Back to Basics Exempting Real Estate Transfers from Taxation Post-Hechinger

Back to Basics Exempting Real Estate Transfers from Taxation Post-Hechinger

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The practice of seeking bankruptcy court approval of an exemption from applicable state and local transfer tax under §1146(c) in conjunction with the pre-confirmation sale of real property was commonplace, even routine, prior to the decision of the Third Circuit Court of Appeals in Baltimore County v. Hechinger Liquidation Trust (In re Hechinger Inv. Co. of Del.), 335 F.3d 243 (3d Cir. 2003). In chapter 11 cases in which a reorganization plan had yet to be formulated or filed, bankruptcy courts frequently incorporated transfer tax exemption provisions in sale orders on a number of grounds.


One justification for the inclusion of the §1146(c) exemption in a pre-confirmation sale order was that the sale proceeds would be segregated and reserved for distribution under a plan to be filed in the future. Another, as in Hechinger, involved the approval of a conditional exemption pending future confirmation of a plan. A third relied on the notion that, absent the debtor's realization of the economic benefits of the proposed sale, it would not be in a position to formulate a plan and that the sale was accordingly integral to the plan process.2 In essence, the liberal availability of the transfer tax exemption in the pre-confirmation context was analogous to baseball's "neighborhood play," in which some logical proximity of the sale to a plan was deemed sufficient to support the exemption.

Hechinger Holding

At least in the Third Circuit, Hechinger changed all that. A majority of the appeals court held that §1146(c) of the Bankruptcy Code does not apply to pre-confirmation real estate sales under any circumstances.3 Section 1146(c) provides as follows:

The issuance, transfer or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under §1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax. (emphasis added)

The majority's holding was premised on what it characterized as the "natural" reading of the "under a plan confirmed" language to mean "made pursuant to a confirmed plan." 335 F.3d at 254. Secondarily, the majority relied on Supreme Court authority holding that statutory provisions relating to the exemption or deferral of taxes are to be construed narrowly, citing United States v. Centennial Savings Bank FSB, 499 U.S. 573 (1991); United States v. Wells Fargo Bank, 485 U.S. 351 (1988); and United States Trust Co. v. Helvering, 307 U.S. 57 (1939).

As one who practices in a high transfer tax jurisdiction (in which real estate transfers are taxed at a combined state and county rate of 4 percent of the purchase price) and in which Hechinger is conclusive on the issue of the availability of the exemption in the context of a pre-confirmation sale, it was important to rethink certain fundamental procedural issues regarding the approval and consummation of the sale of real estate assets in chapter 11 cases. With Hechinger as background and with the filing of a single-asset real estate chapter 11 case imminent, the ability to achieve the transfer tax exemption became critical in order for the case to make economic sense.

[T]he bargain-hunting real estate marketplace loves two things above all else: bankruptcies and auctions.

Facts of the Case

The debtor was a limited partnership that owned vacant commercial real estate in central Philadelphia. As with most entities of its kind, the debtor was indebted to its real estate lender in an amount approximating the market value of its property. The debtor had only a handful of unsecured creditors, consisting of accrued priority real property taxes and relatively minor general unsecured claims for utility charges. Pre-petition, the debtor had engaged in promising negotiations with a prospective purchaser to acquire the property for the sum of $3.425 million, subject to higher and better offers in the context of an auction to be conducted in the debtor's subsequent chapter 11 case. Based on the initial offer, the transfer tax payable in either a non-bankruptcy sale transaction or in a pre-confirmation sale would amount to $137,000, a sum that, if payable, would have rendered impossible payment in full of the lender's secured claim, as well as payments on account of the priority tax, administrative and trade claims against the debtor. Stated otherwise, in order for the transaction to make economic sense for any party other than the lender, the state and local taxing authorities had to subsidize, through the application of the §1146(c) exemption, the other creditors of the estate.

The first step in orchestrating a sale "under a plan confirmed" was entering into an agreement with the prospective buyer in which the parties acknowledged that the transaction was conditioned on the entry of a confirmation order and the applicability of the §1146(c) exemption. Another critical contractual provision involved the buyer's acknowledgement that the transaction would be subject to higher and better offers in the context of an auction that would take place if a qualified overbid was submitted in accordance with bidding procedures to be approved by the bankruptcy court.

The optimal procedural mechanism for accomplishing the debtor's objective was thus to enter into the agreement of sale and to file a liquidating plan and disclosure statement, together with a motion that sought the dual relief of approving the disclosure statement and the debtor's proposed bidding and sale procedures contemporaneously. In tandem with the motion to approve the disclosure statement and the bidding procedures, the debtor also issued a notice to potential overbidders and auction participants advising those parties of the auction and the opportunity to submit a qualified overbid. This notice also indicated that potential overbidders could obtain a copy of the debtor's liquidating plan and disclosure statement upon request and contained a conspicuous disclaimer concerning the debtor's non-solicitation of votes with respect to the plan prior to the bankruptcy court's approval of the disclosure statement. See Century Glove Inc. v. First Am. Bank of N.Y., 860 F.2d 94 (3rd Cir. 1988).

Experience teaches that, even in relation to a previously stigmatized property, the bargain-hunting real estate marketplace loves two things above all else: bankruptcies and auctions. The filing of a liquidating plan, the centerpiece of which was a stalking-horse offer and the prospect of a substantial transfer tax savings, generated the level of interest that the debtor had sought.

After the bankruptcy court approved the disclosure statement and the proposed bidding procedures, the debtor issued a second notice advising prospective bidders of the deadline established by the court for the submission of competing offers. As requested by the debtor, the order approving the disclosure statement also established a date for the auction seven days prior to the confirmation hearing in the event that one or more qualified overbids was received by the specified deadline.

This procedure enabled the debtor to solicit competing bids and to enhance the purchase price payable under the stalking-horse agreement through the auction process. It also permitted the debtor to confirm both the sale and the plan shortly after the auction. A total of 80 days had elapsed between the debtor's execution of the stalking-horse agreement of sale and the confirmation hearing, about the same amount of time as the debtor would have required to obtain separate orders approving proposed sale procedures and a sale of the real estate itself under §363 of the Bankruptcy Code.

Because the debtor had sought approval of the real estate transaction exclusively pursuant to the proposed plan, the state and local taxing authorities did not challenge the propriety of the transfer tax exemption. This fact resulted in the availability of $137,000 for distribution to creditors and equity security-holders under the plan that otherwise would have been allocated to transfer tax obligations. These dollars were critical in facilitating the full payment of allowed creditor claims under the plan.

Against this result was the potential argument, not adopted by the respective state and local taxing authorities, that the principal purpose of the debtor's plan was the avoidance of taxes in violation of §1129(d) of the Bankruptcy Code.4

Despite the statutory allocation of the burden of proof to the taxing authorities, the debtor was relieved that no confirmation objection predicated on §1129(d) was filed, since it would have candidly admitted that an important, if not principal, economic justification of the plan in relation to a §363 sale approach was indeed the avoidance of transfer taxes.5 While I have found no case construing §1129(d) as prohibiting confirmation of a plan incorporating a §1146(c) exemption, I was not anxious to test the interplay of those two Bankruptcy Code provisions in the context of a single-asset real estate case.

Until §1129(d) is determined to have primacy in relation to §1146(c), however, the practice of orchestrating a conveyance of real property under a plan in order to fund creditor distributions with tax savings is a sound one.


1 The author was counsel to the debtor in In re Feld Chestnut L.P., Bankruptcy No. 04-11658(KJC), filed in the Eastern District of Pennsylvania on Feb. 3, 2004. Return to article

2 See, e.g., In re Smoss Enterprises Corp., 54 B.R. 950, 951 (E.D.N.Y. 1985) (holding that the transfer of realty was "under" the plan because it "was essential to the confirmation of the plan" and applying the rule of In re Jacoby-Bender, 758 F.2d 840 (2d Cir. 1985), to a pre-confirmation sale). Return to article

3 The only other appeals court to have addressed the issue, NVR Homes Inc. v. Clerks of the Circuit Courts (In re NVR L.P.), 189 F.3d 442 (4th Cir. 1999), cert. denied, 528 U.S. 1117 (2000), is in accord. Return to article

4 Section 1129(d) states: "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 §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." Return to article

5 See In re Rath Packing Co., 55 B.R. 528 (Bankr. N.D. Iowa 1985) (holding that §1129(d) should be strictly construed to impose on the governmental unit an obligation to prove that the most important purpose of the plan is tax avoidance). Return to article

Journal Date: 
Thursday, July 1, 2004