Debtors operating under Chapter 11 bankruptcy protection routinely sell some or all of their assets during the course of their bankruptcy case. As part of a bankruptcy court approved sale process, debtors often request that the court exempt such transfers from stamp taxes1pursuant to Bankruptcy Code § 1146(a). The exemption generally reduces obligations encumbering a debtor's property and allows for a greater portion of sale proceeds to be available for distribution to creditors. State and local taxing authorities, who lose tax revenue when the exemption is applied, have argued that the exemption should be reserved for very limited circumstances. Balancing the interests of debtors and taxing authorities, courts have reached conflicting conclusions concerning the scope of the exemption. In June 2008, the United States Supreme Court resolved this split of authority in Florida Dept. of Revenue v. Piccadilly Cafeterias , in favor of taxing authorities, by establishing a bright-line rule that only allows the exemption to be applied to those transfers made after the date that a Chapter 11 plan is confirmed. The Supreme Court's ruling will influence bankruptcy planning as debtors must now take into account the additional stamp tax costs associated with transfers made prior to a bankruptcy plan being confirmed.
Exemption To Payments Of A "Stamp Tax Or Similar Tax"
Bankruptcy Code § 1146(a) provides, in relevant part, "[t]he 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."
Generally, a "plan" is a document filed with the bankruptcy court in a Chapter 11 case that outlines how a debtor intends to reorganize its operations to return to profitability, deleverage its balance sheet, and repay certain of its obligations. Alternatively a Chapter 11 plan may provide for the liquidation of a debtor's assets to maximize proceeds available for distribution to creditors. Pursuant to an elaborate procedural framework under the Bankruptcy Code, certain classes of creditors are entitled to vote on whether to accept or reject the proposed treatment under a plan. If the requisite number of creditors vote in favor of a plan, the bankruptcy court will consider whether the plan should be approved, or "confirmed." To confirm a plan the court must find that the plan satisfies certain enumerated criteria set forth in the Bankruptcy Code. Once a plan is confirmed a debtor is bound by the plan's terms. The confirmed plan creates new contractual rights, replacing and/or superseding those that existed prior to the bankruptcy filing. A transfer of assets before entry of the order confirming the plan is a "preconfirmation" transfer while any transfer after entry of the confirmation order is considered a "post confirmation" transfer.
Lower Courts Reach Differing Conclusions On Scope Of Exemption
Lower federal courts have disagreed on the appropriate circumstances under which the tax exemption contained in Bankruptcy Code § 1146(a) applies. The source of the disagreement arose from various interpretations of the phrase " under a plan confirmed " in the statutory language of Bankruptcy Code § 1146(a). Several courts strictly interpreted the phrase to mean only those sale transfers that were " authorized " by a plan that the bankruptcy court previously confirmed. Other courts embraced a more flexible interpretation of the phrase " under a plan confirmed " to encompass those transfers that occurred " in accordance with " a plan (regardless of whether the plan was actually confirmed at the time of the transfer).
The Second Circuit Court of Appeals interpreted the language " transfer . . . under a plan confirmed " to include all transfers necessary to consummate a plan and ruled that a plan implicitly dealt with a post-confirmation transfer even though the plan did not specifically identify the transfer instrument or authorize the sale.2This generally meant that any transfer that occurred after plan confirmation could take advantage of the stamp tax exemption upon a showing that the transfer was necessary under the plan.
By contrast, the Third Circuit Court of Appeals ruled that " under a plan confirmed" meant "authorized" by a plan, and relied on canons of statutory construction to narrow the exemption to only those transfers actually authorized by a plan.3The Third Circuit concluded that preconfirmation transfers were not authorized by a plan confirmed and refused to extend the exemption to preconfirmation transfers even if the court subsequently confirmed a plan that contemplated the preconfirmation sale.Similarly, the Fourth Circuit rejected the premise that every transfer essential to confirmation fell " under a plan confirmed " because such interpretation would render "a plan's terms the master of [section] 1146(a) instead of deferring to the statute itself."4The effect of this ruling was that the stamp tax exemption only applied to those transfers made after a plan was filed and confirmed by the bankruptcy court.
The Eleventh Circuit criticized the "strict temporal interpretation articulated by the Third and Fourth Circuits" as ignoring the practical realities of Chapter 11 proceedings.5The Eleventh Circuit reasoned that the phrase " under a plan confirmed " should not focus on the timing of the transfers (whether preconfirmation or post confirmation), but rather, whether the transfers were necessary to consummation of a plan. The court held that the "tax exemption . . . may apply to those pre-confirmation transfers 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 transfer and the confirmed plan."6Effectively, any transfer that was necessary for the formulation and consummation of a plan would be entitled to the stamp tax exemption regardless of whether the transfer occurred before or after confirmation of the plan.
Supreme Court Resolves Split Among The Lower Courts
In October 2005, Piccadilly Cafeterias ("Piccadilly"), the operator of a cafeteria chain throughout the United States, filed for bankruptcy protection under Chapter 11. Piccadilly filed a motion with the bankruptcy court seeking authorization to sell substantially all of its assets for $80 million; and requested that it be exempted from paying applicable stamp taxes, in the amount of $39,200.7The bankruptcy court approved the sale of Piccadilly's assets and excused payment of the stamp taxes. Following the sale, the Florida Department of Revenue ("DOR") objected to confirmation of the plan of reorganization (the "Plan") and argued that the assessed stamp taxes fell outside the scope of the exemption within Bankruptcy Code §1146(a). The bankruptcy court confirmed the Plan and held that the sale was necessary to consummate the Plan. Therefore, the preconfirmation sale was a transfer under a confirmed plan within the purview of section 1146(a). The decision was affirmed by both the district court and the Eleventh Circuit Court of Appeals.
In a 7-2 decision, the Supreme Court reversed. The Court held that only those transfers made after a plan is confirmed are eligible for the stamp tax exemption.8The Court first addressed the ambiguity of the statute's language. The DOR contended that the text unambiguously limited the exemption to post-confirmation transfers because " under " should be read as "with the authorization of" the plan. Piccadilly countered that "under" should be read as "in accordance with" the plan. The Court concluded that the DOR's interpretation was the more natural reading of the statute, holding that a transfer of a debtor's assets cannot be authorized by a plan that has not yet been confirmed. The Court rejected Piccadilly's distinction between a "plan confirmed" and "confirmed plan" because "confirmed" modified "plan" indicating a completed action.
The Court also rejected Piccadilly's contextual arguments that Congress did not intend to limit the exemption because Congress did not express a clear temporal limitation. The Court found it informative that Congress placed section 1146(a) under the subchapter of the Bankruptcy Code entitled "Postconfirmation Matters." The Court reasoned that placement of the exemption undermined the argument that section 1146(c) was intended to apply to preconfirmation transfers.
Finally, the Court examined canons of statutory construction. The DOR argued that (i) Congress is presumed to adopt a judicial interpretation of a statute when it reenacts the statute without change (arguably, Congress ratified the interpretation espoused by the Third and Fourth Circuits, when it readopted the stamp tax provision in the 2005 Amendments to the Bankruptcy Code without any modification); and (ii) courts should proceed carefully before recognizing an exemption from state taxation that Congress has not clearly expressed. Piccadilly countered that the Bankruptcy Code, as a remedial statute, should be liberally construed for the benefit of the debtors and their creditors. Generally, the Bankruptcy Code accommodates the interests of states by leaving the regulation of property rights in a bankruptcy estate to state law. The Court held that expanding the tax exemption to preconfirmation transfers, as urged by Piccadilly, would amount to recognizing a state taxation exemption not clearly expressed by Congress.
Implications Of The Piccadilly Decision
As a result of the Piccadilly decision, all transfers made by debtors prior to plan confirmation are now subject to applicable stamp taxes, regardless of the jurisdiction where the bankruptcy case is pending. In their bankruptcy planning, debtors will need to evaluate whether the risk that their assets will decline in value, and payment of the administrative costs of Chapter 11 during the plan confirmation process, outweigh benefits to be realized by delaying asset sales until post-confirmation to realize savings under the stamp tax exemption.
Given the limited availability of financing for debtor in today's credit markets, many debtors may be unable to delay an asset sale until after plan confirmation. Allocation of stamp taxes may become a significant negotiation point in asset purchase agreements involving preconfirmation transfers. Debtors may require purchasers to pay applicable taxes as a condition of a sale, which may chill the bidding process. Alternatively, debtors may be forced to pay the applicable taxes, reducing the amount of proceeds available for distribution to creditors.
Some debtors who elect to transfer real property through a confirmed plan to receive the benefit of the stamp tax exemption will likely undergo substantial prebankruptcy planning and file a "prepackaged" bankruptcy ( i.e. , the debtor negotiates a plan with significant creditor constituencies before filing) to minimize the time and cost in Chapter 11 prior to having a plan confirmed by the bankruptcy court.
1 The Bankruptcy Code does not define "stamp tax" or "similar tax." However, courts have identified common elements among such taxes, including that the tax: (i) is imposed only at the time of transfer; (ii) amount is determined by the consideration paid by the buyer; (iii) is a prerequisite to recording; (iv) is a percentage of the consideration; and (v) is imposed regardless of if there is a gain or loss to the seller.
2In re Jacoby-Bender, Inc., 758 F.2d 840 (2d Cir. 1985).
3In re Hechinger Investment Co. of Delaware, Inc., 335 F.3d 243 (3d Cir. 2003).
4In re NVR, LP, 189 F.3d 442 (4th Cir. 1999).
5In re Piccadilly Cafeterias, Inc., 484 F.3d 1299 (11th Cir. 2007).
6Id. at 1304.
7 11 U.S.C. §363(b).
8Fla. Dep't of Revenue v. Piccadilly Cafeterias, Inc., No. 07-312, 2008 WL 2404077 (U.S. June 16, 2008).
Scott Cargill is a Partner and Alison E. Kowalski is an Associate in Lowenstein Sandler's Bankruptcy, Financial Reorganization and Creditors' Rights Group.