Assignment of Funds Page 1

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[99-1 USTC ¶50,577] United States of America , Plaintiff v. Talco Contractors, Inc., et al., Defendants

U.S. District Court, West. Dist. N.Y., 93-CV-6389T, 5/7/99

[Code Secs. 6321 , 6323 and 7403 ]

Liens for taxes: Interpleaded funds: Priority: Claims: Perfection of.--Federal tax liens filed on condemnation proceeds owed to a delinquent taxpayer by a state (New York) had priority over the claim of a bank's successor-in-interest to the interpleaded funds. The record established that the bank and the taxpayer intended that the assignment be for collateral/security purposes; the parties' agreement did not constitute an outright assignment of the proceeds. As a result, the successor's position was confined to the original assignment and could not be expanded because the bank failed to perfect its security position. Since the successor merely held an unperfected security interest, the government gained priority by filing valid tax liens against the condemnation proceeds.

DECISION and ORDER

INTRODUCTION

TELESCA, District Judge:

Plaintiff, the United States of America ("United States" or "the government"), moves this Court for an Order directing Payment from the Court's Registry of certain proceeds deposited by the State of New York in satisfaction of the government's lien. Kendamar Corporation ("Kendamar") objects to entry of such an order, arguing that it is entitled to payment of the funds at issue in preference to the government's lien. For the reasons discussed herein, the United States ' motion for payment is granted.

BACKGROUND

A tax dispute between the government and defendant Talco Contractors, Inc. ("Talco") was settled in February of 1997. As part of a "Stipulated Judgment," this Court retained jurisdiction to enforce the terms of the Settlement Agreement ("the Agreement"). The Agreement contemplated the receipt and distribution of funds from a Court of Claims condemnation suit brought by Talco against the State of New York . The Agreement provided, in pertinent part, that Talco would pay the United States the first $400,000 of the proceeds (plus 8% interest), and an additional 50% of any damages recovery after payment of reasonable attorneys' fees and litigation expenses.

In September of 1998, Talco advised this Court that the New York condemnation suit trial had been resolved and that the State of New York had agreed to settle the case for $850,000. Talco further indicated that the total amount of attorneys' fees and litigation expenses amounted to $330,518.24, leaving a balance of $519,481.76.

However, the State of New York insisted upon the release of three recorded liens before it would pay the settlement proceeds to the Court Registry, specifically: (1) an assignment of proceeds initially given by Talco to Chase Manhattan Bank which was ultimately assigned to Kendamar Corp. in the amount of $124,000; (2) a claim filed by Caledonia Lumber; and (3) a tax lien filed by the United States Internal Revenue Service (related to the instant case).

The attorneys for the United States and the defendants both requested that this Court enter an Order to Show Cause why the settlement proceeds should not be released by the State of New York to the Registry of this Court and that all interested parties show cause why the proceeds should not be distributed in accordance with the terms of the Agreement.

By Order dated September 15, 1998 , this Court directed the State of New York to issue a check in the amount of $850,000 to the Registry of the court and ordered that the State would be discharged from all liability with respect to the various claims upon payment of the condemnation proceeds. This Court further ordered that the Registry of the Court pay out of said proceeds the following sums: (1) $320,618.24 to Redmond & Parrinello, LLP; (2) $400,000 to the United States of America; (3) $40,690.88 to James S. Grossman, Esq. The remainder of the proceeds, $88,690.88, were to remain in the Registry of the Court pending further Order of the Court.

The United States of America now moves for an Order of Payment from the Court's Registry the balance of the condemnation proceeds, plus any interest accrued thereon. [The only two remaining claimants to the proceeds are the United States and Kendamar.] Although Kendamar has not formally responded to the United States' current motion, its attorney, in a letter to Court, indicated that Kendamar objected to any distribution to the United States, and incorporating by reference Kendamar's response to the August 7, 1998 Order to Show Cause.

DISCUSSION

The government argues that its tax liens have priority over Kendamar's unperfected security interest. In support of its position, the government argues that Talco's assignment to Chase was a collateral assignment made for purposes of providing Chase with a security interest, not an outright assignment of proceeds, and, as such, it was subject to the requirements of U.C.C. Article 9. Because Chase did not file the appropriate financing statement with the Department of State and the County of Monroe , the U.S. argues that Kendamar, as successor in interest to Chase, holds only an unperfected security interest. Thus, since the government filed its notices of federal tax lien in 1993, it asserts that its interest in the remaining proceeds is superior to Kendamar's.

Kendamar argues that the original assignment by Talco to Chase was not only a collateral assignment, but also an outright assignment of proceeds and, accordingly, is not subject to the filing requirements of Article 9.

The Agreement between Talco and Chase provides that "[f]or value received, . . . Talco . . . hereby grants a security interest in and assigns, transfers and sets over unto Chase . . . all of Assignor's right, title and interest in a certain claim of the Assignor . . . and all proceeds of the foregoing." (Emphasis mine.) Although the Agreement appears to refer to both a security interest and an outright assignment, other provisions of the Agreement reflect that this was intended by the parties to be an assignment for collateral purposes. The sixth paragraph of the Agreement provides that "[t]his Assignment is made by Assignor as collateral and security for any and all liabilities of Assignor to Bank . . ." Additionally, the last paragraph on page 1 provides that "[i]f the Condemnation Claim exceeds the Liabilities, Bank will refund the difference to the Assignor." Talco also granted Chase the right to file UCC financing statements without Talco's signature with regard to the Condemnation Claim, which Chase failed to do.

Finally, Chase's Vice President and Senior Counsel, John C. Hart, in letter dated November 12, 1991 to the New York State Comptroller, indicated that "[a]s collateral security of all its obligations to Chase, Talco has assigned all of its right, title and interest in [the Condemnation Claim]." Mr. Hart also stated that "it is my understanding that The Office of the New York State Comptroller is the appropriate venue for filing of the Assignment with the State," citing In re Astoria Blvd., 171 Misc. 1018 (Sup. Ct. Queens County, 1939). ¹

Thus, although the Agreement between Chase and Talco might appear to be ambiguous, it is clear that the parties' intent was that the assignment of the condemnation claim proceeds was for collateral/security purposes and not an outright assignment. Kendamar's position as an assignee of Chase's claim is confined to the original assignment and cannot be expanded because Chase failed to perfect its security position.

The collateral assignment between Talco and Chase was subject to the filing requirements of U.C.C. Article 9 as a general intangible. See N.Y.U.C.C. §9-106 [Defining "general intangible" as "personal property, including things in action"]; §9-401(1)(c) [Setting forth filing requirements for perfection of security interest in general intangibles]. Because Chase did not properly perfect its security interest, the United States gained priority by filing valid tax liens on the condemnation proceeds in 1993. See N.Y.U.C.C. §9-301(1)(b) [Priority of lien creditor over unperfected security interest]. Thus, the United States ' claim has priority over the claim of Kendamar, a successor-in-interest to Chase.

Accordingly, the United States ' motion for an Order of Payment is granted. The Clerk of the Court is hereby directed to forthwith pay over the remaining proceeds held in the Registry of the Court in this action, plus any interest which has accrued thereon, to the United States .

ALL OF THE ABOVE IS SO ORDERED.

¹ I note that the case cited by Mr. Hart, In re Astoria Blvd., is a pre-U.C.C. case. New York adopted the Uniform Commercial Code on April 18, 1962 . See N.Y. Session Laws 1962, Chapter 533.

 

 

[99-1 USTC ¶50,264] Edna Kathleen Terry, as Trustee, etc., Plaintiff v. United States of America , Defendant-Appellant, Professional Technical Representatives Money Purchase Plan, Defendant-Respondent

U.S. Court of Appeal of the State of Calif. , 2nd Appellate Dist., Div. One, B117644, B119401, 1/21/99 , Affirming an unreported SuperCt. of Calif. decision

[Code Secs. 6321 and 6323 ]

Tax liens: Priority against third parties: Attachment of: After-acquired property: Trust assets: Beneficial interest: Personal v. real property interests: Equitable conversion: When conversion occurs.--A lender's security interest in a delinquent taxpayer's residual interest in trust property was accorded priority over earlier IRS tax liens. Under state ( California ) law, the tax liens, which were filed in the county where the taxpayer resided, attached only to his personal property and to any real property located in that county. Although the trust's remaining asset was real property, the IRS did not file its liens in the county where the property was located. The taxpayer's interest in the trust was equitably converted to a personal property interest, however, since the trust had to sell the real estate to distribute the residue to the beneficiaries. However, such conversion did not occur until the closing date of the property's sale. As a result, the tax lien did not attach to the taxpayer's interest until after it was assigned to the lender.

Nora M. Manella, United States Attorney, Loretta C. Argrett, Assistant Attorney General, Edward M. Rob bins, Jr., Thomas D. Coker, Randolph L. Hutter, for defendant-appellant. W. Montgomery Jones, Jones and Jones, for defendant-respondent.

è Caution: This court has designated this opinion as NOT FOR PUBLICATION. Consult the Rules of the Court before citing this case.ç

ORTEGA, Acting P.J.: In June 1990, Nellie Whitaker Beasley created a revocable trust into which she transferred both her real and personal property. Beasley, the trust's sole income beneficiary during her lifetime, used the trust as a will substitute to pass her assets to her beneficiaries upon her death, when the trust was to terminate. Beasley died on January 27, 1994. This appeal concerns two competing claims to the interest of Beasley's grandnephew, Marvin Stone, a residual beneficiary of 30 percent of the trust residue. The two claimants are the United States of America (on behalf of the Internal Revenue Service), ¹ which had assessed $2.8 million in tax liens against Stone for delinquent federal taxes, penalties, and interest, and Professional Technical Representatives Money Purchase Plan (Plan), to whom Stone had assigned his interest in the trust residue as additional security for a loan.

For the reasons that follow, we affirm the trial court order awarding Stone's remaining residual interest of $83,985.72 to the Plan. We direct the Los Angeles County Treasurer, who is holding Stone's interpleaded share of the residue, to transfer the funds to the Plan.

BACKGROUND

Before Beasley's death, a conservatorship was established over Beasley and her estate. (Conservatorship of the Person and Estate of Nellie Whitaker Beasley (Super. Ct. L.A. County, 1991, No. BP000175).) The trust instrument was amended to require the trustee to obtain court approval before selling, distributing, or transferring any trust assets. Following Beasley's death, the court exercised its continuing jurisdiction and supervision over the trustee's disposition of the trust assets in accordance with Beasley's testamentary intent as expressed in the trust instrument.

When Beasley died, the trust had personal property valued at about $380,000 and real property in Los Angeles valued at about $400,000. ² On September 1, 1994 , the court entered an order confirming the sale of the trust's real property in Los Angeles . (The escrow on that sale did not close, however, until March 21, 1996.)

In December 1994, the trustee made an initial distribution to the residual beneficiaries, including Stone. Assets remaining to be distributed to the residual beneficiaries included the anticipated proceeds from the sale of the real property (which was in escrow) and about $100,000 in personal property.

Stone anticipated that following the close of escrow, he would receive a second distribution of about $90,000. On August 4, 1995 , Stone assigned to the Plan his interest in the remaining residue. ³ The assignment served as additional security for a $140,000 loan to third parties, John and Heather Bomarito. In return for his assignment, Stone received a portion of the Bomaritos' loan proceeds. With Stone's approval, the Plan's attorney instructed the trustee to send the attorney Stone's second distribution check.

Unbeknownst to the Plan, the IRS had assessed $2.8 million in tax liens against Stone. In 1993 and 1994, the IRS had filed notices of federal tax lien in Monterey County , where Stone resides. ⁴ The bulk of the tax liens were filed before Beasley's death and well before Stone assigned his interest to the Plan in August 1995. In 1996, the IRS served the trustee with a notice of levy against Stone's interest in the trust. ⁵

Escrow closed on the real property sale on March 21, 1996 . After receiving the proceeds from that sale, the trustee filed a final report asking the court to approve her final distributions to the residual beneficiaries, except for Stone. Faced with the two competing claims to Stone's interest, the trustee interpleaded Stone's share of $83,985.72 by depositing that sum with the Los Angeles County Treasurer.

The IRS (through the United States of America ) petitioned for an order establishing its right to the interpleaded funds. (In re The Nellie W. Beasley Revocable Trust (Super. Ct. L.A. County, 1997, BP014805).) The IRS contended it was entitled to priority over the Plan, having recorded its tax liens in 1993 and 1994, well before the Plan received Stone's assignment as additional security for the loan. The Plan, on the other hand, contended the notices of lien were recorded in the wrong county with regard to the trust's real property in Los Angeles . The Plan asserted the notices of lien filed in Monterey County did not establish the IRS' priority as to Stone's interest in the Los Angeles property.

The trial court ruled in favor of the Plan. It concluded that the notices of tax lien filed in Monterey County were "of no force and effect inasmuch as the Claimant, UNITED STATES OF AMERICA, failed to record the lien in the County of Los Angeles, where the principal assets were located, pursuant to the provisions of 26 U.S.C. Section 6323(f)." The trial court awarded the Plan all of the deposited funds. This appeal followed.

CONTENTIONS ON APPEAL

(I) The IRS contends its notices of tax lien attached to Stone's interest in the trust's real property before the Plan's security interest arose. The IRS asserts it is thus entitled to the whole of the interpleaded funds.

(II) Alternatively, the IRS contends its notices of tax lien attached to Stone's interest in the trust's personal property before the Plan's security interest arose. The IRS asserts it is thus entitled to a portion of the interpleaded funds.

DISCUSSION

I

Stone resided in Monterey County , but the trust's real property was located in Los Angeles County . As a general rule, filing the notice of tax lien in Monterey County would have had no effect with regard to the trust's property in Los Angeles County . Both parties agree that, as a general rule in California , a tax lien notice recorded in one county has no effect with regard to real property located in another county. The IRS states in its opening brief. "Under I[nternal ]R[evenue ]C[ode] section 6323(f) and applicable California law, the liens must be filed with the office of the recorder for the county in which the real property is located (where the [trust] assets involved are real property) or in which the Trust beneficiary resides (where the [trust] assets involved are personal property)."

The IRS contends, however, that under the doctrine of equitable conversion, Stone's interest in the trust's real property was converted, upon entry of the order confirming sale, from a real property interest to a personal property interest. Under the IRS' theory, the tax liens attached to Stone's personal property interest in the Los Angeles property as of the date of the order confirming sale.

We will first ascertain the nature of Stone's interest in the trust assets on the date of Beasley's death. We begin by noting that in federal tax lien cases, " 'Property' is a concept which draws its definition from state, not federal, law. Aquilino v. United States [60-2 USTC ¶9538], 363 U.S. 509, 512-13 . . . (1960)." (Cavanaugh v. Cavanaugh (B.R. Ct., N.D. Ill., E.D. 1993) 153 B.R. 224, 228.) Accordingly, we took to California law to determine the nature of Stone's property interest in the trust assets.

Under California law, when Beasley transferred her real property to the revocable trust, she transferred legal title to the trustee. Beasley still retained, however, her beneficial ownership of the real property as sole beneficiary of the trust during her lifetime. This conclusion is consistent with California real property tax law. When Beasley transferred her real property to the revocable trust, that transfer did not constitute a change of ownership to trigger a reassessment because the rights conferred to the residual beneficiaries were entirely contingent during Beasley's lifetime. " 'If the trust is revocable it is excluded [from reassessment] because the rights conferred are contingent. If the trustor is the sole beneficiary during his lifetime, his retained interest is considered to be "substantially equivalent in value" to the fee interest in any real property covered by the trust. He is therefore the true owner and the change in ownership does not occur until the property passes to the remaindermen on the trustor's death.' " (Empire Properties v. County of Los Angeles (1996) 44 Cal.App.4th 781, 788, quoting January 1979 Report of the Task Force on Property Tax Administration commissioned by the Legislature after passage of Proposition 13.)

When Beasley died on January 27, 1994 , the revocable trust became irrevocable and was terminated under the express provisions of the trust instrument. (Empire Properties v. County of Los Angeles, supra, 44 Cal.App.4th at pp. 786-787.) At that time, Stone acquired a present beneficial interest in the trust's residual assets, including the trust's real property. The question we face is whether Stone's beneficial interest in the trust's real property is properly classified as a personal or a real property interest.

Ordinarily, because the asset at issue is real property, Stone's beneficial interest would be classified under California law as a real property interest. The IRS contends that upon entry of the order confirming sale, however, Stone's beneficial interest in the real property was equitably converted into a personal property interest. Under the doctrine of equitable conversion, "Where real property is conveyed to a trustee with directions to sell in any event it will be treated in equity as personal property. But where the property in kind is, or may be, conveyed to the beneficiary no such equitable conversion results." (Lynch v. Cunningham (1933) 131 Cal.App. 164, 173.)

Although the trustee theoretically possessed discretion either to sell the real property or convey it in kind, Beasley's gifts to the residual beneficiaries were not so large as to afford the trustee the option of giving any single beneficiary the real property in whole. Stone, with a 30-percent share of the residuary, received the largest gift of all. By the time the real property was in escrow, Stone knew he was to receive only an additional $90.000, less than half the value of the Los Angeles property. When Stone assigned his interest in the trust's remaining assets, both he and the lender knew the real property was going to be sold and Stone was to receive only a portion of the sale proceeds.

We agree with the IRS that the trustee, by entering into a contract for sale and obtaining an order confirming sale, had legally bound the trust to sell the property. "[W]hen a binding agreement of sale is entered into by the parties, an equitable conversion is worked; the purchaser becomes the equitable owner of the land and the seller the owner of the purchase price." (Vigli v. Davis (1947) 79 Cal.App.2d 237, 254; Lynch v. Cunningham, supra, 131 Cal.App. at p. 173.)

That is not to say, however, that the conversion occurred upon the date of the order confirming sale. Prior decisions have held that the conversion occurs on the closing date, whether or not the sale takes place. " 'The rule of equitable conversion merely amounts to this, that where there is a mandate to sell at a future time, equity, upon the principle of regarding that done which ought to be done, will for certain purposes and in aid of justice consider the conversion as effected at the time when the sale ought to take place, whether the land be then really sold or not.' " (Vigli v. Davis, supra, 79 Cal.App.2d at p. 255.)

The IRS would have us advance the date of sale in this case to the date of the order confirming sale. We see no reason to depart from the existing rule. If a buyer defaults before the closing date, the court may vacate its order confirming sale and direct the trustee to find another buyer. Although a defaulting buyer would remain subject to liability for losses, including consequential damages, caused by the default (Prob. Code. §§10350, 10351), the buyer would not be obligated to purchase the property. We conclude, applying the usual rule, that the IRS' preexisting tax liens immediately attached to Stone's personal property interest upon the date escrow closed, March 21, 1996 . ⁶

Before the IRS liens could attach, however, Stone had assigned his interest to the Plan on August 4, 1995 . Accordingly, the IRS' liens are not entitled to priority. "Under federal tax law, a contest between the federally created tax lien and a competing lien is resolved by the first-in-time, first-in-right rule. United States v. City of New Britain [54-1 USTC ¶9191], 347 U.S. 81, 85 . . . (1954)." (Cavanaugh v. Cavanaugh, supra, 153 B.R. at p. 228.) This priority rule applies "unless Congress has created a different priority rule to govern the particular situation." (Petro Source Partners, Ltd. v. 3-B Rattlesnake Refining (1990) Ltd., supra [93-1 USTC ¶70.029; 94-1 USTC ¶50,053], 827 F.Supp. at p. 1269.) There is no contention that a special priority applies here.

We hold that the federal tax liens are inferior to the Plan's previously acquired assignment of Stone's interest in August 1995. Accordingly, the trial court correctly awarded the interpleaded funds to the Plan.

II

The IRS alternatively contends that it "is entitled to an award of $55,010.65, or 65.5 percent, of the funds deposited with the Los Angeles County Treasurer. This is because at the time of Beasley's death $380,704.90, or 65.5 percent of the total Trust assets worth $580,996.57, consisted of cash, stocks, and bonds, i.e., personal property. This fact is reflected in the Trustee's Final Report--to which no party filed an objection and which the Superior Court approved--and nothing in the record contradicts it."

The trustee's final report, however, was not filed until July 31, 1996 , several months after the escrow on the sale of real property had closed on March 21, 1996 . The final report indicated that "a significant portion of the residue of the Trust was distributed to the residuary beneficiaries" pursuant to a court order entered on December 29, 1994 . That order and the resulting initial distribution were made while the real property transaction was still in escrow. Accordingly, the initial distribution could not have been made with proceeds traceable to the sale of the real property, and must necessarily have been made with personal property assets. It thus follows that the IRS' reliance upon the final report to show the ratio of real and personal property held by the trust at the time of Beasley's death is misplaced. Even assuming there was once a 65.5 to 34.5 percent ratio of real to personal property assets when Beasley died, that ratio no longer existed when the trustee's final report was filed, due to the initial distribution made by the trustee while the real property transaction was in escrow.

The IRS has failed to demonstrate that the trial court's award of the whole of the interpleaded funds to the Plan was erroneous. We rely on the familiar rule that, " 'A judgment or order of the lower court is presumed correct. All intendments and presumptions are indulged to support it on matters as to which the record is silent, and error must be affirmatively shown. . . .' [Citations.]" (Denham v. Superior Court (1970) 2 Cal.3d 557, 564.)

DISPOSITION

We affirm the order awarding the interpleaded funds to the Plan. We direct the county treasurer to release the funds accordingly. The Plan is entitled to costs on appeal.

We concur:

VOGEL (Miriam A.), J.

DUNN, J. ^*

¹ For the sake of convenience, all further references to the Internal Revenue Service (IRS) are meant to include the appellant United States .

² This initial $400,000 valuation was only an estimate by the trustee of the property's value. According to the trustee's final report, the $400,000 valuation was "arbitrarily placed on the property for purposes of this Trust by [the trustee], without benefit of any appraisal, at the time of the creation of this Trust in 1990." Ultimately, the property was sold in 1996 for about $200,000. The trustee's final report explained that the property value "declined substantially because of the effects of both the general real estate depression in Southern California as well as the civil unrest which occurred in the area of Los Angeles County in which the property was located." In her final report, the trustee reported a loss (for accounting purposes) on the sale of $199,708.33.

³ The trust instrument contained a spendthrift clause that prohibited the beneficiaries from selling, assigning, pledging, mortgaging, encumbering, alienating, or impairing all or any part of their interest in the trust or in the trust's principal or income. The Plan argued successfully below that the spendthrift clause was extinguished upon Beasley's death, when the trust terminated. The IRS does not challenge on appeal the trial court's ruling on this point. Accordingly, we will not address it.

⁴ When a federal tax liability is assessed, a lien automatically attaches as of the date of the assessment unless the liability is paid within the allotted time. (26 U.S.C. §6321.) When a notice of federal tax lien is filed, it gives "notice to the rest of the world that the IRS has a tax lien against the taxpayer." (Petro Source Partners, Ltd. v. 3-B Rattlesnake Refining (1990) Ltd. (W.D. Tex. 1993) [93-1 USTC ¶70,029; 94-1 USTC ¶50,053], 827 F.Supp. 1265, 1268.) The notice of tax lien does not affect the validity of the lien itself. It does, however, affect the priority of the lien as against the claim of a third party against the taxpayer's property. (Id. at pp. 1268-1269.)

⁵ The IRS does not, as a general rule, have to levy against the taxpayer's property in order to perfect its liens. In most cases a tax lien is perfected when the notice of federal tax lien is filed. (Petro Source Partners, Ltd. v. 3-B Rattlesnake Refining (1990) Ltd., supra [93-1 USTC ¶70,029; 94-1 USTC ¶50,053], 827 F.Supp. at p. 1269.)

⁶ When notices of tax lien are filed, they attach and " 'continue[to exist] until the taxpayer satisfies the debt, or the statute of limitations runs.' Texas Commerce Bank[- Fort Worth , N.A. v. United States (5th Cir. 1990)] [90-1 USTC ¶50,155], 896 F.2d[ 152.] 161; 26 U.S.C. §6322." (Petro Source Partners, Ltd. v. 3-B Rattlesnake Refining (1990) Ltd., supra [93-1 USTC ¶70,029; 94-1 USTC ¶50,053], 827 F.Supp. at p. 1268.)

^* Judge of the Municipal Court for the Long Beach Judicial District assigned by the Chief Justice pursuant to article VI, section 6 of the California Constitution.

 

 

[97-2 USTC ¶50,893] In re Randolph L. Bruder and Jill R. Bruder, Debtors. Joseph D. Olsen, Trustee, Plaintiff-Counter-Defendant-Appellee v. Bank One Rockford, NA, a banking corporation, f/k/a First National Bank & Trust Co., Defendant-Cross-Defendant-Appellant and Banc One Mortgage Corporation, Intervenor-Cross Defendant-Appellant and Randolph L. Bruder, Jill R. Bruder, Mott Bros. Co., a corporation, Defendants-Cross-Defendants-Appellees and United States of America, Defendant-Counter-Plaintiff-Cross-Claimant-Appellee

U.S. District Court, No. Dist. Ill. , West. Div., 94 B 52222, 95 B 51057, 96 C 50408, 4/10/97 , 207 BR 151. Affirming unreported Bankruptcy Court decision

[Code Sec. 6323 ]

Liens: Priority: Security interest.--An assignee bank's interest in mortgaged property did not take priority over an IRS tax lien because the bank's interest was not a protected security interest under state ( Illinois ) law. Assignment of the mortgage was outside the chain of title and, therefore, ineffective against creditors and subsequent purchasers. Further, satisfaction and discharge of the mortgage filed by the assignor bank released the mortgage; thus, the mortgage no longer existed. Since the assignee bank was no longer a secured creditor, the IRS's lien was superior.

[Code Sec. 6871 ]

Bankruptcy: Jurisdiction: Standing: Property rights involved.--A bank that assigned its mortgage on a debtor's property to another bank lacked standing to appeal the Bankruptcy Court's orders on motions for summary judgment because those orders did not diminish any property or rights of the bank. Since the bank had assigned its interest in the mortgage and a note, it had no claim in the property involved.

Joseph D. Olsen, David A. Aaby, Yalden & Olsen, 1318 E. State St., Rockford, Ill. 61104-2228, for plaintiff. Karl F. Winkler, Oliver, Close, Worden, Winkler, Greenwald & Maier, 124 N. Water St., Rockford, Ill. 61110-4749, Bernard J. Natale, 308 W. State St., Rockford, Ill. 61101, Thomas A. Green, Jason H. Rock, Barrick, Switzer, Long, Balsley & Van Evera, 1 Madison St., Rockford, Ill. 61104, for defendants. Joel R. Nathan, Special Assistant Attorney General, Chicago , Ill. , for U.S.

MEMORANDUM OPINION AND ORDER

INTRODUCTION

REINHARD, District Judge:

Appellants, Bank One, Rockford , NA ("Bank One"), and Banc One Mortgage Corporation ("Banc One Mortgage"), appeal the judgment of the bankruptcy court and its denial of their motion to reconsider entered in the adversary proceeding related to the Chapter 7 bankruptcy petitions filed by the debtors, Randolph L. Bruder and Jill R. Bruder. The court has jurisdiction to hear this appeal pursuant to 28 U.S.C. §158(a).

BACKGROUND

The facts relevant to this appeal are not in dispute and are as follows. The Bruders were joint tenant owners of property commonly known as 5815 Chandler Drive , Rockford , Illinois ("the property"). On or about July 12, 1991 , the Bruders borrowed $106,500.00 from First National Bank & Trust Co. ("First National"), a national bank operating in Rockford , Illinois . In addition to executing a note, the Bruders granted First National a mortgage in the property, which was recorded with the recorder of deeds of Winnebago County , Illinois , on June 12, 1991 .

Sometime in February 1993, First National changed its name to Bank One. Although First National's interest in the note and mortgage devolved and inured to Bank One upon the name-change, see 12 U.S.C. §31, no instrument of record was filed with the recorder of deeds in connection with the mortgage to reflect that Bank One was the successor to First National. On October 29, 1993 , Bank One assigned the mortgage and note to Banc One Mortgage. Significantly, the assignment did not mention Bank One's prior name or the fact that it was formerly known as First National. Thus, when the assignment was recorded with the recorder of deeds on November 12, 1993 , the grantor-grantee index merely reflected an assignment of the mortgage by an entity known as Bank One to Banc One Mortgage.

On March 11, 1994 , a satisfaction and discharge of mortgage was executed. The document, in pertinent part, stated:

The undersigned certifies that it is the present owner of a mortgage executed by RANDOLPH L. BRUDER AND JILL R. BRUDER to FIRST NATIONAL BANK & TRUST CO. . . . The above described mortgage is, with the note accompanying it, fully paid, satisfied, and discharged.

The document gave a full description of the property, cross-referenced the mortgage recorded earlier, and was executed by "FIRST NATIONAL BANK & TRUST CO. NKA BANK ONE, ROCKFORD, NA, by BANC ONE MORTGAGE CORPORATION, their attorney in fact." This document was recorded with the recorder of deeds on April 25, 1994 . The problem with the satisfaction and release was not that it was executed by one having no authority, as Bank One had previously granted a power of attorney in favor of Banc One Mortgage to execute documents of this sort. The problem was that the satisfaction and discharge should not have been issued because the note and mortgage were not, in fact, satisfied. The foregoing errors apparently went unnoticed by Bank One and Banc One Mortgage, as no corrective documents were filed.

On August 22, 1994 and September 19, 1994 , the IRS assessed Randolph Bruder for unpaid employment taxes for the third and fourth quarters of 1993 and the second quarter of 1994, respectively. On November 21, 1994 , the IRS recorded a notice of federal tax lien for those assessments against Randolph Bruder with the recorder of deeds in the sum of approximately $35,000. Thereafter, on December 1, 1994 , Randolph Bruder filed a voluntary petition for bankruptcy under Chapter 7 of the Bankruptcy Code.

On January 31, 1995 , Mott Bros. Co. ("Mott") filed a memorandum of judgment against Jill Bruder with the recorder of deeds for approximately $28,000. On May 23, 1995 , Jill Bruder filed a separate voluntary petition for bankruptcy under Chapter 7.

Joseph D. Olsen was appointed trustee in both bankruptcy cases. During the course of the bankruptcy proceedings, the trustee sought authority to sell the property free and clear of all liens. A title commitment issued prior to the sale of the property listed both the IRS's tax lien and Mott's judgment lien. The mortgage assigned to Banc One Mortgage, however, was not listed as a lien encumbering the property. Because the Bruders had listed Banc One Mortgage as holding a security interest in the property on the schedules attached to their bankruptcy petitions, the trustee and the Bruders notified the title insurance company that there may be another incumbrance on the property. Upon learning of Banc One Mortgage's potential interest in the property, the title insurance company insisted on a court order that required any and all liens to attach to the sale proceeds. On October 20, 1995 , the trustee filed an adversary complaint against the Bruders, Bank One, Mott and the IRS for an order permitting a sale of the property free and clear of all liens and to determine the priority of the various liens. Thereafter, Banc One Mortgage moved to intervene as a defendant. The trustee obtained approval from the bankruptcy court to sell the property for $122,000. The IRS, Mott, Bank One and the Bruders all answered the trustee's complaint, as did Banc One Mortgage once it intervened. The IRS then filed a counter-claim against the trustee and cross-claims against all defendants, asserting that its tax lien was senior in priority to all other liens.

After the trustee, the Bruders, Mott, Bank One and Banc One Mortgage answered the IRS's counter/cross-claims, the IRS and Banc One Mortgage each filed a motion for summary judgment in which the IRS and Banc One Mortgage ¹ each claimed their lien was senior in priority to all others. Mott did not oppose the IRS's motion, as its claim was only against Jill Bruder's interest in the property. Similarly, neither the trustee nor the Bruders disputed the priority of the IRS's and Mott's claims to the separate half interests of Randolph and Jill Bruder in the property. All parties (excluding Bank One and Banc One Mortgage) disputed the validity of Banc One Mortgage's claim that the mortgage was effective against any of them. Thus, in an unusual alignment of the parties, Banc One Mortgage stood alone in contending that its interest was both valid and senior in priority. The bankruptcy court denied Banc One Mortgage's motion and granted the IRS's motion. The bankruptcy court found that the assignment of the note and mortgage from Bank One to Banc One Mortgage filed with the recorder of deeds was not in the chain of title. This finding, in turn, rendered the satisfaction and release effective as to all judgment lien creditors, including the IRS and Mott. This relegated Bank One and Banc One Mortgage to the status of unsecured creditors in both of the Bruders' bankruptcy proceedings.

The bankruptcy court ordered distribution of the net proceeds of the sale of the property in the following manner. The net proceeds were ordered to be divided in half. As to the first half, the trustee was ordered to remit $42,019.52 to the IRS (the amount of its tax lien, at that time), then $7,500.00 to Randolph Bruder for his homestead exemption, and to retain any remaining proceeds, subject to further order of the court. As to the second half, the trustee was ordered to remit $7,500.00 to Jill Bruder for her homestead exemption, then $28,371.63 to Mott, and to retain any remaining proceeds, subject to further order of the court.

Bank One and Banc One Mortgage filed a motion to reconsider and clarify the bankruptcy court's memorandum opinion which denied Banc One Mortgage's motion and granted the IRS's motion. Bank One's sudden reappearance in the litigation was noted by both the bankruptcy court and the other parties, see Transcript of Proceedings of October 23, 1996 , pp. 4-5, 13, but the anomaly was not engaged by any of the parties or the court. For reasons stated on the record during the hearing of October 23, 1996 , the bankruptcy court denied Bank One's and Banc One Mortgage's motion to reconsider and clarify. This appeal ensued.

DISCUSSION

A party takes an appeal from the bankruptcy court to the district court pursuant to 28 U.S.C. §158(a) in the same manner a party in a civil proceeding takes an appeal from the district court to the court of appeals. 28 U.S.C. §158(c). The district court, therefore, reviews the factual findings of the bankruptcy court for clear error, but reviews legal conclusions de novo. In re Rivinius, Inc., 977 F.2d 1171, 1175 (7th Cir. 1992); In re Newman, 903 F.2d 1150, 1152 (7th Cir. 1990). Bank One and Banc One Mortgage seek review of the bankruptcy court's grant and denial of motions for summary judgment. Therefore, this court reviews the judgment of the bankruptcy court de novo. Flaherty v. Gas Research Inst., 31 F.3d 451, 456 (7th Cir. 1994).

A. Standing

The court first addresses whether Bank One has standing to take this appeal. ² None of the parties raise or address this issue in their briefs, but because it is jurisdictional, the court is obliged to address it, particularly when it emerges from the record as it does here. Children's Healthcare is a Legal Duty, Inc. v. Deters, 92 F.3d 1412, 1419 n. 1 (6th Cir. 1996) (Batchelder, J., concurring), cert. denied, -- U.S. --, 117 S.Ct. 1082, 137 L.Ed.2d 217 (1997); Skrzypczak v. Kauger, 92 F.3d 1050, 1052 (10th Cir. 1996), cert. denied, -- U.S. --, 117 S.Ct. 957, 136 L.Ed.2d 844 (1997); Pashaian v. Eccelston Properties, Ltd., 88 F.3d 77, 82 (2d Cir. 1996); FOCUS v. Allegheny County Court of Common Pleas, 75 F.3d 834, 838 (3d Cir. 1996). In order to appeal a bankruptcy court's order, a litigant must qualify as a "person aggrieved" by the order. Depoister v. Mary M. Holloway Found., 36 F.3d 582, 585 (7th Cir. 1994) (quoting Matter of Andreuccetti, 975 F.2d 413, 416 (7th Cir. 1992)). A "person aggrieved" by a bankruptcy court's order must demonstrate that the order diminishes the person's property, increases the person's burdens, or impairs the person's rights. Id.

The court has difficulty understanding how the bankruptcy court's orders diminish any property or rights of Bank One. Bank One's answer to the adversary complaint denies that it has any claim in the property and admits that it assigned its interest in the note and mortgage to Banc One Mortgage. Moreover, the uncontroverted facts adduced during the pendency of the motions for summary judgment showed that Bank One had, in fact, assigned its interest in the note and mortgage to Banc One Mortgage. Bank One did not join in Banc One Mortgage's motion, nor did it contest either of the motions for summary judgment. ³ Although Banc One Mortgage's reply brief submitted in connection with its motion contains a reference to Bank One, that reference, appearing in the "Relief Requested" portion of the brief, is cryptic at best, and relates to Banc One Mortgage's equitable mortgage argument. ⁴ It is not until after the bankruptcy court granted the IRS's motion and denied Banc One Mortgage's motion that Bank One resurfaced in the litigation, jointly filing a motion to reconsider and clarify with Banc One Mortgage. And as noted by the bankruptcy court, Bank One's motion to clarify could have used a little clarification itself. ⁵ Bank One's reappearance in the litigation served only to confuse matters, and the bankruptcy court understandably declined to fully engage the issue of whether an equitable mortgage lien exists and in which entity's favor, other than to note that even if one did, it would not change the result of its order. See Transcript of Proceedings of October 23, 1996 , pp. 5-6.

In this court's opinion, the only way in which Bank One could be aggrieved by the bankruptcy court's order is by the bankruptcy court's conclusion that Bank One assigned its interest in the property to Banc One Mortgage in-fact; for having assigned its interest, it would not be entitled to an equitable mortgage absent setting aside the assignment. See generally Pacini v. Regopoulos, 281 Ill.App.3d 274, 216 Ill.Dec. 433, 439, 665 N.E.2d 493, 499 (1996); Citizens State Bank v. United States [91-1 USTC ¶50,228], 932 F.2d 490, 494-95 (6th Cir. 1991). Notably, the bankruptcy court's conclusion in this regard was not a finding of fact, it was a fact that no party contested, including Bank One. Not only that, but it was admitted to by Bank One twice below--once in its answer and again when it failed to respond to the motions for summary judgment and the statements of fact filed pursuant to Local General Rules 12M and 12N. Thus, having admitted to this fact below, it is difficult to perceive of how Bank One can be an entity aggrieved by the bankruptcy court's order. Clearly, it was not, and Bank One's brief in support of this appeal is a dead give-a-way.

The relief Bank One and Banc One Mortgage request on appeal in connection with the equitable mortgage lien argument requests the court to find an equitable mortgage lien in favor of Banc One Mortgage, not Bank One. Thus, not only did Bank One never seriously contend it had an interest in this litigation when it was before the bankruptcy court, it clearly does not claim to have any interest in this appeal. Whether this is purely a lack of standing, or a blend of this and other related doctrines, see Wright, Miller & Cooper, FEDERAL PRACTICE AND PROCEDURE: JURISDICTION 2d §3902, Bank One has no standing in this appeal. Accordingly, the court dismisses Bank One's appeal for lack of jurisdiction.

B. Validity/Seniority of the Competing Liens

Before reaching the heart of the issue in this case, the court must first acknowledge the over-all framework within which the court must consider the various competing liens. The court shall first address the priority of the IRS's tax lien. The priority of the IRS's lien vis-a-vis all others is a question of federal law, and the Internal Revenue Code, 26 U.S.C. §§6321-6323, governs the validity and priority of the lien. Dragstrem v. Obermeyer [77-1 USTC ¶9301], 549 F.2d 20, 22-23 (7th Cir. 1977). Absent provisions to the contrary, priority of federal tax liens is governed by the common-law principle that "the first in time is the first in right." United States v. McDermott, 507 U.S. 447, 449, 113 S.Ct. 1526, 1528, 123 L.Ed.2d 128 (1993).

Section 6323(a) provides: "[t]he 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." No party disputes the fact that a valid tax lien under section 6321 arose against Randolph Bruder's half-interest in the property and that such lien was properly filed in compliance with section 6323(f). The disputed issue is whether Banc One Mortgage's interest in the property is a protected security interest under section 6323(a), for if it is, then its mortgage on the property takes priority over the IRS's tax lien. "Security interest" is defined as:

"any interest in property acquired by contract for purposes of securing payment or performance of an obligation or indemnifying against loss or liability. A security interest exists at any time (A) if, at such time, the property is in existence and the interest has become protected under local law against a subsequent judgment lien arising out of an unsecured obligation, and (B) to the extent that, at such time, the holder has parted with money or money's worth."

26 U.S.C. §6323(h)(1). In considering whether the security interest is "in existence" and "has become protected under local law," the court looks to Illinois law and examines whether, under Illinois law, Banc One Mortgage's interest was protected against any "hypothetical judgment lien creditor" that might arise, regardless of whether the IRS had actual notice of the security interest. Dragstrem [77-1 USTC ¶9301], 549 F.2d at 26; see also In re Haas [94-2 USTC ¶50,496], 31 F.3d 1081, 1087 (11th Cir. 1994), cert. denied, -- U.S. --, 115 S.Ct. 2578, 132 L.Ed.2d 828 (1995). Thus, if any subsequent judgment lien creditor could prevail over Banc One Mortgage, then the IRS's lien will be found to be senior in priority. Resolution of this issue will also resolve the priority of Mott's lien vis-a-vis Banc One Mortgage's interest, but for now, the court limits its discussion to the IRS's lien.

Illinois is a race-notice jurisdiction, which means that the first to record, without notice, has superior rights to those who record later. 765 ILCS 5/30; Davis v. United States , 705 F.Supp. 446, 450 (C.D.Ill.1989). If, for example "O," the owner of real property, simultaneously executes mortgages on his property to both "A" and "B," and A and B are not aware of each other's interests, the first one to record the mortgage has the senior lien. The reason for this is that the first to give notice of its lien on real property has the senior lien, and, by recording the mortgage with the recorder of deeds, the individual filing that mortgage is said to give "constructive notice" of its lien to all others. See Skidmore, Owings & Merrill v. Pathway Fin., 173 Ill.App.3d 512, 123 Ill.Dec. 395, 397, 527 N.E.2d 1033, 1035 (1988). ⁶ Constructive notice, however, arises only when the encumbrances or conveyances are in the direct chain of title. Estate of Welliver v. Alberts, 278 Ill.App.3d 1028, 215 Ill.Dec. 580, 586, 663 N.E.2d 1094, 1100, appeal denied, 168 Ill.2d 587, 219 Ill.Dec. 562, 671 N.E.2d 729 (1996); Hillblom v. Ivancsits, 76 Ill.App.3d 306, 32 Ill.Dec. 172, 175, 395 N.E.2d 119, 122 (1979). Thus, contrary to Banc One Mortgage's contentions, an instrument will not operate to give constructive notice "to the world" merely because it is filed with the recorder of deeds--it must also be in the chain of title to the property. Glen Ellyn Sav. and Loan Ass'n v. State Bank of Geneva , 65 Ill.App.3d 916, 22 Ill.Dec. 569, 575, 382 N.E.2d 1267, 1273 (1978).

Chain of title is defined as "the successive conveyances commencing with the patent from the government or some other source and including the conveyance to the one claiming title." Seefeldt v. City of Lincoln , 57 Ill.App.3d 417, 14 Ill.Dec. 954, 956, 373 N.E.2d 85, 87 (1978) (quoting Capper v. Poulsen, 321 Ill. 480, 152 N.E. 587, 588 (1926)). An instrument which is recorded, but which cannot be traced back to the original grant because some previous instrument connecting it to the chain of title is unrecorded, lies outside the chain of title and is said to be a "wild" or "stray" instrument. See Exchange Nat'l Bank of Chicago v. Lawndale Nat'l Bank of Chicago, 41 Ill.2d 316, 319, 243 N.E.2d 193, 196 (1968); see also Gregory M. Power, Case Note, Killam v. Texas Oil & Gas Corp.: A Portrait of Uncertainty for Title Examiners and Mineral Interest Owners, 45 Ark.L.Rev. 679, 685-86 (1992). The chain of title can be traced using the grantor-grantee index maintained by the local recorder of deeds, and in order for a recorded instrument to be effective as against subsequent purchasers and creditors, it must operate to give notice to those looking through the grantor-grantee index. Skidmore, 123 Ill.Dec. at 396, 527 N.E.2d at 1034. A wild or stray instrument which merely appears in other indices, such as the tract index, does not operate to give constructive notice. Id. at 397, 527 N.E.2d at 1035.

An example of these principles at work can be illustrated by the following example:

O, the owner of record of certain real property, conveys the property by deed to A for value. A does not record his deed. A then conveys the property to B for value, who does not record either. O, who never liked A to begin with, and being dissatisfied with the price the property fetched when he sold it to A, conveys the same property by deed to C for value. B records his deed, after which C records his deed. Neither B nor C have actual notice of each other's interest. Who has good title?

Under Illinois law, C has good title, notwithstanding the fact that B purchased the property first and recorded his deed first. B's deed is a wild deed; it cannot be traced back to O without A's deed being recorded, and, because A did not record his deed, B's deed lies outside the chain of title.

In this case, the Bruders, owners of the property as joint tenants, conveyed a mortgage to "First National Bank & Trust Co." in return for a loan. First National recorded its interest. First National then changed its name to "Bank One, Rockford , NA," and, under its new name only, recorded an instrument assigning its interest in the property to "Banc One Mortgage Corporation." Thereafter, an instrument executed by Banc One Mortgage acting as attorney-in-fact for "First National Bank & Trust Co., n/k/a Bank One, Rockford , NA," was recorded, releasing the mortgage. After the release was recorded, the IRS and Mott filed their liens. To further add to the mix, the instrument releasing the mortgage was executed by mistake and was intended to release a mortgage on a different property and for a different debtor.

The bankruptcy court held that Bank One's assignment to Banc One Mortgage was outside the chain of title because there was no prior conveyance or instrument of record linking Bank One to First National. The bankruptcy court then held that the satisfaction and discharge filed by First National, in effect, released the mortgage. These findings led the bankruptcy court to conclude that the assignment was ineffective against creditors and subsequent purchasers and that the mortgage no longer existed. This, in turn, meant that Banc One Mortgage was no longer a secured creditor and that the IRS's and Mott's liens were superior to all others. On appeal, Bane One Mortgage challenges these findings by offering three main arguments. The court addresses each argument in turn.

Banc One Mortgage's first argument is that, as a matter of contract, the mortgage is still valid and is prime as against all other lien holders. The argument is outlined as follows. First National held the note and mortgage, and these interests automatically inured to Bank One pursuant to federal law upon First National changing its name to Bank One. Bank One then assigned its interest to Banc One Mortgage. Having already assigned its interest by contract to Banc One Mortgage, Bank One's satisfaction and discharge had no effect because it had no interest to release. Therefore, there is still a valid mortgage and Banc One Mortgage's lien is prime.

This argument is a red herring. The priority of the liens in this case is not determined merely by reference to contract law, but by reference to the Illinois Conveyance Act, of which notice and recording are the key inquiries. Although the assignment was recorded, it was recorded outside the chain of title. Just like "B" in the last example, no prior instrument of record existed giving any interest in the property to the entity known as Bank One, and the assignment itself failed to recite Bank One's former name. Therefore, the assignment was a wild instrument that did not operate to give constructive notice to subsequent judgment lien creditors. This, in turn, made the satisfaction and discharge executed by First National n/k/a Bank One to be the only other instrument of record within the chain of title, and when it was recorded, it had the effect of releasing the mortgage. That is, while it may not have released the Bruder's personal obligation to pay the debt, as the mortgage was no longer, in fact, Bank One's interest to release, the satisfaction and discharge had the effect of releasing Banc One Mortgage's security interest in the property as to other creditors and lien holders. Thus, the bankruptcy court was correct in finding Banc One Mortgage to be an unsecured creditor.

Banc One Mortgage's second argument is that its mortgage interest cannot be construed to be void because a standard title search of the property would have disclosed its interest, or that it would have at least put the title examiner on "inquiry notice." Banc One Mortgage contends that a standard title search would have revealed all do