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Who Owns A Refund? Consolidated Returns and Bankruptcy Add Wrinkles to Refund Dispute

Posted on Sep. 12, 2018

In re United Western Bancorp is an opinion out of the Tenth Circuit Court of Appeals from earlier this year that raises a procedural issue I had not considered: in the consolidated return context who is the true owner of a refund when a refund is wholly attributable to a subsidiary’s net operating losses? Normally, that is not an issue that generates disputes, because affiliated companies have overlapping interests in the refund. In re United Western Bancorp presents facts where this became an issue, because the parent company, UWBI, a bank holding company, filed a petition for Chapter 11 bankruptcy after the Office of Thrift Supervision closed the United Western Bank, the subsidiary/bank of UWBI, and appointed the FDIC as receiver.

In 2011, after the FDIC came in as receiver, but before the bankruptcy, UWBI filed a refund claim of about $5 million for 2008 due to a carryback of the $35 million that the subsidiary/bank lost in 2010. The IRS had not acted on the refund claim when the parent sought bankruptcy protection.  The FDIC, as receiver for the insolvent subsidiary bank, filed a proof of claim in the UWBI’s bankruptcy case, alleging in main part that the refund stemmed exclusively from the subsidiary bank carrybacks and that it was the true owner of the refund. The IRS granted the refund claim but representatives from UWBI and the bank/subsidiary fought over who should be deemed to own the refund.

The trustee in UWBI’s bankruptcy case initiated an adversary proceeding with the bankruptcy court, which agreed with the trustee and held that the refund was part of UWBI’s bankruptcy estate. The district court reversed and found that the subsidiary bank was the rightful owner of the refund, and the trustee appealed to the Tenth Circuit.

The dispute came down to the issue of whether the refund was part of the parent’s bankruptcy estate under 11 USC § 541(a)(1) which includes “all legal or equitable interests of the debtor in property as of the commencement of the [bankruptcy] case.” 11 USC § 541(d), however carves out from the debtor’s estate property which the debtor only has legal title and not an equitable interest.

The Tenth Circuit in resolving the dispute first looked to the consolidated return rules, an area that I have not had the pleasure of studying since my days in big firm practice in New York. The opinion notes that the consolidated return statute and regs  are silent with respect to legal and equitable ownership of refunds. The opinion notes that federal common law presents a framework for resolving the dispute, looking to the Tenth Circuit in Barnes v Harris, 783 F.3d 1185 (10th Cir. 2015), which itself relied on a 1973 Ninth Circuit opinion In re Bob Richards Plymouth-Chrysler. Barnes v Harris held that “a tax refund due from a joint return generally belongs to the company responsible for the losses that form the basis of the refund.” The Ninth Circuit, in Bob Richards, which also involved a dispute as to the ownership of a refund arising from a bankruptcy within a consolidated group, came up with what the Tenth Circuit refers to as the “Bob Richards Rule”:

Absent any differing agreement we feel 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. Allowing the parent to keep any refunds arising solely from a subsidiary’s losses simply because the parent and subsidiary chose a procedural device to facilitate their income tax reporting unjustly enriches the parent.

Complicating the analysis in In Re United Western Bancorp was that the parent and subsidiary corporation had in fact entered into a tax allocation agreement. The opinion takes a deep dive into the tax allocation agreement that the bank and parent had entered into, and it found that the agreement was ambiguous as to whether it intended to create an agency relationship between the parent holding company and sub/bank, which would in turn vest legal and equitable ownership in refund to the sub/bank, or something akin to a debtor-creditor relationship, which would leave the subsidiary bank only with an unsecured claim against the parent in the amount of the refund that the parent received.

The deep dive that the opinion reveals that the tax allocation agreement is not clear; some parts suggest that it reflects an agency/principal relationship between the parent and sub and other parts point more to a debtor/creditor relationship:

On the one hand, portions of the Agreement quite clearly indicate the intent to create an agency relationship between UWBI [parent] and its regulated, first-tier affiliates. For example, Section A.2 states that “each first-tier subsidiary [is to] be treated as a separate taxpayer with UWBI merely being an intermediary between an Affiliate and the” IRS. Likewise, Section G states that UWBI is being appointed by each affiliate to act as its agent for purposes of filing the consolidated tax return and taking any action in connection therewith. On the other hand, portions of the Agreement arguably suggest the intent for UWBI to retain tax refunds before forwarding them on to regulated, first-tier affiliates. For example, parts of Section A.1 imply that UWBI will retain tax refunds and then later take them into account during the annual settlement process. In addition, the fact that Section A.1 affords UWBI with discretion regarding the amount to refund a regulated, first-tier affiliate (i.e, the exact amount of the refund or a greater amount) seems to suggest something other than an agency relationship. Finally, the ambiguity of the Agreement on this issue is compounded by the fact that it contains no language requiring UWBI to utilize a trust or escrow for tax refunds—which would suggest the existence of an agency or trust relationship—nor does it contain provisions for interest and collateral—which would be indicative of a debtor-creditor relationship.

The agreement does provide however that any ambiguity is to be resolved “with a view to effectuating such intent [i.e., to provide an equitable allocation of the tax liability of the Group among UWBI and the Affiliates], in favor of any insured depository institution.” (emphasis added). In light of that mechanism for resolving the ambiguity  the Tenth Circuit concluded  that it is appropriate to consider the agreement as creating an agency relationship between the parent and sub, with the result that it considered the agreement as not displacing the general rule outlined in Bob Richards and Barnes. By concluding that the tax allocation agreement did not displace the Bob Richards rule the court concluded “that the tax refund at issue belongs to the Bank, and that the FDIC, as receiver for the Bank, was entitled to summary judgment in its favor.”

I note one other interesting part of this opinion. In 2014, the Sixth Circuit, in Fed. Deposit Insurance. Corp. v. AmFin Financial Corp explicitly rejected the Bob Richards Rule because it “is a creature of federal common law” and “federal common law constitutes an unusual exercise of lawmaking which should be indulged only in a few restricted instances.” In note 4 of the United Western Bancorp opinion, the Tenth Circuit declined to step into that issue, noting that the Tenth Circuit’s adoption of the Bob Richards Rule in the earlier Barnes case meant that it was bound to follow the circuit’s precedent.

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