Contributed by Yvanna Custodio and Max Goodman
To commemorate Tax Day last year, the Weil Bankruptcy Blog published a case where the bankruptcy court interpreted section 506(c) of the Bankruptcy Code as it related to the claims of the Internal Revenue Service as a secured creditor. For Tax Day 2013, we commence a four-part series on United States v. Bond, a decision penned by Judge Brian M. Cogan of the United States District Court for the Eastern District of New York. The debtors were three related telecommunications corporations (collectively referred to in this series as “PT-1”), whose lengthy bankruptcy proceedings resulted in numerous tax-related disputes that were adjudicated in the bankruptcy court and then appealed to the district court. Part One of this series discusses the factual genesis of the decision and the district court’s determination of the appropriate standard of review. Part Two will discuss whether the IRS waived sovereign immunity with regard to tax refund claims filed by Edward P. Bond, the trustee of the liquidating trust that succeeded to PT-1’s assets, under sections 106(a) and 106(b) of the Bankruptcy Code. Part Three will discuss whether the bankruptcy court had jurisdiction to compel the IRS to accept a tax return filed by PT-1. Finally, Part Four will focus on whether the bankruptcy court had jurisdiction to enjoin the IRS from its future exercise of setoff or recoupment rights against the trustee.
PT-1’s business consisted of selling prepaid calling cards and providing “dial-around long distance.” A series of events transpired in the years 1999 to 2001, giving rise to the plethora of tax issues raised in the case: In 1999, the Star Group acquired PT-1, and for the remainder of that year and the following year, PT-1 was included in the Star Group’s consolidated federal income tax return. In late 2000, WorldCom took control of PT-1 pursuant to a stock pledge agreement with the Star Group on which the Star Group defaulted.
The year 2001, however, did not bode well for either PT-1 or the Star Group; by the end of 2001, the PT-1 entities had filed chapter 11 cases in the Eastern District of New York, and the Star Group was the subject of its own bankruptcy cases in the District of Delaware, which culminated in the liquidation of the Star Group. Exacerbating PT-1’s troubles was its status as a “tax orphan” because neither WorldCom nor the Star Group had included PT-1 in its consolidated return for 2001 or the succeeding years. On its own, PT-1 timely filed a return for the postpetition portion of 2001 (referred to in this series as the “Postpetition 2001 Period”) and paid approximately $6.7 million of tax attributable to this period, but did not include a request under section 505(b)(2) of the Bankruptcy Code for a prompt determination of tax liability, so the IRS was free to assess additional tax for this period. PT-1 also filed two late, unsigned returns: one for the prepetition portion of 2001 (referred to in this series as the “Prepetition 2001 Period”) reporting net losses and one covering all of 2001. The IRS, however, refused to accept these returns. PT-1 timely filed its own federal income tax return for 2002 reporting a net operating loss, which filing did include a request for a prompt determination of tax liability under section 505(b)(2). Although the IRS examined this return, it did not assess any tax within 180 days after the request, as required by section 505(b)(2).
From 2004 to 2006, the IRS filed in PT-1’s chapter 11 cases various requests for payment of administrative expenses for taxes, interest and penalties attributable to the Postpetition 2001 Period and 2002. In March 2005, the liquidating trustee filed a motion (i) to disallow the IRS’s requests for administrative expenses, (ii) for a declaration that PT-1 was permitted to file a tax return for the Prepetition 2001 Period, and (iii) for a refund of the tax paid for the Postpetition 2001 Period. Although the trustee made the refund request in his motion, he did not formally request such refund from the IRS until September 2005. The trustee attached this administrative refund request to its motion for summary judgment filed in September 2007.
The bankruptcy court disallowed the IRS’s requests for administrative expenses, enjoined the IRS from exercising any setoff or recoupment rights on the ground that the provisions of PT-1’s chapter 11 plan barred such exercise, ordered the IRS to accept PT-1’s tax return for the Prepetition 2001 Period, and ordered the IRS to pay a refund of approximately $3.8 million for the Postpetition 2001 Period based on losses carried forward from 2000 and the Prepetition 2001 Period. Both parties appealed to the district court.
Standard of Review
The threshold issue addressed by the district court was the appropriate standard of review to be applied in examining the bankruptcy court’s decisions. The IRS argued that, following Stern v. Marshall, the district court must undertake de novo review of all aspects of the bankruptcy court’s decisions, whether or not the proceeding is core.
The liquidating trustee contended that the tax refund claims fall under the “public rights doctrine,” and as a result, an Article I court such as the bankruptcy court may adjudicate such claims with finality. In describing the “public rights doctrine,” the district court quoted Crowell v. Benson, in which the Supreme Court observed that the doctrine covers those matters arising “between the Government and persons subject to its authority in connection with the performance of the constitutional functions of the executive or legislative departments,” and which those departments historically could have determined exclusively. The theory underlying the public rights doctrine is that, because Congress was free to commit such matters to executive or legislative determination, “there can be no constitutional objection to Congress’ employing the less drastic expedient of committing their determination to a legislative court or an administrative agency.” After observing that the Supreme Court recognized the long history of the public rights doctrine in Stern, the district court noted that the trustee’s refund suit “fits squarely” within the definition of a public right described in case law because it is a suit (i) between the United States and a party subject to the government’s authority (ii) concerning tax collection, a constitutional function of the executive branch, and (iii) possible only as a result of a waiver of sovereign immunity (to be discussed further in Part II). The district court further observed that Congress has committed tax disputes to two other Article I courts – the Tax Court and the Court of Federal Claims. Ultimately, the district court concluded that the bankruptcy court’s final decisions are constitutional and that it would apply the usual appellate standards as its standard of review.
We will discuss the district court’s analysis of whether the IRS waived sovereign immunity with regard to the liquidating trustee’s tax refund claims under section 106 of the Bankruptcy Code in Part Two of our four-part series.