Memo to Federal Judges: Resist Temptation (Rodriguez v. FDIC)

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Temptation (photo by Marilyn Swanson)

By: Donald L Swanson

before federal judges may claim a new area for common lawmaking, strict conditions must be satisfied

—U.S. Supreme Court in Rodriguez v. FDIC (Case No. 18-1269, decided February 25, 2020).

The Rodriguez v. FDIC opinion is a memo from the U.S. Supreme Court to federal court judges saying this: resist the temptation to engage in federal common lawmaking!

The Rodriguez v. FDIC case is a fight over a $4 million tax refund. But the question before the Supreme Court is not, “Who gets the money.”  Instead, it’s about how the dispute should be decided. Namely:

  1. should federal judges rely on state law, together with applicable federal rules, or 
  2. should they create their own federal common law test?

To ask the question, says the unanimous Supreme Court, is nearly to answer it:

  • the cases in which federal courts may engage in common lawmaking are few and far between, and
  • this is one that lies between.

Facts

Here’s what happened.

United Western Bank hit hard times, and the FDIC took it over.  Then, its  parent went into bankruptcy.

These related entities had filed consolidated tax returns, and the related entities became entitled, collectively, to a $4 million tax refund.

Both entities claimed the refund money, and they went to federal court to resolve the dispute.

Legal Background

When a corporate group files a consolidated tax return, regulations ensure the government gets all the taxes due.

But when it comes to distributing a refund to the group, regulations say only, (i) the IRS will pay the group’s designated agent a single refund, and (ii) the IRS’s payment discharges the government’s refund liability to all group members.

As to how group members should distribute refund money among themselves, federal law says little.  To fill the gap, many corporate groups have developed “tax allocation agreements.”  But what if:

  • there is no tax allocation agreement; or
  • the group members dispute the meaning of the terms found in their agreement?

State Law vs. Federal Law

Normally, federal courts would turn to state law to resolve such questions.  That’s because state law is ready-made for such a task.

Some federal courts, however, have crafted their own federal common law rule for this situationi.e., the “Bob Richards” rule, so named for the Ninth Circuit case from which it grew.

Federal Common Lawmaking

Initially, the Bob Richards rule provided that, in the absence of a tax allocation agreement, a refund belongs to the group member responsible for the losses leading to it.

But with passage of time in some jurisdictions, Bob Richards became the presumptive rule to be followed, absent an unambiguous tax allocation agreement—with ambiguity findings becoming common.

And that’s what had happened here.  The U.S. Tenth Circuit Court of Appeals:

  • employed an expansive version of Bob Richards, despite the existence of a tax allocation agreement; and
  • explained the question before it as, whether the allocation agreement unambiguously deviates from Bob Richards’s default rule.

Some Humility

By contrast, the U.S. Sixth Circuit Court of Appeals exercises some humility and rejects Bob Richards.  It views Bob Richards as an improper exercise of federal common lawmaking, which lawmaking can be indulged “only when there is a significant conflict between some federal policy or interest and the use of state law.”

Here’s why: our Constitution vests the federal government’s “legislative powers” in Congress, and it reserves most other regulatory authority to the states.

So, there is “no federal general common law.” Instead, only limited areas exist in which federal judges may appropriately craft the rule of decision, such as admiralty disputes and controversies between States.

Strict Conditions

Before federal common lawmaking can occur, the Supreme Court says, strict conditions must be satisfied. One of the most basic conditions is this: in the absence of congressional authorization, federal common lawmaking must be “necessary to protect uniquely federal interests.”

–None Here

No “uniquely federal interests” exist here.  The federal government:

  • may have an interest in regulating how it receives taxes from corporate groups; and
  • may have an interest in regulating the delivery of any tax refund due a corporate group (e.g., ensuring that others in the group have no recourse against federal coffers).

But the federal government has no unique interest in how a consolidated corporate tax refund, once paid, is distributed among group members.

Even the FDIC concedes that federal courts should not apply a federal common law rule in this case that puts “a thumb on the scale.”

Moreover, corporations are “creatures of state law,” which law is well equipped to handle disputes over corporate property rights.

Ruling

Here’s how the Supreme Court concludes its opinion:

  • We did not take this case to decide how it should be resolved under state law;
  • We took it only to underscore the care federal courts should exercise before taking up an invitation to try their hand at common lawmaking; and
  • “The judgment of the court of appeals is vacated, and the case is remanded for further proceedings consistent with this opinion.”

Conclusion

Federal common lawmaking can occur only when uniquely federal interests are at stake.  No such interest is at stake in Rodriguez vs.FDIC. 

Federal judges must resist the temptation to engage in federal common lawmaking; and the Bob Richards rule’s development is an example of a failure to do so.

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