Whose Refund? Eleventh Circuit Muddies The Law On Ownership Of Bank Tax Refunds In Bankruptcy

Summary: A new decision by the Eleventh Circuit has complicated the question of whether a tax refund is owned by a bank holding company in its bankruptcy, or by the holding company's operating bank subsidiary in its receivership. This issue is of great importance to the distressed investing community because it can create substantial shifts in recovery between creditors of the bank holding company and creditors of the operating bank. In contrast to several earlier cases that ruled for the bank holding company and its creditors, the new decision from the Eleventh Circuit requires the bank holding company to remit the refund to the FDIC as receiver of the operating bank subsidiary. Whether the decision will be followed and lead to a fundamental change in the direction of the case law, or be distinguished or rejected in future cases, remains to be seen. But, in the interim, the decision will create greater uncertainty for creditors of both

* * * * * * * * * *

In a recent decision, the Eleventh Circuit held that tax refunds remitted by the Internal Revenue Service to a holding company were not the property of the holding company's bankruptcy estate, but instead had to be forwarded to the Federal Deposit Insurance Corporation, as receiver for the separate estate of the holding company's bank subsidiary. The ruling, Zucker v. FDIC (In re BankUnited Fin. Corp.), ___ F.3d __, No. 12-11392, 2013 WL 4106387 (11th Cir. Aug. 15, 2013) (In re BankUnited Fin. Corp. II), is contrary to that of several bankruptcy and district courts, including that of the bankruptcy court below in the BankUnited case. Those earlier decisions held that tax refunds received by a holding company were the property of its bankruptcy estate, even if those refunds would have been payable to the subsidiary if the holding company and its bank subsidiary had filed separate returns.

Whether the Eleventh Circuit's decision will result in a fundamental and permanent change in the case law, or end up as a mere odd detour in bankruptcy jurisprudence, will turn on whether courts in the future distinguish it based on its somewhat unusual facts, and, if not, to what extent they are willing to accept its analysis of the applicable legal principles. Under either scenario, however, it appears that when a tax sharing agreement is in place, courts will continue to view disputes between bank holding companies and their bank subsidiaries as a matter of contract interpretation, meaning that tax sharing agreements that clearly and explicitly address who owns any refunds should be dispositive.

Background

In bankruptcy cases or other insolvency proceedings involving more than one affiliated corporation, it is not uncommon for intercompany issues to arise—e.g., which assets and which liabilities belong to the estates of which entities. These issues can be particularly important in the banking industry, when a bank holding company and its subsidiary bank both become insolvent. One reason is that, while the holding company can file for bankruptcy, a bank cannot, because the US Bankruptcy Code does not permit banks to become bankruptcy debtors. Instead, if the bank is insolvent, it is typically placed into receivership with the FDIC appointed as receiver.1 Thus, there are separate fiduciaries for the estates of the holding company and the bank: a debtor-in-possession (or bankruptcy trustee) and perhaps a creditors' committee for the bankruptcy estate of the holding company, and the FDIC for the receivership estate of the bank.

Moreover, the creditor body of the two estates is often very different. The most significant creditors of the holding company may be bondholders or lenders that provided financing to the holding company (often for it to capitalize its bank subsidiary), whereas the most significant creditor of the bank can be the FDIC itself because it will be subrogated to the claims of the bank's depositors to the extent that the FDIC's insurance fund pays those depositors.2

As a result, where a holding company and bank are both insolvent, disputes often arise between the bankruptcy estate of the holding company and the receivership estate of the bank. One leading subject of such disputes has been which estate is entitled to receive any tax refunds that may be payable by the IRS (or state taxing authorities). These tax refunds have been in the tens or hundreds of millions of dollars in some cases; indeed, in the Chapter 11 case of Washington Mutual and the receivership of its bank subsidiary, the tax refunds were potentially in the billions of dollars. Whether the refunds are property of the holding company's estate or, instead, are property of the bank's estate can thus have a significant impact on the respective recoveries of creditors of the two separate estates. If the refunds are owned by the bank holding company, those refunds can potentially lead to a recovery for "structurally subordinated" holding company creditors that is in excess of the recovery for operating bank creditors. It is perhaps not surprising, therefore, that this issue has led to considerable litigation.

The potential for controversy arises because IRS regulations generally permit affiliated corporate entities to file a consolidated income tax return. The regulations provide that if a group of affiliated corporations files such a consolidated return, the common parent will act as the "sole agent" for the group on all matters relating to the group's tax liability.3 Accordingly, the IRS will pay any refund "to and in the name of the common parent."4 But courts have held that these regulations are purely procedural; they do not determine as a substantive matter that the parent, rather than another member of the consolidated group, is entitled to the refund.5 And where the parent is a holding company with no operations of its own, it is unlikely that it generated the losses that give rise to the tax refund. Instead, it is likely that an operating company—in the case of a bank holding company, its subsidiary bank—generated those losses.

In such a context, there is little question that, at the very least, the subsidiary has a claim against the parent for the amount of the refund, either as a matter of common law or contract. But if the parent is insolvent and in bankruptcy, it can make a substantial difference for the creditors of the bank and the creditors of the holding company whether, on the one hand, the refund is held to be the property of the bank, or on the other hand, it is deemed the property of the holding company and the FDIC as receiver of the bank is left with a mere general unsecured claim against the holding company's bankruptcy estate. In the former case, the receivership estate of the bank will receive the full amount of the refund, and the bankruptcy estate of the holding company will receive none of it. In the latter case, the bankruptcy estate of the holding company will receive the full amount of the refund, and the receivership estate of the bank may, at most, get to share, pari passu, with other general unsecured creditors of the holding company in any distributions from the holding company's bankruptcy estate to those creditors.

Because the IRS regulations are purely procedural, several courts have held that the members of the consolidated group are free to decide as a matter of contract which member of the group will be entitled to any refund—that is, whose property the refund will become.6 Thus, in deciding to which entity a tax refund belongs, the courts typically consider whether the parent and the subsidiary (and any other members of the consolidated group) entered into a tax allocation or sharing agreement concerning the consolidated filings and, if so, the terms of that agreement.

Where the members of the consolidated group have not entered into a tax allocation or sharing agreement, the receivership (or other) estate of the subsidiary has generally prevailed. In a leading case in which the members of the group had not entered into any such agreement, the Ninth Circuit held that "a tax refund resulting solely from offsetting the losses of one member of a consolidated filing group against the income of that same member in a prior or subsequent year should inure to the benefit of that member." See Western...