Continuing a string of decisions interpreting tax-sharing arrangements, the Third Circuit recently held that under California law, a tax-sharing arrangement unambiguously created a debtor-creditor relationship and did not create an agency relationship or a trust relationship.  At issue in In re Downey Financial Corp.  2015 WL 307013  (C.A.3 (Del.),2015) was the division of over $370 million in tax refunds held in the holding company’s estate, and if its subsidiaries would receive their full portion of the refund or merely an unsecured claim for that portion of the refund.  The Third Circuit held that under California law, the tax-sharing arrangement unambiguously created a debtor-creditor relationship as the lack of any right of the subsidiaries to control the actions of the parent company precluded an agent relationship.  Furthermore, the lack of any discussion of trusts, beneficiaries, or trustees precluded a finding that the contract created a trust relationship.  This decision contributes to the ambiguity regarding tax-sharing arrangements in bankruptcy, as different circuits applying different state law have reached opposite conclusions from similar language in the agreements.  This ambiguity reinforces the need for any group of companies with a tax-sharing arrangement to clarify the treatment of any refund in bankruptcy to provide certainty to their creditors and to avoid the dissipation of assets litigating the issue in any future bankruptcy proceeding.


Courts have continued to rule on the appropriate treatment in bankruptcy of a tax refund pursuant to a tax-sharing agreement (TSA) that is silent on how the refund should be treated in a bankruptcy proceeding.  In the most recent case, FDIC v. AmFin Financial Corp. et al., the 6th Circuit reversed a district court ruling that a TSA was unambiguous, and remanded the issue for consideration of extrinsic evidence to determine the parties’ intent.

The district court had held, based on language in the TSA such as “reimbursement” and “payment” that the TSA unambiguously created a debtor-creditor relationship between the members of the consolidated entity, making the refund part of the bankruptcy estate of AmFin Financial Corporation (“AmFin”), the company that received the refund, rather than AmTrust Bank (“AmTrust”), the corporation whose losses had created the $170 million tax refund.  This treatment benefited the creditors of AmFin, which would retain much of the tax refund and pay only a portion to AmTrust as an unsecured general creditor.  The 6th Circuit reversed and held that as the TSA was entirely silent on the treatment of refunds the agreement could not be said to be unambiguous, and remanded for further proceedings using extrinsic evidence to determine the parties’ intent in drafting the TSA.  The 6th Circuit also rejected arguments that federal common-law should apply that would, in the absence of an explicit provision stating otherwise, always direct the refund under a TSA to entity whose losses generated the refund.

This is the latest in a line of similar cases in the past few years that have  been covered on this blog (see here and here ) interpreting the proper allocation of any refunds under a TSA in bankruptcy and further reinforces the need for clarity in the TSA itself as to how the refund should be allocated.  This will help provide certainty for the creditors of any conglomerate that uses a TSA how their claims may be treated in bankruptcy, and avoid the potential for costly litigation between the members of the conglomerates that diminishes the assets available for a restructuring or distribution to creditors.

In a follow-up to our post on the treatment of tax-sharing arrangements in bankruptcy, the Ninth Circuit held last month in an unpublished decision that a rebate that a holding company received pursuant to an ambiguous tax-sharing agreement (“TSA”) created a debtor-creditor relationship between the holding company and its banking subsidiary.  In the Matter of: Indymac Bancorp, Inc., (12-56218) (9th Cir., April 21, 2014).  As a result, the refund was property of the bankruptcy estate of the holding company, a significant windfall for the holding company and a significant loss to its subsidiary’s estate.  The Ninth Circuit’s decision is in contrast to the twin decisions of the Eleventh Circuit in the fall of 2013,[1] finding that two separate TSAs in unrelated cases created an agency relationship between a holding company and its subsidiary, thereby excluding the refund from the estate. See In Re Bamkunited Financial Corp., 12-11392 (11th Cir. Aug. 15, 2013); In Re Netbank, Inc., 12-13965 (11th Cir. Sept. 10, 2013)

As explained in our prior post, when a bankruptcy occurs, one affiliate may be holding the rebate for the entire conglomerate and the distinction between the relationships between the affiliated entities affects how that refund will be treated in bankruptcy.  If the TSA created an agency relationship, the refund will be excluded from the estate and the refund will be split as it would in the ordinary course of business.  If, however, the TSA create a debtor-creditor relationship, the entire refund becomes property of the estate holding the rebate and the other entities receive only an unsecured creditor claim for that refund – a potentially significant windfall for creditors of the rebate-holding entity and a significant loss of funds for creditors of the other entities of the conglomerate.

The Ninth Circuit distinguished Indymac from the Eleventh Circuit’s Netbank decision based on two factors: (i) that the Netbank case involved a TSA with an explicit incorporation of the Interagency Statement on Income Tax Allocation in Holding Company Structure (which the Indymac TSA did not), and (ii) that California law applied in Indymac rather than the Georgia law that governed Netbank.  The Ninth Circuit held that under California law, the TSA did not create a principal-agent relationship – despite specific language that appointed the holding company the subsidiary bank’s “agent and attorney-in-fact” because the subsidiary bank did not exercise control over its holding company’s activities with respect to any aspect of the tax filing.  Separately, the Ninth Circuit held that the TSA’s lack of language establishing a trust relationship was explicitly an indication of a debtor-creditor relationship under California law.

This case reinforces the need for a company considering the creation of a TSA to address explicitly how any tax refund will be treated in the event of a bankruptcy.  Given the varying decisions from courts on ambiguous TSAs and the potential effects of different state laws, a TSA that does not address how it should be interpreted in bankruptcy creates uncertainty as to where any tax refund may wind up in a bankruptcy, and creates the risk that in a bankruptcy resources of the estate will be wasted on litigation over the interpretation of an ambiguous TSA.

[1]               In re Bankunited Financial Corp., 12-11392 (11th Cir. Aug. 15, 2013); In Re Netbank, Inc., 12-13965 (11th Cir. Sept. 10, 2013)

When a multi-national conglomerate corporation fails, how the corporation’s tax-sharing arrangements (“TSAs”) will be interpreted in bankruptcy can be a multi-million dollar question, especially where a holding company is being reorganized separately from a subsidiary.  If the TSA is deemed to create debtor-creditor relationships between the affiliates, the affiliate holding the rebate on the date of bankruptcy need only distribute any refund owed to other affiliates at an unsecured creditor rate – resulting in a significant loss to the other companies and a windfall to the affiliate holding the rebate when the music stopped.  If, however, the TSA is deemed to create an agency relationship between the affiliates, the rebate should be distributed between them in parity notwithstanding the bankruptcy.  For a subsidiary – such as a bank owned by a holding company – the difference can be a matter of millions of dollars and have a substantial impact on its creditors’ recovery rates.

Conglomerate corporations use TSAs principally because they offer a mechanism for simplifying and organizing the tax filings of companies in a consolidated group.  Under certain conditions, federal law permits a parent company to file a consolidated tax return on behalf of itself and its subsidiaries.  Since federal law does not specify how the tax liabilities or refunds should be allocated between the companies, TSAs exist to allocate the liabilities and refunds between the companies in the group.

When a bankruptcy occurs, one affiliate may be holding the rebate for the entire conglomerate.  In these cases, the TSA must be interpreted to determine whether the estate of the affiliate holding the rebate effectively gets a windfall, such that a significant portion of the refund will go to that affiliate’s creditors, or whether the rebate will be split between the entities in the conglomerate as it would have been outside of the bankruptcy context.  Many TSAs are silent on how a refund should be handled in a bankruptcy and so bankruptcy courts must determine, according to the governing state’s contract law, how the refund will be treated.

In a pair of recent cases, the Eleventh Circuit interpreted two tax-sharing agreements to create an agency relationship between the parent company and its subsidiary.  In both cases, a dispute arose between the holding company in Chapter 11 and the FDIC as receiver for a subsidiary bank over the proper treatment of the tax refund.

In In Re Bamkunited Financial Corp., 12-11392 (11th Cir. Aug. 15, 2013), U.S. Bankruptcy Judge Laurel Isicoff held that the rebates became the property of the holding company estate on receipt, and that the obligation to transfer the refunds to the FDIC (as receiver for the bank) became a debt of the holding company estate.  On appeal, after finding that the contract was silent on the issue of the holding company’s “ownership” of the refunds before they were forwarded to the bank under the TSA, the Eleventh Circuit applied Delaware law in determining that the contract should be interpreted to create an agency relationship.  The court relied on two key aspects of the contract: first, the absence of any collateral or any other contractual protection for the subsidiary for the obligation owed by the parent company;  and second, the absence of any language from which a debtor-creditor relationship was created or implied, and the absence of any method to determine the terms of the indebtedness.

About three weeks later, the Eleventh Circuit decided In Re Netbank, Inc., 12-13965 (11th Cir. Sept. 10, 2013), again holding in similar circumstances that, under Georgia law, a TSA should be interpreted to create an agency relationship.  The court based its decision on two specific clauses in the TSA; first, a provision that incorporated the language of the FDIC’s Policy Statement on TSAs that notes that the parent receives refunds as an “agent” on behalf of group members; and second, a provision that stated that the TSA should result in “no less favorable” treatment for the subsidiary than if it had filed on its own.  The Eleventh Circuit held that reducing the subsidiary’s claim to the refund to that of an unsecured creditor would result in giving the subsidiary less favorable treatment than if it had filed alone.

While a going concern is free to write its TSA to specify whether the relationship between the entities should be considered a debtor-creditor relationship or an agency relationship, in most cases the situation will never be considered until the conglomerate is in bankruptcy.  Prudence counsels that any corporation considering a new TSA should consider the issue of how the refund should be treated in bankruptcy and explicitly state that the TSA creates an agency relationship (if the corporation desires that the refund distribution not be affected by a bankruptcy), or a debtor-creditor relationship (if the conglomerate seeks to advantage the estate of the company holding the refund in the event of a bankruptcy).

These two Eleventh Circuit decisions provide a blueprint for arguing that existing TSAs that are silent on the status of the refunds should be interpreted to create an agency relationship and remove refunds owed to other companies from the bankruptcy estate.  They strongly support the position that the default interpretation of an ambiguous TSA should be an agency relationship, resulting in complete distribution of the refund in the event of bankruptcy.  This gives the trustee or receiver of a subsidiary company owed a tax refund a significant advantage in obtaining the refund in full from the parent company’s estate, either through a negotiated settlement or litigation.