Supreme Court Puts Quietus on Transfer Tax Exemption for Property Sales Prior to Confirmation

September 2008

On June 16, 2008, the Supreme Court held, in Florida Department of Revenue v. Piccadilly Cafeterias Inc.,[1] that the transfer tax exemption provided by Bankruptcy Code §1146(a)[2] does not apply to property transfers made before a chapter 11 plan is confirmed.  The majority opinion of the 7-2 decision was written by Justice Thomas, and it reversed the holdings of the courts below.  The Supreme Court adopted positions previously taken by the Third and Fourth Circuit Courts of Appeals.[3]  Justice Breyer wrote a dissent, joined by Justice Stevens.

Piccadilly Cafeterias, a formerly successful national restaurant chain, filed a chapter 11 case in the Southern District of Florida in 2003.  Prior to confirmation of a plan, Piccadilly moved to sell substantially all its assets at auction pursuant to Code §363(b)(1).  In contemplation of the impending sale, Piccadilly entered into a settlement agreement with creditor committees that specified the priority of distribution of the sale proceeds among creditors.  The bankruptcy court approved the sale and the settlement agreement and also ruled that the §363(b) transfer of Piccadilly's assets was exempt from stamp taxes under §1146(a).[4]  Subsequently, the court considered Piccadilly's amended chapter 11 plan, which provided for distribution of the asset sale proceeds in accordance with the settlement agreement.  The Florida Department of Revenue objected to plan confirmation, arguing that its assessment of $39,000 in stamp taxes accrued on the transfer was not exempt under §1146(a) because the asset transfer had not been "under a plan confirmed."  The bankruptcy court disagreed and confirmed Piccadilly's amended plan, holding that the asset sale was a transfer "under" the plan because the sale was necessary to consummate the plan.  The district court and Eleventh Circuit affirmed.  The Eleventh Circuit held that the tax exemption applied "to those pre-confirmation transfers that are necessary to the consummation of a confirmed plan of reorganization, which, at the very least, requires that there be some nexus between the pre-confirmation transfer and the confirmed plan."[5]  The Supreme Court accepted certiorari because of the conflict raised by the earlier and contrary decisions of the Third and Fourth Circuits.

In his majority opinion, Justice Thomas treated the issue as primarily one of interpreting the "under a plan confirmed" language of §1146(a).  (Among the parties' multiple arguments, Florida urged that the word "confirmed" modifies "plan" and is a past participle indicating "past or completed action," while Piccadilly argued that "under" is just as easily read to mean "in accordance with."  Both parties cited the American Heritage Dictionary for these grammatical assertions. 128 S.Ct. at 2331.)  After summarizing the parties' positions, Justice Thomas announced his view:  "While both sides present credible interpretations of §1146(a), Florida has the better one." Id. at 2332. Thomas acknowledged the ambiguity of the statute and concluded that the Florida interpretation "is clearly the more natural," while Piccadilly's assertion that "'there must be some nexus between the pre-confirmation transfer and the confirmed plan' for §1146(a) to apply...places greater strain on the statutory text than the simpler construction advanced by Florida and adopted by the Third and Fourth Circuits." Id. at 2333.

After essentially deciding the case, Justice Thomas went on to discuss other arguments advanced by the parties.  Those arguments in large part relied on various canons of statutory construction.  For example, Thomas rejected Piccadilly's argument that the statute should be read in the context of other Code provisions, a position that was ultimately aimed at persuading the Court that the term "under" in §1146(a) should be read to mean "authorized by." Id. Thomas was more receptive to Florida's argument regarding the placement of this Code provision in a subchapter entitled "Postconfirmation Matters."  He saw this placement as suggesting, if anything, how Congress intended §1146 to be applied.  Rather than construing the statute liberally, as urged by Piccadilly, Thomas found that the federalism canon the Supreme Court had previously applied in Cal. State Bd. of Equalization v. Sierra Summit Inc.[6] obliged the Court to construe the statute narrowly.  To do otherwise, he noted, "would in effect be 'recogniz[ing] an exemption from state taxation that Congress has not clearly expressed;'—namely, an exemption for preconfirmation transfers."  Id. at 2338.  This federalism canon seems to be the canon of construction that Justice Thomas found most persuasive; in fact, later in the opinion he declined "to construe the exemption granted by §1146(a) to the detriment of the State." Id. at 2339.

Piccadilly unsuccessfully advanced several arguments to the effect that its interpretation of §1146(a) would facilitate the chapter 11 process, while Florida's proposal to restrict the exemption to post-confirmation transfers only would "undermine Chapter 11's twin objectives of preserving going concerns and maximizing property available to satisfy creditors."  Id. at 2338 (citation omitted).  To Piccadilly's argument that the "'practical realities' of chapter 11 reorganizations are increasingly rendering post-confirmation transfers a thing of the past," Justice Thomas responded that "it is incumbent upon the Legislature, and not the Judiciary, to determine whether §1146(a) is in need of revision."  Id. at 2339.

At the end of his opinion, Justice Thomas summarized his view of the holding: The most natural reading of the statute's text and the placement of the provision within the Code all lead to the same conclusion. "Section 1146(a) affords a stamp-tax exemption only to transfers made pursuant to a Chapter 11 plan that has been confirmed."  Id.

Justice Breyer in dissent did not strongly take issue with the majority's rationale.  He recognized the "perfect ambiguity" in the language of the statute but found it no more difficult to apply the words to plans subsequently confirmed than to plans already confirmed.  He dismissed the importance of the placement of the statute within the Code and declared that the canons of construction help little, including the canon relied upon by the majority—that courts should "proceed carefully when asked to recognize an exemption from state taxation that Congress has not clearly expressed."  Id. at 2341.  Justice Breyer questioned how the Court could apply the federalism canon in the situation before it: "[W]hen, as here, we interpret a provision the express point of which is to exempt some category of state taxation, how can the statement in Sierra Summit prove determinative?"  Id. at 2340.

Justice Breyer's primary concern was: "Why would Congress have insisted upon temporal limits?  What reasonable purpose might such limits serve?"  Id. at 2341.  As he saw it, §1146(a)'s purpose, which "is apparent on its face," is to further the basic objectives of chapter 11: "(1) 'preserving going concerns' and (2) 'maximizing property available to satisfy creditors.'"  Id.  Quoting from Collier, he noted that the purpose of the §1146(a) exemption "is to encourage and facilitate bankruptcy asset sales."  Id.[7]  Justice Breyer's dissenting opinion went on to recite a number of advantages to bankruptcy estates that would be gained if a reorganizing debtor had the ability to sell assets whenever it was most advantageous and without the delays inherent in complex chapter 11 cases.  In the instant case, Piccadilly sold its assets quickly and realized $80 million, which was considerably more than had been offered prior to the chapter 11 filing.  Justice Breyer was of the opinion that §1146(a) provides that "clear enough rule-transfers are exempt when there is confirmation and are not exempt when there is no confirmation" and that the majority's construction of the statute "conflicts with the statute's purpose."  Id. at 2343.

It may be anticipated that the bankruptcy bar's reaction to Piccadilly will be negative because of the adverse impact the decision could have on preconfirmation §363 sales.  The authors of two ABI articles make this case with similar comments to the effect that the Supreme Court should have based the decision on the policy behind §1146(a) and chapter 11—the preservation and maximization of assets available to creditors by permitting tax-free preconfirmation asset sales.[8]  A more interesting take on Piccadilly is expressed by Prof. Jonathan Lipson, writing in the Weblog, "Credit Slips."  Noting that the language of the statute could have been interpreted "either way," he also believes the decision should have been based on policy grounds.  The policy he finds better suited and that supports the decision is one requiring chapter 11 sales to be made through plans that require disclosure statements and voting class approval.  "[A]n unintended (positive) consequence of [Piccadilly]may be that it produces more transparent, and broadly supported, sales."[9]