Non-debtor Transfers May Qualify for 1146(c) Exemption

Journal Issue

Feb 2005

Column Name

Feature

Bankruptcy Code

1146

Topic Tags

Bankruptcy Taxation

Plan Confirmation

Journal HTML Content

After the Third Circuit decided Baltimore County v. Hechinger Inv. Co. of Delaware (In re Hechinger Inv. Co. of Delaware), 335 F.3d 243 (3d Cir. 2003), courts and practitioners began struggling with Hechinger's requirement that only post-confirmation transfers may qualify for an exemption under 11 U.S.C. §1146(c) from stamp taxes or similar taxes. As one example, some courts require that taxes be escrowed in case the plan is not ultimately confirmed. Needless to say, Hechinger has made it more difficult to obtain a §1146(c) exemption for pre-confirmation transfers. However, the Eleventh Circuit's recent ruling in Florida v. T.H. Orlando Ltd., 2004 WL 2711888 (11th Cir. 2004), may have generally tipped the scales of §1146(c) back in the other direction by holding that a transfer of property between two non-debtors as part of a debtor's plan may satisfy §1146(c)'s requirement that the transfer be made "under" a confirmed chapter 11 plan.

<h4>Previous Law: The Debtor Must Be a Party to the Transfer</h4>

Until Orlando, courts had almost uniformly held that §1146(c) only applies to transfers to which the debtor is a party.<a href="#1" name="1a">1</a> Although the Fourth Circuit has held that the exemption applied to a non-debtor transaction, its holding is limited by the fact that it was ruling on a collateral attack on a confirmation order. Maryland v. Antonelli Creditors' Liquidating Trust, 123 F.3d 777, 786 (4th Cir. 1997) (embracing the supporting reasoning but only noting that the confirmation order was not "transparently invalid").

<h4>The Eleventh Circuit Breaks Ranks</h4>

In the Orlando case, the Eleventh Circuit broke ranks with precedent and held that §1146(c) does exempt such a transfer from taxation as long as the transfer is necessary to the consummation of a plan. 2004 WL 2711888, *2. The debtors in the Orlando case entered into an agreement to sell three hotels. The purchaser's lender conditioned its commitment to lend on an adjacent landowner's agreement to refinance its mortgage with the lender. As an accommodation to the debtors, the adjacent landowner agreed to the refinancing. The debtors proposed a plan that provided, among other things, that the refinancing of the adjacent landowner's mortgage would be exempt from "stamp, intangible and similar taxes" pursuant to §1146(c).

The Florida Department of Revenue (FDR) objected to the plan, asserting that the §1146(c) exemption did not apply to transactions between non-debtors. The bankruptcy court sustained FDR's objection without prejudice and confirmed the plan. Thereafter, the adjacent landowner paid the tax under protest and filed suit in Florida state court requesting a declaratory judgment and a refund. FDR removed the case to bankruptcy court. The bankruptcy court found that the refinancing of the adjacent landowner's mortgage was "under a plan" within the meaning of §1146(c) and, therefore, was exempt from taxation. The district court reversed the bankruptcy court because the debtors were not a party to the refinancing.

On appeal, the Eleventh Circuit reversed the district court holding that the exemption applies as long as the transfer is necessary to the consummation of a chapter 11 plan. The court noted that a transfer must satisfy three conditions to receive the §1146(c) exemption:

<blockquote>
(1) there must be a stamp tax or similar tax, (2) imposed upon the making of or the delivery of an instrument of transfer, (3) "under" a confirmed chapter 11 plan.
</blockquote>

2004 WL 2711888, *2 (citation omitted). Because FDR did not dispute that the first two conditions were satisfied, the Orlando court focused on the third condition and reviewed rulings on §1146(c) from other federal appellate courts. Based on the Third Circuit's holding in In re Hechinger Inv. Co. of Del., 335 F.3d 243 (3d Cir. 2003), and the Fourth Circuit's ruling in In re NVR LP, 189 F.3d 442 (4th Cir. 1999), the Eleventh Circuit concluded that a transfer "under" a plan meant that the transfer must be "authorized by a plan confirmed." Relying on the Second Circuit's ruling in City of New York v. Jacoby Bender, 758 F.2d 840 (2d Cir. 1985), the court held that a confirmed chapter 11 plan authorizes all transfers necessary to its consummation. Thus, the Eleventh Circuit concluded that all transfers necessary to consummate a plan were "under" a confirmed chapter 11 plan and therefore satisfy the third condition of the test. 2004 WL 2711888, *2. Applying the rule in that case, the Orlando court found that the refinancing was necessary to consummate the plan because the purchaser's lender had conditioned its commitment to lend on the adjacent landowner refinancing its mortgage. Consequently, the Eleventh Circuit held that the adjacent landowner's refinancing was exempt under §1146(c).

<h4>Application of the Orlando Case</h4>

The significance of the Eleventh Circuit's ruling in Orlando lies not only in the fact that it represents the first ruling by a federal court of appeals to address squarely<a href="#2" name="2a">2</a> whether §1146(c) applies to transactions where the debtor is not a party but also because of the practical ways in which its holding may be used. For instance, a purchaser of assets might seek to exempt from taxation (1) the mortgage on such assets to finance their purchase<a href="#3" name="3a">3</a> or (2) the resale of such assets.<a href="#4" name="4a">4</a> Moreover, because the Orlando holding rests upon the factual finding that the refinancing of the adjacent landowner's property was necessary to consummate the debtors' plan, for those jurisdictions that follow Orlando, confirmation hearings are much more likely to involve contested evidentiary hearings. Indeed, the line courts draw regarding what is necessary to consummate a chapter 11 plan will ultimately dictate the significance of Orlando.

<h4>Conclusion</h4>

It is unknown at this time whether courts outside of the Eleventh Circuit will follow Orlando or how those courts that follow Orlando will apply it. However, just as Hechinger forced practitioners representing chapter 11 debtors and trustees to be more creative to help preserve the §1146(c) exemption, Orlando will likely lead to the creative inclusion of non-debtor transfers in chapter 11 plans. Moreover, Orlando will encourage taxing authorities to challenge aggressively the factual finding that the transfer is necessary to the consummation of a plan.

<hr>
<h3>Footnotes</h3>

1 In re Kerner Printing Co., 188 B.R. 121, 124-25 (Bankr. S.D.N.Y. 1995) (exemption does not apply to third party selling the debtor's property because the debtor did not control the third party and the third party was not the debtor's agent); In re Bel-Aire Invs. Inc., 142 B.R. 992, 995-96 (Bankr. M.D. Fla. 1992) (no exemption for the refinancing of debt associated with assets transferred to the wife's corporation to effectuate divorce decree of the husband-wife owners); In re Amsterdam Ave. Dev. Assoc., 103 B.R. 454,458-61 (Bankr. S.D.N.Y. 1989) (mortgage of purchaser on debtor's assets to a bank to finance the purchase from the debtor was not exempt); see, also, Mensch v. Easter Stainless Corp. (In the Case of Eastmet Corp.), 907 F.2d 1487, 1490 (4th Cir. 1990) (noting in dicta and quoting Amsterdam Avenue that Congress did not intend for §1146(c) to apply to non-debtor transactions). <a href="#1a">Return to article</a>

<a name="2">2</a> In Maryland v. Antonelli Creditors' Liquidating Trust, 123 F.3d 777 (4th Cir. 1997), as discussed above, the Fourth Circuit addressed the issue but only in the context of ruling on a collateral attack of a bankruptcy court order. <a href="#2a">Return to article</a>

<a name="3">3</a> Amsterdam Ave. Dev. Assoc., 103 B.R. at 458-61 (pre-Orlando case holding that the mortgage of purchaser on debtor's assets to a bank to finance the purchase from the debtor was not exempt). <a href="#3a">Return to article</a>

<a name="4">4</a> Kerner Printing, 188 B.R. at 124-25 (pre-Orlando case holding that the exemption does not apply to third party selling the debtor's property because the debtor did not control the third party and the third party was not the debtor's agent). <a href="#4a">Return to article</a>

Journal Authors

Robert D. Mercer

Journal Date

Tuesday, February 1, 2005 - 12:00

Bankruptcy Rule

2005

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