The Nature of a Parent-Subsidiary Relationship Determines How to Allocate a Refund in a Tax Sharing Agreement
By: Samuel Cushner
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Recently, in FDIC v. AmFin Financial Corp.,[i] the Sixth Circuit held that a tax sharing agreement between a bank holding company and its subsidiary was ambiguous as to the ownership of an income tax refund and that the district court erred in refusing to consider extrinsic evidence concerning the parties’ intent as to the ownership of the funds.[ii] In 2009, the bank holding company filed for chapter 11 bankruptcy protection.[iii] As a result, the Office of Thrift Supervision closed the bank holding company’s bank subsidiary and placed it into FDIC receivership.[iv] Later on, the bank holding company filed a consolidated 2008 federal tax return on behalf of itself and its affiliates showing a total net operating loss of $805 million, with the bank subsidiary’s losses accounting for $767 million of that total.[v] After the IRS issued a refund of approximately $195 million to the parent company, the FDIC claimed[vi] that over $170 million of that refund belonged to the bank subsidiary. Finding that the tax sharing agreement was unambiguous, the United States District Court for the Northern District of Ohio concluded that the tax sharing agreement created a debtor-creditor relationship with respect to tax refunds between the parent and its affiliates, including the subsidiary, and thus, the parent owned the refund.[vii] The Sixth Circuit reversed and remanded to the district court to determine whether the tax sharing agreement created either a debtor creditor relationship or a trust or agency relationship under Ohio law with respect to the tax refunds.
A tax sharing agreement between a parent corporation and its subsidiaries governs the rights and obligations between each other regarding their tax obligations. The IRS will provide a tax refund to the parent corporation in order to simplify the filing process.[viii] Although the IRS will return the tax refund to the parent corporation, the tax sharing agreement will determine how the tax refund will be distributed amongst the parent corporation and its subsidiaries. When determining who may claim a portion of a tax refund under a tax sharing agreement, a court will examine the agreement’s plain language. On one hand, if the tax sharing agreement explicitly states how and when a parent corporation will disperse a tax refund, the agreement’s plain language will determine which party owns the tax refund.[ix] For example, in In re IndyMac Bancorp Inc.,[x] the tax sharing agreement specifically stated when the parent corporation would disburse funds from a tax refund to subsidiaries and whether they had to do it at all.[xi] On the other hand, if a tax sharing agreement does not explicitly state who may claim a portion of the tax refund,[xii] the court must determine, by examining extrinsic evidence, the nature of the relationship between the parent company and its subsidiaries. The court will likely hold that the parent company owns the tax refund if the court determines that the tax sharing agreement created a debtor-creditor relationship between the parties.[xiii] Alternatively, the court will likely hold that a subsidiary owns the tax refund if the court determines that the tax sharing agreement creates a trust or agency relationship between the parties because the parent company would only have legal title to the refund with the subsidiary holding beneficial title. For example, in In re BankUnited Financial Corp.,[xiv] the Eleventh Circuit held that that the tax sharing agreement was ambiguous as to whether there was a creditor debtor relationship. Terms such as payables and receivables in a tax sharing agreement do not indicate a creditor debtor relationship.[xv] If a debtor creditor relationship existed, we would expect to see more protections for the creditor in order to guarantee payment by the debtor.[xvi]
In FDIC v. AmFin Financial Corp.[xvii], the Sixth Circuit stated that no protections for the bank holding company existed that would suggest that a creditor-debtor relationship had been created. Like the court in In re BankUnited Financial Corp., the Sixth Circuit stated that the tax sharing agreement “[said] nothing about tax refunds received by AFC on behalf of the group and includes no protections for the putative creditor, as one would expect if the parties intended a debtor-creditor relationship.”[xviii] The Sixth Circuit went on to state that words such as payment or reimbursement did not indicate a creditor-debtor relationship.[xix] As a result of determining that the tax sharing agreement was ambiguous as to what type of relationship had been created, the Sixth Circuit remanded to the lower court to look to extrinsic evidence under Ohio trust and agency law. [xx]
FDIC v. AmFin Financial Corp. is significant because it encourages a parent corporation and its subsidiaries to draft their tax sharing agreement in a way that explicitly provides for the allocation of the ownership of their tax refund. They can do so by having the tax sharing agreement clearly state the type of relationship that will exist between the parent corporation and its subsidiaries. That being said, it is important to be able to determine who may claim a portion of a tax refund in a tax sharing agreement when representing parties in a bankruptcy proceeding. If the language that explicitly provides for the allocation of the funds is not present in the agreement, the court will likely look to extrinsic evidence to determine whether there is a debtor creditor relationship, a trust, or an agency relationship, which will add litigation costs. The parties can avoid unnecessary litigation, by using clear language in the tax sharing agreement. Finally, even if a court would determine that the parent owned the tax refund because there was a debtor-creditor relationship between the parties, the subsidiary, as a creditor, would still be entitled to file a proof of claim for the amount it was owed under the tax sharing agreement at issue. Yet, under such circumstances the subsidiary would recover less than it would have had the court found that it owned the refund because most chapter 11 plans do not provide for creditors to recover in full.
[i] 757 F.3d 530 (6th Cir. 2014).
[iii] Id. at 532.
[vi] Brief for Appellant at 1, FDIC v. AmFin Fin. Corp., 757 F.3d 530 (6th Cir. 2014) (No. 13-3669), 2013 WL 6144206 at 1.
[vii] Id. at 534.
[viii] 11-TX11A Collier on Bankr. P TX11A.09.
[ix] See In re IndyMac Bancorp, Inc., 2012 Bankr. LEXIS 1462. In In re IndyMac Bancorp Inc, the tax sharing agreement specifically stated when the parent corporation would disburse funds from a tax refund to subsidiaries and whether they had to do it at all. See id.
[xii] See Zucker v. FDIC (In re BankUnited Financial Corp.), 727 F.3d 1100 (11th Cir. 2013).
[xiii] In re IndyMac Bancorp, Inc., 2012 Bankr. LEXIS 1462. When determining whether a debtor-creditor relationship exists, courts look to the tax sharing agreement to see if there are “ protection[s] for the creditor [bank] that would help guarantee the debtor [parent company's] obligation, such as a fixed interest rate, a fixed maturity date, or the ability to accelerate payment upon default.” AmFin Fin. Corp., 757 F.3d at 535.
[xiv] In re BankUnited Financial Corp., 727 F.3d 1100.
[xv] FDIC v. AmFin Fin. Corp., 757 F.3d 530, 534–5 (6th Cir. 2014); In re BankUnited Fin. Corp., 727 F.3d at 1108.
[xvi]AmFin Fin. Corp., 757 F.3d at 535 (quoting BankUnited Fin. Corp., 727 F.3d at 1108).
[xviii]AmFin Fin. Corp., 757 F.3d at 535.
[xx] If a trust had been created, there could be an express trust, a constructive trust, or a resulting trust. An express trust arises when there is an oral agreement between two or more parties. Restatement (Third) of Trusts § 2 (2003) (noting an express trust is “a fiduciary relationship with respect to property, arising from a manifestation of intention to create that relationship and subjecting the person who holds title to the property to duties to deal with it for the benefit of charity or for one or more persons, at least one of whom is not the sole trustee.”). A resulting trust arises when “property is transferred under circumstances that raise an inference that the transferor, or the person who caused the transfer, did not intend the transferee to take a beneficial interest in the property.” Brate v. Hurt, 174 Ohio App.3d 101, 880 N.E.2d 980, 985 (2007). A constructive trust arises when “a person holding title to property is subject to an equitable duty to convey it to another on the ground that she would be unjustly enriched if she were permitted to retain it.” Brate v. Hurt, 174 Ohio App.3d 101, 880 N.E.2d 980, 985 (2007). The district court can also determine that an agency relationship had been created. An agency relationship exists when “one party exercises the right of control over the actions of another, and those actions are directed toward the attainment of an objective which the former seeks.” AmFin Fin. Corp., 757 F.3d at 538 (quoting Hanson v. Kynast, 494 N.E.2d 1091, 1094 (1986)).