Does the Bob Richards Rule or State Law Govern the Distribution of a Tax Refund Among Affiliated Groups?
Does the Bob Richards Rule or State Law Govern the Distribution of a Tax Refund Among Affiliated Groups?
The parties are two insolvent entities, a parent corporation, United Western Bancorp Inc. (UWBI), and its subsidiary, United Western Bank (Bank). Simon Rodriguez, bankruptcy trustee for UWBI, is the petitioner. The Federal Deposit Insurance Corporation (FDIC), the receiver for the United Western Bank, is the respondent. UWBI and the bank filed taxes as an affiliated group (with other entities), and both subsequently declared bankruptcy. The Bankruptcy Court in Colorado said the refund belonged to UWBI and thus the bankruptcy trustee, but the Tenth Circuit applied the Bob Richards rule, said to be part of federal common law, and assigned the refund to the bank, thus the FDIC.
Docket No. 18-1269
Argument Date: December 3, 2019
From: The Tenth Circuit
by Barbara L. Jones
Minnesota Lawyer, Minneapolis, MN
Does the Bob Richards rule or state law govern the distribution of a tax refund where the parties have a tax allocation agreement?
The United Western Bancorp Inc. (UWBI) and its subsidiaries filed federal income taxes under a tax allocation agreement (agreement). The agreement allows UWBI to apportion responsibility for taxes and refunds pursuant to Colorado law. The agreement says that any ambiguity therein will be resolved in favor of the insured depository institution.
The Federal Deposit Insurance Corporation (FDIC) claimed that the refund stemmed from the bank’s income and losses and the bank held equitable title to the refund. The Trustee asked the Bankruptcy Court to award the refund to the UWBI because it held legal and equitable title to the funds, which the court did.
But the higher courts disagreed. The district court concluded that the Tenth Circuit had adopted the Bob Richards rule in Barnes v. Harris, 783 F.3d 1185 (Tenth Cir. 2015) and it had to follow it, irrespective of an agreement that is in place. The Bob Richards rule says that the refund belongs to the member of the agreement that incurred the loss that gave rise to the refund (in this case, the respondent).
The Tenth Circuit agreed, asserting that federal common law provided a framework for resolution in favor of the respondent. It also said that the agreement is ambiguous and could suggest a debtor-creditor relationship or an agency. The Tenth Circuit invoked the agreement’s general statement of purpose, determined that the bank held equitable title, and then issued the refund to the bank. The court denied rehearing.
The Bob Richards rule is not a proper creation of federal common law, the petitioner leads off. The Court decades earlier held in the iconic decision Erie Railroad v. Tompkins, 304 U.S. 64 (1938), that there is no such thing as federal common law, with some limited exceptions that don’t apply here, the petitioner asserts.
Three requirements must be met to create a federal common law: first, the law must involve a uniquely federal interest; second, it must occupy an area where Congress has asserted control; and third, there must be a significant conflict between a federal policy or interest and the use of state law. These requirements are not satisfied in the facts of this case, the petitioner says.
As to the first requirement, petitioner explains that the ownership of tax refunds is not a uniquely federal interest, such as admiralty or foreign affairs, and the tax laws or the bankruptcy court do not delegate the authority to make common law. “On the contrary, this Court has repeatedly recognized that the way in which private parties allocate assets issued by the Federal Government is a matter on which the creation of federal common law is not appropriate,” it argues, citing Wallis v. Pan Am. Petroleum Corp., 384 U.S. 63 (1966).
Turning to the second requirement, petitioner notes Congress has displaced authority to create law in this area by delegating regulation-making authority to the IRS, including rules governing consolidated tax returns and payment of tax refunds. “Federal courts have no warrant to seize for themselves the authority Congress vested in a federal agency,” petitioner states.
As to the third requirement to create federal common law, petitioner continues, there is also no significant conflict between state law and any defined federal policy or interest—let alone a conflict sufficient to upset the primacy accorded state law in matters of contract, corporate, and commercial law. State law can fairly allocate tax refunds.
And even if the court could create federal law, it shouldn’t create this one, the petitioner continues. Far from furthering federal policy, this rule conflicts with the text, policy, and structure of the consolidated-return rules that it is purportedly designed to supplement, petitioner says.
The first conflict, petitioner notes, is that IRS consolidated-return rules already specify when tax refunds are paid to a subsidiary rather than parent corporation. Second, the Bob Richards rule assumes that tax refunds are attributable solely to a particular member of an affiliated group, but that is incorrect. The refunds are based on consolidated taxable income and consolidated net operating loss, the petitioner notes.
The third conflict detailed by the petitioner is that the Bob Richards rule contradicts the structure of the tax laws, which allow affiliated tax groups to apportion responsibility for tax liability. It follows that the group should have the same freedom to distribute tax refunds, the petitioner argues. Otherwise a group member who did not pay the tax could be entitled to a refund. Some courts have corrected that by “inventing” another atextual rule, the petitioner continues.
Finally, the rule has no sound policy justification, according to petitioner. It cuts against the central purpose of the consolidated-return laws, which is to treat the members of a group as a single entity, and there is no reason to assume that absent the rule a parent corporation would be unjustly enriched. “At minimum, the function of ‘weighing and appraising’ these complex and competing policy considerations is for Congress and the IRS, not federal courts,” petitioner says.
The petitioner then asks the Court to abandon the rule and determine whether the bank has an equitable interest in the refund as a trustee or agent under Colorado law. It argues that it does not. The bank has not been named a trustee, and it is not controlled by its subsidiary such that it may be deemed the bank’s agent. “The Tenth Circuit reached a contrary conclusion only because its analysis was distorted by the Bob Richards rule,” the petitioner concludes.
Taking a different tack, the respondent initially frames the issue without reference to the Bob Richards rule, seeing the case as a question of the effect of bankruptcy on the title to the refund in view of the parties’ agreement. “The interpretation of that [agreement] is governed by Colorado law, but federal tax and banking regulations establish pertinent background rules that inform the state-law inquiry,” it maintains.
First, the respondent argues, the Court must decide whether UWBI would have been obligated to pay the refund to the bank absent the bankruptcy. It argues that the agreement entitled the bank to the same refund it would have received had it filed a separate return. Under that agreement, UWBI was not entitled to any part of the refund, the respondent argues.
The respondent then argues that the disputed issue instead is whether the IRS’s payment of the refund to UWBI would have given UWBI equitable title to the funds before it distributed the refund to the bank, as petitioner contends, or whether there was an agency relationship under the agreement.
At this point, the respondent does invoke the Bob Richards rule; according to respondent, the rule does not apply because the parties had a tax allocation agreement, which it says established an agency relationship and does not alter ownership of the refund. Thus, the rule and the tax regulations work together to achieve the same result, and the result is an interpretation of the agreement in light of the federal regulations and not a question of federal common law, respondent asserts.
Respondent relies on Court precedent holding that “The IRS’s payment of the refund to the parent as agent for the group’s members does not give the parent any ownership interest that it would not otherwise possess under applicable state law. That aspect of Bob Richards was an interpretation of the text of a federal regulation; it was not federal common law in ‘the strictest sense.’” Burlington Indus., Inc. v. Ellerth, 524 U.S. 742 (1998).
The ultimate question, then, is whether the parties intended to vest equitable title to the refund in the petitioner or the respondent. The respondent argues that the agreement established an agency relationship and obligated UWBI to distribute the refund to the respondent.
That is congruent with instructions that federal financial regulators have issued to insured depository institutions, and the parties would have been aware of those when they made the agreement, respondent says.
Furthermore, no other type of relationship between the two entities has been established. The agreement imposed a duty on the petitioner to distribute the refund and even refers to the petitioner as an agent. If there is any ambiguity, the agreement directs that that be resolved in respondent’s favor.
The petitioner never had equitable title to the refund, and it is not part of the bankruptcy estate, concludes respondent.
And, as the petition for certiorari itself notes, bankruptcy cases only infrequently reach the Court; often, they are mooted out before certiorari because of the entry of a plan of adjustment settling all claims in bankruptcy. This is thus the rare opportunity for the Court to weigh in on this important issue that has divided lower courts for years, it says.
Also, according to the petition for certiorari, this issue comes up regularly in bankruptcy and appellate court decisions. Tax returns for affiliated groups filing jointly can extend into the tens or hundreds of millions of dollars. Under the UWBI scenario, not only the owner of the refund but also the rightful creditors of the owner are walled off.
Business, of course, loathes uncertainty, which the use of state law in different situations would create. Also, many taxpayers have received advice that the parent corporation is the owner of the refund, the petition for certiorari continues. “Until recently, tax and bankruptcy practitioners advised that the majority of cases, involving TAAs have found that a parent rather than a subsidiary owns a refund, and that ‘a tax-sharing agreement must be clearly drafted to provide that any refund received by the parent is to be segregated and held in trust for the benefit of the subsidiary.’” (Emphasis in original.)
Two fundamental principles of law conflict in this case, as amicus American College of Tax Counsel notes in support of the petitioner during the certiorari petition stage. “Equality of distribution among creditors is a central policy of the Bankruptcy Code. In some circumstances, however, if a bona fide trust relationship is found to have been created, the claimant is entitled to the entirety of the claimed trust assets, rather than sharing pro rata in the overall bankruptcy estate.”
Barbara L. Jones is an attorney and editor of Minnesota Lawyer newspaper. She can be reached at firstname.lastname@example.org or 651.587.7803.
PREVIEW of United States Supreme Court Cases 47, no. 3 (December 2, 2019): 12–14. © 2019 American Bar Association