Cross Elec. Co., Inc. v. United States, Civ. A. No. 7-80-01033.

• Citation: 11 BR 998
• Decision Date: 13 November 1980
• Docket Number: Civ. A. No. 7-80-01033.
• Parties: CROSS ELECTRIC COMPANY, INC., Plaintiff, v. UNITED STATES of America (Appellant) et al., Defendants.
• Court: U.S. District Court — Western District of Virginia

11 B.R. 998 (1980)

CROSS ELECTRIC COMPANY, INC., Plaintiff, v. UNITED STATES of America (Appellant) et al., Defendants.

Civ. A. No. 7-80-01033.

United States District Court, W.D. Virginia, Roanoke Division.

November 13, 1980.

M. Lanier Woodrum, Roanoke, Va., for plaintiff.

Thomas R. King, Jr., Asst. U.S. Atty., Olin R. Melchionna, Roanoke, Va., for defendants.

TURK, Chief Judge.

Defendants are appealing the order of the bankruptcy judge in a Chapter 11 bankruptcy proceeding. Plaintiff, Cross Electric Company, Inc. (Cross) is the Chapter 11 debtor. Cross has an account receivable due from defendant James D. Fralin, d/b/a J.H. Fralin & Sons (Fralin). The Internal Revenue Service (IRS) served a notice of levy on Fralin for the account receivable before the Chapter 11 proceeding was instituted by Cross. In the bankruptcy court, the judge held that the account receivable which was subjected to an IRS levy before the bankruptcy suit was commenced ought to be considered as property of the debtor's estate. Therefore, after ensuring that the interests of the IRS were adequately protected, the court ordered Fralin to turn over the funds to the debtor's estate. The order of the bankruptcy judge is affirmed.

Several times during 1978, 1979 and 1980 the IRS filed liens against Cross, pursuant to 26 U.S.C. § 6321, for unpaid withholding and Federal Insurance Contributions Act (FICA) taxes. By June 30, 1980, Cross owed the IRS $43,297.15. On August 21, 1980, the IRS used its power under 26 U.S.C. § 6331 to levy against the funds held by Fralin for Cross. Cross filed a Chapter 11 petition with the bankruptcy court on September 18, 1980. The exact amount that Fralin owes is in dispute. Fralin acknowledges that it owes $5,672.75 to Cross. According to Cross, the sum is closer to $10,000.00.

Cross states that without these funds it will not have sufficient liquid capital to pay the wages and operating costs for the continuation of its current projects. If these debts cannot be paid, Cross would be forced to abandon its current projects and go through the liquidation procedures of the Bankruptcy Code. Cross is unable to secure third party financing to get the necessary liquid capital because the IRS liens on all of Cross' assets preclude Cross from offering security for such financing. Cross urges this court to find that, at least to a limited extent, the fund is property of the estate and should be turned over pursuant to 11 U.S.C. § 542 so that it can be used by Cross for its own benefit.

The IRS claims that as of the date of the levy, it has full legal right to the funds. Although the IRS concedes that Cross still has some limited interest in the funds, it states that because it owns the fund it can't be forced to turn over the fund to Cross. Basically, the IRS wants this court to find that the IRS has a very strong interest in this property and that Cross has a very weak interest. Further, because Cross' interest is so weak, the property ought not to be considered property of the estate under 11 U.S.C. § 541.

Before the new Bankruptcy Code (Code) was enacted, there always arose in cases such as this, the issue of whether or not the bankruptcy court had jurisdiction to hear the suit. Congress has enacted 28 U.S.C. § 1471 which makes it clear that the bankruptcy court has jurisdiction to hear cases of this sort. The role of this court is to sit as an appellate court to review the decisions of the bankruptcy judge. Unless it appears that there was no basis in the evidence for the factual findings, or that there was an erroneous conclusion of law, the decisions of the bankruptcy judge will not be disturbed. Stein v. Hemker (In re Embassy Co.), 157 F.2d 740 (8th Cir. 1946).

The purpose of Chapter 11 proceedings is to provide an arrangement in which a company has the opportunity to rehabilitate its business operations and to become a profit making company despite its past financial difficulties. Citicorp Business Credit, Inc. v. Blazon Flexible Flyer, Inc., (In re Blazon Flexible Flyer, Inc.), 407 F.Supp. 861 (N.D. Ohio 1976). There is a strong public policy which favors rehabilitation of failing concerns to make them viable contributors to society once again, rather than liquidating the companies quickly to turn over a reduced sum to all creditors. In re Aurora Cord and Cable Company, 2 B.R. 342, 5 B.C.D. 1310 (Bkrtcy.N.D.Ill.1980). Under the rehabilitative plan which is approved by the court, the debtor can, hopefully, pay off all of its creditors in full and continue to be an asset to the community.

To provide a business with an adequate start on its rehabilitative plan, it is necessary to include in the debtor's estate all property in which the debtor has an interest. With all of the property at hand, the trustee can make a coherent evaluation of the situation and logically make use of or dispose of all of the debtor's property. H.R. Rep.No. 95-595, 95th Cong., 1st Sess. 176 (1978), U.S.Code Cong. & Admin.News 1978, p. 5787. The Code recognizes this point and provides in 11 U.S.C. §§ 541-2 for all property of the debtor to come into the estate. Section 541 of 11 U.S.C. is all embracing and requires that all legal or equitable interests, tangible or intangible property, or beneficial rights and interests that the debtor has in the property of another be included in the estate. 4 Collier on Bankruptcy ¶ 541.01 (15th ed. 1980). The underlying theory of 11 U.S.C. § 541(a)(1) is to bring into the estate all interests of the debtor in property as of the date the case is commenced. 4 Collier on Bankruptcy ¶ 541.06 (15th ed. 1980) (emphasis supplied). There is no balancing test involved. Those creditors who hold a significantly greater interest in a particular item cannot automatically have the item excluded from the estate if the debtor still retains some interest in it. Troy Industrial Catering Service v. Michigan (In re Troy Industrial Catering Service), 2 B.R. 521, 525 (Bkrtcy.E.D.Mich. 1980).

Although 11 U.S.C. § 541 encompasses all property rights of the debtor, it does not provide for an expansion of the debtor's rights. The trustee will receive no more interest in the property than the debtor had at the commencement of the case. To the extent an interest is limited in the hands of the debtor, it is similarly limited in the hands of the trustee. 4 Collier on Bankruptcy ¶ 541.01 (15th ed. 1980).

To determine how to apply the provisions of 11 U.S.C. § 541 it is necessary, of course, to define what is "property of the estate." Although the answer to this question is guided by the federal standards of the Bankruptcy Code, we must look to the Internal Revenue Code in this case to determine the nature and extent of the debtor's rights. 4 Collier on Bankruptcy ¶ 541.01 (15th ed. 1980). Two sections of the Internal Revenue Code are particularly pertinent here. Under 26 U.S.C. § 6321, the IRS can attach a lien to all property and rights to property of the debtor. A levy on specific property is allowed pursuant to 26 U.S.C. § 6331 after the lien has attached. It is the effect of this levy that is at issue in this case.

The IRS claims that the levy transferred all property rights in the account receivable to the IRS. The authority which the IRS heavily relies on is Phelps v. United States, 421 U.S. 330, 95 S.Ct. 1728, 44 L.Ed.2d 201 (1975) (Phelps). Phelps dealt with the issue of the bankruptcy court's summary jurisdiction powers. The court held that when an assignee for the benefit of creditors is holding funds which belong to the creditors, but which have been subjected to an IRS levy before the bankruptcy case was commenced, the bankruptcy court lacks jurisdiction to summarily adjudicate the controversy. At 337, 95 S.Ct. at 1732, Phelps states, "The levy, therefore, gave the United States full legal right to the $38,000 levied upon as against the claim of the petitioner receiver." The IRS bases its case on this statement. The argument the IRS makes is that because a pre-bankruptcy levy transfers full legal right in the property to the United States, no property rights of significance are left for the debtor to include in his estate under 11 U.S.C. § 541. Therefore, turnover of the fund is not warranted.

The sentence from Phelps quoted above which speaks of the transfer of full legal rights is followed in the very next paragraph by the last sentence of the case which states, "Here the assignee held as custodian for the United States, a bona fide adverse claimant." Phelps at 337, 95 S.Ct. at 1732. It is inconsistent for a party to hold full legal rights yet only be classified as an adverse claimant. The Phelps case dealt mainly with the jurisdictional powers of the bankruptcy court. At best, its statement regarding the transfer of full legal rights can be considered dicta.

That a levy does not transfer full legal rights in property to the IRS is clear from the cases which purport to follow and support Phelps. In the case of In re Pittsburgh Penguins Partners, 598 F.2d 1299 (3rd Cir. 1979) (Pittsburgh Penguins) the court specifically states that the crucial quote from Phelps is dicta and that the levy only gives the government a substantial adverse claim of ownership. Pittsburgh Penguins is, like Phelps, a case which dealt with the summary jurisdiction power of the bankruptcy court. It held that the bankruptcy court did not have the jurisdiction to summarily decide cases dealing with pre-bankruptcy petition levies. That Phelps did not authoritatively rule on post-levy ownership rights is clear from the statement of the Pittsburgh Penguins court at 1302 that "We need not decide, therefore, the further question whether the levy was effective to transfer full title to the assets to the United States." The reliance of the IRS on Pittsburgh Penguins is misplaced because that case dealt only with the jurisdictional question and expressly refused to decide the issue of the effect of the levy on ownership rights.

Another...