The U.S. Supreme Court struck down a long-standing common law rule by which federal courts had decided disputes between members of an affiliated group filing a consolidated return over which of them should be allocated any tax refund. Instead, according to the unanimous decision released Tuesday, state laws should be applied to resolve these disputes.
The case, Rodriguez v. Federal Deposit Insurance Corp., No. 18-1269 (U.S. 2/25/20), grew out of a Chapter 7 bankruptcy case involving United Western Bank and its parent corporation, United Western Bancorp Inc. (UWBI). After heavy losses, the Denver-based bank was closed in 2011 and the Federal Deposit Insurance Corp. (FDIC) named receiver. Soon after, UWBI entered bankruptcy, with Simon Rodriguez named as trustee.
Also in 2011, UWBI filed its 2010 consolidated federal income tax return on behalf of its affiliated group that included United Western Bank, claiming a $4.8 million refund based on a carryback of a 2010 net operating loss to offset taxes paid for 2008. The IRS in 2015 issued the refund, depositing it into the bankruptcy court’s registry, pending resolution of what had by now become an adversary proceeding between UWBI on the one hand and United Western Bank and the FDIC on the other.
The bankruptcy court, relying on a 2008 tax allocation agreement between UWBI and its affiliated subsidiaries, including United Western Bank, held the refund to be part of UWBI’s bankruptcy estate (In re United Western Bancorp, Inc., 558 B.R. 409 (Bankr. D. Colo. 2016)). The FDIC then appealed to district court, which reversed the bankruptcy court (Federal Deposit Ins. Corp. v. Rodriguez, 574 B.R. 876 (D. Colo. 2017)). UWBI appealed to the Tenth Circuit, which affirmed the district court’s decision (Rodriguez v. Federal Deposit Ins. Corp., 893 F.3d 716 (2018)), and then to the Supreme Court.
The Court’s unanimous opinion, written by Justice Neil Gorsuch, noted that such disputes between members of affiliated groups without a tax allocation agreement or with a contested one have been decided under a federal common law rule applied in some jurisdictions known as the Bob Richards rule, after the case out of which it grew, In re Bob Richards Chrysler-Plymouth Corp., 473 F.2d 262 (9th Cir. 1973). Generally, the rule provides that, lacking a tax allocation agreement, or unless the agreement unambiguously specifies differently, a tax refund belongs to the group member responsible for the losses that led to it. The Tenth Circuit had applied the Bob Richards rule in this case.
However, the Bob Richards rule “is not a legitimate exercise of federal common lawmaking,” as the Court’s official syllabus for the opinion puts it. Federal courts can create common law only where “necessary to protect uniquely federal interests,” which are not present here, the Court said (slip op. at 4, quoting Texas Industries, Inc. v. Radcliff Materials, Inc., 451 U.S. 630, 640 (1981)). Rather, “state law is well equipped to handle disputes involving corporate property rights,” even in cases that “happen to involve corporate property rights in the context of a federal bankruptcy and a tax dispute” (slip op. at 5).
The Court remanded the case to the Tenth Circuit for further proceedings consistent with the Court’s opinion, noting that the circuit court could reach the same result again on other grounds.
— Paul Bonner (Paul.Bonner@aicpa-cima.com) is a JofA senior editor.