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
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.
determined that the federal tax levy should have been honored, we next
consider issues which concern priority. Relying on Kan. Stat. Ann. §17-2212
(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.
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
statutory scheme regulating credit unions. See Kansas Credit Union League v.
, 532 P.2d 1039, 1042 (
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.
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,
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,
¶9655 ] 458 F.2d 513 (9th Cir. 1972).
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)
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
does not extend "to any right of setoff" or "to a
transfer of an interest in any deposit account."
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)
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.
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 (
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 (
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.
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.
¶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.
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
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
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.
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.
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.
§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.
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).
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
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).
considered other arguments made in the amicus briefs and find them
At all times relevant, I.R.C. §6332
provided in pertinent part:
PROPERTY SUBJECT TO A LEVY.
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. . . .
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
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.
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.
references are to the Internal Revenue Code of 1954, as amended.
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. . . .
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
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."
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).
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.
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
Definitions.--For purposes of this section and section
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.
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
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:
"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
istering the Federal Credit Union Act).
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.
¶9224]Murdaugh Stuart Madden and Clifford J. Hynning v. The
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.
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.
Chief Judge, LARAMORE, DURFEE,
, COLLINS, and SKELTON, Judges.
lawyers, successfully prosecuted a claim on behalf of Industrial
Finishers, Inc., an
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
argues, among other defenses, that the right of setoff where the
Government is both debtor and creditor is established by statute (31
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
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).
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
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
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.
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.
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."
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.
attorney, as "a modification of the form usually utilized by * * *
[him] in the State of
," 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.
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.]
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.
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.
would be pleased if you will advise us as to what progress you have made
in the settlement of the claim.
Madden forwarded the letter to Mr. Dukes who, on October 21, wrote to
Mr. Madden as follows:
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.
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.
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
October 21, 1959
, from Mr. Dukes to Mr. Madden which, presumably, was in Mr. Madden's
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
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.
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
for negotiation of the amount of the price adjustment.
Hynning went to
, 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.
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.
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.
, 112 Ct. Cls. 391.
thereupon paid $20,000 to SBA and $14,000 to IRS, thereby exhausting the
of conspiracy, deception, misrepresentation, and knavery, without which
plaintiffs cannot prevail, are not warranted by 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
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.
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
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'
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
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
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.
are not entitled to recover and their petition is dismissed.
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.
The specific agreement for a contingent fee of 30 percent of the
recovery was made 16 months later, in October 1960.
Interest charges for the year 1959 would have been of the order of
Payments on principal for the year 1959 would have been of the order of
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.
United States of America
, Intervener, Appellant, v. American Surety Company of
, et al., Appellees
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
has, pending appeal, received credit for the amount in dispute against a
claim by appellee surety's principal against the
under a contract. Dismissing the intervention before the District Court
for the Southern District of Florida, 46-1 USTC ¶9183
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
HUTCHESON, and WALLER, Circuit Judges.
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
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
is that what was deducted from the employees' wages is still unpaid
wages, the law having made the
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
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
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.
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
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
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.
¶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
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.
Julien, for plaintiff. J.
Attorney, for defendant.
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.
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.
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
12, 20; Calhoun v. Massie, 253
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.
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.
, 2 Cir., 188 Fed. (2d) 228; Malman v.
, 2 Cir., 207 Fed. (2d) 897.
¶9839]United States Fidelity & Guaranty Company, a corporation v.
United States of America
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
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.
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.
surety seeks judgment against the
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.
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
February 1, 1956
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
C. A. 1346(a)(2).
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.
, Ct. Cl., 97 Fed. Supp. 829; General Casualty Co. of America v.
United States, Ct. Cl., 127 Fed. Supp. 805; Malman v.
, 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
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.
against Lewis was made pursuant to sec. 6672, I. R. C. of 1954, 26 U. S.
C. A. 6672, which provides:
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."
section, 6671, provides:
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.
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
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
, 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
istrative penalties and are within the impeding statute just as much as
primary taxes." 140 Fed. (2d) at 240-241.
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
. 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.
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
C. A. 6671.
assessed against Lewis in the instant case is a civil penalty, an
istrative penalty; it is not a criminal penalty. Nugent v.
, 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
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
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.
be entered in favor of the defendant, with costs.
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
United States of America
, Plaintiff v.
Fidelity and Guaranty Company, Defendant
S. District Court, East.
, 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,
, for plaintiff. Moffatt, Thomas, Barrett & Blanton, 525 First
Security Bldg., Boise, Idaho, Myers, Reiley & Annis, 855 Lincoln
Bldg., Spokane, Wash., for defendant.
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:
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.
defaulted in the construction contract and refused to continue the work.
At that time the contractor owed the
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.
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.
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.
anomalous situation the taxing authority is the same as the contracting
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.
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).
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
* * 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.
¶9645]Trinity Universal Insurance Company and First National Bank in
Dallas, Appellants v.
United States of America
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
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,
ert H. Solomon, Department of Justice, Washington, D. C. 20530, for
WISDOM and GOLDBERG, Circuit Judges.
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
Building, Inc., the contractor, was awarded a contract for the
construction of a nuclear warfare laboratory at Kirtland Air Force Base,
, for the total sum of $1,008,889.36.
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
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
claim was rejected by the district court upon the authority of United
States v. Munsey Trust Co., 1947, 332
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:
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
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." 6Munsey did not disturb this rule, for as the Court noted in Pearlman:
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
at 140, 141.
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
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.
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
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
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.
Act of Aug. 24, 1935, c. 642; 49 Stat. 493; 49 U. S. C. A. 270a.
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.
3General 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.
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).
5United States v. Munsey Trust Co., 1947, 332
234; Pearlman v. Reliance Insurance Co., 1962, 371
See Prairie State Bank v.
, 1896, 164
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.
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.
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:
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
of Subrogative Rights of the Miller Act Payment Bond Surety,
71 Yale L. J. 1274, 1286.
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.
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
Bonding and Insurance Company and United States of
, Claimants-Appellants v. State of
, Claimant-Appellee In re Fago Construction Corporation, Bankrupt
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
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
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
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
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.
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,
Chief Judge, and SWAN and LUMBARD, Circuit Judges.
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
for unpaid withholding, social security, and unemployment taxes, claims
of the State of
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.
A petition for
adjudication of bankruptcy was filed against Fago Construction
March 31, 1949
, and it was adjudicated a bankrupt on the same day. Prior to
May 15, 1947
, the bankrupt had entered into a contract with the
for the construction of a flood control project at
, 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
for work on a
Proceeds to Go to Surety]
shows that in April 1948, the bankrupt informed the surety that it was
in trouble financially and needed the surety's assistance to proceed
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
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
. 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
for estimates on the
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
course of this arrangement the bankrupt, in breach of its agreement,
sought to collect a check from the
for some $41,000 due on the
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
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
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.
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
then set this sum off against a progress payment otherwise due to the
bankrupt on the
job, and a certificate releasing the lien was filed.
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
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
istration expenses and the
franchise taxes. The district court affirmed the referee with regard to
istration expenses and franchise taxes, but accorded third priority to
the tax claims of the
and the remaining tax claims of the State of
, and fourth priority to the surety's claims. From this judgment both
the surety and the
appeal. The surety argues in substance that the referee's decision was
was improperly afforded priority on its claim for franchise taxes and
is entitled to priority over
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
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
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
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
. 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.
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
, independent of any formal assignment. 1Prairie 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
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.
There a Default?]
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
. Both the State and the
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
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
on the contracts. After bankruptcy and after the
jobs were completed and accepted, the
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
nor the State of
have taken exception to payments, as well they could not, for, as we
have stated, the payments due from the
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
nor the State of
contends otherwise, that the $9,500 is a traceable portion of a payment
made by the
job. In fact if there was a contrary finding below we would have to
reverse it as clearly erroneous.
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
v. State Taxes]
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.
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
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).
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
47 [50-2 USTC ¶9492]; United States v. City of New Britain, 347
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
. 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].
Failure to Assert Claim]
IV. The second
aspect of the contest between the State of
involves the issue whether the
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
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
, 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
appended to its brief in this court the actual certificates of
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
on a "lien theory" never urged to the district court. United
States v. Bess, 357
1054 [58-2 USTC ¶9595]. Here we have such a situation; after careful
consideration it is evident to us that the
showed sufficient facts to warrant priority for its claim.
distribution of the bankrupt's assets, therefore, should proceed with
the payment of
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
and proceeding remanded for the entry of a decree as directed in this
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
C. §203, which are unnecessary to answer here.
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
552 [41-1 USTC ¶9322]; Trop v. Dulles, 356
86, reversing 2 Cir., 239 Fed. (2d) 527.
¶9198]In the Matter of Techcraft, Inc., Bankrupt
S. District Court, So. Dist. N. Y., Bankruptcy No. 90092, 177 FSupp 790,
[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
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,
, N. Y., for bankrupt. Alexander H. Rockmore,
570 Seventh Ave.
18, N. Y., for trustee.
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,
, urges that the Referee's order be confirmed.
for Taxes Against Debt Due Bankrupt]
a voluntary petition for arrangement, the bankrupt commenced performance
of a contract with the
. After filing, the contract, as modified, was completed by the bankrupt
as debtor in possession. A settlement of the amount due from the
was approved by the Court. Subsequently, the
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.
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].
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.
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
. 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.
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.
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
The order of
the Referee denying the relief requested for lack of jurisdiction is
reversed and the matter is returned for further proceedings not
United States of America
, Intervenor, Appellant v. Trinity Universal Insurance Company, Appellee
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.
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,
, for appellee.
HUTCHESON, Chief Judge, and TUTTLE and WISDOM, Circuit Judges.
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.
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.
authorities, particularly United States v. Munsey Trust Co., 332
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
We agree. If
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
, not having paid the contractor, seeks to assert, against the surety's
claim, its right of off-set against the contractor. In this situation,
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
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.
is reversed and the cause is remanded with directions.
"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:
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
Clerk of this Court is directed to deliver said check to the plaintiff's
attorneys 60 days after date of this judgment.
presented in due course, the intervenor,
United States of America
, is required to pay said check according to its tenor."
"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
(b) After the
completion of the work called for under said contract, the
United States of America
December 13, 1954
, issued Treasurer of the
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,
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.
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.
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
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.
(1) Whether the
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
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
¶9198]The United States National Bank of
, Plaintiff v. Hugh H. Earle, Collector of Internal Revenue of the
for the District of Oregon, Defendant
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
a necessary party to the action.
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.
Honorable GUS J. SOLOMON, Judge.
THE COURT: I
have an opinion here in the case of The United States National Bank of
, Plaintiff, versus Hugh H. Earle, Collector of Internal Revenue of the
for the District of Oregon, Civil No. 5764.
brought an action against Hugh H. Earle, the Collector of Internal
, to determine the ownership of certain moneys in the hands of the
Bonneville Power Administration and for an injunction to prevent his
The facts are
not in dispute and were stipulated to in the Pre-trial Order.
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,
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
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.
and Stone became indebted to the
for taxes in an amount in excess of $49,000.00, and notices of said tax
liens were filed with the
, 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
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
and Stone and such amount was thereafter paid by the Collector into the
Treasury of the
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
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
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,
is not a necessary party to this action. (New York Casualty v.
Right to Set-off]
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.)
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
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
shall prepare appropriate Findings of Fact, Conclusions of Law, and a
Judgment for the defendant in accordance with this oral opinion.
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:
is a national bank organized under the laws of the
with its principal place of business at
brings this action as assignee of
and Stone, a partnership which existed under the laws of the State of
at the times here material but has since been dissolved.
defendant was at all the times hereinafter mentioned Collector of
Internal Revenue for the District of Oregon and is a resident of the
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
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
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
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.
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.
plaintiff has failed to make out any cause of action, for legal or
equitable relief and its complaint should therefore be dismissed with
¶9371]South Side Bank & Trust Co., Plaintiff-Appellant v.
United States of America
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
Green, for plaintiff-appellant.
ert Tieken, Alexander O. Walter, John Peter Lulinski, for
Chief Judge, FINNEGAN and SCHNACKENBERG, Circuit Judges.
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.
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.
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
C. A. §1346(c), under which this suit is brought, expressly recognizes
jurisdiction conferred by this section includes jurisdiction of any set-off,
counterclaim, or other claim or demand whatever on the part of the
against any plaintiff commencing an action under this section."
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.
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
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.
from which an appeal has been taken is affirmed.
United States of America
, Plaintiff v. St. Johns Community Bank, Defendant
S. District Court, East. Dist.
, East. Div., No. 68 C 340(2), 302 FSupp 149,
[1954 Code Sec. 6323]
Tax liens: Priority: Set-off.--It would be inequitable to allow a
bank to defeat the lien of the
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.
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.
, for defendant.
was commenced on
July 29, 1968
, by the
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
C., §§ 1340 and 1345.
A notice of
federal tax lien was filed with the Recorder of Deeds,
St. Louis County
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
Debtor Owed Bank]
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
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
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
of Equitable Setoff]
maintains that the
is not entitled to this amount because under
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
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
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.
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.
Local Law Authority]
not reveal any court decisions involving
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
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
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
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
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).
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
v. Crow, 272 S. W. 1040 (Spr. Mo. App. 1925). This does not affect
the equities, however.]
all of these facts, it is not equitable to allow the defendant to defeat
the lien of the
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 of America
, Plaintiff v. First National Bank of
S. District Court,
, 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.
Smitherman, United States Attorney,
, 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
This is an
action brought by the
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
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
938, 78 S. Ct. 780 (1958), is controlling and requires judgment for the
. 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
C. §6323, intended to prohibit the Government from levying on that
which is plainly accessible to the delinquent taxpayer-depositor.
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
, 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
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.
In view of the
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.
shall forthwith prepare and submit to the Court for signature a form of
judgment in accordance herewith.
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
, in the sum of $1,765.21, plus interest at the rate of six per cent per
February 19, 1969
, until paid, together with costs and disbursements incurred.
United States of America
, Plaintiff v. Sierra Charter Corporation of
S. District Court, Cen. Dist. Calif., No. CV-79-876-MML,
[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
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.
, for defendant.
of Fact and Conclusions of Law
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:
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.
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
. Also involved in land development and land contracting was
Environmental Communities, Inc. (ECI), the taxpayer.
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.
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
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
October 25, 1974
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
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
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.
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
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
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
, supra, at 86.
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).
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.
in Favor of
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
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.
¶9429]Bank of America National Trust and Savings Association, a
national banking association, Defendant-Appellant v. United States of
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.
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,
MERRILL and BROWNING, Circuit Judges.
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
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.
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
938 (1958). We agree.
The bank seeks
to distinguish this case upon the ground that in Bank of
, 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,
Under Int. Rev. Code of 1954, §§ 6331 (Levy and Distraint) and 6332
(Surrender of Rpoperty Subject to Levy).
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].
, Appellant v.
United States of America
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
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.
Keefer, B. Mahlon Brown, Las
, 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.
STEPHENS, Chief Judge, LEMMON and HAMLEY, Circuit Judges.
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.
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
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:
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
, 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.
January 12, 1955
, a notice of tax lien pertaining to this assessment was filed with the
February 28, 1955
, and on
August 31, 1954
, the taxpayer submitted financial statements to the appellant. Each
statement read in part as follows:
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.]
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.
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
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.
June 10, 1955
, the taxpayer had on deposit in an account with the appellant "the
sum of not less than $878.16". At
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
will acknowledge receipt of your Notice of Levy against J. D. Bentley,
which was served on our Mr. Phillips at
p. m. today.
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."
"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
June 13, 1955
, a notice of Federal tax lien pertaining to the assessment of Federal
excise taxes was filed in the office of the
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.
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.
Court held that the appellee's "tax liens are paramount and valid
liens", and that the appellee was entitled to judgment as prayed
March 29, 1957
, the District Court handed down a judgment accordingly [57-1 USTC ¶9561].
April 5, 1957
, the Notice of Appeal was filed.
The Appellant's Contentions
appellant's argument may be summarized as follows:
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."
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.
The Applicable Statute
sections of the Internal Revenue Code of 1954 are the following:
Lien for taxes
any person liable to pay any tax neglects or refuses to pay the same
after demand, the amount (including any interest, additional amount,
addition to tax, or assessable penalty, together with any costs that may
accrue in addition thereto) shall be a lien in favor of the United
States upon all property and rights to property, whether real or
personal, belonging to such person.
Period of Lien
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.
Validity against mortgagees, pledgees, purchasers, and judgment
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--* * *
Levy and distraint
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. * * *
Surrender of property subject to levy
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."
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]
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.
States v. Security Trust & Savings Bank, Executor, 1950, 340 U.
S. 47, 49-50 [50-2 USTC ¶9492], the Court said:
effect of a lien in relation to a provision of federal law for the
collection of debts owing the
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
Again, in United
States v. Acri, 1955, 348
211, 213 [55-1 USTC ¶9138] the Supreme Court used the following
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
likewise has adhered to the Federal norm in evaluating a Federal tax
lien. In MacKenzie v.
, 9 Cir., 1940, 109 Fed. (2d) 540, 541 [40-1 USTC ¶9229], Judge
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
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
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
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.
, 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:
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
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
'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. . . .
arguendo that the State of
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.
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
. Therefore the rights of the State of
, with respect to the money accrued as rentals under the leases made
with the taxpayer are inferior to the tax liens of the
." [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.
first in time is the first in right" was declared to be the
determining principle by Mr. Justice Minton, in United States v.
, 1954, 347
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
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:
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.]
of the lengthy paragraph quoted supra from the financial
August 31, 1954
February 28, 1955
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!
of "relation back" cannot avail the appellant here. In the Security
Trust case, supra, 340
at pages 50-51, the Court used language quite apposite here:
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
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
are superior to the INCHOATE attachment lien of Morrison, . .
." [Italics supplied.]
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:
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.
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