Remanded Cases

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[88-2 USTC ¶9408] First American Title Insurance Co., a Calif. Corp., Provident Savings Bank, a Federally Chartered Savings Bank, Plaintiffs-Appellants v. United States of America, Department of the Treasury, Internal Revenue Service, Mark A. Moss, Provident Financial Corp., a California Corp., Defendants-Appellees

(CA-9), U.S. Court of Appeals, 9th Circuit, 87-6190, 6/2/88, 848 F2d 969, Reversing and remanding unreported District Court decision

[Code Secs. 6323 and 7425 --Results unchanged by the Tax Reform Act of 1986 ]

Collection: Validity of lien: Judicial sale: Wrong name: Priority of recorded mortgage: Remanded cases: Discharge of liens: Other state foreclosure proceedings.--A bank could have proven a set of facts which would have entitled it to retain its pre-sale status as senior lienor over the government's federal tax lien with regard to certain real estate. Therefore, the court of appeals reversed the district court's grant of a motion to dismiss and remanded the case to afford the bank an opportunity to establish that its perfected lien survived the sale. Mark A. Moss acquired real estate in which the deed was mistakenly recorded in the name Mark H. Moss. He gave a deed of trust in the property to the bank in order to secure payment of a promissory note which the bank recorded. Subsequently, the name on the original deed was corrected without notifying the bank. Later, the IRS filed federal tax liens on the property recorded under the name Mark A. Moss. Due to its ignorance of the correction of the name, the bank failed to notify the IRS of the nonjudicial foreclosure sale in which it purchased the property. In determining the nature of the bank's property interest after the nonjudicial foreclosure sale pursuant to state law (California), the court found that existing case law and Code Sec. 7425(b)(1) did not preclude the availability of equitable relief recognized under state law whereby the bank's senior lien could survive the sale rather than be extinguished through merger into the fee.

Barry R. Laubscher, Sanford P. Shatz, Rutan & Tucker, 611 Anton Blvd., Costa Mesa, Calif. 92628, for plaintiffs-appellants. William S. Rose, Jr., Acting Assistant Attorney General, Michael L. Paup, William S. Estabrook, B. Paul Klein, Department of Justice, Washington, D.C. 20530, for defendants-appellees.

Before FARRIS, BOOCHEVER and REINHARDT, Circuit Judges.

OPINION

FARRIS, Circuit Judge:

First American Title Insurance Co. and Provident Federal Savings Bank appeal from the district court's grant of a motion to dismiss for failure to state a claim. We reverse and remand.

BACKGROUND

This appeal concerns the status of various liens on real property located in Grand Terrace, California . Mark A. Moss acquired the property in July 1983. He mistakenly recorded the deed under the name Mark H. Ross. In October 1983, Moss gave Provident a deed of trust in the property in order to secure payment of a $156,000 promissory note. Provident recorded the deed on October 19, 1983 . In January 1984, Moss corrected the name on the original deed, but failed to notify Provident of the change.

In November 1985 and January 1986, the Internal Revenue Service recorded tax liens against all of Moss's property, including the Grand Terrace property. The liens on the Grand Terrace property were junior to Provident's lien. On March 10, 1986 , Provident initiated foreclosure proceedings against the property and conducted a title search under the name Mark H. Moss. Provident never discovered the federal tax liens because they were recorded under the name Mark A. Moss. Provident consequently failed to notify the IRS of the upcoming nonjudicial sale. At the sale, Provident purchased the property for $159,444.

Provident's failure to notify the IRS of the sale meant that the property remained subject to the federal tax liens. See 26 U.S.C. §7425(b)(1) . When Provident later discovered the federal liens, it received indemnity from First American Title Insurance Co. Both entities then instituted this action. They conceded that Provident's failure to notify the IRS meant that the sale was "made subject to and without disturbing" the tax liens. They argued, however, that equitable principles would have allowed Provident, and now First American, to retain the senior lien on the property. The district court disagreed. It held that Provident's senior lien was extinguished when Provident purchased the property, leaving the property subject only to the federal tax liens. ¹

STANDARD OF REVIEW

We review de novo the district court's grant of a motion to dismiss for failure to state a claim upon which relief can be granted. Fort Vancouver Plywood Co. v. United States , 747 F.2d 547, 552 (9th Cir. 1984). Dismissal was proper only if Provident and First American could not have proven any set of facts that would have entitled them to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

DISCUSSION

The issue on appeal is whether Provident and First American could have proven any set of facts which would have entitled Provident to retain its pre-sale status as senior lienor over the government. Our resolution of the issue involves two steps. First, we must determine the nature of Provident's property interest after the sale. Second, if Provident's lien survived the sale, we must determine whether the lien has priority over the tax liens. See Aquilino v. United States [60-2 USTC ¶9538 ], 363 U.S. 509, 512-14 (1960). Each step is analytically distinct. If our resolution of the property issue reveals that Provident's lien did not survive the sale, then we need not reach the priority issue because there would be no lien competing for priority with the tax liens. If Provident's lien survived the sale, however, then, and only then, would we reach the priority issue.

Federal law governs the resolution of each issue. United States v. Brosnan [60-2 USTC ¶9516 ], 363 U.S. 237, 240 (1960). If federal statutes do not address the issue, the Supreme Court has specified the source of federal law. We adopt state law as the federal common law when deciding to what extent an individual has an interest in property to which a federal tax lien has attached. Id. at 240-42; Aquilino, 363 U.S. at 512-13; see also United States v. Polk [87-2 USTC ¶9432 ], 822 F.2d 871, 874 (9th Cir. 1987). We generate uniform nationwide federal rules, however, when deciding priority issues. Brosnan, 363 U.S. at 240.

A. The Property Issue

Whether Provident's lien survived the sale requires us to determine the extent of Provident's interest in the Grand Terrace property after the sale. We adopt California law as the federal common law to make this determination. See Aquilino, 363 U.S. at 512-13; Brosnan, 363 U.S. at 240-42; Polk, 822 F.2d at 874. Under California law, the general rule is that a mortgagee's lien is extinguished when the mortgagee purchases the property to which his or her lien was attached. Cal. Civ. Code §2910 (West 1974); Cornelison v. Kornbluth, 15 Cal. 3d 590, 125 Cal. Rptr. 557, 568 (1975); Strike v. Trans-West Discount Corp., 92 Cal. App. 3d 735, 155 Cal. Rptr. 132, 137 (1979). The theory is that the mortgagee's lesser interest (the lien) has "merged" into the greater interest (the fee). If the merger rule applies to Provident, then Provident's lien did not survive the sale and the tax liens are the only encumbrances on the property.

We are not convinced, however, that the merger rule necessarily applies to Provident. California law recognizes an equitable exception to the rule:

Equity will prevent or permit a merger as will best subserve the purposes of justice and the actual and just intent of the parties. . . . In the absence of an expression of intention, if the interest of the person in whom the several estates have united, as shown from all the circumstances, would be best subserved by keeping them separate, the intent to do so will ordinarily be implied.

Ito v. Schiller, 213 Cal. 632, 3 P.2d 1, 2 (1931) (quoting Jameson v. Hayward, 106 Cal. 682, 39 P. 1078 (1895)).

If Provident and First American are entitled to equitable relief, then Provident's lien survived the sale. Before we consider this issue, however, we first address the government's contention that equitable relief is simply unavailable to a senior lienor such as Provident who has failed to notify the IRS of a nonjudicial sale.

1. Does existing case law foreclose the availability of equitable relief?

On the basis of Southern Bank v. I.R.S. [85-2 USTC ¶9670 ], 770 F.2d 1001 (11th Cir. 1985), cert. denied sub nom. Mid-State Homes, Inc. v. United States , 476 U.S. 1169 (1986), the district court concluded that equitable relief was unavailable to Provident and First American. In Southern Bank, two senior lienors conducted nonjudicial foreclosure sales without notifying the IRS. Each lienor purchased the property at the respective sales. The Eleventh Circuit held that the senior liens were extinguished, leaving the property subject only to the government's liens. Id. at 1009.

In reaching this decision, the court applied Alabama 's rule of merger, Id. at 1007. When the lienors contended that elevating the government's junior liens would be inequitable, they did not argue that Alabama law would allow an equitable exception to the merger rule. Instead, after the court determined that the liens did not survive the sale, the lienors apparently argued that Alabama law would provide equitable relief on the priority issue. The court disagreed, stating "we cannot permit states to nullify the effectiveness of the federal tax lien . . . by applying various equitable principles recognized by the state." Id. at 1009.

We agree with the Eleventh Circuit that, as to priority issues, state equitable principles do not apply. If a federal statute does not address a priority issue, courts generate a federal rule to decide the issue. Brosnan, 363 U.S. at 240. In the case before us, however, we deal with a property issue because we must determine whether Provident's lien survived the sale. Aquilino v. United States [60-2 USTC ¶9538 ], 363 U.S., 509, 512-14 (1960), and United States v. Brosnan [60-2 USTC ¶9516 ], 363 U.S. 237, 240-42 (1960), both specify that courts look to state law to determine the extent of an individual's property interest in cases involving the federal tax liens. Aquilino makes clear that the property issue is analytically distinct from the priority issue. 363 U.S. at 512-14. Because Southern Bank dealt with a priority issue, the case does not apply here.

We reject the government's contention that United States v. Polk [87-2 USTC ¶9432 ], 822 F.2d 871 (9th Cir. 1987), precludes the availability of equitable relief on the merger issue. In Polk, the senior lienors conducted a foreclosure sale without notifying the IRS. Id. at 872. The court held that, under Arizona law, the senior liens were extinguished regardless of the senior lienors' intent. Id. at 874 (quoting Best Fertilizers of Arizona, Inc. v. Burns, 116 Ariz. 492, 493, 570 P.2d 179, 180 (1977)). Polk deals with Arizona law and has no bearing on whether equitable relief is available under California law. The senior lienor's intent is irrelevant under Arizona law, but not under California law. See Ito v. Schiller, 213 Cal. 632, 3 P.2d 1, 2 (1931); Strike v. Trans-West Discount Corp., 92 Cal. App. 3d 735, 155 Cal. Rptr. 132, 137-38 (1979). Polk therefore does not preclude the availability of equitable relief.

2. Does 26 U.S.C. §7425(b)(1) preclude the availability of equitable relief?

The government contends that granting equitable relief to Provident would be inconsistent with §7425(b)(1) . We disagree. Before Congress enacted §7425(b)(1) , some state laws allowed senior lienors to conduct nonjudicial sales without notice to junior lienors. Junior liens held by the government could be extinguished by operation of state law even though the government had not been notified of a sale. S. Rep. No. 1708, 89th Cong., 2d Sess., reprinted in 1966 U.S. Code Cong. & Admin. News 3722, 3748. To prevent the extinction of government liens under these circumstances, Congress enacted section 7425(b)(1) to assure that the government received notice of these sales so that it could "review its position and determine the appropriate action . . . ." Id. this would assure that the government could protect its interest in having a fair sale. In the event the government did not receive notice, Congress intended only to shield the government's junior liens from extinction so the government could protect its interest at a later date.

Granting equitable relief to Provident would not undermine Congress's intent. If Provident's lien survives the sale, the government's junior liens still are unaffected by the sale, and the government can protect its interest in having a fair sale in the future when Provident sells the property or when the government forecloses on it. Granting equitable relief also will not discourage senior lienors such as Provident from notifying the government of future sales. Senior lienors have a strong incentive to notify the government because doing so will extinguish the government's junior liens when the property is sold. See 26 U.S.C. §7425(b)(2) and Sohn v. California Pacific Title Ins. Co., 124 Cal. App. 2d 757, 269 P.2d 223, 230 (1954). If notice is not given, the government's liens survive the sale, leaving an encumbrance of the property. We believe that this is the penalty that Congress intended to impose on senior lienors such as Provident. Granting equitable relief to Provident is not inconsistent with that intention. Section 7425(b)(1) therefore does not preclude the availability of equitable relief.

3. Availability of equitable relief under California law

As we understand California law, equitable relief is available to Provident and First American if three conditions are met: (1) Provident's best interests would be best served by preventing a merger of the lien and the fee; (2) the purposes of justice would be served; and (3) the government cannot prove by a preponderance of the evidence that Provident actually intended to merge the lien into the fee. Ito v. Schiller, 213 Cal. 632, 3 P.2d 1, 2 (1931) (quoting Jameson v. Hayward, 106 Cal. 682, 39 P. 1078 (1895)); see also Strike v. Trans-West Discount Corp., 92 Cal. App. 3d 735, 155 Cal. Rptr. 132, 137-38 (1979). We need not discuss the first condition, because there is no dispute that Provident's best interests would be served by preventing a merger.

a. Purposes of justice. To determine whether justice would be served by allowing Provident's lien to survive the sale, we consider how our resolution of the issue would affect the parties. We presume that Provident did not act in bad faith when it failed to discover the government's liens. If we do not grant equitable relief, Provident would lose $159,444 (the amount Provident paid for the property) because the property would be subject to tax liens totalling $534,000. The government, on the other hand, would realize $159,444 which it otherwise would not have received had Provident notified it of the sale. We recognize that any money received by the government would go towards satisfaction of legitimate tax liens. If Provident had notified the government, however, the government's junior liens would have been extinguished, see 26 U.S.C. §7425(b)(2) and Sohn v. California Pacific Title Ins. Co., 124 Cal. App. 2d 757, 269 P.2d 223, 230 (1954), and the government would not have received any proceeds from the sale because the sale yielded only enough money to satisfy a portion of Provident's senior lien, see Caito v. United Calif. Bank, 20 Cal. 3d 694, 144 Cal. Rptr. 751, 754 (1978) (junior lienor draws from proceeds only after foreclosing senior lienor paid off). Under these circumstances, the equities favor Provident, particularly since 26 U.S.C. §7425(b)(1) eliminates virtually any harm the government suffered when it did not receive notice of the sale.

Because Provident failed to notify the government, section 7425(b)(1) provides that the sale was "made subject to and without disturbing" the government's lien. Even if Provident's senior lien survives the sale, the government is virtually in the same position it was in before the sale. If Provident sells the land, or if the government forecloses on it, the proceeds from the sale first go towards satisfaction of Provident's lien and any remaining proceeds go towards satisfaction of the government's liens.

We therefore conclude that Provident and First American could prove a set of facts which would show that the purposes of justice would be served if equitable relief were granted.

b. Intent. The final condition for receiving equitable relief involves the question of Provident's intention on the issue of merger. Because Provident did not express any intention on the merger issue, equity will presume that Provident did not intend to merge its lien with its fee interest if two conditions are met: (1) Provident's best interests would be served by preventing the merger, and (2) the purposes of justice would be served. Ito v. Schiller, 213 Cal. 632, 3 P.2d 1, 2 (1931); Strike v. Trans-West Discount Corp., 92 Cal. App. 3d 735, 155 Cal. Rptr. 132, 137-38 (1979). We have concluded that Provident and First American could prove a set of facts to fulfill these conditions. We have also presumed that Provident intended to prevent a merger of its interests. On remand, the presumption is rebuttable if the government can prove by a preponderance of the evidence that Provident actually intended to merge its interests. See Sheldon v. La Brea Materials, 216 Cal. 686, 15 P.2d 1098, 1101 (1932) (merger rule not applied when no direct or circumstantial evidence of an express intention to merge); see also Strike, 92 Cal. 3d 735, 155 Cal. Rptr. at 137 (placing burden of proof on person arguing that merger occurred).

B. The Priority Issue

If the district court ultimately determines that Provident's lien survived the sale, then the only remaining issue is whether the lien has priority over the tax liens. The Federal Tax Lien Act squarely addresses this issue and therefore obviates the necessity of relying on the federal common law to resolve the issue. See Manalis Finance Co. v. United States [80-1 USTC ¶9158 ], 611 F.2d 1270, 1273 (9th Cir. 1980); AETNA Ins. Co. v. Texas Thermal Industries, Inc. [79-1 USTC ¶9287 ], 591 F.2d 1035, 1037-38 (5th Cir. 1979) (per curiam). If Provident's lien survived, the Tax Lien Act gives priority to it because Provident had perfected its lien before the government recorded its tax liens. See 26 U.S.C. §§6323(a) , (h)(1) ; Manalis, 611 F.2d 1273; AETNA Ins. Co., 591 F.2d at 1038.

CONCLUSION

 

We hold that the district court erred in granting the government's motion to dismiss. We have viewed the facts in the light most favorable to Provident and First American. Whether they can actually prove their case is a matter for the district court to decide on remand.

Reversed and Remanded.

¹ The district court also rejected the contention that 26 U.S.C. §7425 allowed a "taking." We need not address this issue.

 

 

[78-1 USTC ¶9477] United States of America , Appellant v. Commonwealth of Kentucky , ex rel. Rob ert D. Bell, Secretary, Department for Natural Resources and Environmental Protection and Ike Marsee, Appellees

Commonwealth of Kentucky Court of Appeals, No. CA-1122-MR, 568 SW2d 752, 12/16/77

[Code Sec. 6323--result unchanged by the '76 Tax Reform Act]

Lien for taxes: Notice of lien: Place for filing.--Decision of a lower state court determining that a judgment lien creditor had priority over a prior in time Federal tax lien was reversed, and remanded for a determination of whether the notice of the Federal tax lien was filed in the correct state (the state wherein the corporate debtor's "principal executive office" was located).

Eldon L. Webb, United States Attorney, Rob ert F. Trevey, Assistant United States Attorney, Lexington, Ky. 40507, Myron C. Baum, Acting Assistant Attorney General, Gilbert E. Andrews, Crombie J. D. Garrett, William S. Estabrook III, Department of Justice, Washington, D. C. 20530, for appellant. Scott Allen Wilson, Kentucky Department for Environmental Protection and Natural Resources, Frankfort, Ky. 40601, Mark Anderson, 2317 Cumberland Ave., Middlesboro, Ky. 40965, for appellee.

Before: HAYES, HOGGE and LESTER, Judges.

Reversing

* * *

HOGGE, District Judge:

This is an appeal from an order determining that the appellee, Ike Marsee, had a superior right against the United States to the sum of $6,300.00 held by the Kentucky Department of Natural Resources and Environmental Protection as a cash bond for obtaining a strip mining permit, which had been deposited by Carbon Coal Company Inc., a debtor of both Marsee and the United States.

The claim of the United States against Carbon Coal grew out of unpaid taxes. The claim of Marsee against Carbon Coal grew out of a loan to that company by Marsee. There is no question that the claim of the United States predated Marsee's claim. Nor is it questioned that the United States first took action to effectuate its lien. The issue before this court is whether the United States complied with the statutory requirements as to filing of notice of its lien.

A notice of federal tax liabilities was filed on January 3, 1972 , and on June 29, 1972 , in Claiborne County , Tennessee . Ike Marsee did not file suit against Carbon Coal until September 28, 1972 . On October 3, 1972 , Marsee obtained a pre-judgment attachment against Carbon Coal and, on October 6th, served the attachment upon the Kentucky Department for Natural Resources and Environmental Protection. On December 7, 1972 , Marsee obtained judgment against Carbon Coal. The United States had not attempted to file notice of its lien in any place other than Claiborne County , Tennessee , although Carbon Coal had offices and connections in three states, Kentucky , Ohio and Tennessee .

IRC §6321 provides that a lien arises in favor of the United States upon the taxpayer's failure to pay the taxes upon demand. IRC §6323 provides that said lien is not effective against a judgment lien creditor until notice of same is properly filed. That section further provides that the proper place for filing of notice of lein against the personal property of a corporate taxpayer is the state where its "principal executive office" is located. Therefore, if the United States had properly filed its notice of federal tax liability at the time Marsee became a judgment creditor, the claim of the United States would be superior. However, if the notice had not been properly filed at the time Marsee became a judgment creditor, Marsee's claim would be superior.

The location of the "principal executive office" of Carbon Coal is basic to any determination of whether the United States filed its notice in the proper place. Unfortunately, the record is completely void of any evidence on this critical point. As a result, the trial court was unable to make any findings of fact respecting the location of the principal executive office of Carbon Coal.

In the absence of any evidence on this issue, any judgment of the trial court may result in a gross miscarriage of justice.

Judgment reversed and remand for further proceedings consistent with this opinion, including the taking of additional proof if necessary.

ALL CONCUR

 

 

[79-1 USTC ¶9156]State of Connecticut v. Joseph Bucchieri

Conn. Supreme Court, 12/19/78

[Code Sec. 6321]

Lien for taxes: Priority: Federal tax lien v. state seizure of contraband: Choateness of state lien.--Contraband seized by a state during a drug raid was subject to a federal tax lien for taxes on the owner of the contraband. As state law provided that seized property first be declared contraband and then, after hearing, be forfeited to the state, the state interest was not choate until the determination of the forfeiture proceeding. A federal tax lien arising after the seizure and institution of the forfeiture proceeding but before the hearing on that proceeding had priority over that inchoate state interest.

Donald B. Caldwell, state's attorney, for State of Conn. Frank N. Santoro, Richard Blumenthal, United States Attorneys, M. Carr Ferguson, Assistant United States Attorney, New Haven, Conn. 06508, Michael J. Roach, Gilbert E. Andrews, Crembie J. D. Garrett, Department of Justice, Washington, D. C. 20530, for U. S.

COTTER, C. J., LOISELLE, BOGDANSKI, LONGO and PETERS, Js.

PETERS, Justice:

This case arises out of competing claims to funds seized by Coventry police on February 1, 1972 , pursuant to a search warrant authorizing search of a house in that town. The search netted $4718.11 in cash, along with a quantity of drug paraphernalia. ¹ On the day of the search the Circuit Court from which the warrant had been issued instituted an in rem proceeding for adjudication of the seized articles as a nuisance, pursuant to General Statutes §54-33g. ² Some five months later, on June 30, 1972 , the United States filed notices of tax liens against Joseph Bucchieri and Andrew Field, codefendants on drug charges that had resulted from the search of the Coventry premises. Notices of the tax levies were served on the chief of police of the town of Coventry on July 3, 1972 , at that time the custodian of the funds seized in the February 1, 1972 , raid. Subsequently, in April, June, and November of 1973, several proceedings were held in the Superior Court to adjudicate rights to the seized funds. Ultimately the order presently on appeal was entered; it determined that the claim of the state of Connecticut under §54-33g was entitled to priority over the claim of the United States of America under §6321 of the Internal Revenue Code. ³

The United States, the appellant, has framed the issue on appeal as a question of priority in time: Was the currency seized in the narcotics raid effectively forfeited to the state of Conecticut prior to the time that a federal tax lien attached to all of the taxpayers' property, even though there had been no judicial determination of forfeiture at the time the federal tax lien arose? This statement of the issue presupposes appropriate resolution of a threshold question that must first be addressed: Was the property to which the federal tax lien attached the property of the taxpayers? Until it is established that the funds seized were funds in which the taxpayers Bucchieri and Field had property rights, the United States as lienholder has no claim to the funds. Whether taxpayers have "property" or "rights to property" to which the tax lien may attach is a question of state law on which the United States has the burden of proof. Aquilino v. United States [360 USTC ¶9538], 363 U. S. 509, 512-14, 80 S. Ct. 1277, 4 L. Ed. 2d 1365 (1960); United States v. Bess [58-2 USTC ¶9595], 357 U. S. 51, 55, 78 S. Ct. 1054, 2 L. Ed. 2d 1135 (1958); Plumb, Federal Tax Liens 27-30 (3d Ed. 1972). Only after it has been determined that a lien has attached to a state-created interest does federal law come into play to determine the priority of competing liens asserted against the same property. Aquilino v. United States, supra, 514.

The record below established very little with specificity concerning the ownership of the seized currency. At the time of the raid, some of the money was found on the person of Bucchieri, and some of it was found in the room in the Coventry house occupied by Bucchieri and Field. Bucchieri himself, however, twice disclaimed, through counsel, any interest in the money, once on the occasion of his plea of guilty to sale and possession of a controlled drug, and again on the occasion of the April, 1973, hearing in the in rem proceeding. The trial court's memorandum of decision indicates that Field, Bucchieri's codefendant, ⁴ and a cotaxpayer, also made an in-court disclaimer to the currency. The Coventry house was owned by someone other than Bucchieri or Field; whether and to what extent the landlord had access to Bucchieri and Field's room is entirely unclear. The affidavit and application for the search warrant does indicate that the premises were the site of at least one illegal drug sale by a person other than Bucchieri or Field. Although the record would seem to indicate that Bucchieri was engaged in drug traffic for profit, the United States made no request for the taking of evidence to determine whether the money seized pursuant to the search warrant was money derived from the sale of controlled drugs. Nor did the United States offer any other proof of Bucchieri's title to any of the money seized. As counsel for the United States candidly conceded at oral argument, the United States simply assumed that the currency belonged to Bucchieri and Field because of the place where it was found and because no one else had asserted a claim of ownership. Assumptions are no substitute for findings. ⁵

In this state of the record, the United States has certainly not yet established the taxpayer property rights that are a prerequisite to its priority claim. We could, on this basis, affirm the judgment below, since the United States had the opportunity to participate and did participate in a hearing designed to adjudicate competing claims to the fund in dispute. It seems clear, however, that in the proceedings below the issue of ownership was never squarely addressed by anyone. The state's primary concern, in the adjudication of property as a nuisance under §54-33g, is to show that the property "has been possessed, controlled or designed for use . . . with intent to violate or in violation of any of the criminal laws of this state." The state's case focuses on use for an illegal purpose, rather than on ownership. As this court said with regard to a predecessor statute, now repealed, dealing with seizure of intoxicating liquor, "[t]his statute is not a criminal statute, but provides for a civil action in rem for the condemnation and forfeiture of the [property] which was used in violation of the law. . . . In such an action the guilt or innocence of the owner of the [property] is not in issue. The only issue is whether the [property] was used in violation of law. This follows from the nature of the action which is one against the res, an action in rem." Alcorn v. Alexandrovicz, 112 Conn. 618, 623, 153 A. 786 (1931); see State v. One 1960 Mercury Station Wagon, 5 Conn. Cir. Ct. 1, 240 A. 2d 99 (1968).

The trial court specifically found that at the relevant hearing on November 15, 1973 , and in the briefs subsequently submitted, both parties limited their claims to the question of priority. Apparently the state was prepared to presume, having followed the statutory requisites as to notice and in the absence of evidence to the contrary, that the property was contraband, while the United States was prepared to indulge in a similar presumption concerning ownership. The trial court acted on the first presumption, concluding that the seized currency was money derived from the sale of controlled drugs, and hence contraband subject to forfeiture under the state statute. ⁶ The trial court, however, reached no conclusions whatsoever on the question of ownership. It seems reasonable to remand this case for further proceedings to determine this crucial question.

If upon remand the United States is able to prove that the seized currency was the property of Bucchieri and Field, ⁷ the issue of priority between the claim of the state under §54-33g and the claim of the United States under I. R. C. §6321 must be resolved. The court below did address this issue, and concluded that the state was entitled to priority because seizure of the property as contraband by initiation of the in rem proceeding antedated the attachment of the federal tax lien. The United States assigned this conclusion as error, and the issue has been fully briefed and argued. In light of the likelihood of a rehearing, it is appropriate to resolve this claim of error now. Thomas v. Arafeh, 174 Conn. 464, 467, 391 A. 2d 133 (1978); Loewenberg v. Wallace, 147 Conn. 689, 694, 166 A. 2d 150 (1960); Maltbie , Conn. App. Proc. §341.

The priority of federal tax liens as against liens created under state law is governed generally by the common-law rule that "first in time is first in right." United States v. Equitable Life Assurance Society of the United States [66-1 USTC ¶9444], 384 U. S. 323, 327, 86 S. Ct. 1561, 16 L. Ed. 2d 593 (1966); United States v. Pioneer American Ins. Co. [63-2 USTC ¶9532], 374 U. S. 84, 87, 83 S. Ct. 1651, 10 L. Ed. 2d 770 (1963); United States v. New Britain , 347 U. S. 81, 85-86, 74 S. Ct. 367, 98 L. Ed. 520 (1954). See 2 Gilmore, Security Interests in Personal Property §40.3, p. 1054 (1965). Some specific exceptions to this general rule have been carved out by the Federal Tax Lien Act of 1966 in its amendments to I. R. C. §6323, but the state has not suggested that its claim to priority should shelter under any of these special exemptions. In the ordinary case, the federal lien arises, under I. R. C. §6322, when the tax is assessed, while the state lien arises when it is specific and perfected, or choate. United States v. Equitable Life Assurance Society of the United States, supra, 327; United States v. Pioneer American Ins. Co., supra, 88; United States v. New Britain , supra. 84. The determination of when a state interest has become sufficiently choate to defeat a later-arising federal tax lien is a matter of federal and not of state law. United States v. Equitable Life Assurance Society of the United States, supra, 328; United States v. Pioneer American Ins. Co., supra, 88; Aquilino v. United States [360 USTC ¶9538], 363 U. S. 509, 513-14, 80 S. Ct. 1277, 4 L. Ed. 2d 1365 (1960); United States v. New Britain , supra, 84. See Plumb, Federal Tax Liens 27-30 (3d Ed. 1972).

In the case before us, these principles translate into the following question: Did the state's claim to the seized currency immediately become choate at the time of the institution of the in rem proceeding on February 1, 1972, so as to antedate the federal tax lien that attached on June 28, 1972; or did it first become choate after the hearing on the in rem proceeding on April 26, 1973, and thus postdate the federal lien?

The test that determines, under federal law, whether a state interest competing with a federal tax lien is sufficiently choate is that the competing interest 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. New Britain , supra, 84. This language has been cited repeatedly in subsequent cases in the United States Supreme Court. Plumb, Federal Tax Liens 149-50 (3d E. 1972); 2 Gilmore, Security Interests in Personal Property 1054 (1965). The time when a state interest is perfected as against local levying creditors is not dispositive as to choateness; an otherwise effective attachment lien, for example, is always inchoate until the time of judgment, and can be defeated by an intervening recorded tax lien. United States v. Security Trust & Savings Bank [50-2 USTC ¶9492], 340 U. S. 47, 50, 71 S. Ct. 111, 95 L. Ed. 53 (1950).

The in rem proceedings under §54-33g are difficult to align with the case law on state liens because §54-33g provides for forfeiture rather than for a lien. The in rem proceedings are instituted ex parte to seize outright designated property that has been taken as contraband pursuant to a search warrant. A hearing is afforded, as required by constitutional principles of procedural due process, so that interested parties may contest whether the property was in fact "possessed, controlled . . . or . . . used, with intent to violate or in violation of any of the criminal laws" of the state. The purpose of the state's seizure is not to establish a lien to facilitate collection of moneys owed to the state, but rather to exercise the sovereign power to forfeit property shown to have been involved in an illegal enterprise. In determining when the state's interest has become choate, we must bear in mind the purpose of the state's exercise of its sovereign power of forfeiture as well as the procedure that the state has devised for the manifestation of its interest. The state's reliance on United States v. Vermont, 377 U. S. 351, 355, 84 S. Ct. 1267, 12 L. Ed. 2d 370 (1964), is therefore not totally apposite. True, United States v. Vermont is one of the very few cases in recent history ⁸ in which a state interest was held by the United States Supreme Court to be sufficiently choate to survive challenge by a subsequent federal tax lien. United States v. Vermont is noteworthy for its holding that a state-created lien may be valid when it attaches to all, rather than to specifically designated portions, of a taxpayer's property. It is consistent with a conclusion that a state may have the power effectively to exclude property from a federal lien, but it gives little guidance whether in this case, under this statute, this state has exercised such power.

In a case of first impression like this one, it is helpful to consult the holdings of other courts, and the opinions of the textwriters. There are, as far as we can discover, no cases definitively interpreting statutes that, like §54-33g, couple an immediate forfeiture with a subsequent hearing that may result in reclamation of the forfeited property in whole or in part. Some twenty years ago, the United States Court of Appeals for the Third Circuit, while noting the difficulty of the case, expressed in dictum grave doubt that a federal tax lien could attach to property in the possession of the state after its seizure as contraband. United States v. Bleasby, 257 F. 2d 278, 279-80 (3d Cir. 1958). Judge Hastie in Bleasby characterized as "extraordinary" the effort by the federal government to impose its lien on property already in the possession of the state government pursuant to the latter's "sovereign claim of right to keep it in furtherance of its criminal laws." In a similar vein, William T. Plumb, Jr., the leading textwriter of federal tax liens, takes the position that seizure and forfeiture of property under state law leaves the taxpayer with no property to which a subsequent federal tax lien can attach, whether or not judicial proceedings are required to finalize the forfeiture. In his view, whatever judicial proceedings are had are at best analogus to third-party claims of title whose pendency would not postpone the attachment of a lien to the affected property. Plumb, Federal Tax Liens 185-87 (3d Ed. 1972).

The problem with these arguments in favor of the state's priority is that they assume the very points that are ultimately at issue. To what extent in fact is the state's "sovereign claim of right" inconsistent with the federal assertion of a tax lien? To what extent in fact has the state exercised its power of forfeiture by the mere initiation of ex parte proceedings to declare property a nuisance?

The sovereign claim of the state in seizing contraband property must be measured by the purpose forfeiture is intended to serve. That purpose is, clearly, to deprive potential (and actual) criminals of access to useful property, and hence to deter crime. In no way is that purpose the enrichment of the coffers of the state treasury. As the text of §54-33g states, the normal disposition of property declared to be a nuisance under the statute is that the property "be destroyed or disposed of to a charitable or educational institution or to a governmental agency or institution." The property is to be taken from criminals by the state but not for the state. It is only because the contraband in the present case happened to be cash that the normal course of disposition has apparently not been followed. The liquidity of this property undoubtedly accounts also for the federal interest in attaching it. Yet it is undeniable that the state is claiming what is in effect a windfall, while the federal government is pursuing ordinary means, albeit through jeopardy assessments, ⁹ to collect ordinary taxes in the ordinary course of Internal Revenue Service business. The federal lien interferes in no perceptible way with any state policy under the state forfeiture statute.

The absence of a fundamental conflict of policy between the state and the United States should not of course lead us to characterize as inchoate a state interest that under state law has fully vested at a time antedating the federal tax lien. The provisions of §54-33g hardly comport, however, with an overriding legislative intent to characterize as final an ex parte proceeding to declare property contraband, when the section itself provides for a hearing at which competing claims may be heard and at which forfeiture is to be adjudicated. Connecticut law has never recognized any inherent right of forfeiture apart from statute. State v. Certain Contraceptive Materials, 126 Conn. 428, 11 A. 2d 863 (1940); State v. Rosarbo, 2 Conn. Cir. Ct. 399, 199 A. 2d 575 (App. Div. 1963). In recent years this court, like others, has become increasingly sensitive to the significance of hearings that afford participants a meaningful opportunity to challenge seizures, under state law, of private property. See Roundhouse Construction Corporation v. Telesco Masons Supplies Co., 168 Conn. 371, 362 A. 2d 778 (1975), cert. denied, 429 U. S. 889, 97 S. Ct. 246, 50 L. Ed. 2d 172 (1976). In light of this trend, we should not devalue the hearing mandated by §54-33g as insignificant in the determination of when state rights attach. If the hearing and the resultant adjudication seriously matter, as constitutionally they must, the state cannot be deemed to have acquired a fully matured, choate right in the seized property until that time.

For these reasons, we conclude that the court below was in error in its conclusion that forfeiture under §54-33g of the General Statutes occurs as of the time the property becomes contraband because of its illegal use. Even though state seizure of the property may effectively remove the property from the claims of its owners, or those who take under its owners, the state's claim is incomplete and hence inchoate until forfeiture has been adjudicated after interested parties have had an opportunity to be heard. For other purposes, adjudication may enable the state's claim to relate back to the time of initial seizure. Under the governing federal law, however, an intervening federal tax lien takes precedence over the state lien which is not yet fully choate. United States v. Security Trust & Savings Bank [50-2 USTC ¶9492], 340 U. S. 47, 50, 71 S. Ct. 111, 95 L. Ed. 53 (1950). Whether in this case the United States will be entitled to the currency seized in the Coventry drug raid will depend upon its ability to prove, upon remand, that the moneys were the property of its taxpayers, Bucchieri and Field.

There is error, the judgment is set aside and the case is remanded for further proceedings in accordance with this opinion.

In this opinion the other judges concurred.

¹ Only the cash that was seized is presently in dispute.

² "[General Statutes] Sec. 54-33g. Summons to Owner on Seizure of Property. In Rem Action for Adjudication as Nuisance. When pursuant to subdivision (1) of subsection (b) of section 54-33a any property has been seized, which the state claims to be a nuisance and desires to have destroyed or disposed of in accordance with the provisions of this section, the judge or court issuing the warrant shall, within ten days after such seizure, cause to be left with the owner of, and with any person claiming of record a bona fide mortgage, assignment of lease or rent, lien or security interest in, the property so seized, or at his usual place of abode, if he is known, or, if unknown, at the place where the property was seized, a summons notifying the owner and any such other person claiming such interest and all others whom it may concern to appear before such judge or court, at a place and time named in such notice, which shall be not less than six nor more than twelve days after the service thereof, then and there to show cause why such property should not be adjudged a nuisance and ordered to be destroyed or otherwise disposed of as herein provided. Such summons may be signed by a clerk of the court or his assistant and service may be made by a local or state police officer. If shall describe such property with reasonable certainty and state when and where and why the same was seized. If the owner of such property or any person claiming any interest in the same appears, he shall be made a party defendant in such case. Any state's attorney or prosecuting attorney may appear and prosecute such complaint, and, if the judge or court finds the allegations made in such complaint to be true and that the property has been possessed, controlled or designed for use, or is or has been or is intended to be used, with intent to violate or in violation of any of the criminal laws of this state, he or it shall render judgment that such property is a nuisance and order the same to be destroyed or disposed of to a charitable or educational institution or to a governmental agency or institution provided, if any such property is subject to a bona fide mortgage, assignment of lease or rent, lien or security interest, such property shall not be so destroyed or disposed of in violation of the rights of the holder of such interest. Final destruction or disposal of such property shall not be made until any criminal trial in which such property might be used as evidence has been completed . . .. When any money or valuable prize has been seized upon such warrant and condemned under the provisions of this section, such money or valuable prize shall become the property of the state, provided any such property, which at the time of such order is subject to a bona fide mortgage, assignment of lease or rent, lien or security interest shall remain subject to such mortgage, assignment of lease or rent, lien or security interest. When any property or valuable prize has been declared a nuisance and condemned under this section, the court may also order that such property be sold by sale at public auction in which case the proceeds shall become the property of the state; provided, any person who has a bona fide mortgage, assignment of lease or rent, lien or security interest shall have the same right to the proceeds as he had in the property prior to sale. If the judge or court finds the allegations not to be true or that the property has not been kept with intent to violate or in violation of the criminal laws of this state or that it is the property of a person not a defendant, he shall order the property returned to the owner forthwith and the party in possession of such property pending such determination shall be responsible and personally liable for such property from the time of seizure and shall immediately comply with such order. Failure of the state to proceed against such property in accordance with the provisions of this section shall not prevent the use of such property as evidence in any criminal trial."

³ "[Title 26, United States Code §6321] Lien for Taxes. 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."

This priority contest involves only I. R. C. §6321; there are no allegations that the taxpayers are insolvent so as to allow the United States to invoke Rev. Stat. §3466 (1875), 31 U. S. C. §191.

⁴ The charges against Field were nolled on April 4, 1973 .

⁵ Although the United States could have moved to supplement or correct the findings on the issue of ownership of the seized money; Practice Book §§ 3034-3035, 3038-3039; it failed to do so.

⁶ Although the United States initially assigned these conclusions as error, the arguments were not briefed and hence are considered abandoned. State v. Brown, 169 Conn. 692, 706, 364 A. 2d 186 (1975).

⁷ There may also arise the problem of allocation of the fund between Bucchieri and Field, since the tax lien against each individually was in the amount of $3706.75, while the seized property totalled $4718.11.

⁸ The last case prior to United States v. Vermont to give local liens priority over a federal tax lien was United States v. New Britain, 347 U. S. 81, 74 S. Ct. 367, 98 L. Ed. 520 (1954), in which specific, perfected municipal liens for real estate taxes and water rent were held prior to a general, perfected United States tax lien on the theory of "first in time, first in right."

⁹ The jeopardy assessment provision of the Internal Revenue Code is I. R. C. §6861, 26 U. S. C. §6861.

 

 

[76-1 USTC ¶9430] United States of America (Treasury Department, Internal Revenue Service), Appellant v. Globe Corporation, an Illinois corporation, Appellee

Ariz. Supreme Court, No. 11726, 2/5/76, Rem'g unreported Superior Court decision

[Code Sec. 6323]

Tax liens: Priority: Landlord's lien: Filing.--A tax priority dispute between the government and a company that claimed a contractual landlord's lien was remanded for the lower court to determine whether the company had filed an adequate financing statement and, if it had, whether the county recorder's office had established an index for filing financing statements at the time of filing. Had an index been established and the company not directed that its document be filed as a financing statement, the government would not have been charged with notice of it at the time it filed its tax lien and the government's lien would have priority.

William C. Smitherman, United States Attorney, James P. Loss, Assistant United States Attorney, Phoenix, Ariz., Scott P. Crampton, Assistant Attorney General, Meyer Rothwacks, Elmer J. Kelsey, William M. Brown, Department of Justice, Washington, D. C. 20530, for appellant. Francis J. Slavin, Jr., Fennemore, Craig, Von Ammon & Udall, Suite 1700, First Nat'l Bank Plaza, 100 W. Washington St., Phoenix, Ariz., for appellee.

STRUCKMEYER, Vice Chief Justice:

The Valley Gin Company, as plaintiff in the Supreme Court, commenced this action to determine the proper party to receive $15,694.10, the balance of the proceeds from crops grown on land leased by the Globe Corporation to Lee Wong Farms, Inc. The Superior Court, after authorizing the deposit of the fund with the court, awarded the Valley Gin Company $635.40 as costs and attorneys' fees from the fund and ordered that the Valley Gin Company be dismissed from the action. Both the United States and the Globe Corporation were named defendants. Both filed motions for summary judgment. The court below denied the motion of the United States and granted the motion of the Globe Corporation. The United States has appealed. The judgment is set aside and this cause is remanded with directions.

[Facts]

The facts are not in dispute. Lee Wong Farms, Inc. leased certain lands from the Globe Corporation. The lease, dated December 29, 1966 , was for four years and provided for an annual rental of $45,000 payable in equal installments on January 1 and August 1 of each year. Pursuant to the lease, Lee Wong Farms, Inc. was in possession of the demised property in April of 1970, at which time it planted a cotton crop scheduled for harvest in late 1970. The cost of planting and growing the crop was advanced by the Valley Gin Company. In the summer of 1970, Lee Wong Farms, Inc. encountered financial difficulty and was unable to meet its obligations. Consequently, the Valley Gin Company took over the harvesting and processing of the crop and satisfied its claim from the proceeds. The balance was interpleaded with the result as stated.

The United States claimed the fund by reason of certain tax liens filed during June and July of 1970. Globe claimed the fund because Lee Wong Farms, Inc. failed to make the rental payment due August 1, 1970 . Globe has asserted both a statutory and a contractual landlord's lien on the fund, either of which it claims is entitled to priority over the federal tax liens. The United States on appeal contends that the statutory landlord's lien was inchoate (was not a perfected security interest) at the time the federal tax liens were filed, that the contractual landlord's lien did not constitute a properly protected security interest under the Uniform Commercial Code, and that neither the statutory landlord's lien or the contractual landlord's lien is entitled to priority over the federal tax liens. The United States also contends that since its liens are entitled to priority, the trial court erred in awarding Valley Gin Company costs and attorneys' fees.

[Statutory Landlord's Lien]

By the United States Internal Revenue Code, §6321, there is created a lien in favor of the United States upon all property and rights to property belonging to any person who neglects or refuses to pay his tax liability after demand. The lien arises at the time the assessment is made and continues until the liability for the assessed amount is satisfied or becomes unenforceable by reason of lapse of time. Internal Revenue Code, §6322. The liens asserted by the United States are based on taxes assessed during May and June of 1970 and recorded pursuant to the authority of §6323 during June and July of 1970.

Globe asserts a statutory lien by reason of A. R. S. §33-362(C), reading:

"C. The landlord shall have a lien for rent upon crops grown or growing upon the leased premises, * * * and the lien shall continue for a period of six months after expiration of the term of the lease."

As stated, the United States ' position is that Globe's lien was not a perfected security interest and therefore it was not entitled to priority over the federal liens.

Under Arizona law, a landlord has a lien for rent upon crops grown or growing on the leased premises until the rent is paid, A. R. S. §33-362(C), supra, and the lien attaches at the beginning of the tenancy. In re Menzies, 60 F. 2d 1064 (D. C. Ariz. 1932); Dewar v. Hagans, 61 Ariz. 201, 146 P. 2d 208, 151 A. L. R. 673 (1944). The lien is for rent due or to become due, Murphey v. Brown, 12 Ariz. 268, 100 P. 801 (1909). The landlord acquires a fixed, specific lien in the amount of the rent due on his tenant's goods and property rather than a mere claim for priority of payment. In re Menzies, supra. The lien exists independent of any proceedings. Dewar v. Hagans, supra.

While agreeing that the Arizona law is as stated, the United States urges that merely because the landlord's lien attaches at the beginning of the tenancy does not mean that it is so perfected as to have priority over the federal tax lien. As to this, a lien may be classified by the state as choate (specific and perfected) so as to defeat other state liens, but whether it is sufficient to defeat a federal tax lien is a question of federal law. United States v. Pioneer American Insurance Co. [62-2 USTC ¶9532], 374 U. S. 84, 83 S. Ct. 1651, 10 L. Ed. 2d 770 (1963); United States v. Scovil [55-1 USTC ¶9137], 348 U. S. 218, 75 S. Ct. 244, 99 L. Ed. 271 (1955); United States v. City of New Britain, Conn. [54-1 USTC ¶9191], 347 U. S. 81, 74 S. Ct. 367, 98 L. Ed. 520 (1954); Kuffel v. United States, 103 Ariz. 321, [68-2 USTC ¶9487] 441 P. 2d 771 (1968).

To have priority over a federal tax lien, a state lien must be choate under federal law. United States v. State of Vermont [64-2 USTC ¶9520], 377 U. S. 351, 84 S. Ct. 1267, 12 L. Ed. 2d 370 (1964); United States v. Security Trust & Savings Bank [50-2 USTC ¶9492], 340 U. S. 47, 71 S. Ct. 111, 95 L. Ed. 53 (1950); T. H. Rogers Lumber Company v. Apel, 468 F. 2d 14 (10th Cir. 1972). To be choate under federal law, the identity of the lienor, the identity of the property subject to the lien and the amount of the lien must be certain. United States v. City of New Britain, Conn., supra.

Globe's position is that the choate doctrine is no longer applicable because the Federal Tax Lien Act of 1966 was adopted subsequent to the cited cases and that it set new standards for determining when a state lien prevails over a federal tax lien. It is argued that Globe's statutory lien qualifies for priority under the Federal Tax Lien Act of 1966 for either of two reasons. First, because Globe qualifies as a holder of a "security interest" under the Internal Revenue Code §§ 6323(a) and 6323(h)(1).

Section 6323(a) provides that:

"[t]he lien imposed by section 6321 shall not be valid as against any * * * holder of a security interest * * * until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary or his delegate."

Section 6323(h)(1) defines a "security interest" as:

"any interest in property acquired by contract for the purpose 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."

However, while Globe's statutory landlord's lien arises out of the landlord-tenant relationship, the lien is not within the meaning of §6323(a).

The purpose of the Federal Tax Lien Act was to conform the internal revenue laws with the developments in the Uniform Commercial Code, Senate Report No. 1708, House Report No. 1884, 89th Congress, 2d Session (1966). The security interest referred to in the tax act must therefore be read in conjunction with the Uniform Commercial Code.

Article nine of the Uniform Commercial Code does not apply to this statutory lien. A. R. S. §44-3102(B) A lien which is not protected as a security interest by the Uniform Commercial Code is not a security interest within the meaning of §6323(a) of the Federal Tax Lien Act. United States v. Sterling National Bank & T. Co. of N. Y. [73-2 USTC ¶9494], 360 F. Supp. 917 (S. D. N. Y. 1973), aff'd in part, rev'd in part on other grounds, [74-1 USTC ¶9336] 494 F. 2d 919 (2d Cir. 1974). See also Plumb, Federal Liens and Priorities, 77 Yale L. J. 605, 680-682 (1968). Because Globe's statutory lien was not protected as a security interest under the Uniform Commercial Code, it is not entitled to priority under §6323(a) of the Federal Act.

Globe also contends that its statutory lien qualifies for a priority status under the provisions of §6323(c).

Section 6323(c)(1) reads:

"To the extent provided in this subsection, even though notice of a lien imposed by section 6321 has been filed, such lien shall not be valid with respect to a security interest which came into existence after tax lien filing but which--

(A) is in qualified property covered by the terms of a written agreement entered into before tax lien filing and constituting--

(i) a commercial transactions financing agreement,

(ii) a real property construction or improvement financing agreement, or

(iii) an obligatory disbursement agreement, and

(B) is protected under local law against a judgment lien arising, as of the time of tax lien filing, out of an unsecured obligation."

Section 6323(c)(3)(A) defines a "real property construction or improvement financing agreement" as:

"an agreement to make cash disbursements to finance--

(i) the construction or improvement of real property,

(ii) a contract to construct or improve real property,

or

(iii) the raising or harvesting of a farm crop or the raising of livestock or other animals.

For purposes of clause (iii), the furnishing of goods and services shall be treated as the disbursement of cash." (Emphasis supplied)

Globe contends that it meets the requirements of §6323(c)(1) since it had entered into a written agreement of lease before the government's lien was filed, which agreement required it to furnish to Lee Wong Farms the lands upon which it raised and harvested a farm crop. Globe construes the word "goods" as including farm lands and so concludes it is entitled to priority status. But we think such a construction is contrary to the meaning of the word "goods" as personal property. Words must be accorded their obvious and natural meaning. Mendelsohn v. Superior Court, 76 Ariz. 163, 261 P. 2d 983 (1953).

There are, however, other reasons for denying Globe priority status. The disbursements covered in §6323(c)(3) were discussed in Senate Report No. 1708, supra. The types of financing agreements covered:

"are generally those involving disbursements to an owner of a property for the construction or improvement of real property, or to a builder for a contract to construct or improve real property, as well as disbursements for the raising or harvesting of farm crops or the raising of livestock or other animals. Protection is limited to interests arising from cash disbursements by the lender except in the case of the financing of a farm crop, livestock, or other animals, where the disbursement may also be in the form of the supplying of goods or services." Senate Report No. 1708, supra, page 8.

The House also refers to the types of disbursements covered:

"a person financing a farm crop is protected to the extent of the value of the seed he furnishes to the farmer to plant a wheat crop and the value of the use of a combine to harvest that crop, as well as cash disbursements he makes to provide funds to pay farm laborers needed to plant and harvest the crop." House Report No. 1884, supra, page 43.

There is no indication whatsoever that the rent for farm lands is included within the coverage.

Furthermore, the term "qualified property" includes only:

"in the case of subparagraph (A)(iii), property subject to the lien imposed by section 6321 at the time of tax lien filing and the crop or the livestock or other animals referred to in subparagraph (A)(iii)." Internal Revenue Code §6323(c)(3)(B)(iii).

Globe's farm lands are not subject to the lien created by §6321 and are not entitled to priority over the federal tax liens under Internal Revenue Code §6323(c).

Since the Federal Tax Lien Act does not give Globe's lien a priority, this case must be determined by the principle first in time, first in right. United States v. City of New Britain, Conn., supra. The priority of the liens depends on the time they became specific and perfected. In House Report No. 1884, cited supra, at page 35, the choate doctrine as expressed in United States v. City of New Britain, Conn., supra, is specifically retained in the new §6323(a); that is, the state lienor is protected if at the time notice of the tax lien is filed the identity of the lienor, the property subject to the lien, and the amount of the lien are all established. Several federal cases have applied the choate doctrine since 1966. See e.g., Texas Oil & Gas Corporation v. United States [72-2 USTC ¶9653], 466 F. 2d 1040 (5th Cir. 1972); T. H. Rogers Lumber Company v. Apel, supra. The choate doctrine is still viable and must be met by a lienor in order to prevail over a federal tax lien.

Globe's statutory lien does not meet the choate principle. The amount of Globe's lien was not certain and specific within the meaning of the applicable federal law. True, Globe's lien related back to the date of the making of the lease, the beginning of the tenancy, and was good for all State purposes. Still, under federal law, its lien was inchoate in June and July when the federal tax lien was filed.

"It is clear that Lawler's lien for rent cannot be paid out of the fund interpleaded before the Government's tax lien. Section 6321 does not confer a priority on the lien it creates, but the lien created by its language did attach to all of Walker 's property, pursuant to §6322, when the assessment was made on August 31, 1956 . While under Virginia law Lawler has a specific and not merely inchoate lien, which relates back to July 1, 1949 , the beginning of the tenancy, and good for all state purposes, under federal law his lien was inchoate at the time the federal tax lien arose and was duly recorded on October 26, 1956 , in the proper offices. At the time the federal tax lien attached to Walker 's property, he was not in default in the payment of rent, and the distress warrant and writ of attachment were not issued until several months thereafter. Lawler's lien had not been perfected in a federal sense when the federal tax lien came into existence. His lien was only 'a caveat of a more perfect lien to come.'" United States v. Lawler, 201 Va. 686, 112 S. E. 2d 921 at 926 (1960).

And see United States v. Waddill, Holland & Flinn [45-1 USTC ¶9126], 323 U. S. 353, 65 S. Ct. 304, 89 L. Ed. 294 (1945).

[Contractual Landlord's Lien]

Globe also argues that it has a contractual landlord's lien which constitutes a protected security interest and, therefore, it has priority over the federal tax liens. The United States agrees that if Globe had properly recorded its interest in the leased premises it would have had priority over the federal liens, but because Globe only recorded its lease under the index for leases in the Maricopa County Recorder's Office, and not under the index for secured transactions, the lease was not properly recorded as a security interest. Globe replies that it was not required to record its security agreement in order to obtain a priority because A. R. S. §44-3104(2) excludes landlord's liens from the filing requirements of the Uniform Commercial Code. We, however, are of the opinion that contractual landlord's liens are not excluded from the filing requirements of the Uniform Commercial Code.

The principal test as to whether a transaction falls within Article 9 of the Uniform Commercial Code is whether the transaction was intended to have effect as security. Official Comment 1 to U. C. C. §9-102 (A. R. S. §44-3102). Excluded are security interests that arise by statute or common law and not by the consent of the parties. Those cases which have considered the landlord's lien exclusion have concluded that landlord's liens arising out of contract are not excluded from the filing requirements. See In re Leckie Freeburn Coal Company, 405 F. 2d 1043 (6th Cir. 1969); In re King Furniture City, Inc., 240 F. Supp. 453 (E. D. Ark. 1965); Universal C. I. T. Credit Corp. v. Congressional Motors, 246 Md. 380, 228 A. 2d 463 (1967); Dunham's Music House, Inc. v. Asheville Theatres, Inc., 10 N. C. App. 242, 178 S. E. 2d 124 (1970). The reasoning of these cases is persuasive. While statutory liens and liens arising from operation of law are excluded from filing by A. R. S. §44-3104(2), a lien granted a lessor by contract is not excluded by the Uniform Commercial Code. Since the Code's filing requirements apply, Globe's contractual landlord's lien must have properly filed to have priority.

Arizona enacted the Uniform Commercial Code, A. R. S. §44-2201, et seq., effective January 1, 1968 . Pursuant to the Code, A. R. S. §44-3123, a financing statement must be filed to perfect all security interests with certain exceptions not here applicable. A. R. S. §44-3140(A)(1) provided at the time Globe filed its lease that:

"The proper place to file in order to perfect a security interest is as follows:

1. When the collateral is * * * farm products * * * then in the office of the county recorder in the county of the debtor's residence or if the debtor is not a resident of this state then in the office of the county recorder in the county where the goods are kept, and in addition when the collateral is crops in the office of the county recorder in the county where the land on which the crops are growing or to be grown is located." Laws 1967, Ch. 3, §5.

Since both the debtor's residence and the county in which the land is located was Maricopa County , the financing statement had to be filed in the Maricopa County Recorder's Office. Globe filed its lease with the Maricopa County Recorder on February 6, 1970 .

A. R. S. §44-3141(A) provided at the time Globe filed its lease that:

"A financing statement is sufficient if it is signed by the debtor and the secured party, designates by typing or printing the names and mailing addresses of both the debtor and the secured party and contains a statement indicating the types, or describing the items, of collateral. A financing statement may be filed before a security agreement is made or a security interest otherwise attaches. When the financing statement covers crops growing or to be grown, or timber to be cut, or goods which are or are to become fixtures, the statement must also contain a description of the real estate concerned. A copy of the security agreement is sufficient as a financing statement if it contains the above information and is signed by both parties." Laws 1967, Ch. 3, §5. (Emphasis supplied)

Unfortunately, the lease is not a part of the record before this Court and, therefore, we are unable to determine whether the lease was sufficient as a financing statement within the meaning of §44-3141(A).

A. R. S. §11-462, as it read at the time Globe filed its lease, provided for an index of leases, but not for an index of secured transactions. We also find nothing in the record before us to establish that the Maricopa County Recorder's Office kept an index of secured transactions in February of 1970, when Globe filed its lease. Accordingly, we cannot say whether, as the United States argues, Globe's lease was improperly filed under leases. This case must, therefore, be set aside and remanded to the Superior Court.

If it is determined that Globe's lease was sufficient as a financing statement, the Superior Court must then determine whether the Maricopa County Recorder's Office had established an index for the filing of financing statements under the Uniform Commercial Code at the time Globe filed its lease. If there was an index for financing statements and Globe did not direct that its lease be filed as a financing statement, the court below shall enter judgment in favor of the United States, for we consider the law is correctly set forth in In re Leckie Freeburn Coal Company, supra at 1046,

"When dealing with a multi-purpose document, it is incumbent upon the filing party to disclose to the Clerk the purpose for recording. In the present case the record does not show that Appellants had directed the Clerk to record the lease as a financing statement when they paid the filing fee. * * *

* * * To allow constructive [sic] notice in this case would defeat the purposes of the recording statutes. One object of filing a financial statement is to insure a bona fide purchaser that his title will not be encumbered. For the Court to hold that the filing of this instrument as a lease provided constructive notice to those searching the records for a financing statement would be wholly illogical."

[Issue Not Raised Below]

Finally, the United States questions the right of the trial court to award Valley Gin Company costs and attorneys' fees out of the fund. As stated, Valley Gin Company was dismissed from the action by the trial court after it was ordered to deposit the crop proceeds with the Clerk of the Superior Court, less costs and attorneys' fees. The United States did not object to the order allowing costs and attorneys' fees and has not named the Valley Gin Company as an appellee in this appeal. Claimed errors which are not called to the attention of the lower court will not be considered on appeal. City of Tucson v. Wondergem, 105 Ariz. 429, 466 P. 2d 383 (1970); Milam v. Milam, 101 Ariz. 323, 419 P. 2d 502 (1966). Since the United States did not object to the award of costs and attorneys' fees in the court below, the asserted error will not be considered in this Court.

It is ordered that the judgment herein is set aside and this cause is remanded with directions.

 

 

[62-1 USTC ¶9341]J. K. & W. H. Gilcrest Company, Appellee v. A. & R. Concrete Company, United States of America, et al., Appellants

Iowa Supreme Court, Nos. 212, 50465, 112 NW2d 366, 12/12/61, Reversing and remanding decision of Polk District Court of Iowa

[1954 Code Secs. 6321 and 6322]

Priority of liens: U. S. tax lien v. subcontractor's mechanic's lien.--Because Iowa law provided that no owner of real estate must pay the principal contractor any sums under the building contract until the expiration of 60 days from the completion of the improvement and that a subcontractor's mechanic's lien can be perfected only if filed within 60 days after such completion, the date of completion was an essential fact not found. If 60 days from completion had expired, then the taxpayer-principal contractor had "property" to which the federal tax lien could attach. But if the subcontractor had perfected his mechanic's lien within the 60 days, then he would be entitled to priority. The trial court's decision giving the subcontractor's claim priority over the tax lien was without sufficient basis in fact and was thus reversed and remanded for this determination of fact.

Roy W. Meadows, United States Attorney, Louis F. Oberdorfer, Assistant Attorney General, and John B. Jones, Jr., Meyer Rothwacks, and George F. Lynch, Department of Justice, Washington 25, D. C., for appellants. Neiman, Neiman & Stone, Des Moines , Iowa , for appellee.

THOMPSON, Judge:

Plaintiff's action alleged its right to a subcontractor's mechanic's lien against certain real estate and prayed foreclosure as against all defendants. These included the principal contractor, the realty owners, the United States , and certain others. Rights as between the principal contractor and the owners of the real estate were previously determined in A. & R. Concrete & Construction Company v. Braklow, -- Iowa --, 103 N. W. 2d 89. It was there adjudged that the owners were indebted to the contractor in the total sum of $3,933.07. This sum was paid into the clerk of the district court. In the instant case a partial decree of the trial court entered on November 12, 1960 , to which no exception is taken, granted certain defendants other than the United States rights to part of the money on hand, leaving a remainder of $1,814.18. The cause was continued solely on the issues as to the priority of the claims of the plaintiff and the United States to this sum. By answer, the United States denied the priority of plaintiff's claim and prayed that its tax liens against the principal contractor be held to be prior and superior to any rights of the plaintiff to the fund in the hands of the clerk. The trial court found this issue with the plaintiff in the total amount of its claim, with interest, $1,681.04; directed payment of court costs in the amount of $52.00; and awarded the remainder of $81.14 to the United States . The United States appeals.

I. No question is made that the money in the hands of the clerk stands in the place of the real estate which was improved or that the liens attach to it in whatever order of priority may eventually be determined. The United States states in the record that its appeal is limited to the following point on which it relies: "The Court erred in granting priority to the claims of (the plaintiff) over the tax lien of the United States of America . The abstract above contains all matters necessary to review such point."

[Subcontractor's Lien]

The facts were stipulated and the case tried solely on the stipulation. We think it omits one vitally important fact, which we shall later point out. Otherwise, after reciting the agreement between the principal contractors and the owner, it stipulates that the plaintiff herein furnished certain materials used in and upon the premises of the reasonable value of $1,541.92, the last item being supplied on November 20, 1958 . Further facts stipulated are that the plaintiff's claim for a mechanic's lien as a subcontractor was filed on September 3, 1959 , and notice of such filing served on the owners on September 5, 1959 .

[Government's Lien]

That the United States assessed taxes for withholding and social security against the principal contractor on March 27, 1959, in the sum of $3,029.10; and on May 22, 1959, assessed further taxes of $999.03, making a total of $4,028.13. On September 14, 1960 [1959], a notice of levy of taxes was served on the building owners; and on September 29, 1959 , a notice of the federal tax lien was filed in the office of the county recorder of Polk County . It is further stipulated that the funds in the hands of the clerk stand in lieu of the real estate and the liens of the contending parties attach to such funds in the same manner as they would have to the realty; and that the parties are entitled to foreclosure of their liens against said moneys in such order of priority as the court may determine. The stipulation is silent as to the date on which the work on the real estate was completed by the principal contractor.

[Essential Fact Missing]

II. Each party to the contention here asks that its lien be established as prior and superior. We think, because of the absence of an essential fact in the record, that no adjudication in favor of either can be made.

This fact is the above noted absence of the date on which the principal contractor completed its work. We shall attempt to make clear our reasons for so holding.

[ Iowa Statute]

Section 572.13, so far as material, is quoted: "Liability of owner to original contractor. No owner of any building, land, or improvement upon which a mechanic's lien of a subcontractor may be filed, shall be required to pay the original contractor for compensation for work done or material furnished for said building, land, or improvement until the expiration of sixty days from the completion of said building, or improvement * * *." The section further provides that the first paragraph does not apply if receipts or waivers of subcontractors' claims are furnished, or a performance bond is given by the principal contractor. Neither of these exceptions, however, appears in the present case and we give them no further attention. It will be noted the quoted and material part of the section makes sixty days from the completion of the work by the principal contractor the time when he will be entitled to receive payment from the owner, absent any filed claims for subcontractors' liens.

[Relevant Code Sections]

III. The United States relies upon Sections 6321 and 6322 of 26 U. S. C., 1958 edition. We quote them. "Lien for Taxes. 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.

"Period of Lien. 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 is satisfied or becomes unenforceable by reason of lapse of time."

A following section says that "the lien shall not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until notice has been filed by the collector * * * in the office in which the filing of such notice is authorized by the law of the State * * * in which the property subject to the lien is situated." A mechanic's lien is obviously not within any of the four classes named, and we give this section no further consideration.

[Lien Qualifications]

In Illinois ex rel. Gordon v. Campbell, 329 U. S. 362, 374, 375, 376, 67 Sup. Ct. 340, 347, 91 L. Ed. 348, 357, it is said: "The long-established rule requires that the lien must be definite, and not merely ascertainable in the future by taking further steps, in at least three respects as of the crucial time. These are: (1) the identity of the lienor * * *; (2) the amount of the lien * * *; and (3) the property to which it attaches. It is not enough that the lienor has power to bring these elements, or any of them, down from broad generality to the earth of specific identity." We quoted this with approval in In Re Estate of Lanc, 244 Iowa 1076, 1079, 1080, 59 N. W. 2d 593, 595. It is evident that paintiff's lien here meets the first and third tests. The identity of the lienor is established, and likewise the specific property to which it attaches. But it fails as to (2), because the amount is unliquidated and uncertain. It is not enough that a specific amount be named in the lien claim; if further proceedings are required to establish it in a definite amount against the property, as by foreclosure, it is not specific and perfected within the meaning of the law. Evans v. Stewart, 245 Iowa 1268, 1274, 1275, 66 N. W. 2d 442, 445; In re Estate of Lanc, supra, loc. cit., 244 Iowa 1080, 59 N. W. 2d 595; United States v. Texas [42-1 USTC ¶9162], 314 U. S. 480, 62 S. Ct. 350, 86 L. Ed. 356. So at the time the taxes against the principal contractor were assessed by the United States in the instant case, the plaintiff's lien was not specific and perfected and the government's lien was prior.

["No Debt" Rule]

IV. However, there is another consideration which arises from application of what is known as the "no debt" rule. This might also be designated as the "no property" rule. If the debtor against whom the United States taxes were assessed had no property to which their lien might attach, of course it may not be enforced. So far as this case is concerned, the only property with which we need be concerned was the indebtedness, if any there was, owing to the principal contractor by the property owners. This is now represented by the money in the hands of the clerk, the right to which is the subject of the present litigation. It is settled that in this class of cases, the first question is to what property of the taxpayer the federal tax liens may attach. In determining the taxpayer's interest in property claimed to be subject to such liens, the state law is the governing rule. Aquilino v. United States [60-2 USTC ¶9538], 363 U. S. 509, 512, 516, 80 S. Ct. 1277, 1280, 4 L. Ed. 2d 1365; United States v. Durham Lumber Company [60-2 USTC ¶9539], 363 U. S. 522, 524, 527, 80 Sup. Ct. 1282, 1283, 4 L. Ed. 2d 1371. When the property interests have been determined according to the law of the state, the priority of the competing liens is measured by federal law. Aquilino v. United States, supra.

[Contractor's Property Rights Depend on Missing Fact]

It remains to be decided whether the delinquent taxpayer, the principal contractor in the case at bar, had property rights to which the federal liens might attach when the tax assessments were levied or later while they were still unsatisfied. Here section 572.13 of the 1958 code of Iowa becomes of primary importance. It will be noted that under its provisions no owner of real estate is required to pay the principal contractor any sums that might otherwise be due under the building contract until the expiration of sixty days from the time of completion of the improvement. So, under the interpretation put upon this section in previous cases, there is no "debt" due the contractor until the sixty day period has elapsed, and consequently the contractor has no property right which may be subjected to liens of the United States during that time. Wolverine Insurance Company v. Phillips [58-2 USTC ¶9765], 165 Fed. Supp. 335, 354; Fidelity & Deposit Company v. New York City Housing Authority, 2 Cir., [57-1 USTC ¶9410] 241 Fed. 142, 145, 147; United States v. Bess [58-2 USTC ¶9595], 357 U. S. 51, 56, 78 Sup. Ct. 1054, 1057, 2 L. Ed. 2d 1135; Beane Plumbing & Heating Company v. D-X Sunray Oil Company, 249 Iowa 1364, 1371, 1372, 1373, 92 N. W. 2d 638, 643, 644.

So it is clear that the United States liens attached only to such property as the debtor contractor had when the taxes were assessed, or which he might thereafter acquire while they remained unpaid. Under the authorities above cited, there was no debt during the sixty days following the completion of the improvement. But, when this period expired, with the lien of the plaintiff still not filed, if such be determined to be the case, the tax liens at once attached to the sum then due from the owners to the principal contractor. The time of "no debt" was past; a debt existed. For the purpose of this case, it was not important that the plaintiff did not file its claim for a mechanic's lien within sixty days from the time it furnished the materials; it is of decisive importance whether it filed within sixty days from the completion of the work by the principal contractor.

The point is well made by Federal Judge Henry Graven of the United States District Court for the Northern District of Iowa, in Randall v. Colby [61-1 USTC ¶9178], 190 Fed. Supp. 319, 326-337 inclusive. In that case one mechanic's lien claimant, Randall, had not filed his claim within sixty days from the time he furnished material or labor, but did file within sixty days from the completion of the work by the principal contractor. Standard Glass & Paint, another claimant of a subcontractor's lien, did not file until after sixty days from completion of the work. It was held that Randall's lien was superior to the federal tax liens, but Standard's was not. Sixty days after the work was completed, Randall's claim being on file, the "debt" due from the owner to the chief contractor was diminished by that amount and the property to which the federal liens could attach was so much less. But Standard's claim was not on file; the "debt" of the owner to the contractor was matured and became property of the contractor who owed the taxes which had been assessed. The liens for these taxes at once attached. It is said: "It seems clear that under the Federal law once a right arises in favor of a contractor against whom a Federal tax lien is outstanding to a portion of the contract price, the tax lien attaches to that portion immediately. It would also seem clear that once a Federal lien has attached to such a portion it is no longer a part of the balance 'due' the contractor but is 'due' to the Government." Randall v. Colby, supra, loc. cit., 190 Fed. Supp. 335.

[Beane Decision Modified]

This will to some extent modify our holding in Beane Plumbing and Heating Company v. D-X Sunray Oil Company, supra. The United States was not a party to that action and several of the authorities cited above had not then been decided; we did not consider the difference between the situations in which the subcontractor's lien was filed within the sixty day period in which the owner is not required to pay the contractor. and the one in which it was filed later. In the second instance we now hold that the United States tax liens, duly assessed, obtain priority. In fairness to the trial court, it should be said that it apparently followed the Beane case, which it felt it could not modify or disregard.

This points up the deficiency in the stipulation of facts upon which the case was tried. The stipulation says that "the following are the facts in this case." The case must be tried upon the facts so stipulated. But what we consider to be the governing fact--that is, the date when the work was actually completed by the principal contractor so that the sixty day period in which there was no "debt" due from the owner to him could be determined--is nowhere stated.

[Statement of Applicable Law]

Summarizing, our holding is that the law as applied to the instant case is this: United States tax liens can attach only to "property" of the debtor taxpayer, the principal contractor; debts owed by the building owner are "property" of the contractor; there is no debt, and consequently no "property" until the expiration of the sixty day period from completion of the work; this is so because the Iowa statute, Section 572.13, supra, says so; when the sixty day period has ended, there is a debt due from the owners to the principal contractor in such amount as may remain unpaid and not diminished by the amount of any subcontractor's liens that may be then on file; if any such claims for liens are then on file, the debt, and so the "property" is so much less; if such claims are not on file, although they may be in existence, the lien of the assessed and unpaid federal taxes attaches and becomes prior and superior to them.

[Reversed and Remanded]

We have concluded that the only means of resolving this situation is to remand the case to the trial court for a determination of fact. If it is found that the plaintiff's claim for a mechanic's lien was actually filed within this sixty day period, it will be entitled to priority; if not, the United States liens will be superior. No other issues, either of fact or law, will be considered.

The decree of the trial court must be reversed, since there is no sufficient basis in fact for its determination. Nor do we think it would be sufficient to reverse without requiring a finding of the fact as to time above referred to. Each party is affirmatively claiming priority; neither has proven it. This priority should be determined so that the respective rights may be known and disposition of the fund in the hands of the clerk of the court may be made.

Costs will be taxed equally to the parties; except that only $1.50 per page will be allowed appellant for printing the record and its brief and argument.

Reversed and remanded for further determination of facts, and for such decree as may appear proper in view of such determination and our holdings above.

All Justices concur, except Bliss, Judge, not sitting.

 

 

[55-2 USTC ¶9653]Tanenbaum Textile Co., Inc., Plaintiff-Respondent v. Vogue Foundations, Inc., a Corporation Herman Golden, Defendants v. The United States of America , Intervenor-Appellant

In the Superior Court of New Jersey, Appellate Division, A-440-54, 116 A2d 697, September 2, 1955

[1939 Code Sec. 3672--similar to 1954 Code Sec. 6323]

Tax lien: Priority of rights: United States v. subcontractor under government contract: New trial ordered.--In an action involving a determination of rights to a check issued by a government agency in satisfaction of a contract such agency had awarded to a contractor (to whose order the check was made payable), the court ordered a new trial because of many unanswered questions. Claim to the check is made by a firm which had been under contract to furnish raw materials to the original contractor and also by the United States for satisfaction of tax liens against such contractor. The complaint (filed by the raw material supplier) predicated the right to possession of the check on an April, 1952, agreement involving the complainant, the contractor, and a bank in which a special account of the contract proceeds was to be opened for the benefit of the complainant because of the contractor's financial difficulties. However, the trial brought to light further transactions whereby the original contractor, for the same financial difficulties, had assigned the contract to another subcontractor who ultimately finished the work and to whom the complainant also supplied raw materials. This transaction (by virtue of a June, 1952, agreement) raises many other issues on which the determination of a right to the check hinges. Principally, it must be determined to whom the check really "belongs" because the tangible or intangible property must belong to the taxpayer in order to be subject to a lien by the government for unpaid taxes. Consequently, a new trial was ordered so that the case might be fully presented to the court.

Samuel A. Larner (Budd, Larner & Kent, 60 Park Pl. , Newark , N. J.), for respondent. James C. Pitney, 744 Broad St., Newark, N. J., Assistant United States Attorney (Raymond Del Tufo, Jr., Federal Building, Newark, N. J., United States Attorney), for appellant.

Before FRANCIS, HALL and BURTON , Judges.

FRANCIS, Justice:

Plaintiff Tanenbaum Textile Co. brought this action in replevin to obtain possession of a check dated November 13, 1952 , in the amount of $6,284.25 drawn on the Treasurer of the United States by the New York Quartermaster Procurement Agency to the order of defendant Vogue Foundations, Inc. The check had been endorsed in blank by Vogue and was in the hands of its attorney, the defendant Herman Golden, Esq. Pursuant to the writ the Sheriff seized the instrument and delivered it to Tanenbaum which posted a bond to secure payment in accordance with the judgment of the court.

The United States of America intervened through the District Director of Internal Revenue, claiming the proceeds by virtue of certain tax liens against Vogue. Golden asserted rights in the check by reason of an alleged attorney's lien for services rendered to Vogue. Vogue counterclaimed but its answer and counterclaim in the replevin action are not included in the appendix and consequently the nature of the claim does not appear. The pretrial order reserved the counterclaim for disposition by jury trial at a later time. In answer to the intervention, Vogue admitted the existence of tax liens in an amount in excess of the check and also that as to it the United States had a prior right to the sum represented thereby. The admission could not have been avoided since prior to November 13, 1952 unpaid taxes withheld by Vogue totaling $13,193.48 had appeared on the assessment list received by the District Director, and thus constituted liens. 26 U. S. C. A. 3671 (1940). In fact, $11,478.69 of these liens had been recorded with the Register of Essex County prior to the assignment and the agreements hereafter referred to.

After hearing without a jury, the trial court determined that Tanenbaum was entitled to the check and the proceeds thereof and that its right was paramount to the tax lien. Golden was declared to have no interest therein. Judgment was entered for Tanenbaum against all defendants. The United States filed this appeal.

Absence of disposition of the Vogue counterclaim raised a serious question as to whether an appealable final judgment existed. The right of appeal arises only when a controversy presented to the trial court is adjudicated as to all parties and all issues (Peterson v. Falzarano, 6 N. J. 447, 453 (1951); Vollbehr v. Ingram, 22 N. J. Super. 249 (App. Div. 1952)), subject to the qualification established by R. R. 4:55-2, which was not taken advantage of here. However, our inquiry at the oral argument elicited the undisputed information that the counterclaim has since been withdrawn. On this agreement we shall deal with the issues presented.

Recital of the facts is necessary to an understanding of the claims of the parties.

[Facts]

On December 6, 1951 , the New York Quartermaster Procurement Agency awarded a contract to Vogue for the manufacture of 250,000 waterproof clothing bags at a price of $1.05 per bag. Delivery was to be made between March 31 and June 30, 1952 . Apparently in anticipation thereof, Tanenbaum contracted to furnish the material necessary to the making of the bags, namely, 254,500 yards if $.7538 per yard. The terms called for payment 10 days after delivery of each shipment.

Between February and April 1952, Tanenbaum delivered in excess of 21,000 yards of the cloth. On April 15, Vogue was advised that its credit line was exhausted and unless satisfactory arrangements were made, further shipments would be on a cash basis only.

As the result, on April 25, 1952 a letter agreement was entered into under which Tanenbaum undertook to advance $1,500 to Vogue to enable it to meet current payroll expenses, and further to deliver the balance of the yardage to complete the commitment to the government. To assure payment, Vogue agreed to establish a special account in a bank to be selected by Tanenbaum and to deposit therein all moneys received from the United States for performance of the clothing bag contract, subject to withdrawal only on the signature of an officer of Tanenbaum.

Tanenbaum was further authorized thereby to draw on the account for reimbursement of the $1,500 and to the extent of $.76 per bag shipped to the government. Any remaining balance was to be turned over to Vogue. The account was to continue until all goods sent to Vogue were paid for.

It was agreed also that Vogue would execute any documents necessary "to effectively assign to a financial institution to be designated by" Tanenbaum, "all of our right, title and interest" in the government contract to secure all monies due or to become due to Tanenbaum. The record shows that the bank account was opened. An assignment to the Bank of Manhattan Company, dated June 24, 1952 , was put in evidence. The late date was not explained.

In July, when only 26,500 bags had been delivered Vogue experienced further and apparently insurmountable obstacles in its attempt to fulfill the government contract. On July 17, 1952 the Procurement Agency was advised that an "impasse" had been reached "due to factors entirely beyond our control." The letter asserted that the lessor of the premises leased by Vogue for its manufacturing purposes had discovered that the process used in cementing the bags was contrary to the terms of the lease and had refused permission for the work to continue. Efforts to locate other quarters had been unsuccessful.

[Subcontract Approved]

On account of its inability to proceed further, Vogue requested permission to "subcontract the balance" of the contract to Electro-Plastics Fabrics, Inc. of Pulaski , Va. It proposed to do this at "no profit" and in order to expedite delinquent deliveries.

No additional cost was to be involved for the government and if any such cost arose, Vogue would absorb it. The letter pointed out that the cloth necessary for the remaining bags was being held by Tanenbaum which had agreed to deliver it to Electro.

Vogue said also that to safeguard the interests of Tanenbaum and Electro, an assignment "of all the proceeds due and to become due" under the contract would be executed to the Bank of Manhattan Company (Italics ours). This would be done upon the granting of the permission sought from Procurement. Tanenbaum endorsed its consent to the proposal at the foot of the letter and noted an additional agreement to guarantee performance by Electro.

On August 13 the Procurement Agency granted permission to subcontract the manufacture of the balance of the 223,500 bags to Electro on condition that any increased costs would be borne by Vogue and any savings would inure to the government.

Upon receipt of this approval a further tripartite agreement was entered into by Vogue, Tanenbaum and Electro on August 20. By it, Vogue agreed to deliver to Electro 1,250 bags which had been completed and 10,105 which had been partly completed. The finished bags were to be shipped by Vogue to Electro at no cost to Tanenbaum. Electro undertook to finish the partly completed bags at $.15 each. All others were to be manufactured at $.32 per bag exclusive of the cost of material, an increase of $.03 over Vogue's price. This differential was absorbed by Tanenbaum, apparently being reflected in the lower cost of the cloth to Electro.

The compact recited that Electro would be paid out of the proceeds of the contract which were "in the course of being assigned" by Vogue to the Bank of Manhattan Company. And each company stipulated that to the extent necessary to accomplish proper payment of their respective shares, instructions would be given to the Bank.

A receipt introduced in evidence shows that Vogue shipped the materials on hand to Electro on August 21. Thereafter Electro took over. Vogue did no further work on the government contract and about a month later ceased business operations entirely.

[Assignment of Proceeds of Contract]

The only assignment offered in evidence was the one already mentioned, dated June 24, 1952 . Apparently no additional one was executed after Electro was granted permission to complete the contract. Presumably it was considered unnecessary but the absence of explanation or testimony to that effect leaves the relation between this assignment and the June and August agreements in a somewhat unclear state. However the contents of the document must be noted. The recital is that Vogue has requested the Bank to lend money to finance its operations under the government contract, and because the Bank "may from time to time" lend money for such purpose "all moneys due or to become due" to Vogue under the contract are assigned to the Bank as collateral for the loans.

This assignment does not seem to conform with the language of the three-party agreement of August 20 nor the letter to the Procurement Agency of July 17 seeking permission for Electro to furnish the balance of the clothing bags. There is some ambiguous testimony in the record about a $5,000 loan by the Bank to Vogue and the payment of the loan by a check of Tanenbaum of August 12. No proof was offered as to any borrowing from the Bank after Electro entered upon the performance of Vogue's contract.

One inference to be drawn from this situation is that an effort was being made to create an assignment which would appear to run a "bank, trust company or other financing institution" within 31 U. S. C. A. §203 (1954); 41 U. S. C. A. §15 (1952); (see Legislative history, 2 U. S. Code Congressional and Administrative Service 1951, p. 1414, et seq.) and which upon filing with the Procurement Agency would result in the naming of the Bank as payee in the future checks and possibly in precluding a set-off of the assignor's unpaid taxes pursuant to the statute. But it was not filed with the Agency as required by subsection 4 of section 203, supra, until after the check in question was drawn to Vogue. In any event, the statute was designed for the protection of the government against multiple claims and although an assignment which did not meet the conditions imposed by Congress might be void or unenforceable against the United States , such status would not bar its legal efficacy between the parties. McKenzie v. Irving Trust Co., 323 U. S. 365, 65 S. Ct. 405, 89 L. Ed. 305 (1944); Bank of California v. Commissioner, 133 Fed. (2d) 428 (9th Cir. 1943) [43-1 USTC ¶10,012]; California Bank v. U. S. Fidelity & Guaranty Co., 129 Fed. (2d) 751 (9th Cir., 1942).

[Basis of Complaint]

Plaintiff's complaint predicated the right to possession of the check upon the April 25, 1952 agreement, under which, as already noted, Vogue agreed to execute all documents necessary "to effectively assign to a financial institution to be designated" its interest in the contract and the proceeds thereof as security for moneys advanced or to be advanced by Tanenbaum. No reference is made to the specific assignment of June 24 but it is the only one proved at the trial.

The subcontract by Vogue is recited somewhat incidentally without mentioning Electro or its interest resulting therefrom and without a statement of facts showing any rights which flowed to Tanenbaum as a consequence.

Thus the theory of the action as established by the pleading was that by reason of the agreement of April 25, 1952 , the assignment of the contract and the proceeds thereof and the establishment of the special bank account into which the payments from the government were to be deposited, Tanenbaum was entitled to the $6,284.25 check. The pretrial order cannot be said to have made any change in the issues to be tried.

At the trial, plaintiff proceeded on the theory that under the agreement of July 17, 1952 between Vogue and Tanenbaum, and the tripartite concord of Vogue, Tanenbaum and Electro of August 20, following the granting of permission by the Procurement Agency to subcontract to Electro, Electro was substituted as the contractor and Vogue had no further interest in any of the proceeds of the contract. It seems to have been urged in the trial court, as it was before us at the oral argument, that Tanenbaum's right to the check was established by these agreements. The previous contract of April 25 and the assignment to the Bank were claimed to be more surplusage and of no legal consequences.

The United States objected to the introduction of the new theory of substitution of Electro for Vogue (in effect) as the price contractor to complete the contract; it objected also to the receipt in evidence of the correspondence and the agreements relating thereto, contending that the issue pleaded arose out of the April 25 agreement. The objection was overruled.

In the absence of any amendment to the complaint or change in the alleged cause of action by means of the pretrial order, the government was entitled to assume that the trial would proceed on the issue as originally presented.

Counsel for the government concedes that he had copies of the various documents relating to the subcontract to Vogue and the assignment to the Bank, and that he was generally familiar with the situation because of a review of the correspondence file of the Procurement Agency. However, he claims unpreparedness to meet the new issue and says that its projection into the proceedings at the trial prevented him from taking advantage of the discovery rules to ascertain the full rights of Vogue, Tanenbaum and Electro in the proceeds of the contract after Electro's appearance in the matter.

The issues plaintiff expected to try could have been put beyond doubt at the pretrail conference. But it was not done and we think for reasons to be stated that there is sufficient merit in the government's position to require reversal and retrial after adequate specification of the issues in the pleadings or pretrial order. Schlossberg v. Jersey City Sewerage Authority, 15 N. J. 360, 369-370.

[Lien of United States ]

Under 26 U. S. C. A. §3670 (1940), whenever a person neglects or refuses to pay any tax after demand, the amount due constitutes a lien in favor of the United States "upon all property and rights to property, whether real or personal, belonging to such person."

In these times when employers are withholding sums of money from wages for the purpose of paying the employees' income tax, the public interest requires liberal interpretation and application of the lien statute because such money is the life blood of government. Thus it has been declared that the lien attaches to after-acquired property (Glass City Bank v. U. S., 326 U. S. 265, 66 S. Ct. 108, 90 L. Ed. 56 (1945) [45-2 USTC ¶9449]; 26 U. S. C. A. §3671 (1940)) and extends not only to physical things but intangible rights and credits as well. Citizens State Bank v. Vidal, 114 Fed. (2d) 380, 382 (10th Cir. 1940) [40-2 USTC ¶9603]; 30 Am. Jur., Int. Rev. §77.

The crucial word in the section of the statute is "belonging". The tangible or intangible property must belong to the taxpayer in order to be liable to the lien. The rights of the government can rise no higher than those of the taxpayer; if he has no interest in the property sought to be executed against the lien is ineffective. U. S. v. Burgo, 175 Fed. (2d) 196 (3d Cir. 1949) [49-1 USTC ¶9307]; U. S. v. Winnett, 165 Fed. (2d) 149 (9th Cir. 1947) [48-1 USTC ¶9115]; McGraw v. Sherman Plastering Co., 60 Fed. Supp. 504 (D. C. Conn. 1943), aff'd 149 Fed. (2d) 301 (2d Cir. 1945); Karno-Smith Co. v. Maloney, 112 Fed. (2d) 690 (3d Cir. 1940) [40-2 USTC ¶9533]; U. S. v. Long Island Drug Co., 115 Fed. (2d) 983 (2d Cir. 1940) [41-1 USTC ¶9140]; Bankers Title and Abstract Co. v. Ferber Co., 15 N. J. 433 (1954) [54-2 USTC ¶9459].

In this case, Tanenbaum contends that by virtue of the substitution of Electro for Vogue in the Procurement Agency contract, Vogue had no interest in any proceeds which subsequently flowed therefrom. The suggestion is that even though Electro was called a subcontractor, the effect of the writings between the parties and the government from a pragmatic standpoint was to make Electro the prime contractor, in fact, and Vogue simply a guarantor against loss to Procurement. Cf. Thompson v. Commissioner, 205 Fed. (2d) 73, 77 (3d Cir. 1953) [53-1 USTC ¶9424]. And finally it asserts that when the check was issued, Vogue was simply a trustee or holder or nominal payee without beneficial interest therein.

In our judgment, the government may well have been at a disadvantage in being forced to meet this precise issue on a complaint and pretrial order which, to say the least, did not adequately disclose it, and without the advantage of pretrial discovery with respect to it.

[Issues of Interest Raised]

In this connection, reference may be made to some matters which the government indicated it would have looked into in advance of trial had the problem presented to the trial court been properly pleaded.

Under the August 20 agreement of Vogue, Tanenbaum and Electro, Vogue delivered 1,250 completed bags, 10,150 partially completed bags, and a number of rolls of material to Electro. Title to these goods was in Vogue. They could have been subjected to the tax lien. In any event, the 1,250 bags were worth $1.05 each or $1,312.50 on delivery to Procurement; the 10,150 partially completed ones were to be finished by Electro for $.15 each--indicating $.90 each of value produced by Vogue--or $9,135. It is undisputed that the shipment to Procurement for which the $6,284.25 check was issued was made up partly from these finished bags and the remainder from the unfinished ones which were completed by Electro. Was Vogue to receive no compensation or credit for this total work product value of $10,447.50 when Electro made that delivery? The agreements are silent on the subject.

Counsel for Tanenbaum put a question to one of its officials as to whether Vogue received any consideration for the subcontract to Electro. On Vogue's objection, the inquiry was withdrawn "for the moment" but it was never pursued again. The president of Vogue gave some testimony, which was not very clear, to the effect that upon completion of the contract by Electro if Vogue's debt to Tanenbaum had been satisfied, any remaining balance was to go to Vogue. And he asserted that Lawrence Tanenbaum told him that "if we continued the contract, we could expect a reduction in the price" of material, the inference being that after the subcontract in some way Vogue was to receive credits on its obligations to Tanenbaum and in addition any surplus remaining after the interests of the various parties were satisfied.

If Vogue was entitled to a credit for work done on the finished and unfinished bags, how was it to be handled? All of the the proceeds were assigned to the Bank of Manhattan. If they were deposited in a special account there, what would be the priorities as between the United States and Tanenbaum as to Vogue's credit? If pursuant to the assignment the check had been delivered to or received by the Bank of Manhattan, in accordance with the August 20 agreement to give instructions for distribution of the fund represented thereby, and if Vogue was entitled to receive any part of the proceeds thereof either by reason of those instructions, or if none were given but by reason of the understanding which produced the August 20 agreement Vogue was to receive a part thereof, the tax lien would attach to that share. And the lien would have priority over Tanenbaum even though Vogue had agreed and so instructed the Bank to turn the share over to Tanenbaum as a credit on existing indebtedness. Cf. U. S. v. Warren R. R. Co., 127 Fed. (2d) 134 (2d Cir. 1942) [42-1 USTC ¶9391]; Citizens State Bank v. Vidal, supra; Bankers Title and Abstract Co. v. Ferber Co., supra, at page 444.

Tanenbaum argues that after the subcontract, Vogue had no further interest in the prime contract or the proceeds, and that thereafter no part of the proceeds constituted tangible or intangible property belonging to Vogue. If this is true, what is the significance of the November 19, 1952 letter of Electro and Tanenbaum to the Bank? The date attracts attention. It was six days after the $6,284.25 check had been issued to Vogue. Tanenbaum then knew of the check and had demanded possession of it. And this replevin action was instituted nine days later. The letter said in part:

"This is to confirm that any moneys received by you under you assignment may be applied by you as you see fit toward the payment of the obligations of Vogue Foundations, Inc. to you or, in your discretion, may be paid over to Vogue Foundations, Inc., or credited to its account with you, and we shall have no claim whatsoever against you with respect to any such moneys."

The check in litigation was the only one outstanding at this time, so far as the record shows. If its disposition was controlled by the assignment and therefore it was expected to go to the Bank, what interest of Vogue prompted the writing of the letter by Tanenbaum and Electro?

It may very well be that the full facts will provide adequate answers to all of the questions posed. But we think that the shift of theory pursued by Tanenbaum at the trial probably prevented the government from preparing to meet them. In justice, such opportunity should be given.

Moreover, we find no legal justification for a determination that the check in dispute belongs to Tanebaum. The proceeds of the contract were assigned to the Bank of Manhattan presumably in accordance with the tripartite agreement of Vogue, Tanenbaum and Electro. And it was agreed that appropriate instructions would be given by each of them to the Bank to accomplish the proper disbursement of the funds. The only directions disclosed by the proof are those contained in the letter of November 19.

Thus it would appear that legal ownership of the check is in the Bank and not in Tanenbaum. An abortive effort was made to show a judgment in some litigation in New York allegedly to establish last of interest of the Bank in the contract proceeds. Enough of the circumstances of that litigation do not appear to enable us to consider its competency or relevancy.

Moreover Electro became the subcontractor, not Tanenbaum, Electro performed the relatively minor amount of work on the bags which was left unfinished by Vogue. And Electro shipped and billed them to the government. Obviously the check was drawn to Vogue because it was the named prime contractor and the Bank's assignment had not yet been filed. In this posture, Tanenbaum's claim to ownership thereof is no greater than that of Electro.

On the record now before us, both Electro and the Bank of Manhattan would appear to be indispensable parties to a complete adjudication of the rights in the check. Further, or the exhibits and proof submitted, Tanenbaum failed to establish that it is entitled to a finding of ownership thereof.

[Conclusion]

The judgment is therefore reversed and a new trial ordered to the end that both phases of the case we have discussed may be presented fully to the trial court.

 

 

[57-1 USTC ¶9559]In the Matter of Clinton Crockett, doing business as Crockett Furniture Co., Bankrupt

U. S. District Court, No. Dist. Calif. , No. Div., In Bankruptcy No. 13722, 150 FSupp 352, 4/4/57

[1939 Code Secs. 3670, 3671--similar to 1954 Code Secs. 6321, 6322]

Lien for employment withholding taxes: Bankrupt's property: Taxes owed by partnership: Former partner the bankrupt: After-acquired property: Assessment and demand for payment as prerequisite for lien.--The Government asserted a lien for 1953 federal employment withholding taxes owed by a partnership against a bankrupt's individual property which he acquired after the partnership of which he had been a member ceased doing business. None of the assets of the bankrupt were acquired from the partnership. The referee in bankruptcy gave the bankrupt's individual creditors priority over the Government in the distribution of the bankrupt's estate. The Court held that the tax lien attaches to all after-acquired property of the delinquent taxpayer, and its priority is determined by the general rule that first in time is first in right, regardless of the fact that it is a general lien and not a specific lien. However, the case was remanded to the referee to make appropriate findings of fact concerning the assessment date of the federal taxes and as to whether payment was demanded of the bankrupt and whether there was a refusal to pay--all statutory prerequisites for a perfected lien.

Lloyd H. Burke, United States Attorney, Charles Elmer Collett, Assistant United States Attorney, and Joseph O. Greaves, Attorney, Office of Regional counsel, Internal Revenue Service, for the United States. Herbert C. Coblentz, 306 California Bldg., Stockton , Calif. , for the bankrupt.

Memorandum and Order

HALBERT, District Judge:

The United States of America , as petitioner here, has filed with this Court a petition for review of the order of the Referee denying a tax lien claim by petitioner.

It appears that the above named bankrupt was adjudicated a bankrupt by this Court on July 26, 1954 . The United States of America filed a proof of claim of $1511.12 for employment withholding taxes for the first and fourth quarters of 1953 incurred by the partnership of Crockett Brothers, of which the bankrupt was a partner. The partnership apparently discontinued its business operations sometime in 1953. The bankrupt thereafter went into business by himself, individually, with none of the assets of the former partnership.

[Referee's Determination]

Petitioner, in the proceedings before the Referee, claimed that the United States was entitled to the status of a lien creditor, ¹ by virtue of the statutory lien provided for in §3670 of the Internal Revenue Code of 1939. ² (Title 26 U. S. C. A. §6321 [1954]), on the theory that the bankrupt was liable, as a general partner of the former partnership, individually for the tax liability incurred by the former partnership. The Referee determined that petitioner failed to demonstrate that it had a lien on any specific property of the bankrupt, and concluded that the property of the bankrupt should be distributed in the manner prescribed by §5(g) of the Bankruptcy Act (11 U. S. C. A. §23(g)). ³ Accordingly, the Referee relegated petitioner to the status of a partnership creditor, giving all of the bankrupt's inividual creditors priority in the distribution of the estate.

The issue on review, as certified by the Referee, is:

"Whether or not the United States of America can assert a lien on the bankrupt's individual property which he acquired after the partnership ceased business and from which which partnership he secured none of its assets for employment withholding taxes incurred by the former partnership."

[After-acquired Property]

It is well established that the lien provided for in §3670 (I. R. C. 1939) attaches to all after-acquired property of the delinquent taxpayer (Glass City Bank v. United States, 326 U. S. 265 [45-2 USTC ¶9449]; Salsbury Motors, Inc. v. United States, 210 Fed. (2d) 171 [54-1 USTC ¶9217]), and its priority is determined by the general "first in time is first in right" rule regardless of the fact that it is a general lien and not a specific lien. ⁴ ( United States v. New Britain , 347 U. S. 81 [54-1 USTC ¶9191]). It follows, then, that if the bankrupt in the case at bar is subject to the provisions of §3670, supra, his property would have passed into the hands of the trustee impressed with petitioner's lien (§§ 67(b) and (c) (11 U. S. C. A. §§ 107(b) and (c)); and cf.: United States v. Heffron, 158 Fed. (2d) 657 [47-1 USTC ¶9194]), even though such property was acquired after the time at which the lien attached. Furthermore, it cannot be doubted that if petitioner has a valid lien against the individual property of the bankrupt, petitioner should be considered as an individual lien creditor for the purposes of §5(g) of the Bankruptcy Act, irrespective of the fact that the underlying debt could have been asserted against the partnership estate as well (cf.: Mitchell v. Hampel, 276 U. S. 299; Globe Indemnity Co. v. Keeble, 20 Fed. (2d) 34; and see Lewis v. United States, 92 U. S. 618 [holding, inter alia, that the preferential status of the United States as a creditor of a partnership applies as well to the separate and individual estates of the bankrupt partners]; and see also: Anno. 75 A. L. R. 997, 999).

[Prerequisites for Perfected Lien]

In order for the lien of §3670 (I. R. C. 1939) to attach to the individual property of the bankrupt, it must be established that (1) he is a "person liable to pay" the tax, and (2) he has "neglected or refused to pay the same after demand".

Under the law of California, it is clear that an individual partner may be held liable for the entire amount of a partnership debt (§15015(b) of the California Corporations Code, and cf.: Brazil v. Azievedo, 32 Cal. App. 364), and under that rule, an individual partner has been held liable to the United States for the employment withholding taxes of the partnership (Heller v. United States, Civil No. 33545, N. D. California, So. Div. 1955 [55-1 USTC ¶49,084]) and his individual property has been held subject to the lien of §3670, supra (Underwood v. United States, 37 Fed. Supp. 824 [41-2 USTC ¶9514], aff'd., 118 Fed. (2d) 760 [41-1 USTC ¶9296]. Hence, it is the opinion of this Court that the bankrupt is a "person liable to pay" the tax asserted within the meaning of §3670, supra, and that the lien claimed by petitioner, if perfected, entitled petitioner to the status of an individual lien creditor of the bankrupt with priority over all other individual creditors except those asserting senior liens within the meaning of §3672 (I. R. C. 1939).

It cannot be determined, however, on the record now before this Court, whether petitioner has perfected the lien it asserts against the bankrupt's property. By the plain wording of §3670, supra, the lien does not attach unless and until the delinquent taxpayer "neglects or refuses to pay the same after demand". ⁵ It is incumbent upon petitioner to show that these statutory prerequisites have been fulfilled before the Referee can treat petitioner as a lien creditor.

In view of the state of the record, it is within the power of this Court to remand this proceeding to the Referee to make appropriate findings of fact on this issue (Title 28 U. S. C. A. §2106; Huffman v. United States, -- Fed. (2d) -- [9th Cir., No. 15187 (March 21, 1957) [57-1 USTC ¶9521]]; N. M. Landy, Inc. v. Nicholas, 221 Fed. (2d) 923; and In re Rockford Baseball Club, Inc., 201 Fed. (2d) 685).

IT IS, THEREFORE, ORDERED that the case be remanded to the Referee in Bankruptcy with directions that he make a specific finding on the following questions:

1. Whether the bankrupt neglected or refused to pay the tax after demand; and

2. The date on which the assessment list was received by the collector. (§3671)

If it is determined that the statutory prerequisites necessary to perfect petitioner's lien have been fulfilled, then distribution of the bankrupt's estate shall be accomplished in a manner consistent with the views expressed in this opinion, but if said statutory prerequisites have not been fulfilled, then the Referee's order sought to be reviewed by this proceeding may stand affirmed and approved.

¹ Petitioner claims that it has a lien for taxes within the meaning of §67(b) of the Bankruptcy Act, and contends that by virtue of said lien, it is entitled to distribution after reasonable costs of admin istration and priority wage claims.

² Section 3670 of the Internal Revenue Code of 1939 provides:

"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."

³ Under §5(g) of the Bankruptcy Act, the Referee is required to distribute the assets of an individual partner in bankruptcy first to individual creditors, and if any residue remains after such distribution, then partnership creditors are entitled to receive dividends out of the bankrupt estate.

⁴ The Referee apparently concluded that the lien for taxes asserted by petitioner would be general only with respect to partnership property, which could be traced into the hands of the bankrupt, but as to the individual property of the bankrupt, the lien must have been shown to have attached to some specific property, before it could entitled the United States to any preferred position vis-a-vis other individual creditors of the bankrupt.

⁵ Once, however, the existence of these prerequisites is shown, the time that which the lien attaches is the date on which the assessment list was received by the collector. (§3671, I. R. C., 1939)

 

 

[53-2 USTC ¶9589]In the Matter of John W. Holdsworth and William Bauman, Individually and the partnership known as John W. Holdsworth & Co., composed of John W. Holdsworth and William Bauman, and John W. Holdsworth Incorporated, Bankrupts

In the United States District Court for the District of New Jersey, Bankruptcy No. 279-50, 113 FSupp 878, July 27, 1953

Lien for taxes: Validity against trustee in bankruptcy. Levy and distraint.--The referee in bankruptcy denied the petition of the trustee in bankruptcy for an adjudication that certain United States tax liens were invalid, an injunction against the enforcement of the tax liens by the Collector and a turnover order ordering certain debtors of the bankrupts to pay the debts to the trustee. A petition for review was filed by the trustee. The stipulation of facts did not contain essential facts showing whether the conditions precedent to the creation of the liens and the conditions of an effective levy and distraint were met. The referee's conclusions were therefore erroneous. The matter was remanded with instructions to grant a rehearing.

Feld & Breitner for trustee. United States Attorney for United States .

Opinion

SMITH, District Judge:

This proceeding originated with a petition filed by the Trustee in bankruptcy and an order to show cause entered thereon by the Referee in Bankruptcy. The prayers for relief were poorly drafted, but it sufficiently appears from the petition and the record now before the Court that the petitioner sought: first, an adjudication that certain tax liens in favor of the United States were invalid; second, an injunction against the enforcement of the tax liens by the Collector of Internal Revenue; and third, a turnover order requiring certain debtors of the Bankrupts to pay to the Trustee the debts allegedly due and payable. The Referee, after hearing, denied the relief sought. The proceeding is now before this Court on a petition for review filed by the Trustee.

The action of the Referee was obviously predicated upon the conclusions: first, that the tax liens in favor of the United States were existent and valid; and second, that a mere notice of "Levy," served upon each of three debtors of the Bankrupt, was tantamount to an effective levy upon the distraint of "all sums of money due" from the said debtors of the Bankrupts. These conclusions were based solely on the meager facts contained in a Stipulation of Facts, which was deficient; several essential facts were omitted from the stipulation and were not established by competent evidence. The facts before the Referee do not support his conclusions.

The pertinent provisions of the Internal Revenue Code, 26 U. S. C. A. 3670 and 3671, create a statutory lien for taxes in favor of the United States but only upon the fulfillment of the conditions therein prescribed. Section 3670 provides: "If any person liable to pay any tax NEGLECTS or REFUSES to pay the same AFTER DEMAND, the amount * * * shall be a lien in favor of the United States upon all property and rights to property, * * *, belonging to such person." Section 3671 provides: "Unless another date is specifically fixed by law, the LIEN SHALL ARISE AT THE TIME THE ASSESSMENT LIST WAS RECEIVED BY THE COLLECTOR * * *." (Emphasis by the Court.)

These provisions of the Code are unambiguous and must be literally construed. When these provisions are thus construed it is clear that the conditions precedent to the creation of the statutory lien are: first, the receipt by the Collector of Internal Revenue of an assessment list certified by the Commissioner of Internal Revenue in accordance with Sections 61, 3640 and 3641 of the Internal Revenue Code, Title 26 U. S. C. A.; and second, a demand for payment by the Collector of Internal Revenue, and the neglect or refusal of the taxpayer to pay. Cf. Detroit Bank v. United States, 317 U. S. 329, 335 [43-1 USTC ¶9224]; United States v. Reese, 131 Fed. (2d) 446, 467 [42-2 USTC ¶9763]; Citizens State Bank of Barstow, Tex. v. Vidal, 114 Fed. (2d) 380, 384 [40-2 USTC ¶9603]; MacKenzie v. United States, 109 Fed. (2d) 540, 541, 542 [40-1 USTC ¶9229]; Metropolitan Life Ins. Co. v. United States, 107 Fed. (2d) 311, 313 [39-2 USTC ¶9771]; Filipowicz v. Rothensies, 43 Fed. Supp. 619, 623 [42-1 USTC ¶9300]. The lien arises only upon when the fulfillment of these conditions.

An examination of the record discloses no facts which will support a determination that the conditions prescribed by the Code were met, a determination essential to the conclusion that the tax liens were existent and valid. This conclusion of the Referee was therefore erroneous.

We may assume, although the record does not support the assumption, that the action taken by the Collector of Internal Revenue was pursuant to Sections 3690 and 3692 of the Internal Revenue Code, Title 26 U. S. C. A. Section 3690 provides: "If any person liable to pay any taxes NEGLECTS or REFUSES to pay the same WITHIN TEN DAYS NOTICE AND DEMAND, it shall be lawful for the collector * * * to collect the said taxes, * * *, by distraint and sale, in the manner provided in this subchapter, of the goods, chattels, or effects, including * * * evidences of debt, of the person delinquent as aforesaid." Section 3692 provides: "In case of NEGLECT or REFUSAL under Section 3690, the collector may levy, * * *, upon all property and rights to property, * * *, belonging to such person, or on which the lien provided in section 3670 exists, for the payment of the sum due, * * *." (Emphasis by the Court.) We note that these sections are not in pari materia with sections 3670 and 3671, supra.

The right of the Collector of Internal Revenue to proceed under these sections is conditioned upon: first, a notice to the taxpayer of his delinquency and a demand for payment; and second, the neglect or refusal of the taxpayer to pay "within ten days after notice and demand." The record is devoid of facts upon which to predicate a determination that these conditions were met, a determination essential to the conclusion that there was an effective levy and distraint. The conclusion that there was an effective levy and distraint is therefore erroneous.

It sufficiently appears from the Stipulation of Facts that a notice of "Levy" was served upon each of the three debtors of the Bankrupts, and that thereafter, pursuant to Section 3710(a) of the Code, Title 26 U. S. C. A., a formal "Final Notice and Demand" was served upon each of them. We assume, in the absence of any stipulation to the contrary, that no other or further action was taken. We are of the opinion that in the absence of a warrant of distraint a mere notice of levy is not tantamount to an effective levy upon and distraint of "all sums of money due" from the said debtors of the Bankrupts. United States v. O'Dell, 160 Fed. (2d) 304, 307 [47-1 USTC ¶9190]; Givan v. Cripe, 187 Fed. (2d) 225, 228 [51-1 USTC ¶9169]. An actual or construction seizure is essential to a valid levy and distraint; where, as here, the subject matter is an account receivable or chose in action, the seizure may be effected by a levy and the service of a warrant of distraint upon the debtor. Ibid. The reported cases would indicate that this was the usual practice followed by the Collector of Internal Revenue.

The record discloses that the three debtors of the Bankrupts were joined as parties to this proceeding but failed to enter an appearance or otherwise consent to the summary jurisdiction of the Court of Bankruptcy. We agree with the Referee's conclusion that under the circumstances they were not subject to the Court's summary jurisdiction. We would suggest, however, that if the debts are not disputed a multiplicity of actions might be avoided if the debtors would voluntarily enter their appearance in this proceeding. This would permit the determinatin of all the issues in a single action.

The matter will be remanded to the Referee in Bankruptcy with instructions to grant a rehearing. We direct the attention of the Referee in Bankruptcy to the applicable provisions of the Internal Revenue Code, supra, which are determination of the validity, scope and effect of both the liens and the distraints. We further direct his attention to the applicable provisions of the Bankruptcy Act, and particularly to Sections 67 and 70 thereof, 11 U. S. C. A. 107 and 110, which are determinative of the relative rights of the Trustee and the Collector of Internal Revenue. See Collier on Bankruptcy, Vol. 4, pages 155 to 224, inclusive.

We observe that this is another case in which there has been a regrettable waste of judicial time occasioned by the palpable inadequacy of the record made before the Referee in Bankruptcy. We have previously reminded attorneys that the issues which arise in the many collateral matters incident to the admin istration of a bankrupt estate should be fully and properly tried. A hearing before the Court of Bankruptcy is summary but it must be full and adequate if the issues raised are to be justly decided on the merits. Where, as here, the issues are submitted on a stipulation of facts, the facts should be fully and adequately stated, and, if not so stated, the stipulation of facts should be supplemented by competent and relevant evidence.

 

 

[57-1 USTC ¶9521]S. B. Huffman, trustee in bankruptcy of Charles Manfre Transportation Co., bankrupt, Appellant v. United States of America, Appellee

(CA-9), U. S. Court of Appeals, 9th Circuit, No. 15,187, 242 F2d 835, 3/21/57, Reversing and remanding unreported District Court opinion

[1939 Code Secs. 3670 and 3690--similar to 1954 Code Secs. 6321 and 6331]

Tax lien: Repossessed personal property.--Trucks belonging to the taxpayer were repossessed under either a chattel mortgage or a conditional sale contract. Immediately after repossession and before bankruptcy of the taxpayer, the trucks were levied on for unpaid taxes. The taxpayer disputed the repossession, and the trustee in bankruptcy brought suit, which was settled. The Government asserted a prior claim to the settlement fund. A District Court decision holding that the tax lien was entitled to priority was reversed and the cause was remanded because the evidence did not show whether the taxpayer claimed an interest in the trucks or merely claimed money damages. If the claim was for specific property, this court indicated that the Government did not lose its priority merely because the claim was compromised for money.

Milton Maxwell Newmark, Paul E. Anderson, Kent and Brookes, San Francisco , Calif. , for appellant. Lloyd H. Burke, United States Attorney, Charles E. Collett, Assistant United States Attorney, San Francisco, Calif., Joseph O. Greaves, Leon Yudin, Washington, D. C., for appellee.

Before HEALY, LEMMON and CHAMBERS, Circuit Judges.

CHAMBERS, Circuit Judge:

The dispute here involves whether money paid to the bankrupt Manfre's trustee in bankruptcy by a company called Utility Trailer Sales must be turned over to the United States for its ubiquitous tax claim or whether the trustee may subordinate the tax claim to costs of admin istration and wage claims. ¹ The referee, and the district court on review, held that the director of internal revenue must take the entire sum involved which is $2,309.49.

Prior to bankruptcy, we are told Utility Trailer Sales had "repossessed" four trucks apparently belonging to Manfre. It is not clear whether the "repossession" was under a chattel mortgage or a conditional sales contract. After "repossession," we do not know what was done next. It would appear that in some way the bankrupt, prior to the adjudication, was disputing the repossession or some facet of it. The trustee continued the same contentions or made others. We are told that the trustee brought a proceeding "against Utility Trailer Sales in the bankruptcy court below and after a hearing before the referee was successful in achieving a compromise of the matter." The parties attempt to tell us in a scanty way what the "matter" before the referee was. It appears that the district court did not know what this "matter" involved. It seems to have assumed, and events hereafter may vindicate the assumption that at all times Manfre and his trustee were making a claim against Utility Trailer Sales for money.

But we think the nature of the claim prior to its compromise might be important. We note that Utility Sales resold one of the trucks before the adjudication and three trucks after the adjudication.

The purported levy of the agent of the Internal Revenue service was made immediately after the "repossession" and before bankruptcy. If the claim of the now bankrupt was asserted by him as an interest in the trucks (that is, "give me back my trucks") we might have one priority question. If the claim was at all times "you took my trucks and I want money damages," we may have the question of the applicability of United States v. Eiland, 4 Cir., 223 Fed. (2d) 121[118] [55-1 USTC ¶9487], and whether we agree with it.

Prima facie, without deciding, we would think, if the claim which was compromised was one made to specific property, the government should not gain or lose in legal position by the compromise of the trustee for money.

We hold on our own motion that the district court was not given enough facts to make a proper review. If we did not so hold, this court probably would have to decide the applicability of United States v. Eiland, supra. That we are not disposed to do because there is too strong a possibility that we know too little of the actual facts.

It would not be unjust in the rough sense for appellant trustee to lose his appeal because of the inadequacy of the record presented here and to the district court. But we believe it is within our power to send the case back and more consonant with justice that the case go back for an examination of the compromise, and what was compromised, as well as related facts. See M. M. Landy, Inc. v. Nicholas, 5 Cir., 221 Fed. (2d) 923 at 932. McGovock v. Giolitto, 7 Cir., 201 Fed. (2d) 685. When this has been done the legal suspenders that should be taken from the rack can be better determined.

Reversed and remanded for proceedings consistent with this opinion. ²

¹ See 11 U. S. C. A. §107, sub. C.

² A case in which the facts were presented to the district court in good form is Bensinger v. Davidson, D. C., S. D. Cal., 147 Fed. Supp. 240 [57-1 USTC ¶9263].

 

 

[44-1 USTC ¶9180]Publicity Building Realty Corporation, a corporation, individually and as trustee of an express trust, Arthur E. Woerheide, Max W. Kramer, assignee of Nelson Chesman and Company, a corporation, Taylor R. young, Stephen A. Boggiano, Paul E. Coil, executor of the estate of Patrick H. Cullen, deceased, Clem F. Storckman, Cullen Coil, Sigmund M. Bass and Joseph S. Webbe, Appellants, v. Rob ert E. Hannegan, Collector of Internal Revenue, and United States of America, Lee Hess, Estelle L. Hess, and June Estelle Hess, by Lee Hess, Guardian ad Litem, Appellees.

(CA-8), United States Circuit Court of Appeals, Eighth Circuit., No. 12,666., 139 F2d 583, 12/28/43

Appeal from the District Court of the United States for the Eastern District of Missouri.

Lien for taxes: Interpleader: Jurisdiction.--The Court remands the case to permit the creditors of X to prove, if they can, that the insurance policies never belonged to the taxpayer but did belong to X and consequently the Collector never acquired an interest in the policies and therefore the funds of policies belong to the creditors and not the Collector.

Taylor R. Young and Harry A. Frank (Stephen A. Boggiano, Clem F. Storckman, Cullen Coil and Sigmund M. Bass were with him on the brief) for appellants. John V. Lee (Messrs. Lee, Fricke & Lee were on the brief) for appellees, Lee Hess, Estelle L. Hess, and June Estelle Hess, by Lee Hess, Guardian Ad Litem. W.B. Waldo, Special Assistant to the Attorney General (Samuel O. Clark, Jr., Assistant Attorney General, Sewall Key and J. Louis Monarch, Special Assistants to the Attorney General, Harry C. Blanton, U.S. Attorney, and Russell Vandivort, Assistant U.S. Attorney, were with him on the brief) for appellees, Collector of Internal Revenue and the United States.

Before SANBORN, WOODROUGH, and RIDDICK, Circuit Judges.

SANBORN, Circuit, Judge, delivered the opinion of the Court:

The appellants are cross-claimants in an interpleader action. Their cross-claims were dismissed, and they have appealed from the order and judgment of dismissal. The broad question presented is whether their pleadings raised any issues of fact or of law which entitled them to a trial.

[The Facts]

 

The Travelers Insurance Company (hereinafter called "the Travelers"), as plaintiff, on June 16, 1941 , filed a complaint in interpleader under the Interpleader Act of 1936, 49 Stat. 1096 [28 U.S.C.A. §41(26)]. The complaint named Lee Hess, Estelle L. Hess, June Estelle Hess, the United States Collector of Internal Revenue, Publicity Building Realty Corporation (hereinafter called "Publicity"), and George C. V. Fesler, as defendants. The complaint showed that on March 6, 1934, the Travelers had issued two single-premium policies on the life of Lee Hess, one for $50,000, and one for $10,000; that Hess had paid $18,169.50 for the larger policy and $3,633.90 for the smaller one; that Estelle L. Hess, wife of the insured, and June Hess, his daughter, were the named beneficiaries; and that the policies provided for cash surrender values. The complaint further showed that, on or about July 30, 1934, Publicity, as a creditor of George C.V. Fesler, instituted an action against the Travelers and others in the Circuit Court of the City of St. Louis, Missouri, alleging that the policies had been purchased by Lee Hess with money belonging to Fesler; that, as a result. Fesler was entitled to the right, title and interest of the insured and of his wife and daughter in the policies; and that Publicity, as a creditor of Fesler, was entitled to have the cash value of the policies applied in payment of the indebtedness of Fesler to Publicity. The complaint further showed that Fesler filed an intervening petition in the State court action, asserting that the policies were purchased by Hess with the money of Fesler; that Fesler was entitled to the cash value of the policies and to have it applied upon his indebtedness to Publicity; and that the State court action is still pending and undetermined. The complaint further showed that there was filed with the Travelers a written assignment bearing date February 25, 1936, by which Lee Hess transferred his interest in the policies to Thos. H. Butler, Jr., and George A. Ryan; that on or about June 2, 1941, there were filed with the Travelers two written assignments dated January 27, 1938, and February 4, 1938, respectively, transferring the interests of Lee Hess and of Butler and Ryan in the policies to the United States Collector of Internal Revenue; that on June 2, 1941, the Collector surrendered the policies to the Travelers, demanding of it their cash surrender value, and served upon it a written notice of a tax lien for federal income taxes assessed against Lee Hess for the year 1934 for $19,267.47 and interest; and that the Collector also served upon the Travelers a written notice of a levy and also a demand for payment and warrant of distraint. The complaint also showed that the cash value of the two policies on June 16, 1941, was $23,809.80, which the Travelers had paid into the registry of the court below; that the Travelers has and claims no interest in the policies, has no liability to the defendants except under the policies, and is a disinterested stakeholder. The prayer of the complaint was that the defendants be decreed to interplead and settle among themselves their rights or claims to the cash surrender value of the policies, and that the defendants be enjoined from prosecuting their claims in other courts.

Thereafter the appellants other than Publicity (which was named a defendant in the complaint) filed applications for leave to intervene, accompanied by their proposed cross-complaints stating their respective claims to the fund deposited in the registry of the court. These applications were granted. The United States was also permitted to intervene as a claimant to the fund. The Travelers was granted the relief prayed for in its complaint, on April 8, 1942 , and a decree was entered requiring the defendants and interveners to interplead for the fund paid into court, less $400.00, the costs and attorneys' fees which were allowed to the Travelers.

The cross-claims of the appellants (including Publicity) asserted, in substance, that these cross-claimants were creditors of Fesler; that he on October 31, 1931, became a fugitive from justice and a nonresident of the State of Missouri; that he concealed his whereabouts so that he could not be reached by process; that Fesler conveyed all of his property to Lee Less; that Hess agreed with Fesler to convert his property into cash and pay his debts; that, among other assets, Fesler owned a royalty contract for a deodorant; that from October 31, 1931, to February 16, 1934, Hess collected royalties upon this contract amounting to $21,273.30; that on February 16, 1934, Hess sold the contract for $100,000, of which $65,000 was paid in cash; that part of this $65,000 was used to pay the single premiums for the life insurance policies in suit; that the money paid to the Travelers for those policies belonged wholly to Fesler; and that the cash surrender value of the policies is the money of Fesler and constitutes in effect a trust fund in which each of the appellants is entitled to participate.

Fesler filed an answer to the complaint of the Travelers and an interplea in which he asserted, in substance, that Lee Less had fraudulently procured and appropriated Fesler's property and that the policies in suit were purchased by Hess with Fesler's money; that the subsequent assignments of the policies were not made to bona fide purchasers for value; that the assignees had full knowledge that the policies had been purchased with the money of Fesler; and that he is the equitable owner of the fund in suit and has an equitable lien thereon or right thereto superior to the claims of the Collector and of the United States. The prayer of Fesler's answer was for a decree that the fund be awarded to him. Fesler also filed a counterclaim against Lee Hess, Estelle L. Hess, June Hess, and William Hess, demanding an accounting for all of the proceeds of the property of Fesler converted by Lee Hess and held in trust for Fesler by Lee Hess and William Hess.

Issues were joined, and the case came on for hearing on June 12, 1942 . Mr. Claud O. Pearcy, counsel for Fesler, announced that he was advised that his client intended to withdraw his claim to the deposited fund. Fesler was called to the witness stand and was examined. He testified that he did not desire to make any further claim to the fund; that he had informed his counsel of that fact that morning for the first time; that his desire to withdraw his claim had resulted from a conference between Lee Less, Mr. Maher, counsel for the United States, and Fesler; and that Fesler's counsel was not a party to the conference. At that point, Mr. Pearcy notified the court that he withdrew from the case. Mr. Maher then examined Fesler, who testified that Maher did not make him "any promise of any money or anything", and that the conference was held at the suggestion of Lee Hess. We quote the remainder of Fesler's testimony:

"Questions by Mr. Young:

 

"Q. You and Mr. Hess made a settlement yesterday afternoon?

"A. No, sir.

"Q. You talked about an hour?

"A. That is all right; we didn't make a settlement.

"Questions by Mr. Pearcy:

 

"Q. Isn't it a fact, Mr. Fesler, that the District Attorney has told you you would be indicted for concealing certain information when you made a settlement with the Government for 1934 tax?

"The Witness: Do I have to answer that? I had a conversation with the District Attorney.

"Mr. Maher: You can answer for all of me. If you are going to quote me, quote me correctly. You can answer it here.

"A. We did have a conversation along that line.

"Q. Will you, for the benefit of the record, tell us what Mr. Maher said?

"A. He said he would try to prove that I had not divulged my true status in making settlement with the Government.

"Q. In what respect, Mr. Fesler?

"A. In respect to my income-tax claim.

"Q. As to misrepresentations as to your income in 1934?

"A. Yes, sir.

"Q. At the time you had settlement with them for income tax; for not making a return, or for making a false return?

"A. I didn't make the return at all; the return was made by the Government.

"Q. And this was, as I understand it, a statement to you that you would be prosecuted for your failure to give information with regard to the suit pending out here?

"A. No, sir; he said he would make every effort to show that I did that.

"Q. To show what?

"A. That I had misrepresented it.

"Questions by Mr. Maher:

 

"Q. Those were my exact words, that I would do my best to see you were prosecuted for making a false statement?

"A. Yes, sir.

"Q. I didn't say you would be indicted?

"A. No, sir. You said you would make every effort to do it.

"Questions by Mr. Young:

 

"Q. And that is the reason you are withdrawing your claim to this fund?

"A. Yes, sir.

"Mr. YOung: That is all.

"Mr. Maher: I think the case might well be passed for a week or ten days.

"Mr. Young: We are not certain we are ready, in view of the changed situation. We were ready up until this morning.

"The Court: I am not sure when I can give you a setting on that.

"Mr. YOung: I suppose the quicker the better suits us both?

"Mr. Maher: Yes, sir.

"Questions by Mr. Maher:

 

"Q. For the sake of the record, did I promise you would not be prosecuted?

"A. You said you would drop the case.

"Q. I said this case would be dropped?

"A. Yes, sir.

"Q. And did I make any promise about no prosecution?

"A. You said there would be nothing further to do about the case.

"Q. Because, then, it would not have been your money?

"A. Yes, sir.

"Q. I said there would be nothing to do because it would not have been your money that you concealed?

"A. That is right.

"Questions by Mr. Walsh:

 

"Q. What did you understand Mr. Maher to mean when he said there would be nothing further in the case if you withdrew?

"A. He said if I withdrew, the case would be dismissed and I would go on my way.

"Questions by Mr. Maher:

 

"Q. Did I say if you withdrew, or did I say if you got on the stand and told the truth about whose money this was?

"A. Yes, sir; that is right.

"Mr. Maher: There is a difference.

"Q. Didn't I say if this was Mess' money, then you didn't make any false statement in your income tax?

"A. Yes, sir.

"Mr. Maher: That is all."

On September 17, 1942, the Collector of Internal Revenue and the United States filed motions to dismiss the cross-claims of all of the appellants, on the grounds: (1) that they fail to state claims against the fund upon which relief can be granted; (2) that they show no legal or present interest in the fund at the time it was deposited in court; (3) that the claimants take, if at all, through the interest of Fesler and have only unliquidated demands against him, and that Fesler's claim has been eliminated from the case: (4) that the claims of the appellants are between them and Fesler and have no direct relation to the controversy over the ownership of the fund as between Fesler and Hess; (5) that the appellants show that they have no liens of any kind on the fund; (6) that the court should not be required to decide the liability of Fesler to the appellants, since, if such liability were established, no right of the appellants superior to that of the Collector and the United States would exist; (7) that the claims of the appellants could not have been asserted in an independent suit in the District Court, since Fesler resides outside of the district; that, unless the claimants have liens upon the fund, they should not be permitted to assert claims against Fesler in a suit in which he was an involuntary party, and that a determination of the claims against Fesler would deprive him of his constitutional right to a trial by jury.

The District Court, without an opinion and without assigning any reasons therefor, granted the motions to dismiss and decreed that the appellants have no right, title, interest or claim in or to the fund in the registry of the court.

[Parties in Interest]

 

It is apparent that the real parties in interest in this case now are: Lee Hess, who desires to have the fund applied in payment of his liability to the United States for income taxes; the United States, which is endeavoring to obtain the fund to satisfy its unpaid assessment for taxes against Hess; and the creditors of Fesler, who are asserting an equitable right to have the fund, which they assert belongs to Fesler, applied to the payment of their claims against him.

The weakness of the position of the Collector of Internal Revenue and the United States is that their motions to dismiss admit that the appellants have the claims which they have asserted, and deny only the power of the court to grant the relief prayed for by the appellants. Leimer v. State Mut. Life Assur. Co., 8 Cir., 108 F. (2d) 302, 305; Donnelly Garment Co. v. International Ladies' Garment Workers Union , 8 Cir., 99 F. (2d) 309, 316.

This court has repeatedly said that a motion to dismiss a complaint should not be granted unless it appears to a certainty that the plaintiff would be entitled to no relief under any state of facts which could be proved in support of his claim. Leimer v. State Mut. Life Assur. Co. , supra (p. 306 of 108 F. (2d)); Sparks v. England, 8 Cir., 113 F. (2d) 579, 581-582; Cohen v. United States, 8 Cir., 129 F. (2d) 733, 736; Louisiana Farmers' Protective Union, Inc. v. Great Atlantic & Pacific Tea Co., 8 Cir., 131 F. (2d) 419, 423-424; Musteen v. Johnson, 8 Cir., 133 F. (2d) 106, 108.

Rule 22(2) of the Federal Rules of Civil Procedure (28 U.S.C.A. following §723c) provides that actions brought under §24(26) of the Judicial Code as amended [Title 28 U.S.C.A. §41(26)] shall be conducted in accordance with those Rules. The Federal Rules of Civil Procedure do not sanction the disposition of doubtful issues of fact or law upon motions to dismiss for insufficiency of pleadings. The Rules contemplate a determination of all such issues by the trial court after a hearing, and that the trial court shall make findings of fact and conclusions of law, to the end that the parties to the litigation and the reviewing court may know the exact factual and legal basis for the trial court's decision. This, of course, does not mean that if it is certain that a plaintiff has no claim which entitles him to relief, the District Court is obliged to hold a trial. If it clearly appears from a complaint that a trial of the claim asserted will be futile, the court is not required to proceed further. But even in such a case, unless the reason for the dismissal of a complaint is obvious, we think that the court should state the grounds upon which it relies in ordering the dismissal.

[Questions]

 

Some of the questions which are involved in this appeal are: (1) Did the appellants who are interveners have an absolute, or merely a discretionary, right to intervene? (2) If their right to intervene was discretionary, did their elimination from the case by a dismissal of their cross-complaints amount merely to a revocation of leave to intervene? (3) Have the creditors of an adverse claimant who are asserting an equitable right to have his interest in the fund deposited by the stakeholder applied to the payment of their claims, a right to interplead when they have not obtained judgments against their debtor and have not established liens upon the fund prior to the commencement of the interpleader action? (4) Must the claimants in an interpleader action have a present legal right, title or interest in the fund in order to interplead? (5) Does the commencement of an interpleader suit cut off or impair the rights of a creditor of an adverse claimant when that creditor is prosecuting proceedings in the State court for the purpose of obtaining a judgment against the adverse claimant and establishing a lien upon the fund in suit? (6) Do the creditors of an adverse claimant who are attorneys claiming to have acquired a lien under the laws of Missouri upon the fund because of services rendered to an adverse claimant prior to the institution of the interpleader action, have a right to intervene and interplead therein as lienholders? (7) Do the creditors of an adverse claimant who assert that they are beneficiaries of a trust created by him in the fund in suit, have a right to interplead when the amounts of their claims are unliquidated? (8) Do the creditors of an adverse claimant and the beneficiaries of a trust allegedly created by him lose whatever rights they might otherwise have in the fund if the adverse claimant on the eve of trial disclaims any interest in the fund? (9) If a voluntary disclaimer by the adverse claimant will destroy any rights which his creditors may have to the fund, will an involuntary disclaimer coerced by counsel for another adverse claimant likewise destroy such rights?

An attempt by this Court to rule upon these issues of law, which have not been tried below, and which require the assumption of a factual situation as favorable to the appellants as can reasonably be conceived in view of their pleadings, would not be justified. As already pointed out, we do not know upon what rule or rules of law the trial court relied in dismissing the appellants' cross-complaints. It is elementary that appellate courts will not ordinarily consider questions not passed upon by the trial court. Many of the issues of law presented are important questions relating to the present statutory remedy of interpleader. Compare Sanders v. Armour Fertilizer Works, 292 U.S. 190. We are satisfied that these issues should not be decided upon a hypothetical state of facts. A trial may disclose that the appellants have no rights to the fund, or that whatever rights they have are not enforceable or are inferior to those of the United States . The appellants, however, are presently contending that Lee Hess never beneficially owned the policies the surrender value of which constitutes a fund which they seek to have applied to the payment of their claims; that the interest acquired by the United States from Hess was nothing more than a naked legal title; that under the law the fund belongs to Fesler; that in equity it ought to be awarded to the appellants as his creditors and as beneficiaries of a trust created by him; and that the abandonment by Fesler of his claim to the fund, particularly under the circumstances disclosed by the record, could not affect their rights to have the fund distributed to them.

While we shall not, upon this appeal, express any opinion as to the merits of this case, we consider it important that the usefulness of the statutory remedy of interpleader, which has been greatly liberalized by the Interpleader Act of 1936 and by Rule 22 of the Federal Rules of Civil Procedure, shall not be impaired by narrow and restrictive rulings which might prevent bona fide claimants, with meritorious claims to a fund deposited by a stakeholder, from securing an adjudication of their rights. If persons having or claiming interests in a fund are to be enjoined, in an interpleader action, from proceeding in other courts to establish or to enforce their claims against the fund, it would seem that the one court remaining open to them should afford them a fair opportunity to establish the basis for their claims, and give due consideration to their assertions that their rights are superior to those of other claimants. We think that the appellants should be permitted to prove, if they can, that the policies in suit never belonged to Lee Hess, that the Collector of Internal Revenue and the United States acquired from him no interest in the fund in suit, and that the appellants are entitled to have the fund distributed to them. If the appellants' assertions are correct, the dismissal of their claims would result in the Government's receiving the fund, not upon the strength of its claim but upon the weakness of their claims.

The order and judgment appealed from is reversed, and the case is remanded with directions to reinstate the appellants' cross-claims and to try the issues thereby presented upon the merits.