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Court Narrows Chapter 11 Tax Loophole

August 18, 2003

WILMINGTON, Del. (AP) _ The appeals deadline passed Monday for a ruling by a federal court that narrowed a popular tax loophole for real estate sold during Chapter 11 cases, meaning more money for local governments and less for companies restructuring in bankruptcy.

The July 18 ruling by the Third Circuit Court of Appeals involved the liquidating trust that is wrapping up the loose ends for the defunct hardware chain Hechinger Co., which filed for Chapter 11 protection in June of 1999.

The decision already is reverberating in the Wilmington bankruptcy courts, where the case started.

Judges last week struck language referring to the tax loophole from sale documents that transferred real estate in the Chapter 11 cases of Uniroyal Technology Corp. and Fleming Cos.

Neither of those companies has a Chapter 11 plan confirmed yet, and, under the Third Circuit decision, neither is entitled to claim an exemption from state and local transfer and recording taxes until it has plan confirmation.

The decision also marks a larger trend toward states asserting their rights in bankruptcy cases, especially as many U.S. states struggle to hold on to diminishing revenue streams.

Until the ruling, companies restructuring under Chapter 11 often shed excess real estate as quickly as possible, to chop costs and raise operating money early in the case.

Hechinger sold off real estate interests, mostly leaseholds, in 117 stores.

Among those stores was one that former Maryland Assistant Attorney General Julia M. Andrew called Hechinger’s ``crown jewel,″ a Baltimore leasehold sold to Home Depot Inc. for $15 million.

Hechinger invoked a Bankruptcy Code provision exempting property transfers from state and local recording and transfer cases as part of the sales.

For the Baltimore leasehold alone, that meant $700,000 was headed not to the state and local taxing authorities, but to the bankrupt home improvement chain to fund the liquidating plan in the works.

Maryland challenged the exemption, arguing that the language of the statute says companies operating under bankruptcy protection don’t have to pay transfer and recording taxes if they sell property after a Chapter 11 plan has been confirmed, but not before.

After losing in bankruptcy court and in the district court, the state won on appeal.

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