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[1 USTC ¶130]Guaranty Trust Co. of New York v. McKenrick and Peirson, Trustees in Bankruptcy of the Estate of the Baltimore Pearl Hominy Co., Bankrupt

(CA-4), United States Circuit Court of Appeals for the Fourth Circuit, Nos. 2207, 2227, 5 F2d 553, Decided April 14, 1925

On Revise, and Appeal from the District Court of the United States for the District of Maryland.Acceptance by the Government of an offer of compromise of a tax constitutes such a demand as to make the tax a lien on the taxpayer's property, and the offer of compromise constitutes a waiver of such demand as would be otherwise necessary. Unsecured creditors who pay a tax which has become a lien on the property of the debtor are subrogated to the rights of the Government as preferred creditors when the debtor is adjudged bankrupt. Reversing order and dismissing appeal from the District Court, 294 F. 921.

George Weems Williams and James Morfit Mullen, both of Baltimore , Md. , for petitioner and appellant. Edgar Allan Poe, of Baltimore , Md. (Bartlett, Poe and Claggett and Morris A. Rome, all of Baltimore , Md. , on the brief), for respondents and appellees.

Before WOODS and WADDILL, Circuit Judges, and Mc,DOWELL, District Judge.

WOODS, Circuit Judge:

The Baltimore Pearl Hominy Co. was notified on July 10, 1920, by the Commissioner of Internal Revenue, of a claim for additional income and excess profits taxes for the years 1916, 1917 and 1918, amounting to $359,899.54. The letter of notification contained the following statement:

This is not a notice of assessment, and no payment is required in connection herewith until you receive formal notice from the collector of internal revenue for your district.

Some time between the receipt of the notice and February, 1921, the Hominy Company employed the firm of Humphreys, Day & Co., income tax specialists to attempt to secure a reduction in the assessment. After negotiations with the Government by Humphreys, Day & Co., the claim was reduced to $72,192.34.

On February 11, 1921, five banks, including the appellant, unsecured creditors of the Hominy Company to the amount of $233,000, became concerned because of the inability of the company to meet its obligations to the Government and offered to advance a sufficient sum to compromise the tax claim for $42,000 or less and to pay Humphreys, Day & Co. their charge of $20,000. Each bank agreed to contribute to the sum advanced in proportion to its unsecured claim. The letter written jointly by the banks and the Hominy Company to Humphreys, Day & Co., expressing the proposition outlined, contained the following:

It is distinctly understood that in so far as the parties hereto are able to do so the undersigned banks shall be entitled to be subrogated to all of the rights of the Government, as to a prior lien for such amounts paid to the Government for said taxes, and further that we shall receive notes of the Baltimore Hominy Co. covering such advances as may be made under this agreement.

On its books the assets of the Hominy Company at this time were largely in excess of its liabilities. In fact, its liabilities were very largely in excess of its assets.

A settlement with the Government was arranged by Humphreys, Day & Co. for $35,000. The Union Trust Co., one of the five banks mentioned, collected from each of the banks its proportionate share of the sum advanced to cover the amount of the compromise and the counsel fee of $20,000, each bank taking the note of the Hominy Company for the amount it contributed. On February 23, 1921, the Union Trust Co. drew its check for $35,000 in favor of the Hominy Company and that company indorsed it to the order of the Commissioner of Internal Revenue. The Government's representatives refused to accept this check and returned it. On March 17, 1921, the collector of internal revenue at Baltimore received an assessment list from the Commissioner of Revenue at Washington , upon which list appeared an assessment against the Hominy Company for $72,192.34. On the next day, March 18, 1921, a new check was made out by the Union Trust Co. for the amount agreed upon the order of Joshua W. Miles, collector, dated as of February 23, 1921. This check was accepted, being acknowledged as final settlement in a letter from a deputy commissioner under date of March 22, 1921.

On April 4, 1921, the Circuit Court of the City of Baltimore appointed receivers for the Hominy Company, and on May 6, 1921, it was adjudicated a bankrupt. The unsecured debts of the corporation amounted to $591,000 and its principal assets were sold for $178,000. The referee allowed the tax payment as a preference in favor of the banks who had made it. Upon the hearing of petition of one of the trustees of the bankrupt estate, the district judge made an order disallowing the preference and directing the respective claims of the banks for the amounts advanced to be allowed only as unsecured claims. This, as we understand, is a test case, to determine the rights of the banks claiming preference by way of subrogation to the Government's alleged prior lien, brought to this court on petition to superintend and revise and on appeal from the decree of the district court.

We think the Government had a lien for the tax on March 18, 1921, at the time of payment. The applicable statutory provision is:

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 from the time when the assessment list was received by the collector, except when otherwise provided, until paid, with the interest, penalties, and costs that may accrue in addition thereto upon all property and rights to property belonging to such person; Provided, however, that such lien shall not be valid as against any mortgagee, purchaser, or judgment creditor until notice of such lien shall be filed by the collector in the office of the clerk of the district court of the district within which the property subject to such lien is situated. * * *. ( U. S. Compiled Statutes, sec. 5908.)

The tax fixed by the Government at $72,192.34 was on the assessment list received by the collector of internal revenue on March 17, 1921. No payment had then been made, for the collector had refused the check tendered. It is true no demand in formal terms was made of the Hominy Company because of the voluntary agreement of the taxpayer to pay $35,000 which the Government had agreed to accept. The statute prescribes no form and no kind of demand. The whole course of dealing shows that the Government had reduced its original tentative claim at $359,899.54 to a formal assessment of $72,192.34, that it was expecting and requiring payment of $35,000 in settlement of the assessment, and that it had made known to the Hominy Company that expectation and requirement. The expression of this expectation and requirement that the Hominy Company should pay the amount agreed upon was in effect a demand and all that was requisite to make the tax a lien. The accepted definitions support this view: "A demand signifies a request addressed to a person that he will do some act which he is legally bound to do, after the request has been made." (R. & L. Law Dictionary, p. 389.) In 18 C. J., 479 a demand is defined as

The assertion of a legal right; the assertion of a right to recover a sum of money; a calling for a thing due or claimed to be due; a claim; a preemptory claim to a thing of right; a request to pay; a reduisition or request to do a particular thing specified under a claim of right on the part of the person requesting.

If, however, the transactions between the revenue officers and the Hominy Company did not amount to a demand, they clearly proved waiver by the company of demand for payment. The purpose of requiring a demand as a condition precedent to the tax becoming a lien is protection of the taxpayer; and any such right of protection may be waived by the person interested. (Shutte v. Thompson, 15 Wallace, 151; 6 R. C. L., p. 93; 27 R. C. L., p. 906.) Surely if the Hominy Company had written to the collector expressly waiving demand and promising to pay the tax it would be idle for the collector to go through the form of making the demand in order to create the lien. The expressed waiver would have been equivalent to the demand. Here the waiver by conduct was just as effective.

Having paid the lien of the Government at the request of the debtor and thus preventing the seizure and sale of the property thereunder under an agreement with the debtor that if possible they should be substituted, the banks and trust companies have a very strong equity to subrogation in the distribution of the bankrupt's assets. They were in no sense volunteers, but creditors surprised by the Government's large claim for taxes in arrears. They knew the Hominy Company was in danger of failure, but they hoped that the corporation's new method of extracting sugar from corn would bring success. Under these circumstances, believing it to be advantageous to themselves and other creditors, they paid the taxes to prevent destructive enforcement of payment. In doing so we think they brought themselves clearly within the principle and rule of subrogation thus stated in Aetna Life Insurance Co. v. Middleport (124 U. S. 534, 548-549):

These propositions are very clearly stated in a useful monograph on the Law of Subrogation, by Henry N. Sheldon, and are well established by the authorities which he cites. The doctrine of subrogation is derived from the civil law, and "it is said to be a legal fiction by force of which an obligation extinguished by a payment made by a third person is treated as still subsisting for the benefit of this third person, so that by means of it one creditor is substituted to the rights, remedies, and securities of another * * *. It takes place for the benefit of a person who, being himself a creditor, pays another creditor whose debt is preferred to his by reason of privileges or mortgages, being obliged to make the payment, either as standing in the situation of a surety, or that he may remove a prior incumbrance from the property on which he relies to secure his payment. Subrogation, as a matter of right, independently of agreement, takes place only for the benefit of insurers; or of one who, being himself a creditor, has satisfied the lien of a prior creditor; or for the benefit of a purchaser who has extinguished an incumbrance upon the estate which he has purchased; or of a co-obligor or surety who had paid the debt which ought, in whole or in part, to have been met by another." Sheldon on Subrogation, sections 2, 3.

The doctrine of subrogation is not applied for the mere stranger or volunteer, who has paid the debt of another, without being under any legal obligation to make the payment, and without being compelled to do so for the preservation of any rights or property of his own. Sheldon on Subrogation, section 240.

See also MacGreal v. Taylor (167 U. S. , 688, 701); 5 Pomeroy's Equity, section 2347.

It is not contended that the trustees occupied the superior position of judgment creditors without notice of the circumstances which we have held created the lien for taxes in favor of the Government.

There is a labyrinth of decisions on the subject of subrogation. We shall not undertake to go through it. Our conclusion is that the Government had a lien for the taxes and when the banks and trust companies, unsecured creditors, paid it, they were entitled by subrogation to the same preference in the distribution of the assets of the bankrupt that the Government would have had but for the payment. One who pays taxes may in a proper case be subrogated to the rights of the Government in the distribution of the assets of a bankrupt estate. ( Dayton , Trustee, v. Stanard, 241 U. S. , 588.) The question of the right of the person subrogated to the Government's lien for a tax to enforce its collection by all the means available to the Government as a sovereign is not before us. The other grounds upon which the claim for subrogation is made need not be considered.

The doctrine of subrogation has advanced since the decision of this court in Montgomery v. City Council of Charleston (99 Fed., 825). To the extent that the opinion in that case is inconsistent with the views here expressed, we decline to follow it.

The amount of the debt is not in dispute. The sole question is whether the debt is entitled to preference as a lien in the distribution of the assets of the bankrupt. Such a question is a proceeding in bankruptcy and not a controversy arising in bankruptcy proceedings. It is therefore reviewable by a petition to superintend and revise and not by appeal. (Hutchinson v. Otis, 190 U. S., 552, 556; Matter of Loving, Trustee, 224 U. S., 183; 8 Remington on Bankruptcy, secs. 3682, 3728.)

It follows that, the case being here properly on a petition to superintend and revise, the appeal is dismissed and the judgment of the district court, in the matter brought up for review, is reversed.

 

 

54-1 USTC ¶9262]Ferdinando Cattani and Theresa Cattani, his wife, Plaintiffs v. Arthur M. Korsan, Shadrach James and Franklin James, partners, t/a James & Son, Jos. H. Haines & Sons, Inc., United States of America, Howard E. Wills, Leon L. Merefield, Houck Engineering Service Co., Carlton H. Irick, Defendants

In the Superior Court of New Jersey , Chancery Division, Burlington County , Docket No. C-1587-52, 103 A2d 51, February 9, 1954

Lien for taxes: Property subject to lien: Demand necessary.--In the absence of proof that a demand was made upon the contractor, the Government's tax claim against the contractor was not entitled to a priority, as against sub-contractors, laborers, and materialmen, in the distribution of the money due the contractor and paid into the Court by the plaintiffs. The mere statement in the notice of the tax liens that "which after demand for payment thereof remained unpaid" does not satisfy the mandatory requirement under Code Sec. 3670 that a lien in favor of the Government arises only if the taxpayer neglects or refuses to pay the tax after demand.

George M. Hillman, 135 High Street , Mount Holly , N. J., for plaintiffs. Martin L. Haines for defendant Joseph H. Haines & Sons, Inc., (Dimon, Haines & Bunting, 200 High Street, Mount Holly, N. J., Attorneys). Alfred M. Bitting, 4 W. Union Street , Burlington , N. J., for defendants Shadrach and Franklin James. John D. Wooley, 603 Mattison Avenue, Asbury Park, N. J., Assistant United States Attorney, for defendant United States of America. Ephraim Tomlinson, 2nd, 528 Cooper St. , Camden , N. J., for defendant Howard E. Wills. Benjamin F. Friedman, 426 Market Street, Camden, N. J., for defendant Houck Engineering Service Co. Robert E. Dietz, 110 High Street, Mount Holly, N. J., for defendant Leon L. Merefield.

Civil Action Conclusions

HANEMAN, J. S. C.:

On or about October 30, 1952 the plaintiffs, Ferdinando Cattani and Theresa Cattani, his wife, entered into an agreement with defendant Arthur M. Korsan, under the terms of which the latter was to construct a dwelling house on land owned by the plaintiffs, situate at 205 Madison Avenue, Mount Holly, New Jersey, for the price of $13,471.00. Prior to the commencement of any work or the furnishing of any materials in connection with the construction, plaintiffs duly filed said contract on November 1, 1952, together with the specifications accompanying same, in the office of the Clerk of the County of Burlington. Said defendant Korsan proceeded with the construction and from time to time received payments. He discontinued further work under said contract prior to the completion thereof, at which time there still remained due to him the sum of $5653.00. Thereafter, various sub-contractors, laborers and materialmen filed stop notices, the total of which exceeded the amount remaining in the hands of the plaintiffs. Plaintiffs have deposited the balance allegedly due under the contract in this court and have interpleaded the defendant-claimants. The United States of America intervened as a party defendant, contending that it was entitled to a priority in distribution to the extent of a claim against the defendant Korsan in the amount of $2117.25, arising from delinquent income taxes.

[Code Sections Relied Upon By Government]

The United States of America alleges that it is entitled to such priority by virtue of Title 26 of the U. S. Code, Sections 3670, 3671 and 3672, which said sections read as follows:

"Section 3670. If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, penalty, additional amount or addition to such tax, 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."

"Section 3671. Unless another date is specifically fixed by law, the lien shall arise at the time the assessment list was received by the collector and shall continue until the liability for such amount is satisfied or becomes unenforceable by reason of lapse of time."

"Section 3672. Invalidity of lien without notice. Such lien shall not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until notice thereof has been filed by the collector--Under State or Territorial Laws. In the office in which the filing of such notice is authorized by the law of the State or Territory in which the property subject to the lien is situated, whenever the State or Territory has by law authorized the filing of such notice in an office within the State or Territory.--"

[Tax Liens Were Filed]

The United States of America , on or about March 8, 1953, made a levy and warrant for distress upon the plaintiff Ferdinando Cattani, levying upon all monies due from him to the defendant Korsan. Commencing in December 1948, the District Director of Internal Revenue of Camden received various assessment lists from the Commissioner of Internal Revenue, setting forth taxes owed to the United States of America . After an alleged demand was made upon said defendant Korsan in each instance, liens were filed in the County Clerk 's office of Burlington County .

The question now raised by the mechanics lien creditors is whether the United States of America is entitled to any lien, it having failed to prove, consistent with Section 3670 of Title 26 of the U. S. Code, that a "demand" was made upon the defendant Korsan. There is no proof before this court that any such demand was ever made. The statute expressly provides that the lien shall arise only after demand.

In U. S. v. Allen, 14 Fed. 263 (C. C., M. D. Tenn. 1882) and Iowa v. Baltimore Pearl Hominy Co., 5 Fed. (2d) 553 (C. C. A. 4th 1925) [1 USTC ¶130] it was held that such demand must have been made on the taxpayer even though it was informal in nature, before the lien arose. The mere statement contained in the notice of Federal Tax Lien filed with the County Clerk of Burlington County "which after demand for payment thereof remained unpaid" is not sufficient for the present purposes. It is a mandatory requirement, both under the exact language of the statute and of the adjudication in the two above referred to cases, that such demand must be made. As a condition precedent to establish its lien and priority, it was necessary that the United States of America make proof of such demand. Absent any such proof, the said United States of America has failed in a vital respect.

Consistent with the foregoing, it is therefore here held that the United States of America is not entitled to any priority in the funds herein court.

 

 

[61-1 USTC ¶9219] United States of America , Appellant v. James R. Coson, Appellee

(CA-9), U. S. Court of Appeals, 9th Circuit, No. 16,517, 286 F2d 453, 1/23/61, Modifying and affirming decision of DC Calif., 169 F. Supp. 671; 59-1 USTC ¶9168

[1954 Code Sec. 6321]

Validity of Federal tax lien: Suit to quiet title against lien: Necessity of demand.--A tax lien was adjudged null and void and was cancelled and removed as a cloud upon the title to real property where no demand was made upon the owner of the property as required by the statute. Thus the lien was valueless because it failed to comply with the required procedures. In addition it was filed against property not belonging to the taxpayer since the delinquent taxpayer was a partnership and the owner of the property was not an actual partner nor a partner by estoppel.

Charles K. Rice, Assistant Attorney General, Lee A. Jackson, A. F. Prescott, Kenneth E. Levin, Department of Justice, Washington 25, D. C., Laughlin E. Waters, United States Attorney, Edward R. McHale, Assistant United States Attorney, Los Angeles, Calif., for appellant. Wadsworth , Fraser & McClung, Los Angeles , Calif. , for appellee.

Before CHAMBERS, Chief Judge, POPE, Circuit Judge, and KILKENNY, District Judge.

POPE, Circuit Judge:

Coson, as plaintiff, filed his complaint in the court below alleging that he was the owner of certain described real property in Los Angeles County, California; that the defendant United States claimed an interest in and to that property by virtue of its filing on November 15, 1955, in the office of the County Recorder of that County, of a notice of federal tax lien No. 42005, for Federal Withholding taxes, Federal Insurance Contributions Act taxes for the second and third quarters of 1955, and Federal Excise Cabaret taxes for the months of July and August, 1955, amounting, altogether, to the sum of $133,691.80. He alleged that the Government's claim of lien was invalid for two reasons: first, because plaintiff had never been a general partner in Moulin Rouge (the partnership which operated the hotel and gambling establishment at Las Vegas, Nevada, whose operation gave rise to the taxes referred to); and second, for the reason that the defendant had never demanded that plaintiff pay the taxes referred to or any portion thereof as required by Title 26 U. S. C. §3670. ¹

Plaintiff prayed for judgment that he was the owner of the property; that the defendant had no right, title, or interest in or to it or any part thereof; and that the notice of federal tax lien be cancelled and defendant enjoined from claiming any interest in the property under that lien. ²

The complaint, as filed, based the jurisdiction of the district court upon Title 28 U. S. C. §2410. In his brief plaintiff asks leave to amend to allege jurisdiction under Title 28 U. S. C. §1340.

The court found and concluded that the Government has no lien for the taxes asserted in the notice of tax lien and judgment was ordered that it be declared that the United States has no lien for the taxes asserted in the notice of federal tax lien filed as against the property described in the complaint, and ordering that the United States refrain from any further assertion of such a lien based on the assessments which it made in 1955 "of Bisno, Rubin, and the Moulin Rouge."

Upon this appeal the principal attack made by the Government upon the judgment below is through its contention that the trial court was without jurisdiction to entertain the action. As previously noted, the complaint predicated jurisdiction upon, the provisions of Title 28 U. S. C. §2410. Subdivisions (a) and (b) of that section are set forth in the margin. ³

The trial court, relying upon the decisions of this court in Seattle Association of Credit Men v. United States [57-1 USTC ¶9402], 240 F. 2d 906, and Wells v. Long, 162 F. 2d 842, held that the effect of §2410 is only a waiver of sovereign immunity and does not operate to confer jurisdiction upon a federal court to entertain such a suit as this. The trial court proceeded, however, to hold that it had jurisdiction of the action by virtue of §1340 of Title 28 which provides: "The district courts shall have original jurisdiction of any civil action arising under any Act of Congress providing for internal revenue, or revenue from imports or tonnage except matters within the jurisdiction of the Customs Court."

The appellant asserts that §1340 will not support jurisdiction in this case for several reasons: first, that the suit is not one arising under an act of Congress providing for internal revenue. In support of this contention it cites Johnston v. Earle [57-2 USTC ¶9695], 9 cir., 245 F. 2d 793. That was a case in which two officers of the Internal Revenue Bureau were sued for alleged tortious seizure and conversion to their own use of a tractor belonging to the plaintiff. This court held that §1340 did not support the claimed jurisdiction since the recovery sought was solely for tortious conversion, a state tort, by one citizen of the state against other citizens of the same state. There was no claim for the return of federal taxes alleged to have been wrongfully assessed. We think that case is not in point here where the complaint puts in issue the validity of a claimed federal tax lien. In our view, as stated in United States v. Brosnon [60-2 USTC ¶9516], 363 U. S. 237, 241, "such liens form part of the machinery for the collection of federal taxes", and we think therefore that the Act of Congress which provided for such liens, was an Act of Congress "providing for internal revenue."

Second, the appellant says that §1340 "at most is only a general grant of jurisdiction which in order to be effective must be buttressed by some other specific grant of jurisdiction governing any given case." In support of that position the Government cites only First National Bank of Emlenton, Pa. v. United States [59-1 USTC ¶9329], 3 cir., 265 F. 2d 297. That case is not in point here for it held no more than that §1340 did not accomplish a waiver of sovereign immunity. All that the court held was that a suit "against the United States is not maintainable unless the sovereign has consented to be sued in such an action"; that such consent was not contained in §1340, and that it found no sucn consent in Title 28 U. S. C. §§ 1346(a)(1), 1346(a)(2), or §2463.

We find no fault with anything that was said in that case, but we think it is of no assistance here where the court below relies upon Title 28 U. S. C. §2410 for the Government's consent to be sued. If therefore the action here is one within the class of cases defined in §1340 and if it also is the type of case with respect to which sovereign immunity was waived by §2410, we should find that the trial court had original jurisdiction to entertain it.

We proceed to inquire whether this action comes within the language of §1340. The first problem is whether it meets the test referred to in Skelly Oil Co. v. Phillips Co., 339 U. S. 667, 672, where it is stated that "It has been settled doctrine that where suit is brought in the federal courts upon the sole ground that the determination of the suit depends upon some question of a federal nature, it must appear, at the outset, from that declaration or the bill of the party suing, that the suit is of that character."

We think that the case of Hopkins v. Walker, 244 U. S. 486, sufficiently discloses that the instant case meets the test just referred to. That was a case in which the owners of a patented placer mining claim brought suit against defendants who had filed certificates of location of lode claims based upon alleged discoveries of lodes within the exterior boundaries of the placer claim. It was alleged that there were no known lodes within the placer at the time of the application for patent and that in any event the lode claims asserted were excessive in area. The bill in the district court predicated jurisdiction upon the suit being one arising under the laws of the United States and involving the requisite amount in controversy. The Court noted the rule above stated with respect to what the cause of action must disclose to the effect that such a case arises where the statement of plaintiff's cause of action "unaided by any anticipation or avoidance of defenses, discloses that it really and substantially involves a dispute or controversy respecting the validity, construction or effect of a law of Congress." It held that the action satisfied that requirement because "in both form and substance the bill is one to remove a particular cloud from the plaintiffs' title, as much so as if the purpose were to have a tax deed, a lease or a mortgage adjudged invalid and cancelled. It hardly requires statement that in such cases the facts showing the plaintiffs' title and the existence and invalidity of the instrument or record sought to be eliminated as a cloud upon the title are essential parts of the plaintiff's cause of action."

Such is the case here. The complaint not only alleges the plaintiff's title and ownership, but it sets out the notice of federal tax lien filed by the United States and specifically alleges two reasons why that claim of lien is invalid. The action here is as clearly one to remove a particular cloud from plaintiff's title as was the one considered in Hopkins v. Walker , supra.

This poses a further question whether such a suit comes within the provisions of §2410 of Title 28 (see footnote 3, supra), which grants permission to make the United States a party in a suit "to quiet title" to property on which the United States claims a lien.

It is plain that the words "quiet title" used in subdivision (a) in that section are not intended to refer to a suit to quiet title in the limited sense in which that term is sometimes used, (see the discussion in Hopkins v. Walker, supra, pp. 490, 491), but that as used in the section here referred to it comprehends a suit to remove a cloud upon the title of a plaintiff. This is made plain both by the text and the history of the provision. Subdivision (b) of §2410 makes it mandatory that "the complaint shall set forth with particularity the nature of the interest or lien of the United States ." Plainly that stamps the action as one to remove a specific, particularly described, cloud upon the plaintiff's property. In a strictly limited type of suit to quiet title, such a particularization is never necessary. Not only does this language disclose that the words "quiet title" were used in a broad sense to cover a suit to remove a cloud on title but the legislative history of the insertion of this provision in the section demonstrates that it was intended to cover a suit of the character here before us.

It is shown by the Reviser's notes to the 1948 Judicial Code, that §2410 was based on §§ 901 to 905 as they appeared in Title 28 of the 1940 edition of U. S. C. Prior to the Act of December 2, 1942, 56 Stat. 1026, §901 referred merely to suits "for the foreclosure of a mortgage or other lien upon real estate, for the purpose of securing an adjudication touching any mortgage or other lien the United States may have or claim on the premises involved."

The language relating to suits to quiet title was inserted by amendment of the date last mentioned. That amendment followed a report, H. R. 1191, 77th Cong., First Session, dated August 15, 1941. Another amendment then provided for was designed to include actions with respect to personal property as well as those relating to real property, but the language relating to suits to quiet title was inserted pursuant to the recommendation of the then Attorney General of the United States who noted that at that time there was "no provision whereby the owner of real estate may clear his title to such real estate of the cloud of a Government mortgage or lien." (Italics ours.) The text of the letter which served to bring about the insertion of the language we now consider is set forth in the margin. ⁴ In our opinion it is clear that the waiver of immunity exists for the specific type of suit here brought, naniely, one to remove a cloud on the title.

We inquire next whether this is an action "arising under" any Act "providing for internal revenue" within the meaning of §1340. Insofar as the plaintiff's claim is based upon an assertion that the Government's lien is void and ineffective because of a failure to make demand upon the plaintiff, (or for the other failures specified in the appellee's requested amendment, see footnote 2, supra), ⁵ it must be said that the suit "really and substantially involves a dispute or controversy respecting the validity, construction or effect of such a law, upon the determination of which the result depends." ⁶

Plainly enough as concerns his contention that the lien claimed by the United States is void because of want of prior demand, plaintiff undertook to bring a suit the result of which depends upon the meaning of Title 26 U. S. C. §6321 which provides for a lien in favor of the United States against the property of a person liable for a tax who "neglects or refuses to pay the same after demand." (Italics added.) He cites authority to support his claim that the effect of the law was that a lien upon his property was dependent upon a prior demand to him personally. The result so far as that portion of the case is concerned would turn upon the determination of that question which is one involving the construction or effect of the law. ⁷

For reasons hereafter noted we find it unnecessary to consider (except as it bears on the question of whether proper demand was made) the other ground named in the complaint, namely, that Coson never became liable for the taxes. ⁸

The appellant raised one other question relating to the court's jurisdiction to hear the case. It is contended that this suit. which as we have noted is essentially one to remove a cloud upon the plaintiff's title, is tantamount to an attempt to enjoin collection of taxes in violation of §7421 of the 1954 Internal Revenue Code, which provides that "no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court." A similar provision was in §3653 of the 1939 Code.

We think that this argument proves too much, for §2410 of Title 28 was enacted as positive law by the Act of June 25, 1948. We cannot assume that all Government tax liens were excluded from the meaning of §2410(a). Yet such would be the result if the prohibition against injunctions operated to prevent the maintenance of an action such as this. Plainly §2410 authorizes it. We agree with the holding of the trial court that the prohibition against suits to restrain collection or assessment of taxes has no bearing upon this case which is one for a wholly different purpose. ⁹ We think it plain that the only type of relief needed here is a decree holding the tax lien a cloud on plaintiff's title and cancelling it. There is no need for any injunctive relief. We hold that the court below had jurisdiction.

This brings us to the merits of the case. The court's opinion, which the Judge treated as his findings, found there had been no notice or demand respecting these taxes given to Coson, individually, prior to commencement of his action. He also found: "Between March and August of 1955, plaintiff invested $31,000 in a newly organized Las Vegas, Nevada, hotel and gambling establishment known as the 'Moulin Rouge' and obtained a 1.70 per cent interest therein. He reasonably and in good faith thought he was investing as a limited partner in a limited partnership. The Moulin Rouge was not, however, a limited partnership. Upon first ascertaining this, plaintiff promptly mailed notices of renunciation." ¹⁰

The Moulin Rouge establishment and operations were conducted in the State of Nevada . In preparation for carrying out the declared intention of the organizers, articles of limited copartnership were prepared but the required certificate was never filed with the county recorder. Nevada had adopted the Uniform Partnership Act, (now Nevada Revised Statutes, §§ 87.010-87.430) and the Uniform Limited Partnership Act, (now Nevada Revised Statutes, §§ 88.010-88.310). §88.120, which is §11 of the Uniform Limited Partnership Act. provided as follows: "A person who has contributed to the capital of a business conducted by a person or partnership erroneously believing that he has become a limited partner in a limited partnership, is not, by reason of his exercise of the rights of a limited partner, a general partner with the person or in the partnership carrying on the business, or bound by the obligations of such person or partnership; provided, that on ascertaining the mistake he promtly renounces his interest in the profits of the business, or other compensation by way of income."

The announcement of the intended formation of Moulin Rouge, the brochures, prospectuses, leases, and contracts relating to the business, all described it as a limited partnership, and gambling licenses were issued to it as "a limited partnership". That every one connected with the enterprise intended that it be a limited partnership cannot be questioned. What became of Coson's money which he intended to invest in a limited partnership does not appear for his name did not appear in any of the books, accounts or records of the enterprise either as lender, investor or otherwise. At one time Coson at the request of one Zalk prepared a financial statement in response to Zalk's representation that such a statement would need to be furnished to the state licensing authorities in connection with the gambling license for Moulin Rouge, but the record does not show that these were ever used or presented to the state authorities; and that they were not used is confirmed by the fact that Coson's name was not listed on the gambling license although the names of some twenty-five other persons were; and it appeared that those twenty-five persons between them held 100% of the ownership of the enterprise. ¹¹

There is evidence that Coson thought he acquired a 1% interest in the enterprise which he believed was a limited partnership, but evidence is lacking that this object was ever accomplished. A witness who had been a legal adviser for the organizers of the enterprise, at the time of the trial a Superior Court judge in Los Angeles, testified that the books of Moulin Rouge showed no interest of Coson in the enterprise, and that Bisno, one of the two managing partners, had taken credit for money received from many people in his own name as his own capital.

It also appears that in September, 1955, after the enterprise had gotten into financial difficulties, a substantial number of investors or would-be investors gathered at Las Vegas , where the enterprise was carried on, for the purpose of reorganizing the business and creating a corporation. At that time Coson learned that the books and records of Moulin Rouge failed to disclose that he had any interest therein. The attorney mentioned above also testified that he met Coson at that meeting; that Coson asked him whether he, Coson appeared to have any money or interest in Moulin Rouge, to which the attorney replied that the books did not disclose anything of that character; that although stock certificates in the proposed new corporation were being distributed at that time to persons who appeared on the books as creditors or investors, Coson received none of those.

There is in evidence an exhibit which is a certified copy of a special tax return made on Form 11(C) disclosing a tax liability for slot machines amounting of $19,750. The return called for a list of names and addresses of all owners to be attached, and attached to that was a list of individuals which included Coson with his address. This was filed with the district director and purported to be a return for a period ending June 30, 1956; it was dated June 30, 1955, and signed by Rubin, one of the partners mentioned above.

The record shows how Coson's name came to be attached to that return. One Engle, a certified public accountant who represented the Moulin Rouge in the preparation of the return in question, and who believed it to be a limited partnership, explained that Rubin had given him Coson's name as one of a group of individuals "who were prepared to make application to purchase an interest in Moulin Rouge". He stated that it was his understanding that these applications had not yet been made; his thought was that if the new owners came into the enterprise after a slot machine license was procured, it would be necessary to procure another license because of such new members, and that this would involve the expenditure of another $19,000 for slot machine taxes; that if a partnership procured a slot machine license and then a partner were dropped, the enterprise could continue under the same license providing the internal revenue service was notified, "and you would not have to take a new stamp, but if you added new partners you may have to add new stamps." He said that he decided there would be nothing wrong in putting down on the list of owners "all of the people that we knew of that would be making application for the purpose of an interest in the Moulin Rouge." He further testified that Coson's name did not appear as an owner of an interest in the Moulin Rouge on the latter's books and that the first time he heard of Coson was when Rubin suggested that Coson's name be added to the list which was attached to the return. He spoke of Coson and Zalk with whom Coson was associated as "potential" investors.

On the basis of the court's finding and all of the evidence in the case the only conclusion to be drawn is that Coson was simply not a member of the partnership. ¹² Our decision on this point is ruled by Giles v. Vette, 263 U. S. 553. The facts in that case were similar to those here. It was claimed that Hecht and Finn were members of a certain partnership because they had contributed to its capital. The partnership was operated in the State of Illinois where both the Uniform Partnership Act and the Uniform Limited Partnership Act were in effect, the same as is the case in Nevada . Both Hecht and Finn erroneously believed they had become limited partners in a limited partnership; they made the renunciation provided for by §11. This renunciation was not made until after creditors had filed petitions in bankruptcy against the partnership and a receiver had been appointed. It was found that the §11 renunciation was made within a reasonable time notwithstanding. The court said at p. 563-564:

"Hecht and Finn contributed to the capital of the business, and each erroneously believed that he had become a limited partner in a limited partnership. Neither took any part in the control of the business or exercised any rights or powers in respect of it other than those which might belong to one not a general partner. . . . They made the renunciation provided for. No person suffered any loss or disadvantage because it was not made earlier, or because of reliance on any statement in the certificate. . . .

"Section 11 is broad and highly remedial. The existence of a partnership--limited or general--is not essential in order that it shall apply. The language is comprehensive and covers all cases where one has contributed to the capital of a business conducted by a partnership or person erroneously believing that he is a limited partner. It ought to be construed liberally, and with appropriate regard for the legislative purpose to relieve from the strictness of the earlier statutes and decisions."

An interesting thing about that case is that it was held that Hecht and Finn were not liable as general partners at all. The creditors in that case had all become creditors prior to the time of the §11 renunciation, for the bankruptcy preceded it. The legal situation was that they were never partners.

It is not important whether it be said that the renunciation here operated to relieve Coson from liability ab initio, (Cf. Oteri v. Scalzo, 145 U. S. 578, 588) or whether we say that Coson was not a general partner at any time, first because he never had the necessary intent to join a partnership in that capacity, ¹³ and second, because his renunciation under §11 was fully effective.

Since Coson himself had no part in the insertion of his name on the tax return previously described and knew nothing about it, it cannot be said that he represented or held himself out as a partner or consented to any such representation or holding out. He was neither an actual partner nor a partner by estoppel.

At the trial some emphasis was placed on the fact that near the end of July, 1955, one Tonis, purporting to be the owner of an undivided 31/2% interest in the Moulin Rouge business, assigned that interest to Coson and Zalk. Coson testified that it was his understanding this was an assignment of an interest in a limited partnership. However, even if this were an assignment of an interest in a general partnership, it could not operate to make Coson a member of any such partnership. The transfer by a partner of his partnership interest does not make the assignee of such interest a partner in the firm. Hazen v. Warwick, 256 Mass. 302, 152 N. E. 342; Johnston v. Ellis, 49 Idaho 1, 285 P. 1015; Bynum v. Frisby, 73 Nev. 145, 311 P. 2d 972. ¹⁴

All of this is significant in view of the fact that on December 27, 1956, when this suit was started, no notice or demand concerning these taxes had been given to or served upon Coson. This procedural prerequisite to the securing of a Government lien for such taxes is made plain by the statute. See Detroit Bank v. United States , 317 U. S. 329, 335. §6321 of Title 26 U. S. C. recites that the amount of taxes shall be a lien upon the property of a person liable to pay the tax who "neglects or refuses to pay the same after demand." ¹⁵ The procedure for making such demand is set forth in §6303(a) of the same title as follows:

"Where it is not otherwise provided by this title, the Secretary or his delegate shall, as soon as practicable, and within 60 days, after the making of an assessment of a tax pursuant to §6203, give notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof. . . ."

The only notices and demands which were given or served were addressed to "Alexander Bisno and Louis Rubin, Moulin Rouge, 900 W. Bonanza Rd. , Las Vegas , Nevada ." These were given in August, September and October, 1955. The argument of the Government is that those notices constituted sufficient notice to Coson to sustain a lien upon his property because Coson was in law a general partner; that in respect to this type of taxes, the taxes constituted an obligation of the partnership, as such, and hence an obligation of each of the partners. Says the Government: "It is an established principle of partnership law that notice and/or demand on one or more partners is notice to all."

The fallacy in this is the assumption that Coson became a general partner. No authority has been cited for the Government's claim that notice given to Bisno and Rubin would serve as a notice and demand on Coson; nor has our research turned up any support for the Government's contention in that regard. What the Government has attempted to do here is to rely upon the obsolete rule mentioned in footnote 13 supra, that when an attempt to create a limited partnership is abortive or defective for any reason (as for failure to file a certificate) the would-be limited partners automatically become general partners. As noted in Giles v. Vette, supra, at p. 562, this strict ruling was carried so far that in the words of the Commissioner's Note it "deprived the existing statutory provisions for limited partners of any practical usefulness." It was to do away with that ancient rule that the Uniform Act was drafted. See Giles v. Vette, supra; Gilman Paint & Varnish Co. v. Legum, 197 Md. 665, 80 A. 2d 906, 29 A. L. R. 2d 286. And see note under §11 in 8 Uniform Laws Ann. p. 24.

It will be noted that our decision here is based upon our holding that the Government's lien was irregular, insufficient and valueless from a procedural standpoint for failure to serve the statutory notice and demand in connection therewith and for failure to comply with required procedures.

In developing that conclusion many circumstances tend to show that not only were these required procedures not complied with but that Coson was not a taxpayer and not liable for the tax to begin with. Whether that non-liability could also constitute the basis for a suit of this kind, or for relief under §2410(a) of Title 28, we need not here decide. The recent case of Pipola v. Chicco [60-1 USTC ¶15,276], 2d cir., 274 F. 2d 909, appears to give a negative answer to that question. But that case agrees with what we hold here, that in an action of the kind here involved plaintiff may attack the Government lien for taxes as irregular or valueless "from a procedural standpoint", and may raise the question whether the Government "complied with required procedures . . . or whether by error the assessment was made against a taxpayer other than the one intended." ¹⁶

Since our decision here is not based upon any holding that the assessment of the taxes was without merit,--no suggestion is made that the assessment of the partnership was improper,--but rather upon the ground that the lien was valueless for want of compliance with required procedures (as well as because it was filed against property not belonging to the taxpayer), we find no occasion here for comment as to whether we agree with the views expressed in the Pipola case, supra.

In holding as we do that the lack of proper notice or demand was fatal to the acquisition of the Government's lien against Coson, the emphasis here is somewhat different than that employed by the trial judge who held that the assessment itself was void as against Coson because the taxes were never assessed to Coson, the record of assessment in the office of the Bureau making no reference whatever to Coson. The Government argues that there is no requirement that an assessment be made against any person. Although our decision as to the lack of proper notice or demand is sufficient to dispose of this case, it would appear that the trial court was right in holding the assessment was insufficient for failure to comply with the statutory requirements. ¹⁷

That portion of the amendment of the complaint requested here, through the paragraph thereof numbered "4", (see note 2, supra), which conforms to the proof and the findings, is allowed.

The judgment is modified by eliminating therefrom the sentence reciting that defendant "is hereby permanently enjoined from further asserting any claim of lien" and inserting the following:

"It is further ordered, adjudged and decreed that the asserted lien for taxes as set forth in the Federal Tax Lien as filed, is null, void and valueless, and a cloud upon the title of plaintiff to the aforesaid property and the same is hereby cancelled and removed as a cloud upon said title."

As so modified, the judgment is affirmed.

¹ This was a reference to the 1939 Revenue Code.

² In his brief here, and pending the appeal, plaintiff asked leave to amend his complaint by adding a paragraph reading as follows: "That the said claim of lien was arbitrarily and capriciously imposed by reason of the following facts:

1. No assessment upon which said lien was based was ever made against plaintiff;

2. No notice or demand for payment of taxes had been served upon plaintiff at the time of the commencement of this action;

3. No notice of the assessment had ever been furnished to plaintiff, within sixty days from the making of the assessment, or otherwise; and

4. Plaintiff was not a partner in the Moulin Rouge.

That the continued imposition of said lien upon plaintiff's real property will ruin and destroy plaintiff's property rights for the reason that plaintiff borrowed $133,500.00 from the California Bank which he used to purchase real property for $108,000.00 and did then enter into a twenty-year lease to erect a department store building on the said real property incurring and paying a leasing commission of $20,000.00; that thereafter, to-wit, on November 15, 1955, the defendant did file a Claim of Lien upon the said real property and plaintiff is by reason thereof unable to erect the department store pursuant to the terms of said lease; that unless said lien is speedily removed plaintiff will become liable to the lessee for non-performance of the terms of said lease and may be required to file a petition in bankruptcy."

³ "§2410. Actions affecting property on which United States has lien (a) Under the conditions prescribed in this section and section 1444 of this title for the protection of the United States, the United States may be named a party in any civil action or suit in any district court, including the District Court for the Territory of Alaska, or in any State court having jurisdiction of the subject matter, to quiet title to or for the foreclosure of a mortgage or other lien upon real or person property on which the United States has or claims a mortgage or other lien.

(b) The complaint shall set forth with particularity the nature of the interest or lien of the United States . In actions in the State courts service upon the United States shall be made by serving the process of the court with a copy of the complaint upon the United States attorney for the district in which the action is brought or upon an assistant United States Attorney. . . . In such actions the United States may appear and answer, plead or demur within sixty days after such service or such further time as the court may allow."

⁴ H. R. 1191, 77th Cong. First Sess. August 15, 1941. PERMITTING THE UNITED STATES TO BE MADE PARTY DEFENDANT IN CERTAIN CASES INVOLVING PERSONAL PROPERTY. "It should be observed in this connection that under existing law there is no provision whereby the owner of real estate may clear his title to such real estate of the cloud of a Government mortgage or lien. Welch v. Hamilton, (S. D. Calif.) 33 F. 2d 224, and U. S. v. Turner, (C. C. A. 8) 47 F. 2d 86. In many instances persons acting in good faith have purchased real estate without knowledge of the Government lien or in the belief that the lien had been extinguished. In other instances, mortgagees have foreclosed on property and have failed to join the United States . It appears that justice and fair dealing would require that a method be provided to clear real estate titles of questionable or valueless Government liens. Accordingly, I suggest that the bill be amended by inserting the phrase 'to quiet title or' between the words 'matter' and 'for the foreclosure of' in line 4 of page 2 of the bill."

⁵ The propriety of the allowance of an amendment of the complaint pending an appeal is well settled. See Mullaney v. Anderson, 342 U. S. 415.

⁶ The phraseology quoted here is from Shulthis v. McDougal, 225 U. S. 561, 569. This in substance has been repeated many times. See for instance the language first above quoted from Hopkins v. Walker, supra, and the cases cited in South Side Theaters v. United West Coast Th. Corp., 9 Cir., 178 F. 2d 648, 649, in support of the following statement: "An action so arises where an appropriate statement by the plaintiff, unaided by an anticipation or avoidance of defenses, shows that it actually and substantially involves a controversy respecting the validity, construction, or effect of an act of Congress upon the determination of which the result depends."

⁷ We have been discussing the language used in §1340, supra, which is the section relied upon by the trial court. While the court made no formal finding as to the amount in controversy here, it is plain that, as the sum named in the complaint suggests, the amount actually in controversy was in excess of the amount required by Title 28 U. S. C. §1331 to support an action which "arises under . . . laws . . . of the United States." Since, aside from the amount in controversy matter, the considerations involved are the same whether §1340 or §1331 is applied, we see no point in remanding the case for a special finding that the matter in controversy exceeds the requisite sum or value to satisfy §1331.

⁸ If this were the sole basis for the complaint we might have to consider a rule once announced by this court, apparently not recognized elsewhere, that a case does not "arise under" a federal statute where the meaning of the statute is not in question, but the case turns solely on issues of fact. See Marshall v. Desert Properties, Inc., 9 cir., 103 F. 2d 551, 552. But see contra: Hart and Wechsler, "The Federal Courts and the Federal System," p. 763, and Mishkin, "The Federal 'Question' in the District Courts," 53 Columbia Law Review 157, pp. 169 et seq. Regardless of the correctness of our decision in the Marshall case, the court here might, were it necessary, consider this second ground of the complaint under its "pendent" jurisdiction. See Hurn v. Oursler, 289 U. S. 238, 246; Romero v. International Term. Co., 358 U. S. 354, 380.

⁹ We note also that the prohibitions of §7421 are not without exceptions. Appellee's brief asserts that the amount of the claimed lien is so great that he could not, because of his financial limitations, pay the tax and sue to recover the amount; that this leaves him utterly unable to employ the usual device of paying and suing to recover back. If such were the facts, this might be a case "where complainant shows that in addition to the illegality of an exaction in the guise of a tax there exist special and extraordinary circumstances sufficient to bring the case within some acknowledged head of equity jurisprudence," and hence that "a suit may be maintained to enjoin the collector." Miller v. Standard Nut Margarine Co., [3 USTC ¶878], 284 U. S. 498, 509. If such were plaintiff's predicament, his hardship would resemble that of Griffin in Griffin v. Illinois, 351 U. S. 12. A party financially unable to use a remedy available to those more advantaged would appear to suffer extraordinary hardship. See Lassoff v. Gray [59-1 USTC ¶15,325], 6 Cir., 266 F. 2d 745, 747.

There is no finding to support such a position here and we find no cause for a remand for any such purpose.

¹⁰ As hereafter noted, this quoted finding has particular significance upon the question whether notice to Moulin Rouge and Bisno and Rubin was sufficient notice or demand upon Coson.

¹¹ On December 24, 1956, the Gaming Control Board recited: "The files reflect no information re a Mr. Zalk and Mr. Coson. An invested capital statement was submitted, however an application was never submitted and the two subjects were never processed for a license."

¹² Inexplicably, appellant's brief says: "The District Court has found that Coson was a member of the partnership Moulin Rouge and that that partnership was not a limited partnership." The record shows no such finding. It shows, on the contrary, that appellant, in its Points on Appeal, complained that "The District Court erred in failing to find and to hold that plaintiff was a general partner in the 'Moulin Rouge' a general partnership." Appellant's brief does not contend that Coson did not make the mistake stated in the quoted finding or that he did not make prompt renunciation as the court found.

¹³ Of course an intent to become a general partner may be inferred from conduct. In this case no such conduct was shown. Coson had nothing to do with the management of Moulin Rouge, or with its organization. The only conduct shown on his part was consistent solely with his belief that he was dealing with a limited partnership. The ancient rule that a failure to comply with statutory provisions required to form a limited partnership renders the association a general partnership, (cf. 68 C. J. S. p. 1015) vanished with the enactment of the Uniform Limited Partnership Act. As stated in the Commissioners' Note on the Act: "Third: The limited partner not being in any sense a principal in the business, failure to comply with the requirements of the act in respect to the certificate, while it may result in the nonformation of the association, does not make him a partner or liable as such. The exact nature of his ability [liability] in such cases is set forth in Sec. 11." (Vol. 8, p. 4 Uniform Laws Annotated)

¹⁴ In the case last cited the court, after quoting from the Nevada Uniform Partnership Act, said (p. 975, 311 P. 2d): "It is clear from this provision that an assignment of a partnership interest from one partner to a stranger does not bring that stranger into fiduciary relationship with the remaining partners nor require them to resort to dissolution in order to prevent such a relationship from arising. The stranger remains a stranger entitled only to share in the partnership's worth and to demand an accounting upon dissolution." The Nevada case is of interest in that it notes the partners remaining in the firm were under no fiduciary duty to give information concerning the firm to the new assignee. The absence of such a duty shows the reason why notice to a partnership would not be notice to such an assignee for there could be no inference that the information would be passed on to him.

¹⁵ §6321, 26 U. S. C.: "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."

¹⁶ The court in Pipola accepted the Government's argument that the plaintiffs could not question the assessment on the merits or question the liability of the taxpayer for the tax, but that the only permissible issue that could be tried would be whether or not the lien was defective or valueless from a procedural standpoint or for failure to comply with required procedures. It was said that this distinction between the merits of the assessment or the liability for the tax on the one hand, and procedural defects on the other, was the same distinction that would be applied had the Government sought to collect the tax by an action under §3678 of the 1939 Revenue Code, (§7403 of the 1954 Code). Said the court (p. 912): "In a suit by the government to enforce a tax lien under §3678, the defendant clearly can raise such questions as whether the assessment complied with required procedures . . . or whether by error the assessment was made against a taxpayer other than the one intended." The court also said, speaking of the Attorney General's letter referred to in the report mentioned supra, (footnote 4), that the court thought that the Attorney General was speaking "not of cases where an assessment might lack merit but of liens that were irregular from a procedural standpoint, that had been filed against property not belonging to the taxpayer or that were valueless for other reasons not going to the merits of the assessment." Cf. U. S. v. Morrison [57-2 USTC ¶9801], 5 cir., 247 F. 2d 285, 290.

In the Pipola case Chicco was an individual who owned the premises where the business of accepting wagers was carried on. The taxes were assessed against Chicco.

In the case before us the taxes were assessed against Moulin Rouge of which Coson was not a member. It may be said here that this case presents a question "whether by error the assessment was made against a taxpayer other than the one intended," or whether this was a lien "that had been filed against property not belonging to the taxpayer" within the meaning of that language in the Pipola case.

The holding in Pipola, otherwise without precedent, was based on that court's interpretation of certain language used in Bull v. United States [35-1 USTC ¶9346], 295 U. S. 247.

¹⁷ §6203 of Title 26 prescribes the method of assessment as follows: "The assessment shall be made by recording the liability of the taxpayer in the office of the Secretary or his delegate in accordance with rules or regulations prescribed by the Secretary or his delegate. Upon request of the taxpayer, the Secretary or his delegate shall furnish the taxpayer a copy of the record of the assessment." (Italics supplied.)

The regulation on assessment and collection is as follows: "§301.6203.1. Method of Assessment.--The district director shall appoint one or more assessment officers, and the assessment shall be made by an assessment officer signing the summary record of assessment. The summary record, through supporting records, shall provide identification of the taxpayer, the character of the liability assessed, the taxable period if applicable, and the amount of the assessment. . . . If the taxpayer requests a copy of the record of assessment the district director shall furnish the taxpayer a copy of the pertinent parts of the assessment which set forth the name of the taxpayer, the date of assessment, the character of the liability assessed, the taxable period, if applicable, and the amounts assessed." (Italics added.)

 

 

[2001-1 USTC ¶50,312] In re South Independence, Inc., d/b/a Lake Wright Texaco, EIN #541373038, Debtor. South Independence, Inc., d/b/a Lake Wright Texaco, Plaintiff v. United States of America, Commonwealth of Virginia, and Selective Insurance of America, Inc., Defendants

U.S. Bankruptcy Court, East. Dist. Va. , Norfolk Div., 99-25384-S, Chapter 11, APN: 00-2090-S, 11/21/2000, 256 BR 861, 2000 Bankr. LEXIS 1597

[Code Sec. 6321 ]

Liens: Creation of: Debtor in bankruptcy: Priority: State (Virginia) law: Federal tax lien v. state lien.--

The IRS's tax liens against the assets of an insolvent corporation's bankruptcy estate had priority over state (Virginia) liens for unpaid fuel taxes because the federal liens arose before the state liens became choate and, thus, were first in time and first in right. The federal liens were perfected when the IRS made its tax assessments, and the state liens were created on the later dates when the state's tax division filed two memoranda of liens indicating that taxes were past due.

[Code Sec. 6323 ]

Liens: Creation of: Debtor in bankruptcy: Priority: State ( Virginia ) law: Federal tax lien v. state lien: State as judgment lien creditor.--

A state ( Virginia ) did not qualify as a judgment lien creditor and its claim against an estate's assets did not have priority over federal tax liens that were first in time. The state unsuccessfully argued that its lien was perfected before the IRS filed a notice of federal tax lien. Despite the fact that Virginia law gave the state lien the "effect" of a judgment, the state did not satisfy the tax code criteria to be a judgment lien creditor because its lien was not obtained in a court of record or from any type of judicial authority. Monica Fuel, Inc. (CA-3), 95-2 USTC ¶50,477 , distinguished.

W. Greer McCreedy II, for debtor. Gregory D. Stefan, Richard G. Jacobus, for I.R.S. Eric K.G. Fiske, for Commonwealth of Va. Thomas Moore Lawson, Ann K. Crenshaw, for Selective Ins. Co. of America.

Memorandum Opinion and Order

ST. JOHN , Bankruptcy Judge:

This matter came upon the debtor's Complaint to Determine the Extent, Priority and Validity of Liens, and to Authorize Distribution. The parties involved have stipulated to most of the facts. With no major facts in contention, both parties filed summary judgment motions and memoranda in support thereof. After reviewing their briefs, the Court heard oral argument on the summary judgment motions and took the matter under advisement.

FINDINGS OF FACT

The facts are not in dispute. On August 18, 1999, South Independence ("debtor") filed a voluntary petition for bankruptcy under Chapter 11. Following the debtor's bankruptcy filing, this Court authorized the debtor to sell property of the bankruptcy estate free and clear of liens pursuant to 11 U.S.C. §363(b). After executing the sale and making certain payments pursuant to the Court's sale order, the net proceeds of the sale totaled $67,500, exclusive of closing costs and a sales commission. The debtor is prepared to distribute the net proceeds but has filed this Complaint to resolve its concern as to which creditor has priority relative to the other creditors.

In the instant case, two creditors vie for priority--the Commonwealth of Virginia ("Commonwealth") and the Internal Revenue Service ("IRS"). The Commonwealth's claim relates to the debtor's fuel tax obligations. Pursuant to Virginia Code §58.1-2132.2, the Commonwealth filed two memoranda of liens--the first on November 17, 1998 and the second on July 26, 1999--in the Circuit Court for the City of Virginia Beach to secure the fuel tax obligations in the amounts of $52,834.31 and $10,610.59 respectively. ¹ The Commonwealth has accepted $25,707.06 from Selective Insurance Company of America, Inc. ("SIC"), as a compromise to the surety company's payment bond of $68,000, which previously secured the prepetition fuel tax obligation of the debtor. ²

The IRS claim is also for unpaid taxes. Between October 31, 1997 and October 26, 1998, the IRS made numerous tax and penalty assessments for various periods against the debtor, totaling $30,289.26. ³ Since then, the amount of the IRS claim has fluctuated due to accrued interest, additional penalties, and payments credited against the claim. ⁴ In its motion for summary judgment, and consistent with its proof of claim, the IRS has requested that $32,299.87 be distributed to satisfy its claim. ⁵

With $67,500 in sale proceeds to distribute, the estate is unable to pay in full both the claims of the Commonwealth and the IRS. Accordingly, which creditor is entitled to distribution first will have a substantial effect on how much of each creditor's claim will be paid.

CONCLUSIONS OF LAW

The ultimate issue in this case is which claim has priority. Federal law controls when the issue turns on the priority to be given to a federal lien. See United States v. Sec. Trust & Sav. Bank [50-2 USTC ¶9492], 340 U.S. 47, 49, 95 L.Ed. 53, 71 S.Ct. 111 (1950); Monica Fuel, Inc. v. IRS [95-2 USTC ¶50,477], 56 F.3d 508, 511 n.7 (3d Cir. 1995); In re Lehigh Valley Mills, Inc., 341 F.2d 398, 400 (3d Cir. 1965). Under federal law, the priority of a claim is governed by the well-known principle that the "first in time is the first in right." United States v. McDermott [93-1 USTC ¶50,164], 507 U.S. 447, 449, 123 L.Ed.2d 128, 113 S.Ct. 1526 (1993); accord United States v. Pioneer Am. Ins. Co. [63-2 USTC ¶9532], 374 U.S. 84, 87, 10 L.Ed.2d 770, 83 S.Ct. 1651 (1963); United States v. City of New Britain [54-1 USTC ¶9191], 347 U.S. 81, 85, 98 L.Ed. 520, 74 S.Ct. 367 (1954); Air Power, Inc. v. United States [84-2 USTC ¶9732], 741 F.2d 53, 55 (4th Cir. 1984). ⁶ In the instant case, the priority between the claims of the IRS and the Commonwealth depends on which lien arose first. Furthermore, if the Commonwealth is within a certain class of protected creditors, the issue of notice may impact the priority dispute involved in this case. Both issues are examined below.

I. FIRST IN TIME IS FIRST IN RIGHT

A. When the Liens Arose

The relative priority of each lien in the instant case depends on which lien was first in time. See McDermott [93-1 USTC ¶50,164], 507 U.S. at 449; Pioneer Am. Ins. [63-2 USTC ¶9532], 374 U.S. at 87; New Britain [54-1 USTC ¶9191], 347 U.S. at 85; Air Power [84-2 USTC ¶9732], 741 F.2d at 54; Monica Fuel [95-2 USTC ¶50,477], 56 F.3d at 511. The liens of the IRS arose under §6321 of the Internal Revenue Code, which provides:

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 (West 2000). Such a lien arises at the time the IRS conducts the tax assessment. See id. §6322 ("Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made. . . ."); Monica Fuel [54-1 USTC ¶9191], 56 F.3d at 511 ("Under 26 U.S.C. §§6321 and 6322, federal tax liens arise when the underlying taxes are assessed."). As noted earlier, the IRS conducted numerous tax assessments, with the latest occurring on October 26, 1998. Applying §6322, it is clear that all of the IRS liens arose no later than October 26, 1998.

As for the Commonwealth's liens, the Supreme Court stated in United States v. McDermott [93-1 USTC ¶50,164], 507 U.S. 447, 123 L.Ed.2d 128, 113 S.Ct. 1526 (1993): "Our cases deem a competing state lien to be in existence for 'first in time' purposes only when it has been 'perfected'. . . ." Id. at 449. The point at which a state lien is perfected depends "on the time it attached to the property in question and became choate." New Britain [54-1 USTC ¶9191], 347 U.S. at 86, quoted in United States v. Vermont [64-2 USTC ¶9520], 377 U.S. 351, 354, 12 L.Ed.2d 370, 84 S.Ct. 1267 (1964); see Monica Fuel [95-2 USTC ¶50,477], 56 F.3d at 511. ⁷ A lien may be choate "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." New Britain [54-1 USTC ¶9191], 347 U.S. at 84, quoted in Vermont [64-2 USTC ¶9520], 377 U.S. at 355.

In the instant case, the Commonwealth's liens arose under §58.1-2132.2 of the Virginia Code, which provides:

If any taxes or fees, including penalties and interest, become delinquent or are past due, the Commissioner may file a memorandum of lien. . . . Such memorandum shall be recorded in the judgment docket book and shall have the effect of a judgment in favor of the Commonwealth. . . .

Va. Code Ann. §58.1-2132.2 (Michie 2000). At the time the memorandum of lien is filed, the lienor and the property subject to the lien presumably are identified. Moreover, the memorandum of lien should establish the amount of the lien. Consequently, the Commonwealth's liens became choate at the time it filed the two memoranda of liens-specifically, the Commonwealth's liens became choate on November 17, 1998, and July 26, 1999 respectively. Therefore, the earliest lien that arose in favor of the Commonwealth occurred on November 17, 1998.

B. The IRS Liens Are First in Time

The review as to when each lien arose in the present case reveals that all of the IRS liens arose prior to the Commonwealth's two liens. The latest IRS lien arose October 26, 1998, whereas the first Commonwealth lien arose on November 17, 1998-nearly a month after the last IRS lien. Applying the principle of first in time, first in right, it is clear that the IRS liens are first in time and thus first in right. The Commonwealth, however, asserts that its liens are first in time because the IRS did not file its notice of lien until December 28, 1998. Even then, the Commonwealth argues, the notice was illegible and therefore ineffective. The relevance of the IRS notice of federal tax lien depends on whether the Commonwealth is a protected class under the Internal Revenue Code.

II. JUDGMENT LIEN CREDITOR

The Commonwealth argues that it is a judgment lien creditor and therefore must have notice of a federal tax lien before such lien may trump the Commonwealth's lien. As noted above, an IRS lien arises at the time the tax is assessed. See 26 U.S.C. §§6321, 6322 (West 2000). To be valid against certain types of creditors, however, the IRS must file a notice of federal tax lien. Congress saw fit to protect certain types of creditors by legislating that "the lien imposed by section 6321 shall not be valid as against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary." Id. §6323(a); see also Air Power, Inc. v. United States [84-2 USTC ¶9732], 741 F.2d 53, 55 (4th Cir. 1984) ("Congress in the last fifty years has chosen to extend special protection to certain classes of creditors whose interests are perfected and specific before they have notice of outstanding federal tax liens.").

A judgment lien creditor is defined in the IRS regulations:

[A] person who has obtained a valid judgment, in a court of record and of competent jurisdiction, for the recovery of specifically designated property or for a certain sum of money. In the case of a judgment for the recovery of a certain sum of money, a judgment lien creditor is a person who has perfected a lien under the judgment on the property involved.

26 C.F.R. §§301.6323(h)-1(g) (2000). The IRS contends that the definition of a judgment lien creditor requires that the lienor have obtained the judgment through litigation in a court of law. Conversely, the Commonwealth argues that under state law, its lien is given the effect of a judgment in all respects and therefore makes the Commonwealth a judgment lien creditor for purposes of Internal Revenue Code §6323.

On its face, Virginia Code §58.1-2132.2 attempts to create a judgment lien once the lienor files a memorandum of lien. See Va. Code Ann. §58.1-2132.2 (Michie 2000). The state statute, however, is not determinative of whether it is a judgment, because "federal law governs the actual legal effect of the judgment for tax priority purposes." Air Power [84-2 USTC ¶9732], 741 F.2d at 55 n.2 (4th Cir. 1984) (citing Hartford Provision Co. v. United States [78-1 USTC ¶9392], 579 F.2d 7, 9 (2d Cir. 1978)). In Air Power, the Fourth Circuit Court of Appeals held that "whether a judgment issues from a 'court of record' for purposes of section 6323 priority under the Internal Revenue Code is a question of federal law. . . ." Id. at 54. The Air Power court based its holding on the need for uniformity in defining "judgment creditor" as expressed in United States v. Gilbert Associates [53-1 USTC ¶9291], 345 U.S. 361, 97 L.Ed. 1071, 73 S.Ct. 701 (1953):

A cardinal principle of Congress in its tax scheme is uniformity, as far as may be. Therefore, a "judgment creditor" should have the same application in all the states. In this instance, we think Congress used the words "judgment creditor" in §3672 [now §6323] in the usual conventional sense of a judgment of a court of record, since all states have such courts. We do not think Congress had in mind the action of taxing authorities who may be acting judicially as in New Hampshire and some other states, where the end result is something "in the nature of a judgment", while in other states the taxing authorities act quasi-judicially and are considered administrative bodies.

Id. at 364 (footnotes omitted), quoted in Air Power [84-2 USTC ¶9732], 741 F.2d at 56. Likewise, in the instant case, that a state statute declares that it "shall have the effect of a judgment," Va. Code Ann. §58.1-2132.2, is not enough to render the state a judgment lien creditor for the purpose of §6323 of the Internal Revenue Code. See, e.g., Brown v. Maryland [87-2 USTC ¶9639], 699 F.Supp. 1149, 1153 (D. Md. 1987) ("Although, under Maryland law the recording of a notice of a tax lien may be similar to or in the nature of a judgment, this is not sufficient under the Gilbert case. "). Rather, the creditor must meet the criteria enumerated under the Internal Revenue Code to qualify as a judgment lien creditor. In the instant case, the Commonwealth does not qualify as a judgment lien creditor.

The federal regulations note that a judgment lien creditor is one who has obtained a judgment in a "court of record." 26 CFR §§301.6323(h)-1(g) (2000). The regulations go on to state that "the term 'judgment' does not include the determination of a quasi-judicial body or of an individual acting in a quasi-judicial capacity. . . ." Id. These comments make it clear that anything less than a judgment in a court of record with judicial authority will not suffice. A state legislature cannot overcome this barrier by simply declaring its lien to be a judgment. The Commonwealth's lien in this matter was not born from a court of record or any sort of judicial authority. Consequently, the Commonwealth is not a judgment lien creditor and cannot enjoy such protection. Cf. Foust v. Foust [98-1 USTC ¶50,202], No. IP 96-0196-C-T/G, 1997 WL 1037872, at *7 (S.D. Ind. July 9, 1997) ("Therefore, even though the [Indiana Department of Revenue ("IDR")] has a judgment lien under Indiana law, this lien does not qualify the IDR as a 'judgment lien creditor' under federal law that is entitled to the additional protection of section 6323(a). The IDR does not have a judgment granted by a court of record, and would need such a judgment before the IRS filed its notice . . . in order to have priority over the federal tax lien."). Without the status of judgment lien creditor, the timing, as well as the illegibility of the notice of federal tax lien becomes irrelevant. The federal tax liens arose when they were assessed, and as noted above, were first in time relative to the Commonwealth's liens. Under the principle of first in time, first in right, the IRS liens take priority over the Commonwealth's liens.

III. MONICA FUEL, INC. V. INTERNAL REVENUE SERVICE

Finally, the Court must address the case that the Commonwealth argues should control the outcome. In Monica Fuel, Inc. v. Internal Revenue Service [95-2 USTC ¶50,477], 56 F.3d 508 (3d Cir. 1995), the Third Circuit Court of Appeals faced an issue similar to the one faced by this Court today--namely the relative priority of a §6321 lien versus a state fuels tax lien. See id. at 508-09. The state statute in Monica Fuel is substantially similar to the one at issue today. In Monica Fuel, the statute created a lien for fuel taxes owed to the state. See id. at 509. By issuing either a certificate of debt or a warrant of execution, the lien would be "given the same force and effect as any entry of a docketed judgment. . . ." Id. In holding that the state tax liens "were choate and, therefore, entitled to priority over the liens of the IRS," id. at 513, the court noted that the "liens were 'given the force of a judgment' upon assessment." Id. (quoting United States v. Vermont [64-2 USTC ¶9520], 377 U.S. 351, 359, 12 L.Ed.2d 370, 84 S.Ct. 1267 (1964)).

The holding in Monica Fuel is notable as much for its holding as for what it did not hold. The court noted that on reargument the district court "concluded that . . . the Division did not acquire judgment lien creditor status because a certificate of debt 'does not qualify as a "valid judgment, in a court of record and of competent jurisdiction" as specifically required by 26 C.F.R. §301.6323(h)-1(g).' " Id. at 510 n.5 (quoting Monica Fuel, Inc. v. IRS, No. 91-748, at 7 (D. N.J. May 10, 1994)). On appeal, the Division did not contest this ruling and therefore the Third Circuit in Monica Fuel did not have to address whether the Division was a judgment lien creditor.

Yet this is precisely the issue before this Court. In Monica Fuel, whether the Division was a judgment lien creditor was not outcome determinative because, as the court found, the Division was first in time with regard to when the liens arose. ⁸ In the instant case, the Commonwealth's first lien arose nearly a month after the IRS made its last tax assessment. Having lost this race, the Commonwealth had to pin its hopes on protection as a judgment lien creditor. As noted above, this attempt has been proven futile in that the Commonwealth is not a judgment lien creditor.

IV.

The sole issue in this case is which liens have priority: the Commonwealth's liens or the IRS liens. With "first in time, first in right" as the guiding principle, the dates that each lien arose are critical. Under state law, the Commonwealth's liens arose when the Commonwealth filed the two memoranda of liens. Conversely, under federal law, the IRS liens arose at the time the IRS assessed the fuel taxes. Applying this to the undisputed facts, it is clear that all of the IRS liens arose prior to the Commonwealth's liens.

To avoid the consequences of perfecting its lien subsequent to the IRS tax assessments, the Commonwealth seeks protection as a judgment lien creditor. A judgment lien creditor is not bound by the date of tax assessment for purposes of priority, but rather the date of when the notice of federal tax lien was filed controls. Who is a "judgment lien creditor," however, is governed under federal law. The Commonwealth does not fit into this definition despite the state statute giving the lien the effect of a judgment, because the lien was not obtained in a court of a record or from any type of judicial authority.

Without the status of a judgment lien creditor, the first lien in time must prevail. Accordingly, in light of the fact that the IRS liens preceded the Commonwealth's liens, the Court finds that the IRS liens have priority over the Commonwealth's liens. The Court, therefore, orders that the amount of $67,500 being held in trust be distributed first to the IRS in satisfaction of its claim for $32,299.87, with the remainder to be applied to the Commonwealth's liens.

IT IS SO ORDERED.

The Clerk shall mail a copy of this Memorandum Opinion and Order to Gregory D. Stefan, Esq., and Richard G. Jacobus, Esq., counsel for the IRS, Eric K.G. Fiske, Esq., counsel for the Commonwealth of Virginia, Thomas Moore Lawson, Esq., and Ann K. Crenshaw, Esq., counsel for Selective Insurance Company of America, and W. Greer McCreedy, II, Esq., counsel for the debtor.

¹ Between May 19, 1999 and July 28, 1999, the Commonwealth also filed memoranda of liens for various sales tax and employer withholding tax assessments against the debtor for various periods, totaling $5289.18. The Commonwealth, however, does not contend that this amount is entitled to priority over the IRS claims, as these liens were recorded after the IRS filed its notice of federal tax lien.

² SIC is a party to this adversary proceeding. In its pleadings, SIC has adopted the position of the Commonwealth in all respects.

³

                        IRS Tax Assessments

For the tax period ending                          Assessment Date   Amount

September 30, 1997                                October 31, 1997     572.89

February 2, 1998                                                      6365.39

February 2, 1998                                                       636.54

February 2, 1998                                                       127.31

February 2, 1998                                                       162.68

March 9, 1998                                                          318.27

December 31, 1997                                 January 31, 1998     486.86

April 13, 1998                                                        5409.59

April 13, 1998                                                         540.95

April 13, 1998                                                          81.14

April 13, 1998                                                         103.47

May 18, 1998                                                           270.48

March 31, 1998                                    April 30, 1998       259.54

June 29, 1998                                                         5767.50

June 29, 1998                                                          576.74

June 29, 1998                                                           57.68

June 29, 1998                                                           79.77

August 3, 1998                                                         288.37

June 30, 1998                                     July 31, 1998        302.62

September 21, 1998                                                    6724.94

September 21, 1998                                                     672.49

September 21, 1998                                                      67.25

September 21, 1998                                                      80.54

October 26,1998                                                        336.25

                                                                    ---------

TOTAL                                                               30,289.26

 

⁴ At trial, the parties noted an apparent discrepancy in the amounts the IRS claimed in its notice of federal tax lien as compared with its proof of claim. In the notice of federal tax lien, the IRS stated that the amount secured was $30,353.48. In its proof of claim, however, the IRS stated that the amount secured was $32,299.87. To resolve the matter, the IRS submitted a supplemental affidavit in support of its motion for summary judgment. In the affidavit, Pamela Anderson, an "Advisor/Reviewer" for the IRS, explained that the differing amounts reflected activity since the dates the taxes were assessed, as well as since the notice of federal tax lien was filed. Specifically, in addition to the tax assessments previously noted, the proof of claim amount reflects one payment of $4215, a dishonored check penalty of $15, failure-to-pay penalties of $3233.94, and further accrued interest totaling $2976.67. When these amounts are added to the amount of the original tax assessments, which totaled $30,289.26, see supra note 3, the combined total matches the IRS proof of claim--$32,299.87.

⁵ On December 28, 1998, in compliance with 26 U.S.C. §6323(f) and Virginia Code §55-142.1(C)(1), the IRS filed a notice of federal tax lien with the Virginia State Corporation Commission. The parties dispute the legibility, or lack thereof, of the notice of federal tax lien. The parties further dispute who should bear the responsibility for such alleged illegibility. The Court makes no finding on these issues as this opinion makes those issues moot. As discussed in greater detail below, the notice of federal tax lien ultimately has no bearing on the outcome of this proceeding.

⁶ This principle goes back to the days of Chief Justice Marshall, who stated:

The principle is believed to be universal, that a prior lien gives a prior claim, which is entitled to prior satisfaction out of the subject it binds, unless the lien be intrinsically defective, or be displaced by some act of the party holding it, which shall postpone him in a Court of law or equity to a subsequent claimant.

Rankin v. Scott, 25 U.S. (12 Wheat) 177, 179, 6 L.Ed. 592 (1827).

⁷ As the Supreme Court noted in Vermont, "the requirement that a competing lien must be choate in order to take priority over a later federal tax lien stems from the decision in United States v. Security Trust & Savings Bank [50-2 USTC ¶9492], 340 U.S. 47, 71, 95 L.Ed. 53, 71 S.Ct. 111 [1950]." Vermont [64-2 USTC ¶9520], 377 U.S. at 355.

⁸ As in our case, the court in Monica Fuel faced several liens. In Monica Fuel, the IRS made seven tax assessments between September 18, 1989 and June 4, 1990. The Monica Fuel court concluded that on August 30, 1989--nearly three weeks prior to the first IRS assessments--the state tax liens became sufficiently choate under the New Britain test and therefore were first in time and first in right relative to the IRS liens. See id. at 512.

 

 

[95-2 USTC ¶50,477] Monica Fuel, Inc., Appellee v. Internal Revenue Service, Department of Treasury, United States of America, State of New Jersey, Department of Treasury, Division of Taxation, Division of Taxation, Department of the Treasury, State of New Jersey, Appellant

(CA-3), U.S. Court of Appeals, 3rd Circuit, 94-5406, 6/2/95, Reversing and remanding an unreported District Court decision

[Code Secs. 6321 and 6322 ]

Tax liens: Priority: State v. Federal: Assessment: Period of lien.--The IRS's liens for unpaid excise and employment taxes did not have priority over the state (New Jersey) tax division's liens for unpaid motor fuels taxes because the state liens were completed before the IRS liens arose. Pursuant to the state code, the liens were created when the taxes were assessed by the state's tax division. Despite the IRS's argument to the contrary, the amount of the state's liens were sufficiently established even though the corporation had the right to appeal the state's assessment. Furthermore, the state's liens had not been terminated despite the expiration of a warrant of execution because the warrant did not create the lien. Moreover, a requirement that the state's liens be summarily enforceable did not force the state to take possession of the taxpayer's property in order to obtain a choate lien. Therefore, since the state's tax liens were choate, establishing the identity of the lienor, the property subject to the liens and the amount of the liens, the state's liens were entitled to priority.

David A. Kasen, Kasen, Kasen & Braverman, 1874 E. Marlton Pike, Cherry Hill, N.J. 08034, for appellee. Martin L. Wheelwright, Deputy Attorney General, Kevin M. Schatz, Trenton, N.J. 09625, Gary R. Allen, William S. Estabrook, David A. Shuster, Pamela C. Berry, Department of Justice, Washington, D.C. 20530, for appellant.

Before: SLOVITER, Chief Judge, LEWIS and WEIS, Circuit Judges.

OPINION OF THE COURT

LEWIS, Circuit Judge:

This case presents a single issue of law: the relative priority of Internal Revenue Service ("IRS") liens, which arise upon assessment under 26 U.S.C. §§6321 and 6322 , ¹ versus New Jersey motor fuels tax liens, which arise under New Jersey's State Tax Uniform Procedure Law. At summary judgment, the United States District Court for the District of New Jersey found the federal liens to be superior. Because we believe the state liens were choate before the liens of the IRS arose and were, therefore, entitled to priority, we will reverse the district court's judgment.

I.

The material facts of this case are generally undisputed. The necessary factual background concerns New Jersey 's uniform procedures for assessing and collecting taxes and the State of New Jersey , Division of Taxation's ("Division") activities with respect to Monica Fuel, Inc. ("Monica Fuel").

A.

The state liens involved in this case arose under N.J. Stat. Ann. §54:49-1, which provides in pertinent part:

The taxes fees, interest and penalties imposed by any such State tax law . . . from the time the same shall be due, shall be a personal debt of the taxpayer to the State, recoverable in any court of competent jurisdiction in an action in debt in the name of the State. Such debt, whether sued upon or not, shall be a lien on all the property of the debtor except as against an innocent purchaser for value in the usual course of business and without notice thereof, and except as may be provided to the contrary in any other law . . . .

The Division is authorized to make an assessment after a report is filed and it is determined that there is a deficiency in payment. Notice of such a deficiency assessment is then given to the taxpayer and demand for payment is made. N.J. Stat. Ann. §54:49-6. The taxpayer must remit to the Division the assessed amount within fifteen days after the notice and demand are mailed. N.J. Stat. Ann. §54:49-8. Non-payment within the 15-day period results in the imposition of an additional penalty of five percent. N.J. Stat. Ann. §54:49-9.

The Division is not limited to demand and imposition of penalties as the only tools for effectuating collection of unpaid taxes. The Division may, as an alternative remedy, issue a certificate of debt to the Clerk of the New Jersey Superior Court. The clerk immediately enters upon the record of docketed judgments the name and business address of the debtor, the certified amount of the debt and the name of the tax. N.J. Stat. Ann. §54:49-12. The entries are given the same force and effect as any entry of a docketed judgment, and provide the Division with all of the remedies available for recovery of a judgment in action. We note that this alternative remedy creates no additional rights nor additional liabilities; rather "[i]t is a device for collecting taxes[.]" C.J. Kowasaki, Inc. v. New Jersey , 13 N.J. Tax 160, 168-169 (N.J. Tax Ct. 1993).

The New Jersey statute provides an additional remedy to enforce collection of taxes. The Division may issue a warrant of execution to the sheriff of any county who, in turn, files the warrant with the county clerk. ² The clerk then enters in the judgment docket the name of the taxpayer and the amount the taxpayer owes to the State. As with the certificate of debt, the warrant does not create the lien; instead the warrant provides a procedural tool for enforcing a judgment. In re Blease v. New Jersey , 605 F.2d 97, 98 (3d Cir. 1979).

B.

On March 23, 1989, the Division made an assessment of $76,554.19 against Monica Fuel, a Williamstown, New Jersey corporation, engaged in the business of retail fuel oil distribution, for unpaid motor fuels taxes. On August 30, 1989, the Division assessed against Monica Fuel an additional $2,125.61, bringing the total state assessments to $78,679.70. Thereafter, between September 18, 1989, and June 4, 1990, the IRS made seven separate assessments against Monica Fuel for unpaid federal excise and employment taxes, totalling $68,288.37. ³ On February 5, 1990, the Division filed a certificate of debt with the clerk of the New Jersey Superior Court, who entered judgment on the record of docketed judgments on February 14, 1990. Nine days later, on February 23, 1990, the Division issued a warrant of execution on the personalty of Monica Fuel which was available for payment of the taxes due. This amounted to $60,000 which Monica Fuel expected to receive from the bulk sale of its business assets to Star Oil Company, Inc. ("Star Oil"). ⁴

C.

On October 26, 1990, Monica Fuel instituted this interpleader action in the Superior Court of New Jersey. The IRS then removed the action to the district court. On cross-motions for summary judgment, the district court concluded that the IRS's statutory liens were superior to those of New Jersey , and granted judgment in favor of the IRS. Specifically, the court held that the Division's tax liens, arising under N.J. Stat. Ann. §54:49-1, were not sufficiently choate to defeat the priority of the federal tax liens arising under sections 6321 and 6322 . The court further found that the Division's tax assessments did not "elevate the state to the level of 'judgment creditor' within the meaning of 26 U.S.C. §6323(a) ." ⁵ Monica Fuel, Inc. v. IRS, No. 91-748 at 10 (D. N.J. Nov. 20, 1991) (order granting summary judgment). The Division moved for reargument, claiming that the tax deficiency assessments it issued in 1989 rendered its tax liens fully choate and, therefore, superior to the federal liens in question. The court again rejected the Division's argument, noting that "the state liens were not choate at the time assessed because N.J.S.A. 54:49-1 contemplates judicial enforcement of state liens." ⁶ Monica Fuel, Inc. v. IRS, No. 91-748 at 3 (D. N.J. May 10, 1994) (order granting summary judgment). The Division now appeals. We have jurisdiction under 28 U.S.C. §1291 .

The district court's determination that New Jersey 's tax liens were inchoate and therefore not entitled to priority is a legal conclusion subject to plenary review. Keystone Chapter, Associate Builders and Contractors, Inc. v. Foley, 1994 WL 513971 at *5 (3d Cir. 1994), citing Gregoire v. Centennial School Dist., 907 F.2d 1366, 1370 (3d Cir. 1990).

II.

Federal tax liens do not automatically prime all other liens. Rather, priority is governed by the federal common-law principle that " 'the first in time is the first in right.' " ⁷ United States v. McDermott [93-1 USTC ¶50,164 ], 113 S.Ct. 1526, 1528 (1993), quoting United States v. New Britain [54-1 USTC ¶9191 ], 347 U.S. 81, 85 (1954). As stated by Chief Justice Marshall in Rankin & Schatzell v. Scott, 12 Wheat. (25 U.S. ) 177, 179 (1827): "The principle is believed to be universal that a prior lien gives a prior claim, which is entitled to prior satisfaction, out of the subject it binds . . . ." 12 Wheat. at 179. It is critical, therefore, for the purpose of determining priority, to ascertain when competing liens, whether federal- or state-created, arise.

Under 26 U.S.C. §§6321 and 6322 , federal tax liens arise when the underlying taxes are assessed. The priority of a state lien depends on when it "attached to the property in question and became choate." New Britain [54-1 USTC ¶9191 ], 347 U.S. at 86. As the Supreme Court has stated, "a competing state lien [is considered] to be in existence for 'first in time' purposes only when it has been 'perfected . . . .' " McDermott [93-1 USTC ¶50,164 ], 113 S.Ct at 1528, quoting New Britain [54-1 USTC ¶9191 ], 347 U.S. at 84. That is, the state lien must be "perfected in the sense that there is nothing more to be done to have a choate lien--when the identity of the lienor, the property subject to the lien, and the amount of the lien are established." United States v. Vermont [64-2 USTC ¶9520 ], 377 U.S. 351, 355 (1964).

The Division argues that New Britain controls this case and that the state liens have priority because the identity of the lienor (the State of New Jersey), the property subject to the lien (all of Monica Fuel's property, according to N.J. Stat. Ann. §54:49-1) and the amount of the lien (the amount of the assessments) were all established prior to when the federal liens arose.

The IRS does not dispute that the first two choateness requirements were satisfied. It concedes that the identity of the lienor and the property subject to the lien were known well before the federal liens arose. The IRS does, however, claim that the amount of the state liens were not sufficiently established and, consequently, not entitled to priority. Moreover, in the event that we find the state lien amounts were sufficiently fixed to satisfy the final New Britain factor, the IRS makes an additional argument, namely that the state tax liens were inchoate because they were not summarily enforceable. ⁸ We will address these two distinct issues in turn.

A.

As noted above, one requirement of choateness under the standard articulated by the Supreme Court in New Britain is that the amount of the state lien be "established." In an attempt to convince us that the liens met the requirements of New Britain, the Division makes two separate arguments. First, it contends that the amounts were sufficiently established upon assessment. Alternatively, the Division claims that the amounts became fixed when the period for filing a protest expired. ⁹ The IRS suggests that when assessed, the amounts were neither final nor established; rather, they represented nothing more than debts which were open to contest and revision. ¹⁰ Appellee's Br. at 17. Indeed, the taxpayer may, within thirty days of the notice of assessment, file a protest and request a hearing, N.J. Stat. Ann. §54:49-18, or, in the alternative, file an appeal with the New Jersey Tax Court within 90 days of being notified of an assessment. ¹¹ N.J. Stat. Ann. §54:51A-13. Although either process might result in an order modifying or vacating the assessment, these remedies do not interfere in the first instance with the right of the Division to collect the unpaid tax. Significantly, the New Jersey statute specifically authorizes collection by the Division of the amounts assessed prior to the expiration of the protest period. N.J. Stat. Ann. §54:49-18. See also N.J. Stat. Ann. §§54:49-12 and 54:49-13a. In fact, payment must be made within fifteen days of notification to avoid the imposition of an additional penalty of five percent. N.J. Stat. Ann. §§54:49-8 and 54:49-9.

The state lien amounts unquestionably were, in our view, established once the 90-day period for filing an appeal with the tax court lapsed, as they became impervious to challenge and were therefore fixed and specific. We also agree with the Division, however, that the amounts were established sufficiently when the Division notified Monica Fuel of the assessments. The fact that the Division had the authority to enforce the liens--whether sued upon or not--prior to the expiration of the protest period persuades us that the specificity of the amount of a lien arising under N.J. Stat. Ann. §54:49-1 is unaffected by the taxpayer's right to appeal. See In re Lehigh Valley Mills, Inc., 341 F.2d 398, 401 (3d Cir. 1965) (where a lien is enforceable against the property by a summary proceeding, the certainty of the lien amount is established). Accordingly, we conclude that on August 30, 1989--the date Monica Fuel was notified of the Division's second and final assessment--both of the state tax liens satisfied the New Britain test for choateness, as the identity of the lienor, the property subject to the lien and the amount of the lien were all established. ¹²

B.

The IRS insists that the Division nevertheless failed to achieve choate liens because the assessments were not summarily enforceable. The IRS cites several cases--McDermott, Vermont and T.H. Rogers Lumber Co. v. Apel, 468 F.2d 14 (10th Cir. 1972)--which, it contends, stand for the proposition that in addition to satisfying the New Britain test, state liens must also be summarily enforceable to prime a competing federal lien. Appellee's Br. at 17.

We agree that a right to enforce a lien summarily (that is, without a judicial proceeding) is a requirement of choateness in addition to the tripartite rule of fixed identity, property and amount, articulated in New Britain. ¹³ Indeed, a number of courts have expressly indicated that such a requirement exists. See In re Terwilliger's Catering Plus, Inc. [90-2 USTC ¶50,460 ], 911 F.2d 1168, 1176 (6th Cir. 1990) (state lien holder must show that he or she had the right to enforce the lien prior to the attachment of the federal lien); Apel, 468 F.2d at 18 (choateness requirement can only be met if the lien is enforceable by summary proceedings); Burrus v. Oklahoma Tax Comm'n, 850 F. Supp. 963, 964 (W.D. Okl. 1993) (nonfederal tax lien must be enforceable as well as otherwise choate); Homestead Land Title Company v. United States, 1993 WL 360389, at *3 (D. Kan. August 17, 1993) (lien which is not summarily enforceable is inchoate); United States v. Utah State Tax Comm'n, 642 F. Supp. 8, 10 (D. Utah 1981) (nonfederal lien must be summarily enforceable and not have conditions that affect its viability); In re Bright Designed Floors, Inc., 66-2 U.S. Tax Cas. (CCH) ¶9752 (S.D. N.Y. 1966) (test of perfection is whether a lien is "presently enforceable").

Although we agree with the IRS that state liens must be summarily enforceable to attain priority over later arising federal tax liens, we do not agree that New Jersey's liens fail to satisfy this requirement. The IRS argues that the Division's February 1990 filing of its certificate of debt did not perfect the state liens because the Division did not levy on Monica Fuel's property. The IRS argues further that because the Division's warrant of execution (also issued in February 1990) had expired before the Division could actually collect the funds owed, the lien, itself, also expired, leaving the Division without a means for summary enforcement.

As an initial matter, we note again that a warrant of execution does not create the state lien. In re Blease, 605 F.2d at 98. Thus, the expiration of the warrants in this case did not terminate the Division's lien. Moreover, the requirement that state liens be summarily enforceable does not, in our view, compel the state to take possession of the debtor's property in order to obtain a choate lien and achieve priority. Choateness only requires that the state have a right to enforce its lien in a summary fashion.

As the Court recognized in Vermont, where ministerial acts which do not affect the viability of the lien remain, the lien is nevertheless summarily enforceable. See Utah State Tax Comm'n, 642 F. Supp. at 10, citing Vermont [64-2 USTC ¶9520 ], 377 U.S. at 359 n.11. ¹⁴ Section 54:49-1 of the New Jersey tax code gives New Jersey the right to enforce its liens upon assessment. The New Jersey statute also provides two tools for enforcement--the certificate of debt and the warrant of execution--neither of which require the Division to engage in a judicial contest to attain a judgment in its favor. Therefore, the state liens at issue in this case were not susceptible to "[n]umerous contingencies which might prevent the lien from becoming perfected by a judgment awarded and recorded." See United States v. Security Trust & Savings Bank of San Diego [50-2 USTC ¶9492 ], 340 U.S. 47, 50 (1950). In other words, the Division's liens were "given the force of a judgment" upon assessment. Vermont [64-2 USTC ¶9520 ], 377 U.S. at 359.

III.

For the reasons set forth above, we conclude that the state tax liens were choate and, therefore, entitled to priority over the liens of the IRS. Accordingly, we will reverse the district court's grant of summary judgment in favor of the IRS and remand the case for further proceedings consistent with this opinion.

¹ 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 (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. §6322 provides:

Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed (or a judgment against the taxpayer arising out of such liability) is satisfied or becomes enforceable by reason of lapse of time.

² The Division may also issue a warrant to any Division employee who may execute the warrant with all the powers of a sheriff. N.J. Stat. Ann. §54:49-13(a). In this case the Division exercised this option.

³ The amounts and dates of the IRS assessments are as follows:

Assessment Date                                                     Amount

09/18/89 ........................................................ $ 9,253.99

09/25/89 ........................................................  40,365.94

12/04/89 ........................................................   8,472.31

12/18/89 ........................................................       0.00

03/19/90 ........................................................     264.20

03/19/90 ........................................................   7,570.84

06/04/90 ........................................................   2,361.09

                                                                  ----------

Total ........................................................... $68,288.37

 

⁴ On February 7, 1990, Star Oil, pursuant to N.J. Stat. Ann. §54:32-22(c) (West 1986), filed a Notification of Sale, Transfer or Assignment in Bulk with the Division indicating that Star Oil would be purchasing some of Monica Fuel's business assets. The sale was completed in mid-June. At or about that time, Monica Fuel, Star Oil, the IRS and the Division executed an escrow agreement whereby the proceeds from the sale were to be placed in escrow for the purpose of satisfying the claim of either the IRS or the Division or both. The agreement further provided that (1) the funds were to be interpleaded within 90 days absent a resolution regarding the distribution of the funds between the IRS and the Division; and (2) the funds were to be disbursed in accordance with the court's final order once it was no longer subject to appeal.

⁵ 26 U.S.C. §6323(a) provides:

Except as otherwise provided in subsection (c), the lien imposed by section 6321 shall not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until the notice thereof has been filed . . . .

⁶ In its motion for reargument the Division also claimed that the court had failed to consider adequately the certificate of debt which, under state law, entitled the Division to treatment as a judgment lien creditor. The district court granted reargument on the narrow issue of whether the entry of a certificate of debt raises the state to the status of judgment lien creditor. The court concluded that upon such entry the Division did not acquire judgment lien creditor status because a certificate of debt "does not qualify as a 'valid judgment, in a court of record and of competent jurisdiction' as specifically required by 26 C.F.R. 301 6323(h)-1(g)." Monica Fuel, Inc. v. IRS, No. 91-748 at 7 (D. N.J. May 10, 1994) (order granting summary judgment). The Division does not contest this aspect of the district court's judgment on appeal.

⁷ Over the years, the Supreme Court and this court have consistently held that federal law is determinative where the question involved is the priority to be accorded a lien of the federal government, whatever its source. United States v. Security Trust & Savings Bank of San Diego [50-2 USTC ¶9492 ], 340 U.S. 47, 49 (1950); In re Lehigh Valley Mills, Inc., 341 F.2d 398, 400 (3d Cir. 1965) (collecting cases).

⁸ The IRS posits an additional argument which presents a much broader challenge to the Division's right to the interpleaded funds:

"[I]t is submitted that the assets at issue here were not subject to the section 54:49-1 lien because they were purchasable (indeed, they were purchased) in the usual course of business . . . . Thus, not until the Division filed its warrant [of execution] or levied on the property could it be said that the Division had a lien, choate or otherwise, on the property at issue here."

Appellee's Br. at 30.

We have considered this argument and find it to be without merit.

⁹ Based on language in the New Jersey statute providing that a lien on unpaid taxes arises "from the time the [taxes] shall be due[,]" the Division initially argued that the amounts were sufficiently established when Monica Fuel filed its tax returns indicating the amount due. The district court rejected this contention relying primarily upon In re Priest, 712 F.2d 1326 (9th Cir. 1983), modified [83-2 USTC ¶9530 ], 725 F.2d 477 (1984), wherein the Court of Appeals for the Ninth Circuit concluded that the "mere receipt of a delinquent State tax return is too vague and indefinite a standard by which to establish a lien that is capable of taking priority over a federal lien." In re Priest, 712 F.2d at 1329. The Division has abandoned this argument on appeal.

¹⁰ Although in the portion of its brief challenging the specificity of the state lien amounts upon assessment, the IRS consistently refers only to the Division's March 23, 1989, assessment ("[t]he Division's earliest claim to the fund," Appellee's Br. at 11), we understand the IRS's argument to apply to both of the Division's assessments.

¹¹ Effective July 1, 1993, the 30-day protest period was expanded to 90 days. In addition, the commencement date for the 90-day period for appeal to the Tax Court was changed from the issuance of the tax assessment to the issuance by the Division of a final determination on any protest. N.J. Stat. Ann. §54:49-18 (West 1994).

¹² Consequently, we need not reach the federal government's claim that the Division's failure, once the appeal period expired, to "formally record in its books [Monica Fuel's] debt to the State," itself renders the lien inchoate. Appellee's Br. at 25-26.

¹³ The Supreme Court has made passing references to summary enforceability, implicitly recognizing that the right to summarily enforce a state lien is a requirement of choateness. See, e.g., United States v. McDermott [93-1 USTC ¶50,164 ], 113 S. Ct. 1526, 1529-30 n.5 (1993); United States v. Vermont [64-2 USTC ¶9520 ], 377 U.S. 351, 359 n.12 (1964). See also In re Thriftway Auto Rental Corp. v. Herzog [72-1 USTC ¶9311 ], 457 F.2d 409, 414 n.8 (2d Cir. 1972), citing Vermont [64-2 USTC ¶9520 ], 377 U.S. at 359 & n.12.

¹⁴ In footnote 11 the Court cites to a footnote in United States v. Vermont [63-1 USTC ¶9472 ], 317 F.2d 446, 448 n.2 (2d Cir. 1963), wherein the Court of Appeals for the Second Circuit describes the steps required before Vermont could foreclose on the real property at issue in that case.

Concurring Opinion

SLOVITER, Chief Judge

in the judgment.

The majority has written a creditable opinion which reaches a plausible result in light of the positions taken (and not taken) by the Internal Revenue Service in this case. I believe, however, that there are additional considerations that require some discussion.

Of concern to me is that despite the fact that New Jersey's tax scheme does provide methods for enforcement of a tax lien after public notice of the lien, as a result of this opinion the mere assessment of taxes due is enough to render that lien choate and hence entitled to priority over a federal tax lien. I do not question that New Jersey's tax lien would become summarily enforceable, and therefore choate, under United States v. Vermont [64-2 USTC ¶9520 ], 377 U.S. 351 (1964), when a certificate of debt issued by the Director of the Division of Taxation is docketed by the Clerk of the Superior Court under N.J. Stat. Ann. §54:49-12, or when a warrant issued by the Director is filed with the county clerk and docketed under N.J. Stat. Ann. §54:49-13a. However, in this case, neither of these procedures was effectively utilized until the first three federal tax assessments, totalling almost $60,000, had been made. ¹⁵ Nonetheless, the majority relies merely on New Jersey's assessments on March 23, 1989 and August 30, 1989 as fulfilling the requirements for choateness. I am far less certain than the majority that some additional act that would provide public notice of the state tax lien is not required to render the lien summarily enforceable. ¹⁶

It is true, as the Division argues, that the Supreme Court stated in Vermont that the assessment under Vermont's statutory scheme "was given the force of a judgment." Vermont [64-2 USTC ¶9520 ], 377 U.S. at 359 (quoting Bull v. United States [35-1 USTC ¶9346 ], 295 U.S. 247, 260 (1935)). But the State of Vermont in that case had not only assessed taxes; it also had filed a notice of lien with the city clerk before the federal taxes were assessed. See United States v. Vermont [63-1 USTC ¶9472 ], 317 F.2d 446, 447 (2d Cir. 1963), aff'd [64-2 USTC ¶9520 ], 377 U.S. 351 (1964). The Court's holding that Vermont's tax lien was entitled to priority over the subsequent federal tax lien may therefore have reflected an unspoken premise that the public recording of the lien was an element of choateness, either as a matter of federal law or under Vermont's particular statutory scheme.

Whether there is such a requirement has not been addressed by the Supreme Court, ¹⁷ and the few federal district and appellate courts that have broached the question have reached different results. Compare In re Thriftway Auto Rental Corp. [72-1 USTC ¶9311 ], 457 F.2d 409, 412 & 414, n.8 (2d Cir. 1972) (applying state court decisions holding city tax lien to arise, not upon assessment, but upon docketing of warrant, and holding city tax lien that arose upon docketing to be "summarily enforceable" under Vermont) with Noriega & Alexander v. United States, 859 F. Supp. 406 (E.D. Cal. 1994) (holding that state tax lien under California statutory scheme becomes choate upon assessment and rejecting argument that it does not become choate until notice of tax lien filed). Nonetheless, I do not understand the IRS to so argue in this case and thus leave that issue for another day. ¹⁸

I also cannot agree with another aspect of the majority's analysis. I agree that under the facts of this case the tax lien based on the Division's March 23, 1989 assessment met the third requirement of Vermont that "the amount of the lien [be] established" before the federal assessment. Vermont [64-2 USTC ¶9520 ], 377 U.S. at 355 (quoting United States v. New Britain [54-1 USTC ¶9191 ], 347 U.S. 81, 84 (1954)). By then, the time for protest and appeal of that assessment under New Jersey law had passed. I would not decide, as does the majority, that the requirement that "the amount of the lien [be] established" was met under the New Jersey statutory scheme while the amounts assessed were still subject to protest and appeal under N.J. Stat. Ann. §§54:49-18 and 54:51A-13 et seq. We need not include that dictum here, and I believe it is questionable whether the requirement of choateness that the amount of the lien have been established is met as long as the period for appeal and protest has not passed.

Nonetheless, given the IRS's waiver of the public recording issue I agree with the majority's result. ¹⁹ Because the Division's lien for $76,554.19 in taxes assessed on March 23, 1989 became definite in amount as of the expiration of the ninety day appeal period, which preceded the first federal tax assessment on September 18, 1989 and exceeded the amount of the approximately $60,000 in escrowed bulk sale proceeds, I would hold in this case that the Division's lien was entitled to priority as of that time. ²⁰

¹⁵ Three federal tax assessments totalling almost $60,000 were made against Monica Fuel on September 18 and 25, 1989 and December 4, 1989. Thereafter, (1) the Division issued a Certificate of Debt to the clerk of the New Jersey Superior Court on February 5, 1990, and the clerk entered judgment on the record of docketed judgments on February 14, 1990, and (2) the Division issued a warrant of execution to one of its employees on February 23, 1990, which was filed with the Camden County Clerk on the same day.

¹⁶ The Division suggests that any requirement of public recording of state tax liens would impose a "double standard" in determining the choateness of federal and state tax liens. I recognize that a federal tax lien need not be publicly recorded in order to become choate. See 26 U.S.C. §§6321 -22; United States v. McDermott [93-1 USTC ¶50,164 ], 113 S. Ct. 1526, 1531 (1993). Whether public recording is required to render a state lien choate is a matter of federal law to be resolved with reference, in the first instance, to the particular state scheme. See United States v. Security Trust & Sav. Bank [50-2 USTC ¶9492 ], 340 U.S. 47, 49-50 (1950). The Division cites us to no New Jersey appellate case holding that mere assessment, absent more, renders the state tax lien summarily enforceable.

¹⁷ The Supreme Court's decision in United States v. New Britain [54-1 USTC ¶9191 ], 347 U.S. 81 (1954), does not reveal whether the state tax liens at issue in that case had been publicly recorded. Even if there was no recording in that case, the state scheme at issue may have differed significantly from the scheme at issue in this case, where some form of public recording is apparently required before the state may enforce its lien.

¹⁸ At oral argument, the IRS counsel, in response to a direct question, stated that he was not arguing that its lien was entitled to priority on the basis of the lack of any public recording in this case. See Transcript of Oral Argument, Jan. 24, 1995, at 24.

¹⁹ I agree with the majority's holding that neither federal nor New Jersey law requires a state taxing authority actually to levy on a taxpayer's property in order to have a choate lien.

²⁰ Contrary to the IRS's argument, Brief for Appellee at 25-26, such a holding would be consistent with In re Priest, 712 F.2d 1327, 1329 (9th Cir. 1983), modified [83-2 USTC ¶9530 ], 725 F.2d 477 (9th Cir. 1984), which held that a tax lien was not choate upon the taxing authority's mere receipt of a delinquent tax return, in part because the state had taken no action to determine the amount owed by the taxpayer and "the total amount of the lien could not be known until the Director computed the interest, penalties and fees." Here, the Division's computation of tax, interest and penalties was communicated to the taxpayer in the Division's March 23, 1989 assessment, and the amounts became fixed at the expiration of the appeal period. For the same reason, such a holding would also be consistent with Brown v. State of Maryland [87-2 USTC ¶9639 ], 699 F. Supp. 1149, 1154 (D. Md. 1987), aff'd, 862 F.2d 869, 870 (4th Cir. 1988), also relied upon by the IRS.

 

 

[94-2 USTC ¶50,519] Paul Revere Life Insurance Company, Plaintiff v. Thomas E. Brock, Jr., and Marino V. Moleres, Padre (92-4227), United States of America (92-4228), Defendants-Appellants; Newark Orthopedics, Inc., Henry D. Rocco, E. Padro, M.D., Inc., Efrain Padro, Emergency Professional Group, Inc., Necdet K. Orhon, Metin Ercan, TriState Orthopedics, Inc., James W. Valuska, Fort Steuben Orthamologist, Inc., Ronald C. Agresta, Jose L. Pinelli, M.D., Inc., Jose L. Pinelli, Paul N. Mastros, M.D., Inc., Paul N. Mastros, Constantine V. Katsaros, Agresta Clinic, Inc., Sara Agresta Risovich, on behalf of decedent Joseph Agresta, Intervenors-Appellees; Lola V. Brock, Defendant

(CA-6), U.S. Court of Appeals, 6th Circuit, 92-4227/4228, 6/24/94, Reversing and remanding an unreported District Court decision

[Code Secs. 6321 , 6601 and 6665 ]

Insurance companies: Interpleader: Tax liens: Priority: Interest.--Interest accruing from the date tax liens were filed enjoyed the same priority in interpleaded funds as the priority of the perfected tax liens themselves. Since interest is to be collected in the same manner as taxes and tax liens include all interest due from the date a tax payment is due until the date the payment is made, it was proper for the interest owed and the tax liens to have the same priority status. As the perfected tax liens had first priority, interest on the taxes owed also had first priority.

David W. Alexander, Squire, Sanders & Dempsey, 41 S. High St., Columbus, Ohio 43215, for plaintiff. Ronald B. Noga, Ball, Noga & Tanoury, 50 W. Broad St., Columbus, Ohio 43215, for defendants-appellants. Alan Berliner, Carlile, Patchen & Murphy, 366 E. Broad St., Columbus, Ohio 43215, for intervenors-appellees. Jonathan S. Cohen, Department of Justice, 10th & Constitution Ave., Washington, D.C. 20044, for defendant.

Before MARTIN and JONES, Circuit Judges; and DEMASCIO, Senior District Judge. ^*

NATHANIEL R. JONES, Circuit Judge:

This is an interpleader action brought by Plaintiff Paul Revere Life Insurance Company to resolve competing claims to proceeds due under the terms of Defendant Thomas E. Brock's disability insurance policy. Plaintiff deposited the proceeds of this policy with the district court. As of October 14, 1992, the amount in the fund was $120,500.

In 1990, the district court determined the order of priority of the claims of the various defendants. In 1991, a panel of this court affirmed the order of priority, but reversed on other grounds. On remand in 1992, the district court held, inter alia, that although the United States was entitled to first priority in the amount of tax liens it had perfected against Brock, it was not entitled to any priority in the interest due on these tax liens; it would have to pursue Brock directly in order to collect this interest. We reverse the district court with regard to the interest due to the United States, and we remand for further proceedings.

Facts

Defendant United States of America filed tax liens relating to Brock's "tax return preparer's penalty liability" on April 15, 1983. The pre-interest balance due to the United States is $11,001.22. In the present appeal, all parties agree that the United States has first priority to the interpleaded funds, at least to the extent of this pre-interest balance.

Most of the other defendants are former clients of Brock who, in 1982, sued Brock for fraud in an Ohio court of common pleas. On March 23, 1983, the state court certified these former clients as a class under Rule 23 of the Ohio Rules of Civil Procedure. On May 20, 1983, individual class members won a default judgment against Brock for $350,538.55, pursuant to Ohio Civil Rule 37, as a sanction for Brock's failure to comply with discovery orders. Newark Orthopedics, Inc. v. Brock, No. 82CV-07-4282 (Franklin County, Ohio, Court of Common Pleas May 20, 1983).

On March 5, 1986, Brock assigned his entire interest in the insurance proceeds presently at issue to Defendant Padre Marino V. Moleres. A few months later, the plaintiff insurance company filed its Complaint for Interpleader.

In 1988, the United States and Newark jointly moved for summary judgment, arguing that the United States had first priority to the fund, and that the state court class members shared second priority. Brock and Moleres filed a cross-motion for summary judgment, arguing that Moleres had first priority. In 1990, the district court granted summary judgment in favor of the United States and Newark, and against Brock and Moleres, holding that the United States had first priority to $11,001.22 of the funds, and that Newark, representing the class of former clients who became judgment creditors of Brock in the state court suit, had second priority to the rest of the funds. Brock and Moleres appealed.

In 1991, a panel of this court affirmed as to most of the issues, but held that the court below erred by failing to determine whether Newark met the requirements for class certification under Rule 23 of the Federal Rules of Civil Procedure. Paul Revere Life Ins. Co. v. Brock, 1991 WL 59941 at *1 (6th Cir. April 19, 1991). An implication of this holding was that the other state court class members were not yet parties to the federal suit. The panel suggested that joinder may be an option, rather than class certification, because there were so few members of the class. Id.

Meanwhile, in February 1991, while the appeal was pending, Newark asked the district court to distribute $11,001.22 plus post-judgment interest to the United States, and the rest of the fund to Newark. The United States opposed this motion, arguing that it was entitled to interest dating all the way back to April 15, 1983.

On remand, the former class members, (except for Newark and Henry Rocco, who were already defendants), opted to proceed individually rather than as a class, and moved to intervene. The district court granted their motion. Shortly thereafter, the intervenors moved for summary judgment. Brock and Moleres opposed the motion on the basis of new defenses not raised in their 1990 cross-motion for summary judgment nor in their 1991 appeal to the Sixth Circuit.

In its Opinion and Order filed on September 8, 1992, the court resolved both Newark's Motion for Distribution of Funds and the Intervenor's Motion for Summary Judgment. As to the former, the court held, on equitable grounds, that the United States was entitled to first priority only with regard to the amount of its tax liens, and not with regard to interest going back to 1983. As to the latter motion, the court rejected Brock's and Moleres's new defenses both for their untimeliness and on their merits. Therefore, it granted summary judgment in favor of the Intervenors. This appeal followed.

Meanwhile, in March 1993, Brock filed, in the Franklin County, Ohio, Court of Common Pleas, a motion for relief from the default judgment of May 20, 1983. The trial court overruled the motion, but, in January 1994, the Ohio Court of Appeals for Franklin County reversed, holding that the default judgment appeared to be void, and, if it is not actually void, it is at least voidable. Newark Orthopedics, Inc. v. Brock, -- N.E.2d --, 1994 WL 180323 at *5-6 (Ohio App. Jan. 25, 1994). The matter was remanded back to the common pleas court for further proceedings.

Standard of Review

The facts are not in dispute. All of the questions before this court are either questions of law, mixed questions of law and fact, or questions of statutory interpretation. We review each of these de novo. See, e.g., Waxman v. Luna, 881 F.2d 237, 240 (6th Cir. 1989) ("Conclusions of law are . . . subject to de novo review."); Cordrey v. Euckert, 917 F.2d 1460, 1465 (6th Cir. 1990), cert. denied, 111 S. Ct. 1391 (1991) (holding that, where issue is question of law or mixed law and fact, it is "subject to de novo review"); United States v. Brown, 915 F.2d 219, 223 (6th Cir. 1990) ("A district court engages in statutory construction as a matter of law, and we review its conclusions de novo.").

Discussion

A. The Interest Due on the United States' Tax Liens

The United States contends that the district court erred in holding that the government's priority tax claims did not include the full amount of interest that accrued after the filing of its tax liens. We agree. The United States correctly argues that, under I.R.C. §6321 , its tax lien against Brock includes all interest due, and under I.R.C. §6601(a) , the interest on underpaid taxes accrues from the date payment was due until the date payment is made. Furthermore, under I.R.C. §6665(a) , additions to taxes such as penalties and interest are to be collected in the same manner as taxes. From these statutes, it follows that whatever priority the government enjoys with regard to tax liens, the government enjoys the same priority with regard to interest on those liens. Because it is uncontested that the United States has first priority with regard to the insurance proceeds at issue, this priority must include interest accruing from the date the tax liens were filed, April 15, 1983.

The district court acknowledged this argument, but it refused, as a matter of equity, to find for the United States on this issue. Rather, the district court expressly adopted the reasoning of Washington Irrigation & Development Co. v. United States, 110 Wash. 2d 288, 751 P.2d 1178 (1988).

Like the present case, Washington Irrigation involved an interpleaded fund to which the United States had first priority by virtue of tax liens, and to which a private creditor had second priority. 751 P.2d at 1180. The issue before the court was whether the United States could collect the interest due on the tax liens from the interpleaded fund. Id. The court acknowledged that "seemingly straightforward" Internal Revenue Code sections provided that the United States enjoys the same priority with regard to interest due on tax liens as it enjoys with regard to the underlying amount of the liens. Id. at 1181. However, the court found that it would be inequitable to apply the statutes under the circumstances: "In this case, to allow the IRS to recover from the interpleaded funds statutory interest accruing during the pendency of this litigation would substantially prejudice [the private creditor]. The IRS's interest apparently would eat up most, if not all, of the interpleaded funds." Id. The court noted that, due to an intervening bankruptcy petition, the private creditor had no way to collect its money except from the interpleaded fund, whereas the United States could collect its interest directly from the debtor. Id. The court held, then, that as a matter of equity, when interpleaded funds are in the custody of the court, interest is not charged against the party owing a debt. Id. at 1181-82.

This rule--that interest is not charged against a debtor for funds that are in a court's custody--is well-established in bankruptcy and insolvency proceedings, and is codified within the bankruptcy statute. See City of New York v. Saper, 336 U.S. 328, 330-31 (1949). In deciding to extend this rule to interpleader actions, the Washington Irrigation court expressly rejected the reasoning of Zontelli & Sons, Inc. v. Fabyanske, Svoboda & Westra, P.A., 394 N.W.2d 526 (Minn. Ct. App. 1986). 751 P.2d at 1181. Zontelli, like Washington Irrigation and the present case, also involved an interpleaded fund subject to competing claims from the United States and other creditors. The Zontelli trial court held that the IRS was not entitled to interest from the fund as a matter of equity--to hold otherwise would not be fair to the other creditors. The appellate court reversed, holding that, although the equitable principle outlined above is applicable to bankruptcy proceedings, it is not applicable to an interpleader action. "The IRS' right to receive interest and penalties is defined and established by statute. A court of equity cannot disregard explicit and controlling statutory provisions." Zontelli, 394 N.W.2d at 530 (citing In re Fulghum Constr. Corp., 706 F.2d 171, 173 (6th Cir. 1983)). Washington Irrigation, on the other hand, held that the Internal Revenue Code was not "sufficiently explicit to override the equitable rule set out above preventing the accrual of interest during this interpleader action." 751 P.2d at 1182.

We believe that Washington Irrigation was wrongly decided as a matter of law. We find that the relevant Internal Revenue Code sections are straightforward and clear; the import of these provisions is unmistakable--even Washington Irrigation described them as providing a "seemingly straightforward statutory priority." 751 P.2d at 1181. The equitable rule upon which Washington Irrigation relied--that interest is not charged against a debtor for funds that are in a court's custody--cannot override these "explicit and controlling statutory provisions." Zontelli, 394 N.W.2d at 530. See In re Fulghum Constr. Co., 706 F.2d 171, 173 (6th Cir. 1983) (stressing that judicially-created equitable considerations must yield to explicit, controlling statutory provisions); Johnson v. United States [79-2 USTC ¶9577 ], 602 F.2d 734, 738-39 (6th Cir. 1979) (same). Thus, the district court erred by adopting the Washington Irrigation court's reasoning.

B. Brock's and Moleres's New Defense

Brock and Moleres appeal the district court's rejection of their new defenses raised for the first time in 1990. In light of recent developments in the Franklin County, Ohio, Court of Appeals, see Newark Orthopedics, -- N.E.2d --, 1994 WL 180323 (Ohio App. Jan. 25, 1994), we decline to reach this issue at present. The new defenses are relevant only to the intervenors' claim against the interpleaded fund, and this claim stems solely from the default judgment of May 20, 1983, which the state appellate court found to be "voidable if not void." Id. at *6. If and when state court proceedings determine that the default judgment is void, the intervenors will no longer have any claim against the interpleaded fund, and Brock's and Moleres's new defenses will become moot. Therefore, we remand the issue to the district court with instructions to postpone disbursement, either to the intervenors or to Moleres, of the portion of the interpleaded fund not allocable to the United States , until the state court determines the status of the intervenors' default judgment. If it turns out that the default judgment survives Brock's and Moleres's Rule 60(B) motion, Brock and Moleres have leave to re-appeal the district court's rejection of their new defenses at that time.

Conclusion

For the foregoing reasons, we reverse the district court's holding regarding the United States ' recovery of interest on its tax liens. We remand this case to the district court for the disbursement of the interpleaded funds in accordance with this opinion.

^* The Honorable Robert E. DeMascio, Senior United States District Judge for the Eastern District of Michigan, sitting by designation.