Stock Certificates

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Securities and Exchange Commission, Plaintiff-Appellee v. Dennis Levine a/k/a Mr. Diamond, International Gold, Inc., Diamond Holdings, S.A., and Bernhard Meier, Defendants. Arden Way Associates, et al. (The Arden Way Claimants), United States of America, Robert M. Wilkis, Dennis B. Levine, and New York State Department of Taxation and Finance, Appellants

(CA-2), U.S. Court of Appeals, 2nd Circuit, 88-6294, -6296, -6298, -6300, -6302, -6304, 8/2/89, 881 F2d 1165, Affirming in part, reversing in part, vacating and remanding in part unreported District Court decision

[Code Secs. 6321 and 6322 ]

Lien for taxes: Property subject to: Limitations on: Stock certificates.--Securities and other assets obtained by an investment banker pursuant to alleged unlawful stock transactions were subject to an IRS tax lien that attached to his property prior to his disgorging, pursuant to a consent decree, the assets he allegedly obtained illegally. Also, the IRS was entitled as a matter of law to priority with respect to the lien. The tax lien could attach to the property in the alleged culprit's possession because, under state law ( New York ), even a culpable party to a voidable transaction acquires title, albeit voidable title, to the property he has received. However, IRS assessments against the assets of the investment banker and another alleged culprit made subsequent to their disgorgement of assets obtained through their alleged insider trading did not constitute liens on the disgorged assets, but only on the assets retained by the two bankers after ownership of the disgorged assets had been transferred.

Daniel L. Goelzer, General Counsel, Jacob H. Stillman, Associate General Counsel, Richard A. Kirby, Senior Litigation Counsel, Paul Gonson, Solicitor, Joseph H. Harrington, Randall W. Quinn, Securities & Exchange Commission, Washington, D.C. 20549, for plaintiff-appellee. Arthur L. Liman, Martin Flumenbaum, Lewis R. Clayton, Brad S. Karp, Robert L. Ernst, Paul, Weiss, Rifkind, Wharton & Garrison, 1285 Ave. of the Americas, New York, N.Y. 10019, for Levine. Debra L. Brown, George D. Reycraft, Richard J. Wiener, Pamela Rogers Chepiga, Cadwalader, Wichersham & Taft, 100 Maiden Lane, New York, N.Y. 10038, for Arden Way Claimants. James B. Mann, Deputy Assistant Attorney General, William S. Rose, Jr., Assistant Attorney General, James I.K. Knapp, Acting Assistant Attorney General, Gary R. Allen, William S. Estabrook, Joan I. Oppenheimer, Department of Justice, Washington, D.C. 20530, for U.S. Marvin E. Frankel, Gary P. Naftalis, Michael J. Dell, Debora K. Grobman, Kramer, Levin, Nessen, Kamin & Frankel, 919 3rd Ave., New York, N.Y. 10022, for Wilkis. Robert Abrams, Attorney General, Rosalie J. Hronsky, Assistant Attorney General, Frederic L. Lieberman, for New York State . Stanley Nemser, Wolf, Popper, Ross, Wolf & Jones, 845 3rd Ave., New York, N.Y. 10022, David Berger, Berger & Montague, P.C., 1622 Locust St., Philadelphia, Pa. 19103, for amici curiae class-action plaintiffs. Marshall E. Hanbury, General Counsel, Jay L. Witkin, Pat G. Nicolette, Deputies General Counsel, Glynn L. Mays, Senior Assistant General Counsel, Susan M. Milligan, Commodity Futures Trading Commission, Washington, D.C. 20581, amicus curiae. Kevin J. Arquit, General Counsel, Jay C. Shaffer, Deputy General Counsel, Ernest J. Isenstadt, Assistant General Counsel, Heather Hippsley, Leslie Rice Melman, Federal Trade Commission, Washington, D.C. 20580, amicus curiae.

Before OAKES, Chief Judge, KEARSE and MAHONEY, Circuit Judges.

KEARSE, Circuit Judge:

These appeals by (1) Dennis B. Levine and Robert M. Wilkis, defendants in civil actions commenced by plaintiff Securities and Exchange Commission ("SEC" or "Commission"), (2) the United States of America, to wit, the Internal Revenue Service ("IRS"), and the New York State Department of Taxation and Finance (the "State"), which have claims against Levine and Wilkis, and (3) Arden Way Associates, et al. ("Arden Way" or the "Arden Way claimants"), who are plaintiffs in a related action, challenge orders of the United States District Court for the Southern District of New York, Richard Owens, Judge, which, inter alia, imposed constructive trusts on the assets disgorged by Levine and Wilkis in the SEC actions and forbade payment of federal or state tax claims from the disgorged assets. See 689 F.Supp. 317 (S.D.N.Y. 1988). On appeal, Levine, Wilkis, the IRS, and the State contend principally that the district court erred in refusing to require the SEC to pay the tax liabilities of Levine and Wilkis out of the disgorged assets; Arden Way contends that the court abused its discretaion by approving a proposed distribution plan that does not provide for payments to Arden Way . For the reasons below, we conclude principally that the IRS is entitled to priority to the extent of approximately $8.5 million with respect to the assets disgorged by Levine; that in most other respects, the district court properly rejected the claims of Levine, Wilkis, and Arden Way; and that further proceedings are required for determination of certain additional claims advanced by the IRS.

I. BACKGROUND

The present appeals arise out of SEC civil actions against Levine and Wilkis, New York investment bankers accused of engaging in insider trading, in violation of §§10(b) and 14(e) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §§78j(b), 78n(e) (1982), and SEC Rules 10b-5 and 14e-3, 17 C.F.R. §§240.10b-5, 240.14e-3 (1988). The sequence of the procedural events does not appear to be in dispute.

A. The Civil Suit and Liens Against Levine; The Consent Judgment

On May 12, 1986, the SEC commenced its action against Levine and two of his companies (collectively referred to as "Levine"), and one Bernhard Meier for alleged violations of the above securities laws. The complaint charged that from May 1980 through May 12, 1986, Levine had purchased common stock of, or options for common stock of, 54 companies that were targets of potential tender offers or candidates for actual or contemplated mergers or other business combinations. It alleged that Levine had traded on the basis of material nonpublic information that he knew or should have known had been obtained through misappropriation or breach of fiduciary duty, and that he had thereby defrauded other investors. The complaint alleged that Levine had gained some $11 million in profits, and the SEC sought, inter alia, disgorgement by Levine and his companies of funds received as a result of his unlawful conduct.

On May 12, the day its complaint was filed, the Commission obtained a temporary restraining order prohibiting Levine from disposing of any of his assets. On May 29, the district court issued a preliminary injunction extending this temporary freeze order.

In the meantime, the IRS had been investigating Levine's federal income tax liabilities for the years prior to 1986. On May 23, 1986, it issued an assessment for 1983-1985 totaling some $11 million, including deficiencies, interest and penalties, and obtained a lien for some $8.5 million. In November 1987, the IRS issued an assessment against Levine totaling approximately $1.2 million for the years 1980-1982, obtaining an additional lien. By December 31, 1987, Levine's outstanding assessed federal tax liability for the years 1980-1985, including interest, totaled approximately $12.2 million. In December 1987, the State issued an assessment against Levine for approximately $3.8 million of state and New York City (hereafter included in State) income tax liability. All of these amounts were based on Levine's profits in the allegedly unlawful stock transactions during the years 1980-1985, profits he had not reported on his income tax returns.

On June 4, 1986, Levine executed a Consent and Undertaking ("Consent") in which, without admitting or denying any of the allegations in the complaint, he consented to the entry of a "Final Judgment of Permanent Injunction and Other Equitable Relief" ("Proposed Judgment"), as annexed to the Consent. In the Consent, which was "Approved As To Form" by the SEC, Levine agreed to the entry of a permanent injunction prohibiting him from, inter alia, buying or selling securities while he was in possession of material nonpublic information, in violation of the securities laws. Levine also agreed to cooperate fully with the Commission in any other investigation conducted by or on behalf of that body. Most importantly for purposes of the present appeal, in ¶8 of the Consent, Levine agreed to "disgorge assets of a value of approximately $11.5 million dollars [sic] to [a receiver] to be available for satisfaction of any and all claims against the defendants arising out of the purchase and sale of securities by [Levine and his companies] as alleged in the COMPLAINT or by the defendants through Bank Leu International, Ltd. [sometimes referred to as "BLI"], pursuant to a Court approved plan to be proposed by the COMMISSION." The Consent provided that the Consent and the final judgment were to be incorporated in each other.

The Proposed Judgment noted that Levine had consented to the entry of the judgment "without admitting or denying the allegations of the COMPLAINT [and] without . . . adjudication of any issue of fact or law." It provided for the appointment of a receiver to control the disgorged assets and to "distribute the assets to claimants with claims arising out of the purchase and sale of securities by Defendants as alleged in the COMPLAINT or by the Defendants through BLI, as ordered by this Court." It provided that none of the assets in the receivership estate would in any event be returned to Levine or his wife Laurie.

Under the Consent, Levine and his wife retained, inter alia, a cooperative apartment on Park Avenue, a 1983 automobile, an Individual Retirement Account, and the monies on deposit in two bank accounts. The Consent provided that Levine and his companies

will forever disclaim all right, title and interest in [the assets transferred to the receiver] except: (1) the Defendants and Laurie Levine retain the right to be heard as to the disposition of the assets held by the receiver pursuant to the FINAL JUDGMENT and (2) to the extent that any distribution of assets held by the receiver may have the effect of satisfying any claims against the defendants or Laurie Levine arising out of the purchase or sale of securities as alleged in the COMPLAINT or through BLI.

Levine acknowledged that "no promises or threats have been made by Plaintiff COMMISSION or any member, officer, agent, employee or representative thereof to induce him to enter this CONSENT except as provided herein." Consent ¶4.

On June 5, 1986, the court signed the Proposed Judgment, and it was entered as the judgment of the court ("Judgment"). The Judgment ordered Levine to comply with the terms of the Consent and to disgorge the sum described in the Consent.

On June 5, the SEC sent a letter to Levine's counsel ("SEC side letter") stating that, with respect to ¶8 of the Consent, the SEC interpreted the references to "claims arising out of the purchase and sale of securities" as including federal and state tax claims. The letter stated, in pertinent part, as follows:

[P]lease be advised that the Commission interprets the phrase "claims arising out of the purchase and sale of securities by [Levine] as alleged in the COMPLAINT or by the Defendants through Bank Leu International Ltd." to include: (1) claims for taxes due, penalties or interest thereon asserted by the Internal Revenue Service or New York State or New York City revenue authorities, based upon the securities transactions alleged in the Commission's Complaint or conducted by [Levine] through accounts at Bank Leu International Ltd., (2) any other claims, fines or penalties which may be asserted based upon the securities transactions alleged in the Commission's Complaint or conducted by [Levine] through accounts at Bank Leu International Ltd. Further, the Commission will assert all claims for disgorgement or penalties which are based upon the securities transactions conducted by the Defendants through accounts at Bank Leu International Ltd. solely against the sums to be disgorged to the receiver.

On June 19, 1986, Levine turned over approximately $10.6 million worth of assets to a receiver and transferred the remainder of the $11.5 million within a short period thereafter.

B. The Criminal Proceedings Against Levine

On June 5, 1986, the government filed a four-count information against Levine, Levine having waived indictment. Count one charged him with having used material nonpublic information to defraud his employer in connection with the purchase and sale of the stock of Jewel Companies, Inc. ("Jewel"), in violation of the federal securities laws. The remaining counts charged him with perjury and income tax evasion.

On June 11, 1986, Levine pleaded guilty to all four counts. In February 1987, he was sentenced to concurrent two-year prison terms on each count and to fines totaling $362,000.

C. Proceedings Against Wilkis

The proceedings by the SEC, the IRS, and the State against Wilkis were roughly similar to those against Levine. In later June 1986, Wilkis signed a Consent and Undertaking ("Wilkis Consent"), pursuant to which he was to "disgorge all assets in which he . . . ha[d] a beneficial interest, except for [certain enumerated assets]. . . . Wilkis estimate[d] the disgorged assets to be of a value of approximately $3.3 million dollars [sic]." Wilkis retained, inter alia, an Upper West Side cooperative apartment, a 1983 automobile, five Individual Retirement Accounts, a money market account, and the sum of $60,000. The proposed judgment incorporated in the Wilkis Consent paralleled the final judgment entered against Levine. By letter dated June 29, 1986, the Commission sent Wilkis a side letter similar to the June 5 letter it had sent Levine, construing the phrase "claims against the Defendant[ ] arising out of the purchase and sale of securities . . . ," to include claims for taxes due and penalties or interest thereon.

On July 1, 1986, the Commission filed its complaint against Wilkis, together with the Wilkis Consent and proposed judgment. The complaint alleged that since 1978, Wilkis had, inter alia, misappropriated and used material nonpublic information in order to trade in the stock of more than 52 issuers and had disclosed such information to Levine. On July 2, the district court adopted the proposed judgment and entered a Final Judgment of Permanent Injunction and Other Equitable Relief ("Wilkis Judgment").

On July 3, 1986, Wilkis turned over approximately $2.2 million worth of assets to a receiver, and an additional $1 million shortly thereafter.

On December 22, 1986, the government filed a four-count information against Wilkis, Wilkis having waived indictment. Count one charged him with having misappropriated material nonpublic information and having used it to defraud his employer in connection with the purchase and sale of the stock of Textron Inc. ("Textron"), in violation of the federal securities laws. This count also charged that Wilkis passed the information to Levine, who used it to trade in Textron stock. The remaining counts charged Wilkis with mail fraud, income tax evasion, and failure to report certain money transactions.

On December 24, 1986, Wilkis pleaded guilty to all four counts of the information. He was sentenced to various prison terms and probation.

Beginning in April 1987, the IRS obtained liens against Wilkis for federal tax liability for the years 1980-1986 totaling some $2.8 million, including deficiencies, interest, and penalties. In October 1987, the State issued an assessment against Wilkis for state and New York City (hereinafter included in State) tax liabilities in the total amount of $595,000.

D. The SEC's First Proposed Plans and the Objections to Them

In November 1987, pursuant to the consents and the judgments, the SEC submitted to the district court its proposed plans for the distribution of the disgorged assets. Under these plans, each defendant's receivership fund was to be divided into two categories, to be distributed to different groups of claimants.

With respect to the assets disgorged by Levine, approximately 42% of the fund, or $4.87 million (the "Tax Fund"), was to be distributed between the taxing authorities, i.e., the IRS and the State, in proportion to their tax claims against Levine. Approximately 58% of the Levine fund, or $6.63 million (the "Investor Fund"), was to be distributed to the so-called "Eligible Investor Claimants," defined principally as persons who sold stock in the 54 companies on the days that Levine made his alleged purchases or who suffered losses on call options they sold on the stock of those companies contemporaneously with Levine's purchases of such options.

The plan proposed for distribution of the assets disgorged by Wilkis was similar. The principal difference was that the Commission designated approximately 49% of the fund for the authorities that had asserted tax claims against Wilkis, and 51% for investor claimants.

Both plans were opposed in some aspect by virtually every interested person, including Levine, Wilkis, the IRS, the State, Arden Way, and class action plaintiffs in other lawsuits. Levine and Wilkis, relying principally on the SEC side letters, asserted that the SEC had promised to devise plans paying all of the federal and state tax claims before paying any fraud claims of private parties. Levine also contended that his criminal fines and penalties were to be satisfied out of the disgorged assets.

The IRS and the State objected to each proposed plan on the ground that they enjoyed statutory preferences requiring them to be paid before other creditors. The IRS invoked principally 26 U.S.C. §§6321 and 6322 (1982), under which federal tax liens are given priority in the distribution of receivership assets.

The Arden Way claimants, who were limited partners in an entity affiliated with Ivan F. Boesky whom they had sued with Levine, alleging that Levine had aided and abetted Boesky in a fraudulent scheme, also objected to the SEC's proposed plan. The plan did not include Arden Way among the investors to whom distributions were to be made, and they objected on the ground that Levine would be insolvent as a result of his disgorgement and thus unable to satisfy their claims against him.

The representatives of a plaintiff class of allegedly defrauded investors to whom the Investor Fund would be distributed supported the plans in large part. These investors, who had brought suits against Levine, Wilkis, and Boesky, took issue with the proposed method of calculation of a given investor's loss and with the treatment of persons who had traded in options.

In response to the various objections, the SEC argued, inter alia, that it had made no promises to Levine or Wilkis to give priority to payment of their tax liabilities. It stated that the consents belied any such promises, that the parol evidence rule prohibited consideration of any alleged oral promises, and that the side letters had merely "confirm[ed] that the Commission considered tax claims among those that could potentially be satisfied from the disgorged assets."

In opposition to the arguments of the IRS and the State that they enjoyed statutory priority, the SEC argued that Levine and Wilkis had "acquired no title to this money, no interest in this money," and hence the disgorged assets had never been property of the defendants to which tax liens could attach. The Commission argued that the profits had remained the property of the defrauded investors, who had "a valid, constructive trust claim to the monies which were identifiable proceeds of the defendants' illegal trading." As to the objections of Arden Way, the SEC argued that the Arden Way claimants lacked standing to oppose the plans.

The Commission urged the court to approve each plan as a fair accommodation of the various competing interests.

E. The District Court's Rejection of the Initial Plans

In July 1988, in an opinion reported at 689 F.Supp. 317, the district court rejected most of the objections to the plans, but also rejected the plans themselves. The court rejected Levine's argument that his criminal fine should be paid out of the disgorged assets, finding that neither the Consent nor the Judgment provided for such payment. Further, deeming it "almost an affront to suggest that those defrauded by Levine's insider trading activities should have their recovery reduced by the amount of his fine," the court held that the fine should not be paid out of Levine's illegal gains "to the detriment of investors" because the fine was "personal and punitive in nature." Id. at 321.

Addressing the contentions of Levine and Wilkis that the SEC had promised to give their tax debts priority, the court found those arguments untenable by reason of mutual mistake and, in any event, barred by the parol evidence rule.

Since this Court is sitting in equity to review the distribution of the assets currently in receivership, I reject the defendants' claims that the SEC, in entering into side letter agreements with defendants, agreed to accord tax claims priority status to the obvious reduction of the fund available for defrauded investors. A mere cursory review of the parties' representations as to their respective interpretations of the side letters reveals that they did not by any means attach the same or even a similar meaning to these letters. The SEC contends that it intended merely to delineate the group of eligible claims from the receivership funds, defining tax claims as being included under this rubric. Attorneys for Levine and Wilkis, on the other hand, argue strenuously that oral representations by the SEC, when viewed together with the side letters, provided assurance that tax claims were guaranteed to be satisfied on a priority basis. The letters themselves are arguably consistent with either view.

Given the parties' complete disagreement on the intent of the side letter agreements, I must and do treat these letters as void and of no effect here based on mutual mistake of the parties and do not consider them in construing the terms of Wilkis's or Levine's Consent[s] . . . or Final Judgments. Restatement (Second) of Contracts §152 at 385 (1981) states that "where a mistake of both parties at the time a contract was made as to a basic assumption on which the contract was made has a material effect on the agreed exchange of performances, the contract is voidable" (emphasis added). There is no question that treatment of tax claims in the distribution of receivership assets was a hard-fought and much debated issue, and that the underlying assumptions regarding resolution of this issue have had (and continue to have) a material effect on post-agreement proceedings. It is also evident that affording priority to tax claims would leave little or nothing for satisfaction of investors' claims while at the same time conferring substantial benefits on defendants. Under the equity powers of this Court, therefore, the side letters are voided.

689 F.Supp. at 320-21. The court also noted that " 'the scope of a consent decree must be discerned within its four corners, and not by reference to what might satisfy the purposes of one of the parties to it,' " id. at 321 (quoting United States v. Armour & Co., 402 U.S. 673, 682 (1971) (district court's emphasis deleted)), and concluded that Levine and Wilkis were barred by the parol evidence rule from relying on the side letters or any contemporaneous oral representations as modifications of the terms of the consents or the judgments.

The court rejected the arguments of the IRS and the State that their tax liens had priority over other claims ruling that those liens had not attached in the first instance because Levine and Wilkis

obtained the assets they disgorged through illegal trading activities. These assets are therefore analogous to funds which have been embezzled or misappropriated, as they were obtained by wrongful means and cannot properly be considered property of the defendants. Title to the funds was "acquired . . . under such circumstances that [one] is under a duty to surrender it[.]" United States v. Fontana [82-1 USTC ¶9237 ], 528 F.Supp. 137, 146 (S.D.N.Y. 1981), quoting 5 A. Scott, Law of Trusts §462.4 (3d ed. 1967). Consequently, Levine and Wilkis held but bare legal title to these funds from the time they were obtained, with equitable title arising in investors who were injured as a result of their illegal activities. See SEC v. Paige [85-2 USTC ¶9588 ], (D.D.C. July 30, 1985) (under general rule of common law the victim, and not the embezzler, retains title to funds), aff'd, 810 F.2d 307 (D.C.Cir. 1987) . . . . Thus, neither defendant ever had such property interests in the funds to which tax liens could have attached. Instead, holding bare legal title, they serve as trustees for the benefit of defrauded investors.

689 F.Supp. at 321-22.

The court further rejected the SEC's election to pay even a portion of the tax claims against Levine and Wilkis. It concluded that equity dictated imposition of a constructive trust holding all of the disgorged assets for defrauded investors in order to achieve two goals:

the first is restitution to injured investors and the second is preventing Levine and Wilkis from enjoying personal gain in the form of payment of their tax liabilities . . . . Consequently, it is legally and equitably appropriate to declare and recognize that a constructive trust arose at the time of Levine's and Wilkis's wrongdoing . . . and that the disgorged profits are therefore held for the satisfaction of investors' claims.

Id. at 322 (footnote omitted).

The district court found no fault, however, with the SEC plans' exclusion of the Arden Way claimants from the class of persons entitled to make claims against the disgorged assets. The court noted that those claimants asserted "general-type damages . . . much less directly linked to Levine's activities than the harm he caused contemporaneous investors," and that "[t]herefore, the Arden Way claimants do not enjoy a similar priority to Levine's disgorged assets." 689 F.Supp. at 323 n.7.

In sum, the court disapproved the SEC's proposed plans because they included provision for payment of the tax claims, and it directed the Commission to submit revised plans. The court noted that "[s]hould there be funds remaining after the investors' claims have been satisfied, in that event the Court will deal with the issue of relative priorities to such remainder as between Arden Way, the IRS or any other claimants." Id.

F. The SEC's New Plans

In August 1988, the SEC submitted amended plans of distribution. These plans proposed that, except for an administrative reserve, the entire fund would be distributed to "Eligible Claimants," defined in the way that "Eligible Investor Claimants" had been defined in the SEC's originally proposed plans. Thus, virtually all of the disgorged assets were earmarked for defrauded investors, with no allocation for tax liens.

Those who had objected to the original SEC plans objected to the revised plans. In a Memorandum and Order dated October 25, 1988, the court approved the new plans.

The court certified the issues for immediate appeal pursuant to 28 U.S.C. §1292(b) (1982), and this Court granted leave to appeal.

II. DISCUSSION

On appeal, Levine and Wilkis contend that the district court erred in not construing the consents and judgments, as augmented by the SEC letters, to require the SEC to pay their assessed tax liabilities out of the disgorged assets. Levine contends that his criminal fines should similarly be paid out of those assets. The IRS and the State contend that as a matter of law their claims have priority and that the district court erred in not ordering their liens satisfied out of the disgorged assets prior to satisfaction of the claims of any other claimants. Arden Way contends that the district court erred in failing to require that the SEC plan make provision for the satisfaction of their claims out of the disgorged assets. For the reasons below, we conclude that the consents do not require the SEC to give priority to either the criminal fines or the claims of the taxing authorities; that the IRS is entitled as a matter of law to priority with respect to the lien that attached to Levine's property prior to June 19, 1986; that exclusion of the Arden Way claims was a permissible exercise of the Commission's discretion; and that the matter should be remanded for consideration of the IRS's alternative theories of priority and for the SEC to devise plans for the distribution, to the State and other claimants, of any disgorged assets remaining after payment of preferred IRS claims.

A. IRS Priority Under §§6321 and 6322

The IRS contends that as to the tax liabilities it has assessed against Levine and Wilkis, it is entitled as a matter of law under 26 U.S.C. §§6321 and 6322 to payment in full from the assets they, respectively, disgorged. We conclude that under these sections the IRS was entitled to payment from Levine's disgorged assets of its lien filed against his property prior to June 19, 1986, but not with respect to its later assessments against Levine and not with respect to its assessments against Wilkis.

Section 6321 of the Internal Revenue Code provides as follows:

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.

26 U.S.C. §6321 . Section 6322 , in pertinent part, provides that the §6321 lien "shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed . . . is satisfied or becomes unenforceable by reason of lapsed of time." 26 U.S.C. §6322 . The district court rejected the contention that §6321 gave the IRS priority, stating that the assets turned over to the receiver were "analogous to funds which have been embezzled or misappropriated, as they were obtained by wrongful means and cannot properly be considered property of the defendants. . . . Thus, neither defendant ever had such property interests in the funds to which tax liens could have attached." 689 F.Supp. at 321-22. We have two difficulties with the court's ruling.

First, the view that the assets "were" obtained by wrongful means suggests that the allegations of the SEC complaints had somehow been established. In fact, the court in the present case had made no such adjudication; the consents specified that the defendants neither admitted nor denied any of the allegations of the civil complaints; and the judgments specified that they were consented to without admission or adjudication. It is true that between the signing of the consents and the SEC's presentation of the distribution plans, both Levine and Wilkis had pleaded guilty to the criminal informations filed against them. But the charges in those information were by no means coextensive with the allegations of the SEC's civil complaints. The Levine information mentioned only one specified issuer, i.e., Jewel; the civil complaint against him alleged unlawful transactions not only in the securities of Jewel but in securities of 53 other identified issuers as well. The Wilkis information likewise mentioned only one issuer, i.e., Textron; the civil complaint against Wilkis alleged that he had also committed unlawful acts with respect to the securities of more than 50 other issuers. The pleas of guilty thus did not establish wrongdoing in the vast majority of the transactions at issue in the civil suits. For more than 98% of the securities adverted to in the SEC civil suits, there was neither an adjudication nor a concession to ground the district court's premise that the disgorged assets were obtained as a result of the unlawful conduct alleged in the SEC complaints.

Second, even assuming that all of the allegations in the SEC complaints had been established, the district court's conclusion that Levine and Wilkis did not have property rights in the assets they disgorged was not warranted by the applicable legal principles. In determining whether the disgorged assets constituted "property . . . belonging to" the assessed taxpayer within the meaning of §6321 , we look principally to state law, for "it has long been the rule that 'in the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property . . . sought to be reached by the statute.' " Aquilino v. United States [60-2 USTC ¶9538 ], 363 U.S. 509, 513 (1960). Nonetheless, though the federal tax lien statute " 'creates no property rights but merely attaches consequences, federally defined, to rights created under state law,' " id., other provisions of federal law may prevent the formation of such rights. Thus, if a taxpayer has purportedly acquired an interest by means of a transaction that violated a federal statute, the court should consider whether the federal statute has made the supposed transfer of property void:

When a federal statute condemns an act as unlawful, the extent and nature of the legal consequences of the condemnation, though left by the statute to judicial determination, are nevertheless federal questions, the answers to which are to be derived from the statute and the federal policy which it has adopted. To the federal statute and policy, conflicting state law and policy must yield.

Sola Electric Co. v. Jefferson Electric Co., 317 U.S. 173, 176 (1942). If federal law made violative transactions void, the court would properly conclude that the transferee had thereby acquired no property right.

In the present case, the district court refused to recognize statutory priority for the IRS assessments against Levine and Wilkis on the ground that they had engaged in fraudulent transactions in violation of the 1934 Act, that those transactions were void, and that Levine and Wilkis therefore had acquired no property interest in the securities thereby obtained. The long-established interpretation of the 1934 Act, however, does not support the district court's construction. Section 29 of the 1934 Act provides, in pertinent part, that:

[e]very contract made in violation of any provision of this chapter or of any rule or regulation thereunder . . . shall be void (1) as regards the rights of any person who, in violation of any such provision, rule, or regulation, shall have made or engaged in the performance of any such contract, and (2) as regards the rights of any person who, not being a party to such contract, shall have acquired any right thereunder with actual knowledge of the facts by reason of which the making or performance of such contract was in violation of any such provision, rule, or regulation.

. . .

15 U.S.C. §78cc(b) (1982). Notwithstanding this section's use of the word "void," judicial interpretation has established that this provision "render[s] the contract merely voidable at the option of the innocent party." Mills v. Electric Auto-Lite Co., 396 U.S. 375, 387 (1970); see id. at 386-88. Thus the contract remains in force until the innocent party exercises his right to have it judicially set aside. Since federal law does not make the unlawful securities transaction void, but merely voidable, we must look to state law to see what property rights are conferred by a voidable transaction. See Aquilino v. United States, 363 U.S. at 513.

Under New York law, the culpable party to a voidable transaction acquires title, albeit voidable title, to the property he has received. Stanton Motor Corp. v. Rosetti, 11 A.D.2d 296, 203 N.Y.S.2d 273 (3d Dep't 1960). He may convey good title to a good-faith purchaser, see, e.g., Hartford Accident & Indemnity Co. v. Walston & Co., 21 N.Y.2d 219, 287 N.Y.S.2d 58 (1967); Stanton Motor Corp. v. Rosetti, 11 A.D.2d 296, 203 N.Y.S.2d 273, and an innocent party's lien may attach to the property in the culprit's possession, unencumbered by the equities between the parties on either side of the fraud, see Mendelsohn v. R. Simpson & Co., 267 A.D. 564, 47 N.Y.S.2d 489 (1st Dep't 1944). Since federal law makes contracts violating the 1934 Act voidable at the option of the victim, and state law grants title until the contract is voided, we conclude that property acquired by Levine or Wilkis in violation of the 1934 Act constituted property to which the federal tax lien could attach.

We note in passing that in general under state law a party who acquires property from a defrauding party and who has actual knowledge of the fraud may himself acquire only voidable title, see Anderson v. Blood, 152 N.Y. 285 (1897), and that the IRS, as part of the government, could be deemed to have knowledge of the wrongdoing attributed to Levine and Wilkis by other parts of the government. This state-law principle, however, cannot prevent attachment of a valid IRS lien because state law controls only with respect to the question of whether the taxpayer had a property interest. Once the latter question is answered in the affirmative, the validity of the government's tax lien is governed by federal law. See United States v. National Bank of Commerce [85-2 USTC ¶9482 ], 472 U.S. 713, 722-23 (1985). "State law define[s] the nature of the taxpayer's interest in the property, but the state-law consequences of that definition are of no concern to the operation of the federal tax law." Id. at 723; see also United States v. Bess [58-2 USTC ¶9595 ], 357 U.S. 51, 55-57 (1958) (fact that property in question was of a type that under state law was not attachable by creditors' liens did not impede attachment of federal tax lien).

In sum, under federal law, Levine and Wilkis entered into contracts that were not void but merely voidable; state law gave them a property interest in the securities thereby acquired; and under federal law, that property interest was subject to a tax lien in favor of the government under §6321 .

The acquisition of these property interests does not, however, mean that the IRS is necessarily entitled to prevail on all of its claims here, for Levine and Wilkis lost their property rights in the disgorged assets at the time of disgorgement. They transferred all "right, title and interest" in those assets to the receiver, and both consent judgments provided that "[n]o part of the receivership estate shall in any event be returned to the Defendants, . . . their successors, heirs or assigns." Even if the assets in the receivership estate exceeded the value of the claims and the expenses of the receiver, the excess was not to be returned; rather, the balance was to be paid to the United States Treasury as a civil penalty. In transferring the assets, Levine and Wilkis reserved only the right to be heard as to the disposition of the assets. The right to be heard is not the power to control disposition, and the reservations that were agreed to were not sufficient to preserve ownership in the disgorged assets.

The facts that Levine and Wilkis acquired title to the assets in question prior to 1986 and yielded ownership on disgorgement in 1986 have varying implications for the claims at hand.

1. The IRS Liens With Respect to Levine

Preliminarily, we note that the Commission suggests that Levine had lost his property rights in the disgorged assets prior to the IRS's first assessment against him on May 23, 1986, by virtue of the freeze order that was entered by the court on May 12. We reject this contention. The May 12 order was a temporary restraining order prohibiting Levine and his codefendants from "withdrawing, transferring, pledging, encumbering, assigning, dissipating, concealing or otherwise dealing with or disposing of any securities, funds or other assets of any of the defendants whatsoever and wherever situated or permitting any of the foregoing." Though the order required the defendants to deposit securities, funds, and other assets with the court immediately, in order to preclude dissipation, that relief was of a temporary character, as the order contemplated that after the deposits were made, the defendants would show cause why "each of the defendants" should not "hold and retain [these assets] within his or its control." The freeze order plainly did not purport to adjudicate Levine's right eventually to regain possession or full use of the property. Cf. United States v. Safeco Insurance Co. of America, Inc. [89-1 USTC ¶9227 ], 870 F.2d 338, 341 (6th Cir. 1989). Although the restrictions were sufficiently significant to implicate due process concerns, see United States v. Moya-Gomez, 860 F.2d 706, 725-26 (7th Cir. 1988), they did not deprive Levine of ownership.

As noted above, §6322 provides that an IRS lien attaches to the taxpayer's property at the time the assessment is made. Levine transferred ownership of nearly all of his disgorged assets on June 19, 1986. The IRS made its first assessment against him, giving rise to a lien of some $8.5 million, on May 23, 1986. The assessment created a lien on all of the property owned by Levine at that time. That property included the assets that were later transferred to the receiver. Accordingly, the IRS has a lien in that amount on the disgorged assets.

In contrast, the IRS's subsequent assessment on Levine occurred after disgorgement. Though this assessment too created a government lien on all the property then owned by Levine, Levine did not then own the disgorged assets. Hence, the IRS does not have a lien on the disgorged assets resulting from the later assessment.

Under §6321 , therefore, the IRS is entitled to priority payment from Levine's disgorged assets in the amount of approximately $8.5 million, and no more. On remand, the district court will determine the precise amount of the lien.

2. The IRS Lien With Respect to Wilkis

Wilkis disgorged most of his assets to the receiver on July 3, 1986, and the remainder by October 1986. All of the IRS's assessments on Wilkis occurred in 1987, subsequent to his disgorgements. Though these assessments created government liens on all the property then owned by Wilkis, Wilkis did not then own the disgorged assets. Hence, §6321 did not give the IRS a lien on any of the assets disgorged by Wilkis.

B. The IRS Claim of Priority Under 31 U.S.C. §3713(a)

The IRS argues, alternatively, that it is entitled to priority under 31 U.S.C. §3713(a)(1)(A) (1982). That section provides that a government claim is entitled to priority over the claims of others if the person indebted to the government is insolvent, lacks sufficient property to pay all his debts, and makes a voluntary assignment of property, or if that person is insolvent and commits an act of bankruptcy. Since liability for federal income tax arises shortly after the end of the taxpayer's year, i.e., at the time the tax return is due, see 26 U.S.C. §6151(a) (1982); Viles v. Commissioner [56-1 USTC ¶9539 ], 233 F.2d 376, 379-80 (6th Cir. 1956), and the taxpayer at that time becomes indebted to the government for any amounts not then or theretofore paid, the present argument is that, regardless of when the assessments were made, Levine and Wilkis were indebted to the government at the time of their disgorgements, and the disgorgements to the receiver triggered application of §3713(a)(1)(A). We are not in a position to rule definitively on the applicability of that section. Assuming arguendo that the appointment of a receiver would generally constitute an act of bankruptcy, but see Nolte v. Hudson Nav. Co., 8 F.2d 859, 866 (2d Cir. 1925) (appointment of receiver not necessarily act of bankruptcy within meaning of predecessor to §3713(a)); cf. Manufacturers' Finance Co. v. McKey, 294 U.S. 442, 447 (1935) (same with respect to bankruptcy statute), or that the assignment in the circumstances of this case can be termed "voluntary" within the meaning of the statute, the record does not indicate that the government established the insolvency of either Levine or Wilkis. Each was allowed to retain certain specified assets; the record is vague as to the extent of their debts.

The government's §3713(a) argument was rejected in the district court on the ground that the assets in question were held in constructive trust. In all the circumstances, and in light of our discussion in Part II.D. below, we leave it to the district court to consider this argument on remand.

C. The Claims of the State

For reasons similar to those prompting our rejection of the IRS's claim of priority against Wilkis under 26 U.S.C. §6321 , see Part II.A.2. above, we reject the claims of the State to priority on its claims against the assets disgorged by Levine and Wilkis. New York law provides that a line in favor of the State attaches to a taxpayer's property, following the satisfaction of several preconditions, including notice, demand, and the filing of a warrant with the appropriate county clerk. N.Y. Tax Law §§692(b) -(d) (McKinney 1987). As indicated in Parts I.A. and I.C. above, the State's liens attached in late 1987, long after the transfers of assets by Levine and Wilkis to the receiver. Since Levine and Wilkis no longer had any property rights to the transferred assets at the time the State's liens attached to their property, the liens attached only to such property as those individuals retained, not to the assets they had disgorged.

D. The Effects of the Consents

Levine and Wilkis contend that even if the IRS and the State did not have priority for their tax claims as a matter of law, the consent judgments, read in light of the SEC side letters, required that those claims be given priority over the claims of others. Levine also contends that those documents required that his criminal fines be given priority. For the reasons below, we reject these contentions, though we conclude that the district court was not entitled to reject the SEC's initial plans merely because they proposed to pay a portion of the tax claims.

1. General Principles With Respect to Consent Judgments

The SEC suggests that the principal issue before us on these appeals is

whether a court of equity, as part of its ancillary relief in a Commission enforcement action, properly held that a constructive trust should be recognized in the disgorged illegal trading profits for the benefit of the victims of that trading or whether those trading profits should be used to pay taxes, penalties and interest that the defendants owe because they failed to report their illegal trading profits as income.

We disagree. Though this might be a proper characterization of the issues if we were reviewing relief granted after adjudication, it ignores the fact that the Commission gained control of the defendants' assets and was given the authority to propose plans for distribution of those assets only as a result of judgments entered on consent.

A consent judgment, though it is a judicial decree, is principally an agreement between the parties. Such judgments "should be construed basically as contracts, without reference to the legislation the Government originally sought to enforce but never proved applicable through litigation." United States v. ITT Continental Baking Co., 420 U.S. 223, 236-37 (1975). Thus, consent judgments should be interpreted in a way that gives effect to what the parties have agreed to, as reflected in the judgment itself or in documents incorporated in it by reference:

Consent decrees are entered into by parties to a case after careful negotiation has produced agreement on their precise terms. The parties waive their right to litigate the issues involved in the case and thus save themselves the time, expense, and inevitable risk of litigation. Naturally, the agreement reached normally embodies a compromise; in exchange for the saving of cost and elimination of risk, the parties each give up something they might have won had they proceeded with the litigation. Thus, the decree itself cannot be said to have a purpose; rather the parties have purposes, generally opposed to each other, and the resultant decree embodies as much of those opposing purposes as the respective parties have the bargaining power and skill to achieve. For these reasons, the scope of a consent decree must be discerned within its four corners, and not by reference to what might satisfy the purposes of one of the parties to it. Because the defendant has, by the decree, waived his right to litigate the issues raised, a right guaranteed to him by the Due Process Clause, the conditions upon which he has given that waiver must be respected, and the instrument must be construed as it is written, and not as it might have been written had the plaintiff established his factual claims and legal theories in litigation.

United States v. Armour & Co., 402 U.S. 673, 681-82 (1971) (footnote omitted; emphasis in original); see United States v. ITT Continental Baking Co., 420 U.S. at 233-37. In keeping with these principles, we have noted that a court construing a consent decree is "not entitled to expand or contract the agreement of the parties as set forth in the consent decree." Berger v. Heckler, 771 F.2d 1556, 1568 (2d Cir. 1985).

Construction of the consent judgment as a contract is constrained by traditional contract principles. Thus, documents that are expressly incorporated in the consent judgment should be considered. See United States v. ITT Continental Baking Co., 420 U.S. at 238. Extrinsic evidence, however, may generally be considered only if the terms of the judgment, or of documents incorporated in it, are ambiguous. See, e.g., Schurr v. Austin Galleries of Illinois, Inc., 719 F.2d 571, 575 (2d Cir. 1983) (applying New York law). With few exceptions, none of them pertinent here, evidence of contemporaneous agreements is not admissible in evidence to contradict a term of the writing. Restatement (Second) of Contracts §215 , at 136 (1981).

With these principles in mind, we turn to the questions of whether SEC payment of the tax claims and criminal fines was required or permissible.

2. Consensual Priority for the Tax Claims and Criminal Fines

Within the above framework, each defendant's consent and judgment are properly read in tandem, for each consent incorporated the pertinent judgment by reference and provided that the consent was incorporated into that judgment. None of these documents, however, referred to or incorporated the SEC side letters. As set forth below, we conclude that the district court properly found there was no consensual priority for the criminal fines or tax claims over other claims since (1) the consents and judgments did not provide for priority, (2) the side letters or oral exchanges could not be used to vary the terms of the judgments, and (3) even if the side letters were considered, they did not provide for priority.

The documents submitted to the court as the parts of the judgment to be entered, i.e., the consents and the proposed judgments, did not purport to establish any priorities. Paragraph 8 of each consent stated that the disgorged funds were to be available for the satisfaction of any and all claims against Levine and Wilkis, respectively. Neither document stated that any class of claim would be preferred over any other class. Nor did the documents state that the funds were to be disbursed ratably or in proportion to the size of the claims asserted. Rather, the consents stated simply that the assets were to be distributed in accordance with a plan proposed by the SEC and approved by the court. Thus, a straightforward reading of these documents leads to the conclusion that the Commission was accorded substantial discretion in fashioning plans for the payment of claims against Levine and Wilkis arising out of the purchase and sale of securities alleged in the respective complaints.

We reject the arguments of Levine and Wilkis that the criminal fines and tax claims should have been given priority on the theory that the SEC had orally promised such priority during negotiations and had written the side letters to memorialize this undertaking. Plainly the terms of the documents could not properly be varied by oral promises. Nor were the side letters admissible to provide the advocated variation since the consents and judgments neither incorporated the side letters by reference nor provided that those letters could be looked to for assistance in interpreting the terms of the consents, and since the terms of the consents and the judgments were not in any significant respect ambiguous. Thus, we conclude that, as a matter of contract law, extrinsic evidence was not admissible to vary their terms.

Even if the SEC side letters were admissible, however, they would not warrant the interpretation advocated by Levine and Wilkis, for their language simply did not purport to require the SEC to give priority to the tax claims and criminal fines. Each letter stated that the SEC "interprets the phrase 'claims' " against that defendant " 'arising out of the purchase and sale of securities . . . as alleged in the COMPLAINT . . .' to include" tax claims and fines, etc. (Emphasis added.) Nowhere in either letter is there any indication that "inclu[sion]" was intended to mean placement at the top of a prioritized list.

Finally, we are constrained to note that the consent judgment is a special variety of contract, since it is a judicial decree. Thus, it is backed by the court's power to enforce compliance with it by means not available for the enforcement of ordinary contracts, e.g., by the court's power to hold a breaching party in contempt. This factor prompts us to observe that, when the parties have presented documents to the court that purport to reflect the boundaries of their agreements, and the court has given its official approval to those terms, the parties are not entitled to vary those terms without court approval. The court is not required to enforce, as part of the consent judgment, terms that it has not approved. It is an entirely appropriate exercise of the court's discretion to reject later-asserted variations that apparently were agreed to earlier than or contemporaneously with the judgment and that are virtually contradicted by the documents actually presented to the court. In Wilkis's case, for example, the SEC side letter is dated June 29, 1986. The SEC's complaint, the consent, and proposed judgment were submitted to the court on July 1. Thus, had the parties wished to have the terms of that letter deemed part of the judgment entered by the court they could easily have so provided and submitted it to the court. Instead, the Wilkis Consent and proposed judgment were submitted to the court for signing and entry without disclosure that there were any oral promises or side agreements, and, instead, with the express representation that "no promises . . . except as provided herein" (Wilkis Consent ¶4, emphasis added) had been made to induce Wilkis's agreement.

For all of the above reasons, we conclude that the district court properly rejected the contentions of Levine and Wilkis that the SEC, by agreement, was required to give priority to the payment of tax claims or criminal fines.

3. The SEC's Original Plans

On the other hand, we believe the district court did not give proper effect to agreements that in fact were reflected in the consents and judgments. Primarily, we conclude that, because these were consent judgments and because the consents and judgments gave broad discretion to the SEC to propose plans for the distribution of the disgorged assets, the district court erred in disapproving so much of the original SEC plans as provided for payment of portions of the tax claims against Levine and Wilkis and in interposing its equity powers to impose constructive trusts.

The district court imposed constructive trusts because of its views that the assets disgorged by Levine and Wilkis had been "obtained by wrongful means," i.e., "obtained . . . through illegal trading activities," and that as a matter of equity, those assets should be used not to pay defendants' taxes but to provide "restitution to injured investors and . . . [to] prevent[] Levine and Wilkis from enjoying personal gain." 689 F.Supp. at 322. The court further stated that if the amount of disgorged funds exceeded the claims of contemporaneous investors, the court would determine the priorities among the other claimants. For two reasons, we conclude that the court expanded its role inappropriately.

First, the district court's premise was that all of the assets disgorged were the fruits of illegal transactions as alleged in the present complaints. As discussed in Part II.A. above, however, Levine and Wilkis did not admit those allegations; the allegations were not adjudicated in the present action; and the criminal proceedings with respect to each defendant involved only one of more than 50 securities at issue in his civil case. Thus, the court's premise overstated what was established by the record.

Second, as the Supreme Court noted in Armour, when a defendant agrees to a consent judgment, he "waive[s] his right to litigate the issues raised, a right guaranteed to him by the Due Process Clause," and thus, "the conditions upon which he has given that waiver must be respected." 402 U.S. at 682. We have seen no reason in the present cases to depart from the general rule that the proper role of the court vis-a-vis a consent judgment is to give effect to the terms negotiated by the parties. All of the cases relied on by the district court--or by the SEC in support of the district court's decision--for the proposition that a court may properly impose a constructive trust were cases in which the wrongdoing alleged had been established by adjudication. We are unaware of any case in which a constructive trust has been imposed in the absence of consent and in the absence of an adjudication. When the parties have agreed to confer on either party certain rights or privileges, and those agreements have been embodied in a judgment approved by the court, the court is not free to expand or constrict those terms or to impose unagreed-to equitable remedies that it might have fashioned "had the plaintiff established his factual claims and legal theories in litigation." Id.

To be sure, when the district judge is presented with a proposed consent judgment, he is not merely a "rubber stamp." If he found, for example, that the proposed decree would not further the objectives of the law on which the complaint was based, he could properly decline to approve the proposed judgment. See Local No. 93, International Association of Firefighters v. City of Cleveland, 478 U.S. 501, 525 (1986); see generally id. at 524-29. But if he elected to disapprove unless a certain term that he thought appropriate were included, the parties would have the options of including that term or declining to proceed with the consent judgment. For example, had the Levine Consent and Proposed Judgment provided that Levine's taxes and criminal fine were to be paid out of the assets he disgorged, and had the court refused to enter such a judgment, Levine would have been free not to go forward with the settlement. Once the judgment consented to has been entered as the judgment of the court, the court is by and large required to honor the terms agreed to by the defendant. But see System Federation No. 91, Railway Employes' Department v. Wright, 364 U.S. 642, 651 (1961) (court may subsequently modify decree if law has changed).

In accordance with these principles, we note that if the consent judgments in the present matters had explicitly required the SEC to pay a portion of the defendants' taxes out of the disgorged assets, the district court would have been obliged to enforce those provisions. These judgments did not so provide; but they did provide that the SEC was to devise plans for the distribution of the disgorged assets. It is true that each judgment provides that the court "shall . . . determine the appropriate disposition of the assets held by the receiver," but the consents and judgments repeatedly state that the court-approved plan is "to be proposed by the COMMISSION." Implicit in this language was a grant of discretion to the Commission, including the flexibility to decide that certain groups of claimants would receive payments and others would not. No restrictions were imposed on the Commission's authority to make these choices or to give priority to one group over another. Though the Commission's discretion was made subject to the approval of the court, the consents and proposed judgments made clear that the parties gave primary responsibility for devising a plan to the Commission. By approving the proposed judgments, the district court approved the grants of discretion to the SEC.

In light of these provisions, we conclude that the district court was not empowered to exclude from the distribution plans any legitimate claimant or class of claimants designated as eligible by the SEC's plans. Thus, if the SEC believed it appropriate to use a portion of the disgorged assets to pay a portion of the tax claims, federal or state, against the defendants, the court was not entitled to forbid that allocation.

Nor was the court, having entered the consent judgments, entitled to impose its own views as to the appropriate priorities among legitimate claimants and to reorder the choices made by the SEC. For example, though the district court rejected the contention of the Arden Way claimants that they were entitled to be included in the SEC's distribution plan because the claims of contemporaneous investors were more worthy than the more "general" claims of Arden Way in the eyes of the court, we uphold the result on the basis that the exclusion of those claimants was within the prerogative of the Commission. Similarly, the court's statement that if the approved distributions did not exhaust the disgorged funds the court would decide the priorities among the remaining claimants was beyond the scope of its authority. The consent judgments conferred that authority principally on the SEC.

In sum, we conclude that whether or not the court would have been empowered to impose a constructive trust on assets disgorged pursuant to a judgment entered after adjudicating claims unfavorably to a defendant, it did not have a proper basis for imposing such trusts here.

Finally, though we note that the Commission states on these appeals that it "believes that Congress did not intend to allow identifiable, unlawfully obtained property rightfully belonging to the victims of securities fraud, to be used to pay the wrongdoer's taxes," we decline to adopt this position principally for two reasons. First, for the reasons stated in Part II.A.1. above, we have concluded that certain of the predisgorgement tax claims have priority as a matter of federal law. We would find it difficult, in light of this conclusion, to conclude that as a matter of public policy payment of postdisgorgement assessments, simply because they were made later, is forbidden. Second, the SEC's original position, as stated to the district court, was that tax claims were among those that could potentially be satisfied from the disgorged assets, and that its initial plans, which proposed some distribution to the taxing authorities and some to defrauded investors, were fair accommodations of the various competing interests. There being no apparent reason to believe the initial plans were contrary to public policy or were proffered or endorsed by the Commission in bad faith, we think those plans, except to the extent that IRS statutory priorities interfered, should have been upheld.

We do not mean to suggest that the Commission could not properly have taken the position from the outset that no voluntary payments would be made to the taxing authorities. Just as we deem it within the Commission's discretion, under the consents and judgments negotiated here, to exclude the criminal fines imposed against Levine or the claims of persons such as the Arden Way claimants, we think the Commission could properly have exercised the discretion conferred on it in any of a number of ways. If a defendant wishes to ensure that a certain class of claims will be paid out of funds to be disgorged in settlement of an action against him, he is free to insist in negotiations that such a provision be included in the consent and judgment and is free not to agree to the judgment if the desired provision is not included. In the absence of such an enforceable agreement, however, the defendant has no assurance that the allocation he desires will be forthcoming.

In the present case, though the defendants did not have the right to compel specific allocations because they did not negotiate inclusion of such an agreement by the Commission in the consent judgments entered by the court, we conclude that since the SEC exercised its discretion in the first instance to propose distribution of part of the disgorged funds to the taxing authorities and urged the court to approve those plans as fair accommodations of the various competing interests, and since there is no public policy of which we are aware that would preclude that exercise of discretion, the SEC's initial plans should have been largely approved.

E. Proceedings on Remand

For the foregoing reasons, we conclude that the district court erred in ruling that the IRS was not entitled to payment out of the assets disgorged by Levine of the amount of the lien that attached to his property prior to disgorgement. We remand to the district court for a determination of the precise amount of that lien, and for a determination of the IRS's alternative claim that it is entitled to priority under 31 U.S.C. §3713(a)(1)(A) on the ground that Levine and Wilkis were insolvent.

In the event that the court determines the §3713(a) claim to be without merit, the SEC's original plan for distribution of the assets disgorged by Wilkis should be approved; the SEC's original plan with regard to Levine, which had allocated the plan's Tax Fund to the federal and state taxing authorities in proportion to their claims, should be reconsidered by the SEC to determine the amount to be awarded the State in light of the priority to which the IRS is entitled. The SEC should similarly reconsider the distribution plans if the court determines that the §3713(a) claim has merit, and if after application of that section there remain disgorged assets to be distributed.

CONCLUSION

The orders of the district court are (1) affirmed insofar as they (a) rejected the contention of Levine that the SEC is required to pay his criminal fines out of the disgorged assets, (b) rejected the contentions of Levine and Wilkis that the SEC is required by the consents and judgments to give priority to payment of the tax claims made by the IRS and the State, and (c) rejected the objections of the Arden Way claimants; (2) reversed insofar as they rejected the claim of the IRS to priority with respect to the lien that attached to the property of Levine prior to June 19, 1986; and (3) vacated and remanded for a determination of the IRS's claims of priority under 31 U.S.C. §3713(a) and for further proceedings not inconsistent with this opinion.

 

 

 

United States of America, Plaintiff v. John G. Broady and 110-118 Riverside Tenants Corporation, Defendants, and Joseph Jacob, Intervenor

U.S. District Court, So. Dist. N.Y., 79 Civ. 3291 (JMC), 2/7/89

[Code Secs. 6321 and 6322 ]

Lien for taxes: Real property: Proprietary lease: Foreclosure of liens on stock: Escrow funds: State law.--Tax liens filed by the government against a delinquent taxpayer's share of stock in a cooperative corporation took priority over a security interest the cooperative had between it and the taxpayer. The taxpayer's shares of stock in the corporation represented his interest in a cooperative apartment. When the shares were sold to satisfy the liens, the proceeds were placed in an escrow fund but the corporation claimed a portion of the proceeds, stating that it was entitled to the money under the terms of a proprietary lease it had with the taxpayer. The court determined that the terms of the lease did not limit the taxpayer's property interest to the net proceeds of sale of his shares in his cooperative apartment. Under state law, the court determined, the cooperative corporation merely had a consensual security interest in the shares and, consequently, the government is entitled to all of the proceeds. Further, the court noted that the amount of money released by the corporation's attorneys from the escrow fund to pay a real property transfer tax on the sale of the shares was violative of the stipulation entered into between the corporation and the government.

CANNELLA, District Judge:

Plaintiff's motion to compel the law firm of Snow Becker Krauss to turn over certain funds is granted.

BACKGROUND

In 1975, the Internal Revenue Service filed notices of tax liens against John G. Broady for unpaid assessed tax liabilities for the years 1951 through 1954. In 1979, the Government commenced an action against Broady and 110-118 Riverside Tenants Corporation ["RTC"], a cooperative corporation, seeking a judgment against Broady for unpaid assessed taxes and to foreclose tax liens on Broady's shares of stock in RTC, which represented Broady's interest in a cooperative apartment. RTC received notice of the tax liens in 1975.

On March 22, 1984, the Court granted the Government's motion for summary judgment against Broady in the amount of $1,758,721.60. See Memorandum and Order, 79 Civ. 3291 (JMC) (S.D.N.Y. Mar. 22, 1984). Thereafter, the Court granted the Government's request to foreclose the tax liens on Broady's shares of stock in RTC. See Opinion, 79 Civ. 3291 (JMC) (S.D.N.Y. Mar. 3, 1985). In April 1985, Broady stopped paying his monthly maintenance fee to RTC.

On January 27, 1988 the Government and RTC entered into a stipulation and order regarding the sale of Broady's shares. See stipulation and Order, 79 Civ. 3291 (JMC) (S.D.N.Y. Jan. 27, 1988) [the "Stipulation"]. In April 1988, Broady's shares were sold for $901,030. Pursuant to the stipulation RTC retained $90,103, which it claimed it was entitled to under the terms of a proprietary lease between RTC and Broady; Broady owed RTC for unpaid maintenance charges, legal fees and other miscellaneous charges accruing between March 1985 and April 1988. The $90,103 was placed in escrow [the "escrow fund"] by Snow Becker Krauss, counsel for RTC, pending the outcome of the instant motion. The remainder of the sale proceeds, $810,927, was paid to the Government. Finally, Snow Becker Krauss allegedly paid $9,207 out of the escrow fund to the City of New York as a real property transfer tax on the sale of Broady's shares. Payment of the tax was not made pursuant to the stipulation, nor did Snow Becker Krauss receive consent from the Government or permission from the Court before dispensing these funds.

Both the Government and RTC claim the right to the money held in the escrow fund. RTC contends that it is entitled to the escrow fund in order to satisfy Broady's debts to RTC. RTC claims that pursuant to the terms of the proprietary lease between RTC and Broady, ¹ Broady was only entitled to the net proceeds of the sale, after his debts to RTC were paid. Thus, RTC argues that the Government's tax liens only reached Broady's interest in the shares and not the entire proceeds. The Government, on the other hand, asserts that its tax liens attached to the entire proceeds of sale. The Government argues that RTC simply had a lien on Broady's shares which was inferior to the Government's tax liens filed in 1975. Moreover, the Government claims that the $9,207 transfer tax was improperly released from the escrow fund and should be returned to the Government along with the remainder of the fund.

DISCUSSION

Section 6321 of the Internal Revenue Code of 1954, as amended, 26 U.S.C. §6321 , provides: "If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount . . . shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person." The lien arises at the time the taxes are assessed and continues "until the liability for the amount so assessed . . . is satisfied or becomes unenforceable by reasons of lapse of time." 26 U.S.C. §6322 ; see United States v. National Bank of Commerce [85-2 USTC ¶9482 ], 472 U.S. 713, 719 (1985).

"The statutory language 'all property and rights to property' appearing in §6321 . . . is broad and reveals on its face that Congress meant to reach every interest in property a taxpayer might have." National Bank of Commerce, 472 U.S. at 719-20; see Glass City Bank v. United States [45-2 USTC ¶9449 ], 326 U.S. 265, 267 (1945) ("Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes.").

A judicial determination of whether a federal tax lien prevails over a competing claim involves a two step inquiry. First, a court must decide what interest the delinquent taxpayer has in the property subject to the lien, as "the Government's lien under §6321 cannot extend beyond the property interests held by the delinquent taxpayer." United States v. Rodgers [83-1 USTC ¶9374 ], 461 U.S. 677, 690-91 (1983) (footnote omitted); See 21 West Lancaster Corp. v. Maine Line Restaurant, Inc. [86-2 USTC ¶9516 ], 790 F.2d 354, 356 (3d Cir. 1986) (a federal tax lien can only attach to property "belonging to" the taxpayer). Moreover, in assessing the nature and extent of the taxpayer's property interest, a court must look to state law. See National Bank of Commerce, 472 U.S. at 722 (citing Aquilino v. United States [60-2 USTC ¶9538 ], 363 U.S. 509, 513 (1960)); see also United States v. Fontana [82-1 USTC ¶9237 ], 528 F.Supp 137, 143 (S.D.N.Y. 1981) ("whether the tax lien has attached depends on the state law question of ownership").

Second, the court must decide if the tax lien that attached to the taxpayer's property has priority over a competing lien or claim. See 21 West, 790 F.2d at 356. In making this determination, which is a matter of federal law, see United States v. Pioneer American Ins. Co. [63-2 USTC ¶9532 ], 374 U.S. 84, 88 (1963), "courts have long relied on the judicially created 'choateness doctrine.' " J.D. Court, Inc. v. United States [83-2 USTC ¶9454 ], 712 F.2d 258, 261 (7th Cir. 1983), cert. denied, 466 U.S. 927 (1984). Under the choateness doctrine, a nonfederal lien will have priority over a federal tax lien only if the nonfederal lien was "choate" when the federal tax lien was recorded. See Lerner v. United States [87-1 USTC ¶9339 ], 637 F.Supp. 679, 681 (S.D.N.Y. 1986). In United States v. Equitable Life Assurance Soc'y [66-1 USTC ¶9444 ], 384 U.S. 323 (1966), the Supreme Court summarized the "choateness doctrine" as follows:

As against a recorded federal tax lien, the relative priority of a state lien is determined by the rule "first in time is first in right," which in turn hinges upon whether, on the date the federal lien was recorded, the state lien was "specific and perfected." A state lien is specific and perfected when "there is nothing more to be done . . . when the identity of the lienor, the property subject to the lien, and the amount of the lien are established." Thus, the priority of [the nonfederal lien] . . . must depend on the time it attached to the property in question and became choate.

384 U.S. at 327-28 (quoting United States v. City of New Britain [54-1 USTC ¶9191 ], 347 U.S. 81, 84 (1954)).

The Government contends that RTC simply has a "lien" or a "consensual security interest" in Broady's shares. See Government's Memorandum of Law at 9 and 18, 79 Civ. 3291 (JMC) (S.D.N.Y. Aug. 8, 1988). The Government points out that the Internal Revenue Service filed tax liens against Broady in 1975 and RTC received notice of the liens that same year. Broady did not become indebted to RTC until 1985. The Government asserts that the amount of RTC's security interest was undetermined, and thus "inchoate," when the tax liens were filed. Therefore, the Government argues, the federal tax liens have priority over RTC's security interest.

RTC, however, contends that Broady's property interest in his shares was limited by the terms of the proprietary lease. RTC argues that the instant action is not a dispute between competing lienholders, but rather, that it has a contract right and not a lien. In sum, RTC's position is that, pursuant to the terms of the proprietary lease, Broady's property interest in the shares was limited to the net proceeds of sale after setting off the amount owed RTC. Thus, the Government's tax lien could only reach Broady's interest and no more.

In support of its position, RTC relies on Chicago Mercantile Exchange v. United States [88-1 USTC ¶9203 ], 840 F.2d 1352 (7th Cir. 1988). In Chicago Mercantile, a taxpayer owned a seat on the Chicago Mercantile Exchange ["CME"]. See id. at 1353. The Internal Revenue Service placed a lien on the taxpayer's seat. In addition to his federal tax liability, the taxpayer also owed a substantial exchange related debt. After conducting an involuntary sale of the taxpayer's seat, CME claimed that it was entitled to satisfy the taxpayer's exchange related debts from the proceeds of sale before the Government collected on its tax lien. See id. at 1354. CME relied on an internal CME rule which provided that after the sale of a membership, the seat member is only entitled to recover the net amount after payment of exchange related debts. See id.

The Court of Appeals for the Seventh Circuit held that the taxpayer had no property right in the sale proceeds until the exchange related debts were paid. See id. at 1356. The Seventh Circuit stated that the case was essentially controlled by the Supreme Court's decision in Hyde v. Woods, 94 U.S. (4 Otto) 523 (1877), which held that a member's property right in his seat is defined by the rules of the exchange. The Seventh Circuit described the taxpayer's property interest in his seat as follows:

The rules of the exchange create the property and they govern its attributes. . . . [T]he holder of an exchange seat holds that seat subject to the exchange rules, which define and limit his property interest. If he has no property right beyond that granted by the exchange rules, then he has no further property right to which a tax lien can attach.

Chicago Mercantile, 840 F.2d at 1356 (emphasis in original).

Moreover, the Seventh Circuit found that the exchange rules did not give CME an unperfected security interest in the proceeds; instead, the rules were "attributes of the property at its creation." Id. at 1357 (citing Hyde, 94 U.S. at 525-26). The rule in question, the court wrote, "is an incident of the property, not a lien on that property." Chicago Mercantile, 840 F.2d at 1357 (footnote omitted). Thus, the Seventh Circuit concluded that the federal tax lien only attached to the taxpayer's interest in the property, which consisted of the net proceeds after satisfaction of his exchange related debts. See id. at 1358.

RTC argues that the terms of the proprietary lease, like the rules of the exchange in Chicago Mercantile, do not create a lien on Broady's property, but are incidents of the property itself. RTC's reliance on Chicago Mercantile, however, is misplaced. For several reasons, the principles set forth in that context should not be extended to the facts of the instant action.

The court in Chicago Mercantile emphasized the limited scope of its decision. The court stated that "our holding is very narrow. We only reiterate the Supreme Court's holding that property rights in an exchange membership are determined by the exchange rules." Chicago Mercantile, 840 F.2d at 1358. Thus, the Seventh Circuit was bound by the Supreme Court's definition of the property interest an exchange member has in his seat.

Broady's property interest in his shares is determined by state law. See National Bank of Commerce, 472 U.S. at 722 (citing Aquilino, 363 U.S. at 513). Under New York law, "[t]he interest in a cooperative apartment is sui generis . . .; the interest is represented by shares of stock, which are personal property, yet in reality what is owned is not an interest in an ongoing business enterprise, but instead a right to possess real property." In re Estate of Carmer, 71 N.Y.2d 781, 784, 530 N.Y.S.2d 88, 89, 525 N.E.2d 734 (1988) (citing cases). Although RTC argues that the terms of a proprietary lease are, like the exchange rules in Chicago Mercantile, "incidents of ownership," RTC fails to cite any authority under New York law, and indeed the Court can find none, to support this proposition. ²

Moreover, policy considerations counsel against such a finding. The collection of taxes is vital to our national government and Congress recognized as much when it passed the federal tax lien laws. See United States v. Kimbell Foods, Inc., 440 U.S. 715, 734 (1979) ("The importance of securing adequate revenues to discharge national obligations justifies the extraordinary priority accorded federal tax liens . . . ."). Parties should not be allowed to defeat the federal priority scheme "merely by privately contracting to . . . redefine an ordinary security interest as an 'incident of ownership.' " Chicago Mercantile, 840 F.2d at 1359 (Coffey, J., concurring). In concurring with the majority decision in Chicago Mercantile, Judge Coffey cautioned that:

[W]e must be extremely vigilant not to allow either state law or private parties to circumvent . . . important federal policies by attempting to formalistically redefine and codify through rules, regulations, and/or bylaws an ordinary security interest as an incident of property ownership, thereby defeating a valid tax lien that would otherwise take priority.

Id. at 1361.

This reasoning is persuasive in the context of the instant action. The proprietary lease between Broady and RTC was a contract between private parties. Private parties should not be able to evade the federal tax lien statute simply by redefining a security interest as an attribute of property. ³

Finally, even assuming, arguendo, that under New York law the terms of a proprietary lease are "incidents of ownership," the proprietary lease in question does not specifically limit Broady's property interest in his shares. The rule at issue in Chicago Mercantile stated: "Membership in the Exchange is a personal privilege subject to purchase, sale, and transfer only as authorized and on the conditions prescribed herein. A member shall have no rights in or to the membership or the proceeds of the sale of such membership except as specifically granted herein." Chicago Mercantile, 840 F.2d at 1356 (emphasis added). The court stated that this rule, in conjunction with the rule allowing exchange related debts to be satisfied from the proceeds of sale of a member's seat, "puts the world on notice" that the member's property interest is limited. Id. A similar term, however, is not found in Broady's proprietary lease. The lease merely provides that RTC "may apply the proceeds received . . . towards the payment of the Lessee's indebtedness hereunder . . . ." Declaration of Jordan Stanzler, Exh. A, Article III, ¶4, 79 Civ. 3291 (JMC) (S.D.N.Y. Aug. 8, 1988). Thus, the lease does not provide, as did the exchange rules in Chicago Mercantile, that the lessee's property interest in his shares is limited by the terms of the lease.

In sum, the Court finds that the terms of the proprietary lease did not serve to limit Broady's property interest in the shares representing his cooperative apartment. Pursuant to the terms of the proprietary lease, RTC merely had a consensual security interest in Broady's shares. See Chicago Mercantile, 840 F.2d at 1358 n.7. Moreover, as the federal tax liens attached in 1975 and Broady did not stop paying his maintenance fees until 1985, the amount of RTC's security interest was undetermined, and thus "inchoate," when the tax liens attached. See Lerner, 637 F.Supp. at 681 ("a 'lien remains inchoate until the underlying debt becomes due.' ") (quoting Sgro v. United States [79-2 USTC ¶9733 ], 609 F.2d 1259, 1261 (7th Cir. 1979)). Therefore, the Government's tax liens take priority over RTC's security interest and, as the Government is owed over one million dollars by Broady, the Government is entitled to all the proceeds from the sale of Broady's shares.

One final point deserves mention. Snow Becker Krauss, RTC's counsel, allegedly released $9,207 from the escrow fund to pay a real property transfer tax on the sale of Broady's shares. See Plaintiff's Memorandum of Law at 22, 79 Civ. 3291 (JMC) (S.D.N.Y. Aug. 8, 1988). The Court has found that the entire proceeds of sale belong to the Government. Thus, the $9,207, which was part of the proceeds of sale, also belongs to the Government. Furthermore, Snow Becker Krauss released the money in violation of the stipulation entered into between RTC and the Government, which makes no mention of the tax and provides that "[t]he escrow account shall be disbursed in accordance with the decision of the Court or as [the] parties hereafter stipulate." Stipulation at ¶7. RTC's counsel released the funds without consent of the Government or permission of the Court. Accordingly, the Court finds that the $9,207 should not have been used to pay the real property transfer tax and must be returned to the escrow fund.

CONCLUSION

Plaintiff's motion to compel the law firm of Snow Becker Krauss to turn over certain funds is granted. Snow Becker Krauss is hereby directed to transfer the monies held in the escrow fund, plus interest, as well as $9,207, plus interest, to plaintiff, within twenty (20) days of the filing of this Order. Plaintiff is hereby directed to file a proposed Order dismissing this action within ten (10) days of receipt of the money.

SO ORDERED.

¹ The proprietary lease provides that after termination of the lease because of a default by the lessee, the lessee's shares are deemed void and RTC may sell the shares and issue new shares for the apartment. See Declaration of Jordan Stanzler, Exh. A, Article III, ¶Fourth, 79 Civ. 3291 (JMC) (S.D.N.Y. Aug. 8, 1988). The lease further provides that:

The Lessor [RTC] may apply the proceeds received for the issuance of such shares towards the payment of the Lessee's [Broady's] indebtedness hereunder, including interest, attorneys' fees and other expenses incurred by the Lessor and if the proceeds are sufficient to pay the same, the Lessor shall pay over any surplus to the Lessee, but if such proceeds are insufficient the Lessee shall remain liable for the balance of the indebtedness.

Id.

² RTC cites one New York case in support of the proposition that the terms of the proprietary lease can not create a lien on Broady's shares. See Defendant's Reply Memorandum of Law at 16, 79 Civ. 3291 (JMC) (S.D.N.Y. Jan. 15, 1988). However, a careful reading of the case shows that the court did not base its holding on the terms of a proprietary lease, but on a contract of sale entered into at a later date. See Banks v. Cox, Treanor & Shaughnessy, 81 A.D.2d 504, 437 N.Y.S.2d 331 (1st Dept. 1981).

Moreover, it is clear that under New York law the terms of a proprietary lease can create a lien in favor of a cooperative corporation. See State Tax Comm'n v. Shor, 43 N.Y.2d 151, 400 N.Y.S.2d 805, 371 N.E.2d 523 (1977) ("The lease provided the lessor with a 'first lien' on [the lessee's] shares of stock for all monetary obligations arising under the lease.").

³ The court in Chicago Mercantile discussed the possibility of this type of "deceptive activity." Chicago Mercantile, 840 F.2d at 1358. In a footnote the court considered the following hypothetical:

[A] condominium association could draft rules stating that no member could sell his or her unit without paying off debts to other members . . . . [s]uch rule would not have priority over a tax lien on the condominium unit, since the rule is not an attribute of the unit under state law. It is merely a consensual security interest created later, and would therefore not prevail over a filed tax lien.

Id. at 1358 n.7. (citations omitted) (emphasis in original). Although there are differences between condominiums and cooperatives, see e.g., All Seasons Resorts, Inc. v. Abrams, 68 N.Y.2d 81, 90-91, 506 N.Y.S.2d 10, 15, 497 N.E.2d 33 (1986), the above hypothetical is instructive. The Court finds no basis in New York law for concluding that a rule contained in a proprietary lease, which allows the cooperative corporation to collect a shareholder's debt from the sale proceeds of his apartment, is an "attribute" or ownership under state law.

 

 

United States of America, Plaintiff v. Peter J. Schmidt, Jr., as Administrator of the Estate of Peter J. Schmidt, Sr.; Dorothy Schmidt; Peter J. Schmidt, Jr.; Anna Schmidt; and Pork House Super Market, Inc., a Missouri corporation; Defendants

U. S. District Court, East. Dist. Mo., East. Div., No. 60C303(1), 206 FSupp 806, 6/6/62

[1954 Code Sec. 7403]

Lien for taxes: Decedent-taxpayer: Transfer of decedent's stock prior to death.--The court found that there had been no transfer of the decedent-taxpayer's stock just prior to his death. Therefore, the stock was part of his estate to which the government's lien for taxes attached.

D. Jeff Lance, United States Attorney, Grove G. Sweet, Assistant United States Attorney, St. Louis, Mo., for Plaintiff. Morris A. Shenker, 408 Olive St., St. Louis 2, Mo., for Defendants.

Memorandum Opinion

HARPER, District Judge:

This is a proceeding by the United States government under 26 U. S. C. A. Sections 7402-03, and 28 U. S. C. A. Sections 1340, 1345 and 1396. The basic undisputed facts show that Peter Schmidt, Sr. (hereinafter referred to as "Senior"), died intestate on August 2, 1954, and that letters of administration were granted to Peter Schmidit, Jr. (hereinafter referred to as "Junior"), on March 22, 1955. An inventory filed December 19, 1955, showed assets of the estate to be only $600.00. On August 24, 1955, plaintiff filed formal proof of claim with the Probate Court of the City of St. Louis for $17,947.45 of internal revenue taxes for the years 1946-47, upon which liability the period of limitation had been extended by a consent agreement with Senior. This was allowed as a first class claim on September 12, 1955, but only $376.37 had been paid upon closure of the estate and discharge of the administrator on December 15, 1958.

This controversy concerns the ownership of 258 shares of stock (Exhibits H and I) in Pork House Super Market, Inc. The government claims that Senior owned this stock at his death and that it is a part of his estate. Defendants, Junior and Dorothy Schmidt, claim that there was a valid transfer of 257 shares of the stock to them (Exhibit D), and defendant, Anna Schmidt, claims there was a valid transfer of one share of stock to her (Exhibit E), both for substantial consideration, on or about January 10, 1954, but the government urges that there was either a fraudulent conveyance (Count I) or no transfer at all (Count II).

If Senior owned the stock up to and shortly before his death, it seems clear, and has not been disputed, that the government has a lien pursuant to 26 U. S. C. A. Section 6321, which reads:

"If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount * * * shall be a lien in favor of the United States upon all property and rights to property whether real or personal, belonging to such person."

Senior's liability is admitted, and there is evidence of demand in addition to the filing of the claim in the Probate Court. That alone is apparently sufficient to satisfy the "demand" requirement of Section 6321. United States v. Ettelson [47-1 USTC ¶9137], 159 F. 2d 193, l. c. 196.

The action before this court was brought to enforce the Section 6321 lien pursuant to 26 U. S. C. A. Sections 7402 and 7403(a), which read in relevant part as follows:

"In any case where there has been a refusal or neglect to pay any tax, or to discharge any liability in respect thereof, whether or not levy has been made, the Attorney General or his delegate, at the request of the Secretary or his delegate, may direct a civil action to be filed in a district court of the United States to enforce the lien of the United States under this title with respect to such tax or liability * * *."

Defendants, in spite of the apparent jurisdiction under this statute, argue vehemently that the court has no jurisdiction of this cause. The court finds no merit or relevance in the fact pointed out by defendants that the government has not proceeded under the fraudulent transferee section of the internal revenue code. The initial value of this point, if any, is negated since it is applicable only to Count I, and as later pointed out, the court will base its decision on Count II alone.

Defendants' main argument is that this is a proceeding for discovery of assets, and that it requires a trial of the legal title to the stock, which may be had only and exclusively in the Probate Court pursuant to Missouri statutes. Defendants cite 1949 M. R. S. Sections 462.400-.440, which sections are currently embodied in 1959 M. R. S. Sections 473.340-.353, relating to a proceeding for the discovery of assets. These statutes do not on their face claim exclusive jurisdiction for the Probate Court, but defendants have cited eight cases for that proposition. That these cases are not compelling authority for a finding that this court lacks jurisdiction is evident upon examination. The proposition for which seven of these cases are cited is recognized in the eighth, Caldwell v. First National Bank of Wellston, 283 S. W. 2d 921, which cites the seven cases as a footnote for the following statement at l. c. 923:

"Ample authority supports the proposition that an action to discover assets cannot be initiated in the circuit court * * *." (Italics added.)

It is noted that at most these cases are authority that a "discovery of assets proceeding" should be in the Probate Court and not the circuit court. It would be a most strained interpretation to argue that these cases also oust the federal district court from jurisdiction in favor of the state probate court.

Further, an analysis of the case of State ex rel. Lipic et al. v. Flynn, 215 S. W. 2d 446, upon which defendants rely heavily, indicates it is not controlling here. There an administratrix filed a discovery of assets proceeding in the Probate Court, and two days later filed a conversion action for the same property in the circuit court. "The only question in this proceeding," said the court at l. c. 448, "would be whether the probate court on the face of the affidavit had acquired exclusive jurisdiction of the controversy in the discovery of assets proceeding before the conversion suit was filed in the circuit court." (Italics added.) This language allows an inference that the administratrix could have taken her case to the circuit court before filing in the Probate Court and jurisdiction would have attached. The court here specifically concedes that "statutory proceedings for the discovery of assets are special and summary, and are not preclusive as against other legal remedies * * *." (Italics added, l. c. 448.)

Even if the Missouri statutes were specific in giving the Probate Court exclusive jurisdiction in an action like the present one, and even if cases were explicitly in accord, there is ample authority that the federal district court would not be bound by such statutes and decisions. United States v. Pettyjohn [49-1 USTC ¶9247], 84 F. Supp. 423, was a case involving 26 U. S. C. A. Section 3678, the predecessor of Section 7403. The court there said that even though there was a claim in the Probate Court for part of the tax claim, this would not preclude the government from enforcing its lien in the district court (l. c. 426). It is further stated with reference to state authority infringing frderal action:

"It would follow that these statutory provisions of the national government validly enacted by the Congress would prevail over all legislation and all decisions of the state courts. No state could make a law, and no judge of the state could interpret the law, so as to interfere with the government in the collection of its revenue." l. c. 426.

The federal district court of New York, in a suit against estates of deceased taxpayers and family corporation to recover unpaid income taxes assessed against taxpayers and their estates, United States v. E. Regensburg & Sons [54-2 USTC ¶9620], 124 F. Supp. 687, tried the title to shares of corporate stock, resulting in setting aside of a foreclosure of a corporation's alleged liens on the stock, and an adjudication that the liens of the United States were valid liens against the stock. The action to enforce the government's liens was under 26 U. S. C. A. Section 3678, the forerunner of the section involved in the action now before this court. While the court is not apprised of a New York statute specifically denominated as one for the "discovery of assets," New York undoubtedly has statutes under which the government could have accomplished what it set out to do and was allowed to do in the federal court instead. Volume 49, McKinney's Consolidated Laws of New York, Ann. Section 268, is a suggested example. The Court in the Regenburg case again asserts that where sections of the internal revenue code conflict with state law, "under the Supremacy Clause, state law must yield." (l. c. 690.)

It is, therefore, the conclusion of this court that it has jurisdiction to entertain this cause, even though it may entail a trial of the legal title to the stock, and that it is empowered to give the relief prayed for, if warranted.

Turning then to the merits of the controversy, the court is faced with a determination of whether or not the 258 shares of stock were validly transferred to defendants, Junior, Dorothy Schmidt and Anna Schmidt. While some evidence was adduced at the trial relating to purported consideration for the transfer, and the legal efficacy of the "consideration" was argued on both sides, the court does not find it necessary to evaluate this evidence and determine the sufficiency of the "consideration." The case may be decided within the framework of the second count alone. This urges that Senior owned the stock prior to and at the date of his death and that a valid transfer was never effected.

The testimony shows that the 1953 and 1954 income tax returns of the corporation, which were prepared by a C. P. A., a member of a large auditing company, were offered in evidence (Exhibits 8 and 9.) The 1953 return was signed by Junior as president and Dorothy his wife, as secretary-treasurer, and the 1954 return, dated April 13, 1955, was signed by Dorothy as secretary-treasurer. Each of these returns shows Senior as the owner of 99% of the stock of the corporation, Junior .5% and Dorothy .5%. The 1954 return shows Senior as deceased. The capital stock structure set out in the returns was obtained by the auditor from Dorothy, the secretary-treasurer. Each year, including the 1954 return, the auditor discussed the return with Dorothy before it was life for signature and filing. Before preparing the 1954 return the auditor asked Dorothy several questions pertaining to Senior's death.

Dorothy did not deny that the auditor asked her before she signed the 1954 return who owned the stock in the corporation, but stated she did not recall if he asked her for this information or not. She further testified she did not examine the returns before signing them, but on cross-examination admitted that at the deposition she testified she checked the returns before she signed them. She further testified the stock certificate (Exhibit H) was endorsed by Senior in 1947 or 1948, but was not filled out until 1955.

There was expert testimony to the effect that the signatures purportedly made by Senior transferring the stock certificates (Exhibits H and I) were in fact forged. Mr. Webb, the handwriting expert, had highly satisfactory qualifications. He pointed out that several indicia of forgery were manifest in the purported signatures of Senior on the certificates--for example, tracing, hesitation, and lack of the smooth flow characteristic of genuine signatures.

The testimony of both Junior and his wife concerning the circumstances and chronology of events attending the signing and transfer of these particular certificates (Exhibits H and I) is so confused and inconsistent as not to be worthy of belief. It is certainly not sufficient to overcome the contrary testimony of a highly qualified expert, especially when taken in conjunction with the other testimony referred to herein.

It is, therefore, the court's conclusion that the signatures on the certificates (Exhibits H and I) purporting to transfer 258 shares of stock were forged, and the "transfer" was not thereby effected, so that the stock in question was owned by Senior at his death and became a part of his estate. It was "property" owned by "the delinquent," in the terms of Section 7403(a), subject to the government's lien.

Accordingly, it is the judgment of this court that the 258 shares of stock (Exhibits H and I) were never transferred by Peter J. Schmidt, Sr., and are the property of the estate of Peter J. Schmidt, Sr., and that this estate is indebted to plaintiff in the amount of $17,131.24, plus interest, in accordance with law. It is also adjudged that the government has a valid lien on these 258 shares, and an order will be entered pursuant to 26 U. S. C. A. Section 7403, foreclosing the liens and decreeing a sale of such property, all the proceeds necessary for the satisfaction of the debt being applied thereto. In addition, there being some indication that monies or dividends may have been transferred to defendants after decedent's death as dividends or earnings accrued from the stock, the court will order a full and conplete accounting by defendants of such money.

This memorandum opinion is adopted by the court as its findings of fact and conclusions of law, and the attorney for the plaintiff will prepare the proper judgment to be entered by the court in accordance with this opinion.

 

 

 

United States of America v. Donald J. Mueller

U.S. District Court, East. Dist. Pa., Civ. 93-0196, 8/30/93

[Code Sec. 6321 ]

Tax liens: Assessments: Reduction to judgment: Foreclosure: Stock certificates.--An individual who failed to pay assessed taxes after demand was required to surrender his stock certificates to the government in payment of the assessed and liened taxes. The court determined that the individual, and not his children, was the owner of the stock. The government had made timely assessments and had perfected liens on each assessment. Therefore, the liens could be reduced to judgment. Execution of the judgment could reach any property, real or personal, belonging to the individual. The individual did not carry his burden of proving that the assessments were wrong.

Angelo A. Frattarelli, Department of Justice, Washington, D.C. 20530, for plaintiff. Allen L. Feingold, A.L. Feingold Assocs., 809 One E. Penn. Square, Philadelphia, Pa. 19107, for defendant.

MEMORANDUM

 

NEWCOMER, District Judge:

This is a suit brought by the United States ("plaintiff") against Donald J. Mueller ("defendant") to reduce to judgement certain federal tax assessments made against the defendant for the taxable years 1984, 1985, 1986, 1987, 1988 and the taxable quarter ending June 30, 1989 (Count 1), and to foreclose existing federal tax liens on shares of stock currently owned by the defendant (Count II). I conducted a bench trial on July 8, 1993. The following are my Findings of Facts and Conclusions of Law.

I. Findings of Fact:

The parties have stipulated at an earlier pre-trial conference to findings 1-15. As such, the court accepts the following facts as established for the purposes of this case.

A. Count I:

1. On September 25, 1989, the Internal Revenue Service assessed federal income tax in the amount of $6,225.00, accrued interest in the amount of $887.74, and penalties of $600.40 against the defendant for the 1984 taxable year.

2. Proper notice and demand for payment of the assessment referenced in paragraph 1 was made on September 25, 1989, the date of assessment.

3. The following payments and credits were properly applied against the liability referenced in paragraph 1:

a. Withholding credits of $4,961.00;

b. Separate payments of $753.31 and $25.56.

4. On November 27, 1989, the Internal Revenue Service assessed federal income tax in the amount of $8,391.00, accrued interest in the amount of $1,270.49, and penalties of $908.79 against the defendant for the 1985 taxable year.

5. Proper notice and demand for payment of the assessment referenced in paragraph 4 was made on November 27, 1989, the date of assessment.

6. Withholding credits of $6,018.00 were properly applied against the liability referenced in paragraph 4.

7. On December 20, 1991, the Internal Revenue Service assessed against the defendant, as transferee of Pleasure Marine, Inc. pursuant to Section 6901 of the Internal Revenue Code (26 U.S.C.), Form 941, tax liabilities of Pleasure Marine, Inc. for the years ending 1986, 1987, and 1988 in the amounts of $19,116.55, $39,282.05, and $20,451.20 respectively, and interest on those liabilities of $13,936.00, $21,773.45, and $9,521.95 respectively.

8. Proper notice and demand for payment of the assessments referenced in paragraph 7 was made on December 20, 1991, the date of assessment.

9. On May 8, 1989, the Internal Revenue Service assessed $73,693.96 against the defendant, pursuant to section 6672 of the Internal Revenue Code (26 U.S.C.) as a responsible person of Pleasure Marine, Inc. who willfully failed to collect or pay over the withholding taxes of that corporation for the first, second, and third quarters of 1986, and for consecutive quarters beginning with the first quarter of 1987 through the second quarter of 1988.

10. Proper notice and demand for payment of the assessment reference in paragraph 9 was made on May 8, 1989, the date of assessment.

11. The following payments and credits were properly applied against the liability referenced in paragraph 9:

a. Overpayment credits of $14.00, $138.74 and $22.75;

b. Separate payments of $202.19 and $11,473.41.

12. Despite the notices and demands for payment of each of the assessments described in paragraphs 1, 4, 7, and 9, above, the defendant has failed to pay the entire amount due.

13. As of the date that the complaint was filed, the defendant was indebted to the plaintiff in the amount of $231,844.72, which sum includes interest and penalties that have accrued under the law since the respective dates of assessment.

B. Count II:

14. By reason of the assessments described in paragraphs 1, 4, 7, and 9 above, federal tax liens arose on the dates of assessment and attached on those dates to all property and rights to property owned or thereafter acquired by Donald J. Mueller.

15. The plaintiff properly recorded the following notices of federal tax lien against the defendant in the office of the Prothonotary in Bucks County, PA:

a. Lien serial number 238912096, recorded on August 18, 1989 in the amount of $73,693.96 representing the unpaid responsible person "penalty" for the second quarter of 1988.

b. Lien serial number 238918193, recorded November 21, 1989, in the amount of $3,628.94 representing unpaid income tax liabilities for the taxable years 1983, and 1984.

c. Lien serial number 239004243, recorded February 8, 1990, in the amount of $4,532.28 representing unpaid income tax liabilities for the taxable year 1985.

d. Lien serial number 229211209, recorded March 20, 1992, in the amount of $6,535.55 representing unpaid income tax liabilities for the taxable years 1984, and 1985.

e. Lien serial number 229211210, recorded on March 20, 1992, in the amount of $61,872.87 representing the unpaid responsible person "penalty" for the second quarter of 1988.

f. Lien serial number 239215721, recorded on or about April 23, 1992, in the amount of $124,081.20 representing unpaid Form 941 tax liabilities for the taxable years 1986, 1987, and 1988.

g. Lien serial number 229227074, recorded on or about May 4, 1992, in the amount of $124,081.20 representing unpaid Form 941 tax liabilities for the taxable years 1986, 1987, and 1988.

16. The defendant, Donald J. Mueller, and not his children, currently owns the following shares of stock to which the federal tax liens described in paragraph 15 attach: ¹

a. 120 shares of AT&T;

b. 24 shares of NYNEX;

c. 12 shares of Pacific Telesis Group;

d. 36 shares of Bell Atlantic;

e. 30 shares of Ameritech;

f. 36 shares of Bell South;

g. 12 shares of Southwestern Bell;

h. 36 shares of U.S. West.

II. Conclusions of Law:

In a suit to reduce tax assessments to judgment, the United States establishes a prima facie case when it shows a timely assessment was made against the taxpayer. Psaty v. United States [71-1 USTC ¶9346 ], 442 F.2d 1154 (3d Cir. 1971); Sadowski v. United States, 687 F. Supp. 966, 072 (E.D. Pa. 1988). A presumption of correctness attaches to the assessments which form the basis for Count I. Welch v. Helvering [3 USTC ¶1164 ], 290 U.S. 111 (1933); Higginbotham v. United States [77-2 USTC ¶16,265 ], 556 F.2d 1173, 1175-76 (4th Cir. 1977). Once a prima facie case has been established, the burden of proving that the assessments are erroneous falls upon the taxpayer. United States v. Eshelman [87-2 USTC ¶9419 ], 663 F. Supp 285, 287 (D. Del. 1987). This burden is not merely one of producing evidence; it is the burden of persuasion by a preponderance of the evidence that the assessment is wrong. Sinder v. United States [81-2 USTC ¶9612 ], 655 F.2d 729, 731 (6th Cir. 1981).

If any such person liable to pay any tax neglects or refuses to pay such tax after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue thereon) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person. 26 U.S.C. §6321 . As a result of the defendant's failure to pay tax liabilities referenced above, the tax liens described in the preceding paragraphs attached to the shares of stock referenced in paragraph 16 above. 26 U.S.C. §6321 ; Glass City Bank v. United States [45-2 USTC ¶9449 ], 326 U.S. 265 (1945).

Accordingly, plaintiff must turn over his certificates of ownership to the United States government as partial payment of his tax liabilities.

AND IT IS SO ORDERED.

¹ During trial there arose a dispute as to the exact number of stocks owned by Mr. Mueller with respect to certain companies. In an effort to avoid litigating the actual number of stock for each company, the parties agreed any and all stock in the named companies that is titled in Donald J. Mueller's name would be subject to government seizure.

 

 

 

United States of America, Plaintiff v. Harry W. Schuermann, Oscar Lehr, President, St. Louis Finance Co., Inc., St. Louis Finance Company, Inc., Defendants

In the United States District Court for the Eastern District of Missouri, Eastern Division, No. 8441(2), 106 FSupp 86, July 1, 1952

Capital stock subject to lien for taxes: Ownership established under Missouri law: Inadequate proof of taxpayer's interest in certain demand notes: Protection of maker of notes: Injunction to preserve interests of parties in notes pending adequate investigation.--Where the Government established present ownership of capital stock in taxpayer under Missouri law but on the facts failed to show that it made a sufficient investigation to clearly establish the interest and control of taxpayer over certain demand notes, it was held that the Government could avail itself of the capital stock to satisfy the lien but could not demand payment on the notes from the maker until such time as it more conclusively established the interest of the taxpayer therein. It was pointed out that since the Government had other protective privileges as to these notes under Missouri law, the maker should be protected as to possible superior claims of yet undisclosed third parties. The taxpayer and maker of the notes were enjoined from doing any acts which might affect the interest of the taxpayer or the Government's right to payment on the notes.

George L. Robertson, United States Attorney, of St. Louis, Mo., and Harold Bacon, Special Assistant to the Attorney General, of Washington, D. C., for plaintiff. Harry W. Soffer and Joseph Nessenfeld, Dubinsky & Duggan, and Jerome F. Duggan, all of St. Louis, Mo., for defendants.

Memorandum

HULEN, Judge:

The question for ruling is--can plaintiff by this action secure control for sale purposes of capital stock in, and payment to it of promissory notes executed by defendant finance company, originally issued and delivered to taxpayer, defendant Schuermann, to satisfy a tax lien against Schuermann, without proof that the taxpayer is still in control and the owner of the instruments. Defendant taxpayer is in default; the other two defendants in general deny plaintiff's claims.

The facts are not in dispute. The taxpayer now owes income tax or penalty for years 1942, 1943, 1944 and 1945. As of August 16, 1948, the assessment was in excess of $236,000.00. At the time of trial, by stipulation entered before the tax court, tax liability was fixed at:

1942, tax $1,351.75, plus penalty $675.88;

1943, penalty $1,305.94;

1944, tax $73,795.98, plus penalty $36,897.99;

1945, tax $50,310.16, plus penalty $25,155.08.

On January 2, 1945, defendant finance company issued and delivered to taxpayer a certificate for 313 shares of its class A stock and 19 shares of its class B stock. The stock transfer books show there has been no subsequent change in record ownership of the stock.

On January 30, 1947, defendant finance company executed and delivered to defendant taxpayer, for value, its promissory note for $10,000.00. A like transaction took place on November 13, 1947, and again on December 15th, 1947, except the amount of the last two notes was $5,000.00 each. The principal unpaid balance on the three notes, as of trial date, had been reduced from $20,000.00 to $18,120.69, plus accrued interest.

On April 10, 1951, notice of levy was served on defendant Oscar Lehr, as president of the defendant St. Louis Finance Company, demanding that the assets of the taxpayer in the hands of the finance company be paid to plaintiff to be applied on the tax lien.

All preliminary procedural requirements to maintain this suit have been taken by plaintiff.

Defendant taxpayer did not testify.

Neither party has filed a brief.

Defendant finance company by oral argument suggests "it could be" that the notes and stock have been pledged or sold and that until the new owner makes claim the finance company should be left as stakeholder, so to speak. To let the matter remain status quo presents two hazards which we think plaintiff should not be required to run. The liens expire in six years from date, unless renewed by a payment, and for plaintiff to wait beyond that date might foreclose its rights. The statute of limitations runs on the notes in the years from date, no interest payments having been made. The record is silent is to how the principal credits were applied.

I

Plaintiff has a judgment against defendant Schuermann for taxes. This suit is in the nature of a garnishment proceeding against the remaining defendants. It finds authority in Section 3678, Title 26, U. S. C. A. 53 Stat. 450. By rule 64, Federal Rules of Civil Procedure, laws of the State of Missouri applicable to such character of action are available to plaintiff. This Court has jurisdiction of the cause and of the parties.

II

Plaintiff's evidence establishes ownership of record of the two classes of stock in taxpayer Schuermann on January 2nd, 1945. Under Missouri law, absent any showing or claim to the contrary, that is sufficient to establish present title in taxpayer. Osmer v. Le May-Wegmann Brokerage Co. (Mo. App.) 134 S. W. 65, l.c. 69.

The Court is not bound by Missouri law in this case, but since we find no Federal authority on the subject we are disposed to look to Missouri law for guidance.

Defendant St. Louis Finance Co., Inc. is a Missouri corporation. Authority for seizure of its stock by this action will be found in State ex rel. North American Co. v. Koerner (Mo. Sup.) 211 S. W. 2nd 698.

Plaintiff is entitled to the relief prayed for with respect to the stock of defendant finance company in the name of defendant Schuermann. There is no just reason for delay and a final judgment on this phase of the case will be entered. Rule 54(b), Federal Rules of Civil Procedure.

III

The authorities are not uniform on rights of a judgment creditor to proceed against the maker of a negotiable note payable to the judgment debtor.

There is evidence of ownership by Schuermann of the three notes in question at the time they were executed by defendant finance company. In King v. Missouri Pac. R. Co. (Mo. Sup.) 263 S. W. 828, the Missouri Supreme Court declared (l.c. 833):

"* * * where the existence at one time of a certain condition or state of things of a continuous nature is shown, the general presumption arises that such condition or state continues to exist, until the contrary is shown by either circumstantial or direct evidence, so long as is usual with conditions or things of that particular nature".

In Newell v. La Font (Mo. App.) 251 S. W. 472, it was held that a promissory note is a thing of "that particular nature" to which the rule applies. In Diel v. Stegner, 56 Mo. App. 535, the rule was applied to a debt. In Osmer v. Le May-Wegmann Brokerage Co., supra, it was applied to ownership of certificates for shares of stock.

The three notes are demand notes. As such the maker and holder occupy a position analogous to a bank and depositor. Under Section 401.072 R. S. Mo., 1949, demand for payment is not confined to the holder of a note payable on demand. Such demand may be made "by some person authorized to receive payment on his [holder] behalf". By virtue of the law under which plaintiff enforces its judgment, plaintiff is authorized, by law, to receive payment of the notes on behalf of Schuermann, and therefore can demand payment of the maker, in the same manner as if Schuermann had a bank balance subject to levy for the tax judgment.

There are also other facts of record indicating ownership and control of the notes by the taxpayer.

Although plaintiff has the right to demand the payment to it of the three notes given to Schuermann by defendant finance company, we are not disposed at this time to grant plaintiff a final judgment and order the amount due on the notes paid to plaintiff. The authorities for and against such disposition of the case will be found in 38 C. J. S. §102.

Protection of the maker of the note should be given serious consideration. We follow that line of cases, particularly in view of plaintiff's privileges under Section 525.280 R. S. Mo., 1949.

Plaintiff should make a prima facie showing of present control and ownership in defendant taxpayer of the notes in question.

We are not convinced that plaintiff has pursued reasonable avenues of discovery, as to any outstanding claims to the notes. The taxpayer's testimony as to whereabouts of the notes is absent. He knows their whereabouts. There is no apparent reason for his not revealing this fact or volunteering the information. Members of taxpayer's family might shed light on the subject. Officers of defendant finance company may have information. One even claiming an interest in the notes must be brought into this proceeding. Sec. 3678(b), Title 26, U. S. C. A.

As of this stage of the case, the plaintiff's showing on this issue has been superficial and inconclusive.

Submit a decree in accord with this memorandum and providing:

(1) That defendant Harry W. Schuermann is in default. That neither of the defendants has any rights in the property involved.

(2) That plaintiff has a lien on the shares of stock standing in the name of Harry W. Schuermann, in defendant St. Louis Finance Company.

(3) That defendant finance company, and Oscar Lehr, having charge and custody of the stock record books of said finance company, not less than five days from date of decree, shall deposit with the Clerk of this Court certificates of stock, of like kind and number of shares, and with all the rights in same, as now stand in the name of Harry W. Schuermann in said finance company.

(4) That said certificates of stock, and all the right and title of Harry W. Schuermann therein, shall be sold by the Marshal of this Court to enforce the lien of plaintiff, and the proceeds of such sale shall be used to pay and be applied on the tax liability of Harry W. Schuermann.

(5) That on presentation by the purchaser, at Marshal's sale, of such stock certificates, to defendants, new stock certificates in the name of the purchaser will be made and delivered to the purchaser.

(6) That the defendants and each of them shall be enjoined from taking, or aiding or assisting in taking, any action relative to any of the property involved, or any interest therein, that would change or affect in any way the present status of ownership as to taxpayer's interest, or liens or rights of the plaintiff, in and to all of said property.

(7) That jurisdiction of this cause shall be retained for any further proceeding or orders required in the premises.

 

 

 

United States of America, Plaintiff v. Walter C. Updegrave, Defendant

U.S. District Court, East. Dist. Pa., Civ. 95-CV-6054, 5/28/97

[Code Secs. 6020 and 6321 ]

Returns: No return filed: Returns by IRS personnel: Tax liens: Property subject to lien: Stock certificates.--In the absence of evidence raising a genuine issue of material fact regarding an individual's ownership of stock, tax assessments, accrued interest and penalties were reduced to judgments and tax liens on the stock were foreclosed. The individual's arguments, that because he was a citizen of Pennsylvania, he was not a citizen of the U.S. and, thus, not subject to the Internal Revenue Code, that the Internal Revenue Code was not legally effective, and that the preparation of a substitute return and the assessment of tax liability could only be made by the Secretary of the Treasury were considered frivolous and without merit.

MEMORANDUM OF DECISION

MCGLYNN, Judge:

Before this court is a Motion for Summary judgment filed pursuant to Fed. R. Civ. P. 56 on behalf of the United States of America ("United States" or "plaintiff"). In this civil action against Walter C. Updegrave ("Updegrave" or "defendant"), the United States seeks to reduce to judgment federal income tax assessments, accrued interest, and penalties for the taxable years 1986, 1987, 1988, 1989, and 1990 ("Count I"); a declaration that a federal tax lien attached to certain shares of stock allegedly owned by Updegrave and foreclosure of that lien ("Count II"). This court has subject matter jurisdiction pursuant to section 1340 of Title 28 ¹ conferring original jurisdiction on district courts of any civil action arising under any act of Congress providing for internal revenue, section 1345 of Title 28 ² conferring jurisdiction on district courts to entertain all civil suits brought by the United States, section 7402 of Title 26 ³ conferring jurisdiction upon district courts to entertain actions necessary or appropriate for enforcement of internal revenue laws, and section 7403 of Title 28 ⁴ authorizing a civil action in United States district court to enforce an internal revenue tax lien or to subject property to payment of tax. 26 U.S.C. §§7402, 7403; 28 U.S.C. §§1340, 1345. Pursuant to 28 U.S.C. §1396, venue is proper in the Eastern District of Pennsylvania, wherein Updegrave resides. For the reasons setforth herein, the United States' motion will be Granted.

I. STANDARD OF REVIEW

Federal Rule of Civil Procedure 56 provides that a court may grant summary judgment if the pleadings, depositions, answers to interrogatories, admissions on file, and affidavits, show that there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247 (1986). A fact is "material" if it may affect the outcome of the suit under the governing substantive law. Anderson, 477 U.S. at 248. An issue of fact is "genuine" only if the evidence is such that a reasonable jury could return a verdict for the nonmoving party in light of burdens of proof imposed by the substantive law. Anderson v. Liberty Lobby, 477 U.S. 242 (1986).

The party moving for summary judgment bears the initial burden of demonstrating, by a preponderance of the evidence, the absence of a genuine issue of material fact. Celotex v. Catrett, 477 U.S. 317 (1986). Once this burden is discharged, Rule 56, subdivision (e), requires a non-moving party to "set forth specific facts showing that there is a "genuine issue for trial". Fed. R. Civ. P. 56(e).

In determining the motion, the record, and all reasonable inferences drawn therefrom must be viewed in the light most favorable to the party opposing summary judgment and the court may not weigh the evidence, determine the credibility of the witnesses, or substitute its version of the facts. Peterson v. Lehigh Valley Dist. Council, 676 F.2d 81, 84 (3d Cir. 1982; McDaniel's v. Flick, 59 F.3d 446, 453 (3d Cir. 1995).

II. PROCEDURAL HISTORY

On September 26, 1995, the United States of America initiated this civil action against Walter C. Updegrave to reduce to judgment federal income tax assessments against him for the years 1986 through 1990 and to foreclose existing federal tax liens on shares of stock owned by him. The same day the complaint was filed, the United States filed an application for Temporary Restraining Order and a Motion for Preliminary Injunction seeking to enjoin the defendant from transferring the stocks at issue while the case was pending. The court entered a Temporary Restraining Order on October 2, 1995 and scheduled a hearing on plaintiff's Motion for Preliminary Injunction for October 10, 1995. On October 3, 1995, Updegrave was personally served with copies of the complaint, the Temporary Restraining Order, Motion for Preliminary Injunction, and the order scheduling a hearing on the Motion for Preliminary Injunction. On October 10, 1995, the hearing on the Motion for Preliminary Injunction was held. Updegrave appeared at the hearing on his own behalf, cross-examined the United States' witnesses, and argued for denial of the Motion. By order dated October 11, 1995, the Court granted the Preliminary Injunction and directed the defendant to turn over the stock certificates referenced in the order to the Clerk's office in Philadelphia within seven business days (October 20, 1995). When Updegrave failed to comply with the Order, the United States filed a Motion to Show Cause Why Defendant Should Not Be Held in Civil Contempt. Both Updegrave and the United States appeared in Reading, Pennsylvania for a hearing on the Motion on December 12, 1995. However, the case had been reassigned to a Judge sitting in Philadelphia and the hearing was rescheduled for December 13, 1995 in Philadelphia and, in the alternative, for January 16, 1996 in Reading. Updegrave failed to appear at either hearing. Thereafter, the Court entered an order finding Updegrave in civil contempt, and issued a bench warrant for his arrest. Updegrave was arrested on September 19, 1996. He was released the following day after turning over the stock certificates subject to the Order of October 11, 1995 to the District Court clerk in Allentown, Pennsylvania. On October 21, 1996, the United States filed this Motion for Summary Judgment which would (a) reduce its federal income tax assessments to judgment in the amount of $486,060.65, plus additional interest, penalties, and attorney's fees and costs ("Count I") (b) declare that its lien attaches to all property owned by Walter C. Updegrave, including the stock certificates referred to above, and (c) foreclose the tax lien on the shares of stock ("Count II").

III. FACTS

Defendant, Walter C. Updegrave, resides and is domiciled in Reading, Pennsylvania. On August 16, 1993, the United States, by and through a delegate of the Secretary of the Treasury, assessed against Updegrave, federal income taxes due for the years 1986, 1987, 1988, 1989, and 1990, interest thereon, and penalties for non-payment thereof. ⁵ Those assessments are as follows:

Period                                 Tax       Interest    Penalty

1986 .............................. $11,615.00  $12,424.24  $15,864.15

1987 .............................. $11,088.00  $ 7,632.68  $12,073.80

1988 .............................. $18,084.00  $18,758.21  $19,211.50

1989 .............................. $91,073.00  $56,664.21  $74,383.00

1990 .............................. $16,830.00  $ 6,318.68  $13,688.00

(Gov't. Ex. 1: p. 1, line 11; p. 2, line 17; p. 3, line 7; p. 3, line 20; p. 4, line 8). ⁶ On August 16, 1993, notice of these assessments including the amounts assessed was issued to Updegrave and demand for payment was made. (Gov't. Ex. 1: p. 1, line 16; p. 2, line 19; p. 3, lines 10, 22; p. 4, line 10); (Gov't. Ex. 3 ¶2). Thereafter, Updegrave neglected or refused to pay the full amount of his tax liability. (Gov't. Ex. 3, paragraph 3). On November 11, 1993, the Internal Revenue Service recorded a Notice of Federal Tax Lien, Serial Number 239317566, in the amount of $384,152.17 in the office of the Prothonatary in Berks County, Pennsylvania against Walter C. Updegrave representing unpaid federal income taxes, interest, and penalties for the years 1986-1990. ⁷ (Compl. Ex. 1). Interest and penalties on the sum have continued to accumulate since the date of the assessment and according to the complaint, as of September 26, 1995, Udegrave is indebted to the United States in the amount of $486,060.65. (Compl. at ¶12). Updegrave owns the following shares of stock.

(a) 508 shares of Mobile Corporation;

(b) 561 shares of Dupont;

(c) 1000 shares of Vaal Reefs Exploration and Mining, Ltd.;

(d) 300 shares of Rustenburg Platinum Holdings, Ltd.; and

(e) 200 shares of St. Helena Gold Mines, Ltd.

(Compl. at ¶16; Gov't. Ex. 3, ¶5). The certificates of stock evidencing Updegrave's ownership thereof have been delivered to the Clerk of the United States District Court in Allentown, Pennsylvania. The government contends that the federal tax lien has attached to the shares of stock and seeks foreclosure in order to satisfy Udegrave's outstanding tax liability.

IV. DISCUSSION

A. Count I

As noted, the record includes the Notice of tax assessment and a Certificate of Assessments and Payments that was generated by the IRS and issued to Updegrave. In a suit to reduce tax assessments to judgment, when the United States supports assessment of tax liability with a certificate of assessments and payments, the certificate provides presumptive proof of a valid assessment; once the certificate of assessment delineates a taxpayer's liability, the burden is on the taxpayer to overcome the certificate's presumption of accuracy by presenting countervailing proof. Welch v. Helvering [3 USTC ¶1164], 290 U.S. 111, 115 (1933); Patsy v. United States [71-1 USTC ¶9346], 442 F.2d 1154, 1159-60 (3d Cir. 1971) (the United States establishes a prima facie case when it shows a timely assessment was made against the taxpayer); Gentry v. U.S. [92-1 USTC ¶50,225], 962 F.2d 555 (6th Cir. 1992); Bassett v. U.S., 782 F.Supp. 113 (M.D. Ga. 1992). Accordingly, in the case at hand, the United States has established its prima facie case by submitting the Certificate of Assessments and Payments calculating Udegrave's tax liability for the relevant tax years to this court. (Gov't. Ex. 1.); Sadowski v. United States [88-2 USTC ¶9559], 687 F.Supp. 966, 992 (E.D. Pa. 1988); Egbert v. U.S. [91-1 USTC ¶50,048], 752 F.Supp. 1010, (D. Wyo. 1990), aff'd., 940 F.2d 1539, cert. denied, 502 U.S. 1016 ) (the assessments are presumptively correct and the taxpayers have the burden of proving them to be incorrect); Higginbotham v. United States [77-2 USTC ¶16,265], 556 F.2d 1173, 1175-76 (4th Cir. 1977); United States v. Eshelman [87-2 USTC ¶9419], 663 F.Supp. 285, 287 (D. Del. 1987). ⁸ In the case at hand, Updegrave neither argues that the proposed assessments are incorrect nor has he submitted evidence to this court demonstrating that they are incorrect. Accordingly, the United States is entitled to summary judgment that the taxpayer, Walter C. Updegrave, owes federal income taxes in the amount assessed plus statutory additions if he has not raised any other valid defense.

Although not entirely clear, it appears that defendant's opposition to the Motion of the United States is based primarily on the following assertions: (1) the court lacks jurisdiction over the person of the defendant in that he is not a citizen of the United States but a citizen of Pennsylvania, which he considers separate and independent of the United States; (2) the Internal Revenue Code, for several reasons, is not legally effective and does not apply to defendant because he is not a citizen of the United States; and (3) the preparation of a Substitute for Return and the assessment of tax liability by anyone other than the Secretary of the Treasury is invalid. We reject each of these contentions in turn.

(1) PERSONAL JURISDICTION

In his pro se response to this summary judgment motion Updegrave contends that this court lacks personal jurisdiction over him because Pennsylvania, the state in which he admittedly resides, is a "sovereign" entity.

The Commonwealth of Pennsylvania ratified the Constitution of the United States including the Supremacy Clause found in Article VI, and the Fourteenth Amendment thereto. ⁹ Thus, Pennsylvania is clearly not a "sovereign" entity. The state fully recognizes the authority of the United States government over citizens of Pennsylvania. Accordingly, the laws of the United States, including the Federal Rules of Civil Procedure, are valid and enforceable within the Commonwealth of Pennsylvania. The Federal Rules of Civil Procedure govern the method by which the district courts of the United States obtain jurisdiction over a person. Pursuant to Rule 4(k)(1), district courts acquire personal jurisdiction over a defendant by service of summons on a person "who could be subjected to the jurisdiction of a court of general jurisdiction in the state in which the district court is located." Thus, a federal district court is permitted to exercise personal jurisdiction over an individual to the extent authorized under state law of the forum in which it sits. In Pennsylvania, service of summons within the forum state subjects a defendant to the jurisdiction of a court of general jurisdiction. 42 Pa. C.S.A. §5301 provides that "the existence of any of the following relationships between a person and this commonwealth shall constitute a sufficient basis of jurisdiction to enable the tribunals of this commonwealth to exercise general personal jurisdiction over such person and to enable such tribunals to render personal orders against such person: (1) For individuals-(i) presence in this commonwealth at the time when process is served, (ii) Domicile in this Commonwealth at the time when process is served.

In the case at hand, the defendant admits to residing in Pennsylvania in papers submitted to this court. He also admits that he was served with summons in this action at his home in Pennsylvania. One of those documents states that "the alleged summons and complaint for 95-6054 were timely returned for cause". (Doc. #27 at p. "19 of 35"). Indeed, in light of the fact that defendant, himself mailed to the court the summons and other documents served upon him, it cannot seriously be contended that defendant was not properly served. Accordingly, there is no genuine issue as to whether proper service of the summons and complaint occurred and we conclude that this court may properly exercise jurisdiction over the person of the defendant. The defendants subjective belief that Pennsylvania is a sovereign entity does not make it so.

(2) CONGRESSIONAL AUTHORITY TO ENACT THE INTERNAL REVENUE CODE ITS APPLICABILITY TO THE DEFENDANT

Updegrave challenges the authority of Congress and the Internal Revenue Service to tax his income on a number of grounds. Each of Updegrave's articulated challenges has been uniformly rejected by courts in this and other circuits, and we find none of them to have any degree of merit.

First, defendant argues that he is not liable for any taxes because the United States Congress does not have the authority to enact the Internal Revenue Code; in fact, did not enact the Internal Revenue Code into positive law; and, finally, he is not subject to the IRC because he is not a citizen of the United States. We reject these arguments.

The Constitution of the United States delineates the powers delegated to Congress by the states. The power of Congress to impose a federal income tax on citizens and residents of the United States derives from the Sixteenth Amendment to the Constitution. U.S. Const. amend. XVI; See also, Becraft, 885 F.2d at 548-49; Lonsdale v. Commissioner of Internal Revenue [81-2 USTC ¶9772], 661 F.2d 71, 72 (5th Cir. 1981); In re Becraft, 885 F.2d 547, 548 (9th Cir. 1989) ("For over 75 years, the Supreme Court and the lower federal courts have both implicitly and explicitly recognized that the Sixteenth Amendment authorizes a non-apportioned direct income tax on United States Citizens resident in the United States and thus the validity of the federal income tax laws as applied to such citizens"). As noted above, the Fourteenth Amendment controls the definition of citizenship. The Amendment states that "all persons born or naturalized in the United States and subject to the jurisdiction thereof are citizens of the United States and of the States wherein they reside". U.S. Const. Amend. XIV; See, In re Charles Weatherley, 169 B.R. 555, 558 (1994) (citing, O'Driscoll v. IRS, 1991 WL 133417 (E.D. Pa. 1991). The amendment established simultaneous state and federal citizenship, thereby securing the political jurisdiction of the federal government over the residents of the individual states. See, O'Driscoll v. IRS, 1991 WL 133417 (E.D. Pa. 1991) (citing Ainsworth v. United States [90-1 USTC ¶50,006]. 1989 WL 163861 (1989). The Internal Revenue Code, in turn, explicitly confers on the Internal Revenue Service jurisdiction over residents of the fifty states. Pursuant to 26 U.S.C. §7701(a)(10), the taxing authority of the IRS "includes the several states and the District of Columbia as part of the United States of America." In re Charles Weatherly, 169 B.R. 555 (Bankr. Ct. E.D. Pa. 1994) (citing, In re Walters, 166 B.R. 119 (Bankr. N.D. Ind. 1993).

In the case at hand, Updegrave plainly admits to being born and living in Pennsylvania. In documents submitted to this court, Udegrave describes himself as "born and [is] living within the metes and bounds of Pennsylvania" and "native, and freeborn on the land within the metes and bounds now commonly known as Pennsylvania" and further submits that the location of his residence is Reading, Pennsylvania. (Document #27 at p. "2 of 4" and p. "2 of 35"). Because defendant admits to having been born in Pennsylvania and to residing there, and Pennsylvania is within the recognized territorial limits of the United States of America, defendant is indisputably a citizen of the United States and subject to the Internal Revenue Code. His refusal to recognize or accept citizenship of the United States has no legal effect.

Updegrave next argues that if Congress has the power to enact the Internal Revenue Code, it has not exercised that power by "enacting the I.R.C. into positive law". Courts have explicitly rejected this argument, citing 204(a). See, e.g. Ryan v. Bilby [85-2 USTC ¶9524], 764 F.2d 1325, 1328 (9th Cir. 1985) (stating that "Congress' failure to enact a title [of the United States Code] into positive law has only evidentiary significance and does not render the underlying enactment invalid or unenforceable"); United States v. Zuger, 602 F.Supp. 889, 891-92 (D. Conn. 1984) (holding that the failure of Congress to enact a title as such and in such form into positive law . . . in no way impugns the validity, effect, enforceability, or constitutionality of the laws as contained and set forth in the title"), aff'd. without op., 755 F.2d 915 (2d Cir.), cert. denied, 474 U.S. 805 (1985); Young v. IRS [84-2 USTC ¶9860], 596 F.Supp. 141, 149 (N.D. Ind. 1984) (asserting that "even if Title 26 was not itself enacted into positive law, that does not mean that the laws under that title are null and void"). "Like it or not, the Internal Revenue Code is the law". Ryan [85-2 USTC ¶9524], 764 F.2d at 1328. It is clear that a law included in the current edition of the United States Code establishes prima facie evidence of the law of the United States. 1 U.S.C. §204(a) (1994). Accordingly, this argument will be rejected.

The Court must also reject Udegrave's contention that, if indeed the IRC is valid, he is not a taxpayer within the meaning of the Code. See, In re Becraft, 885 F.2d at 548. The Internal Revenue Code, 26 U.S.C. §§1-9722 (1994), imposes an income tax on United States Citizens who reside in the United States and whose income is derived from domestic sources. 26 U.S.C. §1. Section 61 of the Internal Revenue Code imposes a tax on income. 26 U.S.C. §61. Updegrave's, again, contends that he is not a citizen of the United States. (Doc. #27 p. 4). As noted above, Updegrave's own submissions preclude such a finding. Accordingly, this court finds that Updegrave is not only a resident of Pennsylvania, but a citizen of the United States by birth, and as such, he is subject to federal income tax. See also, United States v. Studly [86-1 USTC ¶9390], 783 F.2d 934, 937 (9th Cir. 1986) ("rejecting argument that defendant was "an absolute, freeborn, and natural individual" and therefore, not a 'taxpayer'). ¹⁰

Finally, Updegrave argues that federal jurisdiction, the federal government's authority to impose income tax, is statutorily limited to residents of "federal enclaves" and the District of Columbia and he is not a resident or citizen of those areas. A virtually identical argument has been explicitly rejected by the ninth and eleventh circuit courts of appeals. See, In re Becraft, 885 F.2d 547, 548 n.2 (9th Cir. 1989) (citing, United States v. Ward [88-1 USTC ¶9177], 833 F.2d 1538, 1539 (11th Cir. 1987), cert. denied, -- U.S. --, 108 S.Ct. 1576 (1988) (federal jurisdiction is not limited to federal enclaves and District of Columbia).

(3) PREPARATION OF SUBSTITUTE RETURNS

Updegrave claims that he does not owe taxes to the United States because tax assessments must be calculated with tax returns filed by the taxpayer and that an inferior agent of the IRS may not file the substitute returns for the taxpayer. He argues that, because he did not file returns for the years 1986 through 1990, and because the substitute return and his tax liability was assessed by an employee of the IRS rather than by the Secretary, he cannot be taxed. These arguments are rejected.

First, pursuant to section 6012(a) of Title 26, the filing of returns of income is mandatory. That section exempts certain individuals, however, Udegrave does not claim that any of the exceptions to the general rule are applicable here. Further, section 6020(b) of Title 26 authorizes the IRS to file Substitute Returns on behalf of a debtors who fail to voluntarily file returns. See e.g., In re Bergstrom [91-2 USTC ¶50,558], 949 F.2d 341, 343 (10th Cir. 1991). The Code also provides that the [substitute return] may be prepared from the Secretary's own knowledge and from any information s/he can obtain and that any return filed and signed by the Secretary "shall be prima facie good for all legal purposes". 26 U.S.C. §6020(b)(1) and (2).

Accordingly, we conclude that the IRS did not act improperly in filing returns for Updegrave in those tax years when he refused to do so, nor in assessing his federal income tax on the basis of the substituted returns which it prepared. A potential taxpayer may not stymie the IRS's collection of taxes by simply refusing to file a tax return.

Second, Updegrave contends that the substitute return prepared for him by an employee of the IRS is invalid because §6020 authorizes only the Secretary of the Treasury (not a lesser official) to prepare returns for delinquent taxpayers. Updegrave has misinterpreted the statute. The term "secretary" is defined as "the Secretary of the Treasury or his delegate". 26 U.S.C. §7701(a)(11)(B). The term "or his delegate", when used in reference to the Secretary of the Treasury, means any officer, employee, or agency of the Treasury Department duly authorized by the Secretary of the Treasury directly, or indirectly by one or more regulations of authority, to perform the function mentioned or described in the context. 26 U.S.C §7701(a)(12)(A)(i). 26 C.F.R. §301.6020-1(a)(1) delegates the authority to prepare substitute returns to the District Director or any authorized Internal Revenue officer or employee. Accordingly, the substitute return and the assessments in this case were properly made by an employee of the IRS in accordance with the Internal Revenue Code.

Finally, defendant claims that there are no regulations implementing the provisions of the Internal Revenue Code upon which plaintiff relied in preparing the substitute return and assessing taxes against him. This assertion is based upon the mistaken belief that the sole rule-making authority for those provisions is found under Title 27, Part 70 of the Code of Federal Regulations, Alcohol, Tobacco Products and Firearms, rather than Title 26, Internal Revenue. Thus, defendant argues, the provisions cannot apply to him because he is not engaged in any activity that falls under Title 27 of the United States Code. The patent flaw in defendant's argument is that the Title 27 regulations are not the exclusive source of the government's authority to act and each of the sections upon which plaintiff relies has companion regulations in Title 26 of the Code of Federal Regulations. Consequently, this argument does not provide grounds for denying plaintiff's motion for summary judgment.

Reviewing the entire record, this Court finds that Udegrave has not raised any cognizable defense to the imposition of tax liability. Each of defendant's claims are frivolous and have been consistently rejected by the courts for decades. Indeed, advancement of such utterly meritless arguments can be the basis for imposition of sanctions. Accordingly, summary judgment as to Count I is granted in favor of the United States.

B. Count II

The government asserts a lien upon stock owned by Updegrave pursuant to 26 U.S.C. §§6321 and §6322 of the Internal Revenue Code. §6321 provides that the failure of any person liable for a tax neglects or refuses to pay the tax after demand creates a lien in favor of the United States upon that person's property in the amount of the unpaid tax liability, including interest, costs, and penalties which may accrue. The lien arises "at the time the assessment is made", 26 U.S.C. §6322, and extends to all property belonging to the taxpayer at that time or thereafter acquired. 26 U.S.C. §6322; United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 719-20 (1985); See also, 21 West Lancaster Corp. v. Main Line Restaurant [86-2 USTC ¶9516], 790 F.2d 354, 356 (3d Cir. 1986); 26 U.S.C. 6321; Glass City Bank v. United States [45-2 USTC ¶9449], 326 U.S. 265, 267-68 (1945). In this case, because the taxpayer neglected or refused to pay taxes after assessment, notice, and demand, the United States is entitled to a judgment that it had a valid and subsisting lien against all of Updegrave's property as of the date of original assessment. ¹¹

Because a federal tax lien is not self-executing, the government has instituted this lien foreclosure suit in order to enforce collection of the unpaid taxes. ¹² In determining the threshold question of whether and to what extent a taxpayer has a property interest or a right to property to which the federal tax lien can attach, both federal and state courts must look to state law. See e.g. Aquilino v. United States [60-2 USTC ¶9538], 363 U.S. 509, 512-13 (1960) (in application of federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property . . . sought to be reached by the statute); U.S. v. Sullivan [64-1 USTC ¶9392], 333 F.2d 100 (C.A. Pa. 1964), aff'd. [64-1 USTC ¶9393], 333 F.2d 146. Once it has been determined under state law that the taxpayer owns property, federal law is controlling for the purpose of determining whether a lien will attach to such property. Viva Ltd. v. U.S. [81-1 USTC ¶9169], 490 F.Supp. 1002, 1005 (U.D. Colo. 1980) (citing, United States v. Bess, 35 U.S. 51, 56-57 (1958). Once the court has determined whether, according to state law the taxpayer owns property to which the lien may attach, the court is then required to determine, when the issues are raised, whether the government has complied with the necessary notice and other procedural requirements under federal law. Bauer v. Foley [69-1 USTC ¶9327], 408 F.2d 1331, 1333 (2d Cir. 1969).

In this case, Updegrave has not denied owning the stocks at issue and the government has offered evidence that proper notice and demand for payment of the amounts assessed was given. Indeed, the receipt by defendant of the notices was established when Updegrave returned the notices by mail, albeit unopened. Accordingly, Updegrave has not raised a genuine issue of material fact regarding ownership of the property at issue, and the evidence presently before this court suffices to establish that the lien in favor of the United States attaches to the stock.

Pursuant to 26 U.S.C. §7403, this Court may order the sale of the property subject to the federal tax lien. ¹³ Because there is no evidence that any other person claims an interest in the stock, a foreclosure sale of the property in question is appropriate. The certificates evidencing defendant's ownership of the stock will be turned over to the United States government as partial payment of the defendant's tax liabilities.

V. CONCLUSION

Based on the undisputed facts and the applicable law, this Court will grant the summary judgment motion of the United States and thereby: (1) reduce the federal tax assessments against Walter C. Updegrave to judgment, (2) declare that the United States has a valid federal tax lien on the property in question and that the tax lien is entitled to priority over all other interests in that property, (3) declare that the United States is entitled to a foreclosure sale of the property in question, and (4) order the sale thereof. An appropriate order will be entered.

ORDER

AND NOW, this -- day of June, 1997, upon consideration of the Motion for Summary Judgment submitted on behalf of the United States and defendant Walter C. Updegrave's response thereto, it is ORDERED that,

1.) the United States' Motion for Summary Judgment is hereby GRANTED as to Count I of the Complaint and judgment is entered in favor of the United States and against Walter C. Updegrave in the amount of $486,060.65, plus interest according to law.

This Court having entered judgment against Walter C. Updegrave and having determined that the federal tax lien attaches to the shares of stock listed below, it is further ORDERED that,

2.) the United States' Motion is hereby GRANTED as to Count II of the Complaint and the lien on the stock shall be foreclosed in order to satisfy this judgment. Accordingly, the United States, through its Internal Revenue Service, is ORDERED to sell the following shares of stock pursuant to 28 U.S.C. §2004 and to apply the proceeds to the unpaid tax liabilities of Walter C. Updegrave arising from Count I:

a. 508 shares of Mobile Corp.

b. 561 shares of Dupont

c. 1000 shares of Vaal Reefs Exploration and Mining, Ltd.

d. 300 shares of Rustenburg Platinum Holdings, Ltd.

e. 200 shares of St. Helena Gold Mines, Ltd.

3.) Michael Kunz is ORDERED deliver to the United States, any and all certificates presently in his possession which evidence Walter C. Updegrave's ownership of the shares of stock to the United States, and

4.) Internal Revenue Service Officer, James Berret is granted a limited power of attorney to execute, on behalf of Walter C. Updegrave, any and all documents necessary to effectuate a sale of the stock.

¹ Section 1340 provides: "district courts shall have original jurisdiction of any civil action arising under any act of Congress providing for internal revenue." 28 U.S.C. §1340.

² Section 1345 provides: "Except as otherwise provided by Act of Congress, the district courts shall have original jurisdiction of all civil actions, suits, or proceedings commenced by the United States, or by any agency or officer thereof expressly authorized to sue by Act of Congress". 28 U.S.C. §1345.

³ Section 7402 provides: (a) "the district courts of the United States at the instance of the United States shall have jurisdiction to make and issue in civil actions, writs and orders of injunction, and of ne exeat republica, orders appointing receivers, and such other orders and processes, and to render such judgments and decrees as may be necessary and appropriate for the enforcement of the internal revenue laws. The remedies hereby provided are in addition to and not exclusive of any and all other remedies of the United States in such courts or otherwise to enforce such laws ... (e) The United States district courts shall have jurisdiction of any action brought by the United States to quiet title to property if the title claimed by the United States to such property was derived from enforcement of a lien under this title." 26 U.S.C. §7420.

⁴ Section 7403 provides that,

"(a) In any case where there has been a refusal or neglect to pay any tax, or to discharge any liability in respect thereof, whether or not levy has been made, the Attorney General or his delegate, at the request of the Secretary, may direct a civil action to be filed in a district court of the United States to enforce the lien of the United States under this title with respect to such tax or liability or to subject any property, or whatever nature, of the delinquent, or in which he has any right, title, or interest, to the payment of such tax or liability. (b) All persons having liens upon or claiming any interest in the property involved in such action shall be made parties thereto. (c) The court shall, after the parties have been duly notified of the action, proceed to adjudicate all matters involved therein and finally determine the merits of all claims to and liens upon the property, by the proper officer of the court, and a distribution of the proceeds of such sale according to the findings of the court in respect to the interests of the parties and of the United States. (d) In any such proceeding, at the instance of the United States, the court may appoint a receiver to enforce the lien, or, upon certification by the Secretary during the pendency of such proceedings that it is in the public interest, may appoint a receiver with all the powers of a receiver in equity." 26 U.S.C. §7403.

This civil suit commenced at the request of the Chief Counsel of the Internal Revenue Service, a delegate of the Secretary of the Treasury, and at the direction of the United States Attorney General.

⁵ The following events preceded the assessments. On March 21, 1991 and again on March 29, 1995, the Internal Revenue Agent assigned to Updegrave's case sent Updegrave Appointment letters setting dates and times for him to meet with her. Instead of meeting with the agent on the proposed days, Updegrave returned the unopened envelopes containing the letters to the agent along with his own letter explaining his position. Thereafter, the agent proceeded with the Substitute for Returns Procedures of the Internal Revenue Service because Updegrave did not file Federal Income Tax Returns for the years 19986-1990. First, a copy of a 1040 Tax Return was completed by the revenue agent with the taxpayer's name, address and social security number enabling the IRS to set up an account for the taxpayer so that a tax may be assessed. The agent then secured financial information as to the amount of income received in each year. In this case, the agent determined Updegrave's tax liability based on information on income contained in Form 1099s under Updegrave's social security number. The amounts on those forms were verified through bank statements and by the payees. Updegrave's tax liability was eventually calculated, with deductions allowed for exemption, standard deduction, and for any tax credits. A report detailing his tax liability was compiled and a Statutory Notice of Deficiency was issued to Updegrave by certified mail containing the amounts proposed to be assessed against him. Such a Statutory Notice of Deficiency gives any taxpayer 90 days to either: (1) agree; or (2) to petition the Tax Court. Updegrave returned the unopened Notice after marking it "Refused". (Gov't Ex. 2 at p. 59, lines 14-25). Updegrave failed to file a petition in the tax court within the statutory period and the amounts were then assessed against him.

The case was closed and referred to the Collection Division of the Internal Revenue Service. (Gov't. Ex. 2).

⁶ By this Courts own calculations, the total deficiency in tax, penalties, and interest based on these figures is $385,708.47.

($148,690.00 in Tax + $101,798.02 in Interest + $135,220.45 in Penalties = $385,708.47.)

⁷ The effect of such filing is to perfect the lien so that it will have priority over later-arising or later-filed tax liens. See, e.g U.S. v. Fidelity Philadelphia Trust [72-1 USTC ¶9394], 459 F.2d 771 (C.A. Pa. 1972).

⁸ Pursuant to Fed. R. Evid. 802(1), the Form 4340, is self-authenticating because it is under seal.

⁹ Constitution: December 12, 1787; Fourteenth Amendment: February 12, 1867

¹⁰ We also note that, contrary to defendant's claims, citizens and residents of the United States must pay federal income taxes regardless of whether they receive benefits from the United States government. Lovell v. United States [85-1 USTC ¶9208], 755 F.2d 517, 519 (7th Cir. 1984).

¹¹ A lien arising under §6321 is afforded priority over all other unperfected liens or claims asserted against the taxpayer's property, 26 U.S.C. §6323(a), but is ineffective against certain parties until the notice of the lien has been properly filed by the government under section 6323(a). Id. We merely note that the United States duly filed with the appropriate office, a Notice of Federal Tax Lien, Serial Number 239317566, in the amount of $ 384,152.17 in the office of the Prothonatary in Berks County, Pennsylvania against Walter C. Updegrave. Under 26 U.S.C. §§6321 and 6323, the federal tax lien, duly filed and recorded, is entitled to priority over subsequent purchasers.

¹² A tax lien is not self-enforcing, but rather, the Internal Revenue Service must either file a lien foreclosure suit under 26 U.S.C.A. §7403, or assert an administrative levy under 26 U.S.C. a. §6331; Rodriquez v. U.S. [86-1 USTC ¶9289], 629 F.Supp. 333 (N.D. Ill. 1986). Section 7403 authorizes the institution of a civil action in federal district court to enforce a lien "to subject any property, of whatever nature of the delinquent, or in which he has any right, title, or interest, to the payment of such tax." See generally, United States v. Rodgers [83-1 USTC ¶9374], 461 U.S. 677, 680-682 (1983).

¹³ Section 7403(c) Adjudication and decree - The Court shall, after the parties have been duly notified of the action, proceed to adjudicate all matters involved therein and finally determine the merits of all claims to and liens upon the property, and, in all cases where a claim or interest of the United States therein is established, may decree a sale of such property, by the proper officer of the court, and a distribution of the proceeds of such sale according to the findings of the court in respect to the interests of the parties and of the United States. (d) Receivership-In any such proceeding, at the insistence of the United States, the court may appoint a receiver to enforce the lien, or, upon certification by the Secretary during the pendency of such proceedings that it is in the public interest, may appoint a receiver with all the powers of a receiver in equity.

 

 

 

United States of America, v. Claude M. Worley, Crystal Flash Petroleum Corporation, John E. Fehsenfeld, individually, and as president and director of the Crystal Flash Petroleum Corporation, Ruth A. Fehsenfeld, individually, and as vice president and director of Crystal Flash Petroleum Corporation

District Court of the United States for the Southern District of Indiana, Indianapolis Division, Civil No. 51, 64 FSupp 271, Filed March 8, 1940

Tax liens.--Tax judgment for $19,402.84 plus interest against defendant Worley is granted, lien obtained by Government on certain shares of stock, and orders issued for certain payments due the defendant to be made to the United States.

Val Nolan, United States Attorney, 246 Federal Bldg., Indianapolis, Ind., for the United States. William E. Reiley, Attorney, 108 East Washington St., No. 1502, Indianapolis, Ind., for Claude M. Worley. Noel, Hickam, Boyd & Armstrong, 130 East Washington St., No. 1019, Indianapolis, Ind., for Crystal Flash Petroleum Corporation. Willson, Jones and Willson, 815 State Life Bldg., Indianapolis, Ind., for John E. and Ruth A. Fehsenfeld.

Findings of Fact and Conclusions of Law

BALTZELL, District Judge:

Special Findings of Fact

(1) At all times herein mentioned plaintiff was and now is a corporation sovereign and body politic.

(2) This is a suit by the United States of a civil nature in connection with the Administration of the laws of Congress providing for internal revenue, and particularly Section 802 of the Revenue Act of 1936, and this action is commenced and maintained at the request of the Commissioner of Internal Revenue and the action is further maintained for the collection of a fine assessed against the defendant Worley in a criminal cause No. 5535 in the District Court of the United States for the Southern District of Indiana, both at the direction of the Attorney General of the United States.

(3) The defendants Claude M. Worley, John E. Fehsenfeld, and Ruth A. Fehsenfeld at all times mentioned herein have resided and still reside in the City of Indianapolis, County of Marion, State of Indiana, within the Southern District of Indiana.

(4) The defendant Crystal Flash Petroleum Company, Inc., (whose proper corporate name is Crystal Flash Petroleum Corporation) was incorporated on the 7th day of November, 1930, and ever since has been and now is a corporation duly organized and existing under the laws of the State of Indiana, with its principal place of business in the City of Indianapolis, County of Marion, State of Indiana, within the Southern District of Indiana; the defendant John E. Fehsenfeld at all such times was and now is President and director of said corporation, owning 309 shares of the stock of said company; the defendant Ruth A. Fehsenfeld, his wife, at all such times was and now is a director and Vice-President of said corporation, owning one share of the stock of said company, and the defendant Claude M. Worley at all such times was and now is a director and Secretary of said corporation owning 490 shares of the stock of said corporation. The authorized capital stock of said Crystal Flash Petroleum Corporation is 1,000 shares of no par value, for which $20,000 was paid as the full consideration therefor by the subscribers thereto, and the original capital of said corporation was $20,000.

(5) On or about July 7, 1932, there were duly assessed by the United States, acting by and through the Commissioner of Internal Revenue, against the defendant Claude M. Worley, as income taxes, penalties and interest, for the years 1924 to 1930, inclusive, the amounts for each year being as follows:

                                         25%               50%

Year                   Tax           Penalty           Penalty        Interest

1924               $ 10.42            $ 2.61              None          $ 4.57

1925                262.96             65.74              None           99.56

1926                 42.46             10.62              None           13.53

1927              1,351.36            337.84          $ 675.68          349.48

1928                315.12             78.78            157.56           62.59

1929                 38.31              9.58             21.34           12.31

1930              3,196.84            799.21          1,598.42          251.32

Totals           $5,217.47         $1,304.38         $2,453.00         $793.36

 

Total deficiency in tax, penalties, and interest--$9,768.21.

Interest on the aforementioned sum in the aggregate sum of $4,649.58 has accumulated since the assessment on July 7, 1932, making the total gross amount of taxes, penalty, and interest to date $14,417.79. A credit against the last mentioned amount in the sum of $112.50 is due to be made, representing gold seized in a safety deposit box of the defendant Claude M. Worley on or about the 10th day of October, 1935; a further credit of $1,962.45 is due to be made on account of the sale on or about the 18th day of August, 1936, by the Collector of Internal Revenue for the Collection District of Indiana, of certain Indianapolis Power and Light Company stock belonging to the defendant Claude M. Worley; further credits of $1,960.00 and $980.00 are due to be made against the above sum on account of the payment to the Collector of Internal Revenue for the Collection District of Indiana on or about December 31, 1937, and on or about December 31, 1939, respectively, as dividends on said 490 shares of stock of the Crystal Flash Petroleum Corporation, belonging to the defendant Claude M. Worley, but which said stock was then held and is now held by the Collector of Internal Revenue for the Collection District of Indiana; there is now due the plaintiff from the defendant Claude M. Worley on account of said taxes, penalties and interest, the net sum of $9,402.84.

(6) On or about the 22nd day of July, 1932, in criminal cause No. 5535, upon a plea of guilty to the charges set forth in an indictment then pending in this court under said cause, this Court sentenced defendant Claude M. Worley to a term of five years in the federal penitentiary and assessed a fine against him in the sum of $10,000; that said fine, which is a judgment against the said Claude M. Worley, has not been paid nor any part thereof, and the same is still due and unpaid although frequent demand has been made upon him for payment thereof; that there is now due on said fine in favor of plaintiff in this cause the sum of $10,000.

(7) On or about the 8th day of July, 1932, there was filed of record with the Clerk of this Court and with the Recorder of Marion County, Indiana, an income tax lien in favor of the plaintiff arising under and by virtue of the laws of the United States, particularly Section 3186 of the Revised Statutes of the United States, as amended, the said lien being a lien on all property and rights to property belonging to said defendant, Claude M. Worley.

(8) The defendant Crystal Flash Petroleum Corporation is indebted to the defendant Claude M. Worley in the sum of $2,028.16, which sum is subject to the lien in favor of the United States mentioned in Finding No. 7 herein. The following additional personal property of the defendant Claude M. Worley is likewise subject to said lien; the 490 shares of capital stock of the defendant Crystal Flash Petroleum Corporation now in possession of the Collector of Internal Revenue for the Collection District of Indiana, the same being the stock mentioned in the foregoing Finding No. 5.

(9) That the defendant Claude M. Worley at all times mentioned herein was the owner of 490 shares of stock in said Company, which said 490 shares is recorded on the books of the Company in the name of said Claude M. Worley, but is subject to the income tax lien filed on July 8, 1932, as set out in Special Finding No. 7 herein and said stock ever since July 8, 1932 has been in the possession of plaintiff and by said lien the plaintiff the United States ever since has been and now is entitled to 49% of any dividends paid by said Company since said time.

(10) That there is a sum of $2,028.16 due said Claude M. Worley from said Company, which was entered on the books of said Company at the close of the business for the year 1931 and was in the hands of said Company at the time of the notice of lien referred to in these findings and that said Company at all times has held said sum of money for the benefit of plaintiff and at all times has been ready to pay said sum to the plaintiff, as the plaintiff well knew.

(11) That at an informal meeting of the Directors of said Company held December 19, 1936, said John E. Fehsenfeld was allowed and paid a bonus of $8,000.00 for the year 1936 in addition to his salary of $10,000.00 for said year; that said bonus for the year 1936 was disallowed by the Internal Revenue Department of the Government as excessive in relation to the services rendered for the year 1936 and the court now finds that said sum of $8,000.00 declared and paid to said John E. Fehsenfeld as a bonus for said year should have been and was, in effect, a dividend in the amount of $8,000.00 properly payable and which should have been paid as a dividend on all of the stock of said corporation for the year 1936, and that 49% of said sum of $8,000.00 for the year 1936 should have been paid and credited by said corporation to the plaintiff in the principal amount of $3,920.00; that said sum of $3,920.00 was retained by said Fehsenfeld and the plaintiff is entitled to recover from said Fehsenfeld said sum of $3,920.00, with interest for three years and one and one-half months, amounting to $735.00, and should have been applied to the amounts due from said Worley upon said tax lien.

(12) The court further finds that the Board of Directors on December 19, 1936, ordered paid to said J. E. Fehsenfeld, as President, the sum of $3,150.00 as bonuses to be paid and distributed to such employees of the Company as he should designate; that said Fehsenfeld retained the sum of $1,500.00, from said amount of $3,150.00 so ordered paid as bonuses and appropriated to himself and to his own use said sum of $1,500.00, which said sum should have been paid and was, in effect, a dividend upon all of the stock of said Company; that by reason of his retention of all of said sum the plaintiff is entitled to recover from said defendant 49% of said sum of $1,500.00, in the principal amount of $735.00, together with the interest thereon for three years and one and one-half months amounting to $137.81, which said amount is due and payable to the plaintiff upon its claim against the defendant Worley, and which amount, when paid, should be applied to the reduction of the tax lien against said stock of said Worley.

Conclusions of Law

And the Court now states its conclusions of law upon the foregoing findings of fact as follows:

I. The plaintiff, the United States of America, is entitled to recover from the defendant Worley the sum of $19,402.84, together with interest thereon at the rate of six per cent (6%) per annum from and after the date hereof until paid.

II. The plaintiff, the United States, holds and is entitled to a lien by reason of its notice of levy of July 8, 1932, upon 490 shares of the no par value capital stock of the defendant Crystal Flash Petroleum Corporation standing in the name of the defendant Worley, and upon all sums of money owing to said defendant Worley from said defendant Crystal Flash Petroleum Corporation on or after said 8th day of July, 1932.

III. The plaintiff, the United States, is entitled to an order requiring the defendant Crystal Flash Petroleum Corporation to pay to the plaintiff, to be credited and applied upon the said judgment against the defendant Worley, the sum of $2,028.16.

IV. The plaintiff, the United States, is entitled to an order requiring the defendant J. E. Fehsenfeld to pay to the plaintiff, on account of said amounts paid to him which were in effect dividends, to be credited and applied upon the said judgment against the defendant Worley, the principal sum of $3,920.00 plus interest in the amount of $735.00, and in addition thereto, the principal sum of $735.00 plus interest in the amount of $137.81, aggregating the sum of $5,527.81, together with interest at the rate of six per cent (6%) per annum from and after the date hereof until paid.

V. The plaintiff, the United States, is entitled to be paid from the proceeds of the sale of said 490 shares of capital stock of Crystal Flash Petroleum Corporation the amount of said judgment against the defendant Worley, after crediting thereon the said sum of $2,028.16 to be paid by defendant Crystal Flash Petroleum Corporation and after crediting thereon said sum of $5,527.81 to be paid by said defendant J. E. Fehsenfeld, upon the payment of said respective sums.

VI. The plaint the United States, is entitled to an order directing the sale of said 490 shares of capital stock of Crystal Flash Petroleum Corporation, in the manner and upon the notice and terms provided by the laws of the United States for sales in such cases, the proceeds of said sale to be applied as follows: First, to the payment of the costs in this cause; second, to the payment of said judgment against the defendant Worley; third, as to any overplus of said proceeds to such person or persons as the court may direct; said judgment to remain in full force and effect to the extent that the payments herein ordered to be made and the proceeds of said sale applied as herein provided shall be insufficient to pay the same.

 

 

 

United States of America v. Haskell Telephone Company, et al.

District Court of the United States for the Northern District of Texas, Fort Worth Division, Civil Action No. 23, 42 FSupp 498, Filed June 1, 1939

Lien for taxes.--The Court holds that the Government is entitled to the full amount of a claim against an estate for income taxes of the estate, and that it has a lien against certain telephone stock originally belonging to the estate. The memorandum opinion also contains conclusions as to attorneys' fees and other claims against the estate.

Clyde O. Eastus, United States Attorney, Fort Worth, Texas, for plaintiff. Wilson, Randal & Kilpatrick, Lubbock, Texas, Hamilton, Lipscomb, Wood & Swift, Dallas, Texas, J. S. Kendall, Munday, Texas, and Turner, Seaberry & Springer, Eastland, Texas, for defendant.

Memorandum Opinion

[Claim for Income Taxes]

JAMES C. WILSON, District Judge:

Since this memorandum is only for the information of the parties directly interested in the suit, I will not take the time to state the history and general nature of the case. The suit is by the Government against the Haskell Telephone Company for income taxes alleged to be due by the estate of Kate F. Morton, and asserting a lien on certain telephone stock originally belonging to said estate. The Government undertook to make all with any claims against this telephone stock, and for that matter, all claimants against the estate, parties to this suit; some thirty or forty parties were cited to appear. Many of them disclaimed, others were dismissed from the suit on discovery that they had no claim against the stock or the estate. Those that did appear are Joe Lee Ferguson and A. M. Ferguson, the latter for himself and as administrator of the estate of Kate F. Morton; the defendant Telephone Company, of course; the General Telephone Corporation of New York; The Farmers & Merchants State Bank of Haskell; R. A. Chapman, Jr., and lastly, Freeman and McReynolds, their claim being for attorneys' fees.

[Government's Lien for Taxes]

I reached the conclusion that the Government was entitled to the full amount of its claim, and that it had a lien against the telephone stock in question. The amount of the Government's claim, directly involved here, was at the time of the hearing, $1,492.28. In fact, there was no serious controversy presented as to the Government's claim. No opposition really to it, except such general statements as were made by A. M. Ferguson. The Government has a similar claim against this estate for approximately $4,000.00, in a way involved here, but directly involved in the case of A. M. Ferguson v. Haskell National Bank, now on appeal in the Court of Civil Appeals at Eastland. For the present anyway, no action can be taken as to that claim.

[Claims of Others]

It appears, too, that the Cookingham contract with Joe Lee Ferguson for the purchase of his 20-20/21 shares of stock of the Telephone Company was in all respects a valid contract, and that specific performance of it should be enforced, according to its terms.

It is also my conclusion that the liens, judgments and judicial sale asserted by R. A. Chapman, Jr. are valid, having the effect not only to make his claim allowable, but to place in said Chapman, the title of all the interest that A. M. Ferguson ever had in the telephone stock, subject to any indebtedness against the estate.

The question of attorneys' fees to Wilson, Randal & Kilpatrick for their services in representing the Haskell Telephone Company was an issue, Mr. W. E. Allen of Fort Worth being the only opinion witness introduced, as to the value of the services. From his testimony, together with the facts as to the character and extent of the services performed, I think $2,000 would be a reasonable fee for said attorneys. There were other legal matters in which these attorneys served in addition to this particular case and hearing, among them for instance, an important injunction hearing was had and the injunction granted at their request. This suit, though in the nature only of interpleader, as far as the Telephone Company is concerned, has been most troublesome and has placed considerable responsibility and labor on the attorneys. The Telephone Company seeks nothing for itself, other than protection against the possibility of multiple suits against it in the future. It had at the time of the hearing, $40,000.00 in dividends, ready to pay it out to whom the Courts may finally award it.

There is absolutely no issue made as to the justness nor the amount of the fee claimed by Freeman & McReynolds for legal services performed for the estate. It has been reduced to judgment and is a claim against the estate. It appears to me that it should be allowed for the full amount. The amount of the fee directly involved here is approximately $450.00. There is apparently due an additional $1500.00, which is involved in the suit (supra) between the Fergusons now pending in the Court of Civil Appeals at Eastland. It possibly could become an issue to be disposed of in this suit, but is not now.

[Effect of Transfers]

The chief contender with all claimants is A. M. Ferguson. He makes the point that any of these claims that are merely against the estate, should not be paid out of the telephone stock, or pro rata dividends therefrom, that was awarded to him as his part of the estate. He makes the suggestion that the lands that were awarded to Joe Lee Ferguson, under the arbitration and otherwise, have been disposed of and are now beyond the reach of the creditors for the satisfaction of any estate debts; that it would be unjust and inequitable for all of such debts to be paid out of his part. As between him and his brother, Joe Lee, that might be very true. A. M. Ferguson's transfer and the transfer of Joe Lee Ferguson of their respective interests in the telephone stock was expressly subject to the payment of the estate's debts. It looks to me that A. M. Ferguson in allowing Joe Lee Ferguson to get his part of the estate and dispose of it, or his creditors to dispose of it, simply left himself in an unfortunate situation about it; that just or unjust, if there is no other part of the estate available to its creditors, they would be entitled to collect their debts out of the telephone stock, or the revenues from it, even though practically all of it was awarded to A. M. Ferguson.

[District Court's Jurisdiction]

Of course, A. M. Ferguson makes the point all the way through that this Court has no jurisdiction to adjudicate any of these claims, or as he puts it, to administer upon this estate; that such powers are exclusively with the Probate Court of Haskell County, and that that court is still administering upon the estate. Theoretically that would appear to be correct, and ordinarily would be. The answers of all the claimants to that is, that an arbitration agreement was entered into by Joe Lee and A. M. Ferguson to settle and wind up the estate, and an arbitration was had and an award made by the arbitrators, which award was appealed from, was affirmed and became final, and is now foreclosed by valid and binding judgments of courts of competent jurisdiction; that it carried with it a distribution of all the assets of the estate, and had the effect of closing and ending the Probate administration in Haskell County. They are right about this. The judgments of such Texas courts so provide. Ferguson v. Ferguson, 93 S. W. (2d) 513, and many other decisions of the appellate courts, among them one rendered by the Court of Civil Appeals at Eastland, dated April 28, 1939, abundantly confirm this view.

The Government takes the position and rightly, that it has had its claim filed with the Probate Court for many years; that in view of the destructive history of litigation between Joe Lee and A. M. Ferguson, that no claimant could have ever gotten any relief through the Probate Court, and that, as a practical matter, the only place of relief for the Government was to file its suit in this Court, which of course, it had a right to do, and there to seek to impress the telephone stock with a lien; that since it came into this Court, it follows that those who had liens or claims or judgments against the stock, and certainly those who had liens against it, under valid contracts with Joe Lee and A. M. Ferguson, would have a right to appear here to subject the residue of any of this stock, after the payment of prior claims, to the payment of their individual debts that might be secured by the stock. There is no question in my mind, but what that arbitration award which became final, had the effect to close the estate. That is, if the courts of Texas of last resort can adjudicate and finally settle anything. I think they do. It makes no difference if the Probate Judge of Haskell County has accepted, or is accepting claims, at this time, and is proposing to administer upon the estate. If such is being done, it is wholly without authority of law, and beyond any question true in so far as any proceedings there relate to this telephone stock.

[Claims of Others]

The Farmers and Merchants State Bank of Haskell, presents four claims here. One of them will be allowed and the others denied. The one I allow is based on a judgment, procured on a note executed by Joe Lee Ferguson, of date, December 19, 1938, and which claim at the time of the hearing was approximately $12,381.12. This claim really involves the 20-20/21 shares of the telephone stock which, under the arbitration, was awarded to Joe Lee Ferguson. The note was originally to the Farmers State Bank of Haskell, of which the Farmers & Merchants State Bank of Haskell is the successor. There is quite a history to that indebtedness, with its credits, which need not be entered into. Joe Lee Ferguson entered into a contract of sale of his 20-20/21 interest in the telephone stock, to E. H. Cookingham. As heretofore indicated, that sale is valid and binding and is to be enforced, according to its terms. On the 11th day of June, 1930, Joe Lee Ferguson transferred and assigned all of his interest in the 221-20/21 shares of the telephone stock to the predecessor bank, subject to this Cookingham sale. That assignment provided:

This stock is subject to contract of sale between Joe Lee Ferguson and E. H. Cookingham, dated May 8, 1930. This assignment is made to protect my indebtedness to the Farmers State Bank of Haskell, and after said indebtedness is liquidated from the proceeds of said sale, the balance remaining from said sale is to be paid to the said Joe Lee Ferguson. (Italics mine.)

Thereafter, and on September 8, 1936, Joe Lee Ferguson transferred and assigned to the Farmers & Merchants State Bank, all of his interest in all dividends that had accumulated or might thereafter accumulate from said telephone stock. It provided that it was only to secure said bank and its successors in the payment of a certain specified indebtedness. In that assignment there was this provision:

That the said Farmers & Merchants State Bank of Haskell, Texas, should credit all collections made under and by virtue of this transfer and assignment to the payment of the indebtedness herein stated until the payment of the same, at which time said transfer and assignment shall become null and void and of no effect whatsoever. (Italics mine.)

Neither the assignment of the telephone stock nor the assignment of the dividends from it mentioned anywhere, as an indebtedness to be secured by such assignments, either of the other three claims presented by the bank.

The first of these three claims is known as the Baker-Campbell Company judgment, which, after all credits, at the time of the hearing was figured to be $222.68. This claim also was reduced to judgment, originally for the amount of $3900.00, and was later transferred by the Baker-Campbell Company to the bank.

The second one is what is known as the Tom Davis note, originally in the sum of $2425.00. The aggregate amount of this claim at the time of the hearing was approximately $2842.26. This, also, was transferred from Tom Davis, the original payee in the note, to the bank.

The third one, is what is known as the Henry Johnson note, in the original sum of $2200.00, executed February 23, 1932. It seems the Davis and Johnson notes were not reduced to judgments; at least, it is not alleged that they were. The balance due at the time of the hearing on the Johnson note was approximately $3,691.01. There is a discrepancy in the bank's pleadings as to the aggregate amount due on this note, but the last pleading filed by the bank, December 9, 1938, alleges it to be in the above amount.

After setting out all of these claims, the bank alleges:

That as of May 1, 1938, there is a total balance of Eighteen Thousand and Sixty-four and no/100 ($18,064.00) Dollars owing by Joe Lee Ferguson to this defendant perforce of the deficiencies due on the two above described judgments, and said two notes which total amount is secured by the aforesaid contract lien on said 20-20/21 shares of stock in the Haskell Telephone Company and accumulated dividends, and upon the proceeds of the sale of said stock under the Ferguson-Cookingham contract dated May 8, 1930, and that this defendant is entitled to be paid said sum of Eighteen Thousand, Sixty-four and no/100 ($18,064.00) Dollars out of said dividends and the sale of the stock, and is entitled to such judgment herein. (Italics mine.)

As to the existence of a lien, to secure the sums so alleged to be due the bank, the above allegation is not sustained by the testimony offered, except as to the Joe Lee Ferguson indebtedness to the bank, and to secure which, the said assignment by Joe Lee Ferguson of all of his interest in the telephone stock, and his assignment later of all his interest in the dividends, were executed. The above allegation, as to the bank having security for the Baker-Campbell, the Tom Davis and the Henry Johnson claims, appears to be simply the allegation of a mere general conclusion. There are no facts alleged, showing that there was ever any agreement made by Joe Lee Ferguson in writing or otherwise, that those claims were in any manner to be secured by his interest in the telephone stock or the dividends therefrom. Not only is there no evidence to support any such allegation, but the quoted provision from the stock assignment and the dividend assignment, rather tend to prove the contrary. In one, anything left, after the payment of Joe Lee's indebtedness to the bank, was to be paid by the bank over to him. In the other, when that had happened the assignment was to be void.

It is not even alleged, in connection with the Baker-Campbell Company, Tom Davis or Henry Johnson notes, what they were executed for. Certainly it is not alleged or claimed that they were debts due by the Kate F. Morton Estate. They appear to be the individual indebtedness of Joe Lee Ferguson. This case, of course, cannot be made a clearing house for all of the individual indebtednesses that persons may have against Joe Lee or A. M. Ferguson, where there is no lien disclosed to secure their payment out of the telephone stock, or the dividends therefrom. Such being the circumstances if the Court here should allow those claims and order them paid out of the telephone stock, or the dividends therefrom, it would follow that every current grocery bill, and all similar bills, even though purely personal obligations of Joe Lee and A. M. Ferguson, could likewise be presented here. The Probate Court, in an unchallenged administration of this estate, could not entertain such claims. Only those courts having jurisdiction of them, certainly not this Court, can reduce such claims to judgment. As I have said, no claims even against the estate have the right to be in this Court, or claims against the individual Fergusons, unless the claimants are asserting a lien or something that gives them the right to have such claims paid out of the telephone stock, or, for some reason, to an adjudication of their rights in relation to such stock.

Among the papers I find a letter from L. D. Ratliff of Haskell, Texas, dated March 30, 1939, in which he asks that this Court, in passing upon this matter, take into consideration the claim of the Banking Commission of the State of Texas, stating that, under the law, the Commission has a lien upon the telephone stock, after the payment of the claim of the United States. It appears that Z. Gossett, Banking Commissioner of Texas, in the Government's first amended bill of complaint filed March 25, 1938, was made a defendant. I have not been able, however, to find any pleadings among the papers in behalf of the Banking Commissioner, and I am not able to gather from the papers I have, anything as to even the nature of the claim. For that reason, and for that reason only, I am not able to give any consideration to the claim.

Of course, there are many details which I have not tried to cover that will have to be worked out between the attorneys for the various parties in the preparation of the decree to be entered, in accordance with this opinion. I will designate Mr. Randal, of the firm of Wilson, Randal & Kilpatrick of Lubbock, to assume primarily the responsibility with the aid of the other attorneys, for the preparation of the decree.