>
>
>Daily Development for Wednesday, July 30, 2008
>by: Patrick A. Randolph, Jr.
>Elmer F. Pierson Professor of Law
>UMKC School of Law
>Of Counsel: Husch Blackwell Sanders
>Kansas City, Missouri
>dirt@umkc.edu
>
>Another great submission from Jack Murray:
>
>BANKRUPTCY; TRANSFER TAXES: U.S. Supreme Court resolves the issue of transfer tax exemptions for pre-confirmation transfers that are included in the plan - no exemption available.

>
>Fla. Dept. of Revenue v. Piccadilly Cafeterias, Inc., 128 S.Ct. 2326 (2008) 
>
>Section 1146(a) of the Bankruptcy Code which exempts from state or local transfer or stamp taxes the issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer pursuant to a plan confirmed under Chapter 11 of the Bankruptcy Code, is a benefit of great consequence to secured lenders and to borrowers in connection with mortgage loan workouts and restructuring, especially in these troubled economic times.  Many states (as well as counties and municipalities) impose significant transfer taxes in connection with conveyances of real property, whether made voluntarily or (in some states and municipalities) as the result of foreclosures or other enforcement actions. Such taxes and impositions often add "insult to injury" to secured lenders (or third-party purchasers) who take title (voluntarily or involuntarily) to real property collateral from delinquent borrowers. This is especially so if the value of the property transferred is significant or

 multiple properties are to be conveyed. These expenses often can be eliminated if the transfer occurs as part of a consensual or "pre-packaged" Chapter 11 bankruptcy reorganization plan. Such cost considerations, therefore, could well play a part in determining the "exit strategy" of both lenders and borrowers.

>
>Numerous bankruptcy courts (and several federal courts of appeal) have examined the language in § 1146(a) that states only transfers occurring "under a plan confirmed" are exempt from taxation. The issue that has been raised is whether this specific language applies only to a transfer that occurs subsequent to court approval and confirmation of the plan, or whether it can also be construed to apply to a transfer that is part of a bankruptcy plan that has been submitted and is an essential component of the plan confirmation but is not approved and confirmed by the court until after the transfer of the property. The resolution of this issue has been of utmost importance to bankruptcy trustees and debtors in possession because it is often necessary, in order to pay current debts and to fund the debtor's Chapter 11 reorganization plan, that the debtor be able to sell assets as quickly as possible during the course of the bankruptcy proceeding before they begin to lose value. The cour

t decisions in this area have not been consistent, especially among the federal appellate courts. Governmental tax authorities have, in some cases, argued (successfully) that the property transfer occurred prior to confirmation of the plan and should not be entitled to the § 1146(a) exemption. The meaning of "under a plan confirmed" has generated disagreement among the courts. Fortunately (or unfortunately, depending on one's viewpoint and perspective), ruling that the § 1146(a) exemption applies only to post-confirmation transfers of the debtor's assets.

>
>Because of the split of authority among the federal circuit courts as to whether the § 1146(a) transfer-tax exemption applies to pre-confirmation asset sales under § 363 of the Bankruptcy Code, the U.S. Supreme Court took up the issue on appeal from an Eleventh Circuit case.   It ruled that the Bankruptcy Code's § 1146(a) transfer-tax exemption does not apply to transfers made before a plan is confirmed under Chapter 11.

>
>The Court noted that while "both sides present credible interpretations of § 1146(a), Florida has the better one." The court acknowledged that there was some ambiguity in the language of § 1146(a), but ruled that the interpretation posited by Florida was more plausible and "clearly the more natural," and that Piccadilly's interpretation placed "greater strain on the statutory text than the simpler construction advanced by Florida” [and adopted by the Third and Fourth Circuits.] The Supreme Court noted that it was irrelevant whether or not the statute was ambiguous on its face because "the ambiguity must be resolved in Florida's favor," reasoning that the distinction between "plan confirmed" and "confirmed plan" was irrelevant because § 1146(a) specifies not only that the tax-exempt transfer must be "under a plan," but that it must also be confirmed pursuant to § 1129 of the Bankruptcy Code.

>
>The court then dealt with each of the parties' specific arguments. First, although not dispositive of the issue, the court noted that the subchapter of the Bankruptcy Code in which § 1146(a) appears is entitled, "POST CONFIRMATION MATTERS." The court acknowledged that "a subchapter heading cannot substitute for the operative text of the statute," but reasoned that it was "informative that Congress placed § 1146(a) in [that subchapter]. The court then ruled that the most natural reading of the language "under a plan confirmed" was to require that there be a confirmed plan at the time of the transfer. The court noted that Piccadilly had not even submitted a plan at the time of the asset sale, and therefore the sale could not possibly have been conducted "in accordance with" any plan confirmed under Chapter 11.

>
>The court also noted that, although the sale was conducted in accordance with the procedures set forth in § 363(b)(1) of the Bankruptcy Code, "[t]o read the statute as Piccadilly proposes would make § 1146(a)'s exemption turn on whether a debtor-in-possession's actions are consistent with a legal instrument that does not exist - and indeed may not even be conceived of - at the time of the sale." The court further noted that the provisions of § 365(d)(1) were not analogous to the requirements of § 1146(a), because even though the decision to assume or reject the contract or lease under § 365(d)(1) must be made before confirmation of the plan, the fact remains that the rejection takes effect only upon or after confirmation of the Chapter 11 plan. The court ruled that in this case, only at the point that the court confirms the plan in question does the transfer become eligible for the § 1146(a) transfer-tax exemption. Next, the court agreed with Florida's assertion that it should re

cognize the "federalism canon" that § 1146(a)'s exemption should be construed narrowly, since Congress had not clearly expressed an exemption for pre-confirmation transfers.

>
>The court also rejected Piccadilly's assertion that § 1146(a) was a preference-granting provision, noting that the applicable statutory text made no mention of "preferences." The court then rejected Piccadilly's claim that § 1146(a) should be construed liberally to serve its supposedly remedial purpose. The court reasoned that the aim of the Bankruptcy Code was to strike a reasonable balance between debtors and creditors, and that generally the rights of states with respect to property rights should not be disturbed. The court noted that it was up to Congress, and not the Judiciary, to determine if changes were needed in the language in § 1146(a), and stated pointedly that "we see no absurdity in reading § 1146(a) as setting forth a simple, bright-line rule instead of the complex, after-the-fact inquiry Piccadilly envisions."

>
>In his dissent from the majority's opinion, Justice Breyer (with whom Justice Stevens joined) argued that "the statutory language itself [in § 1146(a)] is "perfectly ambiguous" as to whether a transfer takes place "under a plan" that has already been confirmed or under a plan that is subsequently confirmed. Justice Breyer also argued that he could not "find any text-based argument that points clearly in one direction or the other." He further argued that the canons of interpretation do not provide clarity on this issue and stated that in fact "the majority's reading of temporal limits in § 1146(a) serves no reasonable congressional purpose at all," in light of Chapter 11's purpose of preserving going concerns and maximizing property available to apply to creditors' claims. Justice Breyer noted that the pre-confirmation process can take a great deal of time, even years in some cases, and that the value of the debtor's assets could decline precipitously during this period, reducing

 the funds that would otherwise be available to creditors or for reorganization of the debtor under Chapter 11. Justice Breyer noted that in this case, Piccadilly realized $80 million by selling the assets quickly after the negotiation of a pre-confirmation settlement agreement with its creditors, which was considerably more than the $54 million originally offered to Piccadilly before it filed its Chapter 11 bankruptcy proceeding. Justice Breyer conceded that the majority's ruling provided the advantage of a clear "bright-line" rule, but argued that "the statute supplies a clear enough rule - transfers are exempt when there is confirmation and are not exempt when there is no confirmation."

>
>Reporter’s Comment 1: Twenty-seven states and four cities filed an amicus curiae brief, expressing concern that the public interest would suffer because they would lose billions of dollars in tax revenue if the Supreme Court should rule that pre-confirmation asset sales are entitled to the § 1146(a) transfer-tax exemption.

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>Reporter’s Comment 2:   In a loan workout situation in the current real-estate market, significant transfer-tax costs may have a high level of economic impact and be a critical consideration. When property owned by the bankrupt debtor is transferred subject to the § 1146(a) exemption (especially in single-asset real estate bankruptcy cases), the lender may be able to recover its real property collateral at a lower cost, free and clear of liens and encumbrances and without the payment of (often significant) transfer or stamp taxes. This, in turn, may encourage the lender -- at least in certain factual situations -- to agree to a consensual plan that reduces bankruptcy expenses and delays and perhaps even frees up additional funds for unsecured creditors. But the plan must be structured, as clearly set forth in the U.S. Supreme Court's ruling in Piccadilly, so that the sale of assets occurs after confirmation of the bankruptcy reorganization plan providing for the sale of such asse

ts, and so that it does not run afoul of § 1129(d) of the Bankruptcy Code, which prohibits confirmation of a plan that has as its principal purpose the avoidance of taxes.

>
>The Reporter for this item was Jack Murray of First American Title Insurance, Chicago Office.
>
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