The Bottom Line:
The Eleventh Circuit Court of Appeals has now issued two precedential opinions interpreting tax sharing agreements in bankruptcy in as many months. In its latest decision on the subject, In re Netbank, Inc., No. 12-13965, 2013 U.S. App. LEXIS 18774 (11th Cir. Sept. 10, 2013), the Eleventh Circuit held that a pre-petition tax sharing agreement (“TSA”) entered into by chapter 11 debtor Netbank, Inc., and its subsidiary bank in receivership Netbank, f.s.b., established an agency relationship between them, and therefore, a tax refund belonged to the non-debtor subsidiary bank and could be collected by the FDIC as its receiver. The Netbank decision relied on principles of contract interpretation in accordance with its recent opinion in Zucker v. FDIC (In re BankUnited Fin. Corp.), No. 12-11392, 2013 U.S. App. LEXIS 16896 (11th Cir. Aug. 15, 2013). For more information on the BankUnited opinion, visit Kramer Levin’s Broken Bench Bytes blog post, at: http://www.brokenbenchbytes.com/blog.aspx?entry=189. As a result, the tax refund was not an asset of the debtor’s estate and was required to be turned over to the FDIC as receiver.
Netbank, Inc. (the “Parent”) was the parent corporation of a consolidated tax group which included its subsidiary Netbank, f.s.b. (the “Sub”). Id. at *3. The Parent, the Sub and other subsidiaries were parties to a TSA which established how tax payments and liabilities were to be allocated among members of the consolidated group. Id. For the 2005 tax year, the Parent filed a consolidated tax return for the group, reporting approximately $17M in taxable income and a $6M tax liability.Id. at *3. In the 2006 tax year, the Sub incurred a net operating loss (“NOL”). In 2007, the Sub closed and the FDIC was appointed as its receiver. Id. The Parent filed for chapter 11 bankruptcy in 2007. Id. The Parent and the Sub then filed a federal tax refund claim of approximately $5.7M, attributable to a carryback of the Sub’s 2006 NOL to the 2005 consolidated tax return. Both the FDIC, acting as the receiver for the Sub, and the bankruptcy estate/the Parent claimed ownership of the tax refund. Id.
The Bankruptcy Court granted summary judgment in favor of the Parent, finding that the TSA created a debtor-creditor relationship between the parties, and declared the tax refund property of the bankruptcy estate. Id. at *4. In rendering its decision, the Bankruptcy Court relied on: (i) the discretion given to the Parent under the TSA; (ii) the fact that the Parent was obligated to pay the Sub irrespective of whether the consolidated group received a refund; and (iii) the absence of language requiring the Parent to escrow or segregate tax refunds or restricting the Parent’s ability to use the funds before paying the Sub. Id. at *5.
In holding that the TSA created a debtor-creditor relationship, the Bankruptcy Court discounted language in the TSA that (i) expressly appointed the Parent to act as “agent” on behalf of the consolidated group and (ii) indicated that the parties intended to allocate tax liability in accordance with the Office of Thrift Supervision’s Interagency Statement on Income Tax Allocation in a Holding Company Structure (the “OTS Policy Statement”). On appeal, the District Court affirmed the Bankruptcy Court’s decision. Id. The FDIC then appealed to the Eleventh Circuit Court of Appeals. Id. at *6-12.
On appeal, the Eleventh Circuit held, as it did in its earlier BankUnited opinion, that the issue was one of contract (TSA) interpretation, finding that the contract at issue was ambiguous. In other words, the agreement determined whether a debtor-creditor or agency relationship existed, and thus, whether tax refund was property of the estate. 2013 U.S. App. LEXIS 18774 at *2. The Eleventh Circuit reviewed the TSA and concluded that, because the Bankruptcy Court discounted the agency language in the TSA, the Bankruptcy Court ignored a reasonable interpretation that the TSA created an agency relationship. Id. at *12-13. The Eleventh Circuit determined that there was more than one reasonable interpretation of the TSA, thereby finding the TSA ambiguous. Id. at *13.
After determining that the TSA was ambiguous, the Eleventh Circuit applied Georgia state law rules for interpreting ambiguous contracts. Id. at *13. Applying those rules, the Eleventh Circuit focused on the circumstances under which the TSA was entered into and the intent of the parties. Id. at *13-14. In discerning the parties’ intent, the Court placed great weight on the TSA’s clear expression that it was the intent of the parties to comply with the OTS Policy Statement. Id. at *14-16. The Eleventh Circuit found it material that the OTS Policy Statement specifically provides that a parent corporation that receives tax refunds does so as an “agent” on behalf of its subsidiaries and that any tax allocation agreement should not purport to characterize refunds attributable to the losses of an insured depositary institution as property of the parent. Id. at *14-16.
Moreover, the Eleventh Circuit focused on the language in the TSA which provided that tax settlements between the Parent and the Sub should result in no less favorable treatment to the Sub than if the Sub had filed a separate return. Id. at *16. The Court concluded that requiring the Sub to participate in the Parent’s bankruptcy case as a general unsecured creditor would be less favorable treatment. Id.
Accordingly, the Eleventh Circuit concluded that the parties intended to establish an agency relationship regarding tax refunds received by the Parent that were solely attributable to NOLs generated by the Sub. Id. at *16. In so holding, the Eleventh Circuit did not find the absence of language requiring a trust or escrow of tax refunds persuasive on the question of the intended relationship between the parties. Id. at *116-18. The Court found that the absence of such language offset by the lack of specific language indicative of a debtor-creditor relationship (e.g. provisions for interest and collateral). Id. at *18-19.
Thus, the Eleventh Circuit reversed and remanded the District Court judgment, directing the court to vacate its decision and enter judgment in favor of the FDIC. Id. at *19-20.
Why the Case is Interesting:
The Netbank decision adds to a growing body of case law on the interpretation of TSAs in bankruptcy and whether the right to a tax refund is property of the estate or held in trust for the non-debtor. It underscores the important of the words of the TSA itself, and factors a court will look into in interpreting a contract deemed ambiguous (here, reliance on the OTS Policy Statement). It is interesting that the decision also did not address what rights the non-debtor would have to payment in the event that a refund had not been received by the debtor. Because there was an actual tax refund, the Court limited its analysis to ownership of that refund, as opposed to claim entitlement if the Parent had not elected to receive the refund.