undertaken by the holders of preferred stock were illusory, because the holders acquired various protections that tended to assure the redemption of the stock by a specified date. In particular, if the preferred stock was not redeemed, the holders would be able to take over the management of the company and acquire all of its common stock for a nominal sum. The court disagreed with the Service saying that the indications of success were not so strong as to make redemption of the preferred stock inevitable. Furthermore, the parent's investment was not such as in practical effect to cause it to arrange for the redemption of the preferred stock in order to protect its investment.

[23] In Ragland Investment Co. v. Commissioner, 52 T.C. 867 (1969), considered in AOD 16693 (1969), aff'd per curiam 435 F.2d 118 (6th Cir. 1970), the Service again was in the position of contending for debt classification of preferred stock. The majority stockholders agreed to take all actions within their power to cause the company to redeem the preferred stock within four years from issuance. The Service urged that this, together with other protective provisions, amounted to a guarantee of redemption at a fixed maturity date. The court noted that the corporation, as distinguished from some of its shareholders in their individual capacities, was not obligated to redeem the preferred stock. The failure to redeem would not result in a cause of action against the corporation.

[24] In Ragland, the Tax Court noted that the existence of a fixed maturity date is not a conclusive factor. Later, in Miele v. Commissioner, 56 T.C. 556 (1971), the Tax Court reaffirmed this conclusion. While the stock certificates in Miele contained a definite maturity date, in that they were redeemable at the end of a specified period of time, the court nevertheless held that the indicia of equity predominated. The court noted that it was not unusual for preferred stock to have a maturity date.

[25] The Ragland case is contrary to an earlier case, Bowersock Mills & Power Co. v. Commissioner, 172 F.2d 904 (10th Cir. 1949), rev'g 6 TCM 1107 (1947). In that case a creditor, having a first mortgage on the assets of the company, agreed to become a preferred shareholder in order to improve the credit standing of the company. The agreement was conditioned on a guarantee by the common shareholders that the creditor would receive dividends and principal in fixed amounts on fixed dates, in default of which the creditor would take over the common stock. The Tenth Circuit held that the guarantee amounted to a fixed maturity date and therefore concluded that the "dividends" were deductible as interest. The Bowersock case is distinguishable from the case at hand because there was no guarantee of payment by a third party.

[26] Another case involving the agreement of a creditor to become a preferred shareholder, in order to improve the credit rating of the company, was United States v. Title Guarantee & Trust Co., 133 F.2d 990 (6th Cir. 1943). In that case, the Government was in the position of arguing that the dividends on the preferred stock were not interest, as contended by the taxpayer. In that case, the court held for the taxpayer on the grounds that the provision in the agreement, providing for cumulative dividends to be paid (together with the face value of the stock) on a fixed date, was equivalent to a provision that such payments be made regardless of earnings. See also Choctaw, Inc. v. Commissioner, 12 T.C.M. 1393 (1953). These cases are distinguishable from the one here in that the dividends and principal in those cases were to be paid regardless of the earnings of the company.

[27] In Schott v. Commissioner, T.C. Memo. 1982-222, the Service again argued that the preferred shareholders' investment was not subject to risk and that the dividends were essentially "guaranteed" interest because the company was "a sure bet." The court held that the preferred stockholder had an equity investment which under state law would not rate a high priority on liquidation. See also Richmond. Fredericksburg and Potomac Railroad Co. v. Commissioner, 528 F.2d 917 (4th Cir. 1975) (a special class of "guaranteed stock" was held to be equity so that the premium element on redemption was not deductible as interest as the corporation claimed).

[28] In OM 17355, * * *, I-3615 (1971), the Service once again was in the position of arguing that preferred stock subject to various protective provisions was, in substance, debt. It was stated therein that the preferred shareholders had secured, as a practical matter, their priority of claim to the company's assets as a result of the corporation's covenant not to incur any significant indebtedness or to issue any stock, ranking equally with or prior to the preferred stock, without the consent of the preferred shareholders. The only risk associated with the company was the possibility that the parent corporation would default and that the fair market value of the improved realty would fall below the amount due the preferred stockholders upon liquidation. The OM concluded that it could be demonstrated that the foregoing risk was de minimis and could hardly be equated with the risk ordinarily associated with equity participation.

[29] In GCM 36136, * * * I-462-74 (1975), the Service was faced with the same question here, namely whether the preferred stock should be reclassified as debt so as to deny the dividends received deduction. The redemption was conditioned on the corporation having legally available monies and upon full payment of all prior dividends. The sole remedy on default was the ability to elect a fixed portion of the board of directors. In view of these facts, it was concluded that the holders of the preferred stock did not have a fixed maturity date.

[30] In the instant case, we believe the redemption is not guaranteed. Subject to certain limitations, S may incur direct borrowings up to $ * * * and additional borrowings in the form of reverse repurchase agreements. S may also incur a tax liability if P's operations turn profitable and if P's net operating losses are used up. This latter situation is probably not likely, however, since S would probably exercise its right to redeem the preferred stock. If S were to incur a liability and were thereafter to liquidate, the holders of the preferred stock would be subordinate to the claims of creditors of S. In such circumstances, the right of redemption would not be inevitable because a redemption may only occur, under * * * law, if S is not insolvent or rendered insolvent.

[31] Another reason that a redemption is not guaranteed is that the value of the assets in S's portfolio could fall below $ * * *, the amount needed to redeem the shareholders. The value of the assets might fall, for example, if S were to substitute the mortgage backed securities with commercial paper that subsequently fell in value (due most likely to an increase in interest rates). In such case, the mandatory redemption provision with respect to required asset coverage might not come into play quickly enough to prevent loss to the preferred shareholders.

Based upon the above, we believe there is no fixed maturity date and therefore this factor favors F.

2. Default Remedies

[32] Classic debt provides that the creditor can sue for the amount in default, as well as accelerate the maturity of the entire principal. Equity (such as preferred stock), on the other hand, usually provides for the assumption of control of the management of the corporation, or perhaps the right to appoint a receiver. Gardens of Faith. Inc., 345 F.2d 180 (4th Cir. 1965). cert. denied, 382 U.S. 927 (1965).

[33] Failure to use appropriate security devices is a factor indicating that the instruments are equity rather than debt. Baker Commodities Inc. v. Commissioner, 48 T.C. 364 (1967), aff'd on other grounds, 415 F.2d 519 (5th Cir. 1969), cert. denied, 397 U.S. 988 (1970); and Universal Racquetball Rockville Center Corp. v. Commissioner, T.C. Memo. 1986-363 (1986). The "right to force payment of the sum as a debt in the event of default" is a very significant if not essential factor. Plumb, at 420 (citing United States v. South Georgia Ry. 107 F.2d 3, 5 (5th Cir. 1939)).

[34] The presence of an acceleration clause in the debt instrument has been looked at as a primary factor in determining that a purported debt should not be recharacterized as equity. National Farmers Serv. Corp. v. United States, 400 F.2d 483, 485 (Ct. Cl. 1968).

[35] In the instant case, there is no right of acceleration. The only remedy the preferred shareholders have, upon default of S's obligation to redeem, is the right to vote for a majority of the members of the board of directors. Although creditors often have the right to vote for members of the board of directors upon default, this right tends to be more indicative of stock than of debt. Accordingly, this factor favors F.

3. Certainty of Return

[36] A common attribute of debt is the right to receive interest even though there are no net earnings. Crawford Drug Stores, Inc. v. United States, 220 F.2d 292, 296 (10th Cir. 1955). The fact that interest is absolutely payable is a factor tending to establish a bona fide debt. Wagner Electric Corp. v. United States. 208 Ct. Cl. 1024 (1976). A true lender is concerned with interest. The failure to insist on interest payments ordinarily indicates that the investor is not seriously expecting any substantial interest income, but is interested in the future earnings of the subsidiary or the increased market value of its investment in the subsidiary. Curry v. United States, 396 F.2d 630, 634 (5th Cir. 1968), cert. denied, 393 U.S. 967 (1968).

[37] If payment of interest on purported debt is dependent on the discretionary determination of the board of directors, debt will usually not be recognized as such. Berkowitz v. United States, 411 F.2d 818 (5th Cir. 1969). On the other hand, if payment of interest is conditional upon corporate earnings, but requires no discretionary action by the board of directors, the debt will normally not be recharacterized as equity, in the absence of other significant factors indicating equity. Fin Hay Realty Co., 398 F.2d at 694; and Universal Castings Corp. v. Commissioner, 303 F.2d 620 (7th Cir. 1962).

[38] In the instant case, the Certificate of Incorporation provides for the quarterly payment of dividends on shares of the preferred stock at a prescribed rate. Such dividends are payable only when and if declared by the board of directors of S. The Certificate of Incorporation further provides that dividends may be paid only from funds legally available for the payment of dividends under * * * corporate law. Under * * * law, dividends may only be paid out of current profits (present and preceding fiscal year) or out of surplus (owner's equity over the par value of the stock or other designated capital). * * * . See also Penington v. Commonwealth Hotel Construction Corp., 151 A. 228 (1930) (if a company is a going concern, dividends cannot be paid to the preferred stockholders unless there is a surplus of net earnings out of which to pay them).

[39] As noted in Zilkha, 52 T.C. at 618, the fact that the rights of the preferred stockholders significantly increase the likelihood that dividends will be paid does not justify a conclusion that dividends are, in fact, required to be paid. If S has no current profits or surplus, payment of preferred stock dividends will be prohibited by applicable state law. From a theoretical standpoint, we can envision situations (generally involving the sale of assets that have fallen in value) where S could fail to have current profits or surplus. In such case, S would not be permitted to issue dividends. It is also possible that the board of directors may decide, in their discretion, not to issue dividends. This fact, however, may be without real substance. Failure to declare dividends would enable the preferred shareholders to vote which would result in a deconsolidation of S, thereby preventing P from using its net operating losses. Based upon the above, we conclude that the payment of dividends to the preferred shareholders is not guaranteed and therefore this factor favors F.

4. Adequacy of Capitalization

[40] One of the characteristics of debt is the emphasis on the safety of the principal; thin capitalization is suggestive of a lack of safety. The bottom line is whether the loan is so risky that it can only be regarded as venture capital. Bittker and Eustice, at Para 4.04-2. In determining whether a corporation is or is not thinly capitalized, the issue is whether the corporation is adequately capitalized for its intended purpose. Bradshaw v. United States, 683 F.2d 365, 374 (Ct. Cl. 1982); Gyro Eng. Corp. v. United States, 417 F.2d 437, 439 (9th Cir. 1969); and Piedmont Corp. v. Commissioner, 388 F.2d 886, 890 (4th Cir. 1968).

[41] The adequacy of capitalization can usually be determined by evaluating the debt/equity ratio. A high debt/equity ratio suggests a lack of credit worthiness, unless it is a special situation. See Roth Steel Tube Co., 800 F.2d at 630; and Smithco Engineering, Inc. v. Commissioner, T.C. Memo. 1984-43. Conversely, a low debt/equity ratio indicates credit worthiness. See Litton Business Systems. Inc., 61 T.C. 367 (1974); and W.W. Windle v. Commissioner, 65 T.C. 694 (1976). There is no sacrosanct debt/equity ratio below which the instrument will automatically be considered debt. It is usually assumed, however, that a 3 to 1 debt/equity ratio or less will lead to the conclusion that the corporation is adequately capitalized for its intended purpose. Bittker and Eustice, at Para 4.04-2.

[42] Some courts, however, have refused to hold that the debt/equity ratio is the most crucial factor. Joseph W. Hambuechen v. Commissioner, 43 T.C. 90, 101 (1964); and Henderson V. United States, 375 F.2d 36 (5th Cir. 1967). There are some cases that have held that a loan with a large debt/equity ratio was still valid debt. See Baker Commodities v. Commissioner, 48 T.C. 374 (1967), aff'd on other grounds, 415 F.2d 519 (5th Cir. 1969), cert. denied, 397 U.S. 988 (1970) (692 1/2 to 1 is still true debt); and Leach Corporation v. Commissioner, 30 T.C. 563 (1958), acq. 1959-1 C.B. 4.

[43] In the instant case, if we adopt your position that the preferred stock is debt, a large debt/equity ratio will result. The Service typically argues that a large debt/equity ratio is indicative of equity. We believe that support for your case undercuts the Service's position in the typical case where the Service tries to recharacterize debt as equity. While this factor is admittedly only one of many factors, the representatives of F are sure to make much ado about the Service's double standard.

5. Subordination

[44] If a financial instrument is subordinated to the point that the holder will be able to collect only if the enterprise is successful, an equity classification is likely. Traditionally, creditors are given priority over shareholders to claims against the corporation. In terms of relative standing upon a liquidation of the business, the position of the subordinated debt holder is not much different from that of a preferred stockholder. For this reason the financial community regards subordinated debt as quasi-equity. Accordingly, subordination, in combination with other substantial adverse factors, is a factor which tends to place an instrument in the equity category. Slappey Drive Indus. Park v. United States, 561 F.2d 572 (5th Cir. 1977); Tomlinson v. The 1661 Corporation, 377 F.2d 291 (5th Cir. 1967); and United States v. Henderson, 375 F.2d 36 (5th Cir. 1967).

[45] Under the terms of the Certificate of Incorporation, holders of the preferred stock are expressly subordinate to the claims of all general and secured creditors of S. In addition, * * * law provides that the holders of corporate interests may only participate, upon liquidation or dissolution of the corporation, in assets remaining after the payment of all indebtedness of the corporation. * * *. Accordingly, this factor favors F.

6. Sinking Fund.

[46] The absence of a sinking fund may be a factor in proving that the loan is not true debt. Tyler v. Tomlinson, 414 F.2d 844, 849 (5th Cir. 1969). "The lack may be excused, however, where a sinking fund would be inappropriate, if there is other evidence of the reality of the debt." Plumb, at 468.

[47] It appears that there was no provision for a sinking fund. Accordingly, this factor is indicative of an equity contribution and therefore favors F.

CONCLUSION

[48] In and of itself, the lack of risk of an investment will not support recharacterization of preferred stock as debt. Purported equity may be recharacterized as debt only if other factors combine to show that the investor, in substance, has all the rights of a creditor. Where the instrument is defined as preferred stock and is treated as such for local law purposes, the courts have not been willing to recharacterize the instrument as debt. Based upon the above, we conclude that the preferred stock here should not be recharacterized as debt.

[49] If you have any questions or need additional information, please contact Mr. William Baumer at 566-3335.