Several judicial decisions in the past year have renewed the debate about when the transfer of property during a Chapter 11 bankruptcy is exempt from state and local taxes. Although the debate focuses on a single provision of the Bankruptcy Code, the answer may determine tax liabilities in the hundreds of thousands if not millions of dollars.

Section 1146(c) of Bankruptcy Code provides that "the issuance, transfer or exchange of a security or the making or delivery of an instrument of transfer under a plan confirmed under Section 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax." This exemption applies to any property transfer subject to a stamp tax but typically is of greatest significance when applied to transfers of valuable real estate, where the deed or mortgage stamps may add as much as five percent or more to the cost of the transaction.

For more than 10 years now, the federal courts have been in disagreement about the scope of this provision and, more specifically, the meaning of the phrase "under a plan confirmed." In In re: Beulah Church of God in Christ Jesus, Inc. 316 B.R. 41 (Bankr. S.D. N.Y. 2004), the United States Bankruptcy Court for the Southern District of New York granted the debtor’s request to exempt from taxation the sale of 23 properties despite the fact that at the time of the sale, and at the time of the court’s decision, the debtor did not have a confirmed plan of reorganization. The Bankruptcy Court concluded that "the Debtor’s bulk sale of the 23 properties was necessary and integral to the anticipated confirmation of a Chapter 11 plan." It did not matter that, in the Bankruptcy Court’s view, no confirmed plan existed at the time of transfer of the properties, so long as the debtor ultimately confirmed a plan. The Bankruptcy Court’s decision is entirely consistent with several earlier lower court decisions in the Second Circuit and would likely be endorsed by the Second Circuit Court of Appeals. Had that case been filed in the Third or Fourth Circuits, however, the result would have been just the opposite.

The Courts of Appeals for the Third and Fourth Circuits have rejected the reasoning on which the Beulah Church decision relied, holding instead that the Section 1146(c) exemption applies only to transfers that occur following the confirmation of a plan of reorganization and that are authorized by the confirmed plan. Must that authorization be expressly stated in the plan? No, according to a decision by the Court of Appeals for the Eleventh Circuit. In In re T.H. Orlando Ltd. 391 F. 3d 1287 (11th Cir. 2004), the Court of Appeals held that, so long as the transfer is necessary to the confirmation of the confirmed plan, it is deemed authorized "under" the plan. It is fairly certain that the Courts of Appeals for the Second and Fourth Circuits would agree with this conclusion: whether the Court of Appeals for the Third Circuit would concur is unclear.

In re T.H. Orlando raises a separate question under Section 1146(c) that may be of consequence in certain cases. The transfer at issue in that decision was the refinancing of a property by a party unrelated to the debtor which had to occur in order for the debtor’s plan to be confirmed. The taxing authorities opposed the proposed exemption under Section 1146(c) on the grounds that the exemption is available only for transfers to which the debtor is a party. The Eleventh Circuit disagreed, ruling that any transfer, which includes the granting of a mortgage on a property, is exempt so long as the transfer is necessary to the consummation of a confirmed plan of reorganization. While this decision may be of help to debtors in certain unique circumstances, it is important to recognize that the courts to date have refused to treat mortgage financing by the purchaser of property from a debtor in reorganization as a "transfer" necessary to the consummation of the confirmed plan and, thus, exempt from transfer taxation under Section 1146(c).

None of the other Courts of Appeals has so far ruled on the scope of Section 1146(c): it is not possible to infer reliably from the Eleventh Circuit’s decision in In re T.H. Orlando which camp it would choose to join. Two lower courts in the Seventh Circuit have issued inconsistent decisions and the decisions of lower courts in other circuits, if any, have gone unreported.

Final thoughts: Outside of the Third and Fourth Circuits, it remains open for debtors and transferees to seek the more expansive application of the 1146(c) exemption. For cases involving large transfer taxes, you have yet another venue selection issue.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.