Nonqualified Preferred Stock

The nonqualified preferred stock (NQPS) rules of Sec. 351(g), originally enacted in 1997, generally treat certain preferred stock as boot in certain exchanges under Secs. 351, 354, 355, 356 and 1036. According to Sec. 351(g)(3)(A), the term preferred stock means stock limited and preferred as to dividends and that does not participate in corporate growth to any significant extent.

New Law

AJCA Section 899 further refines the definition of preferred stock for purposes of the NQPS rules, by appending a sentence to the end of Sec. 351(g)(3)(A), providing:

Stock shall not be treated as participating in corporate growth to any significant extent unless there is a real and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation.

Effective Date

The provision is effective for transactions after May 14, 2003.

Implications

The new language is intended to clarify that, labels notwithstanding, stock will be treated as preferred stock under Sec. 351(g) (and, thus, potentially treated as NQPS) when, based on an analysis of the surrounding facts and circumstances, it does not have a real and meaningful likelihood of actually participating in the corporations earnings and profits. An example in the Conference Report illustrates that instruments preferred on liquidation and entitled to the same dividends as may be declared on common stock will not escape preferred stock classification, for purposes of the NQPS rules, by reason of the dividend participation right, if the corporation does not in fact pay dividends either to its common or preferred stockholders.

From Kirsten Simpson, Washington, DC