For our scintillating “Back to School” post, we’ll discuss 11 U.S.C. § 1129(d), which deals with those rare Chapter 11 plans whose “principal purpose” is the “avoidance of taxes.” For most, including judges, § 1129(d) is an afterthought. Until recently, it only crept into my practice by accident: I’ve got a 10 a.m. confirmation hearing in Atlanta. Thus, an hour, maybe a 2 hour drive. It’s 7:25 a.m. My kids need breakfast. I need a confirmation outline. Google “11 U.S.C. 1129”. Copy/paste the good part–1129(a)–and the scary part–1129(b). What the heck, let’s copy/paste the whole thing. Statute in black, my part in green, witness questions (ahem…proffers) in red, with (c) and (d) as stowaways on page 12. Press PRINT–“Kids, you’ve seriously used up all the paper again?!” “Hole punch’s in the playroom, Daddy.” And off I go. 2 hours later:
Your Honor, that brings us to [flipping pages] . . . part (c) which [reading part (c) under my breath] doesn’t apply because…we don’t have competing plans…[reading part (d), half aloud, half to myself]…And part (d) also doesn’t apply because…we aren’t avoiding taxes. Therefore, we satisfy all of the requirements for confirmation under 1129 and request that the Court enter an order confirming the plan [because, of course a 95% LTV and 35% vacancy rate are the hallmarks of a feasible plan].
On its face, § 1129(d) is manageable on the fly. Even the least prepared can stumble through it at the podium. It reads like this:
Notwithstanding any other provision of this section, on request of a party in interest that is a governmental unit, the court may not confirm a plan if the principal purpose of the plan is the avoidance of taxes or the avoidance of the application of section 5 of the Securities Act of 1933. In any hearing under this subsection, the governmental unit has the burden of proof on the issue of avoidance.
Collier teaches us that the purpose of § 1129(d) is to “codify” Gregory v. Helvering, 293 U.S. 465 (1935) in the Bankruptcy Code. If you need a reminder like I did, Helvering is every law student’s introduction to the concept of “substance over form” in Income Tax. As we’ll see below, though, § 1129(d) rarely defeats confirmation. We raised it once and lost rather matter-of-factly. Our concern was well-founded. In a competing plan, our largest creditor had proposed to liquidate all of our assets, take all of the money, and leave the Debtors–or at least their members–with a big tax obligation they couldn’t pay. A “pillage and run” approach that must offend some provision of the Code, right? Maybe, but § 1129(d) wasn’t it, ruled the Court:
“Debtors object that Rialto’s Plans contemplate the disposition of all estate property without an analysis of the tax consequences, violating § 1129(a)(3) and (d). The evidence showed that the tax consequences would affect only non-Debtor entities…[B]ecause all of the Debtors are passthrough entities, any tax consequences flow to the members of the entity, and not the entity itself. As such, there will be no tax consequences to the Debtors. Accordingly, the objection is overruled and the Rialto Plans satisfy § 1129(a)(3).”
Because § 1129 doesn’t, and probably shouldn’t, get a lot of traction, we’ll leave you with the essentials.
Issue 1: Standing
By its express terms, § 1129(d) is limited to challenges by a “party in interest that is a governmental unit,” the clearest examples being the IRS and the SEC. Thus, it doesn’t contemplate, and might even forbid, our debtor challenge. In In re McClean Indus., a SDNY bankruptcy case, the court held that the plan proponent can’t raise it. There is some debate about whether the United States Trustee can make the challenge. Collier points us to Judge Posner’s In re South Beach Securities opinion for that issue.
If all of the governmental units that could raise it are asleep at the switch, then § 105(a) might provide a workaround, as it provides that “[n]o provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.”
Issue 2: Principal Purpose
The word “the” in the phrase “the principal purpose of the plan” means that the the governmental entity has the burden of proving that the principal purpose of the plan is the avoidance of taxes. As Collier points out, § 1129(d)’s predecessor under the Act–Section 269–focused on whether the plan “has for one of its principal purposes the avoidance of taxes.” A tax avoidance purpose could defeat confirmation, even if the plan also had other principal purposes. Not anymore. Section 1129(d) is strictly construed and applied in limited circumstances.
In our case, for example, the tax problem was a real problem, but it’s difficult to argue that the creditor’s singular principal purpose in proposing its competing plan was the avoidance of taxes. That may have been the outcome–and Rialto might’ve even enjoyed the thought of its borrower’s principal being stuck with a big tax, but its principal purpose in proposing the plan was to get paid. As Collier explains, “[i]f the debtor is insolvent, or in need of financial reorganization, it will be rare that taking advantage of tax or securities laws would be the principal purpose.” 7-1129 Collier on Bankruptcy P 1129.07 (16th ed. 2017).
Issue 3: In re Scott Cable Communications
In researching the last part of this post, I came across an ABI article from 1999 that covered § 1129(d). If I had located it before typing this post, I could have linked to it, pressed “Publish,” and been done. In any event, it’s a good article and you should read it. Click here. More than I’m willing to address them here, the article goes into detail about the estoppel and res judicata tensions between bankruptcy courts and the IRS when it comes to assessing the tax consequences of a plan under § 1129(d).
The most interesting part, I think, is the In re Scott Cable Communications, 227 B.R. 603 (Bankr. D. Conn. 1998), discussion. It’s interesting for 2 reasons.
First, Scott Cable shows the IRS raising § 1129(d) in conjunction with § 1129(a)(9)(A), the argument going like this: Not only is the principal purpose of the plan the avoidance of taxes, but the plan also violates § 1129(a)(9)(A) because it doesn’t provide for the payment of administrative expenses in the form of taxes. I can’t remember if we joined our argument with administrative expenses–I think we did because we raised just about every single provision of the Code in opposition–but it’s a good argument, and it prevailed in Scott Cable. Thus, if you have a tax objection that can’t withstand 1129(d)’s strict scrutiny, then test your objection under another provision of the Code.
Second, Scott Cable provides an example of a plan that does violate § 1129(d). In short, Scott Cable involved a pre-packaged liquidating plan that called for the sale of the debtor’s assets to a third party. Junior creditors wouldn’t approve the deal without getting something. They couldn’t get something if the debtor had to pay capital gains taxes instead of paying them. Therefore, the debtor provided that the sale would occur in bankruptcy but outside of the administrative expense period. It also proposed injunctive relief for those debtor principals who might have exposure on the tax liabilities. All very clever.
The court shot it down under § 1129(a)(9)(A) because the plan didn’t provide for the payment of capital gains taxes that would have been administrative expenses but for the proposed closing date. The court concluded that, in such a liquidation, the administrative period should extend through the completion of the sale. It also shot the plan down under § 1129(d) because it concluded that THE principal purpose of the plan was, in reliance on particularities of the Code, to avoid paying the capital gains taxes. The debtor could just as easily have conducted the sale outside of bankruptcy. In other words, the bankruptcy was not motivated by insolvency or a need for financial reorganization. Finally, the court shot down the injunction because there was no basis for it under the Code. Is there every a basis for non-debtor relief?
And there you have it, § 1129(d).