Eleventh Circuit: Tax Refunds Due Pursuant to a Tax Sharing Agreement Are Not Property of the Filer’s Estate

Contributed by Doron P. Kenter.

Nothing Is Certain But Death and Taxes…And We’re Not So Sure About Taxes

Benjamin Franklin (adapted)

Are refunds paid to a party to a tax sharing agreement ever property of the recipient’s estate?  Or do they simply “pass through” the recipient en route to their ultimate destination?  A recent decision from the Eleventh Circuit Court of Appeals parts ways with a number of courts that have recently held that such refunds are estate property.  Though the Eleventh Circuit has not yet definitively answered the question, its decision points to an emerging issue regarding tax sharing agreements in bankruptcy cases.
In Zucker v. FDIC (In re BankUnited Fin. Corp.), holding company BankUnited Financial Corporation and its principal operating subsidiary, the bank, entered into a tax sharing agreement (TSA), which provided that the holding company would file all tax returns for itself and its subsidiaries (on a consolidated basis).  Pursuant to the TSA, the bank agreed to initially pay all taxes due for the entire enterprise, after which the members of the consolidated group would reimburse the bank for their respective shares of the taxes paid by the bank – and the Bank would, in turn, pay its affiliates any tax refund that it received on account of the taxes paid.
Subsequently, the Office of Thrift Supervision closed the bank and appointed the FDIC as receiver, and the holding company filed a petition for relief under chapter 11 of the Bankruptcy Code.  Shortly thereafter, both the holding company and the bank petitioned the IRS for their respective tax refunds, both of which were forwarded directly to the holding company (which had filed the tax return for the consolidated group of BankUnited entities).  The holding company then (i) refused to turn over the refunds to the bank for distribution to its various affiliates and (ii) sought a determination that the tax refunds were property of the bankruptcy estate (in which case the bank’s remedy would be to file a claim against the holding company and to share in whatever recoveries ultimately become available to the holding company’s creditors).  The bankruptcy court ruled that the tax refunds were property of the holding company’s estate and that the proper remedy would be for the bank to pursue a claim in the holding company’s bankruptcy case.
On direct appeal, the Eleventh Circuit looked to the specific language of the TSA in determining whether the tax refunds were property of the holding company (which was obligated, under the TSA, to distribute any tax refunds to its various subsidiaries, as applicable).  Because the TSA was ambiguous as to (i) when the holding company was obligated to forward tax refunds to the bank and (ii) whether the holding Company “owned” the refunds before they were forwarded to the bank, the Eleventh Circuit concluded that it must look to the parties’ intent in determining how to interpret the nature of the tax refunds.  Rejecting the bankruptcy court’s decision, the court concluded that it was “obvious” that the parties to the TSA intended for the holding company to forward the tax refunds to the bank on receipt and did not intend for the holding company to keep the refunds and incorporate them into its own portfolio (subject to subsequently writing a check to the bank).  Noting that “[a] debtor-creditor relationship is created by consent,” the court found that there was no reason to believe that the parties intended to create such a relationship with respect to the tax refunds.  Indeed, the court observed that, if that had been the parties’ intent, the court would have expected the parties to have protected the rights of the creditor (i.e., the bank) in some way – for example, by imposing a fixed interest rate on the debt owed by the holding company, or a fixed maturity date for payments owed pursuant to the TSA.  In short, the court concluded, a primary purpose of the TSA was to ensure that tax refunds were delivered to the various BankUnited entities in the amounts due to them (corresponding to their allocable share of the payments).  Accordingly, the court held that the tax refunds were never the holding company’s property, did not constitute “property of the estate,” and should be immediately remitted to the bank for distribution to the other BankUnited entities.
Incidentally, the Eleventh Circuit did not couch its analysis in existing case law regarding estate property (or other bankruptcy issues), as did the bankruptcy court.  In fact, in Zucker v. FDIC (In re NetBank, Inc.), the same parties had litigated similar issues (though the trustee for the holding company was acting as trustee for a different entity), and the bankruptcy court had also held in that case that tax refunds owed to a subsidiary pursuant to a TSA constituted estate property.  Indeed, the district court affirmed the bankruptcy court’s opinion (and a district court in California similarly recognized), that the bankruptcy court’s opinion in NetBank was the “strong majority view” that refunds due pursuant to a TSA such as the ones at issue in BankUnited and in NetBank are estate property because the TSA itself establishes a debtor-creditor relationship.  The bankruptcy court reached this conclusion because (among other things) the bank’s right to receive payment from the holding company on account of tax refunds was not contingent upon receipt by the holding company of a refund from the IRS – accordingly, because the holding company was not a not mere conduit for transmittal of any refunds, but was independently obligated to make payments to the bank had the bank and its affiliates filed tax returns separately from the holding company.
Instead, the Eleventh Circuit viewed the TSA as though the holding company had not been in bankruptcy and looked to basic principles of contract construction in understanding the parties’ obligations and intentions with respect to the TSA.  Though the BankUnited decision was limited to the specific TSA that was before the court, it will be interesting to see how other courts will approach tax sharing agreements in bankruptcy cases.