Jonathon D. Pressley, a New Solution: 11 U.s.c. Sec. 1146(a) and the Ordinary Course of Business Distinction

• Publication year: 2011

A NEW SOLUTION: 11 U.S.C. Sec. 1146(A) AND THE ORDINARY COURSE OF BUSINESS DISTINCTION

INTRODUCTION

Businesses that seek protection from creditors under Chapter 11 of the Bankruptcy Code enter bankruptcy with the goal of reorganizing and emerging as profitable entities. The provisions in Chapter 11 aid the debtor in achieving this goal by giving a business time to reorganize and maximize the value of its assets.¹Section 1146(a)²of the Bankruptcy Code is one tool a debtor may use to maximize the value of its assets. It states, "[t]he issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed . . . may not be taxed under any law imposing a stamp tax or similar tax."³Plainly speaking, Sec. 1146(a) allows a debtor to issue securities or transfer real property without paying a "stamp tax or similar tax."⁴

Courts have established criteria for determining whether a given transaction constitutes a "stamp tax or similar tax."⁵Bankruptcy and circuit courts have held that real estate transfer and recordation taxes are included in this definition, and thus, these obligations are exempt from taxation under

Sec. 1146(a).⁶Debtors routinely use Sec. 1146(a) to sell assets without incurring transfer taxes to improve liquidity, satisfy creditors, or simply free themselves of a depreciating or underperforming asset. Whether a transfer or sale occurred "under a plan confirmed" was the subject of dispute in courts for over twenty years; however, the Supreme Court resolved the circuit split when it decided Florida Department of Revenue v. Piccadilly Cafeterias, Inc. in 2008.⁷

The Supreme Court's decision is inadequate because it ignores the intent of the statute and creates loopholes by being over-inclusive in some situations and under-inclusive in others. Congress should rewrite Sec. 1146(a) to nullify the Supreme Court's decision and implement the statute's goal.

The circuit split existing before Piccadilly was based on when the transfer was made in relation to the reorganization plan being confirmed.⁸Plan confirmation is the final step a debtor must take to emerge successfully from Chapter 11 bankruptcy and is the result of compromises by the debtor and creditors. One court interpretation of "under a plan confirmed" stated that transfers can take place before or after the plan is confirmed and be eligible for tax relief under Sec. 1146(a) as long as the transfer was essential to the plan's confirmation.⁹The other interpretation of "under a plan confirmed" stated that the transfer must occur after the plan's confirmation to be eligible for tax relief under Sec. 1146(a).¹⁰This interpretation did not consider the character of the transfer; instead, it solely relied on this timing distinction.

The Supreme Court resolved the circuit split in June 2008 when it adopted the circuit court interpretation that limited Sec. 1146(a) to transfers that occur after the plan's confirmation.¹¹While both interpretations were reasonable, an ordinary course of business distinction is superior. The ordinary course of business distinction would eliminate the timing distinction between which the circuit courts are deciding, and it would better serve debtors, creditors, and the state that is attempting to tax the transfers. The ordinary course of business distinction would focus on a transaction's nature, not its timing. Under the distinction, transfers that occur during the ordinary course of business would not be eligible for tax exemption under Sec. 1146(a) while transfers that occur outside the ordinary course would be eligible. Current scholarship¹²and many courts¹³have overlooked this distinction and focused entirely on the competing interpretations adopted by the circuit courts. However, the taxing authority in one landmark case on this issue argued for a similar, yet incomplete ordinary course of business standard.¹⁴Adopting an ordinary course of business distinction eliminates the arbitrary pre/post confirmation test and replaces it with a substantive analysis. This new distinction would create the best standard and would be beneficial to all parties.

This Comment will explore the circuit courts' and Supreme Court's focus and reasoning and the origin and development of the dominant interpretations of the language "under a plan confirmed" in Sec. 1146(a). First, it will explain the problems inherent in both interpretations that made them inadequate. Then, it will detail the Supreme Court's decision and the problems that remain. Finally, this Comment argues Congress should reject the Supreme Court's interpretation and revise the statute to implement an ordinary course of business distinction. It explains what the distinction is, why it is superior to the circuit and Supreme Court interpretations, how it could be applied during bankruptcy, the potential problems it raises, and how it would affect the outcome of the landmark cases already decided by the circuit courts and the Supreme Court.

I. THE CIRCUIT COURTS' FOCUS

Debtors and states have spent significant time and money litigating the scope of Sec. 1146(a), and prior to this year, the circuit courts were split on their interpretations of this statute. Two main problems in Sec. 1146(a) have driven most of the litigation. The first problem is defining what a "stamp tax or similar tax" is and then applying that definition to various state taxes.¹⁵The second problem is determining when a transfer must take place for it to be exempt from taxes "under a confirmed plan."¹⁶

Until Piccadilly, the circuit courts were divided over the scope of the time period to which Sec. 1146(a) applied, and no dominant standard emerged to determine whether a transfer or sale took place "under a plan confirmed."¹⁷

The circuit courts developed two divergent views on what transactions or sales qualify for the exemption.¹⁸The major distinction between the two interpretations was based on timing. The views taken by the Courts of Appeals for the Second and Eleventh Circuits can be labeled the "expansive interpretation," while the views taken by the Courts of Appeals for the Third and Fourth Circuits can be labeled the "restrictive interpretation."

Before these interpretations are explained, a brief history of the origin of

Sec. 1146(a) is helpful to understand part of the problem in interpreting the statute. Section 1146(a) arose when Sec. 77B(f) was enacted as part of the Bankruptcy Act of 1898.¹⁹In its original form, Sec. 77B(f) stated that certain taxes could not be applied to "the issuance, transfers, or exchanges of securities or making of conveyances to make effective any plan of reorganization confirmed under the provisions of this section."²⁰One purpose of the statute was to "exempt the debtor from the payment of a federal stamp tax on new securities issued pursuant to a plan of reorganization that required the debtor to modify the terms of outstanding securities."²¹In the Chandler Act of 1938, Congress replaced Sec. 77B(f) with Sec. 267, which stated, "[t]he issuance, transfer, or exchange of securities, or the making or delivery of instruments of transfer under any plan confirmed under this chapter, shall be exempt from any stamp taxes."²²The amended statute under Sec. 267 changed the statute's language from "to make effective a plan" to "under any plan."²³

The legislative history neither explains why Congress made the language change, nor reveals the actual congressional intent for enacting the original tax provision.²⁴

The Bankruptcy Reform Act of 1978 replaced Sec. 267 with Sec. 1146(a).²⁵The replacement brought little change to the wording. Section 1146(a) now states that "[t]he issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed . . . may not be taxed under any law imposing a stamp tax or similar taxes."²⁶The only significant change in 1978 was that Congress clearly expanded the scope of the exemption to include taxes similar to stamp taxes.²⁷This language was not amended when the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") was enacted.²⁸Ultimately, these predecessors did not clarify what is meant by "under a plan confirmed."²⁹

Under the expansive interpretation, both pre- and postconfirmation transfers qualified as occurring "under a plan confirmed" if the court deemed that the transfers were essential to the plan's confirmation.³⁰The necessity of the transfer, not its timing, was the ultimate factor in this interpretation. This interpretation was based upon the theory that Sec. 1146(a), as part of a Chapter 11 reorganization, was meant to facilitate reorganization, and therefore, the tax exemption should not be limited.³¹

However, under the restrictive interpretation adopted by the Supreme Court, only transfers that occur postconfirmation qualify as "under a plan confirmed" because "under" means "with the authorization of."³²This interpretation is based upon the theory that the only reasonable reading of

"under a plan confirmed" is that the transfer occurs after the plan is confirmed.³³The main thrust of the circuit split was based on a timing distinction of when the transfers occurred. The split needed to be resolved to give debtors certainty in jurisdictions that had yet to interpret the statute. Also, a uniform standard benefits debtors, creditors, and the state when a debtor is deciding whether and when to sell assets during bankruptcy.

Scholarship before the Supreme Court decision was mixed. Some scholarship summarized the status of the split by explaining each side of the argument.³⁴Other scholarship embraced one interpretation and argued its merits. David Stratton rebuked the restrictive interpretation in his article Real Property Transfers and Bankruptcy Tax Exemptions: In re Hechinger and 11

U.S.C. 1146(c).³⁵Stratton argued that the restrictive interpretation used in a

Third Circuit opinion was "easy to apply but effectively...