The recent Supreme Court decision clarifying the bankruptcy transfer tax exemption that allows debtors to avoid paying stamp taxes or similar transfer taxes on assets transferred as part of a confirmed Chapter 11 plan of reorganization. As outlined below, the Supreme Court struck down a ruling that had stated the transfer tax exemption could be applied to pre-confirmation asset sales. As a result, the use of pre-confirmation Section 363 asset sales by debtors may be restricted.
Section 1146(a) of the Bankruptcy Code states that:
The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax.
This provision exempts asset transfers from taxes, but only if the transfer is made “under a plan confirmed under section 1129 of this title.” The circuit courts have been in conflict over the meaning of that phrase with the Eleventh Circuit holding that pre-confirmation asset transfers can be exempted from transfer taxes if there is “some nexus between the pre-confirmation transfer and the confirmed plan” while the Third and Fourth Circuits have found that the transfer tax exemption only applies to post-confirmation transfers made under the authority of a confirmed plan of reorganization.
This issue has become more important in recent years as more debtors are opting to sell some or all of their assets pursuant to a Section 363 asset sale often long before a Chapter 11 plan of reorganization is even filed. These pre-confirmation sales are often used by the debtor to generate funds to continue their operations or as a way of liquidating faster than it would normally take if the debtor were to follow the regular plan confirmation route.[related]
The Supreme Court has now settled the issue in the case of Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc., 2008 U.S. Lexis 5025 (June 16, 2008). In a 7-2 decision authored by Justice Clarence Thomas, the Court overruled the Eleventh Circuit and found that the transfer tax exemption only to transfers made pursuant to a confirmed plan.
In Florida v. Piccadilly, Piccadilly had sold assets prior in a pre-confirmation asset sale held pursuant to Section 363 of the Bankruptcy Code. A Chapter 11 plan had not yet been filed. The majority of the justices held that it was illogical to say that a sale had been conducted “in accordance with” a confirmed plan when such a plan was not even in existence at the time of the sale. The dissent written by Justice Stephen Breyer found the text to be ambiguous and then stated that Congress could not have intended to make a distinction because it did not make any difference whether the transfer took place before or after the plan was confirmed.
The result of this ruling is that Section 363 pre-confirmation sales will no longer be exempt from transfer taxes. This may cause a debtor to delay asset sales until confirmation in order to take advantage of the exemption. However, there has been a strong trend towards early asset sales in bankruptcies because of financing issues and declining asset values, so the actual effect of this ruling remains to be seen.
For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.