Prior to Plan Confirmation, Does the Transfer Tax Exemption Under 11 U.S.C. § 1146(a) Apply to § 363 Sales? Supreme Court Will Resolve Circuit Split
Section 1146(a) of title 11 of the U.S. Code (the "Code") provides as follows:
The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax.
11 U.S.C. § 1146(a) (2008) (formerly § 1146(c), prior to enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA")).
While this short Code provision appears to be straightforward, a split of authority has developed among the circuits as to whether the transfer tax exemption applies to pre-confirmation asset sales under § 363 of the Code. On March 26, 2008, the U.S. Supreme Court heard oral argument in State of Florida Dep't of Revenue v. Piccadilly Cafeterias, Inc. (In re Piccadilly Cafeterias, Inc.) (07-312), on certiorari from the Eleventh Circuit Court of Appeals, to decide that very issue and resolve the split of authority.
Eleventh Circuit Decision in Piccadilly Cafeterias: Section 1146(a) Tax Exemption Applies to Pre-Confirmation Asset Sales Under Section 363
Prior to filing its petition for relief under chapter 11 of the Code, Piccadilly Cafeterias, Inc. ("Piccadilly") was one of the largest cafeteria chains in the nation, operating 145 units in the southeastern United States. After filing its petition on October 29, 2003, Piccadilly sought and obtained authorization from the U.S. Bankruptcy Court for the Southern District of Florida to sell its assets pursuant to 11 U.S.C. § 363(b)(1). After obtaining court approval for the sale of its assets, Piccadilly filed its initial chapter 11 plan of liquidation, which was later amended. The Florida Department of Revenue (the "State") objected to confirmation, seeking a declaration that Piccadilly was not exempt from $39,200.00 in Florida stamp taxes under former § 1146(c).
The bankruptcy court confirmed Piccadilly's amended plan and granted Piccadilly's motion for summary judgment, holding that the sale of assets was exempt from state stamp taxes under former § 1146(c). The court reasoned that the sale of assets was a transfer "under a plan confirmed under section 1129" because the sale of assets was necessary to consummate the plan. The State appealed the decision to the U.S. District Court for the Southern District of Florida, which affirmed the bankruptcy court decision. The State then appealed the decision to the U.S. Court of Appeals for the Eleventh Circuit, which affirmed the district court decision, reasoning that the phrase "under a plan confirmed" does not refer "to the timing of the transfers, but rather to the necessity of the transfers to the consummation of a confirmed plan of reorganization." State of Florida Dep't of Revenue v. Piccadilly Cafeterias, Inc. (In re Piccadilly Cafeterias, Inc.), 484 F.3d 1299, 1303-04 (11th Cir. 2007). The court found that the former § 1146(c) exemption "may apply 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 sale and the confirmed plan." Id. at 1304 (emphasis in original).
Eleventh Circuit Decision in Piccadilly Cafeterias Conflicts With Fourth Circuit Decision in In re NVR, LP and Third Circuit Decision in Hechinger Investment Co. of Delaware, Inc., Holding That Section 1146(a) Tax Exemption Does Not Apply to Pre-Confirmation Asset Sales Under Section 363
In In re NVR, LP, 189 F.3d 442 (4th Cir. 1999), cert. denied, 528 U.S. 1117 (2000), the Fourth Circuit Court of Appeals reached the opposite result of the Eleventh Circuit Court of Appeals in Piccadilly Cafeterias. The NVR court found that although former § 1146(c) relies upon the interpretation of a plan to determine which transfers fall within the scope thereof, the statute itself determines the extent of its operation. The court reasoned that to hold otherwise — that every transfer essential to confirmation of a plan is by definition "under a plan confirmed," as used in former § 1146(c) — would make a plan's terms the master of the statute. Instead, the court found that the provisions of the statute were clear and that the statute must control the contents of a plan. See NVR, 189 F.3d at 456-57. The court consulted two dictionaries and concluded that "under" means "subordinate," "inferior" or "with the authorization of," and that a pre-confirmation transfer could not be subordinate to, or authorized by, a confirmed plan — something that did not exist at the date of the transfer. See id. at 457. The court also concluded that congressional intent was to relieve reorganized debtors from the burden of certain taxation in order to facilitate the implementation of a plan of reorganization, and that before implementation of a plan, state and local tax systems may not be disturbed. See id. at 458.
In Hechinger Investment Co. of Delaware, Inc., 335 F.3d 243 (3d Cir. 2003), the Third Circuit Court of Appeals, in a decision authored by Justice Samuel Alito when he was a judge of that court, was faced with the same issue and found the word "under," as used in former § 1146(c), to be ambiguous. After considering several dictionary definitions, the court concluded that the most natural reading of the phrase "under a plan confirmed," as used in former § 1146(c), is "authorized." Reasoning that an action taken "under" a provision of law or legal document is an action that is "authorized by" such provision or document, the court concluded that if a transfer is made "under" a bankruptcy plan, the plan must provide authority for the transaction. Because the transfers at issue were made under the authority of 11 U.S.C. §§ 363 and 365, and because the plan had not been confirmed at the time of such transfers, the court concluded that the plan could not provide the legal authority for such transfers. See Hechinger, 335 F.3d at 252.
Other Recent Bankruptcy Court Considerations
Rule 6004-1 of the Local Rules of the U.S. Bankruptcy Court for the District of Delaware, effective as of February 1, 2008, provides that a motion for a § 363 sale must highlight certain material terms, including any provision seeking to have the sale declared exempt from taxes under § 1146(a) of the Code, and the type of tax (e.g., recording tax, stamp tax, use tax, capital gains tax) for which the exemption is sought. The rule further provides that it is not sufficient to refer simply to "transfer" taxes and the state or states in which the affected property is located.
In addition, the Section 363 Sale Guidelines promulgated by the U.S. Bankruptcy Court for the Northern District of California in August 2007 provide that the court will not approve a sale order that contains any provision that purports to exempt the transaction from transfer taxes pursuant to § 1146(a). These guidelines further provide that "[b]y its own terms, [§ 1146(a)] applies only to a sale pursuant to a plan of reorganization, not a sale outside of a plan under § 363(b)."
The Case Before the U.S. Supreme Court
In Piccadilly Cafeterias, the U.S. Supreme Court must decide whether § 1146(a) of the Code applies to transfers of assets occurring prior to the actual confirmation of such a plan. The State argues that principles of statutory construction and the plain language of the statute itself mandate a narrow reading. The State cites a risk of litigation and uncertainty surrounding § 1146(a), should the Eleventh Circuit Court of Appeals decision stand, and claims that it will deprive state governments of revenues in the future. Further, the State argues that in spite of the NVR and Hechinger decisions, Congress opted not to substantively amend § 1146(a) through BAPCPA in 2005 (though it did renumber such section from § 1146(c)), indicating agreement with those decisions.
In response, Piccadilly argues that the language of § 1146(a) is ambiguous, that the phrase "under a plan confirmed" can be read to include a plan confirmed at the time of the transfer, or to impose a restriction as to when confirmation must occur. Due to such ambiguity, Piccadilly looks beyond the text of the statute to congressional intent, legislative history and public policy and argues further that a more liberal construction should be used in order to facilitate reorganization by granting tax relief.
In addition, 27 states and four cities filed an amicus curiae brief expressing concern that they will lose billions of dollars in tax revenue should the Court rule that pre-confirmation asset sales are entitled to protection under § 1146(a), and that public interest will suffer as a result. The group argues that there is no evidence of congressional intent to exempt pre-confirmation sales to encourage reorganization of distressed companies. However, even if Congress did intend this, the group argues that the Eleventh Circuit Court of Appeals decision will not further this goal because chapter 11 debtors recently have tended to liquidate, rather than to reorganize, and that expanding the exemption will encourage this trend. And for those chapter 11 debtors that file plans of reorganization, the group argues that financially beneficial transactions upon which reorganizations depend will continue to occur, even without a tax exemption.
Oral Argument
The Supreme Court heard oral argument on March 26, 2008. The parties made both policy and statutory interpretation arguments, and the Justices' questions addressed both. Certain Justices questioned why Congress would exempt post-confirmation but not pre-confirmation transfers, while others suggested that the plain language of the statute limited the exemption to transfers made "under" a confirmed plan. Others focused on the administrative ramifications of states' exempting pre-confirmation transfers but later taxing them should no plan be confirmed.
Whether the § 1146(a) tax exemption applies to pre-confirmation transfers notably has generated a split of authority among courts. The Supreme Court's term ends in the next few months, and a decision on this issue is forthcoming.
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