The Federal Deposit Insurance Corporation (FDIC), as the appointed receiver of hundreds of failed domestic banks, is in the midst of litigation in several jurisdictions with the creditors of certain bank holding companies over the right to billions of dollars in tax refunds. The FDIC argues that as the statutory successor to certain defunct banks, it—not the debtor holding companies—is entitled to the substantial tax refunds generated by the shuttered banks’ operating losses. The majority of U.S. bankruptcy and district courts to have considered this issue have disagreed. Just last month, for example, the U.S. Bankruptcy Court for the District of Delaware in In re Downey Financial Corp.1 held that a $364 million tax refund was property of the debtor bank holding company’s bankruptcy estate and available for distribution to its creditors. In so holding, the court joined several bankruptcy and district courts across the country, which had previously rejected the FDIC’s position upon consideration of similar facts.2
As discussed in detail below, these disputes are a matter of contract interpretation and hinge on whether the terms of the tax sharing agreement (TSA) between the subsidiary bank and its parent holding company create a debtor-creditor relationship that entitles the holding company’s bankruptcy estate to the refund, or alternatively, create an agency relationship pursuant to which the tax refund would be forwarded to the FDIC as the bank’s receiver. Downey and similar decisions have interpreted the applicable TSA as creating a debtor-creditor relationship and as a result deemed the refund at issue property of the parent holding company’s bankruptcy estate. Under these decisions, the refund is available for distribution to the estate’s creditors, which include the FDIC as holder of an unsecured claim, but must be shared pro rata among all unsecured creditors.
However, in August and September of this year, the U.S. Court of Appeals for the Eleventh Circuit ruled in two separate decisions that the TSAs at issue created an agency relationship that entitled the FDIC to a direct recovery of the tax refunds in question.3 It remains to be seen whether the Eleventh Circuit’s opinions were merely a product of certain unusual terms in the TSAs at issue or mark a shift in case law toward the FDIC’s position.
During the recent financial crisis, banks across the nation failed and were placed in FDIC receivership by the Office of Thrift Supervision. In several cases, the bank holding companies that owned these failed banks subsequently filed for bankruptcy protection, triggering a dispute as to whether the FDIC or the parent holding company’s bankruptcy estate was entitled to the tax refunds generated on account of losses sustained by the failed bank.
As with parent entities in many corporate groups, the bank holding companies involved in these cases filed consolidated income tax returns, as permitted under 28 U.S.C. §1501, on behalf of themselves and their subsidiaries in accordance with a TSA. A TSA generally apportions responsibility for tax liabilities and the right to tax refunds within the group and specifies which entities will be responsible for submitting returns and distributing refunds to other group members.
In adjudicating disputes between bank holding companies and the FDIC, courts have focused on the express terms of the TSAs in order to determine whether a particular TSA creates a debtor-creditor relationship between the bank holding company and the defunct bank (in which case a refund would be property of the estate), or an agency relationship (with the bank holding company, as the bank’s agent, obligated to forward the refund directly to the FDIC as receiver for the failed bank subsidiary). There is no bright-line rule as to what TSA terms create a debtor-creditor relationship. However, where a TSA provides that a parent must “reimburse” its subsidiaries any refund and does not appoint the parent as the “agent” for the consolidated group, does not expressly require a parent company to escrow or segregate funds owed to subsidiaries following receipt of a tax refund, and grants the parent sole authority to make decisions with respect to tax matters, courts have generally found that the TSA results in a debtor-creditor relationship.4
Eleventh Circuit Decisions
The Eleventh Circuit recently issued two decisions interpreting TSAs in favor of the FDIC, and in doing so, diverged from the emerging trend in lower court decisions. In the first case, In re BankUnited Financial Corp., the TSA required the bank subsidiary, not the parent holding company, to make tax payments and file returns on behalf of the consolidated group and allocate any tax refunds received among members of the group. The Eleventh Circuit concluded that this arrangement created an agency relationship, and therefore, the tax refund received by the parent holding company post-bankruptcy was deemed held in escrow for the benefit of the bank in FDIC receivership (and should be forwarded to the FDIC). It further recognized that a debtor-creditor relationship could be created by express or implied consent, but that no such consent could be inferred from the TSA at issue. The Eleventh Circuit also noted the absence of protections indicative of a debtor-creditor relationship, “such as a fixed interest rate, a fixed maturity date, or the ability to accelerate payment upon default,” in finding that the TSA created an agency relationship.5
Approximately a month later, in In re NetBank, the Eleventh Circuit again held that a TSA between a parent holding company and subsidiary bank created an agency relationship. Unlike the unusual TSA in BankUnited, the TSA at issue in NetBank included standard provisions requiring the parent holding company to file a tax return on behalf of itself and its subsidiaries and apportion any tax refund to the appropriate subsidiary. However, the Eleventh Circuit found the TSA to be ambiguous with respect to the nature of the relationship created between members of the consolidated group, and considered the “background against which the TSA was entered into,” particularly a federal tax policy statement referenced in the TSA, which instructed that “a parent receives refunds from a taxing authority as ‘agent’ on behalf of the group members.”6
It also highlighted a provision of the TSA requiring that tax settlements between the parent holding company and its tax sharing group result in “no less favorable treatment” than if an individual of the group had filed a separate tax return, and stressed that to leave a subsidiary bank as an unsecured creditor would contravene this provision. Finally, in finding in favor of the FDIC, the Eleventh Circuit noted that it did “not believe that the absence of language requiring a trust or escrow has much persuasive value” in determining the presence of an agency relationship.7
‘Downey Financial Corp.’
Less than a month after the Eleventh Circuit’s decision in NetBank, the U.S. Bankruptcy Court for the District of Delaware in Downey held that the TSA at issue created a debtor-creditor relationship that entitled the parent holding company’s bankruptcy estate to the refund, and by so holding, effectively distinguished the discussed Eleventh Circuit decisions based on their unique set of facts. In determining the nature of the relationship created by a TSA, the court discussed three factors adopted from the U.S. Bankruptcy Court for the Central District of California’s decision in In re IndyMac Bancorp, and considered whether “(1) the TSA creates fungible payment obligations among the parties; (2) there are no escrow obligations, segregation obligations nor use restrictions under the TSA; and (3) the TSA delegates the tax filer under the agreement with sole discretion regarding tax matters.”8
With respect to the first factor—the creation of fungible payment obligations—the TSA created a system of intercompany “payments” and “reimbursements,” and gave the parent sole discretion to determine whether any tax refunds would be paid or credited against future tax liabilities.9 The court concluded that these terms created a debtor-creditor relationship, and were distinguishable from the TSAs interpreted by the Eleventh Circuit. Specifically, unlike the TSA in BankUnited, the members of the Downey consolidated group did not pay taxes directly to the government, but rather paid their estimated liability to the parent holding company. And unlike NetBank, the Downey TSA did not reference the federal tax policy statement.10
The second factor—the presence of any escrow, segregation or use restrictions—also supported a debtor-creditor relationship as the TSA contained no such restrictions on the parent holding company’s use of any tax refund, nor did the TSA require that the tax refund be held in trust. Notably, in contrast to the Eleventh Circuit’s decision in NetBank, the court stressed the importance of this factor and also found that the standard TSA provision requiring that a consolidated group’s tax allocation not result in any “less favorable” treatment than if a member of the group filed a separate tax return did not create an agency relationship. The court reasoned this provision merely restricted a parent from extracting tax liabilities from a group member in excess of what would be owed under a separate return, and did not impact ownership of a refund.11
Finally, the third factor—the discretion afforded the tax filer—unambiguously supported the finding of a debtor-creditor relationship as the TSA gave the parent holding company “sole discretion” over the manner and filing of tax returns, whether refunds were credited toward future liability, and how to resolve disputes with taxing authorities.
The court likewise rejected the FDIC’s position that an agency relationship is presumptively created where a parent company files a tax return and receives a refund on behalf of a consolidated group. The FDIC relied principally on a 1970s case titled In re Bob Richards,12 in which the U.S. Court of Appeals for the Ninth Circuit presumed that a principal-agent relationship exists where a parent company files a consolidated tax return, but did not explicitly agree on a procedural mechanism to distribute any refund. The court noted that this presumption only applies when there is no agreement defining the nature of the relationship between members of a consolidated group. Where the parent-holding company and the subsidiary bank have an agreement defining their relationship (i.e., the TSA), the gap-filling rule does not apply.
Bankruptcy practitioners should monitor whether any future U.S. bankruptcy courts that consider these issues follow or are influenced by the discussed Eleventh Circuit opinions, or, like the court in Downey, distinguish these decisions based on the terms of the TSA at issue. Additionally, the IndyMac decision is currently on appeal in the Ninth Circuit, which will have an opportunity to comment on the factors courts should consider in determining whether a TSA creates a debtor-creditor or agency relationship and on how these factors apply to common TSA provisions.
John J. Rapisardi is a partner and co-chair of the global restructuring practice at O’Melveny & Myers. Joseph Zujkowski is a counsel in the restructuring practice at the firm and an adjunct professor at Cardozo School of Law. Matthew P. Kremer, an associate of the O’Melveny firm, assisted in the preparation of this article.
1. Wilmington Trust v. Fed. Deposit Ins. (In re Downey Fin. Corp.), No. 10-53731, 2013 WL 5531392 (Bankr. D. Del. Oct. 8, 2013).
2. Imperial Capital Bancorp Inc. v. Fed. Deposit Ins. Corp. (In re Imperial Capital Bancorp, Inc.), No. 10cv1991, 2013 WL 2149982 (S.D. Cal. May 16, 2013); Fed. Deposit Ins. Corp. v. AmFin Fin. Corp., No. 1:11CV2574, 2013 WL 1234955 (N.D. Ohio March 26, 2013); Siegel v. Fed. Deposit Ins. Corp. (In re IndyMac Bancorp, Inc.), No. 08-bk-21752, 2012 WL 1037481 (Bankr. C.D. Cal. Mar. 29, 2012);
3. Zucker v. Fed. Deposit Ins. Corp. (In re BankUnited Fin. Corp.), No. 12–11392, 2013 WL 4106387 (11th Cir. Aug. 15, 2013); Fed. Deposit Ins. Corp. v. Zucker (In re NetBank, Inc.), No. 12-13965, 2013 WL 4804325 (11th Cir. Sept. 10, 2013).
4. Downey, 2013 WL 5531392, at *11.
5. BankUnited, 2013 WL 4106387, at *1108-1109.
6. Netbank, 2013 WL 4804325 at *4-5 (citing Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure, 63 Fed. Reg. 64, 757 (Nov. 23. 2009)).
7. Id. at *6.
8. Downey, 2013 WL 5531392, at *11.
9. Id. at *11-12.
10. Id. at *13-14.
11. Id. at *14-15.
12. Richards Chrysler-Plymouth v. England (In re Bob Richards), 473 F.2d 262, 264-65 (9th Cir. 1973).