Thursday, July 31, 2008

Transfer Taxes Post-Piccadilly

Many of our commercial clients ask us about the tax consequences of purchasing assets from Chapter 11 debtors. In order to encourage successful reorganizations, the Bankruptcy Code, at 11 USC §1146(a), prevents the taxation of transfers under a confirmed Chapter 11 reorganization plan. This section of the Code was at issue in a recently decided Supreme Court case, Florida Department of Revenue v. Piccadilly Cafeterias, Inc., 2008 WL 2404077. The Court, in a 7-2 decision by Justice Thomas, held that the statute is applicable only to transfers made after the confirmation of a Chapter 11 plan of reorganization.

The case arose when Florida sought to tax the transfers from Piccadilly to others that were made before the Chapter 11 plan was confirmed by the Bankruptcy Court. The 11th Circuit held that the tax exemption could cover pre-confirmation transfers, while the 3rd and 4th Circuits previously held that §1146(a) applied only to post-confirmation transfers. Interestingly, Justice Alito drafted the 3rd Circuit opinion and held that §1146(a) applied only to post-confirmation transfers. Baltimore County v. Hechinger Liquidation Trust (In re Hechinger Inv. Co. of Del., Inc.), 335 F.3d 243 (3d Cir. 2003). Had the Supreme Court found for Piccadilly and upheld the 11th Circuit's decision, it would have overruled one of its own Justices.

Piccadilly will impact state and local taxing authorities by providing additional revenue, but may also delay asset sales until after plan confirmation. However, depending on the facts, Chapter 11 debtors may also realize that the transfer tax exemption is less important where assets are depreciating.

For questions about transfer taxes, please contact Jim Shenwick of Shenwick & Associates.

Tuesday, July 01, 2008

Doctrine of Necessity

Many of our commercial bankruptcy clients that supply goods to Debtors have asked us about the Doctrine of Necessity, which permits creditors to be paid on pre-petition debts after a bankruptcy filing. The Doctrine is found in the Bankruptcy Code at 11 USC §105(a), which permits the court to "issue any order…that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]." In the late 19th century, the Doctrine was applied at common law in railroad reorganizations by judges who reordered priorities so that certain creditors would be paid in the name of "necessity."

Today, Section 105 of the Bankruptcy Code does not allow Judges to set aside the Code's priority rules. The rule in present-day Courts prohibits payments to selected unsecured creditors unless all unsecured creditors are paid, but exceptions to this rule exist depending on the circumstances. One exception is where the non-payment of an unsecured pre-bankruptcy filing claim would significantly weaken a Debtor's ability to function – i.e. if a supplier were not paid for goods and threatened to withhold future shipments, jeopardizing the Debtor's business and reorganization.

An example of a District Court allowing a Debtor to pay unsecured creditors pre-petition is In re Just for Feet, Inc., 242 B.R. 821 (D. Del. 1999), in which the United States District Court for the District of Delaware allowed Just for Feet, Inc., to continue to purchase name-brand athletic footwear from its vendors. Just for Feet, which filed for bankruptcy in 1999, was a shoe store that primarily sold name-brand athletic shoes. If the Court refused the Debtor's request to pay unsecured creditors' claims for pre-petition goods, the business would have ceased to exist because the Debtor would not have been able to buy merchandise for its stores.

For more information on the Doctrine of Necessity and the powers of Bankruptcy Courts, please contact Jim Shenwick of Shenwick & Associates