Chicago Mercantile Exchange v. U.S.

• Decision Date: 22 February 1988
• Docket Number: No. 87-1316,87-1316
• Parties: -781, 88-1 USTC P 9203 CHICAGO MERCANTILE EXCHANGE, Plaintiff, v. UNITED STATES of America, Defendant-Appellant, and GNP Commodities, Inc., Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1352

840 F.2d 1352

61 A.F.T.R.2d 88-781, 88-1 USTC P 9203

CHICAGO MERCANTILE EXCHANGE, Plaintiff, v. UNITED STATES of America, Defendant-Appellant and GNP Commodities, Inc., Defendant-Appellee.

No. 87-1316.

United States Court of Appeals Seventh Circuit.

Argued Nov. 4, 1987.

Decided Feb. 22, 1988.

Jane S. Kimball, Asst. Atty. Gen., Appellate Sec. Tax Div., Dept. of Justice, Roger M. Olsen and William S. Estabrook, Asst. Attys. Gen., Washington, D.C., for defendant-appellant.

Jerrold E. Salzman, Freeman, Freeman & Salzman, Kenneth F. Levin, Law Office of Kenneth F. Levin, Chtd., Chicago, Ill., for defendant-appellee.

Before CUDAHY and COFFEY, Circuit Judges, and NOLAND, Senior District Judge. ^*

CUDAHY, Circuit Judge.

Chicago Mercantile Exchange ("CME") brought this interpleader action under 28 U.S.C. Sec. 1335 (1982), naming as defendants the United States and GNP Commodities, Inc. ("GNP"). Bruce Yermack, a CME member, owed more than $274,000 in federal income taxes; he also owed GNP over $93,000 in CME exchange-related debt. CME holds $166,361.57 in proceeds from the involuntary sale of Yermack's seat on the exchange. CME instituted this action to resolve conflicting claims to the proceeds. The district court found for GNP, in an opinion reported at 650 F.Supp. 141 (N.D.Ill.1986). The government appeals. We affirm.

I.

The relevant facts are not in dispute. The Internal Revenue Service (the "IRS"), on October 9, 1985, served a Notice of Levy on CME, levying on all property or money in CME's possession belonging to Yermack. The IRS claimed a tax lien on Yermack's property up to $274,672.29, under 26 U.S.C. Sec. 6321 (1982). ¹

In addition to his federal tax liability, Yermack incurred a substantial debt to GNP. GNP was the clearing member of the exchange responsible for Yermack's trades. Among other responsibilities, "[i]n the event that an original party to a contract defaults on his obligation to answer margin calls or to make or take delivery, it is the duty of the clearing member to satisfy its customer's obligations." I P.M. Johnson, Commodities Regulation Sec. 1.31 (1982) (emphasis in original). Yermack owed GNP $93,670.57 in exchange-related debts.

GNP claims that CME rules grant it priority to the proceeds from the seat's sale. Yermack's property interest in the CME seat is determined by CME rules, approved by the Commodity Futures Trading Commission under the Commodity Exchange Act, 7 U.S.C. Secs. 1-24 (1982 & Supp.1986). CME Rule 100 states:

Membership in the Exchange is a personal privilege subject to purchase, sale, and transfer only as authorized and on the conditions prescribed herein. A member shall have no rights in or to the membership or the proceeds of the sale of such membership except as specifically granted herein.

Brief for Appellant at 6a. The exchange rules contain an elaborate transfer mechanism by which CME sells the membership and distributes the proceeds. See CME Rules 103-110, Brief for Appellant at 6a-16a. To begin voluntary or involuntary transfer of membership, the exchange first locates a prospective buyer, who must forward a check payable to the exchange. CME Rule 105, Brief for Appellant at 7a. The exchange must approve the transfer. See CME Rules 107-108, Brief for Appellant at 13a. If the transfer is approved, the exchange distributes the proceeds under CME Rule 110, Brief for Appellant at 14a-15a.

Rule 110 sets up a priority scheme for internal exchange claims. ² The seller is entitled only to the remainder, if any, of the proceeds after the internal claims are paid. Under CME rules, this remainder is the full extent of his property interest in the seat.

Thus, we are presented with a classic confrontation: two parties claim an interest in the same limited pot. GNP argues that Yermack had no interest in the proceeds to which the tax lien could attach until after Rule 110 claims were satisfied. The IRS, on the other hand, argues that since Yermack had some interest in the seat, the lien could attach to the entire proceeds and Rule 110 claimants are simply unperfected secured creditors whose claims are subordinate to the tax lien under 26 U.S.C. Sec. 6323 (1982). According to this argument, in order to prevail over a tax lien, Rule 110 creditors would have to file financing statements to perfect their "security interests" under local law. Further, the IRS argues that even if CME Rule 110 gives GNP's claim priority, that rule must give way to the paramount federal interest in collecting taxes. This argument is based on the premise that Rule 110 conflicts with the language or purposes of federal tax lien law.

The district court rejected the government's arguments, finding that Yermack's interest in the property was limited to the net proceeds after payment of Rule 110 claims and holding that the government's lien attached only to that remainder.

II.

The government's argument in this case has great surface appeal. It is axiomatic that section 6321 reaches "every interest in property that a taxpayer might have." United States v. National Bank of Commerce, 472 U.S. 713, 720, 105 S.Ct. 2919, 2924, 86 L.Ed.2d 565 (1985). It is also clear from the statute's face that a perfected tax lien has priority over a prior unperfected security interest. See 26 U.S.C. Sec. 6323 (1982); see also infra p. 1357 n. 5. We do not dispute these statements of the applicable law; however, they do not in themselves compel judgment for the government.

The government's position requires us to accept two propositions. First, we must find that the tax lien attached to the entire membership proceeds. Second, we must find that GNP's interest was an unperfected security interest in the seat. Careful analysis shows that neither proposition is true.

The initial question in this case is not whether an unperfected security interest prevails over a properly filed tax lien; rather the issue is whether Yermack, the taxpayer, had any interest in the proceeds. Section 6321 states that a tax lien attaches to "all property and rights to property, whether real or personal, belonging to [the taxpayer]." 26 U.S.C. Sec. 6321 (1982); see also supra p. 1353 n. 1. The lien attaches only to property "belonging to" the taxpayer.

The nature and extent of the taxpayer's property interest is a matter of state law. See National Bank of Commerce, 472 U.S. at 722, 105 S.Ct. at 2925; United States v. Rodgers, 461 U.S. 677, 683, 103 S.Ct. 2132, 2137, 76 L.Ed.2d 236 (1983); United States v. Bess, 357 U.S. 51, 55, 78 S.Ct. 1054, 1057, 2 L.Ed.2d 1135 (1958); see also Avco Delta Corp. Canada Ltd. v. United States, 459 F.2d 436, 440 (7th Cir.1972) ("a federal court must look to state law to determine the nature of the legal interest which the taxpayer had in the property sought to be reached"). As the Supreme Court explained in Bess, section 6321 "creates no property rights but merely attaches consequences, federally defined, to rights created under state law." Bess, 357 U.S. at 55, 78 S.Ct. at 1057; see also Rodgers, 461 U.S. at 683, 103 S.Ct. at 2137. In the case before us, we must look to the CME rules creating the property right to determine the attributes of that property.

The government urges us to hold that, because Yermack has an interest in some of the proceeds, a tax lien can attach to the entire amount. We reject that contention as inconsistent with the plain language of the statute and the Supreme Court's statements on the subject. Indeed, the Court has stated that "if [the statute] allowed for the gratuitous confiscation of one person's property interests in order to satisfy another person's tax indebtedness, such a provision might pose significant difficulties under the Due Process Clause of the Fifth Amendment." Rodgers, 461 U.S. at 697, 103 S.Ct. at 2144. The tax lien can attach to Yermack's interest in the membership proceeds, but to nothing beyond that interest.

III.

A more plausible government argument is that Yermack had an interest in the entire proceeds, so the tax lien could attach to the whole. Unfortunately for the IRS, the Supreme Court has consistently held that the seller of an exchange seat has only an interest in property subject to the exchange rules, including exchange priority rules. See Board of Trade v. Johnson, 264 U.S. 1, 12, 44 S.Ct. 232, 234, 68 L.Ed. 533 (1924); Hyde v. Woods, 94 U.S. (4 Otto) 523, 525, 24 L.Ed. 264 (1877); see also In re Sorkin, No. 86 B 1905, slip op. at 10 (Bankr.N.D.Ill. Nov. 26, 1986) (facts identical to this case).

The Hyde case is especially apposite and essentially controls the case before us. In Hyde, a trustee in bankruptcy tried to override an exchange rule identical in effect to CME Rule 110. ³ The Court upheld the rule, explaining that the debtor's rights in the seat were defined by the exchange rules:

A seat in this Board is not a matter of absolute purchase. Though we have said it is property, it is encumbered with conditions when purchased, without which it could not be obtained.... The rule entered into and became an incident of the property when it was created, and remains a part of it into whose hands soever it may come. As the creators of this right--this property--took nothing from any man's creditors when they created it, no wrong was done to any creditor by the imposition of this condition.

Hyde, 94 U.S. at 525. The rules of the exchange create the property and they govern its attributes. The Court reiterated this holding in the landmark Johnson case. See 264 U.S. at 12, 44 S.Ct. at 235 ("By operation of the bankruptcy law, the membership passes, subject to rules of the Exchange, to the trustee.") (emphasis added).

Both Hyde and Johnson arose in the bankruptcy context. Their property analysis is, however, in no way limited to that context and must apply with equal force in a tax lien context. ⁴ Both Hyde and Johnson found that the holder of an exchange seat holds that seat subject to the exchange rules, which define and limit...