The Supreme Court ruled this morning in Rodriguez v. Federal Deposit Insurance Corp. that federal courts may not employ federal common law to decide who owns a tax refund when a parent holding company files a tax return but a subsidiary generated the losses giving rise to the refund.
In his eight-page opinion for the unanimous court, Justice Neil M. Gorsuch used a dispute in bankruptcy court to hold that “cases in which federal courts may engage in common lawmaking are few and far between.”
The Facts
A bank’s holding company was in chapter 7 with a trustee. The bank subsidiary was taken over by the Federal Deposit Insurance Corp. as receiver. The bank subsidiary’s losses resulted in a $4 million tax refund payable to the parent under a pre-bankruptcy tax allocation agreement, or TAA, between the parent and the bank subsidiary.
Both the trustee for the holding company and the FDIC, as receiver for the bank, laid claim to the refund. If the holding company owned the refund, the FDIC would have nothing more than an unsecured claim.
The bankruptcy court in Colorado granted summary judgment in favor of the holding company’s trustee, concluding that the TAA did not create a trust or agency under Colorado law. In the view of the bankruptcy court, the parent and subsidiary only had a debtor/creditor relationship under the TAA, leaving the FDIC with an unsecured claim for the refund.
On appeal, the district court believed that the Tenth Circuit had adopted the Bob Richards rule, first enunciated by the Ninth Circuit in In re Bob Richards Chrysler-Plymouth Corp., 473 F.2d 262 (9th Cir. 1973). Bob Richards made a presumption under federal common law that the subsidiary with the losses is entitled to the refund absent a TAA that clearly gives the refund to the parent.
The district court, however, went on to analyze the TAA and found provisions supporting a ruling in favor of the holding company and other provisions where the bank subsidiary would come out on top. The district court ended up relying on tie-breaking language in the TAA that resolved ambiguity in favor of the bank subsidiary. The district court therefore reversed and awarded the refund to the FDIC.
The Tenth Circuit affirmed the district court, first saying that the appeals court had adopted Bob Richards in Barnes v. Harris, 783 F.3d 1185 (10th Cir. 2015).
Unlike Barnes and Bob Richards, the Tenth Circuit said that the case on appeal had a written agreement in the form of the TAA. The appeals court ruled that the tie-breaking provision in the TAA created an agency relationship. In the view of the circuit court, the FDIC was entitled to the refund because the holding company was an agent for the bank.
The Tenth Circuit created ambiguity about the basis for its ruling by saying at the end of the opinion that the result did not differ from the rule in Barnes and Bob Richards.
The circuits are split 3/4. The Fifth, Ninth and Tenth Circuits have followed Bob Richards, while the Second, Third, Sixth and Eleventh Circuits reject Bob Richards and employ state law to decide who owns a refund and whether the TAA creates an unsecured debtor/creditor relationship.
The holding company’s trustee filed a petition for certiorari in April 2019. The Court granted the petition at the end of June to answer the one question presented: Does federal common law (Bob Richards) or state law determine the ownership of a tax refund?
Courts Have Only ‘Limited Areas’ for Making Federal Common Law
The handwriting was on the wall on the second page of the opinion. Justice Gorsuch said that state law — such as “rules for interpreting contracts, creating equitable trusts, avoiding unjust enrichment” — are “readymade” for deciding the ownership dispute.
“Judicial lawmaking,” Justice Gorsuch said, “plays a necessarily modest role under a Constitution that vests federal” legislative power in Congress. As a result, “only limited areas exist in which federal judges may appropriately craft the rule of decision.” Appropriate areas, he said, are in admiralty law and disputes among states.
Citing Supreme Court precedent, Justice Gorsuch said that federal common law is appropriate only when “necessary to protect uniquely federal interests.” He found no federal interest in deciding the owner of the tax refund.
Returning to where he began, Justice Gorsuch said that “state law is well equipped to handle disputes involving corporate property rights.” A federal bankruptcy, he said, “doesn’t change much.”
The Remedy
The trustee and the FDIC disagreed on whether the lower courts relied on Bob Richards or decided the case based on state law, but Justice Gorsuch said the Supreme Court did not grant certiorari to decide how the case should end up under state law.
Vacating and remanding, Justice Gorsuch said that the Court “took this case only to underscore the care federal courts should exercise before taking up an invitation to try their hand at common lawmaking.”
Observations
The case is an example of how the Supreme Court will make law when the justices feel like it, even if there is no longer a dispute between the parties. By the time of oral argument, neither side nor the Solicitor General was defending the Bob Richards rule.
With no live controversy regarding Bob Richards, several justices made comments at oral argument suggesting that the Court might dismiss the petition as having been improvidently granted. For instance, Justice Ruth Bader Ginsburg said, “we usually don’t decide an abstract” question when there is a lack of “adversarial confrontation.”
However, several justices seemed primed to strike down Bob Richards. Justice Brett M. Kavanaugh said the federal common law was “patently indefensible.” Hinting that he would be the author of the Court’s opinion, Justice Gorsuch said at oral argument that the outcome should be determined by state law, without “any thumb on the scale by federal common law.”
The opinion presents a question for bankruptcy judges: May they announce a rule of bankruptcy common law if the Bankruptcy Code does not provide an answer? Must courts always purport to find an answer in the statute?
The Supreme Court ruled this morning in Rodriguez v. Federal Deposit Insurance Corp. that federal courts may not employ federal common law to decide who owns a tax refund when a parent holding company files a tax return but a subsidiary generated the losses giving rise to the refund.
In his eight-page opinion for the unanimous court, Justice Neil M. Gorsuch used a dispute in bankruptcy court to hold that “cases in which federal courts may engage in common lawmaking are few and far between.”
The Facts
A bank’s holding company was in chapter 7 with a trustee. The bank subsidiary was taken over by the Federal Deposit Insurance Corp. as receiver. The bank subsidiary’s losses resulted in a $4 million tax refund payable to the parent under a pre-bankruptcy tax allocation agreement, or TAA, between the parent and the bank subsidiary.
Both the trustee for the holding company and the FDIC, as receiver for the bank, laid claim to the refund. If the holding company owned the refund, the FDIC would have nothing more than an unsecured claim.
The bankruptcy court in Colorado granted summary judgment in favor of the holding company’s trustee, concluding that the TAA did not create a trust or agency under Colorado law. In the view of the bankruptcy court, the parent and subsidiary only had a debtor/creditor relationship under the TAA, leaving the FDIC with an unsecured claim for the refund.