In the case of Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc.,1 the United States Supreme Court ruled that the exemption from the payment of stamp taxes or similar taxes on transfers of property of a Chapter 11 debtor's estate, contained in section 1146(a) of the Bankruptcy Code,2 does not apply to transfers of property made before a Chapter 11 plan is confirmed.
Prior to Piccadilly, the Third and Fourth Circuit Courts of Appeals had both held that the section 1146 tax exemption applied to post-confirmation transfers only.3 The Eleventh Circuit, in Piccadilly, by holding that the 1146(a) tax exemption applies to post-confirmation transfers and to "those pre-confirmation transfers that are necessary to the consummation of a confirmed plan of reorganization,"4 created a split in the circuits. By ruling that the section 1146(a) exemption does not apply to pre-confirmation transfers, the Supreme Court resolved the circuit split and, in the process, created a "bright-line" test for the application of section 1146(a).
Background
On October 29, 2003, Piccadilly Cafeterias, Inc. ("Piccadilly") commenced a Chapter 11 case in the Bankruptcy Court for the Southern District of Florida. Almost immediately after filing its petition for relief under Chapter 11, Piccadilly filed a motion in the Bankruptcy Court for authority to sell substantially all of its assets pursuant to section 363(b)(1) of the Bankruptcy Code and requested a determination that such sale was exempt from stamp taxes under section 1146(a). The Bankruptcy Court approved the sale of Piccadilly's assets, approved a global settlement agreement controlling the distribution of the sale proceeds among Piccadilly's creditors, and deemed the sale transfer to be exempt from stamp taxes pursuant to section 1146(a). The assets were sold to the highest bidder for $80 million.
Following the consummation of the sale, Piccadilly filed a Chapter 11 plan incorporating the scheme for distribution of the sale proceeds contained in the global settlement agreement approved by the Bankruptcy Court. Consistent with the Bankruptcy Court's prior ruling, the Chapter 11 plan did not provide for the payment of stamp taxes. The Florida Department of Revenue ("Florida") objected to the Piccadilly plan on the basis that the exemption from stamp taxes under section 1146(a) was not applicable because the asset sale in question had taken place before the Chapter 11 plan had been confirmed. Reasoning that the sale of Piccadilly's assets was a transfer "under" its Chapter 11 plan because the sale was "necessary to consummate the plan," the Bankruptcy Court found the exemption in section 1146(a) applicable to the pre-confirmation transfer, overruled the objection, and confirmed Piccadilly's Chapter 11 plan.
The decision was appealed to the District Court and, subsequently, to the Court of Appeals for the Eleventh Circuit, both of which affirmed the Bankruptcy Court's decision. In its opinion, the Eleventh Circuit recognized that its decision was contrary to the holdings of the Courts of Appeals for the Third and Fourth Circuits, which had both reasoned that section 1146 implicitly imposes a temporal restriction on transfers by exempting only those transactions that occur after the confirmation of a Chapter 11 plan. The Eleventh Circuit affirmed the Bankruptcy Court's decision on the basis that there was a "nexus" between the transfer at issue and the Chapter 11 plan that was subsequently confirmed by the Bankruptcy Court.
"Under a Plan Confirmed"
Writing for the majority of seven, Justice Thomas began the Court's opinion by evaluating whether the language of section 1146(a) could be construed as applying the stamp tax exemption to both pre- and post-confirmation transfers. In finding that section 1146(a) does not apply to pre-confirmation transfers, the Court considered several arguments set forth by the parties based upon textual and statutory interpretation and certain legal canons. The Court first considered the parties' textual arguments with respect to the language of section 1146(a): "... the making or delivery of an instrument of transfer under a plan confirmed ... may not be taxed under any law imposing a stamp tax or similar tax." Piccadilly had encouraged a broad textual interpretation of the phrase to include transfers made in accordance with a plan that is eventually confirmed. Florida had argued that the phrase essentially referenced only transfers made under plans already confirmed. Finding the language overall to be ambiguous, the Court found Florida's interpretation of the phrase to be "clearly the most natural" and held that the term "under a plan confirmed" in fact referenced only plans already confirmed.
Turning next to the parties' contextual arguments, the Court rejected Piccadilly's contention that Congress' failure to expressly limit section 1146(a)'s application to post-confirmation transfers meant that the section could apply to pre-confirmation transfers. Rather, the Court focused on the fact that Congress could have removed all ambiguity by using more precise language, but chose not to do so. Particularly persuasive to the Court was the fact that in the 2005 Bankruptcy Code amendments, passed following the decisions of the Third and Fourth Circuits (holding that section 1146 does not apply to pre-confirmation transfers), Congress made substantial changes to section 1146, but Congress did not make the exception explicitly applicable to pre-confirmation transfers. In the Court's view, the silence and inaction by Congress were implicit ratifications of the holdings of the Third and Fourth Circuits. The placement and retention of section 1146(a) within a subchapter of the Bankruptcy Code, entitled "POSTCONFIRMATION MATTERS," provided the Court with further evidence that Congress intended this section to apply only to post-confirmation transfers.
The Court also found support for its ruling in a federalism canon expressed in the Court's prior decision in California State Board of Equalization v. Sierra Summit, Inc.5 In Sierra, the Court set out a cautionary directive for courts to "proceed carefully when asked to recognize an exemption from state taxation that Congress has not clearly expressed."6 Agreeing with Florida's argument that a tax exemption for preconfirmation transfers is not "clearly expressed" in section 1146(a), the Court ruled that the federalism canon restricted the Court from inferring such an exemption into the statute. Finally, responding to the contention that the "practical realities" of Chapter 11 reorganizations "are increasingly rendering postconfirmation transfers a thing of the past," the Court remarked that it would be up to Congress, and not the courts, to determine whether section 1146(a) should be revised.
The Dissent
Justice Breyer, joined by Justice Stevens, dissented from the majority's opinion, finding the statutory language "perfectly ambiguous" on the issue and the canons of interpretation of "little help."7 Justice Breyer, however, commented that the purpose of section 1146(a) – to further the fundamental objectives of Chapter 11 – was clear. Those objectives, which are to preserve going concerns and to maximize the value of the bankruptcy estate for creditors, necessitate a liberal construction of the section 1146(a) tax exemption. Given the purpose of section 1146(a), to provide an exemption to stamp or transfer taxation, the dissent also found the Court's reliance on a canon instructing it against interference with such taxation to be misplaced. Finally, the dissenting Justices commented that the Court's ruling would serve to have little beneficial effect considering that, in reality, debtors would likely continue to sell assets prior to confirmation where necessary under the circumstances.
Effects of Piccadilly on Distressed Asset Sales
Piccadilly provides a clear rule for the avoidance of stamp or transfer taxes in connection with transfers of assets of a Chapter 11 estate: post-confirmation transfers enjoy the exemption while pre-confirmation transfers do not. Timing is everything. The likely impact of the Court's decision is that the consummation of asset sales otherwise subject to substantial transfer taxes will be delayed whenever feasible until the plan confirmation process has been completed. However, given the risk of depreciation in the value of certain assets, the cost of maintaining assets prior to sale (particularly for those assets to be sold as a going concern), and the presence of an offer to purchase assets without delay, debtors may need to sell assets before a plan can be negotiated and formulated, much less filed. In those situations, the Court's ruling in Piccadilly makes clear that parties must bear the cost of stamp or transfer taxes, which may be substantial (especially for real estate sales) in certain geographic areas. While, depending on market forces, part of the increased costs of the sale may be borne by purchasers, it is more likely that all or substantially all of the incremental tax costs will be borne by debtors and passed along in the form of decreased distributions to the debtor's creditors and interest holders.
IRS Circular 230 Disclosure: Any US tax advice herein (or in any attachments hereto) was not intended or written to be used, and cannot be used, by any taxpayer to avoid US tax penalties. Any such tax advice that is used or referred to by others to promote, market or recommend any entity, plan or arrangement should be construed as written in connection with that promotion, marketing or recommendation, and the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.
Footnotes
1. Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc., 2008 WL 2404077 (June 16, 2008).
2. Bankruptcy Code section 1146(a) provides: "The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under [Chapter 11 of the Bankruptcy Code], may not be taxed under any law imposing a stamp tax or similar tax." 11 USC. § 1146(a). Although the stamp tax exemption is now found in section 1146(a), prior to the 2005 amendments to the Bankruptcy Code, the stamp tax exemption was found in section 1146(c).
3. See In re NVR, LP (4th Cir. 1999) (holding that the debtor, under the terms of its reorganization plan or section 1146, was not entitled to a refund of transfer and recordation taxes paid to both state and local governments for its pre-confirmation transfers of real property); In re Hechinger Inv. Co. of Delaware, Inc., (3d. Cir. 2003) (holding that section 1146 does not exempt preconfirmation sales of real estate interests, sold under sections 363 and 365, from state transfer and recording taxes).
4. In re Piccadilly Cafeterias, Inc., 484 F. 3d 1299, 1304 (11th Cir. 2007) (per curiam).
5. California State Board of Equalization v. Sierra Summit, Inc., 490 US 844 (1989).
6. Id. at 851-52.
7. Florida Dept. of Revenue, 2008 WL 2404077 at * 13-14.
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