Argument preview: Whose refund is it anyway?
on Nov 26, 2019 at 10:55 am
Where’s my refund? Millions of Americans ask that question each spring as they await checks from the Internal Revenue Service for tax overpayments. The question takes on added significance if your refund exceeds $4 million and you are teetering on the edge of insolvency. This was the circumstance facing United Western Bank, whose eight-year wait for a $4 million refund gave rise to Rodriguez v. Federal Deposit Insurance Corp. On December 3, the Supreme Court will decide whether—and when—to bring that wait to an end.
United Western Bank—a wholly owned subsidiary of United Western Bancorp, Inc., or UWBI—was a Denver-based bank with eight branches across Colorado. UWBI, like many other corporate parents, filed consolidated federal income tax returns on behalf of itself and its subsidiaries, including United Western Bank. Per IRS regulations, a parent company may file a consolidated return on behalf of subsidiaries in which it owns at least an 80 percent stake. If the consolidated return establishes a claim to a refund, the IRS sends the check to the parent rather than to the subsidiary whose losses gave rise to the refund claim. That’s what happened here.
In 2010, United Western Bank—the subsidiary—suffered more than $35 million in losses. At the time, federal tax law allowed a corporation to “carry back” losses up to two years. UWBI—the corporate parent—sought to do just that. In 2011, it requested a refund from the IRS of more than $4 million, which reflected the carryback of United Western Bank’s 2010 losses to offset the bank’s 2008 income.
Meanwhile, both the bank and its corporate parent were falling apart. In January 2011, federal authorities closed United Western Bank, and the FDIC stepped in as the bank’s receiver. In March 2012, UWBI filed for Chapter 11 bankruptcy, and the court appointed Simon Rodriguez, a Colorado lawyer, to be UWBI’s trustee. The FDIC, as the receiver for United Western Bank, argued that the refund was the bank’s property. Rodriguez, as the trustee for the corporate parent, argued that the refund was the corporate parent’s property and therefore part of the parent’s bankruptcy estate. The refund itself did not arrive until 2015, well after litigation over its ownership had commenced.
The bankruptcy court sided with Rodriguez, holding that the refund was property of the parent company’s bankruptcy estate. The district court disagreed and determined that the refund was property of the bank. The U.S. Court of Appeals for the 10th Circuit, in a unanimous decision, sided with the district court (and, thus, with the bank and the FDIC).
In reaching that result, the 10th Circuit cited the U.S. Court of Appeals for the 9th Circuit’s decision in a 1973 case called In re Bob Richards Chrysler-Plymouth Corp., Inc., which addressed the allocation of a refund between a corporate parent and its car-dealer subsidiary. Bob Richards established a two-step process for resolving disputes among corporate affiliates over the ownership of tax refunds. At the first step, the court looks for an express or implied agreement among the parties. If no such agreement exists, the court moves to the second step and allocates the refund to the affiliate that generated the losses and income giving rise to the refund claim.
Bob Richards has been characterized as a rule of “federal common law,” because its second step applies a federal rule of decision rather than deferring to state law to resolve the refund ownership question. The Supreme Court has said that federal common law—federal law emanating from federal courts rather than from the Constitution, statutes or regulations—governs only in “narrow areas” such as admiralty, interstate and international disputes, and cases concerning the rights and obligations of the United States. The U.S. Court of Appeals for the 6th Circuit has explicitly rejected Bob Richards as an unwarranted extension of federal common law. In his successful petition for certiorari, Rodriguez—on behalf of UWBI—urged the justices to resolve the circuit split regarding the Bob Richards rule’s vitality.
In his merits-stage briefs, Rodriguez argues forcefully that the Bob Richards rule is an illegitimate exercise of federal common lawmaking. Federal common law is limited to areas involving “uniquely federal interests,” Rodriguez emphasizes, and there is nothing “uniquely federal” about the disposition of a tax refund. The court already has determined that state law, not federal common law, governs disputes over the ownership of federal debt securities. The same result would seem to hold for federal tax refunds too.
The FDIC doesn’t dispute that point. Instead, it argues that this case doesn’t implicate Bob Richards’ controversial second step. Here, UWBI and United Western Bank entered into a written agreement that allocated any refund to the affiliate whose losses and income gave rise to the refund claim. The agreement, moreover, required UWBI to remit the refund to United Western Bank within 10 days after receiving it from the IRS. The 10th Circuit, according to the FDIC, simply interpreted that agreement according to Colorado contract law. Federal common law had nothing to do with the lower court’s decision.
Rodriguez does not deny that UWBI was ultimately obligated to pay the refunded amount to United Western Bank. He emphasizes, though, that under Colorado law the refund became the property of UWBI upon receipt from the IRS, and that the obligation to pay United Western Bank was a debt obligation. If that’s the case, then the refund is properly part of UWBI’s bankruptcy estate, and United Western Bank is a mere unsecured creditor. United Western Bank is thus entitled to the same pro rata payout as other unsecured creditors (which here will likely mean something less than 100 cents on the dollar).
The FDIC, for its part, says that UWBI received the $4 million refund as United Western Bank’s agent, and that the refund never became UWBI’s own property. If that is so, the refund did not enter UWBI’s bankruptcy estate, and United Western Bank should receive the full amount.
The FDIC bases its agency theory not on federal common law but on IRS regulations. Specifically, 26 CFR 1.1502-77(d)(5) says that any refund resulting from a consolidated return will be paid to the filing entity as “agent” for other members of the affiliated group, at which point the federal government’s liability to all members of the group will be discharged. The 9th Circuit in Bob Richards cited that regulation when it held that the parent company there “received the tax refund from the government only in its capacity as agent for the consolidated group.” And that holding, the FDIC says, is a correct interpretation of the relevant regulation, whether or not the 9th Circuit was right to think that federal common law displaces state law on the issue of ultimate entitlement.
Rodriguez interprets the IRS regulations differently. In his view, the regulations “disavow any concern with how a refund is distributed” after it is paid to the entity filing a consolidated return. And he notes that the relationship between United Western Bank and UWBI lacked one of the hallmarks of a principal-agent relationship: that the putative principal (the bank) exercised control over the ostensible agent (UWBI).
But here’s the catch: The 10th Circuit’s decision doesn’t appear to have hinged on IRS regulations at all. The court of appeals said that the agreement between United Western Bank and UWBI was, “on its face, ambiguous” as to whether it established a principal-agent relationship with respect to refund receipt. It then looked to a clause in the contract stating that any ambiguity should be resolved in favor of the “insured depository institution”—which here means the bank. And it said that its interpretation of the agreement was guided by Colorado law, with only passing references to federal common law and IRS rules.
So what will the justices do? One possibility is that they will dismiss the case as improvidently granted (or “DIG it,” in Supreme Court speak). The reason for a DIG would be that the 10th Circuit’s decision doesn’t turn on federal common law at all, and so the question presented isn’t actually implicated. DIGs are disfavored, though, and the 10th Circuit may have said enough about Bob Richards to satisfy the justices that the federal-common-law issue is fair game. (The 10th Circuit noted that “[f]ederal common law … provides a framework for resolving this issue,” though it then added that federal common law directs it to start with the parties’ agreement, and it went on to interpret that agreement in light of Colorado law.)
Perhaps more likely, the justices may say that state law controls the allocation of refunds within an affiliated group—and send the case back to the 10th Circuit to figure out the rest. The 10th Circuit then may repeat its conclusion that the FDIC wins under Colorado contract-law principles, but at least the Bob Richards issue will be resolved once and for all. It is harder to imagine the current Supreme Court holding that federal common law or IRS regulations control the outcome, given its general antipathy in recent decades toward extensions of federal common law as well as the preference of several justices for narrower interpretations of administrative-agency rules.
A decision is expected by summer. By that point, United Western Bank’s wait for a refund will have entered its 10th year. And even then, it might not be over.