Daily Development for Friday, December 3, 2004

by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

BANKRUPTCY: CHAPTER 11; TRANSFER TAX EXEMPTION; TRANSFER TO NON-DEBTOR OF NON-ESTATE PROPERTY: Where a transfer transaction is necessary for the consummation of a confirmed Ch. 11 plan, the exemption from stamp or similar taxes contained in § 1146(c) of the Bankruptcy Code applies, even as to third-party transactions involving non-estate property.

State of Florida v. T.H. Orlando, Ltd. (In re T.H. Orlando, Ltd.), 2004 U.S. App. LEXIS 24692 (11th Cir. Nov. 30, 2004)

Two debtors owned three hotels in the Orlando, Florida area. Facing foreclosure of the $70 million mortgage loan on the hotels, the debtors filed a Chapter 11 bankruptcy proceeding. The mortgage lender agreed to accept a discounted payoff in full of $23.5 million, contingent on receipt of this amount not later than August 31, 1997. The debtors obtained a loan commitment from another lender to advance the $23 million payoff amount, subject to the additional requirement that the non-debtor owner of a hotel adjacent to one of the debtor's hotels also refinance its hotel with the new lender as part of the same transaction. The adjacent owner agreed to this arrangement, solely as an accommodation to the debtors, even though it was under no obligation to do so.

The Chapter 11 plan of reorganization filed by the debtors contained an express provision stating that the new lender would not have provided the refinancing unless the adjacent landowner also refinanced its hotel with the lender, and that such additional refinancing "therefore is incident to and a condition precedent to the reorganization of the [debtors]" and thus exempt from the imposition of Florida documentary stamp taxes pursuant to § 1146(c). [Note: Florida is one of the relatively few states that taxes mortgage transactions.]

The Florida Department of Revenue ("FDOR") filed an objection, claiming that the § 1146(c) exemption did not apply, as a matter of law, to sales of non-estate property to non-debtor parties. The bankruptcy court confirmed the debtors' plan, but ruled that the amount of the mortgage transaction would not, until further order of the court, be deemed exempt under § 1146(c). The debtors paid the disputed tax amount ($161,425) under protest, and then filed an action for declaratory relief in the Osceloa County Circuit Court, seeking a refund of this payment. The FDOR removed this proceeding to the bankruptcy court, which then ruled that because the adjacent landowner's agreement to refinance was done pursuant to the approved plan and was necessary in order to consummate and implement the plan, it was "under a plan" as required by § 1146(c), and the debtors were entitled to a refund of the disputed amount. The district court reversed, holding that the § 1146(c) exemption did not a!
pply t
o transfers involving non-debtors.

The Eleventh Circuit began by analyzing the language "under the plan." The court reviewed the applicable decisions on this issue by other federal circuit courts, i.e., In re Hechinger (4th Circuit), In re NVR LP (4th Cir.), and City of New York v. Jacoby Bender (2nd Cir.), and agreed with their conclusion that a transfer "under a plan" refers to a transfer authorized by a confirmed Chapter 11 plan. The Eleventh Circuit therefore reasoned that a plan authorizes any transfer that is necessary to the consummation of the plan, irrespective of whether the transfer involves the debtor or estate property. The court noted that even though in this case the transaction involved two non-debtor parties (the adjacent landowner and the new lender), without the participation of these parties the plan would not have been consummated, the first lender would have foreclosed its mortgage, and the unsecured creditors would have received nothing. The court distinguished this factual situation !
from t
hat of cases (cited by the FDOR) where the transaction could be completed either by outright purchase or financing of the purchase and no mention of the necessity of obtaining any particular form of financing (or any financing at all) was mentioned in the plan, i.e., the transfer in this case was not "irrelevant" and was essential to the consummation of the plan "because the plan could not have been consummated absent that transfer."

The Eleventh Circuit also found that the determination of whether the exemption applied was a matter within the "core jurisdiction" of the bankruptcy court, and noted that Florida's own regulatory interpretation of § 1146(c), contained in the Florida Administrative Code, "implicitly recognizes that an exemption may extend to third parties," and does not restrict the exemption solely to transfer taxes imposed on debtors (although it restricts the exemption to transactions in which the debtor is a party).

Finally, the Eleventh Circuit declined to rule on the "policy" arguments raised by the debtors (i.e., that applying the exemption would further the Congressional policy of encouraging financing of debtors to enable the debtors to continue in business and provide funds for unsecured creditors) and by the FDOR (i.e., that U.S. Supreme Court decisions have articulated a policy of construing tax exemptions narrowly), because the court could find no ambiguity in the language of § 1146(c).

Reporter's Comment 1: The T.H. Orlando case -- which the Reporter believes was very well reasoned and correctly decided -- involves a very unusual (and perhaps unique) fact situation, and very little case-law precedent exists in this area. The § 1146(c) exemption generally has been deemed to limit eligible transfers to those over which the bankruptcy court has jurisdiction; i.e., those which affect the debtor and property of the debtor's estate, and not to transfers between third parties. For example, in In re Kerner Printing Co., 188 B.R. 121 (Bankr. S.D.N.Y. 1995), the bankruptcy court held that subsequent sales and purchases of condominium units by non-debtor parties were not exempt under § 1146(c) from New York City's Real Property Transfer Tax. The confirmed bankruptcy plan provided for the transfer of the bankruptcy estate's property interests in the condominiums to a non-debtor entity, which subsequently resold the units to third-party purchasers. The court found tha!
t the
exemption did not apply because no agency relationship existed between the debtor and the newly created party to whom the debtor's fee interest in the condominium units was transferred. The court stated that, "[c]ases in which § 1146(c) has been found applicable uniformly involve transfers of estate assets by debtors in possession." Id. at 124. See also Mensh v. Eastern Stainless Corp. (In the Case of Eastmet Corp.), 907 F.2d 1487, 1489 (4th Cir. 1990) (holding that while non-debtor purchase money deed of trust can be described as "part of the same transaction by which the buyer acquired debtor's real property, that does not elevate the deed of trust to the status of something 'under a plan confirmed'"); In re Bel-Aire Invs., Inc., 142 B.R. 992, 995 (Bankr. M.D. Fla. 1992) (holding that § 1146(c) exemption does not apply to non-debtor transactions); California State Bd. of Equalization v. Sierra Summit, Inc., 490 U.S. 844, 851-52 (1989) ("Although Congress can confer an immu!
nity f
rom state taxation . . . '[a] court must proceed carefully when asked to recognize an exemption from state taxation that Congress has not clearly expressed ' . . .") (citations omitted). Cf. Maryland v. Antonelli Creditors' Liquidating Trust, 123 F.3d 777, 785 (4th Cir. 1997) (ruling that transfers at issue fell within literal terms of § 1146(c) exemption because liquidating trust established by debtor to take title to properties and subsequently sell them to third parties was an "adequate means" for liquidating substantially all of debtor's property; it was not "patently invalid" means of disposition; and it was "entirely appropriate to use a liquidating trust to sell and distribute an extremely large estate . . . which would otherwise consume a large amount of judicial resources and dissipate much of the estate in legal costs"; and stating that bankruptcy court had correctly distinguished Kerner on the basis that "in that case the so-called new entity was actually the sing!
le cre
ditor (or its assignee) most likely to be benefitted by the transfers over time").

Reporter's Comment 2: As the Eleventh Circuit noted in the T.H. Orlando case, because § 1146(c) focuses on the transaction itself, and not the individual parties involved, the exemption generally applies regardless of whether the debtor or the grantee is obligated to pay the tax under applicable state law. See In re CCA Partnership, 70 B.R. 696, 698 (Bankr. D. Del. 1987) (upholding ruling of bankruptcy court that precluded State Director of Revenue from dividing liability for stamp or similar tax between debtor-grantor and solvent grantee when transfer was pursuant to confirmed plan, and stating that "a stamp tax is, by definition, a tax on the instrument of transfer, not on the parties to the transfer or the act of recording the transfer"); In re Cantrup, 53 B.R. Bankr. D.Colo. 1985) (ruling that because city's real estate transfer tax was stamp tax or similar tax, grantee of deed from trustee was entitled to § 1146(c) exemption, whether presented for recording by grantor !
or gra
ntee). Cf. Lake v. Gleeson, 11 Pa. D & C 2d 584, 586 (Pa. 1956) (holding that, under § 267 of Bankruptcy Act, while trustee could not be made liable for transfer tax for "making or delivering of instruments of transfer," nothing in Bankruptcy Act relieved grantee who "accepted the deed and presented it for recording" (emphasis in text); In re Amsterdam Ave. Dev. Ass'n., 103 B.R. 454, 460-61(Bankr. S.D.N.Y. 1989) (finding argument that proper focus is not on parties to tax but on instrument itself "misplaced"; while acknowledging that § 1146(c) exemption may apply to non-debtor grantee required to pay transfer tax, court held that issue - and not answer - was whether mortgage executed by nondebtors was an "instrument under a plan" for purposes of § 1146(c) exemption).

Reporter's Comment 3: Bankruptcy courts consistently have held that the giving of a mortgage or deed of trust is a "transfer" under § 1146(c). See Amsterdam, 103 B.R. at 458 ("like a stamp tax, the mortgage recording tax is on a written instrument recognized in law as evidence of the enforcement of legal rights (citation omitted"); Eastmet Corp., 907 F.2d at 1489 ("there can be no doubt that the deed of trust transaction involved the making or delivery of an instrument of transfer"); Hughes v. Lawson (In re Lawson), 122 F.3d 1237, 1240 (9th Cir. 1997) ("Granting of security for a debt is a transfer under the Bankruptcy Code"); Jacoby-Bender, 758 F.2d at 842 (reflecting "Congress' understanding that 'transfer' is a word of broad meaning" under Bankruptcy Code); First Fidelity Savs. & Loan v. Hulm, 738 F.2d 323, 27 (8th Cir. 1984) (broad definition of 'transfer' includes grant of mortgage). "Transfer" is defined in the Bankruptcy Code as follows:

"[T]ransfer" means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor's equity of redemption.

11 U.S.C. § 101(54) (2003).

The recording of a mortgage modification agreement pursuant to a Chapter 11 plan presumably also would be a "transfer" entitled to the § 1146(c) exemption.

Furthermore, the § 1146(c) exemption applies to taxes imposed at the time of recording the mortgage, at least in those situations where the debtor obtains the mortgage or deed of trust as a means to fund the plan. In New York City v. Baldwin League of Independent Schools (In re The Baldwin League of Independent Schools, 110 B.R. 125, 127-28 (Bankr. S.D.N.Y. 1989), the District Court ruled that the § 1146(c) exemption applied to a recording tax on a pre-confirmation convertible mortgage that the debtor obtained to fund its Chapter 11 reorganization plan. The court reasoned that the exemption applied because the debtor was the borrower, and recording the mortgage was a practical necessity to the consummation and effectiveness of the plan. The court also noted the mortgage was the only source of funding for the plan. The court also noted that "the mortgage recording tax is in fact a 'stamp tax or similar tax,' because the amount is determined by the consideration cited in the !
nt , because payment is a prerequisite to recordation, and because the tax is imposed on a written instrument (citations omitted)"). Id. at 126. See also Eastmet Corp., 907 F.2d at 1489 (ruling that purchase-money deed of trust was an "instrument of transfer" under § 1146(c)). Cf. Amsterdam, 103 B.R. at 459-60 (holding that while giving of mortgage is "transfer" of property pursuant to approved plan and § 1146(c) exemption applies to mortgage tax, exemption does not apply to mortgage tax imposed on mortgage given by non-debtor borrower-buyer to conclude purchase).

Presumably, transfers of the debtor's leasehold interest (or interests) under a confirmed Chapter 11 bankruptcy plan also would benefit from the § 1146(c) exemption.

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