The U.S. Court of Appeals for the Eleventh Circuit recently held that a mortgage refinancing could qualify as a bankruptcy-related tax free transaction, even though the deal took place between two nondebtors and did not involve property from the bankruptcy estate.

The transaction was exempt from Florida’s stamp tax because the refinancing was "necessary to the consummation" of a plan of reorganization, the Eleventh Circuit ruled in State of Florida v. T.H. Orlando Ltd., (In re T.H. Orlando Ltd.), 391 F.3d 1287 (11th Cir. 2004).

Orlando is the latest circuit decision to address the circumstances under which a sale or related transaction qualifies for the tax exemption extended to asset sales during the course of a chapter 11 case. Four circuit courts have addressed the issue over the past 20 years.

Despite the confusion, the ability to sell assets without incurring transfer taxes is a key consideration in strategic bankruptcy planning. The Bankruptcy Code section in question, 1146(c), provides that "the issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under [the Bankruptcy Code], may not be taxed under any law imposing a stamp tax or similar tax."

In re T.H. Orlando Ltd. involved three hotels in Florida, encumbered by mortgages totaling more than $70 million. Facing foreclosure, debtor T.H. Orlando filed for chapter 11 protection, and secured an agreement from the mortgagee to satisfy all mortgage obligations for $23.5 million, provided the payout was made by August of the year the agreement was reached.

The only lender willing to advance T.H. Orlando the sum by the specified deadline was Berkshire Mortgage Finance Corporation. Berkshire conditioned its offer on an agreement by the owner of a hotel adjacent to the properties in question, Kissimmee Lodge, Ltd., to refinance through Berkshire as part of the same transaction.

Kissimmee, a nondebtor, agreed to the refinancing solely as an accommodation to T.H. Orlando. T.H. Orlando filed a plan of reorganization noting that the Kissimmee Lodge refinancing was "incident to and a condition precedent" to the reorganization, and therefore exempt from Florida documentary stamp taxes.

The Florida Department of Revenue objected to confirmation of the plan, and the bankruptcy court agreed, denying tax-exempt status to the refinancing.

The Eleventh Circuit reversed, concluding that the statutory language providing tax exemptions for transfers "under a plan" covers transfers "authorized by a confirmed Chapter 11 plan," and circumstances in which "a plan authorizes any transfer that is necessary to the confirmation of the plan."

The court rejected the assertion by the Florida tax authority that a bankruptcy court does not have jurisdiction to determine whether a nondebtor third party is entitled to an exemption from state stamp and intangible taxes. Because the Kissimmee refinancing was found to be necessary to the consummation of T.H. Orlando’s chapter 11 plan, the transaction was exempt from Florida’s stamp tax regardless of whether the transfer involved a debtor or property of the bankruptcy estate, the appeals court held.

The ruling expands the potential reach of the tax exemption granted by section 1146(c) of the Bankruptcy Code. Debtors now have added leeway to incorporate into their reorganization plans tax-free transactions between nondebtors, which do not necessarily involve estate property, as long as such transactions can be portrayed as "necessary to the consummation" of a chapter 11 plan of reorganization.

This article is presented for informational purposes only and is not intended to constitute legal advice.