In re Dow Corning Corp.

• Decision Date: 30 October 2001
• Docket Number: No. 95-20512.,95-20512.
• Citation: 270 BR 393
• Parties: In re: DOW CORNING CORPORATION, Debtor.
• Court: U.S. Bankruptcy Court — Eastern District of Michigan

270 B.R. 393 (2001)

In re: DOW CORNING CORPORATION, Debtor.

No. 95-20512.

United States Bankruptcy Court, E.D. Michigan, Northern Division.

October 30, 2001.

COPYRIGHT MATERIAL OMITTED

John M. Newman, Jr., Jones, Day, Reavis & Pogue, Cleveland, OH, for Debtor.

John Lindquist, U.S. Department of Justice, Washington, DC, for United States.

OPINION REGARDING DEDUCTIBILITY OF POSTPETITION INTEREST

ARTHUR J. SPECTOR, Chief Judge.

Introduction

The Internal Revenue Code ("IRC") generally permits corporations to deduct from income subject to federal tax "all interest paid or accrued within the taxable year on indebtedness." 26 U.S.C. § 163(a). Dow Corning Corporation ("the Debtor") is an "accrual basis taxpayer." Declaration of Gifford E. Brown at ¶ 30. See generally 26 U.S.C. § 446(c)(2) (The "accrual method" is a permissible "method of accounting" for purposes of "computing taxable income."); Comm'r v. South Texas Lumber Co., 333 U.S. 496, 498, 68 S.Ct. 695, 92 L.Ed. 831 (1948) (Under the "accrual basis of accounting . . . , all obligations of a company applicable to a year are listed as expenditures, whether paid that year or not, and all obligations to it incurred by others applicable to the year are set up as income on the same basis." With "cash basis" accounting, on the other hand, "annual net income is measured by the difference between actual cash received and paid out within the taxable year."). The Debtor included in its 1995 and 1996 federal tax returns deductions "attributable to postpetition interest expense on its . . . pre-petition bank debt and other capital borrowings." Brown Declaration at ¶¶ 31 & 32. Interest on these obligations, which will hereafter be referred to as the "Institutional Debt," was calculated at the interest rates specified in the underlying loan agreements. See Debtor's Memo at p. 13.

The returns were audited by the Internal Revenue Service ("IRS") and, on November 30, 1998, the Debtor submitted to the auditing team an "informal claim . . . for deduction of additional amounts of postpetition interest on pre-petition debt that had been erroneously omitted from the 1995 and 1996 returns." Brown Declaration at ¶ 34. See also Exhibit 26 of Brown Declaration. The indebtedness underlying this interest deduction "encompasses trade payables, forward contracts, swaps, and . . . various . . . settlement agreements" with, and prepetition judgments obtained by, certain tort creditors. Brown Declaration at ¶ 35. See also id. at ¶ 16. Hereafter, these disparate obligations will for convenience be collectively referred to as the "Trade Debt." In contrast to the Institutional Debt, the interest deduction relating to Trade Debt was not based on any contractual provisions. See Debtor's Memo at p. 9 (wherein the Debtor makes the rather implausible assertion that the Trade Debt "carried no contractual interest").¹ Consistent with 11 U.S.C. § 726(a)(5), the Trade Debt deductions were instead based on an interest rate of 6.28% — the federal judgment rate in effect when the Debtor filed its petition for bankruptcy relief. See Brown Declaration at ¶ 35; Debtor's Memo at p. 13; see generally 11 U.S.C. § 726(a)(5) (requiring that if the bankruptcy estate is sufficiently solvent, holders of claims against it are to be paid "interest at the legal rate from the date of the filing of the petition"); 11 U.S.C. § 1129(a)(7)(A)(ii) (To be confirmed, a plan must provide that each holder of a claim within an impaired, nonaccepting class "will receive . . . property of a value . . . that is not less than the amount that such holder would . . . receive . . . if the debtor were liquidated under chapter 7."); In re Dow Corning Corp., 237 B.R. 380, 412 (Bankr.E.D.Mich.1999) (Section 726(a)(5) requires that interest be paid at "the federal judgment rate."); 28 U.S.C.A. § 1961(a) (West 1994) ("Interest on a money judgment shall be . . . at a rate equal to the coupon issue yield equivalent . . . of the average accepted auction price for the last auction of fifty-two week United States Treasury bills settled immediately prior to the date of the judgment."); Historical & Statutory Notes foll. 28 U.S.C.A. § 1961 (West Supp. 2001) (indicating that the "Equivalent Coupon Issue Yield" on the last auction date before the Debtor filed its bankruptcy petition was 6.28%).

The IRS "rejected" the informal claim. Brown Declaration at ¶ 34. It also disallowed the Institutional Debt deductions. Id. at ¶ 33.

On behalf of the IRS, the United States filed a request for payment of certain administrative expenses. See generally 11 U.S.C. § 503. The Debtor objected to the request, which is based in substantial part on the government's contention that the foregoing deductions are improper. Both sides have filed a motion for partial summary judgment on this issue.

Discussion

The Debtor argues that the interest obligations to which the deductions relate accrued during the 1995 and 1996 tax years — a contention which the United States disputes. We must therefore identify the standard for determining when accrual occurs for purposes of IRC § 163.

That standard is set out in IRC § 461. This statute refers to an "all events test," which "is met with respect to any item if all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy." 26 U.S.C. § 461(h)(4). As a general rule, "the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs." 26 U.S.C. § 461(h)(1).

I. The United States' Motion

The United States does not question that "economic performance" occurred with respect to the deductions at issue. See generally In re West Texas Mktg. Corp., 155 B.R. 399, 403 (Bankr.N.D.Tex.), aff'd, No. 182-10034-7, 1993 WL 610926 (N.D.Tex. Dec.20, 1993), aff'd, 54 F.3d 1194 (5th Cir.1995) ("In the case of interest, economic performance occurs with the passage of time. H.R.CONF.REP. NO. 861, 98th Cong., 2d Sess. 875 U.S.Code Cong. & Admin.News 1984, pp. 697, 1563. . . ."); compare 26 U.S.C. § 461(h)(2)(D) (With exceptions not relevant here, "economic performance occurs at the time determined under regulations prescribed by the Secretary of the Treasury.") with Treas. Reg. § 1.461-4(e), WL 26 CFR s 1.461-4 (2001) ("In the case of interest, economic performance occurs as the interest cost economically accrues, in accordance with the principles of relevant provisions of the Code."). It argues, however, that neither prong of the all-events test is satisfied.

A. The Fixing of Liability

As indicated, an expense cannot be deducted unless "all events have occurred which determine the fact of liability." 26 U.S.C. § 461(h)(4). A more user-friendly description of this requirement is that the liability must be "fixed." See United States v. Hughes Props., Inc., 476 U.S. 593, 600, 106 S.Ct. 2092, 90 L.Ed.2d 569 (1986) ("To satisfy the all-events test, a liability must be `final and definite in amount,' . . . must be `fixed and absolute,' . . . and must be `unconditional'. . . ." (citations omitted)).

The United States asserts that "the Debtor's postpetition interest obligation was . . . contingent as a matter of law under 11 U.S.C. §§ 502(b)(2) and 1129." United States' Brief at p. 15. Alternatively, it argues that the obligation to pay postpetition interest is contingent by virtue of (i) 11 U.S.C. § 726(a); (ii) insolvency; or (iii) the Debtor having disputed such obligation.

(i) Section 502(b)(2)

Section 502(b)(2) states that a claim to which an objection has been filed "shall be . . . allowed . . ., except to the extent that . . . such claim is for unmatured interest." 11 U.S.C. § 502(b)(2). The United States argues that a creditor's right to postpetition interest is invalidated by this provision. See United States' Brief at pp. 11-13. This argument does not withstand analysis.

The net result of § 502(b)(2) is that, with an exception not relevant here,² claims for postpetition interest are subject to disallowance. See United Sav. Ass'n of Tex. v. Timbers of Inwood Forest Assocs., 484 U.S. 365, 373, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988) (referring to "the general rule disallowing postpetition interest," and citing § 502(b)(2)). Contrary to what the United States apparently believes, however, disallowance does not necessarily render a claim unenforceable.

As of the commencement of a bankruptcy case, a new entity — the bankruptcy "estate" — is created. 11 U.S.C. § 541(a). This estate acquires title to most property interests formerly held by the Debtor. See id. The Debtor and the estate, however, are separate and distinct legal entities. See In re Thompson Boat Co., 252 F.3d 852, 854 (6th Cir.2001);³cf. 26 U.S.C. § 6012(a)(9) (providing that an income tax return "shall be made by . . . every estate of an individual under chapter 7 or 11 of the Bankruptcy Code . . . the gross income of which for the taxable year is not less than the sum of the exemption amount plus the standard deduction under 26 U.S.C. section 63(c)(2)(D)"); 26 U.S.C. § 6012(b)(4) ("Returns of . . . an estate of an individual under chapter 7 or 11 of the Bankruptcy Code . . . shall be made by the fiduciary thereof."); Rev. Rul. 72-387, 1972-2 C.B. 632 ("The bankrupt as an individual, and the estate in bankruptcy are separate taxable entities. . . . The intervention of the status of bankruptcy into the affairs of . . . an individual . . . creates an entity separate and apart from the individual . . . bankrupt.").⁴

The objective of the claims-allowance process is to identify those claims which are enforceable against the bankruptcy estate. Disallowance, therefore, does not necessarily mean that the claim is also invalid as against the debtor. See, e.g., In re Kielisch, 258 F.3d 315, 323 (4th Cir.2001); In re Cousins, 209 F.3d 38, 40-41 (1st Cir.2000).

Of course, the grounds for disallowance must be taken into account. The Code provides that a...