United States v. Wolff; Case No. 09-1107; August 13th, 2010
The procedural history for this case is rather convoluted, but ultimately, this case involved the involuntary Chapter 7 bankruptcy of FirstPay, a company that provided payroll services to businesses. FirstPay also made the proper withholding and then made the proper payments of the withholding to the IRS at the proper time.
The company began using money intended for the IRS for its own expenses. The company then developed a sort of “ponzi scheme” using funds from some clients to pay the IRS obligations of other clients to make up for the funds that were taken.
The Trustee estimated that there were payments made to the IRS of about $300 million dollars within the three years preceding FirstPay’s bankruptcy, of which $28 million was transferred in the 90 days preceding the filing of the bankruptcy petition.
The Trustee sued the IRS on four separate grounds:
1. for declaratory judgment that the US has no claim for taxes, interest or penalties against FirstPay clients whose payroll taxes were paid to FirstPay but not remitted to the United States’
2. avoidance of preferences under 11 USC §547(b)(4)(A) and (B);
3. avoidance as fraudulent conveyances under §548 and Maryland law; and
4. turnover of preferences and/or avoided transfers under §550.
With respect to the turnover preferences, the court looked at the principles of bankruptcy law, ie “that creditors of equal priority should receive pro rata shares of the debtor’s property.” Begier v. IRS, 496 U.S. 53, 58 (1990). The question becomes, what is property of the estate? Under §541(a)(1), the commencement of a bankruptcy action creates an estate, “comprised of all legal or equitable interests of the debtor in property as of the commencement of the case.” However, “property in which the debtor holds. . . only legal title and not an equitable interest. . . becomes property of the estate only to the extent of the debtor’s legal title to the property, but not to the extent of any equitable interest in such property that the debtor does not hold.” 11 USC § 541(d).
The Court cited a similar case out of the First Circuit that found that “the plain text of §541(d) excludes property from the estate where the bankrupt entity is only a delivery vehicle and lacks any equitable interest in the property it delivers.” City of Springfield v. Ostrander, 329 F.3d 204, 210 (1st Cir. 2003).
The Court ultimately held that the Bankruptcy Court needed to take a closer look at the status of the payments held for the government; specifically, whether that property was held in trust for the government, or became the property of the debtor that was then transferred to the government.
With respect to the claims dealing with the tax obligation of third party, the court declined to change the ruling of the lower courts and affirmed “substantially for the reasons stated,” that the Trustee lacked standing to assert a claim against the government on behalf of the Debtor’s clients and that section 505(a) does not extend the bankruptcy court’s jurisdiction to parties other than the debtor.
Finally, the court addressed the District court’s ruling preventing the government from amending its answer to the Complaint to allow the entry of an affirmative defense. The Court noted that “[w]hen a party fails to assert an affirmative defense in the appropriate pleading, such a failure will sometimes result in a binding waiver.” Emergency One, Inc. v. American Fire Eagle Engine Co., Inc., 332 F.3d 264, 271 (4th Cir. 2003). The court went on to point out that it had, “nevertheless,. . . observed that where there is a waiver, it ‘should not be effective unless the failure to plead resulted in unfair surprise or prejudice.” S. Wallace Edwards & Sons, Inc. v. Cincinnati Ins. Co., 353 F. 3d 367, 373 (4th Cir. 2003). The court then cited a “longstanding approach to the liberal amendment of pleadings in the absence of undue prejudice” which “applies equally to amendments to assert affirmative defenses.”
The Court then remanded the case for further proceedings.
