Majestic Star Casino, LLC v. Barden Development, Inc.

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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