Circuit court clears confusion over tax-sharing agreements

On July 8, the 6th U.S. Circuit Court of Appeals reversed and remanded the district court's decision in FDIC v. AmFin Financial Corporation, holding that it erred in refusing to consider the FDIC's extrinsic evidence that the parties intended to establish an agency or trust relationship in their tax-sharing agreement.

The dispute centered on ownership of a $170 million tax refund that the Internal Revenue Service issued to the AmFin Financial Corporation, the parent company of a group of banks that filed a consolidated tax return, but which was generated by AmTrust Bank, the subsidiary bank whose net operating losses created the refund.

In 2006, AmFin entered into a tax-sharing agreement with its affiliates, including AmTrust, to allocate tax liability. Three years later, AmFin filed for bankruptcy, which resulted in AmTrust's closure and placement into receivership with the Federal Deposit Insurance Corporation. Later that year, AmFin filed a consolidated 2008 tax return that generated a $194 million refund that the IRS issued to AmFin. The FDIC asserted that $170 million of the refund belonged to AmTrust because it resulted from the use of AmTrust's net operating losses to offset the consolidated group's income. While AmFin conceded that $170 million of the refund was generated by losses of AmTrust, it maintained that the refund belonged to AmFin's bankruptcy estate.

The District Court and the Appeal

The district court held that the tax-sharing agreement unambiguously designated the refund to AmFin's bankruptcy estate and refused to allow the FDIC to introduce extrinsic evidence that demonstrated an agency or trust relationship existed between the parties. The 6th Circuit, however, reversed and remanded the decision, instructing the district court to consider the evidence concerning the parties' intent in accordance with Ohio trust and agency law.

Unlike the district court, the 6th Circuit did not find that the tax-sharing agreement unambiguously established a debtor-creditor relationship entitling AmFin to the refund. Like many other tax-sharing agreements, the agreement at issue only addressed each affiliate's responsibility to pay for its portion of the tax liability and excluded any discussion regarding ownership of any resulting refund. Therefore, according to the 6th Circuit, the district court's citation of cases in which a tax-sharing agreement directly addressed the distribution of refunds was not dispositive. Additionally, the 6th Circuit cited an 11th Circuit case, In re BankUnited Financial Corp., 727 F.3d 1100 (11th Cir. 2013), that rejected a debtor-creditor relationship where a tax-sharing agreement lacked protections for the creditor. The 6th Circuit also refused to sustain the district court's assignment of specialized meaning to common terms such as "payment" and "reimbursement".

The 6th Circuit also declined to apply the principle stated in In re Bob Richards Chrysler-Plymouth Corp., 473 F.2d 262 (9th Cir.1973), where the 9th Circuit held that, absent any opposing agreement, a tax refund that results from offsetting one affiliate's losses against the income of the consolidated filing group should be allocated to that affiliate member. Rather than applying this federal common law, the 6th Circuit found that Congress generally permits state law to determine whether to include property in a bankruptcy estate and that Ohio law should resolve ownership of the tax refund.

Finally, the 6th Circuit reversed and remanded the decision with specific instructions to allow extrinsic evidence because it believed such evidence may establish a resulting trust or agency relationship which would be determinative in allocating the refund. Ohio law recognizes a resulting trust as one that is implied based on the intentions of the parties. Specifically, a resulting trust has been defined as a situation in which "the legal estate in property is transferred or acquired by one under facts and circumstances which indicate that the beneficial interest is not intended to be enjoyed by the holder of legal title." First Nat'l Bank of Cincinnati v .Tenney, 138 N.E.2d 15, 17 (Ohio 1956) (internal quotation marks omitted). The Sixth Circuit was comfortable allowing a resulting trust to exclude property from a bankruptcy estate, because unlike a constructive trust, the resulting trust effected the original parties' intent. The resulting trust does not inhibit ratable distribution among competing creditors because the property never belonged to the debtor and therefore was never intended to be included in the bankruptcy estate. While Ohio law specifies situations in which a resulting trust may appear, the Sixth Circuit clarified that this was not an exhaustive list. Ohio courts are free to recognize resulting trusts in other situations by evaluating the parties' original intentions.

The 6th Circuit also recognized that the FDIC's extrinsic evidence may establish an agency relationship. Ohio law recognizes an agency relationship "when one party exercises the right of control over the actions of another, and those actions are directed toward the attainment of an objective which the former seeks." Hanson v. Kynast, 494 N.E.2d 1091, 1094 (Ohio 1986). Additionally, Ohio law permits introducing extrinsic evidence in the occurrence of unclear contract language or contract circumstances that impute special meaning on the contract's language. Since the tax-sharing agreement was silent on the issue of allocating tax refunds, the 6th Circuit instructed the district court to permit the FDIC to introduce evidence as the contract's circumstances may establish an agency relationship.

The Concurrence

Judge Ronald Gilman authored a concurrence that agreed with the result reached but disagreed with the interpretation of the principles from the Bob Richards decision. Gilman believed that the Bob Richards principle does not require choosing whether state or federal law applies but simply enunciates a hierarchy as follows: (1) analyze the tax-sharing agreement to resolve the refund issue; (2) if the tax-sharing agreement is ambiguous, then determine if an agreement between the parties can be implied under state law; and (3) if the state law inquiry is also inconclusive, defer to federal law and distribute the loss to the entity that generated it because federal tax law does not change the ownership of the refund.

The Takeaways

The 6th Circuit's decision in AmFin is instructive in how to draft tax-sharing agreements that not only specify each subsidiary's tax liability in a consolidated group tax return, but also expressly state the distribution process for any tax refunds issued to the group.

The FDIC is now requiring that insured depository institutions amend their tax-sharing agreements to make explicit that any tax refunds attributable to income earned, taxes paid and losses incurred by the insured depository institution are the property of and owned by the insured depository institution.

Stephen Turanchik is an associate and Nancy Iredale is a partner at Paul Hastings LLP. Haley Horton is a student at Stanford Law School and was a 2014 summer associate with the firm.