If we structure our sale as an installment contract under Section 453, how do we protect our deferred payments from being wiped out if the buyer files for bankruptcy or insolvency before the note is fully paid?

Question

Tyler Smith · Accepted Answer

An installment sale under Section 453 allows you to defer tax payments, but it exposes you to the ultimate credit risk: buyer bankruptcy. If the buyer files for Chapter 11, your unsecured installment note will be grouped with other unsecured creditors, and you may receive pennies on the dollar. To safeguard your deferred payments, you must structure the transaction with robust bankruptcy-remote protections. First, require the buyer to secure the installment note with an irrevocable letter of credit from a reputable bank. If the buyer defaults or files for bankruptcy, you can draw down on the letter of credit to receive your remaining payments directly from the bank. Under Section 453, a letter of credit that merely secures an installment note does not trigger immediate tax recognition, meaning you preserve your tax deferral while eliminating buyer credit risk. Second, include an acceleration clause in the note that makes all future payments immediately due and payable upon any event of default, including a covenant breach or a material drop in their debt-service coverage ratio. Use your leadership team to continuously monitor the buyer's post-closing performance metrics. De-risking your exit means preparing for the worst-case scenario so you do not pay a massive tax and financial penalty for a buyer's corporate insolvency.