When the IRS pays a tax refund to the corporate group, it always issues that refund to the corporate parent — even if some or all of the losses are attributable to one of its subsidiaries. That raises an oft-litigated and highly significant question: Who owns the refund? Is it the parent who holds it, or the subsidiary that gave rise (in whole or in part) to the underlying tax losses? Circuits are intractably divided on the answer to that question.[1]
The U.S. Supreme Court may answer the question after hearing argument in Rodriguez v. Federal Deposit Insurance Corp. later this year.[2] Specifically, the Supreme Court will consider whether ownership of a tax refund should be determined based on the federal common law “Bob Richards rule,” as three circuits have held, or based on relevant state law, as four circuits have held.[3] The Bob Richards rule provides, “[a]bsent any differing agreement ... [that] a tax refund resulting solely from offsetting the losses of one member of a consolidated filing group against the income of that same member in a prior or subsequent year should inure to the benefit of that member.”[4] The outcome of Rodriguez carries important ramifications in delineating property of the estate, as tax refunds paid to affiliated groups can reach into the hundreds of millions of dollars.
Factual Background
United Western Bancorp Inc. (UWBI) was a bank holding company that owned several affiliate subsidiaries, including United Western Bank (the “Bank”).[5] Beginning in 2004 and continuing thereafter, UWBI, the Bank and other affiliates (the “Group”) filed consolidated federal income tax returns. In 2008, the Group entered into a Tax Allocation Agreement (the “Agreement”) that stated that the parties to the Agreement “desire[d] to establish a method for (1) allocating the consolidated tax liability of the Group among its members, (2) reimbursing UWBI for the payment of such tax liability, and (3) compensating each member of the Group for the use of its losses by any other member of the Group.”[6]
In 2008, the Group filed a tax return that reported $34,397,709 in taxable income.[7] In 2010, the Bank suffered $35,351,690 in losses. In 2011, UWBI, on behalf of the Group, filed a tax refund request seeking the return of $4,846,625 based on the Bank’s 2010 losses.[8] Subsequently, the Office of Thrift Supervision closed the Bank and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver.[9]
Because the Bank was UWBI’s principal source of income, in 2012 UWBI filed a chapter 11 bankruptcy case. As of the petition date, the refund request was still pending before the IRS. In 2013, UWBI’s bankruptcy case was converted to chapter 7, and Simon Rodriguez was appointed chapter 7 trustee.
Adversary Proceeding
In 2014, the trustee initiated an adversary proceeding seeking, inter alia, a declaratory judgment that the tax refund belonged to the UWBI bankruptcy estate. The FDIC counterclaimed that it was entitled to the refund. Both parties filed motions for summary judgment.[10]
The FDIC argued, among other things, that (1) nothing in the Agreement altered the “widely recognized default rule” that the ownership of a tax refund in a jointly filed tax return belongs to the entity that generated the tax refund,[11] and (2) UWBI, as agent to the Bank, would hold only bare legal title upon receipt of the tax refund.[12]
In contrast, the trustee argued that (1) the Agreement created a debtor/creditor relationship between UWBI and the Bank, and (2) therefore, if and when the refund was paid to UWBI, the funds would become property of the estate, on which the Bank would have an unsecured claim.[13] While the motions for summary judgment were pending, the IRS issued a refund to UWBI in the amount of $4,081,334.67.[14]
On Sept. 16, 2016, the bankruptcy court granted summary judgment in favor of the trustee, relying in part on § 541 of the Bankruptcy Code, which provides that the bankruptcy estate includes “all legal or equitable interests of the debtor in property as of the commencement of the bankruptcy case ... wherever located and by whomever held.”[15] The bankruptcy court noted that “[a] long line of bankruptcy cases (even pre-dating the modern Bankruptcy Code) dictate that if a debtor owns or is entitled to a federal loss carryback tax refund, such refund generally becomes property of the debtor’s bankruptcy estate.”[16] Thus, the bankruptcy court concluded that UWBI held, at the very least, bare legal title to the tax refund. The bankruptcy court further concluded that (1) the FDIC failed to establish equitable title, as the Internal Revenue Code and IRS do not address ownership of a refund stemming from a jointly filed return, and (2) the Agreement created a debtor/creditor relationship.[17] Accordingly, the bankruptcy court held that the trustee was entitled to the refund.[18] The FDIC appealed.
District Court Decision
The district court first recognized that, absent governing federal law, “property and interests in property are creatures of state law.”[19] Thus, ownership of the tax refund would ordinarily be determined by Colorado law, which would “essentially always” require a finding that the Agreement (and similar contracts) create a debtor/creditor relationship, thereby entitling the Ttrustee to the refund.[20] However, the district court noted that the federal common law Bob Richards rule had been adopted by the Tenth Circuit, thus Colorado law did not govern.[21] Applying the Bob Richards rule, the district court concluded that the Agreement was ambiguous and that, per the Agreement, any ambiguity should be construed against the trustee.[22] Thus, the Agreement required UWBI to act as the Bank’s agent, and the Bank held equitable title.[23] The trustee appealed.
The Court of Appeals Decision
The Tenth Circuit Court of Appeals began its analysis by noting that the Tax Code does not specify which of the affiliated entities is entitled to a refund, but that federal common law provides a framework for resolving the dispute via the Bob Richards rule. While the trustee argued that the Bob Richards rule simply cannot apply where a tax-allocation agreement exists, the U.S. Court of Appeals for the Tenth Circuit disagreed: The Bob Richards rule did apply, and because of the Agreement, the court was required to examine the Agreement to determine whether the parties clearly intended a departure from the general rule.[24] Ultimately, the court affirmed: The Agreement was ambiguous and, absent a “differing agreement,” the return belonged to the Bank.[25] Undeterred, the trustee appealed.
Supreme Court Grants Certiorari
On June 28, 2019, the U.S. Supreme Court granted certiorari. The Supreme Court’s decision may provide bankruptcy practitioners with clear guidance on, among other things, the delineation of property of the estate in jointly administered cases. Moreover, if the Bob Richards rule is confirmed applicable, the Rodriguez decision may serve as an important reminder that affiliated entities should only file joint tax returns pursuant to an unambiguous agreement establishing the rights and obligations of each party, and including a clear framework establishing the beneficiaries of any tax refund.
[1] Petition for writ of certiorari at p. 2, Rodriguez v. Federal Deposit Insurance Corp., 139 S. Ct. 2778 (No. 18-1269) (April 1, 2019).
[2] Rodriguez v. Federal Deposit Insurance Corp., 139 S. Ct. 2778 (2019).
[3] The Sixth and Eleventh Circuits hold that ownership of a tax refund should always be determined according to state law, while the Second and Third Circuits hold that state law should apply if a tax agreement exists. The Fifth, Ninth and Tenth Circuits follow the Bob Richards rule.
[4] Id.
[5] Rodriguez v. Federal Deposit Insurance Corp. (In re United W. Bancorp Inc.), 914 F.3d 1262, 1264 (10th Cir.), cert. granted sub nom., Rodriguez v. Federal Deposit Insurance Corp., 139 S. Ct. 2778 (2019).
[6] Id. at 1264.
[7] Id. at 1266.
[8] Id.
[9] Id.
[10] Id.
[11] Id. at 1266-67.
[12] Id. at 1267.
[13] Id.
[14] Id.
[15] 11 U.S.C. § 541.
[16] Rodriguez v. Federal Deposit Insurance Corp. (In re United W. Bancorp Inc.), 558 B.R. 409, 420 (Bankr. D. Colo. 2016), rev’d and remanded, 574 B.R. 876 (D. Colo. 2017), aff’d, 893 F.3d 716 (10th Cir. 2018), amended and superseded on reh’g, 914 F.3d 1262 (10th Cir. 2019), and aff’d, 914 F.3d 1262 (10th Cir. 2019).
[17] 914 F.3d at 1267.
[18] Id.
[19] United Western Bancorp Inc. v. Rodriguez (In re United Western Bancorp Inc.), 574 B.R. 876, 883 (internal quotation marks omitted).
[20] Id. at 886.
[21] Id. at 884.
[22] Id.
[23] Id. at 895.
[24] 914 F.3d at 1267.
[25] Id. at 1274.