Fidelity Bank, N. A. v. U.S.

• Decision Date: 22 April 1980
• Docket Number: No. 77-1972,77-1972
• Citation: 616 F.2d 1181
• Parties: 80-1 USTC P 9275 FIDELITY BANK, N. A., Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant, v. FIDELITY BANK, N. A., Defendant on Counterclaim-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1181

616 F.2d 1181

80-1 USTC P 9275

FIDELITY BANK, N. A., Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant, v. FIDELITY BANK, N. A., Defendant on Counterclaim-Appellee.

No. 77-1972.

United States Court of Appeals Tenth Circuit.

Argued March 15, 1979.

Decided March 6, 1980.

Rehearing Denied April 22, 1980.

Murray S. Horwitz, Atty., Washington, D. C. (M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews and Michael L. Paup, Attys., Dept. of Justice, Washington, D. C., with him on brief; Larry Patton, U. S. Atty., Oklahoma City, Okl., of counsel), for the United States.

Michael E. Krasnow, Oklahoma City, Okl., for Fidelity Bank, N.A.

Before SETH, Chief Judge, and BARRETT and LOGAN, Circuit Judges.

LOGAN, Circuit Judge.

CDI Homes, Inc., a construction company, failed to pay $36,150.42 in income and Federal Insurance Contribution Act (FICA) taxes it withheld from wages paid to its employees during the second quarter of 1973. The Commissioner assessed against Fidelity Bank, N.A., a lender to CDI, a penalty in the amount of one hundred percent of the withholding taxes owed by CDI, relying upon I.R.C. § 6672. Fidelity paid.$381.23 of the amount assessed and brought this refund suit. ¹ The government counterclaimed for the unpaid balance and also alleged that Fidelity was liable for a sum equal to the taxes under I.R.C. § 3505(b). The jury found in favor of Fidelity and against the government on the refund claim and the counterclaims. Following denial of the government's motion for judgment notwithstanding the verdict, the trial court awarded $3,303.75 in attorney's fees to Fidelity. This appeal ensued. ²

The questions argued here are (1) whether the government's motions for judgment n. o. v. were erroneously denied, (2) whether the trial court's instruction to the jury that the government bore the risk of nonpersuasion with respect to the section 6672 counterclaim was error, and (3) whether the trial court erred in awarding attorney's fees pursuant to 42 U.S.C. § 1988 without finding the government's action was in bad faith, frivolous, unreasonable or without foundation.

Viewing the facts and reasonable inferences drawn therefrom in a light most favorable to Fidelity, the record shows the following. Beginning in 1971, CDI built prefabricated homes for the Kiowa Housing Authority (KHA), which apparently is affiliated with the Department of Housing and Urban Development. This contract was acquired from another construction company, and pursuant to the acquisition agreement contract payments owed by KHA to CDI were sent directly to an escrow account maintained at Fidelity. Under the terms of the escrow contract, a certain portion of the funds received were distributed to the old construction company and other specified entities, and the balance was available to CDI.

In order to be able to perform the construction contract, CDI obtained from Fidelity a one million dollar revolving credit line. This loan was used by CDI for construction of a prefabrication plant and for general working capital. In conjunction with the extension of credit, CDI assigned to the bank the proceeds from the KHA construction contract, CDI's only source of income, and granted to the bank a security interest in all CDI's assets.

In January 1973 financial difficulties forced CDI to shut down its operations. At that time the bank requested financial information from the company and discovered the company had lost a substantial amount of money. After securing additional collateral, the bank agreed to provide the funds necessary for resuming operations. Since CDI had by that time exceeded the $1,000,000 line of credit, the bank allowed CDI to overdraw its account, but only when a sale of homes to KHA was imminent. From January 1973 until June 26, 1973, the CDI account was overdrawn in amounts generally of $60,000 to $80,000 and as much as $180,000.

The procedure followed for approving the overdrafts was as follows. An officer of CDI would contact Mickey Johnson, the bank officer in charge of monitoring the CDI account, apprise Johnson that a sale was forthcoming and that certain creditors must be paid to complete the transaction, and request that the bank extend sufficient credit by honoring checks drawn in excess of the credit line. CDI would then draft checks and when they came to the bank through normal banking channels, Johnson would examine each; if the payee appeared to be a bona fide CDI creditor connected with the KHA project, Johnson initialled the check, which was then honored. These additional extensions of credit, although made separately, were secured by the same security agreements and assignments of contract proceeds that applied to the original extension of credit. Until June 26, the bank honored all CDI checks.

In conjunction with the reopening of the plant in January, and at the bank's request, CDI closed its payroll account maintained in a bank in Anadarko, Oklahoma; thereafter all payroll checks were paid through the general account at Fidelity. Payroll checks paid through this account were easily identifiable; the word "payroll" was prominently printed on the upper left hand corner of the face of the check. These checks were for net wages only. CDI withheld income and FICA taxes and, because it had no other funds, depended on the bank to honor checks drawn in the amount of the withholdings and deposited with the bank.

During a part of the second quarter of 1973, officials at the bank thought CDI's financial situation would improve and CDI would be able to complete the contract on a profitable basis. But KHA did not continue to provide CDI with work orders sufficient to justify continued production. On June 26 the bank dishonored all CDI checks presented on June 25 through the normal banking channels. Among those checks was one for the taxes withheld from wages paid in April, the first month of the second quarter. Thereafter, the bank returned all CDI checks unprocessed, among them checks for taxes withheld from wages paid during May and June. On June 29 the bank shut the company down, foreclosing on its security interests, and began to liquidate the assets.

Thereafter, some homes built by CDI before its operations were shut down were sold to KHA. In connection with this transaction, KHA demanded that the bank honor payroll checks that had been dishonored during the second quarter. Had the bank refused to pay these wages, KHA would have paid them and would have sent to the bank the net proceeds, if any. Fidelity acceded, honoring some of those checks and issuing cashier's checks drawn by the bank for the remainder. Proceeds from the sale were used by the bank to reduce the overdraft status of CDI's account. Taxes withheld from these, as well as the prior payroll checks, were not paid, the only exception being those paid by the bank in order to initiate this refund suit.

I

To be held liable under I.R.C. § 3505(b) ³, Fidelity must have supplied funds for the specific purpose of paying wages and must have had actual knowledge that CDI did not intend to or would not be able to timely deposit or pay the income and FICA taxes required to be withheld from the wages of its employees. Notwithstanding the verdict of the jury, we believe the evidence conclusively establishes liability in this case.

The bank supplied funds for the specific purpose of paying wages by honoring payroll checks that were drawn in excess of the credit line. It is true, as the bank argues, that a lender making an ordinary working capital loan with knowledge that some funds may be used for payroll purposes does not violate section 3505(b). See Treas.Reg. § 31.3505-1(b)(3); S.Rep. No. 1708, 89th Cong., 2d Sess. (1966), reprinted in (1966) U.S.Code Cong. & Admin.News, pp. 3722, 3744. In this case, however, each check honored after the $1,000,000 lending limit was exceeded and the account was in an overdraft position constituted a separate loan. Each check was individually initialled and approved for payment by Mickey Johnson, the bank's loan officer; each payroll check prominently bore the notation "payroll" on its face and was known by the bank to be for the specific purpose of paying wages; and each was an overdraft. Although the overdrafts were secured by the agreements relating to the general credit line, the bank, through Mickey Johnson, see I.R.C. § 6323(i) (1), knew it was supplying funds specifically for wages. See United States v. Park Cities Bank & Trust Co., 481 F.2d 738 (5th Cir. 1973).

The bank had actual notice that CDI would not be able to make timely deposit or payment of the taxes due for the second quarter. At least after January 1973, when CDI's payroll account at Anadarko was closed and all creditors were paid from the general account with Fidelity, that bank had to know that without loans from it CDI would be unable to pay taxes due. All assets of CDI were pledged to the bank; but more importantly, the bank had control of all CDI's income. The KHA contract proceeds, CDI's only income, were sent directly to the bank, which applied them to the reduction of the company's indebtedness. Thus, every time the bank supplied funds for payment of wages it had to know it would be requested to supply the funds for paying the withholding taxes. This, we believe, fits well within the situations envisioned for application of section 3505(b).

It is thus clear that the trial court should have entered judgment in favor of the United States on this issue. Because section 3505(b) limits the penalty to 25% of the amount of funds supplied for payment of wages, however, further proceedings to determine the amount of the penalty recoverable by the government will be necessary before judgment in favor of the government can be entered.

II

The government also asserts that the evidence conclusively shows the bank to be liable under I.R.C. § 6672 ⁴ for the unpaid withholding taxes. Section 6672 imposes a one hundred...