In a move signaling the end of 6 years of litigation, the bankruptcy trustee for the holding company of failed mortgage lender IndyMac Bancorp, Inc. (“Bancorp”) negotiated a settlement agreement with the FDIC regarding the ownership of nearly $60 million of tax refunds.  If approved by the bankruptcy court, the settlement would resolve one of the most highly publicized tax refund disputes involving the FDIC, a number of which arose in the wake of 2008’s financial crisis.

The litigation between Bancorp and the FDIC began shortly after Bancorp commenced its bankruptcy case on July 31, 2008 (In re: IndyMac Bancorp Inc., Case No. 2:08-bk-21752, Bankr. C.D. Cal.).  The bankruptcy case was filed after the Office of Thrift Supervision seized Bancorp’s operating subsidiary, IndyMac Bank, F.S.B. (the “Bank”) on July 11, 2008, and placed it into a receivership with the FDIC as receiver a few days later.

The FDIC filed a proof of claim asserting, among other things, an administrative priority claim in the amount of any group tax refunds that the bankruptcy estate is deemed to own, an unliquidated unsecured claim for Bancorp’s alleged capital maintenance obligations (the FDIC contended that this portion of the claim exceeded $5 billion and was entitled to priority under section 507(a)(9) of the Bankruptcy Code), and alleged prepetition fraudulent transfers for amounts upstreamed from the Bank.  In response to the FDIC’s claim, the Chapter 7 trustee commenced an adversary proceeding seeking disallowance or subordination of the claim and a declaration that group tax refunds resulting from consolidated tax returns are property of Bancorp’s bankruptcy estate.

The tax refund issue arose because prior to the receivership and the bankruptcy, Bancorp and the Bank filed consolidated tax returns and shared various tax burdens and benefits under an Amended and Restated Tax Sharing Agreement (the “TSA”).  Under the TSA, Bancorp, as the parent, was responsible for filing consolidated returns and for making tax payments and receiving payment of refunds from the IRS.

Tax sharing agreements dictate how tax burdens and benefits are divided among corporate affiliates.  Such tax sharing agreements are common among corporate families, but can be problematic, especially when the parent is a bankruptcy debtor and large refunds are generated using a subsidiary’s prepetition losses.  This has become an especially contested issue in numerous bank holding company bankruptcy cases filed since 2008.

In recent years, courts in Delaware and the Ninth Circuit have found that tax refunds generated using a subsidiary’s losses under a tax sharing agreement that were unpaid at the time of the bankruptcy are property of the holding company’s estate.  In cases like IndyMac, where the FDIC is receiver of the subsidiary, the FDIC is relegated to the status of a creditor asserting a claim against the bank holding company’s bankruptcy estate.  By contrast, in two separate decisions construing similar agreements, the Eleventh Circuit found that group tax refunds belonged to the bank subsidiary that generated the losses and not to the holding company’s bankruptcy estate.

As a result of several recent regulatory changes, tax sharing disputes may become much less common in the future.  Part of 2010’s Dodd-Frank Act allows the FDIC to place certain troubled bank holding companies into receivership – a power the FDIC was previously only able to exercise over banks.  If the FDIC is able to control troubled banks and their holding companies simultaneously, consolidated tax refund disputes likely disappear.  Also, in 2014 the Federal Reserve and the FDIC issued an amendment to the Interagency Policy Statement on Income Tax Allocation in Holding Company Structure that requires financial institutions to add unambiguous language to their tax sharing agreements specifying that refunds are owned by the particular group members that generate them.  For now though, there are a number of disputes like IndyMac that are still working their way through the legal system.

Under the proposed settlement, the bankruptcy estate will take ownership of approximately $58.6 million of tax refunds that currently reside in an escrow account and the FDIC will be granted an allowed unsecured nonpriority claim against the estate in the amount of approximately $58.4 million – representing the principal amount of the refund originally received from the IRS and deposited in escrow.  A hearing to consider approval of the IndyMac-FDIC settlement agreement is scheduled for December 3, 2014 in the U.S. Bankruptcy Court for the Central District of California.