The Third Circuit Rules in Favor of the Bankruptcy Estate Creating a Further Circuit Split

The Third Circuit recently weighed into the ongoing debate over the ownership of tax refunds generated by a failed bank in FDIC receivership, but paid to a failed bank holding company due to the existence of a tax sharing agreement (TSA) between the bank and the holding company. In Cantor v. FDIC (In re Downey Financial Corp.), 2015 WL 307013, No. 14-1586 (3d Cir. Jan. 26, 2015) (Downey), the Third Circuit affirmed a Bankruptcy Court decision finding that a creditor/debtor relationship existed between the bank holding company, Downey Financial Corporation (DFC), and the failed bank, Downey Savings and Loan, F.A. (Downey Bank). As a result, the tax refunds were found to be property of DFC’s bankruptcy estate. The Downeydecision furthers a division in the Circuits regarding this issue, which will likely need to be resolved by the US Supreme Court.


DFC filed a Chapter 7 bankruptcy on November 25, 2008, several days after the Federal Deposit Insurance Corporation (FDIC) was appointed as receiver for its wholly-owned subsidiary, Downey Bank, and all of the assets of Downey Bank were sold to US Bank National Association. Thereafter, the FDIC filed a protective proof of claim against the bankruptcy estate of DFC for tax refunds generated as a result of carrying back losses generated by Downey Bank. In October 2010, the Chapter 7 Trustee of DFC commenced an adversary proceeding against the FDIC seeking a declaratory judgment determining that the tax refunds are property of the DFC bankruptcy estate.

After an answer by the FDIC and the intervention of Wilmington Trust Company, as indenture trustee for senior notes issued by DFC (Indenture Trustee), the Bankruptcy Court held a hearing on summary judgment motions filed by the Chapter 7 Trustee and the Indenture Trustee. The Bankruptcy Court, in a lengthy opinion, granted those summary judgment motions and held, among other things, that DFC owned the tax refunds, the FDIC merely had a claim as a creditor to its share of the tax refunds, and that the TSA did not create an express trust, constructive trust, or resulting trust under California law. See Giuliano v. FDIC, 499 B.R. 439 (Bankr. D. Del. 2013). The FDIC appealed the Bankruptcy Court’s decision directly to the Third Circuit.

Third Circuit Opinion

On January 26, 2015, the Third Circuit affirmed the Bankruptcy Court’s decision granting summary judgment to the Chapter 7 Trustee and the Indenture Trustee. See Downey at *1. The Third Circuit began with an analysis of the TSA under California law and found that the Bankruptcy Court’s conclusion that the TSA was an unambiguous and integrated contract that expressly stated the intent of the parties “to establish a method for allocating the consolidated tax liability of each member among the Affiliated Group” was correct. Id. Given that the TSA was unambiguous, the Third Circuit reviewed and affirmed the Bankruptcy Court’s rulings on several different issues.

First, the Third Circuit agreed that the TSA could not be read to create a principal/agent relationship under California law because Downey Bank “did not exercise control over DFC’s activities under the agreement.” Id. at *2.Indeed, the TSA did not give any subsidiary of DFC, including Downey Bank, the ability to control DFC’s activities with respect to tax filing and refund allocation and that DFC had the sole authority to decide whether to seek a refund. See id. The Third Circuit also quickly dismissed the FDIC’s reliance on Western Dealer Management, Inc. v. England (In re Bob Richards Chrysler-Plymouth Corp., Inc.), 473 F.3d 262 (9th Cir. 1973) which, according to the FDIC, stands for the proposition that the default rule should be a principal/agent relationship whereby the parent company is the agent and holds the refund in trust for the subsidiary.  See id. The court found no support for that proposition.

Second, the Third Circuit did not find the FDIC’s argument that the tax refunds were merely held in trust for Downey Bank persuasive since that argument is inconsistent with the terms of the TSA. See id. The Downey court, in relying on the Ninth Circuit’s decision in FDIC v. Siegel (In re IndyMac Bancorp, Inc.), 554 F. App’x 668 (9th Cir. 2014) (IndyMac), found that since the word “trust” does not appear in the TSA, nor is there a designated “trustee” or “beneficiary” in the TSA, a trust was not created under California law. See Downeyat *2. Further, the Third Circuit stated that the TSA contains words such as “make payment,” “reimburse,” “compensate,” and “refund,” which are all common terms used in the creation of a debtor/creditor relationship. See id.  Moreover, the court found that, since the TSA did not contain any requirement for DFC to escrow or segregate the tax refunds, and that DFC had sole discretion to control the application for a refund or the disposition of that refund once received, no trust relationship was created. See id.

Finally, the Third Circuit addressed and dismissed the FDIC’s argument that a resulting trust was created. See id. at *3. A resulting trust is an equitable remedy applied when it is shown that a transferee of property was not intended to take a beneficial interest. In dismissing this argument, the Downey court found that, since the TSA granted DFC the sole discretion to make decisions regarding the tax filings, it was clearly the intent of the parties that DFC obtain a beneficial interest in the refunds. See id. Therefore, DFC was not unjustly enriched by receipt of the tax refunds in accordance with the terms of the TSA. See id.

As a result of the Third Circuit’s affirmation of the Bankruptcy Court decision, the FDIC is merely a creditor of the DFC bankruptcy estate.

Thoughts and Conclusions

The Third Circuit’s decision in Downey relied on, and is similar, to the Ninth Circuit’s decision inIndyMac. Both of these decisions found that tax refunds paid to a bank holding company pursuant to a TSA were property of the bank holding company’s bankruptcy estate. These decisions, however, are in contrast to those recently issued by the Eleventh and Sixth Circuits. InZucker v. FDIC (In re NetBank, Inc.), 729 F.3d 1344 (11th Cir. 2013) and Zucker v. FDIC (In re BankUnited Fin. Corp.), 727 F.3d 1100 (11th Cir. 2013), the Eleventh Circuit reversed bankruptcy court rulings determining that tax refunds paid under valid tax sharing agreements were property of the respective bankruptcy estates. Further, in FDIC v. AmFin Financial Corp., 757 F.3d 530 (6th Cir. 2014) (AmFin), the Sixth Circuit reversed a lower court decision determining that tax refunds paid to a bank holding company under a similar tax sharing agreement were property of that company’s bankruptcy estate and remanded the case to the lower court for further proceedings.

In AmFin, the FDIC filed a petition for certiorari so that the Supreme Court can resolve the emerging Circuit split. It is not clear whether the Supreme Court will grant the petition in AmFin; it previously denied similar petitions in BankUnited and NetBank. However, since those decisions were issued, there have been further cases out of the Circuits, including Downey from the Third Circuit, which should warrant review from the Supreme Court. Until such a review occurs, however, bankruptcy estates and their creditors involved in these disputes should continue to pursue estate ownership of tax refunds that are paid to bank holding companies pursuant to valid tax sharing agreements. The recovery from the pursuit of those assets is very often the only available assets to provide recoveries to all creditors; not just the FDIC.