Energy Resources Co., Inc., In re

• Decision Date: 02 November 1988
• Docket Number: Nos. 87-1896,88-1175,s. 87-1896
• Citation: 871 F.2d 223
• Parties: -1010, 57 USLW 2583, 89-1 USTC P 9249, 20 Collier Bankr.Cas.2d 1552, 19 Bankr.Ct.Dec. 226, Bankr. L. Rep. P 72,846, Unempl.Ins.Rep. CCH 14630A In re ENERGY RESOURCES CO., INC., Debtor. INTERNAL REVENUE SERVICE, Plaintiff, Appellant, v. ENERGY RESOURCES CO., INC., Defendant Appellee. In re NEWPORT OFFSHORE, LTD., Debtor. UNITED STATES of America, Plaintiff, Appellee, v. NEWPORT OFFSHORE, LTD., Defendant, Appellant. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 223

871 F.2d 223

63 A.F.T.R.2d 89-1010, 57 USLW 2583, 89-1

USTC P 9249,

20 Collier Bankr.Cas.2d 1552, 19 Bankr.Ct.Dec. 226,

Bankr. L. Rep. P 72,846,

Unempl.Ins.Rep. CCH 14630A

In re ENERGY RESOURCES CO., INC., Debtor.

INTERNAL REVENUE SERVICE, Plaintiff, Appellant, v. ENERGY RESOURCES CO., INC., Defendant Appellee.

In re NEWPORT OFFSHORE, LTD., Debtor.

UNITED STATES of America, Plaintiff, Appellee, v. NEWPORT OFFSHORE, LTD., Defendant, Appellant.

Nos. 87-1896, 88-1175.

United States Court of Appeals, First Circuit.

Heard Nov. 2, 1988.

Decided March 31, 1989.

Gary D. Gray, Tax Div., Dept. of Justice, Washington, D.C., with whom William S. Rose, Jr., Asst. Atty. Gen., Frank L. McNamara, Jr., U.S. Atty., Boston, Mass., Gary R. Allen and Wynette J. Hewett, Tax Div., Dept. of Justice, Washington, D.C., were on brief for I.R.S.

Guy B. Moss with whom Widett, Slater & Goldman, P.C., Boston, Mass., was on brief, for Energy Resources Co., Inc.

Matthew J. McGowan with whom Salter, McGowan, Swartz & Holden, Incorporated, Providence, R.I., were on brief, for Newport Offshore, Ltd.

Gary D. Gray, Tax Div., Dept. of Justice, Washington, D.C., with whom William S. Rose, Asst. Atty. Gen., Lincoln C. Almond, U.S. Atty., Providence, R.I., Gary R. Allen and Wynette J. Hewett, Tax Div., Dept. of Justice, Washington, D.C., were on brief, for U.S.

Before BOWNES and BREYER, Circuit Judges, and CAFFREY, ^* Senior District Judge.

BREYER, Circuit Judge.

The Internal Revenue Code requires employers to withhold from their employees' paychecks money representing employees' personal income taxes, unemployment insurance and social security taxes that those employees owe or will owe the government. 26 U.S.C. Secs. 3102(a), 3402(a) (1982). Because federal law requires employers to hold these funds in "trust for the United States," 26 U.S.C. Sec. 7501(a) (1982), these taxes are commonly referred to as "trust fund" taxes. Slodov v. United States, 436 U.S. 238, 242-43, 98 S.Ct. 1778, 1783, 56 L.Ed.2d 251 (1978). And, should employers fail to pay them, the government can collect an equivalent sum directly from the officers or employees of the employer who are responsible for their collection and payment. 26 U.S.C. Sec. 6672 (1982). These individuals are commonly referred to as "responsible" individuals. Slodov, 436 U.S. at 244 n. 5, 98 S.Ct. at 1784 n. 5. An employer, of course, may also fail to pay the government its ordinary corporate income tax or other "non-trust fund" taxes (i.e., taxes owed directly by the corporation and not withheld or collected from third parties).

These two cases involve corporations in Chapter 11 bankruptcy reorganizations. Each corporation owes the government both trust fund and ordinary (non-trust fund) taxes. In each instance, the reorganization plan says that the corporation must satisfy its total tax debt to the government by making partial payments each year for several years. In each instance, the bankruptcy judge specified that, as the reorganized corporation paid off its tax debts, the government should treat the payments as satisfying the corporation's trust fund tax debts first; only after it received enough money to satisfy all trust fund debts may the government apply the money received to the corporation's non-trust fund tax debts. This order of payment helps the "responsible" individuals associated with the corporation, for it diminishes the likelihood that they will end up having personally to pay the "trust fund" tax debts that the corporation owes. That fact also means that the government may find it harder to collect the entire tax debt (trust fund and non-trust fund). If, for example, the reorganized corporation were to run out of money a few years from now and "trust fund" debts were still owed, the government might collect them from "responsible" individuals. But, if all "trust fund" debts have been paid, and if the only debts are for, say, ordinary corporate income taxes, the government will be out of luck, for there are no personal guarantors of payment of a corporation's ordinary tax liabilities.

The IRS has appealed these two bankruptcy court decisions. It wants to apply the debtors' payments to the ordinary, non-trust fund, tax debts first. It argues that it is entitled to do so because payments pursuant to a Chapter 11 reorganization plan are "involuntary " payments; and under a longstanding IRS policy, backed by caselaw authority, the IRS may designate the allocation of "involuntary" payments among a firm's various tax debts as the IRS sees fit. The IRS adds that to allocate Chapter 11 tax payments to "trust fund" tax debts will frustrate the congressional policy underlying Section 6672 of the Internal Revenue Code, 26 U.S.C. Sec. 6672 (1982), which holds "responsible" individuals personally liable for a corporation's "trust fund" tax debts. In Energy Resources, the district court rejected these arguments and affirmed the bankruptcy court's allocation of payments to "trust fund" debts first; in Newport Offshore the district court accepted these arguments and reversed the bankruptcy court's order for payment of "trust fund" tax debts first.

The basic legal question that these two cases raise on appeal is whether the bankruptcy court has the legal authority to order the government to apply the tax payments made by the reorganized corporation to the corporation's "trust fund" debts first. We conclude that the bankruptcy court does possess that legal power, regardless of whether the payments are characterized as "voluntary" or "involuntary." Our result is consistent with that of the Eleventh Circuit in In re A & B Heating & Air Conditioning, Inc., 823 F.2d 462 (11th Cir.1987), vacated and remanded for consideration of mootness, --- U.S. ----, 108 S.Ct. 1724, 100 L.Ed.2d 189 (1988). Our result is not consistent with that reached by the Third Circuit in In re Ribs-R-Us, Inc., 828 F.2d 199 (3rd Cir.1987) (tax payments made pursuant to a Chapter 11 reorganization are per se "involuntary" and "no provision of the Bankruptcy Code allows either the debtor or the bankruptcy court to direct" the allocation of such payments). Two other circuits have followed the Third Circuit. In re DuCharmes & Co., 852 F.2d 194 (6th Cir.1988) (per curium); In re Technical Knockout Graphics, Inc., 833 F.2d 797 (9th Cir.1987).

I. Background

The first case before us concerns a Chapter 11 debtor called Newport Offshore, Ltd. Newport Offshore failed to pay the government employee social security and unemployment withholding taxes ("trust fund" taxes) in 1985; it owes the government some ordinary, non-trust fund, taxes as well. On November 13, 1985, Newport Offshore filed a petition for reorganization under Chapter 11 of the Bankruptcy Act, 11 U.S.C. Secs. 101-1330 (1982). In June 1986, the bankruptcy court appointed a trustee to run Newport Offshore's business. See 11 U.S.C. Sec. 1104 (1982 & Supp. IV 1986). Subsequently, Allied Marine Associates, a Rhode Island partnership, agreed to pay all Newport Offshore's prepetition tax liability, to pay various other debts, and to invest additional money in the corporation; in return, it would receive 85 percent of the shares of the new, reorganized Newport Offshore. The reorganization plan provided that the reorganized Newport Offshore would pay its tax debts (totaling about $300,000) over a period of about six years and that the money would be applied to extinguish all "trust fund" tax debts "prior to the commencement of payment of the non-trust fund portion" of the tax debts owed. The IRS objected to the plan's tax debt payment designation provision. The bankruptcy judge, after hearing the IRS's objections, approved the plan. The IRS appealed to the district court, which reversed, following the Third Circuit in Rib-R-Us, supra. The debtor now appeals that decision here.

The second case involves a debtor called Energy Resources Co., Inc. In January 1983, the debtor petitioned for reorganization under Chapter 11. In September 1984 the bankruptcy court confirmed a reorganization plan under which all of Energy Resources' assets, except those of its Environmental Division, would be placed in a special trust (called the ERCO Liquidation Trust) to pay debts owed, including about $1,000,000 in federal taxes, most of which were trust fund taxes. The ERCO Liquidation Trust was to pay the tax debt over a period of about five years. The plan also provided that a reorganized Energy Resources, Inc. would, upon merging with an independent company, continue to operate under the name Enseco, Inc. In November 1985 the trustee of ERCO Liquidation Trust sent checks to the IRS for about $280,000, which represented the scheduled payment and $78,000 in additional payments. The trustee asked the IRS to apply the money to Energy Resources' "trust fund" tax debt. The IRS refused to accept the trustee's designation. The trustee then asked the bankruptcy court to order the IRS to apply the money to the "trust fund" tax liabilities. After hearing argument, the bankruptcy court held that tax payments made pursuant to a Chapter 11 reorganization are "voluntary" payments, and it "ordered" the IRS "to apply tax payments under the Plan as designated by the Trustee." The IRS appealed this order to the District Court, which affirmed the bankruptcy court. The IRS now appeals that decision.

II. The Law

In our view, these cases require us to answer two legal questions. The first legal question concerns the scope of IRS policy. It is whether a payment made pursuant to a Chapter 11 reorganization plan is "voluntary" or "involuntary," as IRS rules and regulations use these terms. Our answer to that question is similar to that of the Third Circuit. We believe that the law permits the IRS to call tax payments within a Chapter 11 reorganization "involuntary," for purposes of applying its own regulations. We reach a result that differs from the Third Circuit, however, because we believe we must ask a...