Delaware Bank v. Lehman Bros.


Oral Argument
05/23/07 – 05/23/07

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Case Description: In 1999, LBH acquired Delaware Savings Bank, FSB, a federal savings bank organized under the Federal Home Owner’s Loan Act, and subject to regulation and supervision by the United States Office of Thrift Supervision, and changed its name to Lehman Brothers Bank, FSB (the “Bank”). The Bank’s federal stock charter, which became effective on June 30, 1999, designated Wilmington, Delaware as the Bank’s “home office.” That designation enabled the Bank to access FHLB funds from the Pittsburgh FHLB.In 2003, the Bank filed its 2002 Franchise Tax Return, again under subsection (a), and again claiming a line 4(b) deduction. By letter dated October 6, 2003, the Commissioner advised the Bank that its Returns for the tax years 2000-2002 were incorrect, because (in the Commissioner’s view) the Bank had no basis to claim a line 4(b) deduction. The Commissioner then recalculated the Bank’s 4 Del. Admin. C. § 1105, Item 4(b), based on 5 Del. C. § 1101(a)(1)(b)(2),liability based on the disallowance of the line 4(b) deduction, and also assessed “late penalties.” The Bank disputed both the assessment and the penalties. That dispute prompted the Commissioner to issue a notice of proceedings under 29 Del. C. § 10122 for purposes of finally determining the Bank’s franchise tax liability for tax years 2000, 2001, and 2002. In response to the Commissioner’s disallowance of the line 4(b) deduction in its 2000-2002 Returns, the Bank did not claim that deduction in its 2003 Franchise Tax Return (filed in 2004). The Bank filed its 2003 Return under subsection (a)—as before—but instead of claiming a line 4(b) deduction, the Bank reported only that portion of its income it claimed to be attributable to Delaware.On August 2, 2004, the Commissioner issued a revised notice of proceedings, this time covering the Bank’s franchise tax liability for all four years in question, i.e. 2000-2002 and 2003. An evidentiary hearing before the Commissioner was scheduled for September 30 and October 1, 2004. After it received the Commissioner’s August 2, 2004 notice, the Bank submitted amended Franchise Tax Returns for all four tax years. The basis for the amended Returns was that, for all the years at issue, the Bank was not domiciled in Delaware, contrary to what the Bank had represented in its original Returns. Therefore, the Bank should be taxed under subsection (b), only on the income reported on the 2003 Franchise Tax Return was, therefore, significantly less than the amounts reported on the Tax Returns filed for the previous three years earned from its Delaware operations. In submitting those amended Returns, the Bank reported that it used a separate accounting method, based on a study prepared by Ernst & Young, to segregate the income generated by the Bank’s Delaware retail operations from the income generated by the Bank’s “nationwide” mortgage and trust operations. Based on that accounting method, the Bank claimed that it was entitled to tax refunds for all four years, totaling approximately $14 million. After the evidentiary hearing, the Commissioner determined that because the Bank was domiciled in Delaware, subsection (a) of Section 1101 was applicable. The Commissioner further decided that the Bank was not entitled to claim a line 4(b) deduction, because it had no out-of-state “branches” or “subsidiaries.” Therefore, the Commissioner concluded that a franchise tax balance of $10.5 million was due, and assessed “late penalties” for each tax year, at a daily rate of 0.05% of the balance, to accrue at the same rate until the additional assessed tax was paid. Because the Bank has not paid the additional tax assessed, the aggregate penalties have increased to approximately $7.8 million as of the date of oral argument before the Court. The Bank appealed to the Superior Court, which upheld the Commissioner’s decision.

Proceedings Description: On appeal, the Bank advances several claims of error. The Bank first claims that the Commissioner and the Superior Court reversibly erred by concluding that the Bank was domiciled in Delaware and, thus, subject to Section 1101(a). cond, and alternatively, the Bank argues that even if Section 1101(a) is the applicable statute, the Commissioner and the Superior Court reversibly erred in holding that the Bank was subject to Delaware bank franchise tax on 100% of its income. Third, the Bank claims that the Superior Court reversibly erred in finding that the Commissioner properly refused to abate the penalties. Fourth, the Bank argues that if this Court finds that the Bank is entitled to a tax refund, the Bank is entitled to pre-judgment interest on that refund.

Outcome: The Supreme Court of Delaware upholds the Superior Court’s ruling.


The Supreme Court of Delaware upholds the Superior Court’s ruling.


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