Protecting Tax Refunds of Consolidated Tax Filers in Bankruptcy

• Publication year: 2014
• Citation: Vol. 2014 No. 2
• Author: Jennifer E. Niemann and Paul J. Pascuzzi

Protecting Tax Refunds of Consolidated Tax Filers in Bankruptcy

Jennifer E. Niemann and Paul J. Pascuzzi

Jennifer E. Niemann is counsel at Felderstein Fitzgerald Willoughby & Pascuzzi, LLP in Sacramento. Ms. Niemann previously served as a long-term judicial law clerk at the U.S. Bankruptcy Court for the Northern District of California in San Francisco as well as in San Jose. Ms. Niemann's practice focuses on all aspects of business bankruptcy and insolvency law.

Paul J. Pascuzzi is a partner at Felderstein Fitzgerald Willoughby & Pascuzzi, LLP in Sacramento. Mr. Pascuzzi is a former chair of the Executive Committee and Insolvency Law Committee of the Business Law Section. Mr. Pascuzzi's practice focuses on all aspects of business bankruptcy and insolvency law.

Introduction

The rash of bankruptcy cases filed since 2008 by bank holding companies whose subsidiary banks have been taken over by the Federal Deposit Insurance Company ("FDIC") has resulted in conflicting decisions across the country over what entity owns a tax refund when affiliated entities file consolidated income tax returns and one of those entities subsequently files a bankruptcy case. The decisions analyze the type of relationship created by a written tax sharing agreement or tax allocation agreement (hereafter generically referred to as "TSA") to determine whether the tax refund should be considered property of the entity in bankruptcy. While the recent decisions have arisen in the context of banks and bank holding companies, the principles set forth in these decisions would apply in the bankruptcy case of any consolidated tax filer.

This article first discusses the context for recent case law regarding consolidated tax filers and analyzes the key factors considered by the courts to determine the type of relationship created by a TSA. The article then addresses issues counsel to consolidated tax filers should consider in drafting or reviewing a TSA to ensure such agreement unambiguously expresses the intended relationship between the consolidated filers should one of the affiliated entities file a bankruptcy case.

Context of Recent Case Law When affiliated entities file consolidated income tax returns, the taxing authority pays the tax refund to the entity which filed the tax return. Absent an implied or express agreement among the parties, it is presumed that the entity receiving the tax refund holds the refund in a principal-agent relationship for the other affiliated entities.¹ In other words, the entity receiving the tax refund holds the refund as the agent, or in trust, for the other affiliated entities. If the entity receiving the tax refund has filed a bankruptcy case, the tax refund would belong to the other affiliated entities, and only the tax filer's interest in the tax refund, based on an allocation of the tax filer's tax attributes, would be part of the bankruptcy estate.²

Affiliated entities can, however, adjust the presumptive principal-agent relationship through a TSA. For example, a TSA can create a debtor-creditor relationship between the filing entity and the other affiliated entities instead of a principal-agent relationship. Where a debtor-creditor relationship is created among the affiliated entities, the entity receiving the tax refund is determined to own the tax refund and the other entities are merely creditors of the entity receiving the tax refund.³

Recently, the type of relationship created by a TSA has resulted in significant litigation in the context of bankrupt bank holding companies. This is because the tax refunds at issue typically involve tens of millions of dollars and represents significant assets for both the bankrupt bank holding company and the insolvent bank (or its receiver, typically the FDIC). Pursuant to the Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure ("Policy Statement") issued in November 1998 by the FDIC, the Board of Governors of the Federal Reserve System ("Board"), the Office of the Comptroller of the Currency ("OCC") (collectively, "Agencies"), and the Office of Thrift Supervision, a written TSA between a bank and bank holding company should create a principal-agent relationship.⁴ Two recent Eleventh Circuit opinions determined that the written TSAs at issue did create a principal-agent relationship between the parties, so the tax refunds belonged to the FDIC, as receiver for the failed bank subsidiary, and not to the bankruptcy estate of the bank holding company.⁵ Most decisions involving bankrupt bank holding companies, however, have determined that the language of a written TSA created a debtor-creditor relationship among the consolidated tax filers.⁶ As a consequence, the tax refund was determined to be property of the bank holding company's bankruptcy estate, not the FDIC, and the FDIC held only a claim against the bankruptcy estate.

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As a result of the unsettled nature of the law, in December 2013, the Agencies published a proposed addendum to the 1998 Policy Statement ("Proposed Addendum") for comment before the Agencies formally adopt the Proposed Addendum.⁷ The Proposed Addendum, among other things, provides sample language to be included in a TSA to "ensure the [tax allocation] agreements (1) clearly acknowledge that an agency relationship exists between the holding company and its subsidiary [banks] with respect to tax refunds, and (2) do not contain other language to suggest a contrary intent."⁸The comment period for the Proposed Addendum expired on January 21, 2014, without significant comment. The Proposed Addendum was formally adopted by the Agencies as of June 12, 2014, in substantially the same form as proposed.⁹

Principles From Recent Case Law

The recent decisions in the bank holding company bankruptcy cases split in part over whether the language in the TSA was ambiguous. Because the TSA is a contract, the rules of contract interpretation apply: namely, if the contract is not ambiguous, the contract is to be...