Supreme Court strikes down attempt at federal common-lawmaking

The Supreme Court held that the Bob Richards rule, a rule of federal common law, was not a legitimate exercise of federal common-lawmaking because the rule is not necessary to protect unique federal interests.

Background

United Western Bancorp Inc. (Bancorp) was a holding company that owned 13 subsidiaries, one of which was United Western Bank (UWB). Bancorp and the subsidiaries filed consolidated returns.

In 2011 UWB entered receivership and was taken over by the Federal Deposit Insurance Corporation (FDIC). UWB was the principal asset of Bancorp, and in 2012 Bancorp went bankrupt. Simon Rodriguez was appointed trustee of Bancorp.

In 2008, UWB had net income. This was included in the consolidated return of Bancorp and the subsidiaries, and Bancorp paid tax on the income. UWB had losses in 2011 exceeding the income it earned in 2008, and Bancorp carried those losses back to 2008. As a result, Bancorp received a $2.8 million refund. The refund was entirely due to the income and losses of UWB, and Bancorp and the subsidiaries other than UWB did not generate any income or losses that contributed to the refund.

Both the FDIC, as receiver for UWB, and Rodriguez, as trustee for Bancorp, wanted the refund. Bancorp and its subsidiaries had a tax allocation agreement, which set out the allocation of taxes and tax refunds among the members of the affiliated group. The FDIC claimed that UWB was entitled to the refund under the agreement, and Rodriguez claimed that Bancorp was entitled to the refund under it. The parties initially took their dispute to the bankruptcy court.

The Bob Richards rule

If a dispute arises among the members as to which member of a consolidated group is entitled to a refund, and the group has no tax allocation agreement in place, federal courts have normally turned to state law to determine how the refund should be distributed among the group members. However, the Ninth Circuit was not satisfied with this approach and crafted a federal common law rule (commonly called the Bob Richards rule) in In re Bob Richards Chrysler-Plymouth Corp., 473 F. 2d 262 (9th Cir. 1973).

The Bob Richards rule initially provided that, in the absence of an agreement, a refund belongs to the group member responsible for the losses that led to it. But it has since evolved, in some jurisdictions, into a general rule that is always followed unless an agreement unambiguously specifies a different result. The Tenth Circuit adopted this general version of the Bob Richards rule in Barnes v. Harris, 783 F.3d 1185 (10th Cir. 2015).

The bankruptcy court and district court decisions

Following the Tenth Circuit’s version of the Bob Richards rule, the bankruptcy court found that the groups unambiguously specified in their tax allocation agreement that Bancorp was entitled to the refund (In re United Western Bancorp, Inc., 558 B.R. 409 (Bankr. D. Colo. 2016)). The FDIC appealed the bankruptcy court’s decision to the district court.

The district court, while admitting that it was not clear that the Bob Richards rule applied to the case, found that whether it did was irrelevant. The court determined that the relevant contract between the UWB and Bancorp was ambiguous regarding whether Bancorp might keep the tax refund under the circumstances in the case, and that the contract further required that any ambiguity be construed in favor of UWB. Thus, the district court held that the tax refund was not a part of Bancorp’s bankruptcy estate and belonged to UWB (Federal Deposit Ins. Corp. v. Rodriguez, 574 B.R. 876 (D. Colo. 2017)). Rodriguez then appealed the case to the Tenth Circuit.

The Tenth Circuit’s decision

The Tenth Circuit, following its precedent, applied the more expansive version of the Bob Richards rule. Because the parties did have a tax allocation agreement, the court of appeals explained, the question it faced was whether the agreement unambiguously deviated from Bob Richards‘s default rule. After laying out its analytical framework for making its decision, the court reviewed the tax allocation agreement and determined that the agreement created an agency relationship between Bancorp and UWB that gave UWB ownership of the tax refund. This treatment of the refund under the agreement did not differ from the general rule under Barnes and Bob Richards, so the refund belonged to UWB (Rodriguez v. Federal Deposit Ins. Corp., 893 F.3d 716 (10th Cir. 2018)). Rodriguez petitioned the Supreme Court for certiorari, which was granted.

The Supreme Court weighs in

In a unanimous decision, the Supreme Court held that the Bob Richards rule was not a legitimate exercise of federal common-lawmaking and remanded the case to the Tenth Circuit to be decided under the applicable state law. The Court explained while in certain situations a federal court can engage in federal common-lawmaking, it is only permissible in limited areas and under strict conditions that were not met in this case.

The Supreme Court stated that federal common law necessarily plays a modest role because the Constitution vests the federal government’s legislative powers in Congress and reserves most other regulatory authority to the states. The Court noted that in Erie R. Co. v. Tompkins, 304 U.S. 64, 78 (1938), it had stated there is “no federal general common law” and that in Sosa v. Alvarez-Machain, 542 U.S. 692 (2004), it had held that only limited areas exist in which federal judges may appropriately craft the rule of decision. The court gave admiralty disputes and certain controversies between the states as examples of such areas.

To claim a new area of law for federal common-lawmaking, the Supreme Court explained, certain strict conditions must be satisfied. One of these is that in the absence of congressional authorization, common-lawmaking must be necessary to protect uniquely federal interests. Agreeing with the Sixth Circuit’s analysis in Federal Deposit Ins. Corp. v. AmFin Financial Corp., 757 F. 3d 530 (2014), the Court found that the Ninth Circuit in Bob Richards had not addressed whether a unique federal interest existed in that case and had merely bypassed the question. Likewise, the courts that later followed and extended the Bob Richards rule had failed to show that a unique federal interest existed that would justify federal common-lawmaking.

The Supreme Court found that no unique federal interest existed in the situation in Bob Richards or the present case. The federal government might have an interest in regulating how it receives taxes. It might also have an interest in how a refund is delivered to a corporate group, to ensure that once a refund is paid to the group’s designated agent, no other member of the group could receive a duplicate refund. However, the Court was unable to see any unique interest the federal government could have in how a refund is distributed to group members after it is paid to the designated agent of the group.

The Supreme Court observed that corporations are generally creatures of state law and that “state law is well equipped to handle disputes involving corporate property rights.” As the Court had long recognized, Congress has left the determination of property rights in bankruptcy to state law, and the Bankruptcy Code generally does not create property rights. According to the Court, “[if] special exceptions to these usual rules sometimes might be warranted, no one has explained why the distribution of a consolidated corporate tax refund should be among them.”

The FDIC urged that even if the Supreme Court found that the Tenth Circuit erroneously applied the Bob Richards rule, the Court could affirm the Tenth Circuit’s decision because the Tenth Circuit had consulted applicable state law in making its determination, and, under that law, the result would be the same. The Court refused to do so, stating that it had not taken the case to decide how it should be resolved under state law or how IRS regulations might interact with state law. Rather it had taken the case to address the issue of whether the Bob Richards rule was a valid exercise of federal common-lawmaking, and, having done so, it remanded the case to the Tenth Circuit to decide whether the result would be the same or different in the absence of the Bob Richards rule.

Reflections

The common law — as opposed to law enacted by legislatures — derives from court decisions enforcing “usages and customs” (as Black’s Law Dictionary puts it). And while federal common law — “decisional law developed by the federal courts untrammeled by state court decisions” (Black’s Law Dictionary) — theoretically exists, its use was strictly limited by the Erie Railroad and Sosa decisions.

The Supreme Court’s unanimity in this decision shows how far the Ninth and Tenth Circuits had strayed from these strict limits when they crafted and expanded the Bob Richards rule. The decision in Bob Richards could easily have been made under state law without resorting to the creation of a new federal common law rule. The Supreme Court’s striking down of the Bob Richards rule puts the brakes on these circuits’ forays into federal common-lawmaking.

Rodriguez v. Federal Deposit Ins. Corp., No. 18-1269 (U.S. 2/25/20)