UAL Bankruptcy Court Looks to Context of Specific Code Chapter in Refusing to Exercise Jurisdiction Over Question of Whether Plan Distributions on Union Employee Claims are Taxable as "Wages"

UAL's proposed plan of reorganization provides for a modicum of distributions on the plan effective date of UAL's plan to unionized employees, as required by the terms of revised collective bargaining agreements. UAL, relying upon Bankruptcy Code section 505(a) (which allows the bankruptcy court to "determine the amount or legality of any tax"), sought a declaratory ruling from the bankruptcy court that distributions to employees under the plan cannot be taxed by the IRS as "wages." This issue is quite significant to UAL because a favorable ruling would save UAL tens of millions of dollars in federal withholding taxes and the like that would have to be paid were the distributions to be characterized as "wages" for federal tax purposes.

The UAL bankruptcy court, however, refused to even reach the merits because it concluded (opinion available here) that it lacked jurisdiction to decide the tax effects of a Chapter 11 plan before it has been confirmed.

In so doing, the Court noted the paucity of cases and consensus on "when a tax issue must arise in order to be subject to adjudication" as compared with "whose tax issues may be adjudicated under looked at the language of Code § 505(a)." The Court stated:

At least one decision has stated that § 505(a) does not permit preconfirmation determinations of tax questions that only arise after confirmation of a Chapter 11 plan. See Allis-Chalmers Corporation v. Goldberg (In re Hartman Material Handling Systems, Inc.), 141 B.R. 802, 812-13 (Bankr. S.D.N.Y. 1992).... Another decision states that § 505(a) never encompasses tax issues arising postconfirmation. See In re Holly’s, Inc., 172 B.R. 545, 562 (Bankr. W.D. Mich. 1994) (“[E]ven though § 505(a) speaks in broad terms, it does not grant a bankruptcy court subject matter jurisdiction over postconfirmation tax years.”). However, other decisions have exercised jurisdiction to determine postconfirmation tax disputes under § 505(a), at least in the context of a confirmed Chapter 11 plan. See, e.g., Unsecured Creditors’ Comm. of Goldblatt Bros., Inc. v. United States (In re Goldblatt Bros., Inc.), 106 B.R. 522, 529 (Bankr. N.D. Ill. 1989). There appear to be no published decisions applying § 505(a), as United requests, to determine the tax effects of a Chapter 11 plan before it has been confirmed. [FN 6]
[FN6] Scholarly commentary reflects the unsettled state of the case law on this point. See, e.g., Donald D. Haber, Tax Consequences of Chapter 11 Plans, 3 Am. Bankr. Inst. L. Rev. 407, 417 (1995) (“[T]he ability of the bankruptcy courts to expand the powers of section 505 to determinations regarding the federal income tax consequences of Chapter 11 reorganization plans is by no means certain.”); Shu-Yi Oei, Rethinking the Jurisdiction of Bankruptcy Courts over Post-Confirmation Federal Tax Liabilities: Towards a New Jurisprudence of 11 U.S.C. § 505, 19 Akron Tax J. 49, 51 (2004) (“[T]he current approach that bankruptcy courts have taken in circumscribing the reach of § 505 over liabilities that may arise after the plan has been confirmed and discharged is unsatisfactory.”); Jack F. Williams, National Bankruptcy Review Commission Tax Recommendation: Notice, Jurisdiction, and Corporate Debtors, 14 Bankr. Dev. J. 261, 270 (1998) (“As to postconfirmation tax matters, the authorities are in disagreement.”).

Heeding the 7th Circuit's "warning [in Handy Andy] against ignoring the context of question provisions of the Bankruptcy Code," the Court then considered "[t]wo contextual considerations [that] compellingly demonstrate that § 505(a) does not apply to tax issues arising after confirmation of a Chapter 11 plan."

Particularly noteworthy is Judge Wedoff's creativity in approaching the question by focusing first and foremost on the fact that the power vested in the bankruptcy courts to determine tax liability is contained in Chapter 5 of the Bankruptcy Code and not some other chapter. In holding that if Code section 505(a) is read within the context of the specific chapter of the Bankruptcy Code within which it is found, then the Court clearly lacks jurisdiction to determine the tax effects of a Chapter 11 plan before it has been confirmed, the Court reasoned:

This subchapter, titled “Creditors and Claims,” deals with the allowance and priority of claims against a bankruptcy estate. To be treated properly in this subchapter, the tax issues subject to bankruptcy adjudication under § 505(a) must be those that generate or offset claims against the estate, thus including matters that arose before the case was filed or during its administration, but not claims based on facts that would only arise after the estate has been terminated by confirmation of a plan. (Citations omitted). Indeed, since a plan of reorganization deals with the claims against the estate that are provided for in Subchapter I of Chapter 5, it would be anomalous for provisions of that subchapter to deal with the effects of a reorganization plan itself. To the contrary, provisions regarding the effect of Chapter 11 plans are included where they would be expected, in Chapter 11 itself—specifically in Subchapter II, “The Plan,” and Subchapter III, “Postconfirmation Matters.”

The Court also looked to Code section 1146(d) to understand the context of Code section 505(a). The Court stated:

[Additionally,] as noted above, one of the provisions in Subchapter III of Chapter 11, § 1146(d), provides explicit authority for the court to declare the tax consequences of a proposed plan, but only with respect to state and local taxation. See supra note 4. If determinations of the “amount or legality of any tax,” provided for in § 505(a), included declarations of the consequences of a proposed plan, then § 1146(d) would either be surplusage (providing an unnecessary procedure for declaring the tax consequences of plans in light of § 505(a)) or else a limitation (as to state and local taxes only) on a general declaratory power provided for in § 505(a). [FN7]
[FN 7] United seeks to avoid this conclusion by arguing that “tax consequences” under § 1146(d) describes a different set of issue than the “amount or legality of any tax” treated by § 505(a). However, questions about the “tax consequences” of a plan can easily be phrased as issues involving the amount or legality of a tax. For example, in the Debtors’ Objection to the IRS’s Motion to Dismiss (at 7), United asserts that the question of whether a plan would limit the debtor’s future use of net operating losses is a “tax consequence” that does not involve “the amount or legality of any tax.” But the future availability of NOLs would certainly affect the amount of taxes that the debtor would be required to pay after plan confirmation. And indeed, in another of its briefs, United acknowledged that under its reading, “the plain language of Section 505(a)(1) gives bankruptcy courts the authority to determine any tax issues.” Debtor’s Reply in Support of Their Motion for Determination of Tax Liability under 11 U.S.C.§ 505 at 12 (emphasis in original). Thus, under United’s reading, § 505(a) is indeed either duplicated or limited by § 1146(d).

The Court concluded the opinion with a lengthy discussion of applicable legislative history (which, the Court said, "emphatically supports the conclusion that § 505(a) does not grant bankruptcy courts power to determine the tax consequences of a Chapter 11 plan") and policy considerations (which, the Court said, "are not one-sided," but present what one commentator called a “violent clash between bankruptcy and tax policies”).

The stakes here are so great that it's hard to imagine UAL not appealing this decision. However, with Judge Wedoff batting .750 at the 7th Circuit on UAL decisions (with judgments affirmed here (order approving settlement with PBGC affirmed), here (grant of relief from aircraft lease assumption order affirmed), and here (order denying "interested party" status to pension plan fiduciary affirmed); and only one reversal here (injunction against ESOP's postpetition sales of stock vacated and remanded)), odds are that this decision gets affirmed on appeal.

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