Set-Off Page3

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For purposes of a federal tax levy, the legal consequence of this unrestricted right to withdraw deposits from a share account is unmistakable. The funds in the share account are subject to the levy, even if priority or ownership questions are not yet resolved. United States v. National Bank of Commerce, 472 U.S. at 724-25; see also United States v. Central Bank, 843 F.2d at 1305; United States v. Citizens and Southern Nat'l Bank [76-2 USTC ¶9665 ], 538 F.2d 1101, 1106-07 (5th Cir. 1976), cert. denied, 430 U.S. 945 (1977); United States v. Sterling Nat'l Bank & Trust Co. [74-1 USTC ¶9336 ], 494 F.2d 919, 921-23 (2d Cir. 1974). We reject out of hand the credit unions' contention that taxpayer-member shares in a credit union may not be "forcibly transferred" to the government. The government steps into the shoes of the taxpayer and acquires "whatever" rights to the property that the taxpayer had. United States v. National Bank of Commerce, 472 U.S. at 713. The credit unions' restrictions concerning transferability of shares relate only to incidents of credit union membership. ² Thus, the credit unions had no valid basis for refusing to honor the federal tax levies.

II.

Having determined that the federal tax levy should have been honored, we next consider issues which concern priority. Relying on Kan. Stat. Ann. §17-2212 ³ (Supp. 1987), the credit unions suggest that member shares are in the nature of equity capital, for which a setoff would not be permitted. They then argue that a lien attaches to the shares, either by statute or contract, whenever an amount is owed to the credit union and without any further action on the part of the credit union. This lien supposedly has priority over a federal tax lien.

We acknowledge that there are differences between banks and credit unions, but just as a bank has a right of setoff with respect to deposits under Kansas law, Karner v. Willis, 710 P.2d 21, 22 (Kan. 1985), aff'g 700 P.2d 582, 583 (Kan. App.; 1985); see also Kan. Stat. Ann. §84 -4-403 (1983); United States v. Central Bank, 843 F.2d at 1309 (applying Colorado U.C.C.), so too does a credit union with respect to shares, Kan. Stat. Ann. §17-2212 (Supp. 1987). We look to the Kansas statutory scheme regulating credit unions. See Kansas Credit Union League v. Redmond , 532 P.2d 1039, 1042 ( Kan. 1975). Section 17-2212(a) provides a credit union with "a lien and right of setoff" on member shares and dividends to the extent of amounts owed the credit union. ⁴ Thus, it is ludicrous to argue that the shares of the credit union, be they called capital or deposits, are not subject to a right of setoff. Moreover, in these circumstances, the lien is characterized accurately as "an equitable right of setoff" which allows the credit union to setoff the unmatured indebtedness of an insolvent member against the credit union's liability for the share deposit. Stann v. Mid American Credit Union, 39 B.R. 246, 248 (D. Kan. 1984). ⁵

Equally meritless is the credit union's argument that its interest, whether it be contractual or statutory, attaches automatically and defeats the federal tax lien. As noted, the federal tax lien attached at the time of assessment. I.R.C. §6322 ; United States v. Central Bank, 843 F.2d at 1306. The federal rule of priority is first in time first in right, meaning that the first lien to attach and become choate prevails. United States v. City of New Britain, Connecticut [54-1 USTC ¶9191 ], 347 U.S. 81, 85-86 (1954). Until the credit unions "affirmatively acted" against the taxpayers' accounts, the credit union's rights were contingent or inchoate. United States v. Central Bank, 843 F.2d at 1310. The affirmative action necessary required: (1) a decision to exercise a setoff right, (2) an action which accomplishes the setoff and (3) a record corroborating that a setoff right has occurred. Id. ; Baker v. National City Bank, 511 F.2d 1016, 1018 (1975). The credit unions did not take these affirmative steps until after notice of the federal tax levies. The cases are legion holding that a federal tax lien prevails when a bank attempts to offset after service of a notice of levy. See, e.g., United States v. Central Bank, 843 F.2d at 1310; People's Nat'l Bank v. United States [85-2 USTC ¶9849 ], 777 F.2d 459, 462 (9th Cir. 1985); United States v. Euclid Nat'l Bank [75-1 USTC ¶9239 ], 510 F.2d 461, 463 (6th Cir. 1975); United States v. First Nat'l Bank [72-2 USTC ¶9654 ], 348 F. Supp. 388, 389 (D. Ariz. 1970), aff'd, [72-2 USTC ¶9655 ] 458 F.2d 513 (9th Cir. 1972).

The credit unions cannot claim priority based upon either the statutory lien created by Kan. Stat. Ann. §17-2212(a) (Supp. 1987) or upon contractual language in loan documents requiring the borrower to "pledge" shares or payments on shares as security. I.R.C. §6323(a) ⁶ provides that a claim of a purchaser, holder of a security interest, mechanics lienor or judgment lien creditor has priority if that claim arises before notice of the tax lien is filed. Id. ; Treas. Reg. §301.6323(a)(1) . There is no mention of a statutory lien or right of setoff like that created by Kan. Stat. Ann. §17-2212(a). In discussing §17-2212(a), the credit unions claim the protection of I.R.C. §6323(a) as it relates to a security interest. Reliance on I.R.C. §6323 here is misplaced for two reasons. First, art. 9 of the U.C.C. as adopted in Kansas does not extend "to any right of setoff" or "to a transfer of an interest in any deposit account." Kan. Stat. Ann. §84 -9-104(i) & (j) (1983); id. Official UCC Com. 7. Thus, the credit unions do not have a security interest based on the interest created by Kan. Stat. Ann. §17-2212(a) (Supp. 1987). Second, I.R.C. §6323(h)(1) ⁷ makes it clear that only security interests arising by contract are covered. Id. ; Treas. Reg. §301.6323(h)-1(a) . Thus, §6323(a) does not apply to any statutory lien or right of setoff that the credit unions might have had.

With respect to a lien arising by contract, the loan documents executed by the taxpayers purported to pledge their shares as security for the amount owed. The credit unions contend that they have a "floating" security interest in or lien ⁸ upon the share accounts, subject to temporary waiver when unrestricted withdrawals are permitted. This approach cannot be squared with exiting law. To rely on I.R.C. §6323(a) , the credit unions would need to establish that their interest would be protected against a subsequent judgment lien. I.R.C. §6323(h)(1) ; Treas. Reg. §301.6323(h)-1(a)(2) . As noted, art. 9 of the Kansas U.C.C. does not provide for a security interest in share accounts. Thus, we must look at common law concerning pledges to determine whether the credit unions had a security interest in the taxpayers' accounts.

The basis of a pledge is possession by the pledgee. Walton v. Piqua State Bank, 466 P.2d 316, 326 ( Kan. 1970). A pledge of a passbook savings account may be accomplished by delivering possession of the passbook savings account to the bank or by delivering a valid assignment to the bank. Id. at 328-29. Although there can be a pledge of an intangible interest, the interest must be represented by an indispensible instrument such as a document of title. Restatement of Security §1 com. a. (1941). An indispensible instrument is "the formal written evidence of an interest in intangibles so representing the intangible such that the enjoyment, transfer, or enforcement of the intangible depends upon the possession of the instrument." Walton v. Piqua State Bank, 466 P.2d at 328 (relying on Restatement of Security §1 com. e.) "Where the chose in action is not represented by an indispensible instrument, the assignment of the chose in action for the purpose of security is not considered in the Restatement as a pledge." Restatement of Security §1 com. a. Here, the shares are not evidenced by an indispensable instrument, nor would the language of an assignment constitute an indispensable instrument. Wellsville Bank v. Nicolay, 638 P.2d 975, 979 ( Kan. App. 1982). Thus, there is no pledge, quite apart from the disqualifying facts that the credit unions did not hold the shares openly or adversely to the taxpayers or exercise an unlimited power to control the shares. See Walton v. Piqua State Bank, 466 P.2d 327. We must conclude that I.R.C. §6323(a) does not apply to any contractual interest the credit unions had in the taxpayers' share accounts.

In general, only liens which are choate and attach before the government files appropriate notice have priority over a federal tax lien. See United States v. Central Bank, 843 F.2d at 1307. The credit unions argue that this proposition has been superseded by the Federal Tax Lien Act of 1966, specifically I.R.C. §6323(a) & (h), concerning priority for perfected security interests that would have priority over a subsequent judgment lien. We acknowledge that one of the main purposes of the Federal Tax Lien Act was to conform the federal tax lien law to the U.C.C. S. Rep. No. 1708, 89th Cong., 2d Sess., reprinted in 1966 U.S. Code Cong & Admin. News 3722. And when the provisions of the Act provide "an unambiguous federal law answer" as to tax lien priority, it is unnecessary to rely on the concept of choateness. Aetna Ins. Co. v. Texas Thermal Ind., Inc. [79-1 USTC ¶9287 ], 591 F.2d 1035, 1038 (5th Cir. 1979). Thus, when called upon to determine the relative priority of a federal tax lien and a security interest created by contract, we have recognized the importance of resolving the issue with reference to the Act. Donald v. Madison Ind., Inc. [73-2 USTC ¶9623 ], 483 F.2d 837, 840 (10th Cir. 1973). Here, the credit unions cannot claim priority based on I.R.C. §6323(a) & (h) because they lack any contractual security interest which would prevail over a subsequent judgment lien.

When not inconsistent with the Federal Tax Lien Act, reference to the choateness doctrine is entirely appropriate. See United States v. Central Bank, 843 F.2d at 1307; J.D. Court, Inc. v. United States [83-2 USTC ¶9454 ], 712 F.2d 258, 262-64 (7th Cir. 1983), cert. denied, 466 U.S. 927 (1984). A state-created lien is inchoate unless all steps have been taken to establish a choate lien, that is " 'the identity of the lienor, the property subject to the lien, and the amount of the lien are established.' " United States v. Pioneer American Ins. Co. [63-2 USTC ¶9532 ], 374 U.S. 84, 89 (1963) (quoting United States v. City of New Britain, 347 U.S. at 84). As against an inchoate state-created lien, a federal tax lien has priority. United States v. Central Bank, 843 F.2d at 1307.

The credit unions claim priority based on a lien pursuant to Kan. Stat. Ann. §17-2212(a) however, any such interest was inchoate and contingent. More would have been required of the credit unions to perfect their interest, including action which restricted the rights of the taxpayers to withdraw the funds from the share accounts. The credit unions needed to present evidence that their liens were more than just a possibility. The liens could have been considered for priority had the credit unions decided, prior to the date of the federal tax lien, to restrict the taxpayers' access to the funds or to exercise the lien by setoff. See United States v. Central Bank, 843 F.2d at 1310; Baker v. Nat'l City Bank, 511 F.2d at 1018. Although the identity of the lienors was clear, the amount of property subject to the lien was not. The amount of the lien was discretionary with the taxpayers because they could withdraw, and reduce any lien, without restriction.

III.

Finally, we must decide whether the district court was correct in imposing the 50% penalty on the credit unions for failing to honor the tax levies. I.R.C. §6332(c)(2) ; Treas. Reg. §301.6332-1(b)(2) (`The penalty described in this subparagraph is not applicable in cases where bona fide dispute exists concerning the amount of the property to be surrendered pursuant to levy or concerning the legal effectiveness of the levy."). The district court imposed the penalty for a variety of reasons. United States v. Bell Credit Union, 635 F.Supp. at 404-05. After considering the arguments and authorities of the credit unions below and on appeal, we need only base our decision on one ground. In April 1983, when the notices of levies were served on the credit unions, the state of the law was clearly established concerning the duty of a third-party custodian to turn over taxpayer funds when the taxpayer previously had unrestricted access to those funds. See, e.g., United States v. Euclid Nat'l Bank, 510 F.2d at 463 (6th Cir. 1975); United States v. Sterling Nat'l Bank & Trust Co., 494 F.2d at 921-22 (2d Cir. 1974); Bank of Nevada v. United States [58-1 USTC ¶9228 ], 251 F.2d 820, 827 (9th Cir.), cert. denied, 356 U.S. 938 (1958).

Although the credit unions attempted to put a different spin on their position by stressing the differences between banks and credit unions, they steadfastly ignored the limited defenses to an admin istrative levy and the critical fact that the taxpayers, at the moment the notices of levy were served, had an unrestricted right to the funds in the share accounts. Questions of priority could have been resolved pursuant to I.R.C. §7426 ; merely because we address the priority issues in this case in no way validates the procedure relied upon by the credit unions. Stated another way, although priority issues may be resolved in an I.R.C. §6332 proceeding, such is a perilous path because of the 50% "lack of reasonable cause" penalty the government can be expected to seek when property held by a third-party custodian is not surrendered and the government must litigate. Reasonable cause for failing to honor the levies, I.R.C. §6332(c)(2) , "should not be ready to include a clearly erroneous view of the law, stubbornly adhered to after investigation should have disclosed the error." United States v. Sterling Nat'l Bank & Trust Co., 494 F.2d at 925 (Friendly, J., dissenting).

We have considered other arguments made in the amicus briefs and find them without merit.

AFFIRMED.

¹ At all times relevant, I.R.C. §6332 provided in pertinent part:

SURRENDER OF PROPERTY SUBJECT TO A LEVY.

(a) Requirement.--Except as otherwise provided in subsection (b), any person in possession (or obligated with respect to) property rights or property subject to levy upon which a levy has been made shall, upon demand of the Secretary, surrender such property or rights (or discharge such obligation) to the Secretary, exept such part of the property or rights as is, at the time of such demand, subject to an attachment or execution under any judicial process. . . .

(c) Enforcement of levy.--

(1) Extent of personal liability.--Any person who fails or refuses to surrender any property or right to property, subject to levy, upon demand by the Secretary shall be liable in his own person and estate to the United States in a sum equal to the value of property or rights not so surrendered, but not exceeding the amount of taxes for the collection of which such levy has been made, together with costs and interest on such sum at an annual rate established under section 6621 from the date of such levy (or, in the case of a levy described in section 6331(d)(3) , from the date such person would otherwise have been obligated to pay over such amounts to the taxpayer). Any amount (other than costs) recovered under this paragraph shall be credited against the tax liability for the collection of which such levy was made.

(2) Penalty for violation.--In addition to the personal liability imposed by paragraph (1), if any person required to surrender property or rights to property fails or refuses to surrender such property or rights to proerpty without reasonable cause, such person shall be liable for a penalty equal to 50 percent of the amount recoverable under paragraph (1). No part of such penalty shall be credited against the tax liability for the collection of which such levy was made.

All references are to the Internal Revenue Code of 1954, as amended.

² Kan. Stat. Ann. §17-2212(b) (Supp. 1987) provides: (b) A credit union may charge a membership fee, as may be established by a board of directors. Fully paid-up shares of a credit union may be transferred to any person upon election to membership, upon such terms as the board may establish. . . .

³ 17-2212. Capital and revenue of credit union; right of setoff; dormant accounts; unmatured shares; transfer to reserve fund, when. (a) The capital of a credit union shall consist of payments that have been made to it by the several members thereof on all types of shares. A credit union shall have a lien and right of setoff on the shares of any member and on the dividends or other earnings payable thereon for and to the extent of any obligation of the member and of any dues and fines payable by the member. A credit union may, upon the resignation or expulsion of a member, cancel the shares of such member, and apply the withdrawal value of such shares toward the liquidation of the member's indebtedness.

⁴ A "lien" is "[a] charge or security or encumbrance upon property." Black's Law Dictionary 832 (5th ed. 1979). A "setoff" is "[a] discharge or reduction of one demand by an opposite demand." Ballentine's Law Dictionary 1167 (3rd ed. 1969). A prior version of the statute, Kan. Stat. Ann. 17-2212 (1980), provided that a credit union "shall have a lien on the shares" of a member for amounts owed the credit union by the member. The statute was amended in 1982 to provide that a credit union "shall have a lien and right of setoff on the shares." Kan. Stat. Ann. §17-2212 (Supp. 1987). The credit unions argue that they each sought to enforce a lien, not exercise a right of setoff, when they liquidated the taxpayer share accounts. Although we recognize that a lien is different than a setoff, United States v. Central Bank, 843 F.2d at 1310, in these circumstances each credit union sought to enforce its lien (in an amount equal to outstanding loan balances) by exercising a right of setoff in the taxpayer share accounts (in an amount equal to the balance of the account).

⁵ The credit unions take issue with reliance on Stann v. Mid American Credit Union, claiming that the portion relied on is obiter dicta. We disagree. In deciding that a freeze, rather than a setoff of assets occurred, the district court was required to discuss the nature of a lien under Kan. Stat. Ann. §17-2212 (Supp. 1987). Merely because a court rejects a theory does not mean that a discussion of the theory is dicta.

⁶ I.R.C. §6323(a) provides:

(a) Purchasers, Holders of Security Interests, Mechanic's Lienors, and Judgment Lien Creditors.--The lien imposed by section 6321 shall not be valid as against any purchaser, holder of security interest, mechanic's lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary.

⁷ I.R.C. §6323(h) provides:

(h) Definitions.--For purposes of this section and section 6324 --

(1) Security interest.--The term "security interest" means 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.

⁸ Amicus Wyoming Credit Union League refers us to a federal credit union's power "to impress and enforce a lien upon the shares and dividends of any member, to the extent of any loan made to him and any dues or charges payable to him." 12 U.S.C. §1757(11). The National Credit Union Administration (NCUA) has determined that:

If a credit union evidences its intent to do so, it may impress the lien when the loan is granted. This may be done, for instance, by noting the existence of the lien in the credit union's records at the same time the loan is granted, by reciting in the loan documents that shares and dividends are subject to the lien or are pledged to secure the loan, or by adopting a bylaw or board policy to the same effect. The lien dates from the time it is impressed and applies to all the member's shares outstanding at the time the loan is made. If during the loan term the member's shares are reduced by withdrawal or increased by deposit or dividend payments, the lien will apply to the balance of the same from time to time and may be enforced with respect to any shares in existence at the time of enforcement. The credit union may enforce the lien on the shares and dividends of the member by applying those funds directly to the outstanding indebtedness, which may include the unpaid loan balance together with interest, fees and other charges. The credit union does not need to obtain a court judgment to enforce the lien, even if a court judgment is usually required under state law before a lien can be enforced.

NCUA, Interpretive Ruling and Policy Statement (IRPS) 82-5 ( Dec. 16, 1982 ). This ruling essentially describes a lien which must be enforced by a right of setoff to be effective, it does not establish priority with respect to a federal tax lien.

Supplementary Information with IRPS 82-5 indicates:

The lien "floats" as outstanding obligations, as well as account balances, vary from time to time. The lien enables a credit union to take priority over other creditors when claims are asserted against a member's account. See D. Bridewell, Bridewall on Credit Unions 710 (1942 ed.) (quoting from the May-June, 1940 edition of Cooperative Savings, an official publication of the Farm Credit Administration, the agency then charged with admin istering the Federal Credit Union Act).

Id. While this supplementary information describing the floating lien theory is interesting, it does not convince us that a credit union's "floating lien" would have priority in these circumstances. Without a documented restriction on a taxpayer-member's right to withdraw shares, a federal tax lien which predates a credit union's right of setoff has priority.

 

[67-1 USTC ¶9224]Murdaugh Stuart Madden and Clifford J. Hynning v. The United States

U. S. Court of Claims, No. 399-62, 178 CtCls 121, 371 F2d 469, 1/20/67

[1954 Code Sec. 6323]

Tax liens: Attorney's lien: Priority.--Attorneys who successfully prosecuted a claim on behalf of a delinquent taxpayer against an Ordnance District (of the Army) for an equitable adjustment under a contract performed by the taxpayer for the District were not entitled to priority in the judgment fund for attorneys' fees as against the claims of the Internal Revenue Service for tax liens and the Small Business Administration as an assignee. The attorneys failed to establish a basis for precluding the government's superior right of setoff where it is both debtor and creditor.

Clifford J. Hynning, 301 Anchorage Office Bldg., 1555 Connecticut Ave., Washington, D. C., pro se, and for Murdaugh Stuart Madden, plaintiff. Manfred J. Schmidt, Barefoot Sanders, Assistant Attorney General, Department of Justice, Washington, D. C. 20530, for defendant.

Before COWEN, Chief Judge, LARAMORE, DURFEE, DAVIS , COLLINS, and SKELTON, Judges.

Opinion

PER CURIAM: ^*

The present plaintiffs, two Washington lawyers, successfully prosecuted a claim on behalf of Industrial Finishers, Inc., an Ohio corporation, against the Cleveland Ordnance District (of the Army) for an equitable adjustment under a contract performed by Finishers for Cleveland Ordnance. They accepted the retainer on a contingency basis which was later amplified by an express agreement for 30 percent of the recovery. After they had established Finishers' right to an equitable adjustment in the amount of $34,000 (reflecting a fee of $10,200), the Small Business Administration asserted rights to $20,000 of the fund under an assignment theretofore executed by Finishers, and the Internal Revenue Service asserted tax liens for $16,904.67. Ordnance ultimately disbursed the fund to SBA and IRS, leaving nothing for plaintiffs. They sue here, claiming an attorney's lien under Ohio law.

[Setoff]

Defendant argues, among other defenses, that the right of setoff where the Government is both debtor and creditor is established by statute (31 U. S. C. §227) and by controlling decisions. "[O]ne whose own appropriation and payment of money is necessary to create a fund for general creditors is not a general creditor. He is not compelled to lessen his own chance of recovering what is due him by setting up a fund undiminished by his claim, so that others may share it with him. In fact, he is the best secured of creditors; his security is his own justified refusal to pay what he owes until he is paid what is due him." United States v. Munsey Trust Co., 332 U. S. 234, 240 (1947). See also General Casualty Co. v. United States, 130 Ct. Cl. 520, 526, 127 F. Supp. 805, 808 (1955), cert. denied, 349 U. S. 938; Standard Accident Ins. Co. v. United States, 119 Ct. Cl. 749, 766, 97 F. Supp. 829, 831 (1951); and Seaboard Surety Co. v. United States, 107 Ct. Cl. 34, 46, 67 F. Supp. 969, 972 (1946), cert. denied, 330 U. S. 826 (1947).

Plaintiffs would negate defendant's right of offset "by involing the doctrine of equitable estoppel" because of alleged deceptive practices by the Government agencies, primarily Small Business Administration. It is unnecessary to decide the applicability of equitable estoppel in a proper case because in this instance the alleged deceptive practices are not established in fact.

As shown by the findings, Finishers (plaintiffs' client), in June 1958, undertook a contract with Cleveland Ordnance for the modification of certain shell cartridge cases. At the same time Finishers obtained a loan from the Small Business Administration, payable in monthly installments over a period of 10 years. In the performance of the contract, Finishers incurred substantial losses attributable, according to it, to requirements imposed by the contracting officer, because of which Finishers pressed the claim for an equitable adjustment which ultimately resulted in the creation of a fund (in the hands of Ordnance) of $34,000.

Six months after the SBA loan was made, in January 1959, Finishers failed to make the monthly payment due on the SBA loan. Regular payments were never resumed, and the loan was ultimately called. Meanwhile, however, there were many conferences between Finishers and SBA looking toward possible methods of retrieving the business losses and restoring the borrower's credit to acceptable levels.

In June 1959, the plaintiff Madden was requested and agreed to handle Finishers' claim against Cleveland Ordnance for an equitable adjustment. Mr. Madden agreed to take the case on a contingent fee basis without specifying the percentage of the contingent fee. ¹

Three weeks later, in one of many conferences between Finishers' president, Mr. Paul R. Dukes, its Cleveland attorney, Mr. Howard C. Cook, and SBA's Cleveland Loan Examiner, Mr. T. J. Nolan, Mr. Dukes told Mr. Nolan that Finishers' claim against the Government had been filed in the approximate amount of $60,000 by attorneys in Washington on a contingent basis. Mr. Nolan informed Mr. Dukes that SBA would like to have some assurance from the Washington attorneys as to the validity of the claim and some idea as to when it would be settled; also assurance from Mr. Dukes that if the claim was valid, he (Mr. Dukes) would pay the interest on the loan until such time as funds were received as a result of the claim; otherwise, SBA would have to take steps to protect its interest.

After another 2 weeks, on July 10, 1959 , Mr. Madden, at the request of Mr. Dukes, wrote to SBA, saying that he was confident Finishers would be successful since the Army had ordered modifications of the contract. Mr. Madden received no acknowledgment of or reply to his letter until the SBA letter of October 5, 1959 , hereinafter noted.

Meanwhile, during August and September 1959, SBA continued to press Mr. Dukes for measures by which the status of Finishers' loan might be improved. The exchanges between Mr. Dukes and Mr. Nolan culminated in late September in an arrangement whereby Finishers would pay $500 per week until the end of the year to cover interest charges ² and consent to an assignment of 50 percent of its claim against Ordnance ("but in no event on an amount not less than would be required to pay the principal amount delinquent on account of the loan"); ³ in return for which SBA "would continue to work with him for the next 90 days which would no doubt be sufficient time for the settlement of the * * * claim."

On September 30, 1959, Finishers executed for delivery to SBA "in consideration of the extension of credit" an assignment of $20,000 "of any and all amounts now due or owing, or which may hereafter be or become due or owing * * * by the United States * * * to the assignor * * *" under the Ordnance contract. The assignment was propared by Mr. Cook, Finishers' Cleveland attorney, as "a modification of the form usually utilized by * * * [him] in the State of Ohio ," and its execution was supervised by him. The amount of the assignment was related to the amount of the additional security requested by SBA in the light of the delinquency of the debt of Finishers to SBA.

Finishers' contract with Ordnance contained, as Article 8(a) of the General Provisions, the text of the Assignment of Claims Act of 1940, as amended (31 U. S. C. §203, 41 U. S. C. §15) which authorized the assignment of claims for monies due or to become due to a contractor from the Government to "a bank * * * or other financing institution, including any Federal lending agency." The Act specifically provided that "any such assignment shall cover all amounts payable * * *." [Italics supplied.]

When Finishers made the assignment to SBA of $20,000 of its claim against Ordnance, the claim had not been allowed, wherefore no monetary amount had been determined. The claim was being discussed, however, in terms of $40,000 to $60,000, and there can be no doubt from the evidence of record that both Finishers and SBA intended an assignment of part only (approximately half) of the estimated value of the claim.

If any of the individuals who participated in the assignment transaction, including its ultimate approval by the Regional Director of SBA, was aware of the requirement (by contract and statute) that "any such assignment shall cover all amounts payable" under the contract, the fact is not in evidence. By reason of the presence of the requirement in the contract, it goes without saying that they should have been aware of it.

On October 5, 1959 , SBA wrote to Mr. Madden, referring to his letter to SBA of July 10, 1959 , and saying:

* * * As you no doubt know we have a direct interest in this claim, insofar as our loan is concerned and the subject Borrower's operations.

We would be pleased if you will advise us as to what progress you have made in the settlement of the claim.

Mr. Madden forwarded the letter to Mr. Dukes who, on October 21, wrote to Mr. Madden as follows:

We are very much interested and concerned about our claim for reimbursement, and if the writer can help with any information at the present time please let me know.

Small Business Administration is interested in our claim progress, as per their letter to you of October 5th, because the writer has signed over half of what we obtain when the time comes, to pay against reimbursement of the SBA loan.

This exchange of correspondence made no particular impression upon Mr. Madden at the time. He had filed Finishers' claim with the contracting officer at Ordnance and there was little more that he could do until the contracting officer rendered his decision. Since he had no responsibility for Finishers' efforts to improve the status of its loan with SBA, he did not undertake to inform himself of the progress of those efforts. Mr. Hynning, when he came into the picture a year later (October 1960), likewise failed to attach any importance to the letter of October 21, 1959 , from Mr. Dukes to Mr. Madden which, presumably, was in Mr. Madden's file.

On May 11, 1960 , Ordnance's contracting officer denied Finishers' claim, and Mr. Maddens, on June 14, docketed an appeal to the Armed Services Board of Contract Appeals. The board scheduled a hearing for November 15, 1960 .

Meanwhile, although SBA continued to work with Mr. Dukes in his efforts to attain a satisfactory payment structure for his loan, the results were discouraging. In September 1960, Finishers ceased operations.

Hearings on the claim were held by ASBCA on November 15 and 16, 1960, with Mr. Hynning appearing for Finishers. At the request of Government counsel, the board ordered a severance of the issues, for determination separately of the issues of liability and damages. Seven months later (June 1961) the ASBCA sustained Finishers' appeal and remanded the case to the contracting officer in Cleveland for negotiation of the amount of the price adjustment.

When Mr. Hynning went to Cleveland , in July 1961, to negotiate the adjustment, he learned for the first time of Finishers' assignment to SBA. Although he was astonished and somewhat perturbed by it (and considered it legally invalid as being in contravention of the Assignment Act of 1940), he persevered in his efforts to negotiate an adjustment and, in October 1961, obtained Ordnance's confirmation of settlement in the amount of $34,000. A month later the Internal Revenue Service served on Finishers a Notice of Levy for $16,904.67 for taxes assessed and unpaid. SBA had already filed with Ordnance copies of its assignment from Finishers.

Thereafter, correspondence was exchanged between Mr. Hynning, on the one hand, and attorneys for SBA, Ordnance, and IRS, on the other, and between attorneys for SBA and attorneys for IRS. The end result was that plaintiffs' claim was referred to the General Accounting Office which disallowed it by letter of July 3, 1962 , to Mr. Hynning, advising him:

* * * The relationship of attorney and client is purely a matter of their mutual arrangement and does not render such attorney privy to contractual relationship between the Government and its contractors.

It is the general rule that attorney fees are not allowed in suits against the Government without an express statutory provision allowing them. Piggly Wiggly Corp. v. United States , 112 Ct. Cls. 391.

Ordnance thereupon paid $20,000 to SBA and $14,000 to IRS, thereby exhausting the fund. ⁴

The inferences of conspiracy, deception, misrepresentation, and knavery, without which plaintiffs cannot prevail, are not warranted by the evidence.

The evidence upon which plaintiffs must rely for such inferences relates to two separate episodes in the unfolding of the transactions. One episode pertains to the actions of SBA in obtaining the assignment and the alleged conspiracy of silence and concealment thereafter, with SBA's Loan Examiner, Mr. Nolan, and Finishers' president, Mr. Dukes, and its Cleveland attorney, Mr. Cook, as participants. The other episode concerns the actions of attorneys for SBA, for IRS, and for Ordnance in the negotiations more than 1 year later with Mr. Hynning concerning disbursement of the fund. There is nothing in the evidence to relate one group of participants to the other.

The correspondence which passed between attorneys in the later of the two episodes reflects the determination of the Government attorneys to protect the interest of their respective agencies, even at the expense of plaintiffs, if necessary, and there is about it an aura of lack of candor toward Mr. Hynning. As of that time, however, the merit or lack of merit of the charges of improper silence, ignorance, and deception on the part of those who participated in the assignment transaction was already fixed, and the maneuvers of the attorneys in protecting the rights of their agencies could have no effect upon those facts. In other words, the Government's rights of offset, on behalf of both SBA and IRS, were already fixed, and the validity of the SBA assignment or the priority of the IRS tax levy had nothing to do with the final outcome, absent proof of the alleged conspiracy, deception, or misrepresentation.

As noted in the findings, ⁵ the evidence as a whole does not warrant an inference that knowledge of the assignment by Finishers to SBA was deliberately withheld from plaintiffs by Finishers, SBA, or Ordnance, or that any action by any of the three was designed or intended to keep such knowledge from plaintiffs.

SBA's Loan Examiner, Mr. Nolan, was not a lawyer, and the office routine of SBA within which he worked apparently did not require scrutiny for legal clearance of his action in obtaining the assignment from Finishers. Having applied a banker's instinct to the improvement of the appearance of Finishers' paper, he was content to have Finishers' Cleveland lawyer, Mr. Cook, draw up and supervise the execution of the assignment. Mr. Cook, as Finishers' loan attorney, appears to have been oblivious to the Assignment of Claims provision in Finishers' contract with Ordnance or to any possible impact of such an assignment upon the prosecution by other lawyers of Finishers' claim for an equitable adjustment. Mr. Dukes evidently thought he was apprising Mr. Madden of the situation when he wrote, on October 21, 1959 , that he had "signed over half of what we obtain when the time comes, to pay against reimbursement of the SBA loan." Moreover, both plaintiffs knew or should have known of the existence of the SBA loan (apart from the assignment), and they are charged with knowledge of the Government's right to offset a debt owed to it. In all the circumatances, there was no such obligation on SBA, itself, to notify the plaintiffs of the assignment as could possibly destroy or diminish the Government's ancient right of set-off.

The failure by plaintiffs to establish a basis upon which to preclude defendant's right to offset Finishers' debts to SBA and IRS, independently of the assignment to SBA and the levy of IRS, requires recognition of the right of offset as superior to the claimed attorneys' lien. Therefore, discussion is unnecessary of (1) the validity of the assignment, (2) the priority of the levy, (3) the impact or lack thereof of the Anti-Assignment Act upon the claimed attorneys' lien, (4) the effect on the Government's right of set-off of proved malfeasance or misrepresentation by its representatives, (5) whether plaintiffs had an attorneys' lien under whatever law was applicable, (6) what law is applicable to determine such a lien, or (7) the jurisdiction of this court over any claim grounded on an attorney's lien. In particular, the court does not reach or decide whether an attorney can ever assert an attorney's lien against the United States for the collection of fees to which his client (a claimant against the Government) has agreed. See Pittman v. United States, 127 Ct. Cl. 173, 116 F. Supp. 576 (1953), cert. denied, 348 U. S. 815 (1954); Empire Ordnance Corp. v. United States, 130 Ct. Cl. 719, 128 F. Supp. 744 (1955); and Kearney v. United States, 152 Ct. Cl. 202, 285 F. 2d 797 (1961), cert. denied, 366 U. S. 935.

[Judgment of Court]

The plaintiffs are not entitled to recover and their petition is dismissed.

* * *

["Findings of Fact" and "Conclusion of Law" omitted.--CCH.]

^* This opinion is largely based on portions of the opinion prepared by Trial Commissioner W. Ney Evans at the direction of the court. The court does not consider certain issues discussed by the commissioner.

¹ The specific agreement for a contingent fee of 30 percent of the recovery was made 16 months later, in October 1960.

² Interest charges for the year 1959 would have been of the order of $6,650.

³ Payments on principal for the year 1959 would have been of the order of $10,000.

⁴ SBA, standing on its rights under the assignment from Finishers, had persuaded IRS to yield priority to SBA, authorizing payment to SBA of the full amount of the assignment, while IRS, in accepting the balance, suffered a reduction of its claim.

⁵ Finding 16(b) and n. 24.

 

 

[46-2 USTC ¶9397] United States of America , Intervener, Appellant, v. American Surety Company of New York , et al., Appellees

(CA-5), United States Circuit Court of Appeals for the Fifth Circuit, No. 11645, 158 F2d 12, November 23, 1946

Appeal from the District Court of the United States for the Southern District of Florida.

Tax liens: Invalidity after receiving credit against claim of surety's principal.--A tax lien may not be asserted after the United States has, pending appeal, received credit for the amount in dispute against a claim by appellee surety's principal against the United States under a contract. Dismissing the intervention before the District Court for the Southern District of Florida, 46-1 USTC ¶9183

Arthur L. Jacobs, Special Assistant to Attorney General, Sewall Key, Acting Assistant Attorney General, Washington, D. C., Herbert S. Phillips, U. S. Attorney, Tampa, Fla., Edith House, Assistant U. S. Attorney, Jacksonville, Fla., for appellant. Joseph H. Ross, Cyril C. Copp, Walter C. Shea, Gordon McCauley, George C. Bedell, Joseph M. Glickstein, William A. Carter, Jacksonville, Fla., Roger H. West, Frank E. Newlin, W. J. Gardiner, Daytona Beach, Fla., T. G. Futch, Leesburg, Fla., James J. Marshall, Miami, Fla., Willis Sherill, West Palm Beach, Fla., for appellees.

Before SIBLEY, HUTCHESON, and WALLER, Circuit Judges.

SIBLEY, Circuit Judge:

The American Surety Company was surety on the bond of a public contractor conditioned "to pay all persons supplying labor and material in the prosecution of the work provided for in the contract." The contractor failed to make payment and the surety filed a bill in the nature of an interpleader, paying into court the amount of the bond, which is insufficient to pay all claimants. The United States intervened to assert a claim of over $16,000 due it for taxes, withheld by the contractor from the wages of employees in the work as income taxes and social security taxes due by the employees, as certain federal statutes required the employer to do. The intervention and objections to the claim were referred to a master, who reported the amount of the claim to be $16,150.42, but held it not to be a claim for labor or material supplied in the prosecution of the work within the coverage of the bond, and that the United States should not participate in the distribution of the fund in court. It was so decreed, and this appeal was taken.

The contention of the United States is that what was deducted from the employees' wages is still unpaid wages, the law having made the United States the payee thereof. The contention of the appellees is that by the express provision of the Revenue Code, 28 U. S. C. A., Sec. 1427, the "amount so deducted shall be considered to have been paid to the employee at the time of such deduction," so that there is no longer any liability on the employer to pay as wages, but he is under a new liability to the United States for taxes thus collected for the United States.

Counsel for appellant, however, presents to us, that we may consider whether the cause is moot, (but not conceding that it is), authenticated copies of two certificates of credits allowed the United States in the General Accounting Office by the Comptroller General on Feb. 1, 1946, and Aug. 6, 1946, since the date of the decree appealed from, which show that the United States has been allowed credit for the very tax deductions here in dispute against the contractor's claim for work done under this contract. The certificates mean that the United States has elected to collect this tax claim directly from the contractor instead of out of this fund arising from the bond, and has received payment by offset in this way.

Appellees assert this appeal has thus become moot. We agree. The General Accounting Office has authority to make settlement and adjustment of all accounts for and against the United States . 31 U. S. C. A., Secs. 44, 71, 74. Sections 227 and 228 relate to offsetting judgments, but the General Accounting Office has also the right to make set-off of opposing claims before judgment. See citations in Note 12 under Sec. 71. Because the United States has collected its money since the decree in this way, and is certainly not entitled to have it twice, it is unnecessary to decide whether or not it might have been collected from the fund in court. The judgment on the intervention is therefore set aside, and the intervention dismissed as moot, without costs of appeal.

 

 

[54-2 USTC ¶9696]Frank T. Kleiger and Conrad Rosenbaum, Plaintiffs v. Denis J. McMahon, as Director of Internal Revenue for the United States Government, and the United States of America, Defendants

In the United States District Court for the Southern District of New York, Civ. 78-137, 128 FSupp 741, November 16, 1954

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

Lien for taxes: Accountants' fees: Set-off.--Regardless of the effect of an alleged retainer, the government has a setoff against a refund, which was supposedly assigned to the plaintiffs, based upon other claims against the assignor. This setoff is superior to the rights of the plaintiffs as assigness or equitable lienors.

Alfred S. Julien, for plaintiff. J. Edward Lumbard , U. S. Attorney, for defendant.

Memorandum

WALSH, District Judge:

Plaintiffs, as certified public accountants, by this action have attempted to recover $1,258.07 from the government as assignees of a refund for overpayment of taxes allegedly due their client. The government's motion for summary judgment based upon its counterclaim against the assignor is granted.

Plaintiffs claim that they were retained on a contingent fee basis to prosecute the claim for this refund and that the amount of their fee was to be fixed later. They also claim that the amount in question, which is the full amount recovered from the government, was assigned to them by a writing executed after recovery and before payment by the government.

The latter assignment fails to conform with the requirements of the statute because it was not properly witnessed. The earlier alleged retainer which did not fix the amount or percentage of the fee could not sustain an assignment of the entire recovery. Whether it established an equitable lien enforceable against the government as well as against the assignor for some lesser amount would require the reconciliation of Nutt v. Knut, 200 U. S. 12, 20; Calhoun v. Massie, 253 U. S. 170, 175; Wardman v. Leopold, C. A. D. C. 85 Fed. (2d) 277, 281 [36-2 USTC ¶9348]; Malman v. U. S., 2 Cir., 202 Fed. (2d) 483, 484; Brooks v. Mendel-Witte Co., 2 Cir., 54 Fed. (2d) 992, 995, and need not now be considered.

Regardless of the effect of this alleged retainer, the government concededly has a setoff against the refund in question based upon other claims against plaintiffs' assignor. This setoff is superior to the rights of the plaintiffs as assignees or equitable lienors. Ozanic v. U. S. , 2 Cir., 188 Fed. (2d) 228; Malman v. U. S. , 2 Cir., 207 Fed. (2d) 897.

Claim dismissed.

 

 

[58-2 USTC ¶9839]United States Fidelity & Guaranty Company, a corporation v. United States of America

U. S. District Court, Dist. Md., Civil No. 9830, 164 FSupp 703, 9/10/58

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

Lien for taxes: Enforcement by set-off against government's debt to taxpayer: Priority over interest of surety.--Plaintiff, surety on performance and payment bonds covering a contract with the U. S. Army, sought to recover $4,243.05, a portion of the retained percentage under the contract which the government had taken to satisfy its lien for a tax liability of the plaintiff's principal. Having paid over $23,000 in labor and material claims as a result of the contractor's default, plaintiff claimed it was entitled to subrogation to the retained funds due its principal, and that the government had no right to use that money as a set-off against its creditor's tax liability. The basis for plaintiff's argument was that taxpayer's liability, the result of the 100% statutory "penalty" levied by 1954 Code Sec. 6672 for failure to pay over social security taxes, was collectible only by direct action and not by counterclaim. Indicating that this rule as to the manner of enforcing penalties was not inflexible, the Court pointed out that since the fine involved here was intended to secure the payment of funds held by an employer in the nature of a trust, it was a civil or admin istrative penalty, not a criminal one. It was therefore capable of being collected by means of a set-off against a debt owed by the government to the taxpayer, and similarly enforceable against the taxpayer's surety claiming through subrogation.

Rob ert D. Bartlett, J. Kemp Bartlett, Jr., 131 Redwood Street, Baltimore 2, Md., S. R. Starnes of Spain, Gillon & Young, First National Building, Birmingham, Ala., for plaintiff. Leon H. A. Pierson, United States Attorney, John R. Hargrove, Assistant United States Attorney, 508 Post Office Building, Baltimore 2, Md., for defendant.

THOMSEN, Chief Judge:

Plaintiff surety seeks judgment against the United States for $4,243.05, a portion of the retained percentage under a contract between its principal and the government. The government has applied the $4,243.05 to extinguish a civil penalty, assessed against the principal under 26 U. S. C. A. 6672, for failing to pay over FICA taxes ¹ deducted from the wages of employees of a corporation of which he was president and sole stockholder. Plaintiff contends that the government has no right, as against the claim of the surety, to apply any part of the retained percentage to such an obligation.

In 1954, John C. Lewis, Jr., was the president and sole stockholder of Consolidated Building Corporation, which was unable to obtain surety bonds because of financial difficulties. Lewis therefore bid on various contracts in his own name, doing business as A & W Construction Company, and was awarded a contract by the Department of the Army. Plaintiff became surety for Lewis on the performance bond and the payment bond required by the Miller Act, 40 U. S. C. A. 270(a). As part of the application for such bonds, Lewis executed an assignment to plaintiff of all monies and retained percentages due or to become due under the contract. That assignment, however, did not meet the requirements of the Assignment of Claims Act of 1940, as amended, 31 U. S. C. A. 203, and need not be considered further in this case.

Lewis caused Consolidated to enter upon the performance of the contract, but it defaulted in its payments for labor and materials and plaintiff, as surety for Lewis, paid out $23,267.19 on claims for labor and materials prior to February 1, 1956 .

Consolidated did not pay over to the government the FICA taxes which it had deducted from the wages of its employees during the last quarter of 1955 and the first quarter of 1956. Assessments for those taxes were made against Consolidated, and notices of lien were filed.

On March 21, 1956, the Commissioner of Internal Revenue, acting through the District Director of Internal Revenue at Birmingham, Alabama, assessed a 100% penalty, in the amount of $3,363.43, against John C. Lewis, Jr., d/b/a A & W Construction Company, as the responsible officer of Consolidated Building Corporation, for FICA taxes not paid by Consolidated for the fourth quarter of 1955. A similar assessment for the first quarter of 1956, in the amount of $878.22 plus a lien fee of $1.40, was made on March 21, 1956 . The validity of those assessments is not challenged here. On March 22, 1956 , the Chief of Delinquent Accounts and Returns sent a notice of the assessments to the Finance Officer, Corps of Engineers, Mobile District. At that time there was due and owing under the construction contract the sum of $4,847.98. The Finance Officer deducted $4,243.05 from the amount due under the construction contract and transferred that amount over to the General Accounting Office for direct settlement of the government's lien. It is that $4,243.05, with interest, which plaintiff seeks to recover in this action under the Tucker Act, 28 U. S. C. A. 1346(a)(2).

In United States v. Munsey Trust Co., 332 U. S. 234, the Supreme Court held that the United States is entitled to set off its creditor's debt to it before paying its debt to the creditor, and that the United States cannot be deprived of its right of set-off by the circumstance that the creditor-contractor's surety, which has paid claims for labor and materials furnished the contractor, is claiming the fund. This rule has been applied to permit a set-off by the government of a contractor's liability for taxes. Standard Accident Ins. Co. v. United States , Ct. Cl., 97 Fed. Supp. 829; General Casualty Co. of America v. United States, Ct. Cl., 127 Fed. Supp. 805; Malman v. United States , 2 Cir., 202 Fed. (2d) 483; Sanders v. Commissioner of Internal Revenue, 10 Cir., 225 Fed. (2d) 629 [55-2 USTC ¶9636]. In the Sanders case the liabilities offset included taxes, interest and penalties. ²

Plaintiff relies upon the rule that "a statutory penalty generally cannot be used as a set-off or counterclaim". 47 Am. Jur. (Set-off and Counterclaim, sec. 35) p. 735. But the rule does not say that a penalty may never be set-off against a debt. The nature of the penalty and circumstances of the case must be considered.

The assessment against Lewis was made pursuant to sec. 6672, I. R. C. of 1954, 26 U. S. C. A. 6672, which provides:

"Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under section 6653 for any offense to which this section is applicable."

The preceding section, 6671, provides:

"(a) Penalty assessed as tax.--The penalties and liabilities provided by this subchapter shall be paid upon notice and demand by the Secretary or his delegate, and shall be assessed and collected in the same manner as taxes. Except as otherwise provided, any reference in this title to 'tax' imposed by this title shall be deemed also to refer to the penalties and liabilities provided by this subchapter.

"(b) Person defined.--The term 'person' as used in this subchapter, includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs."

Sec. 6672 of the I. R. C. of 1954 is substantially similar to sec. 2707(a), I. R. C. of 1939, 26 U. S. C. A., 1952 ed., sec. 2707, which was made applicable to social security taxes by sec. 1430, I. R. C. of 1939, 26 U. S. C. A., 1952 ed., sec. 1430. In Reams v. Vrooman-Fehn Printing Co. , 6 Cir., 140 Fed. (2d) 237, the plaintiff sought to enjoin the collection of an assessment imposed under sec. 2707(a), I. R. C. of 1939, but the court sustained the collector's contention that the suit was barred by sec. 3653, I. R. C. of 1939, which prohibited suits to enjoin the collection of a tax. The court stated: "It is true that Section 3653 of Title 26 U. S. C. A., Int. Rev. Code, does not specifically include penalties as such. However, those here in question are an integral part of the tax and interwoven into it. They are admin istrative penalties and are within the impeding statute just as much as primary taxes." 140 Fed. (2d) at 240-241.

In a bankruptcy case, In re Haynes, D. Kan., 88 Fed. Supp. 379, 384, the court said of sec. 2707(a): "The purpose of this statute is not to punish but to secure the collection of a fund that has passed into the hands of the employer, which is in the nature of a trust fund, the employer acting as a collecting agency for the United States . This statute would have been just as effective without the use of the word penalty and for this reason it should be construed as making the managing officer of the corporation personally liable if he willfully fails to remit the funds that comes (sic) into his hands as such officer. We do not think the statute imposes a penalty not collectible against the bankrupt's estate."

Taylor v. Sandiford, 7 Wheat. 13, cited by plaintiff, dealt with a contractual penalty in the guise of liquidated damages; it was not enforceable either by way of set-off or by direct suit. Priebe v. United States , 332 U. S. 407.

In Globe Indemnity Co. v. Cooper Motor Lines, S. C., 33 S. E. 2d 405, 406, also cited by plaintiff, the court stated: "It is generally held that where only recovery by direct action is expressly provided by statute, the statutory penalties may not be recovered by way of counterclaim or other defensive pleading." The statute with which we are dealing, however, specifically provides that "the penalties and liabilities provided by this subchapter * * * shall be assessed and collected in the same manner as taxes." 26 U. S. C. A. 6671.

The penalty assessed against Lewis in the instant case is a civil penalty, an admin istrative penalty; it is not a criminal penalty. Nugent v. United States , N. D. Ill., 136 Fed. Supp. 875, and cases cited at p. 879. The government had the right to set it off against the retained percentage due Lewis.

The surety in the instant case is claiming by way of subrogation to the rights of the principal, and the government is entitled to set-off against the surety any liabilities of the principal to the government which it might set-off against the principal. United States v. Munsey Trust Co., 332 U. S. 234; Standard Accident Ins. Co. v. United States, Ct. Cl., 97 Fed. Supp. 829. The principles which would control a suit by the government on the surety's bond do not apply here. Cf. United States v. Crosland Construction Co., 4 Cir., 217 Fed. (2d) 275 [55-1 USTC ¶9112].

The penalty assessed against Lewis was of such nature that under the facts of this case the government has the right to set it off against the claim of the surety to the retained percentage.

Let judgment be entered in favor of the defendant, with costs.

¹ See I. R. C. of 1954, secs. 3101, 3102.

² Most of the cases cited by plaintiff dealt with the efforts of individuals to set-off unrelated claims against the sovereign in suits for the collection of taxes. Such cases involve a question of public policy not present here. Other cases cited by plaintiff turned on jurisdictional points.

 

 

[71-1 USTC ¶9377] United States of America , Plaintiff v. United States Fidelity and Guaranty Company, Defendant

U. S. District Court, East. Dist. Wash. , No. Div., Civil No. 3282, 328 FSupp 69, 4/12/71

[Code Sec. 6323--Result unchanged by '69 Tax Reform Act]

Tax liens: Contractor in default: Surety: Setoff.--The United States may not apply the retained percentage on a construction contract to non-trust fund taxes due by the contractor in default but unrelated to the contract in question where the surety was ready, willing and able to perform its obligations under its bonds.

Dean C. Smith, United States Attorney, Spokane , Wash. , for plaintiff. Moffatt, Thomas, Barrett & Blanton, 525 First Security Bldg., Boise, Idaho, Myers, Reiley & Annis, 855 Lincoln Bldg., Spokane, Wash., for defendant.

POWELL, District Judge:

The parties have stipulated that this cause be submitted to the Court without argument on cross motions for summary judgment. The facts are set forth in the pleadings and are not disputed. The facts are as follows:

The United States of America let a contract for the construction of certain facilities of the Reclamation Bureau. The contract was to Wells Construction Company in the amount of $144,336.30. The United States Fidelity and Guaranty Company became its surety for the performance bond in that amount and also executed a payment bond in the amount of $72,160.15.

The contractor defaulted in the construction contract and refused to continue the work. At that time the contractor owed the United States trust fund tax deductions from employees in the amount of $8,031.62 (withheld income taxes and F. I. C. A. payments). The surety was requested to complete the contract by performing the balance of the work but did not do so and the Government contracted the balance of the work to Grant Constitution Company.

The Grant Construction Company completed the work for less than the unpaid balance due on the contract at that time and there remained in the hands of the Government as a retained percentage $4,756.90. The surety on its performance bond was liable at all times for the performance of the contract. Under the existing Miller Act laws the performance bond was also liable for the unpaid trust fund taxes of $8,031.62. The United States of America seeks to apply the $4,756.90 toward the payment of non-trust fund tax obligations of the principal contractor in the amount of $3,150.56, being taxes which are unrelated to the contract involved in this case.

The surety maintains that it has at all times been ready, able and willing to perform its obligations under its performance contract and to pay the trust fund taxes of $8,031.62, but upon a payment of such taxes it is entitled to the unpaid balance of the retained percentage, to-wit, $4,756.90 without reduction for any non-trust fund taxes due by the contractor to the Government.

In this anomalous situation the taxing authority is the same as the contracting authority, the United States of America . The surety maintains its rights under the bond and contract to recover the amount due it on payment of the trust fund taxes.

Under the authority of Trinity Universal Insurance Company v. United States [67-2 USTC ¶9645], 382 F. 2d 317 (5 Cir. 1967), and Security Insurance Co. of Hartford v. United States, 428 F. 2d 838 (United States Court of Claims 1970), it is the opinion of the undersigned that the Government is not entitled to take the unpaid retained percentages and apply them against the payment of the contractor's non-trust fund taxes. As is said in Trinity Universal (fn. 2).

"The record does not disclose whether these taxes arose from the work covered by the contract. We agree with the obvious assumption that that fact was not material."

"* * * The performance bond is to assure that the government has a completed project for the agreed contract price. The obligation may be performed either in kind or in money. Performance results equally when the surety completes the contract or when the surety pays the government any damage which the government incurs in completing the job. In either event, the surety is entitled to have the full contract price applied to the performance of the contract. * * *." 382 F. 2d at 321.

It is my opinion that the surety here has fully discharged its obligation to the plaintiff and that the plaintiff cannot apply the retained percentage to the payment of non-trust fund taxes. The motion for summary judgment of the defendant is granted and the motion for summary judgment of the plaintiff is denied and defendant will recover its costs and disbursements herein. Defendant is to submit form of judgment.

 

 

[67-2 USTC ¶9645]Trinity Universal Insurance Company and First National Bank in Dallas, Appellants v. United States of America , Appellee

(CA-5), U. S. Court of Appeals, 5th Circuit, No. 24246, 382 F2d 317, 9/12/67, Reversing District Court decision, 66-2 USTC ¶9712

[1954 Code Sec. 6323]

Tax liens: Priority: Surety: Setoff.--A setoff by the United States on account of employment taxes owed by a defense production contractor in default, against the contractor's surety on its faithful performance bond (not a financial institution), was improper. A surety who undertakes to complete the project is entitled to the funds in the hands of the government not as a creditor and subject to setoff, but as a subrogee having the same rights to the funds as the government. The surety is entitled to have the full contract price applied to the performance of the contract. The surety is not liable for taxes owed by the contractor.

Lloyd E. Elliott, Room 720, 2020 Live Oak St., Dallas, Tex., for appellants. Melvin M. Diggs, United States Attorney, Fort Worth, Tex., Kenneth J. Mighell, Assistant United States Attorney, Dallas, Tex., Mitchell Rogovin, Assistant Attorney General, Lee A. Jackson, Joseph Kovner, Rob ert H. Solomon, Department of Justice, Washington, D. C. 20530, for appellee.

Before RIVES, WISDOM and GOLDBERG, Circuit Judges.

RIVES, Circuit Judge:

This case presents the clear-cut issue of whether, when a Miller Act ¹ surety completes a defaulted contract pursuant to its performance bond, the government may set off taxes owed by the contractor against the surety's claim to the fund retained by the government to insure performance.

Dallas Building, Inc., the contractor, was awarded a contract for the construction of a nuclear warfare laboratory at Kirtland Air Force Base, Albuquerque , New Mexico , for the total sum of $1,008,889.36.

Trinity Universal Insurance Company, the surety, executed for the contractor the two bonds required by the Miller Act; one to guarantee performance and the other payment of laborers and materialmen for work done. When 90% of the contract had been completed and most of the progress payments made, the contractor defaulted and its rights to proceed further was terminated by the government. The retained, unpaid amount earned by the contractor was then $39,906.96, and the amount to be earned upon completion of the remaining work was $67,276.16. Federal unemployment, withholding and F. I. C. A. tax liabilities of the contractor in the amount of $6,495.07 were unpaid. ²

The surety, in discharge of its obligations, agreed with the government to take over and complete the contract. The surety thereafter expended the amount of $116,623.37 for the work done. It was paid for that work by the government the sum of $67,276.16. In addition, on October 14, 1965 , the government paid the surety $33,411.89 the retainage for work done by the contractor less the $6,495.07 owed by the contractor for taxes. In this suit the surety seeks to recover the $6,495.07 setoff.

Upon some of the principles of law involved, the surety and the government are in agreement, viz: (1) The government has no claim against the surety by reason of the taxes of the contractor. ³ (2) The surety has certain equitable or derivative rights, such as rights acquired through subrogation or assignment. ⁴ (3) The surety is subrogated to the rights of the contractor, but such rights will, of course, not suffice because the government has a valid setoff against the contractor. ⁵

The decisive question in dispute between the parties is whether a surety under a Miller Act performance bond which, under agreement with the government, completes the contract upon contractor's default and expends in such completion more than the full contract price has a right to have the contract price, free from setoff, applied to the completion of the project.

The surety's claim was rejected by the district court upon the authority of United States v. Munsey Trust Co., 1947, 332 U. S. 234. In that case the contractor had failed to pay materialmen and laborers and they had been paid by the surety on the payment bond. The Court held that the laborers and materialmen paid by the surety had no rights to which the surety could be subrogated, and rejected the surety's claim to the retainage free from setoff. The Court noted, however, that a distinction might exist in the case of a surety which chose to complete the contract under its performance bond:

"Respondent argues that if the work had not been completed, and the surety chose not to complete it, the surety would be liable only for the amount necessary to complete, less the retained money. Moreover, if the surety did complete the job, it would be entitled to the retained moneys in addition to progress payments. The situation here is said to be similar. But when a job is incomplete, the government must expend funds to get the work done, and is entitled to claim damages only in the amount of the excess which it pays for the job over what it would have paid had the contractor not defaulted. Therefore, a surety would rarely undertake to complete a job if it incurred the risk that by completing it might lose more than if it had allowed the government to proceed. When laborers and materialmen, however, are unpaid and the work is complete, the government suffers no damage. The work has been done at the contract price. The government cannot suffer damage because it is under no legal obligation to pay the laborers and materialmen. In the case of the laborer's bond, the surety has promised that they will be paid, not, as in the case of performance bond, that work will be done at a certain price. The law of damages is therefore not pertinent to the payment bond." 332 U. S. at 244.

In Pearlman v. Reliance Insurance Co., 1962, 371 U. S. 132, 138, the Supreme Court recognized the well-established doctrine that "a surety who completes a contract has an 'equitable right' to indemnification out of a retained fund." ⁶ Munsey did not disturb this rule, for as the Court noted in Pearlman:

"We held that the Government could exercise the well-established common-law right of debtors to offset claims of their own against their creditors. This was all we held. * * * We hold that Munsey left the rule in Prairie Bank and Henningsen undisturbed." 371 U. S. at 140, 141.

The rights of the suety in Munsey were those of a subrogee of the contractor. Whoever, be it the contractor or his surety, pays the laborers and materialmen would be a creditor of the government insofar as the retained funds are concerned. Pearlman at p. 141. Of course, however, the government has a right to set off claims against its creditors.

A different situation occurs when the surety completes the performance of a contract. The surety is not only a subrogee of the contractor, and therefore a creditor, but also a subrogee of the government and entitled to any rights the government has to the retained funds. ⁷ If the contractor fails to complete the job, the government can apply the retained funds and any remaining progress money to costs of completing the job. The surety is liable under the performance bond for any damage incurred by the government in completing the job. On the other hand, the surety may undertake to complete the job itself. In so doing, it performs a benefit for the government, and has a right to the retained funds and remaining progress money to defray its costs. The surety who undertakes to complete the project is entitled to the funds in the hands of the government not as a creditor and subject to setoff, but as a subrogee having the same rights to the funds as the government. ⁸

We recognize that our holding is in conflict with that of the Court of Claims in Standard Accident Insurance Co. v. United States, 1951, 97 F. Supp. 829. With deference, however, we cannot agree with that decision. ⁹

The same result is reached more directly by the alternative concept that the surety's contract with the government contemplates that the full contract price will be applied to the completion of the contract. Subsequent to the default by Dallas Building, Inc., the surety agreed with the government to take over and complete the principal contract. Implicit in this agreement is the right of the surety to all retained funds and any remaining progress sums. In the words of Munsey: "the surety has promised that * * * in the case of performance bond, that work will be done at a certain price." 332 U. S. at 244.

We are not convinced that the government, after entering an agreement such as the one in this case, should have a right to retained funds superior to the rights of the surety. ¹⁰ If the government undertook to complete the contract, the surety would be liable for costs exceeding the contract price, but not for taxes owed by the contractor. ¹¹ The surety should not be worse off because it undertakes to finish the job. The performance bond is to assure that the government has a completed project for the agreed contract price. The obligation may be performed either in kind or in money. Performance results equally when the surety completes the contract or when the surety pays the government any damage which the government incurs in completing the job. In either event, the surety is entitled to have the full contract price applied to the performance of the contract. The judgment is therefore reversed and the cause remanded with directions to enter judgment for Trinity.

REVERSED.

¹ Act of Aug. 24, 1935, c. 642; 49 Stat. 493; 49 U. S. C. A. 270a.

² The record does not disclose whether these taxes arose from the work covered by the contract. We agree with the obvious assumption that that fact was not material. See note 3, infra.

³ General Casualty Co. v. United States, 5 Cir. 1953, [53-2 USTC ¶9483] 205 F. 2d 753, 755; United States v. Crosland Construction Co., 4 Cir. 1954, [55-1 USTC ¶9112] 217 F. 2d 275, 277; United States v. T. E. Hill, 5 Cir. 1966, [66-2 USTC ¶9736] 368 F. 2d 617, 624; United States v. Seaboard Surety Co., N. D. Tex. 1961, [61-2 USTC ¶9770] 201 F. Supp. 630, 633.

⁴ The surety's derivative rights have been discussed in a number of excellent law review articles and comments, e.g.: Reconsideration of Subrogative Rights of the Miller Act Payment Bond Surety, 71 Yale L. J. 1274 (1962); Cushman, The Surety's Right of Equitable Priority to Contract Balances in Relation to the Uniform Commercial Code, 39 Temp. L. Q. 239 (1966); Comments, The Surety's Rights to Money Retained from Payments Made on a Public Contract, 31 Fordham L. Rev. 161; Notes, Subrogation-Miller Act--Surety's Right to Recover Withheld Funds Under a Government Contract, 9 N. Y. L. Forum 226; Turner, The Dutcher Decision in Retrospect, Insurance Counsel Journal 96 (Jan. 1964).

⁵ United States v. Munsey Trust Co., 1947, 332 U. S. 234; Pearlman v. Reliance Insurance Co., 1962, 371 U. S. 132.

⁶ See Prairie State Bank v. United States , 1896, 164 U. S. 227, 239.

⁷ Compare the rationale employed in the following opinions: Prairie State Bank v. United States, supra note 5; Henningsen v. United States Fidelity & Guaranty Co., 1908, 208 U. S. 404; National Surety Corp. v. United States, Ct. Cl. 1955, 133 F. Supp. 381, 383.

⁸ If the government can set off the amount of the unpaid taxes when the surety has completed the job, the surety would be forced to work for less than the contract price. An equity court should attempt to avoid such an unfair result.

⁹ Note has been taken that the opinion apparently ignores the rule that an obligee, as against a surety, may not apply security in satisfaction of a debt other than the one it secured, and the rationale of the case has been criticized as follows:

"Such reasoning is clearly erroneous in light of (1) the express declaration of Munsey granting the surety superiority where there exists a sound basis of subrogation, (2) the accepted principle of equitable subrogation to the rights of the Government where the surety has benefited the Government by assuming the contractor's duty to pay damages, Prairie State Bank v. United States, 164 U. S. 227 (1896); Hardin County Sav. Bank v. United States, 65 F. Supp. 1017 (Ct. Cl. 1946), and (3) Munsey's explicit recognition of the rule regarding diversion of security, 332 U. S. at 243."

Reconsideration of Subrogative Rights of the Miller Act Payment Bond Surety, 71 Yale L. J. 1274, 1286.

¹⁰ There seems no dispute in the cases that the surety who completes the project has a prior claim to the so-called unearned sums existing when the contractor defaulted. See Massachusetts Bonding & Ins. Co. v. State of New York, 2 Cir. 1958, [58-2 USTC ¶9704] 259 F. 2d 33, 37.

¹¹ See cases cited in note 3, supra. The government's rights to set off funds in its hands is not absolute. See Central Bank v. United States, 1953, [53-1 USTC ¶9408] 345 U. S. 639, where the Court, construing the Assignment of Claim Act of 1940, 54 Stat. 1029, 31 U. S. C. §203, "so as to carry out the purpose of Congress to encourage the private contracts," held that the government had no right to set off for the taxes owed by the contractor where a financial institution, as an assignee, was seeking proceeds held by the government.

 

 

[58-2 USTC ¶9704] Massachusetts Bonding and Insurance Company and United States of America , Claimants-Appellants v. State of New York , Claimant-Appellee In re Fago Construction Corporation, Bankrupt

(CA-2), U. S. Court of Appeals, 2nd Circuit, Docket No. 25032, 259 F2d 33, 7/11/58, Rev'g Dist. Ct. decision, 58-1 USTC ¶9267, 162 F. Supp. 238

[1939 Code Sec. 3670--similar to 1954 Code Sec. 6321]

Lien for taxes: Priority: Bankruptcy.--In 1948, taxpayer construction company became financially embarrassed while it was engaged in performing construction work for the United States. Its surety advanced funds to enable the company to proceed with the work, under an agreement that the partial payments received from the United States were to be paid directly to the surety. The construction company, however, collected some of these payments, and part of them were diverted to the construction company's controlling stockholder. Of these funds, the latter used $9,500 to purchase a tract of land in the name of another corporation which he controlled. This $9,500 plus interest eventually was recovered by the trustee in bankruptcy after the construction company became bankrupt in 1949. In 1947 and 1948, federal withholding and social security taxes were assessed, and were collected by the United States setting them off against amounts due the contractor on one of the two projects. Additional federal withholding and social security taxes remain unpaid and are the subject of this action. Priority of the state claim for franchise taxes for 1947 is also in issue. The surety claims that it is entitled to recovery of the federal taxes which had been collected by offset, since it expended more than the amount of these taxes under its agreement with the construction company to advance funds for completion of the contracts, and that such payments amounted in effect to a payment of the taxes by the surety. The court holds that this contention has no merit, since the funds never become payable by the United States because of the offsets, and, therefore, the surety never owned or became entitled to the funds and cannot be subrogated to the position of the creditor who made the setoff. However, the $9,500 in the hands of the trustee belonged to the surety from the beginning, and it should be paid to the surety after payment of admin istration expenses and before any taxes are paid. The unpaid federal taxes have priority over the state franchise tax, the latter not having been assessed before the bankruptcy.

Mark N. Turner, of Brown, Kelly, Turner & Symons, Buffalo, N. Y. (Raymond C. Vaughan, Buffalo, N. Y., on brief), for claimant-appellant Massachusetts Bonding and Insurance Company. George F. Lynch, Attorney, Department of Justice Washington, D. C. (Charles K. Rice, Assistant Attorney General, Lee A. Jackson, I. Henry Kutz, Department of Justice, Washington, D. C., John O. Henderson, United States Attorney, W. D. N. Y., John C. Broughton, Assistant United States Attorney, Buffalo N. Y., on brief), for claimant-appellant United States of America. Ruth Kessler Toch, Assistant Attorney General of the State of New York, Albany, N. Y. (Louis J. Lefkowitz, Attorney General of the State of New York, Paxton Blair, Solicitor General, New York City, Michael P. Geraci, Assistant Attorney General, Buffalo, N. Y., on brief), for State of New York, claimant-appellee.

Before CLARK, Chief Judge, and SWAN and LUMBARD, Circuit Judges.

CLARK, Chief Judge:

This is an appeal in a bankruptcy proceeding in which the parties contest their relative priorities to some $41,000 now left in the bankrupt's estate. Involved are claims of the United States for unpaid withholding, social security, and unemployment taxes, claims of the State of New York for unpaid franchise, motor fuel, and unemployment insurance taxes, and two claims of Massachusetts Bonding and Insurance Company, a surety on two contracts performed in part by the bankrupt.

[Bankrupt Taxpayer]

A petition for adjudication of bankruptcy was filed against Fago Construction Corporation on March 31, 1949 , and it was adjudicated a bankrupt on the same day. Prior to bankruptcy, on May 15, 1947 , the bankrupt had entered into a contract with the United States for the construction of a flood control project at Bath , New York , at a contract price of $417,860. In compliance with the Miller Act, 40 U. S. C. §§ 270a et seq., it furnished two bonds to the United States--one guaranteeing performance and the other securing the payment of laborers and materialmen. On both bonds Massachusetts Bonding and Insurance Company was the surety pursuant to the bankrupt's applications, in which, as consideration for the bond, it inter alia assigned to the surety, effective upon its default under the contract with the United States, all deferred payments or retained percentages, and any and all moneys and properties that might be due and payable at the time of claim or default, or that might become due and payable to the bankrupt in connection with the contract. And in August 1947, the bankrupt made a similar arrangement with the surety in connection with another contract with the United States for work on a Veterans Hospital in Buffalo , New York .

[Job Proceeds to Go to Surety]

The record shows that in April 1948, the bankrupt informed the surety that it was in trouble financially and needed the surety's assistance to proceed with the Bath and Buffalo jobs. As a result of this, the surety presented a program to assure completion of the projects and the bankrupt gave the surety a collateral chattel mortgage on its equipment. In addition Dominick S. Fago, the bankrupt's principal shareholder and president, gave the surety a collateral mortgage on certain real property which he owned. Under the surety's program the bankrupt executed a letter of authority addressed to the United States Engineers directing that all checks due on the Bath project be sent to J. Herbert Crafts, the surety's attorney. In addition the bankrupt executed a Treasury form power of attorney authorizing Crafts to receive, endorse, and collect checks in its name drawn on the Treasurer of the United States . The surety and the bankrupt then opened a joint bank account in which the surety deposited substantial sums of its own money and certain checks of the United States for estimates on the Bath job. The bankrupt agreed that all such porceeds would be deposited in that account, which was used to pay labor and material bills on the two projects.

During the course of this arrangement the bankrupt, in breach of its agreement, sought to collect a check from the United States for some $41,000 due on the Bath job. The surety brought an action to attach the check and eventually was successful in collecting those proceeds. Massachusetts Bonding & Insurance Co. v. Fago Construction Corp., D. C. Md., 82 Fed. Supp. 619. On another estimate check on the Bath job, however, the surety was less successful, for Fago, after improperly revoking the bankrupt's instructions to the United States Engineers to mail checks due on the Bath job to Crafts, succeeded in securing $25,893 due on that job which he deposited in the bankrupt's own account. The record shows that immediately afterwards Fago withdrew $18,000 of these proceeds, which he put in his own personal account. Of this he used $9,500 to purchase a tract of land in the name of another of his corporations. This $9,500, plus interest, eventually was recovered by the trustee and is now part of the assets in the bankrupt's estate.

[Federal Tax Liabilities]

Well prior to the adjudication, the bankrupt became delinquent in the payment of federal withholding and social security taxes. Between January 1947 and September 1948, the Commissioner of Internal Revenue received assessment lists on these taxes which, with interest and penalties, aggregated $51,868.41. He duly filed notices of these deficiencies in December 1948 and January 1949. The United States then set this sum off against a progress payment otherwise due to the bankrupt on the Bath job, and a certificate releasing the lien was filed.

[Priority of Claims]

The relevant claims filed in this proceeding disclose the following: The United States claims $31,166.40 for social security, unemployment, and withholding taxes for the years 1947 and 1948. The State of New York claims $8,829.77 for franchise, motor fuel, and unemployment insurance taxes for the years 1947, 1948, and 1949. The surety claims for unrecompensed expenditures of over $136,000 on the two projects, $51,868.41 as a subrogee to the tax liens of the United States which were satisfied by the setoff and $9,500 as the equitable owner of the proceeds recovered by the trustee which were used by Dominick S. Fago to purchase land for another of his corporations. The referee ruled that the surety became subrogated to the satisfied tax liens and awarded it all the assets of the bankrupt, less admin istration expenses and the New York franchise taxes. The district court affirmed the referee with regard to the admin istration expenses and franchise taxes, but accorded third priority to the tax claims of the United States and the remaining tax claims of the State of New York , and fourth priority to the surety's claims. From this judgment both the surety and the United States appeal. The surety argues in substance that the referee's decision was proper. The United States contends that New York was improperly afforded priority on its claim for franchise taxes and that the United States is entitled to priority over New York to the extent of $5,757.41. We proceed to the surety's appeal first.

I. The surety contends that it is entitled to be subrogated to the position of the United States in relation to the latter's liens for taxes with interest and penalties of $51,868.41, which were satisfied prior to bankruptcy by setout against money earned by the bankrupt on the Bath job. Basic, of course, to this contention is that the surety paid the tax, or, in the context of this case, owned the funds against which the setoff was made. But the surety cannot establish this fact, for under the doctrine of United States v. Munsey Trust Co. of Washington, D. C., 332 U. S. 234, neither the bankrupt nor the surety ever became entitled to these funds, so that there was nothing for the surety to own. In short, the surety by way of subrogation might be entitled to progress payments and retained percentages due its principal if the surety completes the job after the principal's default. See, e.g., Henningsen v. U. S. Fidelity & Guaranty Co., 208 U. S. 404; Prairie State Nat. Bank of Chicago v. United States, 164 U. S. 227; American Surety Co. of N. Y. v. Sampsell, 327 U. S. 269. See also annotations at 45 A. L. R. 379, 134 A. L. R. 738, and 164 A. L. R. 613. But this right relates only to funds otherwise due to the principal. U. S. Fidelity & Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31, 74 N. E. (2d) 226 [47-2 USTC ¶9327]. Where, as here, the funds never became payable because of the creditor's right to a setoff for other debts, the surety never owned or became entitled to the funds and hence cannot be subrogated to the position of the creditor who made the setoff.

II. The surety also claims that $9,500 in the hands of the trustee belongs to it, and not to the bankrupt's estate. These funds were part of the progress payment of $25,893 made to the bankrupt after the surety commenced supervising the bankrupt's operations. Prior to the bankruptcy the surety instituted an action against Fago and the bankrupt to impress a lien on the real estate purchased with part of the payment and for conversion of the remainder, alleging that the payment belonged to it. The bankruptcy intervened and the action against the bankrupt (now represented by the trustee) was severed. The action against Fago came to trial and resulted in a judgment in favor of the surety for the full amount of the progress payment. This judgment remains unsatisfied. The trustee then instituted an action to impress a lien on the real property purchased with the $9,500. This was settled, and the trustee received a general mortgage on the property which has now been satisfied by payment of $9,500.

The surety's position below and here is that it was entitled to the payment in question which was converted by Fago and the bankrupt. It urges that the trustee recovered the proceeds of the real estate mortgage impressed with a trust in its favor and that the estate now contains at least $9,500 belonging to it. The referee declined to rule on the surety's claim because he found that the surety was otherwise entitled to the major portion of the assets in the estate as a subrogee to the satisfied tax liens of the United States . Therefore he never reached the question which the district court thought necessary to decide, viz., whether the bankrupt, in addition to Fago, converted the payment in question. Thus the district court refused to rule that the $9,500 belonged to the surety because of the failure of the referee to find that the bankrupt converted the payment.

We believe that a finding of conversion is unnecessary to entitle the surety to the $9,500 and that on familiar principles of subrogation the surety has a prior claim to this sum which the record clearly shows represents a traceable portion of a payment made by the United States to the bankrupt under the construction contract which was completed by the surety. It is settled law that a surety which undertakes to complete a construction contract after its principal has defaulted and pays laborers and materialmen becomes entitled to payments due the principal from the owner, here the United States , independent of any formal assignment. ¹ Prairie State Nat. Bank of Chicago v. United States, supra, 164 U. S. 227; Henningsen v. U. S. Fidelity & Guaranty Co., supra, 208 U. S. 404. This right to "first" priority attaches not only to moneys due the principal at the time of default, but to so-called "unearned" moneys which arise from the surety's activities in completing the contract after the principal's default. Arrow Iron Works v. Greene, 260 N. Y. 330, 183 N. E. 515; Maryland Casualty Co. v. Board of Water Com'rs of City of Dunkirk, 2 Cir., 66 Fed. (2d) 730, certiorari denied 290 U. S. 702. Of course the surety's rights might be defeated if the payment is received by the principal, who then pays it to another of his creditors who is unaware of the surety's rights. See, e.g., California Bank v. U. S. Findelity & Guaranty Co., 9 Cir., 129 Fed. (2d) 751. But if the payment is still in the hands of the principal, its trustee in bankruptcy, or a stakeholder, the surety's rights are superior even to those of formal assignees of the proceeds of the contract, for its rights arise at the time of the making of the surety contract. Henningsen v. U. S. Fidelity & Guaranty Co., supra, 208 U. S. 404; Prairie State Nat. Bank of Chicago v. United States, supra, 164 U. S. 227; In re Scofield Co., 2 Cir., 215 Fed. 45; In re P. McGarry & Son, 7 Cir., 240 Fed. 400.

[Was There a Default?]

The questions here are whether the bankrupt defaulted to as to bring into operation the rights of the surety, and if so, whether these rights to payments from the owner take priority over tax claims of the State of New York and the United States . Both the State and the United States vehemently argue that the default contemplated in the contract between the bankrupt and the surety never occurred, and hence the assignment never matured; nor did the surety acquire a lien by way of subrogation. To some extent the arrangement created by the bankrupt and the surety whereby construction costs were paid out of the joint account into which they deposited progress payments supports this argument, for nominally the bankrupt continued its operations subject only to financial supervision by the surety. In this way construction activity never ceased and bills were paid without material delay. But to analyze these facts so as to deprive the surety of tis claim based on subrogation when it actually provided over $136,000 of its own money to pay laborers and materialmen is too technical to warrant serious consideration. Cf. Century Cement Mfg. Co. v. Fiore, 264 App. Div. 475, 36 N. Y. S. (2d) 332. The nub of the bankrupt's default was its inability to continue paying its bills. Whether the surety stepped in prior to or after the bankrupt failed to pay these bills is of little moment. The important fact is that the surety expended large sums of its own money to complete the contracts for which it has not been recompensed.

The trustee in bankruptcy acted upon this state of facts in at least two instances, thereby recognizing the surety's rights to payments from the United States on the contracts. After bankruptcy and after the Bath and Buffalo jobs were completed and accepted, the United States paid to the trustee the final balances due of $8,800 and $3,501.05 respectively which he paid over to the surety. Neither the United States nor the State of New York have taken exception to payments, as well they could not, for, as we have stated, the payments due from the United States after the surety entered the scene were due the surety as a subrogee. The only difference between these sums and the $9,500 here at issue is the ease with which they can be identified as payments on the construction contracts. But the record clearly shows, and neither the United States nor the State of New York contends otherwise, that the $9,500 is a traceable portion of a payment made by the United States on the Bath job. In fact if there was a contrary finding below we would have to reverse it as clearly erroneous.

[Priority]

The remaining question on this aspect of the case is whether the surety's claim as a subrogee takes precedence over the tax claims. This identical issue was treated in a well reasoned opinion by Fuld, J., in U. S. Fidelity & Guaranty Co. v. Triborough Bridge Authority, supra, 297 N. Y. 31, 74 N. E. (2d) 226 [47-2 USTC ¶9327], where the Court of Appeals of New York determined that a surety's claim was entitled to priority over a claim of the United States on a lien for unpaid taxes filed after the making of the surety contract, but before payments by the surety on account of the principal's default. The court there concluded that the surety became subrogated to the owner's rights against the principal and that the surety's "equity" became available and enforceable when it carried out the contract's provisions, thus resulting in a "lien" which arose prior to the tax liens. This is in accord with the federal authorities cited above. And the case at bar is even stronger than the New York case, for here the surety carried out the contract provisions, i. e., paid laborers and materialmen, before the filing of the tax liens in question. Moreover, had Fago desisted from improperly securing the payment in question, it would have been used to pay some of the costs of the projects, thereby reducing the surety's loss; and it would not have been available to satisfy the tax claims in issue. Now that a portion of that payment is in the hands of the trustee, equitable considerations demand that it be applied to the surety's claim.

[Federal v. State Taxes]

III. The contest between the United States and the State of New York involves two issues: whether or not the State's claim for franchise taxes became a lien entitling it to a priority status superior to that afforded tax claims under §64a(4) of the Bankruptcy Act, 11 U. S. C. §104(a)(4); and whether or not the United States procured a similar lien on the bankrupt's property for certain unpaid withholding and social security taxes under the Internal Revenue Code of 1939, §§ 3670, 3671.

Under §213(2) of the N. Y. Tax Law, corporate franchise taxes become a lien on the real and personal property of a corporation on the date the corporation is required by §211(1) to file its franchise tax report or return. The latter section required the bankrupt to file its returns for each fiscal year on the 15th of May following the close of such fiscal year, but it does not appear from the record that the bankrupt complied with this filing requirement for its fiscal years 1947 (return due May 15, 1948 ) or 1948 (return due May 15, 1949 ). Nor does it appear that the State, prior to the bankruptcy, assessed the taxes it now claims or issued warrants to enforce its statutory liens. Clearly the presumed failure of the bankrupt to file the required returns is immaterial, for the statute, §213(2), plainly says that the tax becomes a lien "on the date on which the report is required to be filed." But the question arises whether the State's lien for these taxes was sufficiently perfected prior to bankruptcy to gain precedence over the tax claims of the United States .

We are dealing here only with the franchise taxes due for the bankrupt's fiscal year 1947, for its returns for the years 1948 and 1949 were not required to be filed until after the adjudication and hence no statutory liens, inchoate or otherwise, could have arisen within the prescribed time for taxes due for the latter years. Bankruptcy Act §67b, 11 U. S. C. §107(b).

The United States argues that the State's lien, although perhaps effective against various classes of private creditors in some types of action, see e.g., In re Century Steel Co. of America, 2 Cir., 17 Fed. (2d) 78; Engelhardt v. Alvino Realty Co., 248 N. Y. 374, 162 N. E. 287, is too imperfect or inchoate to operate so as to deprive the United States of its alleged lien priority or general priority uinder the Bankruptcy Act §64a(4), 11 U. S. C. §104(a)(4). It cites numerous cases in support of this position, especially New York v. Maclay, 288 U. S. 290, 292, which involved a contest between New York, claiming lien priority under the forerunner to the present franchise tax section, and the United States, which claimed priority under §3466 of the Revised Statutes, 31 U. S. C. §191. In that case the State presented a claim for franchise taxes against the receivers of an insolvent corporation. But the taxes had not been assessed or liquidated until after the appointment of the receivers and the Court sustained the priority of the United States on the ground that the State's lien was "not so perfected or specific as to change the rule of distribution" of the statute. Although the priority created by 31 U. S. C. §191 has no effect in a bankruptcy proceeding instituted under §59 of the Bankruptcy Act, 11 U. S. C. §95, the same principles announced in those cases where the statute was relevant apply to the issue whether the lien claimed by New York is specific enough to be effective against the competing federal claim. United States v. Security Trust & Sav. Bank of San Diego, 340 U. S. 47 [50-2 USTC ¶9492]; United States v. City of New Britain, 347 U. S. 81 [54-1 USTC ¶9191]. See 4 Collier on Bankruptcy 265 (14th Ed. 1942); but cf. United States v. Sampsell, 9 Cir., 153 Fed. (2d) 731 [46-1 USTC ¶9186]. Under the doctrine of those cases it is evident that here the State obtained merely a general or inchoate lien which was not sufficiently perfected to warrant priority over the tax claims of the United States . State Tax Commission v. Union General Corp., 208 Misc. 133, 144 N. Y. S. (2d) 75; Smith v. Meader Pen Corp., 255 App. Div. 397, 8 N. Y. S. (2d) 39, affirmed 280 N. Y. 554, 20 N. E. (2d) 13; New York v. Maclay, supra, 288 U. S. 290 [3 USTC ¶1044].

[Government's Failure to Assert Claim]

IV. The second aspect of the contest between the State of New York and the United States involves the issue whether the United States has a lien on the assets in the estate, and therefore priority over the State's claims, for a portion of the taxes due it. It now appears that assessment lists were received by the Commissioner of Internal Revenue showing that social security and withholding taxes in the amount of $5,757.41 (including assessed interest) were assessed against the bankrupt prior to the adjudication. Under §§ 3670 and 3671 of the Internal Revenue Code of 1939, this resulted in perfected liens in favor of the United States to the extent of these taxes which arose prior to the bankruptcy, and thus are enforceable as priority claims under §67b of the Bankruptcy Act, 11 U. S. C. §107(b).

On this issue the United States is met with the contention that it waived or lost its claim by failing to assert it before the referee or the district court. It appears from the record that this "lien theory" was never urged below. It is also clear, however, that the formal claim presented in the proceeding by the United States , and other portions of the record, contained sufficient facts to sustain the lien and the priority. Thus the uncontested claim of the United States showed that the bankrupt owed it social security taxes for the quarter ending December 1948, together with interest which began to run on March 9, 1949, and withholding taxes for the quarters ending December 1947 and 1948, together with interest which commenced to run on November 22, 1948, and February 28, 1949, respectively. Obviously the interest could not begin to accrue until after the taxes were assessed and until after the local collector received from the Commissioner of Internal Revenue the assessment lists in question. Internal Revenue Code of 1939, §3655. In addition the United States appended to its brief in this court the actual certificates of assessment.

Of course it is always desirable to urge to the district court the legal theories upon which a party claims decision. But as Rule 54(c), F. R. Civ. Proc., points out, it is the court's responsibility to award relief required by the facts on any proper ground, regardless of the theories urged by the parties. Thus on numerous occasions, as noted in the margin, ² we, as well as other courts, have granted relief on legal theories not presented by the parties to the district court. In fact in a recent case similar to this one, the Supreme Court affirmed a recovery by the United States on a "lien theory" never urged to the district court. United States v. Bess, 357 U. S. 51, 78 S. Ct. 1054 [58-2 USTC ¶9595]. Here we have such a situation; after careful consideration it is evident to us that the United States showed sufficient facts to warrant priority for its claim.

The distribution of the bankrupt's assets, therefore, should proceed with the payment of admin istration expenses, including proper counsel fees, and the sum of $9,500 to Massachusetts Bonding and Insurance Company, followed by the payment of $5,757.41 to the United States for taxes owed by the bankrupt which were secured by liens perfected prior to the adjudication, and then by the pro rata payment of all other taxes claimed by the United States and the State of New York, including franchise taxes. All other claims are necessarily postponed.

Order reversed and proceeding remanded for the entry of a decree as directed in this opinion.

¹ We do not reach a consideration of the effect of the assignment executed by the bankrupt in favor of the surety. That issue raises difficult questions under the Anti-Assignment Act, 31 U. S. C. §203, which are unnecessary to answer here.

² See, e.g., Columbia Research Crop. v. Schaffer, 2 Cir., May 13, 1958; Vibra Brush Corp. v. Schaffer, 2 Cir., May 13, 1958; Joint Council Dining Car Emp. Local 370, Hotel and Restaurant Emp. International Alliance v. Delaware, L. & W. R. Co., 2 Cir., 157 Fed. (2d) 417, 420; Hormel v. Helvering, 312 U. S. 552 [41-1 USTC ¶9322]; Trop v. Dulles, 356 U. S. 86, reversing 2 Cir., 239 Fed. (2d) 527.

 

 

[60-1 USTC ¶9198]In the Matter of Techcraft, Inc., Bankrupt

U. S. District Court, So. Dist. N. Y., Bankruptcy No. 90092, 177 FSupp 790, 7/29/59

[1954 Code Sec. 6323]

U. S. claims in bankruptcy: Taxes set-off against bankrupt's contractual claim: General unsecured claim for taxes: Necessity of mutuality for set-off.--A referee in bankruptcy improperly determined that he lacked jurisdiction to grant a trustee's request to cancel claims of the U. S. against the bankrupt unless the U. S. first paid over an amount due the bankrupt under a contract complated by the latter, as debtor in possession, after the filing of a voluntary petition in bankruptcy, the amount due under the contract being retained for taxes concededly due but not assessed before bankruptcy. Under the circumstances, the U. S. claim remained a general and unsecured claim; also, the mutuality of set-off was absent because the claim for taxes arose before the petition in bankruptcy was filed, while the bankrupt's claim arose afterward.

David W. Kahn, 120 Broadway, New York , N. Y., for bankrupt. Alexander H. Rockmore, 570 Seventh Ave. , New York 18, N. Y., for trustee.

PALMIERI, District Judge:

This is a petition brought by a Trustee to review an order of a Referee in Bankruptcy. The Referee ruled that he lacked jurisdiction to grant the Trustee's request for a direction pursuant to Section 57(g) of the Bankruptcy Act, 30 Stat. 560 (1898), as amended, 11 U. S. C. §93 (1952), expunging claims of the United States against the bankrupt unless the United States first pays over an amount alleged to constitute a void transfer or voidable preference. The Trustee seeks a reversal of this ruling while the respondent, United States , urges that the Referee's order be confirmed.

[Set-off for Taxes Against Debt Due Bankrupt]

Before filing a voluntary petition for arrangement, the bankrupt commenced performance of a contract with the United States . After filing, the contract, as modified, was completed by the bankrupt as debtor in possession. A settlement of the amount due from the United States was approved by the Court. Subsequently, the United States refused to make payment and claimed a right to retain the amount due on the contract as a set-off against the bankrupt's indebtedness for taxes which had accrued prior to the filing of the petition for arrangement.

The respondent's claim of lack of jurisdiction rests on the proposition that the requested relief would be tantamount to the entry of judgment against the sovereign in a case in which it has withheld consent to be sued. The bare use of the term "creditor," without specific reference to the United States, in the definition of a preference set forth in section 60(a)(1), 11 U. S. C. §96, is relied upon as expressive of a congressional intent to insulate the United States from the operation of section 57(g). That section provides, "claims of creditors who have received . . . preferences voidable under this Act, shall not be allowed unless such creditors shall surrender such preferences . . ." See Abeken v. United State, 26 F. Supp. 170 (E. D. Mo. 1939) [39-1 USTC ¶9269].

The statutory text will not bear the interpretation urged by respondent. If, as contended, sections 60 and 57(g) are not to be applied against the United States for want of consent, there would be no reason for the specific provision of section 67(b), 11 U. S. C. §96, which exempts from section 60 only "statutory liens for taxes and debts owing to the United States," and not claims for taxes generally.

Since the papers presented with the petition do not show that the taxes due were assessed prior to bankruptcy, section 67(b), in the present posture of the case, cannot be invoked by respondent. Although the Government's status as a lienor may be perfected by a lawful acquisition of the possession of property on which a lien has arisen, without the filing of notice of the lien or the making of a demand prior to bankruptcy, see United States v. Sands, 174 F. 2d 384 (2d Cir. 1949) [49-1 USTC ¶9264], no lien arises for taxes concededly due but not assessed prior to bankruptcy, and such claims remain unsecured. Brust v. Sturr, 237 F. 2d 135 (2d Cir. 1956) [56-2 USTC ¶9954].

It should be noted that an order disallowing the tax claims unless the amount due on the contract is paid over would not constitute an affirmative judgment against the United States . Compare United States v. Roth, 164 F. 2d 575 (2d Cir. 1948) [48-1 USTC ¶9157] with Danning v. United States, 259 F. 2d 305 (9th Cir. 1958). The tax claims exceed the amount due under the contract. If the tax claims were disallowed, a subsequent discharge would not release the bankrupt from liability for the amount due. See §17(a)(1), 11 U. S. C. §35.

[Mutuality of Set-Off]

Since the Referee disposed of the application on the jurisdictional ground, he did not reach a further defense set up by respondent--that section 68(a) of the Bankruptcy Act, 11 U. S. C. §108, permits the Government to set off the amount due on the contract against its claim for taxes. The tax claim accrued against the bankrupt prior to filing the petition; the claim against respondent arose in favor of the bankrupt as debtor in possession after the petition was filed. Therefore the mutuality necessary for set-off is absent. E.g., Brust v. Sturr, supra; In re Autler, 23 F. Supp. 756 (S. D. N. Y. 1938). And see §342, 11 U. S. C. §742, which equates the position of the debtor in possession to that of a trustee.

Respondent has failed to show that it is entitled to have its claim passed upon in a plenary suit. See Cline v. Kaplan, 323 U. S. 97 (1944). A right to set off is asserted. No claim of ownership or lien has been shown and no defense based on want of summary jurisdiction appears to have been made before the Referee. Nor would it be reasonable to interpret 18 Stat. 481 (1875), as amended, 31 U. S. C. §227 (1952), as applicable to upset the operation of the distribution provisions set forth in the Bankruptcy Act.

The order of the Referee denying the relief requested for lack of jurisdiction is reversed and the matter is returned for further proceedings not inconsistent herewith.

SO ORDERED.

 

 

[58-1 USTC ¶9125] United States of America , Intervenor, Appellant v. Trinity Universal Insurance Company, Appellee

(CA-5), U. S. Court of Appeals, 5th Circuit, No. 16605, 249 F2d 350, 11/18/57, Decision of the District Court, rev'd and rem'd, 57-1 USTC ¶9297

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

Collection of taxes: Surety's exoneration action v. Government's claim for unpaid taxes: Set-off of claim for unpaid taxes against money owing by the Government.--After completion of the work under a Government contract, the United States issued a check for the balance due to the contractor. Before the contractor could cash the check, the surety on the contract brought an exoneration action against him as a result of his failure to pay claims for material and labor. The Government intervened in the suit, seeking a return of the check upon learning that unpaid F.I.C.A. and F.U.T.A. taxes had not been paid. The District Court held (1) that the surety's claim dated from the date of the contract of suretyship and was superior to any lien for taxes which might arise at a later date and (2) that the Government lost its right of set-off since it had failed to stop payment on the check before commencement of the suit. The appellate court reversed and remanded the decision of the District Court. It held that, in a situation like this, the issuance of the check in no way affected the Government's right of set-off against the contractor for unpaid taxes, under the general principle of law that a debtor is justified in its refusal to pay what it owes--the check was deposited with the clerk of the appellate court pending this determination--until it is paid what is due it. The court found it unnecessary to consider the question relating to the superiority of the surety's claim versus the Government's claim to priority of its lien for taxes.

Charles K. Rice, Assistant Attorney General, Ellis N. Slack, John N. Stull, George F. Lynch, Department of Justice, Washington, D. C., for appellant. Vance Custer, Charles H. Kirbo, Bainbridge , Ga. , for appellee.

Before HUTCHESON, Chief Judge, and TUTTLE and WISDOM, Circuit Judges.

HUTCHESON, Chief Judge:

This appeal is from a judgment [57-1 USTC ¶9297], ¹ based on a stipulation of facts ² with exhibits attached, in favor of appellee, the surety on a government construction contract awarding it custody, control and payment of a treasury check for $5,259.31, payable to Harry B. Gay, the contractor, and representing the balance due under the contract.

Appellant, insisting that the judgment was wrong and must be reversed, presents two questions for decision. ³

In support of its contention that the first question requires an affirmative answer, the United States, invoking the rule prevailing in Georgia and generally elsewhere, that the issuance of a check by a debtor for the amount of his indebtedness to the payee is not in the absence of agreement to that effect a payment or discharge of the debt, points to the stipulation showing that there was no such agreement in this case and no circumstances from which one could be inferred, and to the fact that in law the attempted assignment by taxpayer to the surety of sums due and to become due under the government contract was invalid and ineffective as against the United States under the Anti-Assignment Statutes, Sec. 3477 of the Revised Statutes, 31 U. S. C. Sec. 203.

Marshalling authorities, particularly United States v. Munsey Trust Co., 332 U. S. 234 and South Side Bank and Trust Co. v. United States, 221 Fed. (2d) 813 [55-1 USTC ¶9371], and pointing out that in Central Bank v. United States, 345 U. S. 639 [53-1 USTC ¶9408], relied on by appellee, the assignment was to a bank under a special statute, the Assignment of Claims Act of 1940, the United States, insisting that appellee's arguments on exoneration, subrogation and equitable lien are wholly beside the mark, urges upon us that the fund evidenced by the check remained legally in the possession and control of the United States and subject to being set off against the tax indebtedness owed by the taxpayer.

We agree. If the United States had not issued the check, we believe no one would claim that it was not entitled, under the Munsey case and the generally controlling principles, to protect itself.

As to debts owed it by the contractor, no reason is presented and no authorities cited to support the view that the issuance of the check in any manner changed or affected the government's right to set-off under applicable law. The cases cited by appellee, while good enough law for their facts, do not at all support its contention in this case. None of those cases dealt with a situation like this, where the United States , not having paid the contractor, seeks to assert, against the surety's claim, its right of off-set against the contractor. In this situation, the United States is the best secured of creditors, its security is its own justified refusal to pay what it owes until it is paid what is due it. United States v. Munsey, 322 U. S. at p. 240.

We think it plain that the district judge was wrong and that his judgment must be reversed with directions to cause return of the check to the government so that it may cancel it and effect the set-off to which it is entitled.

Because of the above set out answer to the first question, it is unnecessary to, and we will not, consider appellant's second question.

The judgment is reversed and the cause is remanded with directions.

¹ "It appearing that by stipulation entered herein the check of the United States in the amount of $5,259.31 drawn upon the Treasury of the United States and payable to Harry B. Gay doing business as Gay-Smith Roofing & Supply Co. was deposited with the Clerk of this Court and should be held by said Clerk until the determination by the court of the rights to said check and its proceeds and based upon its findings of fact and conclusions of law herein, the court having found that the plaintiff, Trinity Universal Insurance Co. is entitled to the possession of the check and that the defendant, Harry B. Gay, should endorse the check to the plaintiff and that the plaintiff should be paid by the United States when presented, whereupon

"It is by the court considered, ordered, adjudged and decreed:

"1. That the Defendant, Harry B. Gay, doing business as Gay-Smith Roofing & Supply Co. be and he is hereby required to endorse said check over to the plaintiff.

"2. The Clerk of this Court is directed to deliver said check to the plaintiff's attorneys 60 days after date of this judgment.

"3. When presented in due course, the intervenor, United States of America , is required to pay said check according to its tenor."

² "It is hereby stipulated and agreed between the undersigned as counsel for the remaining parties hereto, that is, the Trinity Universal Insurance Company and the United States of America, that the following facts and circumstances are true:

The purpose of this stipulation is to provide a factual basis upon which the Court, without a jury, will be able to determine the legitimacy of the basis for each of said party's claim, and then to determine the priority of said claims, one to the other;

(a) That on the 15th day of July, 1954, the defendant, Harry B. Gay, executed and submitted to Trinity Universal Insurance Co. application for bond, a copy of which is hereto attached, marked Exhibit A and made a part of this agreement. Further, on August 3, 1954 , Trinity Universal Insurance Co., (a Taxas corporation, Dallas, Taxas), became surety on a payment bond in the penal sum of $14,257.21, on Government contract No. NOY 78167, between the United States of America and Harry B. Gay, d.b.a. Gay-Smith Roofing & Supply Co. for the installation of asbestos siding and esterior painting on ten new buildings at Ellyson Field, Naval Air Station, Pensacola, Florida. (Copy of said bond attached hereto, marked Exhibit B and made a part of this agreement).

(b) After the completion of the work called for under said contract, the United States of America on December 13, 1954 , issued Treasurer of the United States check in the amount of $5,259.31, payable to Harry B. Gay, d.b.a. Gay-Smith Roofing & Supply Company, and representing the balance due under said contract. Said check did thereafter come into the possession of the said Harry B. Gay, and to date has never been cashed.

(c) That on Jan. 10, 1955 , said Insurance Company filed a bill of exoneration against the said Harry B. Gay, seeking the application of the proceeds from said check on the payment of unpaid amounts due for labor and materials used in the performance of said contract. Thereupon the Court enjoined the said Harry B. Gay from cashing or negotiating and disposing of said check, and H. Grady Rawls, Attorney at Law, was appointed receiver for the purpose of taking possession of said check. Pursuant thereto said check was turned over to the said Rawls. However, he thereafter did not give bond as receiver in accordance with the appointment order, and therefore has never qualified as such receiver and did immediately turn over said check to John P. Cowart, Clark of this Court. By agreement of all parties hereto said check is to be held by said Clerk until determination by this Court of rights to said check and its proceeds.

(d) Withholding and Federal Insurance Contribution Act taxes were assessed the defendant, Harry B. Gay, d.b.a. Gay-Smith Roofing and Supply Co. on March 11, 1955, in the amount of $2,156.77, together with penalty in the sum of $539.19 and interest of $64.70 thereon, for the second quarter of the year 1954, in the amount of $2191.58, together with penalty in the sum of $438.32, and interest of $43.83 thereon, for the third quarter of the year 1954, and in the amount of $1773.02, together with penalty in the sum of $88.65 and interest of $8.87 thereon, for the fourth quarter of the year 1954; that on the same date, March 11, 1955, the said Harry B. Gay was assessed Federal Unemployment Tax Act taxes in the amount of $620.80, together with penalty in the sum of $155.02, and interest of $37.20 thereon, for the year 1953, and in the amount of $2,640.09 together with penalty in the sum of $132.00 and interest of $13.20 thereon for the year 1953; that the taxes, penalty and interest assessed, as aforesaid, total $10,902.53.

Notice and demand for payment of said amounts were served and made upon the said defendant by the District Director of Internal Revenue on or about March 11, 1955 . However, no payments have been made or credits earned by the said Harry B. Gay on account of the assessments of said taxes, penalties and interest aforesaid, so as to reduce the said total amount. At the time of the issuance of the check referred to in Par. (b) above, the United States of America did not know of this tax indebtedness.

(e) That said Insurance Company, after March 11, 1955 , as surety under and on account of said bond paid and satisfied amounts due by the said Harry B. Gay for labor and materials used in the performance of said contract in an amount exceeding the amount of said check. No reimbursement has been received by said Insurance Company for these payments. (See Exhibit C)."

To which may be added:

In his application for a bond, which becamd a part of the contract, the Defendant assigns to the Plaintiff, as security for his obligations, any monies which may be due and payable to the Defendant at the time of any breach or default in its contract, or in payment of any bills for which the Plaintiff might be liable, and all monies which may thereafter become due and payable to the Defendant on account of said contract.

³ (1) Whether the United States may set-off a sum owed to the taxpayer under a construction contract, for which sum a Treasury check was issued to taxpayer as payee, but not cashed, against the greater amount of unpaid federal taxes owing by the taxpayer.

(2) Alternatively, even if the United States may not set-off such taxes, whether its lien for taxes is entitled to priority over the claim of the surety, as assignee of any moneys due or to become due the taxpayer at the time of any breach or default in the contract, to the proceeds of the check.

 

 

[52-1 USTC ¶9198]The United States National Bank of Portland , Oregon , Plaintiff v. Hugh H. Earle, Collector of Internal Revenue of the United States for the District of Oregon, Defendant

In the United States District Court for the District of Oregon, Civil Action No. 5764, January 18, 1952

Priority of tax liens: Assignee of contract payments.--The government's lien for income taxes had priority in 1948 over the bank as assignee of a claim for payments due to the debtor under his contract with the United States. Such assignee acquired no greater rights than its assignor. Accordingly, the government was entitled to a set-off against any amount due from it under the contract, although the tax lien was filed subsequent to assignment for value received.
Prohibition of suits to enjoin collection: Priority claim by non-taxpayer.--In a suit brought by the bank in contesting the government's priority of tax lien on payments assigned to the bank by the debtor under its contract with the United States, the provision for enjoining the collection of taxes and the provision for exemption from the Declaratory Judgment Act are not applicable to such non-taxpayer in seeking to establish a right to any money unlawfully obtained or seized by the Collector. The fact that the Collector may have deposited the money in the Treasury is no bar to a judgment against him. Nor is the United States a necessary party to the action.

Platt, Henderson, Warner, Cram & Dickerson, United States National Bank Building, James Arthur Powers, Norman N. Griffith, and F. Brock Miller, 1935 S. W. 12th Ave., all of Portland, Oregon, for plaintiff. Henry L. Hess, United States Attorney, and Victor E. Harr, Assistant United States Attorney, United States Courthouse, Portland, Oregon, and Thomas R. Winter, Special Assistant to Chief Counsel, Bureau of Internal Revenue, Seattle, Washington, for defendant.

Before Honorable GUS J. SOLOMON, Judge.

[Opinion]

THE COURT: I have an opinion here in the case of The United States National Bank of Portland , Oregon , Plaintiff, versus Hugh H. Earle, Collector of Internal Revenue of the United States for the District of Oregon, Civil No. 5764.

The plaintiff brought an action against Hugh H. Earle, the Collector of Internal Revenue for Oregon , to determine the ownership of certain moneys in the hands of the Bonneville Power Administration and for an injunction to prevent his collection thereof.

The facts are not in dispute and were stipulated to in the Pre-trial Order.

Denison and Stone entered into two written contracts with the Bonneville Power Administration for the clearing of right-of-way and for the construction of transmission lines. The first one was dated June 26, 1947, and the second one, August 1, 1947. In October, 1947, by separate assignments, Denison and Stone assigned all the moneys due or to become due to them to the plaintiff, a national banking association. The assignments complied in all respects with 41 U. S. C. A. 15. Both contracts were performed on or before December 22, 1948, and the Bonneville Power Administration liquidated the balance due under said contracts except for the sum of $14,924.76.

Denison and Stone became indebted to the United States for taxes in an amount in excess of $49,000.00, and notices of said tax liens were filed with the County Auditor of Multnomah County , Oregon , on or before June 15, 1948. On December 31, 1949, a notice of levy for such taxes was served upon the Bonneville Power Administration, which had in its possession on said day the sum of $14,924.76, due by reason of the construction contracts with Denison and Stone.

Subsequent to the filing of this action, the Bonneville Power Administration paid to the defendant the sum of $14,924.76, which amount was applied to the taxes, interest, and penalties due from Denison and Stone and such amount was thereafter paid by the Collector into the Treasury of the United States .

[Jurisdictional Issue]

The Government contends that this Court has no jurisdiction. First, because the Declaratory Judgment Act exempts controversies involving Federal taxes; second, because the United States of America is a necessary party; third, because the case is now moot, the Collector having turned over to the Treasury of the United States the amount so paid to him.

In my opinion, the Court has jurisdiction. The provisions of 26 U. S. C. A. 3653, which prohibit the Court from enjoining the collection of taxes, and the provisions of 28 U. S. C. A. 400, which exempt from the Declaratory Judgment Act controversies involving federal taxes, are not applicable to cases brought by non-taxpayers seeking to establish a right to money or property unlawfully obtained or seized by a Collector of Internal Revenue. (Stuart v. Chinese Chamber of Commerce, 168 F. 2d 709 [48-2 USTC ¶9315]; Tomlinson v. Smith, 128 F. 2d 808 [42-2 USTC ¶9540]; New York Casualty v. Zwerner, 58 F. Supp. 473 [45-1 USTC ¶9140].)

The fact that the Collector may have deposited the money in the Treasury is no bar to a judgment against him. (Stuart v. Chinese Chamber of Commerce, supra.)

The United States is not a necessary party to this action. (New York Casualty v. Zwerner, supra.)

[Government's Right to Set-off]

The next question is whether the Government may set off, against the balance due to the assignee of construction contracts, taxes incurred by the contractor in connection with the performance of such contracts when the taxes were incurred subsequent to the receipt by the Government of the notice of assignments. 41 U. S. C. A. 15 and 31 U. S. C. A. 203, which permit assignments under certain limited circumstances, do not permit the assignee to acquire any greater rights than those of the contractor and the assignee cannot recover any more than the contractor could have recovered in the absence of an assignment. (Modern Industrial Bank v. U. S., 101 Ct. Cls. 808, and Hardin County Savings Bank v. U. S., 65 F. Supp. 1017.)

"The Government has the same right 'which belongs to every creditor, to apply the unappropriated moneys of his debtor, in his hands, in extinguishment of the debts due to him'." ( U. S. v. Munsey Trust Company, 332 U. S. 235, 239.) In that case, the Supreme Court permitted the Government to set off against money, not yet dispersed, due to the assignee of the contractor on an earlier completed contract, the damages which the Government sustained by reason of the non-performance by the contractor of a later and wholly separate contract. In the present case, all, or at least a substantial portion, of the amount due the Government represented taxes incurred by the contractor in performance of the assigned contracts. In my opinion, the present case is a stronger one for the application of the principle enunciated in this Supreme Court case.

The defendant shall prepare appropriate Findings of Fact, Conclusions of Law, and a Judgment for the defendant in accordance with this oral opinion.

Findings of Fact and Conclusions of Law (February 8, 1952)

Hugh H. Earle, Collector of Internal Revenue, the defendant above-named, by Henry L. Hess, United States Attorney for the District of Oregon, his attorney, requests that the Court make the following findings of fact and conclusions of law:

Findings of Fact

1. Plaintiff is a national bank organized under the laws of the United States with its principal place of business at Portland , Oregon .

2. Plaintiff brings this action as assignee of Denison and Stone, a partnership which existed under the laws of the State of Oregon at the times here material but has since been dissolved.

3. The defendant was at all the times hereinafter mentioned Collector of Internal Revenue for the District of Oregon and is a resident of the State of Oregon .

4. On or about June 26, 1947, Denison and Stone entered into a contract in writing with the United States of America, acting through its agency, to wit, Bonneville Power Administration, for clearing the right-of-way and for the construction of a certain transmission line in Flathead County, Montana, and on or about August 1, 1947, Denison and Stone entered into a further contract in writing with the United States of America, acting through said Bonneville Power Administration, for clearing the right-of-way for an electrical transmission line in Thurston and Mason Counties, Washington.

5. On or about August 25, 1947, Denison and Stone, for a valuable consideration, assigned to the plaintiff all moneys due or to become due under the first of said contracts above-mentioned, and on October 23, 1947 Denison and Stone, for a valuable consideration, assigned to the plaintiff all moneys due or to become due under the second of said contracts above-mentioned.

6. The contracts above-mentioned were fully performed by said Denison and Stone not later than December 22, 1948, and, upon full performance of said contracts, there was an unpaid balance thereon in the total sum of $14,924.76.

7. That on or about June 15, 1948, the defendant filed in the office of the County Clerk of the County of Multnomah, Oregon, tax liens against all of the property of Denison and Stone for unpaid taxes due and owing by them to the United States in the sum of $37,962.82, which said taxes were incurred by said Denison and Stone and arose out of their performance of the contracts with the United States above set forth.

8. That on or about December 30, 1949, a notice of levy under a warrant for distraint was served by the defendant upon said Bonneville Power Administration and the amount of $14,924.76 in the hands of said Bonneville Power Administration was paid over by said Administration to the defendant-Collector to apply upon the taxes due and owing from Denison and Stone as aforesaid; that said payment was made prior to the commencement of this action.

Conclusions of Law

1. That the plaintiff by the assignments of the contracts recited above acquired no greater right than its assignor and the United States was entitled to set-off against any amounts due under said contracts the amount of any taxes owed by Denison and Stone.

2. The plaintiff has failed to make out any cause of action, for legal or equitable relief and its complaint should therefore be dismissed with costs.

 

 

[55-1 USTC ¶9371]South Side Bank & Trust Co., Plaintiff-Appellant v. United States of America , Defendant-Appellee

(CA-7), In the United States Court of Appeals for the Seventh Circuit, No. 11271. October Term, 1954, January Session, 1955, 221 F2d 813, April 19, 1955

Appeal from the United States District Court for the Northern District of Illinois, Eastern Division.

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

Lien for taxes: Validity against third parties: Government's right of set-off: Purchase money assigned to bank as security.--The Government ordered house trailers from S. Corporation, agreeing to pay $17,000. S. borrowed $11,000 from appellant bank and as security for the loan S. assigned to the bank its rights to any money due under the purchase order. The Government accepted the delivery of the trailers but refused to pay the bank because S. owed taxes in excess of $17,000. The Court of Appeals affirmed the District Court that the Government had a right to set off the past due taxes against the purchase price of the trailers, and also as against the bank on the ground that the bank had no greater rights to the purchase money than S. Corporation would have had.

Harold J. Green, for plaintiff-appellant. Rob ert Tieken, Alexander O. Walter, John Peter Lulinski, for defendant-appellee.

Before DUFFY, Chief Judge, FINNEGAN and SCHNACKENBERG, Circuit Judges.

SCHNACKENBERG, Circuit Judge:

Plaintiff, a banking corporation (sometimes hereinafter referred to as the "bank"), appeals from a judgment entered by the district court in favor of the defendant (sometimes hereinafter referred to as the "government"), in a suit brought by plaintiff for $10,000 plus attorney's fees, under 28 U. S. C. A. §1346.

The case was submitted to the district court on the complaint and an answer filed by the government, together with a stipulation of facts.

It appears that the government through the Public Housing Administration ordered seven house trailers from Streamlite Corporation, agreeing to pay about $17,000. Streamlite, in order to build the trailers, borrowed $11,000 from the bank, and as security for that loan entered into a trust receipt arrangement under the Illinois Uniform Trust Receipts act, ¹ and assigned to the bank its rights to any money due under the purchase order. The government accepted delivery of the trailers and referred the matter to its General Accounting Office. Thereafter the government refused to pay plaintiff, stating that Streamlite was indebted to it in excess of $17,000 for past due taxes (not arising out of this contract). Plaintiff had no notice of this tax indebtedness when it advanced money to Streamlite. To give the district court jurisdiction of the subject matter of this suit, plaintiff reduced its claim to $10,000.

The district court, in entering judgment for the government, did so on the theory that the government had a right to set off the past due taxes against the purchase price of the trailers, as against the bank. Whether this right of set-off exists under the circumstances is the contested issue here.

[Set-off Permitted]

28 U. S. C. A. §1346(c), under which this suit is brought, expressly recognizes that:

"The jurisdiction conferred by this section includes jurisdiction of any set-off, counterclaim, or other claim or demand whatever on the part of the United States against any plaintiff commencing an action under this section." (Italics supplied.)

This is statutory recognition that the government has a right to present a set-off against a plaintiff commencing an action under this section. The statute does not limit such set-off to the subject matter of the claim sued on. Under a prior statute ² which required a United States district attorney to file in suits against the government, "a notice of any counterclaim, set-off, claim for damages, or other demand or defense whatsoever of the government in the premises" (which language, insofar as it differs from the present statute, is somewhat limited as to the scope of a set-off), we held in United States v. Harris, 77 Fed. 821 at 825, that a right of set-off by the government is not affected by an assignment of the claim to the one who sues the government upon it.

We conclude that the district court properly allowed the government's set-off against the bank's claim and hence, it is unnecessary for us to consider the questions raised by the government as to the assignability of Streamlite's claim in view of the provisions of 31 U. S. C. A. §203 and 41 U. S. C. A. §15. We consider that the manner in which the bank's interest in the purchase price of the trailers was created is of no significance. Under applicable federal law, the bank had no greater rights to the purchase money than Streamlite would have had. If the result, as it affects the bank, appears harsh, it should be remembered that it knew that it was dealing with the holder of a government contract. It was bound to ascertain the applicable federal law. If it had done so, it would have known before it advanced its money to Streamlite that possible unpaid taxes of the latter could be set off by the government against the bank's claim to the proceeds of the sale of the trailers by Streamlite to the government. While Congress has provided ³ that "Any contract of the Department of Defense, the General Services Administration, the Atomic Energy Commission, or any other department or agency of the United States designated by the President, * * * may * * * provide or be amended without consideration to provide that payments to be made to the assignee of any moneys due or to become due under such contract shall not be subject to reduction or set-off, * * *," and be given effect accordingly, no showing has been made that this provision has, by designation of the President, been made applicable to the Public Housing Administration. Moreover, it appears that any intention to apply that provision to the instant contract was expressly negatived by apt language inserted therein.

The judgment from which an appeal has been taken is affirmed.

FINNEGAN, Chief Justice:

I concur in the result.

¹ Ill. Rev. Stat., c. 1211/2, §§ 166-187 (1953).

² R. S. §3477, 24 Stat. 506 (1887).

³ 31 U. S. C. A. §203.

 

 

[69-2 USTC ¶9518] United States of America , Plaintiff v. St. Johns Community Bank, Defendant

U. S. District Court, East. Dist. Mo. , East. Div., No. 68 C 340(2), 302 FSupp 149, 6/10/69

[1954 Code Sec. 6323]

Tax liens: Priority: Set-off.--It would be inequitable to allow a bank to defeat the lien of the United States against a depositor and borrower for unpaid taxes. Accordingly, the bank's right of equitable set-off for amounts owed it by the tax debtor-depositor was denied.

Jim J. Shoemake, Assistant United States Attorney, St. Louis, Mo., James McBride, Department of Justice, Washington, D. C. 20530, for plaintiffs. Richard A. Roth, 7751 Carondelet Ave. , Clayton , Mo. , for defendant.

Memorandum

MEREDITH, District Judge:

This action was commenced on July 29, 1968 , by the United States to enforce a levy for unpaid tax liability of Manuel L. and Lillian W. Sislen. The matter was submitted to the Court upon stipulations of facts. Each party filed briefs in support of its contentions. The stipulations of facts will be adopted as the Court's findings of facts. Particular facts will be set forth here only in the interest of clarity. This Court has jurisdiction of this action under the provisions of 28 U. S. C., §§ 1340 and 1345.

[Enforcement of Lien]

A notice of federal tax lien was filed with the Recorder of Deeds, St. Louis County , Missouri , on August 23, 1967 , against Manuel L. and Lillian W. Sislen for an unpaid assessment for federal income tax in the amount of $28,387.40. A notice of levy was served upon the defendant, St. Johns Community Bank, on September 8, 1967 , seizing all property and rights to property of the taxpayer which were in the possession of the defendant. Manuel L. Sislen, at the time notice of the levy was served, had on deposit with the defendant $2,622.96 in a checking account.

[Tax Debtor Owed Bank]

The defendant, after receiving notice of the levy, caused $2,622.92 to be withdrawn from the taxpayer's checking account by a debit memorandum dated September 8, 1967 . This amount was not actually withdrawn from the checking account until September 11, 1967 . It was credited to a loan account of Manuel L. Sislen with the defendant on April 11, 1968 . This loan was obtained by Manuel L. Sislen on September 15, 1964 , in the amount of $20,000. The note was payable in monthly installments with interest at the rate of six percent per annum. The note provided if default was made in the payment of any of the monthly installments, that the defendant, at its option, could declare the entire note immediately due and payable. In the event the defendant did not exercise its option to declare the remaining balance due and payable, then interest was to be eight percent per annum during the period of delinquency. The note was secured by chattel mortgages and by assignment of leases on real property. At the time of the levy, on September 8, 1967 , the balance due on this note was $14,311.52, and Manuel L. Sislen was in default in the amount of $5,145.49

On September 8, 1967 , the defendant had not, nor has it since that time, exercised its option to declare the entire note due and payable. Exhibit D to the stipulation of facts shows that payments have been made on the loan at various times both before and after September 8, 1967 . The defendant, although it withdraw the $2,622.92 from the taxpayer's checking account on September 8, 1967 , did not credit this amount to the loan account until April 11, 1968 .

[Claim of Equitable Setoff]

The defendant maintains that the United States is not entitled to this amount because under Missouri law an equitable right of set off exists in the money on deposit in the taxpayer's checking account. Title 26, U. S. C., §6321, provides that when a tax is not paid by the person liable, that there "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." Bank deposits of the taxpayer are subject to this lien. MacKenzie v. United States [40-1 USTC ¶9229], 109 F. 2d 540 (9th Cir. 1940). Section 6331(a) of 26 U. S. C. provides for levy and distraint upon property and rights to property subject to such lien, and section 6332 provides for surrender of such property or rights to property by persons in possession thereof. The defendant in this case contends, in essence, that the amount in the taxpayer's checking account, under the facts in this case, is not "property or rights to property" belonging to the taxpayer because of the existence of the equitable right of setoff which defendant claims exists under Missouri law. The United States Supreme Court in Aquilino v. United States [60-2 USTC ¶9538], 363 U. S. 509 (1960), held that the federal courts must look to state law to determine the extent to which a taxpayer had property or rights to property on which the tax lien could attach. Once the tax lien has attached, then federal law determined the priority of competing liens.

The defendant maintains that it is a general rule of Missouri law that a bank may look to any deposits in its hands for repayment of indebtedness due to the bank, citing Adelstein v. Jefferson Bank & Trust Co., 377 S. W. 2d 247 (Mo. 1964). The Court in that case noted that such right arose out of the debtor and creditor relationship, and found its basis in the right of setoff and in equitable principles.

[No Local Law Authority]

Research did not reveal any court decisions involving Missouri banks and the federal tax lien on depositors' accounts. There have been several decisions in other circuits involving banks and deposits in other states. Equitable setoff absent a state statute was allowed by the Fifth Circuit in United States v. Bank of Shelby [4 USTC ¶1226], 68 F. 2d 538 (5th Cir. 1934), in a situation involving an insolvent taxpayer and in which the credit balance in the checking account arose out of the same transaction which created the debt to the bank. Setoff was also allowed in United States v. Bank of United States [1934 CCH ¶9099], 5 F. Supp. 942 (S. D. N. Y. 1934), where the bank held a demand note which the Court held was entitled to "offset" under New York law. The taxpayer in United States v. National Bank of Commerce [65-2 USTC ¶9720] (E. D. La. 1965), had two checking accounts, one overdrawn and one with a balance. The Court held that the tax lien did not reach the latter because a Louisiana statute gave the bank a right of "compensation" and no positive act was required by the bank to perfect this right.

The cases of United States v. Home Savings & Loan Ass'n [66-1 USTC ¶9451], (D. N. Mex. 1966), and United States v. Harris [66-1 USTC ¶9180], 249 F. Supp. 221 (W. D. La. 1966), do not concern the present issue. Both of these cases involved accounts which had been assigned as collateral for loans. These concern the issue of priority of liens and not the determination of the property interest that the tax lien may reach. See Aquilino v. United States , supra.

[Cases Denying Setoff]

Setoff was denied by the Ninth Circuit in Bank of America National Trust and Savings Ass'n v. United States [65-1 USTC ¶9429], 345 F. 2d 624 (9th Cir. 1965), affirming [64-2 USTC ¶9533] 229 F. Supp. 906 (S. D. Cal. 1964), and in Bank of Nevada v. United States [58-1 USTC ¶9228], 251 F. 2d 820 (9th Cir. 1957), affirming [57-1 USTC ¶9561] 155 F. Supp. 164 (D. Nev. 1957). The Court denied Setoff in the Bank of Nevada case because the attempted exercise of the option of setoff occurred after the Government's levy. The setoff was denied in the Bank of America National Trust & Savings Ass'n case because, although the depositor's debt was due and payable at the time of the levy, the attempted setoff was not exercised until after the levy.

It is not necessary, however, for this Court to rule upon the point raised by the Government that the attempted setoff by the defendant here was not exercised until after notice of the levy had been served on September 8, 1967 . The Missouri law applicable to this situation is enunciated by the Missouri Supreme Court in Adelstein v. Jefferson Bank & Trust Co., supra. The Court in that case states that as a general rule a bank has a right to apply funds of a depositor to offset an indebtedness owed to it by that depositor. The Court points out that this right arises out of equitable principles. That this is an equitable right is clear from other Missouri decisions. See, e.g., Bollow v. Farmers' Bank of Leonard, 45 S. W. 2d 882 (St. L. Mo. App. 1932); Iler v. Midland National Bank, 69 Mo. App. 64 (K. C. Mo. 1897); Kortjohn v. Continental National Bank of St. Louis, 63 Mo. App. 166 (St. L. Mo. App. 1895).

The application of equitable principles to the particular facts in this case requires that the defendant not be allowed to apply the taxpayer's checking balance to the loan account here. The taxpayer obtained the loan in October of 1964. Payments were to be monthly. The first payment missed by the taxpayer, as evidenced by Exhibit D, was in February of 1965. At the time of the levy, on September 8, 1967 , the taxpayer was in default in a total amount of $5,145.49. The defendant had the option to declare the entire note due and payable upon default of any monthly payment. In the event the option was not exercised, then the note provided that interest would be at the rate of eight percent rather than the original six percent. Although the note was in default beginning originally in February of 1965, payments had been made prior to and subsequent to the date of the levy. When the defendant received notice of the levy on September 8, 1967 , it withdrew $2,622.92 from the taxpayer's checking account, leaving a balance of four cents. The defendant did not, then, nor has it ever, declared the entire note due and payable. The defendant did not credit this amount to the loan account until April 11, 1968 . There is no showing that the taxpayer is insolvent and the defendant in danger of taking a loss on the loan. The loan is secured by chattel mortgages and by assignment of leases on real property. [This Court is aware that a bank has the option of pursuing the security or of seeking to apply other funds in its hands to a depositor's debt. See Boydston v. Bank of Camden Point, 141 S. W. 2d 86 (K. C. Mo. App. 1940), and Southern Missouri Trust Co. v. Crow, 272 S. W. 1040 (Spr. Mo. App. 1925). This does not affect the equities, however.]

[Setoff Denied]

Considering all of these facts, it is not equitable to allow the defendant to defeat the lien of the United States for taxes owed by the depositor. The defendant was content to carry the note in default prior to the levy and collect the eight percent. It is still content to carry the note in default even after the levy; the checking account balance does not cure the default. There is no showing that the defendant will be injured if the levy is allowed. Only the taxpayer benefits if the bank's setoff is allowed in this case. Accordingly, judgment will be entered for the United States .

 

 

[72-2 USTC ¶9654] United States of America , Plaintiff v. First National Bank of Arizona , Defendant

U. S. District Court, Dist. Ariz. , No. Civ. 69-494 Phx., 348 FSupp 388, 4/8/70

[Code Secs. 6323 and 6332]

Tax lien against bank account: Right of bank to set-off.--The government's tax lien with respect to a delinquent taxpayer's bank account was superior to the bank's right of set-off attempted to be applied by it to the same bank account which was not executed until after the government's lien became effective.

William Smitherman, United States Attorney, Phoenix , Ariz. , for plaintiff. Kramer, Roche, Burch, Streich & Gracchiolo, 411 N. Central Ave., Phoenix, Ariz., Earl E. Weeks, Streich, Lang, Weeks, Cardon & French, 567 First National Bank Bldg., Phoenix, Ariz. for defendant.

Memorandum and Order

COPPLE, District Judge:

This is an action brought by the United States to enforce a levy for unpaid tax liability. Involved is a priority of claims to funds in a delinquent taxpayer's bank account. The Government asserts a tax lien; the bank asserts a right of setoff. Both parties have moved for summary judgment on stipulated facts and have filed memoranda setting forth their respective positions. A hearing on the motions was held before this Court on April 6, 1970 , and subsequent to hearing the arguments of both parties the motions were taken under advisement.

This Court has jurisdiction under 28 U. S. C. §§ 1340 and 1345.

In the Court's view, the decision in Bank of Nevada v. United States [58-1 USTC ¶9228], 251 F. 2d 820 (9th Cir. 1967), cert. denied, 356 U. S. 938, 78 S. Ct. 780 (1958), is controlling and requires judgment for the United States . Broadly read, the case stands for the proposition that the Government's lien has priority wherever "the attempted exercise of the option of setoff occur[s] after the Government's levy." United States v. St. Johns Community Bank [69-2 USTC ¶9518], 302 F. Supp. 149, 151 (E. D. Mo. 1969); see United States v. Bank of America National Trust & S. Ass'n [64-2 USTC ¶9533], 229 F. Supp. 906 (S. D. Cal. 1964), aff'd, [65-1 USTC ¶9429] 345 F. 2d 625 (9th Cir. 1965). At minimum, it sets forth the doctrine that the federal tax lien prevails if the depositor's debt is not yet due and it is the levy itself which triggers acceleration and maturity of the obligation and the bank's claimed right of setoff. This is precisely the situation herein, where the Government levy substantially antedated the due date of the obligation which the defendant is attempting to set off. Until a bank has notified its depositor and then exercised its right of setoff, the depositor is free to withdraw from his account, and it is inconceivable that Congress, by virtue of 26 U. S. C. §6323, intended to prohibit the Government from levying on that which is plainly accessible to the delinquent taxpayer-depositor.

United States v. Winnett [48-1 USTC ¶9115], 165 F. 2d 149 (9th Cir. 1947), relied upon by the defendant, is not in point. As pointed out in Bank of Nevada , supra, the Court in Winnett applied the now discredited "relation back" doctrine. Furthermore, the Winnett holding was primarily premised on the insolvency of the debtor. See Bank of Nevada at 828. Here, there is no indication that the debtor has not or will not make good on the debt, let alone any allegation that the debtor is insolvent. Finally, the Winnett court observed that Winnett would be required to pay the same debt twice, where here, as in Bank of Nevada, the defendant "is in no such danger" inasmuch as "payment to the government pursuant to the levy and notice is a complete defense to the debtor against any action brought against him on account of the debt." Id. at 828.

In view of the above conclusions,

IT IS ORDERED that defendant's motion for summary judgment is denied.

IT IS FURTHER ORDERED that plaintiff's motion for summary judgment is granted.

The plaintiff shall forthwith prepare and submit to the Court for signature a form of judgment in accordance herewith.

Judgment

Pursuant to opinion heretofore filed in the above captioned matter,

IT IS ORDERED, ADJUDGED AND DECREED that the Plaintiff, United States of America , have judgment against the defendant, First National Bank of Arizona , in the sum of $1,765.21, plus interest at the rate of six per cent per annum from February 19, 1969 , until paid, together with costs and disbursements incurred.

 

 

[80-2 USTC ¶9821] United States of America , Plaintiff v. Sierra Charter Corporation of Nevada , Defendant

U. S. District Court, Cen. Dist. Calif., No. CV-79-876-MML, 10/23/80

[Code Sec. 6323]

Tax liens: Priority of liens: Summary judgment.--The government's motion for summary judgment was granted in an action to recover a money judgment based upon a levy, the subject matter of which was the proceeds of a loan made by the taxpayer to the defendant corporation. The District Court rejected the defendant's assertion that it did not possess any property or right to property of the taxpayer because of offset payments made by the defendant which created equitable liens prior to the tax liens. The defendant admitted that all offset payments it made were made after the date the defendant received notice of the federal tax lien. Thus, under federal law, any equitable state lien was inchoate at the time of the federal tax lien and the federal tax lien had priority.

Andrea Sheridan Ordin, United States Attorney, Charles H. Magnuson, Kenneth M. Barish, Assistant United States Attorney, Los Angeles, Calif. 90012, for plaintiff. Alvin B. Green, 10850 Wilshire Blvd. , Los Angeles , Calif. , for defendant.

Findings of Fact and Conclusions of Law

LUCAS, District Judge:

This matter came on for hearing on plaintiff, United States of America 's Motion for Summary Judgment before the Honorable Malcolm M. Lucas, United States District Judge on October 20, 1980. Defendant appeared by and through its counsel Alvin B. Green, and defendant was represented by its counsel, Andrea Sheridan Ordin, United States Attorney for the Central District of California, Charles H. Magnuson, Assistant United States Attorney, Chief, Tax Division and Kenneth M. Barish, Assistant United States Attorney. The Court having considered the pleadings, briefs, memorandum and all other documents herein, as well as oral argument, and being fully advised in the premises, makes the following Findings of Fact and Conclusions of Law:

Findings of Fact

1. This action was brought by the United States of America to enforce an Internal Revenue Service Tax levy. The purpose of the action is to recover a money judgment against Sierra Charter Corporation (Sierra Charter) in the amount of $80,003.21, plus interest from January 22, 1975, the date of the tax levy.

2. Sierra Charter was at all times herein relevant in the business of land development and sale of lots and homes throughout the southwestern portion of the United States . Also involved in land development and land contracting was Environmental Communities, Inc. (ECI), the taxpayer.

3. Sometime prior to 1974, Sierra Charter entered into business relationships with ECI, which included contracts whereby ECI would perform construction work on various projects in which Sierra Charter was engaged. Also, Sierra had signed an indemnity agreement on construction bonds issued by Argonaut Insurance in regard to projects in which ECI was engaging, but Sierra Charter was not involved. Lastly, there occurred the circumstances of a loan of $135,000 being made by ECI to Sierra; it is the proceeds of this loan which are the subject matter of the levy involved in this case.

4. On February 8, 1974 , Sierra executed a promissory note in favor of ECI whereby it promised to repay $135,000 which ECI had loaned it on or before February 7, 1975 . On that same date checks were issued by ECI on Sierra Charter's behalf.

5. On September 16, 1974 , the Internal Revenue Service assessed the tax liability against ECI in relation to employment taxes it had not paid for the quarter ended June 30, 1974 . Notices of Federal Tax Liens were filed in regard to the unpaid balance of the assessment with the Orange County Recorder and Secretary of State, California on October 25, 1974 and October 28, 1974 , respectively. On January 22, 1975 Notice of Levy was served upon Sierra Charter by the Internal Revenue Service in regard to the proceeds of the promissory note executed in favor of ECI on February 8, 1974 . At that time the levy sought a total of $80,003.21 from Sierra Charter in regard to the note.

6. By way of defense to the levy, Sierra Charter alleges that it owes no money on the loan because of offsets occasioned by its being required to make payments due to its having signed a general indemnity agreement on the bonds issued by Argonaut Insurance in relation to ECI. All of the alleged offsetting payments were made after the service of levy.

7. By letter dated November 6, 1974 , Sierra Charter acknowledged that as of that date it owed ECI $103,087.12 ($104,087.12 is correct amount due to arithmetic error) and that amount applied to the $135,000 loan in issue here. Through the testimony of Eric Swanson, former Controller of Sierra Charter, it was ascertained that this same amount was owed by Sierra Charter to ECI as of January 31, 1975 . Defendant has shown no evidence that any right of set off was exercised by it prior to February 7, 1975 .

8. Any of the foregoing findings of fact deemed to be conclusions of law are hereby incorporated in the Conclusions of Law.

Conclusions of Law

1. There are only two defenses to an Internal Revenue Service levy. They are first that at the time of a levy, the person levied upon did not possess any property or rights to property of the taxpayer and, second, the property or right to property levied on is subject to an attachment or execution under a judicial process. United States v. Sterling National Bank and Trust Co. of N. Y., 360 F. Supp. 917, 923 (S. D. N. Y. 1973), aff'd in relevant part, 494 F. 2d 919 [74-1 USTC ¶9336], 921 (2d Cir. 1974); Bank of Nevada v. United States [58-1 USTC ¶9228], 251 F. 2d 820 (9th Cir. 1957); United States v. Trans-World Bank [74-2 USTC ¶9632], 382 F. Supp. 1100 (C. D. Cal. 1974).

2. In this case defendant has asserted that it did not possess any property or right to property of taxpayer ECI, because of offset payments made by defendant, that created equitable liens prior to the federal tax lien. Under United States v. Pioneer American Insurance Co. [63-2 USTC ¶9532], 374 U. S. 84, 88-89 (1963), any priority of state-created liens over federal tax liens depends on the time when state liens attach to the property and become choate. A choate lien is one that is perfected so that nothing more need be done to make it enforceable. United States v. City of New Britain, Conn. [54-1 USTC ¶9191], 347 U. S. 81, 84-86 (1954).

3. In Pioneer American, supra, the Supreme Court held that it is federal law, not state law, that determines when a lien has acquired sufficient substance and has become so perfected as to defeat a later-arising or later-filed federal tax lien. It is the federal rule that liens are perfected when 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. Pioneer American, supra; City of New Britain , supra, at 86.

4. Defendant has admitted that all offset payments it made on behalf of taxpayer ECI were made after the date defendant received notice of the federal tax lien. Thus, under federal law, any equitable state lien was inchoate at the time of the federal tax lien and the federal tax lien has priority. Pioneer American, supra. See also, Bank of Nevada v. United States [58-1 USTC ¶9228], 251 F. 2d 820 (9th Cir. 1957) (asserted right to set off arising from debt that was not in existence at time tax lien arose is inchoate lien, with no priority to federal tax lien).

5. Summary judgment is appropriate in cases of this type where, as here, the record before the Court clearly shows there is no genuine triable issue as to any material fact.

Judgment in Favor of Plaintiff , United States of America

The motion of plaintiff, United States of America, having come on for hearing before this Court on October 20, 1980, defendant having been represented by Alvin B. Green and Plaintiff having appeared through its counsel, Andrea Sheridan Ordin, United States Attorney for the Central District of California, Charles H. Magnuson, Assistant United States Attorney, Chief, Tax Division, and Kenneth M. Barish, Assistant United States Attorney, and the Court having fully considered the pleadings and other documents filed herein, the motion papers and arguments of counsel, and accordance with the findings of fact and conclusions of law filed herewith.

IT IS ORDERED, ADJUDGED, AND DECREED that judgment be and the same hereby is, entered in favor of plaintiff, United States of America , in the sum of $104,087.12.

 

 

[65-1 USTC ¶9429]Bank of America National Trust and Savings Association, a national banking association, Defendant-Appellant v. United States of America, Plaintiff-Appellee

(CA-9), U. S. Court of Appeals, 9th Circuit, No. 19,469, 345 F2d 624, 5/13/65, Affirming District Court, 64-2 USTC ¶9533

[1954 Code Sec. 6323]

Tax liens: Priority: Setoff.--The government had a tax lien priority against the funds in a delinquent taxpayer's bank account over the claim of the bank for setoff arising under state law for obligations owed the bank by the taxpayer.

Samuel B. Stewart, Rob ert H. Fabian, Bank of America, Los Angeles, Calif., Alfred T. Twigg, Legal Department Bank of America, Los Angeles, Calif. for appellant. John B. Jones, Jr., Acting Assistant Attorney General, Lee A. Jackson, Joseph Kovner, Fred E. Youngman, Department of Justice, Washington, D. C. 20530, Manuel L. Real, United States Attorney, Loyal E. Keir, Assistant United States Attorney, Los Angeles , Calif. for appellee.

Before POPE, MERRILL and BROWNING, Circuit Judges.

PER CURIAM:

This appeal presents the question whether a Government tax levy ¹ upon the taxpayer's checking and savings accounts prevails over an existing indebtedness from the taxpayer to the bank. ²

Assessment for delinquency against the taxpayer was made by the Director in 1955. Notices of tax lien were recorded in 1955 and January, 1958. Obligations of the taxpayer to the bank arose by virtue of various loans made commencing in March of 1958. The amounts here involved were deposited to the taxpayer's accounts prior to August 27, 1959 . Notice of levy was served on the bank on August 27, 1959 . At that time the taxpayer was in debt to the bank in the sum of $11,570.49. His bank accounts then amounted to $6,658.31. The day following the Government levy, by bookkeeping entry, the bank credited the amount in the taxpayer's accounts against the taxpayer's indebtedness to the bank.

The District Court, in holding for the Government, ruled that this case is controlled by our decision in Bank of Nevada v. United States [58-1 USTC ¶9228], 251 F. 2d 820 (9th Cir. 1958), cert. denied, 356 U. S. 938 (1958). We agree.

The bank seeks to distinguish this case upon the ground that in Bank of Nevada , supra, it was the levy itself which accelerated and rendered mature the obligation of the depositor to the bank, while here the obligation was mature at the time the deposit was made and at all times thereafter. The language and rationale of the Bank of Nevada case do not permit of such a distinction, [58-1 USTC ¶9228] 251 F. 2d 820, 827.

Judgment affirmed.

¹ Under Int. Rev. Code of 1954, §§ 6331 (Levy and Distraint) and 6332 (Surrender of Rpoperty Subject to Levy).

² The opinion of this court on a prior appeal is reported at 317 F. 2d 859 (1963) [63-2 USTC ¶9501]. The District Court's opinion on the remand from which this appeal is taken is reported at 229 F. Supp. 906 (S. D. Cal. 1964) [64-2 USTC ¶9533].

 

 

[58-1 USTC ¶9228]Bank of Nevada , Appellant v. United States of America , Appellee

(CA-9), U. S. Court of Appeals, 9th Circuit, No. 15,541, 251 Fed 820, 12/31/57, Aff'g Dist. Ct., 57-1 USTC ¶9561, 155 F. Supp. 164

[1939 Code Secs. 3672(a) and 3710--similar to 1954 Code Secs. 6323 and 6332]

Tax lien against bank account: Right of bank to set-off.--The appeal court, affirming the trial court, held that the government's tax lien, with respect to a delinquent taxpayer's bank account, dating back to assessment date, was superior to the appellate bank's right of set-off attempted to be applied by it to the same bank account on account of a personal note of the taxpayer and his wife, which was not executed until after the government's lien became effective and where the note had not become due the the option to avail itself of the right of set-off granted to the bank by agreement of the taxpayer was not exercised by the bank until after it had received notice of levy.

Milton W. Keefer, B. Mahlon Brown, Las Vagas , Nev. , for appellant. Charles K. Rice, Assistant Attorney General, Lee A. Jackson, Charles Freeman, A. F. Prescott, Sheldon I. Fink, Department of Justice, Washington, D. C., Franklin P. R. Rittenhouse, United States Attorney, Reno, Nev., for appellee.

Before STEPHENS, Chief Judge, LEMMON and HAMLEY, Circuit Judges.

LEMMON, Circuit Judge:

While the Internal Revenue Code of 1954 "contains a variety of important changes in the estate and gift tax areas", ¹ it has left untouched the well established principle that the amount of an unpaid tax "shall be a lien in favor of the United States upon all property and rights to property" ² of the delinquent taxpayer.

No government worthy of the name will permit itself to be rendered incapable of collecting the public fisc.

At any rate, in this respect at least, the United States Government has not been left impotent.

1. Statement of Facts

The facts as found by the Court below were entirely stipulated. They may be summarized as follows--with especial regard to the chronology, since time-sequence is important here:

On November 15, 1954 , certain Withholding and Federal Insurance Contributions Act taxes for the calendar year 1954 in the amount of $804.50 were assessed against J. D. Bentley of Las Vegas , Nevada , hereinafter referred to as the taxpayer. On the following day, the taxpayer was notified of this assessment and demand was made upon him to pay it, but he has refused to do so.

On January 12, 1955 , a notice of tax lien pertaining to this assessment was filed with the County Recorder of Clark County , Nevada .

On February 28, 1955 , and on August 31, 1954 , the taxpayer submitted financial statements to the appellant. Each statement read in part as follows:

"The undersigned, for the purpose of procuring and establishing credit from time to time with you and to induce you to permit the undersigned to become indebted to you on notes, endorsements, guarantees, overdrafts or otherwise, furnishes the following as being a true and correct statement of the financial condition of the undersigned on the above date, and agrees to notify you immediately of the extent and character of any material change in said financial condition, and also agrees that if the undersigned, or any endorser or guarantor of any of the obligations of the undersigned, at any time fails in business or becomes insolvent, or commits an act of bankruptcy, or if any deposit account of the undersigned with you, or any other property of the undersigned held by you, be attempted to be obtained or held by writ of execution, garnishment, attachment or other legal process, or if any of the representations made below prove to be untrue, or if the undersigned fails to notify you of any material change as above agreed, then and in such case, at your option, all of the obligations of the undersigned to you, or held by you, shall immediately become due and payable, without demand or notice. This statement shall be construed by you to be a continuing statement of the condition of the undersigned, and a new and original statement of all assets and liabilities upon each and every transaction in and by which the undersigned hereafter becomes indebted to you, until the undersigned advises in writing to the contrary." [Italics supplied.]

On March 1, 1955 , certain Federal excise taxes for the calendar year 1954 amounting to $187.51 were assessed against the taxpayer, and on that same date the taxpayer was notified of this assessment. Demand was made upon him to pay it, but he has refused to do so.

On April 16, 1955 , the taxpayer and his wife, Doris L. Bentley, Borrowed $2,000 from the appellant and executed a promissory note in favor of the appellant for that amount.

On May 31, 1955 , the taxpayer submitted to the appellant another financial statement, containing the same provision relating to the appellant's right of set-off that has been quoted supra.

On June 10, 1955 , the taxpayer had on deposit in an account with the appellant "the sum of not less than $878.16". At 1:45 p. m. on that day, the appellee, through one of its collection officers, served a "Notice of Levy" upon the appellant by delivering it to E. K. Phillips, the assistant cashier. This Notice of Levy covered both of the assessments referred to above.

On that same day, A. M. Smith, vice president and manager of the appellant's First and Fremont Branch, wrote to the appellee's collection officer as follows:

"This will acknowledge receipt of your Notice of Levy against J. D. Bentley, which was served on our Mr. Phillips at 1:45 p. m. today.

"I would like to take this opportunity to inform you that we have exercised our right to setoff and applied the funds in this account to an unsecured indebtedness held at this bank; consequently, there are no funds available under your levy."

The "unsecured indebtedness" referred to in the above letter was the balance of the note for $2,000, referred to above, which balance, at the time of the levy, amounted to approximately $1,500. The appellant exercised its "claimed" right of setoff subsequently to 1:45 p. m. on June 10, 1955, the precise time at which the appellee's collection officer delivered the Notice of Levy to the appellant's assistant cashier. The appellant concedes that it exercised its right of setoff "thereafter".

On June 13, 1955 , a notice of Federal tax lien pertaining to the assessment of Federal excise taxes was filed in the office of the County Recorder of Clark County , Nevada .

On June 14, 1955 , the appellee's collection officer served a final demand upon the appellant's vice president and manager of its First and Fremont Branch.

On September 28, 1955 , the appellee filed suit in the Court below to recover from the appellant the sum of $878.16, with interest and costs. As we have seen, the sum represented the amount which the taxpayer had on deposit with the appellant on June 10, 1955 .

The case was submitted upon a stipulation of facts, together with attached exhibits.

The District Court held that the appellee's "tax liens are paramount and valid liens", and that the appellee was entitled to judgment as prayed for.

On March 29, 1957 , the District Court handed down a judgment accordingly [57-1 USTC ¶9561].

On April 5, 1957 , the Notice of Appeal was filed.

2. The Appellant's Contentions

The appellant's argument may be summarized as follows:

The trial court erred in "ignoring the established principle that the bank has a general lien or right of setoff against the deposits of the depositor for the indebtedness of the depositor to the bank."

The Court erred in finding that the promissory note was not a demand note and due immediately upon delivery.

There was no property of the depositor-taxpayer in the possession of the appellant subject to the tax lien.

The right of set-off in the appellant was paramount to the appellee's tax lien.

3. The Applicable Statute

The pertinent sections of the Internal Revenue Code of 1954 are the following:

"§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.

"§6322. 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.

"§6323. Validity against mortgagees, pledgees, purchasers, and judgment creditors

"(a) Invalidity of lien without notice.--Except as otherwise provided in subsection (c), the lien imposed by section 6321 shall not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until notice thereof has been filed by the Secretary [of the Treasury] or his delegate--* * *

"§6331. Levy and distraint

"(a) Authority of Secretary or delegate.--If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary or his delegate to collect such tax (and such further sum as shall be sufficient to cover the expenses of the levy) by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in that chapter for the payment of such tax. * * *

"§6332. Surrender of property subject to levy

"(a) Requirement.--Any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which a levy has been made shall, upon demand of the Secretary or his delegate, surrender such property or rights (or discharge such obligation) to the Secretary or his delegate, except such part of the property or rights as is, at the time of such demand, subject to an attachment or execution under any judicial process."

4. Liens for Federal Taxes and the Provisions for Their Collection Are Strictly Federal and Strictly Statutory

At the outset, what appears to be a basic misconception of the appellant should be cleared up. In its main brief, the appellant cites a number of state decisions to the effect, inter alia, that a party in the appellant's position "has a general lien or right of set off against the deposits of the depositor for the indebtedness of the depositor to the bank"; and that there is a right to set off enjoyed by a bank "by virtue of a specific agreement with its depositor", and that only the sum left, "after deducting the debits from the credits, in favor of the depositor was the balance or property subject to the tax lien." [Italics supplied]

The Supreme Court has repeatedly and emphatically stated that Federal tax liens and the provisions for their collection are strictly Federal and strictly statutory. Those provisions are unaffected by any alleged "general rule" that a bank has a "general lien" upon deposits.

In United States v. Security Trust & Savings Bank, Executor, 1950, 340 U. S. 47, 49-50 [50-2 USTC ¶9492], the Court said:

"The effect of a lien in relation to a provision of federal law for the collection of debts owing the United States is always a Federal question. Hence, although a state court's classification of a lien as specific and perfected is entitled to weight, it is subject to reexamination by this Court." [Italics supplied.]

Again, in United States v. Acri, 1955, 348 U. S. 211, 213 [55-1 USTC ¶9138] the Supreme Court used the following language:

"The relative priority of the lien of the United States for unpaid taxes is, as we said in United States v. Waddill Co., 323 U. S. 353, 356, 357 [45-1 USTC ¶9126]; Illinois v. Campbell, 329 U. S. 362, 371; United States v. Security Trust Co., 340 U. S. 47, 49 [50-2 USTC ¶9492], always a federal question to be determined finally by the federal courts. The state's characterization of its liens, while good for all state purposes, does not necessarily bind this Court. [Cases cited.]"

This Court likewise has adhered to the Federal norm in evaluating a Federal tax lien. In MacKenzie v. United States , 9 Cir., 1940, 109 Fed. (2d) 540, 541 [40-1 USTC ¶9229], Judge Stephens said:

"The federal tax lien is entirely statutory, therefore its scope and effect are to be determined solely by the statute and the decisions interpreting it." ³

5. The Appellant Could Not Shield the Taxpayer's Account By an Inchoate Agreement with Its Depositor or by a Claimed Equitable Right of Setoff Springing From a Debt Not In Existence When the Tax Liens Arose

Section 6332(a), supra, gives the appellant only two defenses; namely, (1) that it was not in possession of property of the taxpayer which was subject to levy; or (2) that the property was subject to a prior judicial attachment or execution. The statute admits of no other defenses. ⁴

In the instant case, of course, judicial attachment or execution does not figure. The appellant does maintain, however, that it did not have in its possession "property rights [sic] to property subject to levy" at the time of demand or levy by the District Director of Internal Revenue on June 10, 1955 .

This is based upon the further contention that the appellant had a "right of set off" bottomed upon the agreement of August 31, 1954 , and "the demand note" of April 16, 1955 , supra. It is argued that by virtue of the agreement of August 31, 1954, which "prior to the assessment of taxes against the taxpayer on November 15, 1954 [supra], or the recording of the notice of tax lien on January 12, 1955 [supra]," the appellant has acquired "a right of set off by contract which was paramount to the subsequent tax lien." Finally, it is urged that "there existed no balance in the depositor-taxpayer's account which was subject to levy by the District Director of Internal Revenue".

We do not agree. The appellant could not protect itself from a Federal tax levy by the taxpayer's inchoate agreement, or by an asserted right of setoff arising from a debt that was not in existence at the time the tax liens arose, supra. The liens came into being at the time the assessments were made. See §6322, supra.

In United States v. Graham , DC Cal. , 1951, 96 Fed. Supp. 318, 321 [51-1 USTC ¶9218], affirmed per curiam sub nom. State of California v. United States, 9 Cir., 1952, 195 Fed. (2d) 530 [52-2 USTC ¶9425], certiorari denied, 1952, 344 U. S. 831, the District Judge said:

"The 1942 income tax assessment against the taxpayer, Warren C. Graham, was received by the Collector on March 23, 1945 , more than a year and three months before the leases with the State of California were entered into. The tax due under this assessment is still due. Any money that accrued to the taxpayer under the lease with the state accrued with a lien impressed upon it. There was no period of time in which the State of California 's right of set-off could have been asserted against the debt to the taxpayer that the property was not impressed with the tax lien. In U. S. v. Winnett, supra, the right of set-off accrued before any tax liens arose. . . .

* * *

"Assuming arguendo that the State of California may assert an equitable set-off against a delinquent taxpayer, the set-off could have been asserted no earlier than the time at which the lease agreements were entered into with the taxpayer. No set-off could arise until such time as there existed something to be set-off against. But the rights of the taxpayer under the lease were born with the tax lien impressed thereon.

"Assuming further that the set-off and the tax liens attached simultaneously to the interest of the taxpayer created by the lease agreements, no citation of authority is needed to establish that the federal tax lien is superior to any simultaneously attaching interest of the State of California . Therefore the rights of the State of California , with respect to the money accrued as rentals under the leases made with the taxpayer are inferior to the tax liens of the United States ." [Italics supplied.]

It should be noted here that this Court affirmed the District Court's judgment in the Graham case, supra, "On the ground and for the reasons stated" in the District Judge's opinion. We adhere to the teaching of Graham.

"The first in time is the first in right" was declared to be the determining principle by Mr. Justice Minton, in United States v. New Britain , 1954, 347 U. S. 81, 85-86 [54-1 USTC ¶9191].

In that case, the Court quoted the following language of Mr. Chief Justice Marshall in Rankin & Schatzell v. Scott, 25 U. S. 177, 179:

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

In its opinion in the New Britain case, supra, the Supreme Court continued:

"This principle is widely accepted and applied, in the absence of legislation to the contrary. 33 Am. Jur., Liens, §33; 53 C. J. S., Liens, §10b. We think that Congress had this cardinal rule in mind when it enacted §3670 [the predecessor of §6321, supra], a schedule of priority not being set for therein. Thus, the priority of each statutory lien contested here must depend on the time it attached to the property in question and became CHOATE." [Italics supplied.]

An examination of the lengthy paragraph quoted supra from the financial statements of August 31, 1954 , February 28, 1955 , and May 31, 1955 will convince even the casual reader of the record that whatever lien the appellant had upon the taxpayer's deposit on those dates was INCHOATE in the extreme!

The doctrine of "relation back" cannot avail the appellant here. In the Security Trust case, supra, 340 U. S. at pages 50-51, the Court used language quite apposite here:

"Nor can the doctrine of relation back--which by process of judicial reasoning merges the attachment lien in the judgment and relates the judgment lien back to the date of attachment--operate to destroy the realties of the situation. When the tax liens of the United States were recorded, Morrison did not have a judgment lien. He had a mere caveat of a more perfect lien to come. . . .

* * *

". . . Accordingly, we hold that the tax liens of the United States are superior to the INCHOATE attachment lien of Morrison, . . ." [Italics supplied.]

Finally, the Court in United States v. Kings County Iron Works, 2 Cir., 1955, 224 Fed. (2d) 232, 237 [55-2 USTC ¶9536], tersely summarized the rule that is applicable here:

"The mere attachment of the government's [tax] lien gives it a fully perfected claim superior to all except mortgagees, pledgees, purchasers, or judgment creditors of the taxpayer."

No amount of legalistic sophistry can erode the Gibralter of that rule.