PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
_____________
Nos. 12-3200/3201
_____________
In Re: The Majestic Star Casino, LLC, et al,
Debtors
The Majestic Star Casino, LLC, et al.
v.
Barden Development, Inc;
United States of America on behalf
of the Internal Revenue Service; State of Indiana
Department of Revenue; John M. Chase, Jr., as
Personal Representative of Don H. Barden
United States of America on behalf
of the Internal Revenue Service,
Appellant No. 12-3200
Barden Development, Inc and
John M. Chase, Jr., as Personal
Representative of Don H. Barden,
Appellants No. 12-3201
_______________
On Appeal from the United States Bankruptcy Court
for the District of Delaware
(B.C. No. 10-56238)
Bankruptcy Judge: Hon. Kevin Gross
_______________
Argued
February 19, 2013
Before: AMBRO, JORDAN, and VANASKIE, Circuit
Judges.
(Filed: May 21, 2013)
_______________
Kathryn Keneally
Thomas J. Clark
Ivan C. Dale [ARGUED]
Tax Division
Department of Justice
P.O. Box 502
Washington, DC 20044
Melissa L. Dickey
United States Department of Justice
Tax Division
P.O. Box 227
Ben Franklin Station
Washington, DC 20044
2
Charles M. Oberly
United States Attorney
1007 N. Orange Street
Wilmington, DE 19801
Counsel for Appellants
The United States of America
Steven D. Carpenter
100 North Senate Avenue
Indianapolis, IN 46204
Counsel for Appellant
Indiana Department of Revenue
Mary F. Caloway
Buchanan Ingersoll & Rooney
1105 N. market St. - #1900
Wilmington, DE 19801
Gerald M. Gordon [ARGUED]
Erika Pike Turner
Gordon Silver
3960 Howard Hughes Pkwy – 9th Fl.
Las Vegas, NV 89169
Anthony Ilardi, Jr.
Katherine Murphy
William Lentine
Dykema Gossett, PLLC
39577Woodward Avenue - #300
Bloomfield Hills, MI 48304
Counsel for Barden Appellants
3
Lauren O. Casazza [ARGUED]
Warren Haskel
Kirkland & Ellis
601 Lexington Avenue
New York, NY 10022
Kathleen P. Makowski
James E. O‟Neill, III
Pachulski Stang Ziehl & Jones
919 N. Market Street – 17th Fl.
Wilmington, DE 19801
Counsel for Appellees
_______________
OPINION OF THE COURT
_______________
JORDAN, Circuit Judge.
This case arises from a corporate reorganization under
Chapter 11 of the Bankruptcy Code, 11 U.S.C. § 101 et seq.
(the “Code”), and puts at issue whether a non-debtor
company‟s decision to abandon its classification as an “S”
corporation for federal tax purposes, thus forfeiting the pass-
through tax benefits that it and its debtor subsidiary had
enjoyed, is void as a postpetition transfer of “property of the
bankruptcy estate,” or is avoidable, under §§ 362, 549, and
550 of the Code. This appears to be a question of first
impression in the federal Courts of Appeals.
4
Barden Development, Inc. (“BDI”), John M. Chase, as
the personal representative of the estate of Don H. Barden1
(together with BDI, the “Barden Appellants”), and the
Internal Revenue Service (the “IRS”) appeal an order of the
United States Bankruptcy Court for the District of Delaware
granting summary judgment to The Majestic Star Casino,
LLC and certain of its subsidiaries and affiliates (collectively
“Majestic” or the “Debtors”) on their motion to avoid BDI‟s
termination of its status as an “S” corporation (or “S-corp”),
an entity type that is not subject to federal taxation. In
November 2009, the Debtors, which had been controlled by
Barden, filed petitions for relief under Chapter 11 of the
Code. After the bankruptcy filing, Barden, as sole
shareholder of BDI, successfully petitioned the IRS to revoke
BDI‟s S-corp status. Under the Internal Revenue Code
(“I.R.C.”), that revocation also caused Majestic Star Casino
II, Inc. (“MSC II”), an indirect and wholly-owned BDI
subsidiary and one of the Debtors, to lose its status as a
qualified subchapter S subsidiary (or “QSub”), which meant
that it, like BDI, became subject to federal taxation.
The Debtors were by then effectively controlled by
their creditors and, naturally, did not agree with shouldering a
new tax burden. They filed an adversary complaint asserting
that the revocation of BDI‟s S-corp status caused an unlawful
postpetition transfer of property of the MSC II bankruptcy
estate. The Bankruptcy Court agreed and ordered the Barden
Appellants and the IRS to reinstate both BDI‟s status as an S-
1
Don H. Barden died on May 19, 2011. His personal
representative was substituted for him in this action in July
2011. For simplicity, Don H. Barden and Mr. Chase are
referred to in this opinion as “Barden.”
5
corp and MSC II‟s status as a QSub. The case was certified
to us for direct appeal. For the reasons that follow, we will
vacate the Bankruptcy Court‟s January 24, 2012 order and
remand this matter to the Court with directions to dismiss the
complaint.
I. BACKGROUND
A. Facts
1. The Parties
Defendant-Appellant BDI is an Indiana corporation
with its headquarters in Detroit, Michigan. Defendant-
Appellant Barden was, at all pertinent times, the sole
shareholder, chief executive officer, and president of BDI. At
the time of the complaint, BDI qualified as a “small business
corporation” under I.R.C. § 1361(b), and, presumably at
Barden‟s direction, had elected under I.R.C. § 1362(a) to be
treated as an S-corp for purposes of federal income taxation.
As an S-corp, BDI was not subject to federal taxation, see
I.R.C. § 1363(a),2 or state taxation.3 Rather, its income and
2
The Internal Revenue Code presumes that a business
entity incorporated under any federal or state statute is taxable
as a “C” corporation, the letter designation having reference
to the subchapter of the I.R.C. which governs the tax
treatment of various corporate transactions and interests. See,
e.g., I.R.C. §§ 331-346 (covering corporate liquidations); id.
§§ 351-368 (corporate organizations and reorganizations); id.
§ 385 (treatment of corporate interests as stock or
indebtedness); Treas. Reg. § 301.7701-2(a), (b) (defining a
business entity that is “recognized for federal tax purposes”).
6
losses were passed through to its shareholder, Barden, who
was required to report BDI‟s income on his individual tax
returns. See I.R.C. §§ 1363(b), 1366(a).4
Subchapter S of the I.R.C. creates an exception for a business
entity that qualifies as a “small business corporation” and
whose shareholder or shareholders elect S-corp status for that
entity. See I.R.C. § 1361(a) (providing that any corporation is
a taxable C-corporation unless it qualifies for, and elects, S-
corp status); id. § 1362(a) (providing for the “S” election).
To qualify as a small business corporation, the business entity
must be a domestic corporation that does not have more than
100 shareholders, has only individual persons as shareholders,
does not have a nonresident alien as a shareholder, and has
only a single class of stock. Id. § 1361(b). As discussed in
more detail infra, an S-corp is a “disregarded entity” for
federal tax purposes and is not taxed on its income. Id.
§ 1363(a); see also Treas. Reg. § 301.7701-3(c)(v)(C)
(providing that an entity that elects S-corp status is treated as
an “association” rather than as a corporation for tax purposes
so that only its shareholders are taxed on the entity‟s income).
3
Indiana follows the federal entity classification rules
for state tax purposes, so that an entity classified as an S-corp
for federal tax purposes is automatically classified as such for
Indiana state tax purposes. Ind. Code Ann. § 6-3-2-2.8(2).
BDI was therefore treated as a disregarded entity by Indiana
tax authorities as well.
4
An S-corp is sometimes referred to as a “pass-
though” or “flow-through” entity because the entity itself
pays no tax but its income, deductions, losses, and credits
flow-through to its shareholders, who must report those
amounts in their personal income tax returns. United States v.
7
Plaintiff-Appellee MSC II is a Delaware corporation
that owns and operates the Majestic Star II Casino and the
Majestic Star Hotel in Gary, Indiana. MSC II generates
income from those operations. BDI acquired MSC II in 2005
and was, at all times relevant to this dispute, the ultimate
owner of 100 percent of its stock.5 Prior to the Debtors‟
bankruptcy petition, BDI elected to treat MSC II as a QSub
for federal tax purposes, pursuant to I.R.C. § 1361(b)(3)(B).6
Tomko, 562 F.3d 558, 576 n.14 (3d Cir. 2009) (en banc).
5
MSC II was a wholly-owned subsidiary of The
Majestic Star Casino, LLC, which in turn was wholly-owned
by Majestic Holdco, LLC. BDI owned 100 percent of the
stock of Majestic Holdco, LLC. Due to the 100 percent
tiered ownership of Majestic Holdco, LLC and The Majestic
Star Casino, LLC, those intermediate subsidiaries are treated
as “disregarded entities” for federal income tax purposes, see
Treas. Reg. § 307.7701-3(b)(ii), and BDI is treated as the
owner of MSC II.
6
The 1996 amendments to the I.R.C. enacted as part of
the Small Business Job Protection Act of 1996, Pub. L. No.
104-188, 110 Stat. 1755, introduced QSubs as a new tax
entity. An S-corp may elect QSub status for its subsidiary if
(1) the S-corp parent holds 100 percent of the subsidiary‟s
stock, (2) the subsidiary is otherwise eligible to qualify as an
S-corp on its own, but for the fact that it has a corporate
shareholder, and (3) the S-corp parent makes the appropriate
election on IRS Form 8869. See generally The S Corporation
Handbook § 2:6 (Peter M. Fass & Barbara S. Gerrard, eds.
2012). Treasury regulations provide that a QSub is generally
not treated as a corporation separate from its S-corp parent.
8
That meant that MSC II was not treated as a separate tax
entity from BDI, but rather that all of its assets, liabilities, and
income were treated for federal tax purposes as the assets,
liabilities, and income of BDI. See id. § 1361(b)(3)(A). As a
result, MSC II paid no federal taxes and all of its income and
losses flowed through to Barden (through BDI), and he was
required to report them on his individual tax returns. See
Treas. Reg. § 1.1366-1(a). BDI was able to elect to treat
MSC II as a QSub because the latter met the statutory
requirement that it was wholly owned by an S-corp,
ultimately BDI. See I.R.C. § 1361(b)(3)(B); supra notes 5
and 6.
2. The Majestic Bankruptcy and the
Revocation of MSC II’s QSub Status
On November 23, 2009 (the “Petition Date”), MSC II
and the other Debtors filed voluntary petitions for bankruptcy
relief under the Code, and the Bankruptcy Court subsequently
ordered that their Chapter 11 cases be jointly administered.
The Debtors became debtors-in-possession of their respective
Treas. Reg. § 1.1361-4(a)(1). If an S-corp makes a valid
QSub election with respect to an existing subsidiary, as in this
case, the subsidiary is deemed to have liquidated into the
parent under I.R.C. §§ 332 and 337. Treas. Reg. § 1.1361-
4(a)(2). If a subsidiary ceases to qualify as a QSub – for
example, because its corporate parent is no longer an S-corp –
the subsidiary is treated as a new corporation acquiring all of
its assets (and assuming all of its liabilities) from the parent
S-corp immediately before termination, in exchange for stock
of the new subsidiary corporation, under I.R.C. § 351. I.R.C.
§ 1361(b)(3)(C); Treas. Reg. § 1.1361-5(b).
9
bankruptcy estates, and thus had, with limited exceptions not
relevant here, all of the powers and duties of a bankruptcy
trustee in a Chapter 11 case. At the Petition Date, both BDI
and MSC II retained their status as, respectively, an S-corp
and a QSub. Barden and BDI did not file bankruptcy
petitions, nor did they participate as debtors in any of the
petitions at issue in this case.
In addition to certain events that automatically revoke
an entity‟s election to be treated as an S-corp,7 that tax status
may also be revoked if more than half of the corporation‟s
shareholders consent to the revocation. I.R.C.
§ 1362(d)(1)(B). If S-corp status is revoked, the entity cannot
elect such status again within five years of the revocation
without the consent of the Secretary of the Treasury. Id.
§ 1362(g).8
Sometime after the Petition Date, Barden, BDI‟s sole
shareholder, caused and consented to the revocation of BDI‟s
7
Those events include the purchase of the company‟s
stock by more than 100 shareholders, by a shareholder who is
not a natural person, or by a shareholder who is a nonresident
alien, I.R.C. § 1361(b)(1)(A)-(C), or the company‟s issuance
of more than one class of stock, id. § 1361(b)(1)(D). Any of
those events cause the S-corp to lose its required status as a
“small business corporation.”
8
Like an S-corp that elects to revoke or otherwise
loses its S-corp status, see I.R.C. § 1362(g), a QSub that loses
its QSub status is not eligible for that status again for five
years, without the consent of the Secreatary or the IRS, id.
§ 1361(b)(3)(D); Treas. Reg. § 1.1361-5(c)(1).
10
status as an S-corp, and BDI filed a notice with the IRS to
that effect. The revocation was retroactively effective to
January 1, 2010, the first day of BDI‟s taxable year.9 As a
result, MSC II‟s QSub status was automatically terminated as
of the end of the prior tax year (the “Revocation”), because it
no longer met the requirement that it be wholly owned by an
S-corp. Thus, both BDI and MSC II became C-corporations
as of January 1, 2010. As a consequence of becoming a C-
corporation, MSC II became responsible for filing its own tax
returns and paying income taxes on its holdings and
operations.
Neither BDI nor Barden sought or obtained
authorization from the Debtors or from the Bankruptcy Court
for the Revocation. The Debtors did not learn of the
Revocation until July 19, 2010, which is believed to be at
least four months after Barden and BDI filed the S-corp
revocation with the IRS. See supra note 9. The Debtors
allege that, because MSC II was not informed of the
Revocation, it was unaware that it had a new obligation to
report and pay income taxes. They also allege that, due to the
change in MSC II‟s tax status, MSC II had to pay
approximately $2.26 million in estimated income tax to the
Indiana Department of Revenue for 2010 that it otherwise
9
It is not clear from the record at what point during the
pendency of the Majestic bankruptcy proceedings BDI
revoked its S-corp status. However, it presumably did so
before March 15, 2010, because the revocation was effective
on the first day of 2010 and would otherwise have been
effective on the first day of 2011. See I.R.C. § 1362(d)(1)(C)
(setting forth the effective dates for revocation of S-corp
status).
11
would not have had to pay. However, as of April 2011 (the
first date federal taxes would have been due following the
Revocation), the Debtors had paid no federal income taxes as
a result of the Revocation.
3. Confirmation of the Majestic Plan and
Its Effect on MSC II
On December 10, 2010, prior to the Debtors‟ filing of
the adversary complaint that initiated this action, the
Bankruptcy Court issued an order permitting the Debtors to
convert MSC II from a Delaware corporation to a Delaware
limited liability company (“LLC”). On March 10, 2011, the
Court entered an order confirming the Debtors‟ Second
Amended Plan of Reorganization (the “Plan”). Pursuant to
the Plan, as of December 1, 2011 (the “Effective Date”), new
membership interests representing all of the equity interests in
MSC II were to be issued to holders of certain senior secured
debt. On November 28, 2011, just prior to the Effective Date,
the Debtors went ahead and caused MSC II to convert to an
LLC. That conversion meant that MSC II would no longer
have qualified for QSub status, even if the Revocation had not
already occurred. See I.R.C. § 1361(b)(3)(B) (requiring that a
QSub be a “domestic corporation”).10 Also, as part of the
10
An LLC may opt to elect to be taxed as a
partnership, see Treas. Reg. § 301.7701-3(c), so the
conversion of MSC II to an LLC effectively reinstated its
status as a “flow-through” entity. But the conversion of MSC
II, at that time a C-corporation as a result of the Revocation,
into an LLC may itself have been a taxable event to the
extent the conversion could have been treated as a corporate
liquidation. See I.R.C. § 336. The Debtors were aware of the
12
Plan of Reorganization, MSC II ceased to be wholly owned
by an S-corp, so that, even absent the LLC conversion, and
independent of the Revocation, MSC II would no longer have
qualified as a QSub. The Debtors‟ Plan of Reorganization
was substantially consummated on December 1, 2011, and
MSC II emerged from bankruptcy together with the other
Debtors on that date.
B. Procedural History
On December 31, 2010, the Debtors filed an adversary
complaint in the Bankruptcy Court, asserting that the
Revocation caused an unlawful postpetition transfer of MSC
II‟s estate property, in violation of §§ 362 and 549 of the
Bankruptcy Code. The complaint sought recovery of that
“property” under Code § 550, through an order “directing the
IRS and [the] Indiana [Department of Revenue] to restore
BDI‟s status as an S corporation and MSC II‟s status as a
QSub retroactively effective January 1, 2010.” (App. at 50.).
The IRS moved to dismiss the Debtors‟ adversary
complaint on February 14, 2011, contending that the
Bankruptcy Court lacked jurisdiction and that the Debtors
failed to state a claim under Federal Rules of Civil Procedure
12(b)(1) and 12(b)(6) (incorporated by Federal Rule of
Bankruptcy Procedure 7012(b)). More particularly, the IRS
argued that the Bankruptcy Court lacked jurisdiction under
Code § 505(a)(1) because the Debtors had not alleged that
MSC II had actually paid any federal corporate income taxes
or filed any federal income tax returns prior to initiating their
possible taxable nature of the conversion to an LLC when it
occurred.
13
adversary proceeding, so that their claims were not ripe. The
IRS also argued that the Debtors had failed to state a claim
because MSC II‟s status as a QSub was not “property” of the
MSC II estate because MSC II “never had a right to claim,
continue, or revoke” that status “either before or after it filed
its bankruptcy petition” (App. at 81), and that no “transfer” of
estate property occurred when BDI terminated its S-corp
election and triggered the loss of MSC II‟s QSub status,
(App. at 83-84).
Barden and BDI answered the Debtors‟ adversary
complaint on February 28, 2011, and moved for judgment on
the pleadings under Federal Rule of Civil Procedure 12(c).
They contended that because a QSub has no separate tax
existence, MSC II had no cognizable property interest in that
status. They also argued that, because a subsidiary‟s QSub
status depends entirely on elections made by its S-corp
parent, even if MSC II‟s QSub status were a species of
property, it was property that belonged to BDI and Barden.
The Debtors moved for summary judgment on
March 16, 2011, and, on January 24, 2012, the Bankruptcy
Court granted their motion and denied both the IRS‟s motion
to dismiss and the Barden Appellants‟ motion for judgment
on the pleadings. The Court held that MSC II‟s status as a
QSub was the property of MSC II, and that, as such, it
belonged to MSC II‟s bankruptcy estate. The Court therefore
concluded that the revocation by non-debtor BDI of its status
as an S-corp, and the resulting termination of MSC II‟s status
as a QSub, were void and of no effect. Finally, the Court
ordered the defendants, including the IRS, to take all actions
necessary to restore the status of MSC II as a QSub of BDI.
14
That order, of course, has significant practical
implications for the parties. As with many bankruptcy
reorganizations, the Debtors‟ emergence from bankruptcy
resulted in the cancellation of a substantial amount of
indebtedness, which, in turn, generated “cancellation of debt”
(“COD”) income equal to the amount by which the debt was
reduced in bankruptcy. At oral argument before us, the IRS
said that the amount of that COD income was $170 million.
COD income is generally subject to federal taxation. See
I.R.C. § 61(a)(12) (including in the definition of “gross
income” “income from the discharge of indebtedness”). If
BDI is restored to S-corp status, then it, and ultimately
Barden, is the taxpayer and would be liable for the taxes on
the COD income. See Prop. Treas. Reg. § 1.108-9, 76 Fed.
Reg. 20593-01 (Apr. 13, 2011) (providing that, when the
debtor is a disregarded entity, such as an S-corp, then the
owner of that entity is the taxpayer). Normally, under the so-
called “Bankruptcy Exception,” a taxpayer in bankruptcy
does not recognize COD income on debt that is cancelled or
written down as part of a plan of reorganization. I.R.C.
§ 108(a)(1)(A). However, in this case, neither Barden nor
BDI was part of the Majestic bankruptcy, so they may not
qualify for the Bankruptcy Exception and could be liable for
the tax on the COD income. See Prop. Treas. Reg. § 1.108-9
(limiting the Bankruptcy Exception to entities under the
jurisdiction of the Bankruptcy Court). Also, the Bankruptcy
Court‟s order caused the IRS to lose the benefit of MSC II‟s
tax liabilities being treated as an administrative expense of the
bankruptcy estate, which would have allowed the government
to be paid before most other creditors. See 11 U.S.C.
§ 503(b)(1)(B).
15
By contrast, the Debtors – or, more precisely, their
former creditors who replaced BDI as the holders of MSC II‟s
equity – benefit in at least two dramatic ways if the
Revocation is deemed to have been void or is otherwise
avoided. First, if MSC II remains a QSub even after having
emerged from bankruptcy, then it (and its new equity holders)
will continue to enjoy its tax-free status, while BDI retains
liability for MSC II‟s income taxes, even though BDI no
longer has access to MSC II‟s income and cash flow to fund
the tax payments. Second, by shifting the tax liability for
COD income to BDI, MSC II need not make use of the
Bankruptcy Exception, which would ordinarily come with a
substantial cost. Under the I.R.C., a debtor that makes use of
the Bankruptcy Exception must reduce the value of other tax
attributes dollar-for-dollar by the amount of COD income
excluded from gross income. See I.R.C. § 108(b)(1). That
means that the reorganized debtor loses the value of various
deductions and credits that would have been available to
reduce taxes in the future. See id. § 108(b)(2). As a
consequence of the Bankruptcy Court‟s order, however, the
Debtors avoid liability for COD income without the adverse
impact on their tax attributes.
The Bankruptcy Court granted the IRS and the Barden
Appellants leave to appeal on March 7, 2012, even though the
Court‟s judgment and order had left open the calculation of
the damages for which Barden and BDI were liable as a result
of the Court‟s conclusion that they had violated the automatic
stay. The United States District Court for the District of
Delaware certified the appeals to us on May 23, 2012, and we
authorized the appeals on July 9, 2012.
II. JURISDICTION AND STANDARDS OF REVIEW
16
The Bankruptcy Court had jurisdiction over the
adversary proceeding pursuant to 28 U.S.C. §§ 157(b)(2),
1334(a)-(b). We have jurisdiction over this direct appeal
under 28 U.S.C. § 158(d)(2)(A). We reject the Barden
Appellants‟ argument, raised for the first time in this appeal,
that the Bankruptcy Court, as an Article I court, lacked
jurisdiction to order the IRS to reinstate BDI‟s status as an S-
corp and MSC II‟s status as a QSub. Leaving aside that
arguments not raised below are normally waived on appeal,
see In re American Biomaterials Corp., 954 F.2d 919, 927
(3d Cir. 1992), that argument is without merit. The
Bankruptcy Code gives bankruptcy courts the power to
“„issue any order, process, or judgment that is necessary or
appropriate to carry out [its] provisions.‟” Official Comm. of
Unsecured Creditors of Cybergenics Corp. ex rel.
Cybergenics Corp. v. Chinery, 330 F.3d 548, 567 (3d Cir.
2003) (quoting 11 U.S.C. § 105(a)). The IRS is subject to
that power as an “entity” referred to in specific provisions of
the Code, because that term expressly includes a
“governmental unit.” 11 U.S.C. § 101(15). The Court‟s
ability to exercise jurisdiction over the IRS has been affirmed
in a number of contexts. See United States v. Energy Res.
Co., 495 U.S. 545, 549 (1990) (holding that “a bankruptcy
court has the authority to order the IRS to apply the payments
[made by a debtor] to trust fund liabilities if the bankruptcy
court determines that this designation is necessary to the
success of a reorganization plan”); United States v. Whiting
Pools, Inc., 462 U.S. 198, 209 (1983) (concluding that the
Code authorizes a bankruptcy court to recover property seized
to satisfy a lien prior to the filing of a petition for
reorganization, and noting that “[w]e see no reason why a
different result should obtain when the IRS is the creditor”).
17
Transactions to which the IRS is a party are also subject to
the general rule that they are void if they violate the automatic
stay. See United States v. Galletti, 541 U.S. 114, 124 n.5
(2004) (noting that the automatic stay barred the IRS from
bringing suit against a debtor in bankruptcy); In re Schwartz,
954 F.2d 569, 571 (9th Cir. 1992) (holding that an IRS tax
assessment that violated the automatic stay was void).
Although we reject the Barden Appellants‟ argument
that the Bankruptcy Court lacked jurisdiction, we note that
this case raises a jurisdictional question of standing that the
parties did not raise and the Bankruptcy Court did not
consider. We address that question in Parts III.A and III.B,
infra, in the context of the merits.
When reviewing a bankruptcy court‟s grant of
summary judgment, “we review the ... findings of fact for
clear error and exercise plenary review over the ... legal
determinations.” In re Kiwi Int’l Air Lines, Inc., 344 F.3d
311, 316 (3d Cir. 2003) (citing In re Woskob, 305 F.3d 177,
181 (3d Cir. 2002); In re Cont’l Airlines, 125 F.3d 120, 128
(3d Cir. 1992)). A grant of summary judgment is “proper
only if it appears that there is no genuine issue as to any
material fact and that [each of] the moving part[ies] is entitled
to a judgment as a matter of law.” Id. (alterations in original)
(quoting Fed. R. Civ. P. 56(c)) (internal quotation marks
omitted). In evaluating the evidence, we “view inferences to
be drawn from the underlying facts in the light most favorable
to the party opposing the motion.” Bartnicki v. Vopper, 200
F.3d 109, 114 (3d Cir. 1999).
We exercise plenary review over rulings on motions to
dismiss, In re Avandia Mktg., Sales Practices & Prods. Liab.
18
Litig., 685 F.3d 353, 357 (3d Cir. 2012), and over rulings on
motions for judgments on the pleadings, Rosenau v. Unifund
Corp., 539 F.3d 218, 221 (3d Cir. 2008).
III. DISCUSSION
This appeal requires us to answer two related
questions. As a threshold matter of justiciability, we must
decide whether the Debtors have standing to challenge the
revocation of MSC II‟s QSub status. That, however, requires
us to address the merits of whether the MSC II bankruptcy
estate had a property interest in MSC II‟s QSub status such
that the Debtors had the right to challenge what they
characterize as the postpetition transfer of that interest.
A. Standing
Front and center in this case is the question of whether
a debtor subsidiary‟s entity tax status is “property” at all, and,
if so, whether it is property belonging to that subsidiary or to
its non-debtor corporate parent. That implicates standing,
even though the issue was not addressed before this appeal.
Inasmuch as the “[s]tanding doctrine embraces ... judicially
self-imposed limits on the exercise of federal jurisdiction,”
Allen v. Wright, 468 U.S. 737, 751 (1984), we turn to it first.
The doctrine of standing “focuses on the party seeking
to get his complaint before a federal court and not on the
issues he wishes to have adjudicated.” Valley Forge
Christian Coll. v. Ams. United for Separation of Church &
State, Inc., 454 U.S. 464, 484 (1982) (quoting Flast v. Cohen,
392 U.S. 83, 99 (1968)) (internal quotation marks omitted). It
“involves both constitutional limitations on federal-court
19
jurisdiction and prudential limitations on its exercise.” Warth
v. Seldin, 422 U.S. 490, 498 (1975). One of those prudential
limits demands that “the plaintiff generally ... assert his own
legal rights and interests, and []not rest his claim to relief on
the legal rights or interests of third parties.” Id. at 499.
The Debtors‟ effort to pursue claims under Code
§§ 362, 549, and 550 is dependent upon Code § 541, which
provides that a bankruptcy estate succeeds only to “legal or
equitable interests of the debtor ... as of the commencement of
the case.” 11 U.S.C. § 541(a)(1). It is a given that “[t]he
trustee [or debtor-in-possession] can assert no greater rights
than the debtor himself had on the date the [bankruptcy] case
was commenced.” Guinn v. Lines (In re Trans-Lines West,
Inc.), 203 B.R. 653, 660 (Bankr. E.D. Tenn. 1996) (quoting 4
Collier on Bankruptcy ¶ 541.06 (15th ed. 1996)) (internal
quotation marks omitted).
20
As discussed in more detail in Part III.B.1, infra, “a
corporation cannot alter its tax status through election,
revocation or rescission, without some form of shareholder
consent,” so that “the corporation, standing alone, cannot
challenge the validity of a prior Subchapter S revocation ...
without the consent of at least those shareholders who
consented to the revocation.” Trans-Lines West, 203 B.R. at
660. As a result, “[a] trustee [or debtor-in-possession] who
attempts to challenge the validity of a revocation without such
consent is asserting the rights of a third party,” i.e., the equity
holder, and “does not have standing ... .” Id.; cf. Simon v. E.
Ky. Welfare Rights Org., 426 U.S. 26, 37 (1976) (declining to
decide “whether a third party ever may challenge IRS
treatment of another”).
Following that reasoning, if we assume that a
subsidiary‟s entity tax status, e.g., its existence as a pass-
though entity, is “property” but hold that such status belongs
not to the subsidiary itself but rather to its parent, then the
right to challenge the revocation of QSub status belongs
solely to the parent corporation, and the bankruptcy estate of
a QSub does not succeed to that right under Code § 541. If
that is the case, then a debtor subsidiary that challenges a
revocation, as MSC II has done in this case, is endeavoring to
assert the rights of a third party, namely its S-corp parent,
which is contrary to general principles of standing.
The prohibition on third party standing, however, “is
not invariable and our jurisprudence recognizes third-party
standing under certain circumstances.” Pa. Psychiatric Soc’y
v. Green Spring Health Servs. Inc., 280 F.3d 278, 288 (3d
Cir. 2002). We have recognized that “the principles
21
animating ... prudential [standing] concerns are not subverted
if the third party is hindered from asserting its own rights and
shares an identity of interests with the plaintiff.” Id. (citing
Craig v. Boren, 429 U.S. 190, 193-94 (1976); Singleton v.
Wulff, 428 U.S. 106, 114-15 (1976) (plurality opinion);
Eisenstadt v. Baird, 405 U.S. 438, 443-46 (1972)). “More
specifically, third-party standing requires the satisfaction of
three preconditions: 1) the plaintiff must suffer injury; 2) the
plaintiff and the third party must have a „close relationship‟;
and 3) the third party must face some obstacles that prevent it
from pursuing its own claims.” Id. at 288-89 (citing
Campbell v. Louisiana, 523 U.S. 392, 397 (1998); Powers v.
Ohio, 499 U.S. 400, 411 (1991); Pitt. News v. Fisher, 215
F.3d 354, 362 (3d Cir. 2000)).
If the entity tax status of MSC II is “property” that
belongs to BDI, then the present case does not satisfy the
third condition for third-party standing. Nothing in the record
suggests that BDI, as the former shareholder of MSC II and
the “third party” with standing, is unable to protect its own
interests. The term “third party” is actually something of a
misnomer here because BDI, as well as its ultimate
shareholder Barden, are both defendant parties in the present
action and have vigorously fought to protect their interests.
Sticking with that nomenclature, though, it is settled that
“third parties themselves usually will be the best proponents
of their own rights,” Singleton, 428 U.S. at 114, and the fact
that BDI chose not to backtrack and challenge the Revocation
does not mean that MSC II or the Debtors have standing to do
so.
We thus find ourselves in a circumstance where what
is ordinarily the preliminary question of standing cannot be
22
answered without delving into whether the entity tax status of
MSC II is “property” and, if so, whether it belongs to MSC II.
In short, we must consider the merits.
B. QSub Status Claimed as “Property” of the MSC
II Bankruptcy Estate
Referring to MSC II‟s QSub status, the Bankruptcy
Court said that “because the debtor-corporation‟s subchapter
„S‟ status provided the debtor-corporation the ability to pass-
through capital gains tax liabilities to its principals, the right
to make or revoke its subchapter „S‟ status had value to the
debtor and constituted property or an interest of the debtor in
property.” In re Majestic Star Casino, LLC, 466 B.R. 666,
675 (Bankr. D. Del. 2012). The Barden Appellants argue that
the Bankruptcy Court erred in that conclusion because the
Court “applied a general overarching bankruptcy principle
that anything that brings value into a bankruptcy estate must
be a property right” (Barden Appellants‟ Opening Br. at 21),
despite the fact that “the Bankruptcy Code by itself ... does
not constitute a source of property rights” (id. at 18).
Likewise, the IRS asserts that simply because an S-corp
election “means that the corporation may „use‟ and „enjoy‟”
the benefits of a pass-through entity tax status, “it does not
follow that the postpetition revocation of ... [that] election is a
transfer of estate property.” (IRS Opening Br. at 27.)
In their adversary proceeding, the Debtors sought
relief under §§ 549, 550, and 362 of the Code.11 Section 549
11
Specifically, the Debtors sought “an order voiding
the Avoidable Transfer under section 549 of the Bankruptcy
Code, and[,] pursuant to section 550 of the ... Code,” orders
23
provides that a debtor-in-possession or trustee “may avoid a
transfer of property of the estate that occurs after the
commencement of the case[] and that is not authorized ... by
the court.” 11 U.S.C. § 549(a). Section 550 permits the
debtor-in-possession or trustee to “recover, for the benefit of
the estate” property whose transfer has been avoided under §
549. Id. § 550(a). Finally, § 362 provides for an “automatic
stay” such that the filing of a chapter 11 petition “operates as
a stay, applicable to all entities,” of, inter alia, “any act to
obtain possession of property of the estate or of property from
the estate or to exercise control over property of the estate.”
Id. § 362(a)(3). Section 362 also provides that “an individual
injured by any willful violation of [the] stay ... shall recover
actual damages, including costs and attorneys‟ fees, and, in
appropriate circumstances, may recover punitive damages.”
Id. § 362(k)(1).
Section 362 operates differently than §§ 549 and 550.
Those latter sections authorize the bankruptcy court to
“avoid” the violative transfer, but the debtor-in-possession or
trustee must commence an adversary proceeding. See Fed. R.
Bankr. P. 7001(1) (requiring that a “proceeding to recover
money or property” be brought as an “adversary
proceeding”); In re Doll & Doll Motor Co., 448 B.R. 107,
111 (Bankr. M.D. Ga. 2011) (denying bank‟s motion seeking
directing all of the defendants to return any transferred
property and directing the IRS and Indiana Department of
Revenue to return any tax payments made by MSC II as a
result of the Avoidable Transfer, an order invalidating the
Revocation, and an order “voiding the Avoidable Transfer
under section 362(a)(3) ... and section 362(k)(1) of the
Bankruptcy Code ... .” (App. at 51.)
24
an order to recover property sold by a Chapter 11 debtor
because the bank had not filed an adversary proceeding
against the buyer). By contrast, a transfer that violates the
automatic stay is generally considered to be void without any
action on the part of the debtor. In re Myers, 491 F.3d 120,
127 (3d Cir. 2007) (citing In re Siciliano, 13 F.3d 748, 750
(3d Cir. 1994) (“[T]he general principle [is] that any creditor
action taken in violation of an automatic stay is void ab
initio.”)).
Notwithstanding that difference, all three sections have
three elements in common for purposes of the problem before
us. For the Revocation to be void under § 362 or avoidable
under §§ 549 and 550, QSub status must be (1) “property” (2)
“of the bankruptcy estate” (3) that has been “transferred.”
Though a lack of any one of those elements is dispositive, we
choose to consider – in the alternative – only the first two.
25
1. QSub Status as “Property”
Section 541(a) of the Bankruptcy Code defines
“property of the estate” as “all legal or equitable interests of
the debtor in property as of the commencement of the case.”
11 U.S.C. § 541(a)(1). “[W]e have emphasized that Section
541(a) was intended to sweep broadly to include all kinds of
property, including tangible or intangible property, [and]
causes of action[.]” In re Kane, 628 F.3d 631, 637 (3d Cir.
2010) (second alteration in original) (quoting Westmoreland
Human Opportunities, Inc. v. Walsh, 246 F.3d 233, 241 (3d
Cir. 2001)) (internal quotation marks omitted). “[T]he term
„property‟ has been construed most generously and an interest
is not outside its reach because it is novel or contingent or
because enjoyment must be postponed.” In re Fruehauf
Trailer Corp., 444 F.3d 203, 211 (3d Cir. 2006) (quoting
Segal v. Rochelle, 382 U.S. 375, 379 (1966)) (internal
quotation marks omitted). “It is also well established that the
mere opportunity to receive an economic benefit in the future
is property with value under the Bankruptcy Code.” Id.
(internal quotation marks omitted).
However, “[f]iling for bankruptcy does not create new
property rights or value where there previously were none.”
In re Messina, 687 F.3d 74, 82 (3d Cir. 2012); cf. Butner v.
United States, 440 U.S. 48, 56 (1979) (noting that the holder
of a property interest “is afforded in federal bankruptcy court
the same protection he would have had under state law if no
bankruptcy had ensued”). Consequently, “[t]he estate is
determined at the time of the initial filing of the bankruptcy
petition ... .” Kollar v. Miller, 176 F.3d 175, 178 (3d Cir.
1999).
26
This appears to be a matter of deliberate Congressional
choice. Although the constitutional authority of Congress to
establish “uniform Laws on the subject of Bankruptcies
throughout the United States,” U.S. Const., art. I, § 8, cl. 4,
could, in theory, encompass a statutory framework defining
property interests for purposes of bankruptcy, “Congress has
generally left the determination of property rights in the assets
of a bankrupt‟s estate to state law,” Butner, 440 U.S. at 54;
see also In re Brannon, 476 F.3d 170, 176 (3d Cir. 2007)
(“[W]e generally turn to state law for the determination of
property rights in the assets of a bankrupt‟s estate.” (internal
quotation marks omitted)). However, if “some federal
interest requires a different result,” Butner, 440 U.S. at 55,
then property interests may be defined by federal law. Cf.
McKenzie v. Irving Trust Co., 323 U.S. 365, 370 (1945)
(noting that, “[i]n the absence of any controlling federal
statute,” a creditor may acquire rights to property transferred
by a debtor “only by virtue of state law”).
Given the importance of federal tax revenues, one
might assume that the Internal Revenue Code determines
whether tax status constitutes a property interest of the
taxpayer, but it does not do so explicitly and the case law is
not entirely clear. See Drye v. United States, 528 U.S. 49, 57
(1999) (considering whether “state law is the proper guide to
... „property‟ or „rights to property‟” under a provision of the
I.R.C. and noting that the Court‟s “decisions in point have not
been phrased so meticulously”). On one hand, the I.R.C.
“creates no property rights but merely attaches consequences,
federally defined, to rights created under state law.” United
States v. Bess, 357 U.S. 51, 55 (1958). Thus, “[i]n the
application of a federal revenue act, state law controls in
determining the nature of the legal interest which the taxpayer
27
had in the property.” United States v. Nat’l Bank of
Commerce, 472 U.S. 713, 722 (1985) (quoting Aquilino v.
United States, 363 U.S. 509, 513 (1960)) (internal quotation
marks omitted). On the other hand, “[o]nce it has been
determined that state law creates sufficient interests in the
[taxpayer] to satisfy the requirements of [the federal revenue
statute], state law is inoperative, and the tax consequences
thenceforth are dictated by federal law.” Id. (second
alteration in original) (quoting Bess, 357 U.S. at 56-57)
(internal quotation marks omitted). In Drye v. United States,
the Supreme Court ultimately concluded that “the [I.R.C.] and
interpretive case law place under federal, not state, control the
ultimate issue whether a taxpayer has a beneficial interest in
any property subject to levy for unpaid federal taxes.” 528
U.S. at 57. Also, the I.R.C. does address the handling of tax
attributes in the bankruptcy context, at least when “the debtor
is an individual,” see I.R.C. § 1398(a), and provides that the
“[e]state succeeds to tax attributes of [the] debtor ...
determined as of the first day of the debtor‟s taxable year in
which the case commences ... .” I.R.C. § 1398(g); see also
United States v. Sims (In re Feiler), 218 F.3d 948, 953 (9th
Cir. 2000) (“I.R.C. § 1398 determines what tax attributes of
the debtor rightfully belong to the bankruptcy estate ... .”).
The Bankruptcy Code itself defers to the I.R.C. with respect
to the creation and character of certain tax attributes of the
bankruptcy estate. See 11 U.S.C. § 346(a) (providing that the
I.R.C. governs whether the creation of a bankruptcy estate
creates a tax entity separate from the debtor). Thus, we
conclude that the I.R.C., rather than state law, governs the
characterization of entity tax status as a property interest for
purposes of the Bankruptcy Code.
28
With this background, we review the case law that the
Debtors say supports their claim that MSC II‟s QSub status
was “property.”
i. S-Corp Status as “Property”
The Bankruptcy Court reasoned that QSub status is
analogous to S-corp status and, based on a few cases holding
that the latter is “property” for purposes of the Code,
concluded that the former is “property” too. The principal
case is In re Trans-Lines West, Inc., 203 B.R. 653 (Bankr.
E.D. Tenn. 1996), which concerned whether a corporation‟s
revocation of its S-corp status prior to filing for bankruptcy
was a prepetition transfer of property avoidable by the trustee
pursuant to Code § 548.12 The bankruptcy court in that case
acknowledged that, “[i]n the absence of controlling federal
law, the question of whether a debtor possesses an interest in
property is governed by state law,” but the court reasoned
that, “[b]ecause the subject of the alleged transfer is the
Debtor‟s status as a Subchapter S corporation, a status created
under title 26 of the United States Code, ... federal law, and
more specifically the Internal Revenue Code,” determines
whether a debtor holds a property interest in its S-corp status.
203 B.R. at 661.13 The court observed that “„property‟ refers
12
Section 548 provides, in relevant part, that “the
trustee may avoid any transfer ... of an interest of the debtor
in property, or any obligation ... incurred by the debtor, that
was made or incurred on or within 2 years before the date of
the filing of the petition ... .” 11 U.S.C. § 548(a)(1).
13
Courts that have followed Trans-Lines West have
reached the same conclusion. See, e.g., Parker v. Saunders (In
re Bakersfield Westar, Inc.), 226 B.R. 227, 233 (B.A.P. 9th
29
... to the right and interest or domination rightfully obtained
over [an] object, with the unrestricted right to its use,
enjoyment, and disposition.” Id. (quoting 63A Am. Jur. 2d
Property §1 (1984)) (internal quotation marks omitted). It
then jumped to the conclusion that,
once a corporation elects to be treated as an S
corporation, I.R.C. § 1362(c) guarantees and
protects the corporation‟s right to use and enjoy
that status until it is terminated under I.R.C.
§ 1362(d). Moreover, § 1362(d)(1)(A) provides
that “[a]n election under subsection (a) may be
terminated by revocation.” I.R.C.
§ 1362(d)(1)(A) ... . Thus, I.R.C.
§ 1362(d)(1)(A) guarantees and protects an S
corporation‟s right to dispose of that status at
will.
Id. (first alteration in original).
The court also noted that I.R.C. § 1362(c) provides
that an S-corp election “shall be effective ... for all succeeding
taxable years of the corporation, until such election is
terminated,” id. at 661-62 (internal quotation marks omitted),
and it reasoned that the I.R.C. thus “affords a corporation
which has elected the Subchapter S status a guaranteed,
indefinite right to use, enjoy, and dispose of that status,” id. at
661. From that, the court concluded that “the Debtor
possessed a property interest (i.e., a guaranteed right to use,
enjoy and dispose of that interest) in its Subchapter S status ...
Cir. 1998) (“[A] debtor‟s subchapter S status is a creation of
I.R.C. § 1362, and federal law therefore determines whether a
debtor holds a „property‟ interest in its subchapter S status.”).
30
.” Id. at 662. Other courts that have considered the issue of
S-corp status as a property right have all come to the same
conclusion. See Halverson v. Funaro (In re Funaro), 263
B.R. 892, 898 (B.A.P. 8th Cir. 2001) (“[A] corporation‟s right
to use, benefit from, or revoke its Subchapter S status falls
within the broad definition of property [under the Code].”);
Parker v. Saunders (In re Bakersfield Westar, Inc.), 226 B.R.
227, 234 (B.A.P. 9th Cir. 1998) (concluding that the holding
in Trans-Lines West “is consistent with the Ninth Circuit‟s
definition of property”); Hanrahan v. Walterman (In re
Walterman Implement Inc.), Bankr. No. 05-07284, 2006 WL
1562401, at *4 (Bankr. N.D. Iowa May 22, 2006) (“[T]he
right to revoke [a] Subchapter S election is property ... as
defined in § 541[] ... [and] the revocation of Debtor‟s
subchapter S status is also voidable under § 549 as a
postpetition transfer.”).
The Trans-Lines West decision and those that follow it
base their conclusion that S-corp status is “property” on a
series of precedents holding net operating losses (“NOLs”) to
be property.14 In Segal v. Rochelle, the Supreme Court
14
Net operating losses
are created when the taxpayer‟s deductible
business expenses for a given year exceed her
net income for that year. [I.R.C.] § 172(c). Once
NOLs are sustained, the taxpayer may carry the
loss back three years and use it as a deduction in
that year. NOLs that remain are applied to the
next two years and deducted accordingly. Id.
§ 172(b)(1)(A), (b)(2). If any loss remains at
the end of the three-year carryback period, it is
carried forward and deducted from the
31
declared that the right to offset NOLs against past income (a
“loss carryback”) is property of an individual debtor, because
it entitles the debtor to a refund of taxes already paid. 382
U.S. at 380-81. The Court decided that a debtor‟s NOLs,
because they arise from prior losses, are “sufficiently rooted
in [its] pre-bankruptcy past” that, when carried back to
generate a tax refund, they “should be regarded as „property‟
under [the Code].” Id. at 380.
Subsequent cases extended the holding in Segal to the
right to use NOLs to offset future tax liability (a “loss
carryforward”). For example, in Official Committee of
Unsecured Creditors v. PSS Steamship Co. (In re Prudential
Lines, Inc.), 928 F.2d 565, 567 (2d Cir. 1991),15 a corporate
taxpayer‟s income over the next fifteen years
(or until it is exhausted), beginning with the
year after the loss was initially sustained. Id.
§ 172(b)(1)(B). Alternatively, the Tax Code
permits the taxpayer to forego the carryback
option and instead use the NOLs exclusively in
future years. Id. § 172(b)(3)(C). Such an
election, once made, is irrevocable for that tax
year. Id.
Gibson v. United States (In re Russell), 927 F.2d 413, 415
(8th Cir. 1991). An NOL “carryback” against past earnings
therefore generates a claim for a refund of taxes paid on those
earnings, while an NOL “carryforward” represents the ability
to shelter future income from taxation.
15
Although Prudential Lines and cases that followed it
extended Segal‟s holding, the Segal Court expressly reserved
judgment on whether future tax benefits, such as loss
32
subsidiary had $74 million of NOLs attributable to its past
operations when an involuntary petition for reorganization
under Chapter 11 was filed against it. Its corporate parent
attempted to take a $39 million “worthless stock” deduction,
based on the anticipated loss of its investment in the
subsidiary, which would have eliminated the value of its NOL
for future use, but creditors of the subsidiary sued the parent
“carryforwards” (or “carryovers”) would also constitute
bankruptcy estate property. The Court observed that “a
carryover into post-bankruptcy years can be distinguished
both conceptually as well as practically” from a benefit
available against past taxes because “the supposed loss-
carryover would still need to be matched in some future year
by earnings, earnings that might never eventuate at all.”
Segal, 382 U.S. at 381. Despite that dictum, the court in
Prudential Lines concluded that “[t]he fact that the right to
a[n] NOL carryforward is intangible and has not yet been
reduced to a tax refund ... does not exclude it from the
definition of property of the estate.” 928 F.2d at 572. That
conclusion relied on the Segal Court‟s reasoning that
“postponed enjoyment does not disqualify an interest as
„property,‟” and that “contingency in the abstract is no bar” to
finding that an interest is property of a bankruptcy estate. 382
U.S. at 380. But that reasoning in Segal was addressed only
to the argument that an NOL carryback was not property of
the estate at the commencement of the proceeding because
“no refund could be claimed from the Government until the
end of the year” of filing, during which “earnings by the
bankrupt ... might diminish or eliminate the loss-carryback
refund claim ... .” Id. It does not support the broad
proposition that any contingent tax attribute can necessarily
be labeled as “property.”
33
to enjoin it from doing so. The bankruptcy court held that the
NOL carryforward was property of the subsidiary‟s
bankruptcy estate and that the parent‟s planned tax deduction
would violate the automatic stay. The court thus granted the
injunction. In re Prudential Lines Inc., 114 B.R. 27, 32
(Bankr. S.D.N.Y. 1989). The United States Court of Appeals
for the Second Circuit affirmed, holding that the “right to
carryforward [the] $74 million NOL to offset future income is
property of the [subsidiary‟s] estate within the meaning of
§ 541.” 928 F.2d at 571. Accord In re Feiler, 218 F.3d at
955-56 (holding that a prepetition election to carry forward
NOLs, making them unavailable to the debtor to claim a
refund of past taxes, constituted a preference payment
avoidable under the Code); Gibson v. United States (In re
Russell), 927 F.2d 413, 417-18 (8th Cir. 1991) (same). The
Second Circuit also held that the non-debtor parent‟s
proposed worthless stock deduction was barred by the
automatic stay because, “where a non-debtor‟s action with
respect to an interest that is intertwined with that of a
bankrupt debtor would have the legal effect of diminishing or
eliminating property of the bankrupt estate, such action is
barred by the automatic stay.” Prudential Lines, 928 F.2d at
574.16
16
We have not yet addressed the question of whether
NOL carrybacks or carryforwards constitute property. The
closest we have come to deciding the question was an issue
arising under the Employee Retirement Income Security Act
of 1974 (ERISA), 29 U.S.C. § 1001 et seq., rather than the
I.R.C. In In re Fruehauf Trailer Corp., 444 F.3d 203 (3d Cir.
2006), a debtor made an irrevocable election to increase
pension benefits that denied the bankruptcy estate the ability
to recoup an accumulated surplus in plan assets. We held that
34
Trans-Lines West and the decisions that follow it
extended Prudential Lines, saying that the ability to make an
S-corp election, like the ability to elect whether to carry
forward or carry back NOLs, is property. We think that
extension untenable, though, for several reasons.17 First, in
“[t]his recoupment right is a transferable property interest”
because,“[a]lthough the right to recover [the surplus from an
ERISA-qualified retirement plan] is a future estate, the
reversion itself is a present, vested estate. As a result, the
employer‟s reversionary interest falls within the broad reach
of section 541(a) of the Bankruptcy Code and is considered
property ... .” Id. at 211 (second alteration in original)
(internal quotation marks omitted); see also id. (“Property of
the estate includes all interests, such as ... contingent interests
and future interests, whether or not transferable by the
debtor.” (quoting Prudential Lines, 928 F.2d at 572) (internal
quotation marks omitted)).
17
We are not the only ones to find the Trans-Lines
West line of cases wanting. See James S. Eustice & Joel D.
Kuntz, Federal Income Taxation of S Corporations ¶ 5.08[1]
(4th ed. 2001) (“These cases seem like little more than hard
bankruptcy cases making bad tax law.”); Camilla Berit
Galesi, Shareholders’ Rights Regarding Termination of a
Debtor Corporation’s S Status in a Bankruptcy Setting, 10 J.
Bankr. L. & Prac. 157, 161-62 (2001) (“[D]ue to the [Trans-
Lines West] court‟s misunderstanding of the rules governing
S election and termination[] ... the court adopts an erroneous
conception of the nature of a corporation‟s interest in its S
status.”); Richard A. Shaw, Taxing Shareholders on the
Income of an S Corporation in Bankruptcy, 1 No. 6 Bus.
Entities 40, 1999 WL 1419055, at *46 (1999) (“In its haste to
provide cash for creditors, the Ninth Circuit BAP in
35
applying the NOL-as-property principle, which had been
extended once already by Prudential Lines, see supra note 15,
the decision in Trans-Lines West and the other S-corp-as-
property cases fail to consider important differences between
the two putative property interests.18 In holding that tax
status is property, the S-corp cases reason from the premise
Bakersfield [Westar] and the Tennessee Bankruptcy Court in
... Trans-Lines West ... are simply creating a windfall for the
bankruptcy estate at the expense of third parties who are not
in the bankruptcy proceeding.”); id. (“The NOL cases are
somewhat easier to accept ... [but] [t]he case for disrespecting
the revocation of an S election is, in many ways, much more
troublesome.”).
18
The reasoning of the “NOL-as-property” cases is
itself not without flaws. Those cases looked, in part, to
Congressional intent that “property of the estate” be
construed to “include[] all interests, such as ... contingent and
future interests.” Prudential Lines, 928 F.2d at 572 (quoting
H.R. Rep. No. 95-595, at 176 (1978), reprinted in 1978
U.S.C.C.A.N. 5963, 6136) (internal quotation marks omitted);
see also Feiler, 218 F.3d at 956-57 (quoting same and
suggesting that “Congress affirmatively adopted the Segal
holding when it enacted the present Bankruptcy Code”). But
Code § 541 contains no reference to “contingent” or “future”
interests and refers only to “legal or equitable interests of the
debtor in property as of the commencement of the case.” 11
U.S.C. § 541(a)(1) (emphasis added). Moreover, “the crucial
analytical key [is] not ... an abstract articulation of the
statute‟s purpose, but ... an analysis of the nature of the asset
involved in light of those principles.” Kokoszka v. Belford,
417 U.S. 642, 646 (1974).
36
that the “prospective ... nature [of a right] does not place it
outside the definition of „property.‟” Bakersfield Westar, 226
B.R. at 234. Even accepting that this will sometimes be the
case, not all contingencies are of equal magnitude or
consequence. NOLs when carried back are hardly contingent
at all. In all events, a debtor in possession of NOLs has a
defined amount of them at the time of the bankruptcy filing;
they are a function of the debtor‟s operations prior to
bankruptcy and are not subject either to revocation by the
shareholders or termination by the IRS. See Segal, 382 U.S.
at 381 (noting that “[t]he bankrupts in this case had both prior
net income and a[n] [NOL] when their petitions were filed”);
Prudential Lines, 928 F.2d at 571 (noting that the subsidiary
had “a $74 million NOL attributable to its pre-bankruptcy
operation” when it filed for Chapter 11 reorganization). By
contrast, the shareholders of an S-corp can terminate its pass-
through status at will, regardless of how long it has been an S-
corp and whatever its pre-bankruptcy operating history has
been. The tax status of the entity is entirely contingent on the
will of the shareholders.
NOLs also have value in a way that S-corp status does
not. The value of an NOL is readily determinable as a tax
refund immediately available to the bankruptcy estate to the
extent that it is applied to prior years‟ earnings, and it is still
subject to relatively clear estimation if the debtor decides to
carry it forward against future earnings. The value of the S-
corp election, however, is dependent on its not being revoked,
as well as the amount and timing of future earnings.
Moreover, NOL carryforwards may be monetized in a manner
that continuing S-corp status cannot. A corporation that does
not expect to generate sufficient future earnings to use its
NOLs may be purchased by another more profitable
37
corporation which may then use the NOLs to shelter its own
income, a transaction expressly contemplated by the I.R.C.
See I.R.C. § 382 (setting forth certain limitations on the use of
NOL carryforwards after a change in the corporation‟s
ownership). By contrast, the sale of an S-corp will generally
result in the termination of its tax-free status. See I.R.C.
§ 1361(b)(1) (setting forth the requirements for “small
business corporation” status and providing that the sale of an
S-corp to most corporate purchasers would terminate its “S”
status). Thus, the analogy of S-corp status to NOLs is of
limited validity.
A further flaw in the S-corp-as-property cases is that
they presume that “once a corporation elects to be treated as
an S corporation, [the I.R.C.] guarantees and protects the
corporation‟s right to use and enjoy that status ... [and]
guarantees and protects an S corporation‟s right to dispose of
that status at will.”19 Trans-Lines West, 203 B.R. at 662.
That reflects an incomplete and inaccurate understanding of
the law. The I.R.C. does not, and cannot, guarantee a
corporation‟s right to S-corp status, because the corporation‟s
shareholders may elect to revoke that status “at will.” See
I.R.C. § 1362(d)(1)(B) (providing for termination of S-corp
status by revocation with the approval of shareholders
holding more than one-half the corporation‟s shares). Even if
the shareholders do not vote to revoke their corporation‟s S-
corp status, any individual shareholder may at any time sell
his interest – without hindrance by the Code or the I.R.C. – to
another corporation, or to a nonresident alien, or to a number
19
To speak of the revocation as a “disposition,” as
Trans-Lines West does, is to assume that the tax status is a
property interest, which is exactly the issue in contention.
38
of new individuals sufficient to increase the total number of
shareholders to more than 100.20 Any of those sales would
trigger the automatic revocation of the company‟s S status
because the corporation would no longer qualify as a “small
business corporation.” See I.R.C. § 1361(a)(1), (b)(1). Thus,
the Trans-Line West line of cases is incorrect in concluding
that S-corp status is a “right” that is “guaranteed” under the
I.R.C.21
20
There may, of course, be contractual agreements
among the shareholders limiting the alienability of shares.
21
Our holding in Fruehauf Trailer, see supra note 16,
is not to the contrary. In that case, we held that a corporate
debtor‟s right to recoup an accumulated surplus in its pension
plan was property, even though the plan trustee had the right
to make an irrevocable election under ERISA to increase
pension benefits, denying the debtor the benefit of that
surplus. See 444 F.3d at 211 (noting that property may be
“contingent” and that “the mere opportunity to receive an
economic benefit in the future is property with value under
the Bankruptcy Code” (internal quotation marks omitted)).
But in that case the debtor had a contractual right to recover
the surplus, which we found to be a “future estate, [in which]
the reversion itself is a present, vested estate,” and one that
was “transferable and alienable.” Id. As a result, we held
that the debtor‟s “reversionary interest falls within the broad
reach of section 541(a) of the Bankruptcy Code and is
considered property of the debtor‟s estate.” Id. An S-corp
has no such contractual or otherwise “reversionary” interest
in its tax status, let alone one that is “transferable and
alienable.”
39
Perhaps recognizing those flaws, some courts holding
that S-corp status is “property” have defaulted to the
argument that such status must be property because it has
value to the estate. See Prudential Lines, 928 F.2d at 573
(“[W]e must consider the purposes animating the Bankruptcy
Code ... [and] Congress‟ intention to bring anything of value
that the debtors have into the estate.” (internal quotation
marks omitted)); Bakersfield Westar, 226 B.R. at 234 (“The
ability to not pay taxes has a value to the debtor-corporation
in this case.”). Indeed, the Bankruptcy Court in this case
essentially defined the Debtors‟ property interest as “the right
to prevent a shifting of tax liability from the shareholders to
the QSub through a revocation of the „S‟ corporation‟s
status.” Majestic Star Casino, 466 B.R. at 678. But § 541
defines property only in terms of “legal or equitable interests
of the debtor in property as of the commencement of the
case.” 11 U.S.C. § 541(a)(1). It goes without saying that the
“right” of a debtor to place its tax liabilities on a non-debtor
may turn out to have some value, but that does not mean that
such a right, if it exists, is property. Capacious as the
definition of “property” may be in the bankruptcy context, we
are convinced that it does not extend so far as to override
rights statutorily granted to shareholders to control the tax
status of the entity they own. “[T]he Code‟s property
definition is not without limitations ... .” Westmoreland, 246
F.3d at 256. Even accepting that an interest that is “novel or
contingent” may still represent property under the Code,
Segal, 382 U.S. at 379, a tax classification over which the
debtor has no control is not a “legal or equitable interest[] of
the debtor in property” for purposes of § 541.
Finally, aside from their flawed reasoning, Trans-Lines
West and its progeny (and the Bankruptcy Court‟s decision in
40
this case) also produce substantial inequities. Taxes are
typically borne and paid by those who derive some benefit
from the income. Cf. I.R.C. § 1 (imposing taxes on “the
taxable income” of the parties listed in that section). As the
IRS observes in its brief, “[i]n the typical case where an S
corporation or Q-sub receives income, the shareholder has the
ability to extract the income from the corporation in order to
pay the taxes due on that income.” (IRS Opening Br. at 29.)
See also supra notes 2 and 4 (discussing the “flow-through”
nature of S-corps). If a bankruptcy trustee is permitted to
avoid the termination of a debtor‟s S-corp or QSub status,
then any income generated during or as part of the
reorganization process (such as from the sale of assets) is
likely to remain in the corporation, and ultimately in the
hands of creditors, but the resulting tax liability must be borne
by the S-corp shareholders. The Trans-Lines West decision,
despite its flaws, clearly recognized that unfairness:
The Trustee‟s successful challenge of the
Debtor‟s revocation of its Subchapter S status in
the present case would have dire tax
consequences to the non-consenting
shareholder. Upon the Trustee‟s sale of the
Debtor‟s real estate, the liability for any capital
gain would be passed on to the shareholder.
Conversely, in its present C corporation status,
the Debtor‟s estate will be liable for the capital
gains tax.
203 B.R. at 660 n.9. Trans-Lines West treated that
inequitable outcome as indicating a problem with the
bankruptcy trustee‟s standing to challenge the transfer of a
supposed property interest in a debtor‟s S-corp status without
41
the consent of the company‟s shareholders. Id. at 660. That
bit of Trans-Lines West is true enough. But the inequity also
calls into question the soundness of the court‟s holding that
an entity‟s tax status is property in the first place. “Under the
scheme contemplated by the Bankruptcy Code, a debtor‟s
creditors are typically compensated to the extent possible and
in as equitable a fashion as possible ... after the trustee
marshals the debtor‟s bankruptcy property ... .”
Westmoreland, 246 F.3d 251. It would be impossible for a
trustee (or a debtor-in-possession) to “marshal” a debtor‟s S-
corp status and use it to compensate creditors, as that status is
not controlled by the debtor and has no realizable value.
For all these reasons, we decline to follow the rationale
of Trans-Line West and its progeny, and we conclude that S-
corp status is not “property” within the meaning of the Code.
ii. MSC II’s QSub Status as
“Property”
QSub status is an a fortiori case. As with S-corp
status, the I.R.C. does not (and cannot) guarantee a QSub “the
unrestricted right to [the] use, enjoyment and disposition” of
that status, see Trans Lines West, 203 B.R. at 661, because it
depends on a variety of factors that are entirely outside the
QSub‟s control. The QSub has an even weaker claim to the
control of its status than does an S-corp. The use and
enjoyment of its entity tax status is not only dependent on its
S-corp parent‟s continuing to own 100 percent of its stock,
see I.R.C. § 1361(b)(3)(B)(i), (b)(3)(C)(i), but also on the
parent‟s decision to not revoke the QSub election, see id.
§ 1361(b)(3)(B)(ii), as well as the parent‟s continuing status
as an S-corp, see id. § 1361(b)(3)(B)(i). That last
42
contingency, in turn, depends on the S-corp contingencies
already discussed.22 Therefore, a QSub‟s use and enjoyment
of its tax status may be terminated by factors not only outside
its control, but outside the control of its S-corp parent.
Nor can the QSub transfer or otherwise dispose of its
QSub status. “As a practical matter,” rights to which a debtor
asserts a property interest “must be readily alienable and
assignable,” Westmoreland, 246 F.3d at 250, to fulfill the
equitable purpose of bankruptcy, which is to generate funds
to satisfy creditors. See id. at 251 (holding that a license for
which few entities other than the debtor would qualify was
not a property interest of a bankruptcy estate because it is
“dubious, as a practical matter, that any potential buyers
would actually bid for that right”). QSub status itself is
neither alienable nor assignable, and an S-corp that wishes to
sell its QSub and preserve its tax status can only sell it to
another S-corp that is willing to purchase 100 percent of its
shares and to make the QSub election. See I.R.C.
§ 1361(b)(3)(B) (setting forth the requirements for QSub
status). The subsidiary would no longer qualify as a QSub
after any other type of sale, and the I.R.C. expressly provides
for the loss of QSub status as a result of a sale of the
subsidiary‟s stock. See id. § 1361(b)(3)(C)(ii). Thus, a QSub
can hardly be said to control the disposition of the alleged
property interest in its entity status. Again, a tax
classification over which a debtor has no control and that is
not alienable or assignable is not a “legal or equitable
interest[] of the debtor in property.” 11 U.S.C. § 541(a)(1).
22
See supra note 2. The S-corp parent‟s contingencies
include preservation of its own S-corp election which, as
discussed above, is controlled by its shareholders.
43
We therefore hold that MSC II‟s QSub status was not
“property” and that the Bankruptcy Court‟s contrary
conclusion was error.
2. QSub Status as Property of the Estate
Even if QSub status were property, it would still have
to be property “of the estate” for a transfer of that status to be
void under Code § 362 or avoidable under § 549. The Code
defines “property of the estate” as “all legal or equitable
interests of the debtor in property as of the commencement of
the case.”23 11 U.S.C. § 541(a)(1) (emphasis added).
Notwithstanding “Congress‟ intention to bring anything of
value that the debtors have into the estate,” Prudential Lines,
928 F.2d at 573 (internal quotation marks omitted), the
legislative history of § 541 also demonstrates that it was “not
intended to expand debtor‟s rights against others more than
they exist at the commencement of the case.” S. Rep. 95-989,
at 82 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5868; see
also 4 Collier on Bankruptcy ¶ 541.06 (15th ed. 1996))
(“Although [§ 541(a)(1)] includes choses in action and claims
by the debtor against others, it is not intended to expand the
debtor‟s rights against others beyond what rights existed at
the commencement of the case. ... The trustee can assert no
greater rights than the debtor himself had on the date the case
was commenced.”).
As discussed above, whether a tax attribute is property
of a corporate entity for purposes of Code § 541 is a function
23
The terms “property of debtor” and “interests of the
debtor in property” are co-extensive for purposes of
§ 541(a)(1). Begier v. IRS, 496 U.S. 53, 59 n.3 (1990).
44
of the I.R.C. and related regulations. Even if it were proper to
think of S-corp status in terms of “ownership,” the ownership
question would rightly be decided by considering the S-corp‟s
“flow-through” treatment for tax purposes. See supra note 4.
For example, an NOL may belong to a debtor that is a “C”
corporation, such as in Prudential Lines, or to an individual
debtor, as in Feiler and Russell, because “when [a] C
corporation and/or ... individuals file[] for bankruptcy, the
estate created contain[s] all of their assets[,] [and] [i]ncluded
therein [are] their tax attributes, including NOLs.” Official
Comm. of Unsecured Creditors of Forman Enters., Inc. v.
Forman (In re Forman Enters., Inc.), 281 B.R. 600, 612
(Bankr. W.D. Pa. 2002). However, when an S-corp files for
bankruptcy, its estate cannot contain any NOLs because
“[u]nder the provisions of the [I.R.C.] ... , the NOL and the
right to use it automatically passed through by operation of
law to [the] ... S corporation shareholders.” Id. “Any tax
benefits resulting from the NOL and the right to use it inure
solely to the benefit of ... shareholders and would not be
available to satisfy claims of the corporation‟s creditors.” Id.
The same can be said of an S-corp‟s entity tax status
itself. The S-corp debtor is merely a “conduit” for tax
benefits that flow through to shareholders. The corporation
retains no real benefit from its tax-free status in that, while
there is no entity-level tax, all of its pre-tax income is passed
on to its shareholders. See I.R.C. § 1363(a) (providing that an
S-corp is a disregarded entity for federal tax purposes and is
not taxed on its income); United States v. Tomko, 562 F.3d
558, 576 n.14 (3d Cir. 2009) (en banc) (noting that the
shareholders of an S-corp receive their individual shares of
the corporation‟s income, deductions, losses, and tax credits).
45
For its part, a QSub does not even exist for federal tax
purposes. If an S-corp makes a valid QSub election with
respect to an existing subsidiary, the subsidiary is deemed to
have liquidated into the parent under I.R.C. §§ 332 and 337.
Treas. Reg. § 1.1361-4(a)(2).24 As a result, a QSub is
generally not treated as a corporation separate from its S-corp
parent. Id. § 1.1361-4(a)(1).25 If a subsidiary ceases to
qualify as a QSub – because, for example, its corporate parent
is no longer an S-corp – the subsidiary is treated as a new
corporation acquiring all of its assets (and assuming all of its
liabilities) from the parent S-corp immediately before
termination, in exchange for stock of the new subsidiary
corporation, under I.R.C. § 351. I.R.C. § 1361(b)(3)(C);
Treas. Reg. § 1.1361-5(b). Lastly, a QSub that loses its QSub
status cannot return to that status for five years, at which time
a new QSub election by the parent S-corp is required. I.R.C.
§ 1361(b)(3)(D); Treas Reg. § 1.1361-5(c)(1). Pertinent
24
That is what happened in this case; MSC II was
incorporated in 2005, and BDI made the QSub election in
2006.
25
The Debtors argue that a QSub‟s separate existence
“is respected for a number of ... purposes, including various
tax purposes as set forth in the U.S. Treasury regulations.”
(Debtors‟ Br. in Resp. to Barden Appellants‟ Opening Br. at
23.) However, the purposes they cite for which a QSub‟s
separate existence is respected (for taxes due on pre-QSub
income, employment and excise taxes, and the obligation to
file information returns, see Treas. Reg. § 1.1361-4(a)(6)-
(a)(9)) are the narrow exceptions to the general rule that a
QSub has no independent status under the I.R.C., see id.
§ 1.1361-4(a)(1)(i).
46
regulations thus strongly suggest that a QSub‟s tax status is
not “owned” by the QSub.
If QSub status were property at all, it would be
property of the subsidiary‟s S-corp parent. Because “[t]he
desirability of a Subchapter S election depends on the
individual tax considerations of each shareholder[,] [t]he final
determination of whether there is to be an election should be
made by those who would suffer the tax consequences of it.”
Kean v. Comm’r, 469 F.2d 1183, 1187 (9th Cir. 1972).
Trans-Lines West was correct in that regard. It acknowledged
that “[a] corporation‟s election and revocation of the S
corporation status under I.R.C. § 1362 is shareholder driven,”
and “[a]lthough the corporation is the sole entity that makes
the election or revocation under I.R.C. § 1362, both acts are
contingent upon various degrees of consent by the
corporation‟s shareholders.” 203 B.R. at 660 (citing I.R.C.
§ 1362(a)(2), (d)(1)(B)).
Moreover, allowing QSub status to be treated as the
property of the debtor subsidiary rather than the non-debtor
parent, as the Bankruptcy Court did in this case, places
remarkable restrictions on the rights of the parent, restrictions
that have no foundation in either the I.R.C. or the Code. First,
the corporate parent loses not only the statutory right to
terminate its subsidiary‟s QSub election, see I.R.C.
§ 1361(b)(3)(B), (D), but also its right to terminate its own S-
corp election, see id. § 1361(d). Second, the corporate parent
loses the ability to sell the subsidiary‟s shares to any
purchaser other than an S-corp, and would then be required to
sell 100 percent of the shares, because any other sale would
trigger the loss of the subsidiary‟s QSub status. See id.
§ 1361(b)(3)(B). Third, the S-corp parent and its
47
shareholders lose the ability to sell the parent to a C-
corporation, partnership, or other non-S-corp entity, to a non-
resident alien, or to more than 100 shareholders, because any
of those transactions would also trigger the loss of the
subsidiary‟s QSub status. See id. § 1361(b)(1)(B), (C), (A).
Filing a bankruptcy petition is not supposed to “expand or
change a debtor‟s interest in an asset; it merely changes the
party who holds that interest.” In re Saunders, 969 F.2d 591,
593 (7th Cir. 1992). But under the Bankruptcy Court‟s
holding in this case, a QSub in bankruptcy can stymie
legitimate transactions of its parent as unauthorized transfers
of property of the estate, even though the QSub would have
had no right to interfere with any of those transactions prior to
filing for bankruptcy.26
26
For similar reasons, we question whether the relief
that the Bankruptcy Court granted was permissible or
appropriate. Code § 550, which authorizes relief for transfers
avoided pursuant to § 549, places several limitations on the
scope of that relief. First, the trustee may only recover “the
property transferred, or, if the court so orders, the value of
such property.” 11 U.S.C. § 550(a). Therefore, “only net
amounts diverted from, that is damages consequently suffered
by the creditor body of, a debtor may be recovered” pursuant
to § 550. In re Foxmeyer Corp., 296 B.R. 327, 342 (Bankr.
D. Del. 2003) (considering a claim under Code § 548).
Second, “[t]he trustee is entitled to only a single satisfaction”
under § 550. 11 U.S.C. §550(d); see also HBE Leasing Corp.
v. Frank, 48 F.3d 623, 640 (2d Cir. 1995) (prohibiting an
“unjustified double recovery” in an avoidance action); In re
Skywalkers, Inc., 49 F.3d 546, 549 (9th Cir. 1995) (applying
the “single satisfaction” rule to a debtor‟s recovery of both a
liquor license and the payments made to procure that license).
48
Third, a debtor may avoid transfers and recover transferred
property or its value only if the recovery is “for the benefit of
the estate.” In re Messina, 687 F.3d 74, 82-83 (3d Cir. 2012)
(citing 11 U.S.C. §550(a)). A debtor is not entitled to benefit
from any avoidance, id., and “courts have limited a debtor‟s
exercise of avoidance powers to circumstances in which such
actions would in fact benefit the creditors, not the debtors
themselves,” In re Cybergenics Corp., 226 F.3d 237, 244 (3d
Cir. 2000). Because “the rule is that the estate is dissolved
upon confirmation of the plan, ... there is no post-
confirmation bankruptcy estate … to be benefitted,” and
property recovered as a result of an avoidance action after a
plan has been confirmed may represent an impermissible
benefit to the reorganized debtor. Harstad v. First Am. Bank,
39 F.3d 898, 904 (8th Cir. 1994) (citing Code § 1141). For
that reason, some courts have required a specific mechanism
whereby the prepetition creditors, rather than the reorganized
debtor, receive the benefit of a post-confirmation avoidance
and recovery of transferred property. See In re Kroh Bros.
Dev. Co., 100 B.R. 487, 498 (Bankr. W.D. Mo. 1989)
(authorizing relief pursuant to which creditors would receive
at least one half of preference recoveries); In re Jet Fla. Sys.,
Inc., 73 B.R. 552, 556 (Bankr. S.D. Fla. 1987) (authorizing
relief pursuant to which creditors would receive 80 percent of
the proceeds of preference actions).
The remedy fashioned here by the Bankruptcy Court
runs afoul of such limitations. The Bankruptcy Court held
that “[t]he revocation of Defendant [BDI‟s] status as a
subchapter „S‟ corporation and the termination of MSC II‟s
status as a qualified subchapter „S‟ subsidiary are void and of
no effect” and ordered that “[t]he Defendants shall take all
actions necessary to restore the status of Debtor [MSC II] as a
49
qualified subchapter „S‟ subsidiary of Defendant [BDI].”
Majestic Star Casino, 466 B.R. at 679-80. However, MSC II
had already emerged from bankruptcy and was no longer a
wholly-owned subsidiary of BDI. That meant that MSC II
“recovered” not only its transferred “property” – its tax-free
status that was subject to BDI‟s claim on 100 percent of its
income – but also its ability to retain all of its pre-tax
earnings. That represented a double recovery and then some.
Likewise, because the relief ordered by the Bankruptcy Court
was of indefinite duration, it would continue to benefit MSC
II long after its creditors had been compensated and sold their
interests, thus impermissibly benefitting MSC II itself as the
former debtor.
Relief under § 362 admittedly is not subject to the
limitations of § 550 because a transfer that violates the
automatic stay is void ab initio. Siciliano, 13 F.3d at 749.
Nevertheless, under § 362, in order to define the relief due as
a result of a void transfer, it is still necessary to identify the
postpetition transfer that violated the stay. See 11 U.S.C.
§ 362(a)(3). The Bankruptcy Court failed to do that, and
simply treated the revocations at both BDI and MSC II as
void. But those revocations were themselves irrevocable, see
I.R.C. §§ 1361(b)(3)(D), 1362(g); Treas. Reg. § 1.1361-
5(c)(1), and the Court‟s treatment of them as simply void
raises a question of whether § 362 “could, under the tax laws
of the United States, be utilized to undo previously executed
acts.” Forman, 281 B.R. at 612.
Finally, MSC II no longer qualified as a QSub after the
Majestic Plan was confirmed both because it was owned by
its former creditors rather than being wholly-owned by an S-
corp, see I.R.C. § 1361(b)(3)(B)(i), and because those
creditors had converted it to an LLC, see id. § 1361(b)(3)(B)
50
The Debtors argue that “the manner in which an S-
corp or QSub obtains or maintains its status is not
determinative” of who holds the property right. (Debtors‟ Br.
in Resp. to Barden Appellants‟ Opening Br. at 26). They say
that “the proper focus is on the fact that, under the Internal
Revenue Code, the corporation possesses and enjoys the
benefits that result from such status at the time of its chapter
11 petition.” (Id.) In support of that contention, they cite In
re Atlantic Business & Community Corp., 901 F.2d 325 (3d
Cir. 1990), for the proposition that “mere possession of
property at the time of filing suffices to give an interest in
property protected by section 362(a)(3).” (Id. at 26-27
(quoting Atl. Bus. & Cmty. Corp., 901 F.2d at 328) (internal
quotation marks omitted).)
There are two problems with that argument. First, the
holding in Atlantic Business & Community Corp. was, by its
own terms, limited to possessory interests in real property.
See 901 F.2d at 328 (holding that “a possessory interest in
real property is within the ambit of the estate in bankruptcy
under Section 541”); id. (“[W]e hold that a debtor‟s
possession of a tenancy at sufferance creates a property
interest as defined under Section 541, and is protected by
Section 362 ... .”). The case does not support the broad
principle that any interest that “benefits” the debtor or that
(requiring that a QSub be a “domestic corporation”).
Therefore, treating the revocation of MSC II‟s QSub status as
void pursuant to Code § 362 left that entity in violation of at
least those two I.R.C. provisions. “Humpty Dumpty could
not be restructured using this scenario.” Forman, 281 B.R. at
612.
51
“the corporation possesses and enjoys” (Debtors‟ Br. at 26) is
necessarily property of the estate rather than property of a
non-debtor. Cf. 11 U.S.C. § 541(a)(1) (limiting property of
the estate to “legal or equitable interests of the debtor”).
Second, the QSub‟s S-corp parent – and the parent‟s ultimate
shareholders – have at least as strong an argument that they
possess and enjoy the benefits that result from the
subsidiary‟s QSub status due to the pass-through of income,
the pass-through of losses which may be used to shelter other
income, and the elimination of entity-level tax at the QSub.
Based on the foregoing, we conclude that, even if
MSC II‟s QSub status were “property,” it is not properly seen
as property of MSC II‟s bankruptcy estate, and the contrary
conclusion of the Bankruptcy Court cannot stand.27
27
We also doubt that, even if MSC II‟s QSub status
were property of its bankruptcy estate, the Revocation would
constitute a transfer for purposes of Code §§ 549 and 550.
The Code defines a “transfer” as, inter alia, “each mode,
direct or indirect, absolute or unconditional, voluntary or
involuntary, of disposing or parting with ... property[] or an
interest in property.” 11 U.S.C. 101(54)(D) (numbering
omitted). “Congress intended this definition to be as broad as
possible.” Russell, 927 F.2d at 418. However, both §§ 549
and 550 presume that a “transfer” requires that there be a
“transferee” that receives the property interest conveyed from
the debtor. See 11 U.S.C. § 549(b) (providing that the trustee
has avoidance powers “notwithstanding any notice or
knowledge of the case that the transferee has”); id.
§ 550(a)(2) (providing for the recovery of value from “any
immediate or mediate transferee of such initial transferee”).
There are only two candidates for transferee in this case –
52
C. Standing Revisited
Having determined that a debtor‟s QSub status is not
property of its bankruptcy estate, we return to the question of
whether such a debtor has standing to challenge the
revocation of that status by its corporate parent. As
discussed in Part III.A, supra, an S-corp, “standing alone,
cannot challenge the validity of a prior Subchapter S
revocation without the consent of at least those shareholders
who consented to the revocation.” Trans-Lines West, 203
B.R. at 660. “A trustee [or debtor-in-possession] who
attempts to challenge the validity of [such] a revocation
without such consent is asserting the rights of a third party,”
i.e., its shareholders, and “does not have standing ... .” Id.
By analogy, a debtor QSub that seeks to challenge the
revocation of its tax status is asserting the rights of a third
party, its S-corp shareholder, and can do so only if it can
claim third-party standing. That, in turn, requires that the
QSub plaintiff demonstrate both that its S-corp parent “is
hindered from asserting its own rights and shares an identity
Barden and BDI – and neither can be said to have been the
“transferee” of MSC II‟s QSub status or of its “right” not to
pay taxes on its income. The Revocation was itself triggered
by BDI‟s revocation of its S-corp status, so that, far from
enjoying a transfer of MSC II‟s tax-free status, BDI itself
became a taxpayer. Likewise, Barden did not somehow
become an S-corp or a QSub as a result of the revocations at
BDI and MSC II. The transfer envisioned by the Bankruptcy
Court thus seems very far removed from the definition set
forth in 11 U.S.C. § 101(54) and suggested by the concept of
a “transferee” as that term is used in §§ 549 and 550.
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of interests with the plaintiff.” Pa. Psychiatric Soc’y, 280
F.3d at 288.
Neither of those conditions exists in this case. Far
from being “hindered,” BDI and its ultimate shareholder
Barden are both parties to this suit and have effectively
defended BDI‟s right to revoke its own S-corp status and, by
extension, the QSub status of MSC II. And far from having
an “identity of interests,” the interests of MSC II and the
other Debtors are diametrically opposed to those of Barden
and BDI, onto whom they would like to shift substantial on-
going tax liabilities. “The extent of potential conflicts of
interests between the plaintiff and the third party whose rights
are asserted matters a good deal.” Amato v. Wilentz, 952 F.2d
742, 750 (3d Cir. 1991). “While it may be that standing need
not be denied because of a slight, essentially theoretical
conflict of interest, ... genuine conflicts strongly counsel
against third party standing.” Id. We therefore hold that the
Debtors lacked standing to initiate an adversary proceeding to
seek avoidance of the alleged “transfer” of MSC II‟s QSub
status.
IV. CONCLUSION
Sections 362, 549, and 550 of the Code set forth
guidelines to determine whether a voidable transfer of estate
property has occurred. The Bankruptcy Court‟s decision, like
the S-corp-as-property cases on which it relied, was based in
part on the conclusion that “a broad range of property
[should] be included in the estate,” due to the “Congressional
goal of encouraging reorganizations and Congress‟ choice of
methods to protect secured creditors.” Majestic Star Casino,
466 B.R. at 673. But, as the Supreme Court recently
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observed, “nothing in the generalized statutory purpose of
protecting secured creditors can overcome the specific
manner of that protection which the text [of the Code]
contains.” RadLAX Gateway Hotel, LLC v. Amalgamated
Bank, 132 S. Ct. 2065, 2073 (2012).
Given that principle, and for the reasons set forth in
this opinion, we will vacate the Bankruptcy Court‟s
January 24, 2012 order and remand this matter with directions
to dismiss the complaint for lack of jurisdiction.
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