Bankruptcy Newsletter

Court Lacked Jurisdiction Over Tax Liability Determination
A New York bankruptcy court lacked subject matter jurisdiction over a liquidating trustee's request for a determination that the Chapter 11 estate incurred no excise tax liability for selling its ownership interest in a corporation.

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A bankruptcy court lacked subject matter jurisdiction over a liquidating trustee's request for a determination that the Chapter 11 estate incurred no excise tax liability for selling its ownership interest in a corporation. The Bankruptcy Code's provision for a prompt determination of tax liability, 11 U.S.C.A. § 505, was not intended to obtain a determination of future tax consequences, the New York bankruptcy court concluded.

Under the confirmed Chapter 11 plan of a corporate debtor and several of its wholly-owned subsidiaries, the debtor's employee retirement plan was to be terminated. An alternate approach arose, however, under which, pursuant to a plan modification, the debtor transferred the sponsorship of the retirement plan to one of its subsidiaries, and the stock of the subsidiary was then sold. Neither the transfer of the plan's sponsorship nor the transfer of the subsidiary's stock was opposed by the United States, although the Internal Revenue Service (IRS) reserved its rights with respect to determining whether the retirement plan was a "qualified plan."

Under the confirmed plan, the liquidating trustee was authorized to request an expedited determination as to the tax liabilities of the liquidating trust under the Bankruptcy Code, pursuant to 11 U.S.C.A. § 505(b). The plan also provided for the bankruptcy court's retention of jurisdiction to determine matters under § 505. According to the liquidating trustee, the IRS did not object to the confirmation of the plan after being provided with a copy of it.

During the year following the sale transaction, the debtor filed an IRS form reporting a "zero" excise tax liability arising from the transaction, and also filed a request for a prompt determination as to whether the transaction had resulted in a reversion of plan assets under the Internal Revenue Code, 26 U.S.C.A. § 4980. Thereafter, the debtor filed its income tax return, which reported a tax liability that, according to the liquidating trustee, resulted primarily from the sale transaction. Again, the debtor filed a request for prompt determination, seeking an IRS determination as to whether the sale transaction resulted in a reversion of plan assets under the tax code.

The liquidating trustee then filed its motion in the bankruptcy court, pursuant to 11 U.S.C.A. § 505, for an order determining that the bankruptcy estate had incurred no excise tax liability due to the sale transaction. Since the case was filed before the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), the pre-BAPCPA version of the statute applied. The United States moved to dismiss for lack of jurisdiction, and the bankruptcy court made an initial determination that it could decide the jurisdictional question of whether the liquidating trustee's motion was within the scope of § 505.

As of the date of its hearing, the New York bankruptcy court noted, the IRS had not advised whether it agreed with either of the filings made by the debtor. The liquidating trustee voiced the concern that the issue would be "reopened" later by the IRS, and sought a determination that the debtor's reported excise tax and income tax liabilities were accurate, as reported to the IRS, so that he could make distributions of the proceeds from the sale transaction without establishing a reserve for taxes. The government opposed the liquidating trustee's motion on several grounds.

The United States first contended that § 505(b) did not apply to determinations sought by the trustee of a liquidating trust that was created under state law to carry out the provisions of a confirmed Chapter 11 plan under which all estate property was vested in the debtor and then transferred to the trust. The bankruptcy court rejected this argument, finding that the liquidating trustee had standing to file a motion pursuant to § 505 postconfirmation. The bankruptcy court emphasized that the confirmed plan expressly granted standing and relied upon a prior case, In re PT-1 Communications, Inc., 403 B.R. 250 (Bktcy.E.D.N.Y. 2009), which held that the Bankruptcy Code permitted a Chapter 11 plan to designate an estate representative to enforce a claim of the debtor or the estate and provide for the vesting of estate property in an entity other than the debtor.

The court thus turned to the issue of sovereign immunity. It explained that the filing of a proof of claim by a governmental entity waived sovereign immunity as to claims asserted by the debtor arising out of the same transaction. It concluded, however, that although the liquidating trustee contended that the IRS had filed a proof of claim, there was no showing that any proofs of claim filed on the IRS's behalf arose from the postconfirmation sale transaction. The court recognized that the Bankruptcy Code, in 11 U.S.C.A. § 106(a), expressly provided for the abrogation of sovereign immunity with respect to § 505. "The fact that sovereign immunity has been abrogated does not necessarily mean that the Court has jurisdiction to grant the requested relief, however," the court said.

The bankruptcy court construed the liquidating trustee's request for a determination that no excise tax liability was incurred by the bankruptcy estate in connection with the sale transaction as seeking an order declaring that there was no tax liability, as asserted on the form filed with the IRS. The court then noted that the Declaratory Judgment Act, 28 U.S.C.A. § 2201, permitted declaratory judgments to be entered only in cases involving actual controversies, and precluded declaratory judgments in actions involving taxes except those brought under certain statutes. These included § 505, the only exception possibly applicable in the case at bar. "Thus," the court said, "if Code § 505 does not govern the Liquidating Trustee's request in the Motion, then the Declaratory Judgment Act bars the Court from considering it."

The court thus turned to 11 U.S.C.A. § 505 and the question of its subject matter jurisdiction. It acknowledged that the statute, read literally, would provide for bankruptcy jurisdiction over any tax dispute, but noted prior cases recognizing limitations on a court's § 505 powers. It also recognized that subject matter jurisdiction could not be conferred by the parties' consent, or created through a confirmation order. In the case before it, the bankruptcy court explained, the potential tax liability as to which the liquidating trustee sought a determination did not exist when the debtor's petition was filed, and was not originally contemplated by the liquidating plan. Rather, the liquidating trustee was seeking to establish the tax consequences of a transaction that occurred postconfirmation. The fact that the court had approved the transaction, through a postconfirmation plan modification, did not confer subject matter jurisdiction.

The court concluded that it lacked jurisdiction under § 505(a) to declare that the bankruptcy estate did not incur excise tax liability in connection with the postconfirmation sale transaction. "The Court does not believe," it said, "that Congress intended that Code § 505 be used to determine tax liability arising after confirmation under these circumstances." The court pointed out that the IRS had taken no action at the time the liquidating trustee filed his motion, and had not expressed any disagreement with the reported liabilities. Instead, it simply sought to reserve its right to dispute those liabilities in the future. Therefore, the requisite actual controversy did not exist, and the court lacked authority to render an advisory opinion. Given this conclusion, the court continued, it also lacked jurisdiction to find that the liquidating trustee, the debtor, and the liquidating trust were discharged from any liability for the excise taxes under § 505(b). The court therefore denied the liquidating trustee's motion. In re Agway, Inc., 2009 WL 2857365 (Bkrtcy.N.D.N.Y., Judge Davis).

A contractor who obtained a judgment on his lien prior to the commencement of a Chapter 7 case by the homeowners for whom he had performed work was not barred by the automatic stay from recording his judgment postpetition to perfect the statutory contractor's lien to which he was entitled under Vermont law. As long as the contractor recorded his judgment within the five-month window set forth in a Vermont statute, its perfection would relate back as provided under Vermont law. However, in failing to record his judgment despite the fact that the stay did not apply, the contractor failed to "strictly adhere" to applicable statutory procedures under Vermont law, such that his lien expired. In re Cusson, 2009 WL 959965 (D.Vt., Judge Sessions).

Cement block that was sitting on the debtors' homestead land, but was not yet installed as a retaining wall necessary to prevent severe damage to the home, was a part of the debtors' exempt homestead. The fact that the block had not yet been moved into a place where it would clearly be a fixture was insufficient to distinguish the case from one in which the wall was constructed prepetition, but had to be disassembled to be moved to a more effective placement. In re Grucza, 2009 WL 2902083 (Bkrtcy.W.D.N.Y., Judge Kaplan).

For the "hanging paragraph" in 11 U.S.C.A. § 1325 to apply and preclude the "strip off" of a junior mortgage lien that was unsupported by any equity in a Chapter 13 debtor's residence, the junior mortgagee had to hold a purchase money security interest, no less than any creditor that provided financing within 910 days of the petition date to allow the debtor to acquire a motor vehicle for the debtor's personal use. The requirement that a creditor hold a purchase money security interest was equally applicable to both groups of creditors protected by the "hanging paragraph": those whose claims are secured by a motor vehicle that the debtor acquired for personal use, if the claim is for credit extended within 910 days of the petition date, and those whose claims are secured by "any other thing of value," if the claim is for debt incurred within one year of the petition date. In re Fernandez, 2009 WL 1372731 (Bkrtcy.D.N.J., Judge Ferguson).

A Chapter 7 debtor's attempts to avoided paying a judgment creditor by hiding and/or misrepresenting the value of his assets, including his manipulation of a substantial account receivable which was owed to him on the petition date by his closely-held corporation in belatedly attempting to reclassify this debt as equity, while passing along nearly all financial questions to his accountant and failing to explain any of the many serious questions about his financial dealings, were all sufficient reasons for denial of the debtor's discharge based on his fraudulent postpetition transfer, concealment or other disposition of property of the bankruptcy estate. The mere fact that a creditor had sought to deny the debtor a discharge based on his fraudulent prepetition transfer, concealment, or other disposition only of assets which he possessed prior to the petition date did not prevent the court from denying the debtor a discharge under 11 U.S.C.A. § 727(a)(2)(B) when the evidence showed that the alleged concealment occurred postpetition. In re Pearlman, 2009 WL 3047228 (Bkrtcy.D.R.I., Judge Votolato).