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Tax Refund Rules in Corporate Bankruptcies are Changing

A new U.S. Supreme Court case, Rodriguez, S. Ct. No. 18–1269, 2/25/20, finally signals an end to the so-called “Bob Richards rule” for tax refund distribution after a bankruptcy.

Feb 27th 2020
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In the new case decided by the Supreme Court, a financial institution concentrating on banking matters was forced into bankruptcy soon after it sustained substantial financial losses. Eventually, a $4 million tax refund was awarded to the financial institution’s receiver, the Federal Deposit Insurance Company (FDIC). A consolidated tax return was filed for the subsidiaries.

There was never a disagreement that a refund was owed to the subsidiary under a pre-existing agreement. But it wasn’t clear what should happen after the parent company declared bankruptcy while it was still holding the refund.

Both the subsidiary and the parent company laid claim to it. At this point, the court could have applied the Bob Richards rule and called it a day. But not anymore! The new Supreme Court ruling, in an opinion authored by Justice Neil Gorsuch, invalidates the rule and vacates the decision from the Tenth Circuit Court of Appeals.

“The cases in which federal courts may engage in common lawmaking are few and far between,” said Gorsuch. “This is one of the cases that lie between.” Furthermore, the opinion stated that “the Bob Richards rule is not a legitimate exercise of federal common lawmaking.”

The unofficial rule, which had existed for decades without being formally written into any specific law or statute, has been used to determine the outcome when parent companies and subsidiaries fight over refunds in bankruptcy proceedings.

But now the top court in the land has ruled that state law must be applied in bankruptcy cases where corporate property is distributed, thereby invalidating the long-standing common law principle. Critics of the rule have hailed its demise.

At least the origins of the Bob Richards rule are clear. It goes back to a 1973 Ninth Circuit Court of Appeals case Bob Richards Chrysler-Plymouth Corp., 473 F.2d 262, 2/12/733, which involved the bankruptcy of a car dealership.

In essence, the rule stated that when a parent corporation receives a refund on behalf of its subsidiaries, the presumption is that, absent any tax allocation agreement, the money belongs to “the group member responsible for the losses that led to it.”

Now it’s up to the lower court to decide the case based on the merits of state law.

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