On August 15, 2013, in Zucker v. FDIC (In re BankUnited Finance Corp.), the United States Court of Appeals for the Eleventh Circuit, reversing a decision by the Bankruptcy Court for the Southern District of Florida, held that a holding company in chapter 11, BankUnited Financial Corporation (the “Holding Company”), could not retain as property of its bankruptcy estate tax refunds received during its bankruptcy case.1 Before bankruptcy, the Holding Company entered into a tax sharing agreement (the “TSA”) with one of its subsidiaries, BankUnited FSB (the “Bank”), through which the Holding Company would file income tax returns in its own name for itself and its subsidiary corporations (the “Consolidated Group”) and the Bank would pay all taxes due on behalf of the Consolidated Group. The Court of Appeals determined that pursuant to its interpretation of the TSA, when the Holding Company received tax refunds, it received such refunds intact—as if in escrow—for the benefit of the Bank, and in turn, the other members of the Consolidated Group. Therefore, the Holding Company was required to give those tax refunds to the Bank for distribution to members of the Consolidated Group in accordance with the TSA.

Background

Federal Income Tax Law

According to United States Department of Treasury regulations, a parent company may file in its own name a consolidated income tax return for itself and its subsidiary corporations.2 The parent company then receives in its name any income tax refunds due to itself and those subsidiaries for which the company filed the consolidated tax return. Because the federal income tax regulations do not address the manner in which such tax refunds must be allocated, the parent and its subsidiaries may provide, by way of contract, how such tax refunds should be allocated.

In re BankUnited Fin. Corp.

In 1997, the Holding Company and the Bank, the principal operating entity for the Consolidated Group, entered into a TSA for the benefit of the Holding Company, the Bank and the remaining Holding Company subsidiaries in the Consolidated Group. The TSA provides that the Holding Company would file the Consolidated Group’s income taxes and the Bank would pay all of the taxes due. Pursuant to the TSA, within thirty days after the filing of the tax return and payment of taxes, each member of the Consolidated Group would reimburse the Bank for its respective share of taxes that the Bank paid on its behalf. Although the TSA requires the Bank to pay to other members of the Consolidated Group their allocated shares of any tax refund the Bank receives, the TSA does not expressly require the Holding Company to transfer tax refunds to the Bank.

On May 21, 2009, the Office of Thrift Supervision closed the Bank and appointed the Federal Deposit Insurance Corporation (the “FDIC”) as the Bank’s receiver. On the following day, the Holding Company filed a petition for relief under chapter 11 of the Bankruptcy Code. Subsequently, both the Holding Company and the Bank requested refunds from the Internal Revenue Service for $5,566,878 and $45,552,226 for the fiscal years 2007 and 2008, respectively. The IRS granted the request and sent the tax refunds to the Holding Company. Instead of forwarding the tax refunds to the FDIC for distribution on behalf of the Bank, the Holding Company retained the tax refunds as an asset of its bankruptcy estate. The FDIC responded by filing a claim in the Bankruptcy Court asserting that it was entitled to the tax refunds in order to comply with its obligation to distribute the funds to the Consolidated Group pursuant to the TSA. The Holding Company thereafter filed an adversary proceeding in the Bankruptcy Court in which it sought, among other things, a declaration that the tax refunds were property of the bankruptcy estate.3 Under section 541 of the Bankruptcy Code, property of the estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case.”4

The Holding Company argued that, because the tax refunds were part of its bankruptcy estate, not property of the Bank or the other subsidiaries, the Bank, as a creditor of the Holding Company, had nothing more than an unsecured claim against the Holding Company’s estate for a sum equal to the tax refunds that should have been distributed to the Bank. The FDIC argued that under the terms of the TSA, the Holding Company was acting solely as an agent or trustee for the Bank and the other members of the Consolidated Group with respect to their interests in the tax refunds and, accordingly, the tax refunds to be allocated to the members of the Consolidated Group belonged to such members and not to the Holding Company.

Bankruptcy Court Ruling

The Bankruptcy Court agreed with the Holding Company and held that the tax refunds were property of the bankruptcy estate. Noting that some courts have recognized a federal common law presumption that, in the absence of an implied or express agreement, the parent of a consolidated group that receives a tax refund holds the refund as a trustee or agent for the benefit of the other members of the group, the Bankruptcy Court turned to the TSA as the controlling agreement.5 Analyzing the TSA, the Bankruptcy Court determined the contractual intent of the parties from the use of such words as “payables” and “receivables” and concluded that the Holding Company and the Bank did not have a trustee-beneficiary relationship, but instead had a debtor-creditor relationship, which gave the Bank only an unsecured claim against the Holding Company and not the right to the delivery of the tax refund.6

Circuit Court’s Analysis

On direct appeal from the Bankruptcy Court, the Court of Appeals was faced with the issue of whether the Bankruptcy Court erred in declaring that the tax refunds were property of the Holding Company’s bankruptcy estate.7 The appellate court acknowledged that the issue at hand was a matter of contract interpretation, pointing out that the TSA is ambiguous in that it does not explain whether the Holding Company “owns” the tax refunds before forwarding them to the Bank.

Judge Tjoflat, writing for the Eleventh Circuit, took issue with the Bankruptcy Court’s seemingly contradicting statements: On the one hand, the Bankruptcy Court began with the assumption that under the TSA, the Holding Company was going to forward the tax refund to the Bank at some point in time so that the Bank could forward the allocable shares of any refund to the other members of the Consolidated Group; while, on the other hand, the Bankruptcy Court noted that nothing in the TSA required the Holding Company to deliver the tax refund to the Bank.

In examining the TSA, Judge Tjoflat emphasized the importance of determining the intent of the parties. While the TSA may not have expressly required that the Holding Company forward the tax refunds, Judge Tjoflat stated that was what the parties had intended. He also found that it was not the intention of the parties for the Holding Company to keep the tax refunds and incorporate them into their own portfolio as if the Bank had loaned the tax refunds as unencumbered assets to the Holding Company.

Furthermore, Judge Tjoflat stated that while a debtor-creditor relationship can be created by express or implied consent, there was nothing in the TSA that could be used to infer that this is the relationship that the two parties desired. If the Bankruptcy Court’s decision was followed, then the Bank would be unable to satisfy the primary purpose of the TSA, which was to ensure that tax refunds were delivered to the members of the Consolidated Group in full and with dispatch.

The Court of Appeals found that the Holding Company received and held the funds for the benefit of the Bank, and in turn, the other members of the Consolidated Group, and declared that the tax refunds were not property of the Holding Company’s bankruptcy estate and had to be turned over to the Bank for distribution to the members of the Consolidated Group in accordance with the TSA.

Conclusion

This case underscores the importance of careful drafting of tax sharing agreements. It will remain to be seen whether other circuits will follow the method of analysis of the Eleventh Circuit, but to the extent parent companies and their subsidiaries who are members of a consolidated tax group wish to control the determination of ownership of tax refunds, they should clearly set forth their intentions regarding the relationship between the parties and other rights concerning tax refunds in their tax sharing agreements.

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IRS Circular 230 Disclosure

Any U.S. tax advice herein (or in any attachments hereto) was not intended or written to be used, and cannot be used, by any taxpayer to avoid U.S. tax penalties. Any such tax advice that is used or referred to by others to promote, market or recommend any entity, plan or arrangement should be construed as written in connection with that promotion, marketing or recommendation, and the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.