11th Circ. Sows Doubt Over Insolvent Bank Tax Refunds

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1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: th Circ. Sows Doubt Over Insolvent Bank Tax Refunds Law360, New York (January 03, 2014, 6:04 AM ET) -- In the context of the insolvencies of banks and their holding companies, one highly litigated issue has been the ownership of tax refunds that result from losses suffered by the bank. While early in 2013 the issue may have seemed fairly settled, two Eleventh Circuit decisions have left the direction of the law on this issue uncertain. When a bank holding company and its subsidiary bank become insolvent, the holding company may file for bankruptcy, but the bank cannot.[1] Instead, an insolvent bank is typically placed in receivership, with the FDIC appointed as receiver. Thus, there are separate fiduciaries for the estates of the holding company and the bank. In addition, the creditor body of the estates is often different. The most significant creditors of the parent company may be bondholders or lenders that provided financing on a structurally subordinated basis to the holding company, while the FDIC, as the result of its subrogation to the claims of depositors it pays, may be the most significant creditor of the bank. 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 tax refunds payable by the IRS or state taxing authorities. Whether the refunds (which have often been in the tens or hundreds of millions of dollars) are property of the holding company s estate or, instead, are property of the bank s estate can have a significant impact on the recoveries of the respective creditors of the two separate estates. 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 file 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, and that the IRS will pay any refund to and in the name of the common parent. [2] As a result, it is common for the IRS to remit a tax refund to the parent for such a consolidated group even if the refund is attributable to losses by one or more of the subsidiaries. Because these regulations are purely procedural, however, members of the consolidated tax group are free to contract among themselves as to which member of the group will be entitled to any refund.[3] Where affiliated groups have entered into tax sharing agreements, courts resolving disputes with respect to the ownership of refunds look to the terms of the applicable tax sharing agreement to resolve the disputes. Until the Eleventh Circuit issued two decisions in the latter half of 2013, a clear majority of courts construing tax sharing agreements in cases in which such disputes had arisen interpreted such agreements to create only a debtor-creditor relationship between the holding company and its bank subsidiary with respect to tax refunds. These courts have therefore awarded refunds paid to the holding company to its bankruptcy estate even when those refunds were attributable to losses of the bank subsidiary.[4]

2 BankUnited In an apparent break from this line of cases, in the bankruptcy case of BankUnited Financial Corporation, the Eleventh Circuit held that a tax refund paid to BankUnited but attributable to the losses of its subsidiary bank belonged not to BankUnited s bankruptcy estate, but to the FDIC as receiver for the bank. Zucker v. FDIC (In re BankUnited Fin. Corp., 727 F.3d 1100 (11th Cir. 2013). Just a few weeks later, the Eleventh Circuit reached this same result in a dispute between the bankruptcy estate of NetBank Inc. and the FDIC as receiver for NetBank s subsidiary bank. FDIC v. Zucker (In re NetBank Inc.), 729 F.3d 1344 (11th Cir. 2013). In the BankUnited case, BankUnited, its subsidiary bank and subsidiaries of the bank had entered into a tax sharing agreement. The agreement provided for BankUnited to file consolidated tax returns for the family of companies, but contained one unusual provision: the bank, rather than the holding company, was responsible for the payment of all taxes on behalf of, and the distribution of refunds to, members of the consolidated group. The tax sharing agreement specified that each member of the group would determine its tax liability as if it were filing its own separate return and that each member of the group would pay the amount of its tax to the bank or, that the bank would pay to each member any net receivable. But the agreement did not explicitly address BankUnited s obligation to remit to the bank any tax refunds it received. BankUnited received a tax refund attributable to losses of the bank (or its subsidiaries). The bankruptcy court concluded that any obligation of the holding company to remit the refund to the bank was nothing more than a contractual duty giving rise to a debt, thus making the bank only an unsecured creditor of the holding company with respect to the refund at issue. BankUnited Fin. Corp. v. FDIC (In re BankUnited Fin. Corp.), 462 B.R. 885 (Bankr. S.D. Fla. 2011), rev d sub nom. Zucker v. FDIC (In re BankUnited Fin. Corp.), 727 F.3d 1100 (11th Cir. 2013). On a direct appeal, the Eleventh Circuit rejected the bankruptcy court s analysis. It concluded that the tax sharing agreement was ambiguous because it did not state when [BankUnited] must forward the tax refunds to the Bank, and did not explain whether [BankUnited] owns the refund before forwarding them to the Bank. Zucker v. FDIC, 727 F.3d at But notwithstanding this ambiguity, the court concluded that the parties intent, which controlled under Delaware law, was obvious : the parties intended that BankUnited forward the tax refunds to the Bank on receipt. Id. at In the Eleventh Circuit s view, this reading of the tax sharing agreement was necessary to fulfill the agreement s paramount purpose to ensure that that the tax refunds are delivered to the Group s members in full and with dispatch. Id. The court noted that it found nothing in the language of the agreement to suggest the opposite. In particular, the agreement did not specify a fixed interest rate, a fixed maturity date, or the ability to accelerate payment upon default the sorts of protection[s] the panel would have expected the bank to have demanded if it were merely a creditor of the holding company. Id. NetBank The tax sharing agreement in the NetBank case was different from the agreement in BankUnited but also contained a provision that was not, as far as we can tell, typical in the tax sharing agreements construed in earlier decisions. Pursuant to the tax sharing agreement, NetBank was responsible for preparing and filing consolidated returns on behalf of its affiliated tax group (including its subsidiary

3 bank and its subsidiaries) and was given sole discretion with respect to most matters concerning the consolidated returns, including the right to file and settle any claims for refunds. Each member of the consolidated group appointed NetBank as its agent and attorney-in fact to take such action... as NetBank may deem appropriate. In re NetBank Inc., 729 F.3d at If the bank incurred a net operating loss, a net capital loss or [was] entitled to credits against tax, the tax sharing agreement further required NetBank to pay the bank, not later than 30 days after the date on which a credit was allowed or refund was received, no less than the amount the Bank would have received as a separate entity (including its subsidiaries), regardless of whether the consolidated group [was] receiving a refund. Id. at With respect to allocation, the tax sharing agreement further stated that it was intended to allocate the tax liability in accordance with the Interagency Statement on Income Tax Allocation in a Holding Company Structure, and thus that tax settlements between NetBank and the bank (and its subsidiaries) should result in no less favorable treatment to the Bank Affiliated Group than if it had filed its income tax return as a separate entity." Id. at 1348.[5] The holding company received a refund from the IRS attributable to losses of the subsidiary bank. The bankruptcy court in NetBank concluded that the tax sharing agreement created only a debtorcreditor relationship between the holding company and the bank. It therefore awarded the refund to the holding company s bankruptcy estate. Zucker v. FDIC (In re NetBank Inc.), 459 B.R. 801 (Bankr. M.D. Fla 2010). In reaching this conclusion, the bankruptcy court relied on the broad discretion the tax sharing agreement gave to NetBank with respect to the processing of refunds, the fact that NetBank could be obligated to pay the subsidiary bank even if NetBank did not receive a refund, and the absence of any language in the tax sharing agreement requiring NetBank to segregate any refund it received. The district court summarily affirmed the bankruptcy court s decision. Zucker v. FDIC (In re NetBank), No. 11- CV-11-J-32 (M.D. Fla. June 25, 2012). As in BankUnited, the Eleventh Circuit rejected the NetBank bankruptcy court s analysis and instead concluded that the tax sharing agreement was ambiguous. NetBank, 729 F.3d at Applying Georgia law regarding contract interpretation, the Eleventh Circuit looked to the background of the contract and the circumstances under which it was entered into, particularly the purpose for the particular language to be construed. Id. In the Eleventh Circuit s view, the Interagency Policy Statement was key to all of these factors: The Policy Statement, which the agreement referenced, states that a parent receives refunds from a taxing authority as agent on behalf of the group members and counsels against entering into a tax allocation agreement that would grant ownership to the parent of refunds attributable to the Bank. Id. Based on the language of the tax sharing agreement and the Policy Statement, the court of appeals concluded that the parties to the tax sharing agreement intended to create an agency relationship with respect to refunds attributable solely to the bank group i.e., the parties intended that NetBank would hold such refunds as agent for the bank group. Id. at It therefore entered judgment for the FDIC. Aftermath Because the Eleventh Circuit in BankUnited and in NetBank relied on specific provisions in the respective tax sharing agreements at issue that may be unique, other courts may well treat those decisions as limited to their facts. In the first bankruptcy court decision after the Eleventh Circuit s BankUnited and NetBank opinions, that is exactly what the Bankruptcy Court for the District of Delaware did.

4 In its decision in Giuliano v. FDIC (In re Downy Fin. Corp.), 499 B.R. 439, 459 (Bankr. D. Del. 2013), the bankruptcy court concluded that the tax sharing agreements in BankUnited and NetBank contained provisions not present in the tax sharing agreement in the case before it, rendering those decisions factually distinguishable. The bankruptcy court therefore awarded the tax refunds paid to the holding company but attributable to losses suffered by the bank subsidiary to the bankruptcy estate of the parent. That decision, however, has now been appealed, so it remains to be seen whether that view of the BankUnited and NetBank decisions will be upheld. To the extent the Eleventh Circuit decisions are not seen as limited to their facts, time will tell whether future courts will follow the Eleventh Circuit s analysis which seems to assign less significance to the absence of explicit agency or trust language with respect to refunds than earlier decisions or whether they will adhere to the analysis applied by those earlier decisions. In one respect, however, the law remains clear even after the Eleventh Circuit decisions in BankUnited and NetBank. The cases are in agreement that the issue of which entity owns a tax refund is a matter of contract interpretation and that clear language in a tax sharing agreement will control. As a result, interested parties on all sides have every incentive to try to ensure that tax sharing agreements between a bank and its holding company state clearly the intentions of the parties as to which entity owns any tax refunds. By Philip D. Anker and Nancy L. Manzer, WilmerHale Philip Anker is a partner and vice-chairman of WilmerHale s bankruptcy and financial restructuring group. Nancy Manzer is a special counsel in the practice and they are both based in the firm s New York office. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. [1] 11 U.S.C. 109(b)(3) [2] 26 C.F.R (a)(2)(v). [3] Where the members of a consolidated tax group have not entered into a tax sharing agreement, the prevailing case law indicates that a tax refund belongs to the member of the group that generated the losses resulting in the refund. See Western Dealer Mgmt., Inc. v. England (In re Bob Richards Chrysler- Plymouth Corp.), 473 F.2d 262, 265 (9th Cir. 1973); Capital Bancshares, Inc. v. FDIC, 957 F.2d 203, 207 (5th Cir. 1992). [4] In a May 2013 decision, the Bankruptcy Court for the Southern District of California followed this majority line of case. See Imperial Capital Bancorp, Inc. v. FDIC (In re Imperial Capital Bancorp., Inc.), 492 B.R. 25 (S.D. Cal. 2013). For earlier cases, see, e.g., FDIC v. Amfin Fin. Corp., 490 B.R. 548 (N.D. Ohio 2013); Zucker v. FDIC (In re NetBank, Inc.), 459 B.R. 801 (Bankr. M.D. Fla. 2010), aff d, 2012 WL (M.D. Fla. June 25, 2012), rev d 729 F.3d 1344 (11th Cir. 2013); Team Fin., Inc. v. FDIC (In re Team Fin., Inc.), No , 2010 WL (Bankr. D. Kan. Apr. 27, 2010); In re IndyMac Bancorp Inc., No. 12- cv-02967, 2012 WL (C.D. Cal. May 30, 2012); Resolution Trust Corp. v. Franklin Sav. Corp. (In re Franklin Sav. Corp.), 182 B.R. 859 (D. Kan. 1995); United States v. MCorp. Fin., Inc. (In re MCorp. Fin.,

5 Inc.), 170 B.R. 899 (S.D. Tex. 1994). [5] See Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure, 63 Fed. Reg. 64, 757 ( Nov. 23, 1998). All Content , Portfolio Media, Inc.