Graham, In re

• Decision Date: 22 September 1992
• Docket Number: No. 91-1980,91-1980
• Citation: 973 F.2d 1089
• Parties: -5580, 61 USLW 2187, 92-2 USTC P 50,447, 27 Collier Bankr.Cas.2d 984, 23 Bankr.Ct.Dec. 641, Bankr. L. Rep. P 74,821 In re Thomas A. GRAHAM; Elizabeth M. Graham, Debtors. Thomas A. GRAHAM; Elizabeth M. Graham v. INTERNAL REVENUE SERVICE; James J. O'Connell, Trustee, United States of America, on behalf of its agency, Internal Revenue Service, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 1089

973 F.2d 1089

70 A.F.T.R.2d 92-5580, 61 USLW 2187,

92-2 USTC P 50,447,

27 Collier Bankr.Cas.2d 984, 23 Bankr.Ct.Dec. 641,

Bankr. L. Rep. P 74,821

In re Thomas A. GRAHAM; Elizabeth M. Graham, Debtors Thomas A. GRAHAM; Elizabeth M. Graham v. INTERNAL REVENUE SERVICE; James J. O'Connell, Trustee United States of America, on behalf of its agency, Internal Revenue Service, Appellant.

No. 91-1980.

United States Court of Appeals Third Circuit.

Argued May 19, 1992.

Decided Aug. 24, 1992.

Rehearing Denied Sept. 22, 1992.

Michael M. Baylson, U.S. Atty., Philadelphia, Pa., and Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, William S. Estabrook, and Bridget M. Rowan (argued), U.S. Dept. of Justice, Tax Div., Washington, D.C., for appellant.

Spencer Ervin, Jr. (argued) and Maria Frigoletto, Gratz, Tate, Spiegel, Ervin & Ruthrauff, Philadelphia, Pa., for Thomas Graham.

PRESENT: HUTCHINSON, COWEN and GARTH, Circuit Judges.

OPINION OF THE COURT

HUTCHINSON, Circuit Judge.

The Internal Revenue Service (IRS) appeals a district court order affirming a bankruptcy court decision discharging Thomas and Elizabeth Graham (the Grahams) from liability for federal income taxes and a concomitant fraud penalty. IRS contends that an earlier final judgment of the United States Tax Court holding the Grahams liable for income tax deficiencies resulting from fraudulent tax returns, a circumstance which would preclude discharge, is controlling on the discharge issue. According to IRS, the Tax Court judgment requires reversal of the discharge order entered in the bankruptcy proceeding under either claim (res judicata) or issue preclusion (collateral estoppel). Alternately, IRS argues that this case must be remanded to the bankruptcy court for a new trial because that court incorrectly required IRS to establish its right to a fraud penalty by clear and convincing evidence, instead of by a mere preponderance. We will reject IRS's preclusion arguments, accept its argument on burden of proof and vacate the judgment of the district court and direct it to remand the case to the bankruptcy court for a new trial.

I.

Thomas Graham was the President, majority stockholder and Chief Operating Officer of Meridian Engineering, Incorporated (Meridian) in 1971 when Meridian was implicated in a federal grand jury investigation concerning violations of federal law in connection with contracts between private companies and the City of Philadelphia. See Graham v. Commissioner, 770 F.2d 381, 382-83 (3d Cir.1985). In 1974, Graham testified before the grand jury under a grant of immunity. Id. at 383. In connection with this testimony, Graham's bank account records for 1969 through 1973 and other personal records were subpoenaed by the government. Id. With the district court's permission, IRS agents were allowed to use information gleaned from the subpoenaed materials for civil matters. See id. at 382-83.

On February 20, 1980, IRS sent the Grahams a notice of income tax deficiencies for the years 1969 through 1972. Id. at 383. IRS determined that during those years, Meridian paid a substantial amount of Thomas Graham's expenses that should have been, but were not, reported as dividends from the corporation. Id. IRS added fraud penalties and interest pursuant to 26 U.S.C.A. § 6653(b) (West 1989) ¹ to the resulting tax deficiency.

The Grahams challenged the deficiency in the Tax Court, arguing that IRS improperly used documents from the grand jury proceedings. Id. The parties entered into a stipulation there which read, in part:

Petitioners Thomas A. Graham and Elizabeth Graham agree that if it is finally determined that the notice of deficiency issued to them for the years in issue is not invalid[,] the deficiencies in income tax and additions to tax determined therein, although not admitted, are uncontested so that decision may be entered in accordance with respondent's determinations contained in the statutory notice of deficiency ... without the necessity for the introduction of any evidence by petitioners or respondent.

Graham v. Commissioner, 82 T.C. 299, 305 (1984) (emphasis added). ² The Tax Court determined that even if the documents in question were improperly obtained, the statutory notice of deficiency was still valid and, in accordance with the stipulation, entered judgment in favor of the Commissioner for the taxes and the fraud penalties. Id. at 310-11. We affirmed. Graham, 770 F.2d at 386.

II.

On June 23, 1987, the Grahams petitioned for relief under Chapter 11 of the Bankruptcy Code, see 11 U.S.C.A. §§ 1101-74 (West 1979 & Supp.1992). IRS filed a claim for unpaid income taxes and fraud penalties it said the Grahams owed for the years 1969 through 1975, 1984 and 1985. According to IRS, the Grahams owed it a total of $711,801.52. The Grahams contested IRS's claim by filing an adversary proceeding in the bankruptcy court in which they sought a discharge from liability for the amount claimed by IRS.

IRS moved for partial summary judgment, asserting that the Grahams' discharge request was barred under principles of claim and issue preclusion because of the prior Tax Court judgment against them. Because the Tax Court judgment included fraud penalties, IRS contended that both the taxes and penalties claimed from the Grahams automatically fell under 11 U.S.C.A. § 523(a)(1)(C) (West 1979 & Supp.1992) which excepts from discharge in bankruptcy taxes owed and penalties accrued as a result of a fraudulently filed tax return. The United States Bankruptcy Court for the Eastern District of Pennsylvania denied IRS's motion, see In re Graham, 94 B.R. 386, 391 (Bankr.E.D.Pa.1988), and the case proceeded to trial. ³ On December 14, 1989, after a hearing on the dischargeability issue, the bankruptcy court entered an order holding that the taxes were dischargeable. See In re Graham, 108 B.R. 498, 505 (Bankr.E.D.Pa.1989). In so deciding the bankruptcy court held that claim preclusion did not apply in bankruptcy proceedings for discharge, id. at 501, and that issue preclusion did not apply because the issue of fraud was not actually litigated in the Tax Court, id. at 500. Finally, the bankruptcy court held that IRS had the burden of proving by clear and convincing evidence that the Grahams had fraudulently underreported their income and had failed to meet that burden. Id. at 501, 505.

IRS filed a timely appeal from the bankruptcy court's decision. After initial briefing before the United States District Court for the Eastern District of Pennsylvania, IRS filed a supplemental brief in which it argued that it was not required to prove fraud in the bankruptcy court by clear and convincing evidence under the holding of the Supreme Court of the United States in Grogan v. Garner, --- U.S. ----, ----, 111 S.Ct. 654, 661, 112 L.Ed.2d 755 (1991), an intervening decision decided January 15, 1991. There the Supreme Court held that the preponderance standard applies to all exceptions to discharge under 11 U.S.C.A. § 523(a). Id.; see In re Graham, 131 B.R. 275, 281 (E.D.Pa.1991). On August 23, 1991, the district court issued an order affirming the bankruptcy court. In the accompanying opinion it agreed with the bankruptcy court that neither claim nor issue preclusion applies to discharge proceedings and also held that Chevron Oil Co. v. Huson, 404 U.S. 97, 92 S.Ct. 349, 30 L.Ed.2d 296 (1971), precluded Grogan's retroactive application. Graham, 131 B.R. at 278-83.

Under Federal Rule of Appellate Procedure 4(a)(1), IRS would normally have had sixty days to file its notice of appeal, a period that would have run on October 22, 1991. Here, however, the IRS did not receive notice of the district court's decision until October 4, 1991 and requested an extension of time within which to file a notice of appeal pursuant to Federal Rule of Appellate Procedure 4(a)(5). Having received no objection from the Grahams, the district court granted IRS an extension until November 21, 1991 to file its notice of appeal. IRS filed its notice of appeal on the last day of the extension.

III.

We have appellate jurisdiction over the final decision of the district court under 28 U.S.C.A. § 158(d) (West Supp.1992). The district court had jurisdiction to hear the appeal from the bankruptcy court by virtue of 28 U.S.C.A. § 158(a) (West Supp.1992). The bankruptcy court had subject-matter jurisdiction over the Grahams' adversary proceeding. See 28 U.S.C.A. § 157(b) (West Supp.1992).

Our review of the two preclusion issues is plenary. See Rider v. Pennsylvania, 850 F.2d 982, 988-95 (3d Cir.), cert. denied, 488 U.S. 993, 109 S.Ct. 556, 102 L.Ed.2d 582 (1988). Our review of the retroactivity question is also plenary. See James B. Beam Distilling Co. v. Georgia, --- U.S. ----, ----, ---- - ----, 111 S.Ct. 2439, 2443, 2446-47, 115 L.Ed.2d 481 (1991).

IV.

Since the resolution of either of the preclusion issues in IRS's favor would require a reversal, we address them first.

A.

Both the bankruptcy court, see In re Graham, 108 B.R. at 501, and the district court, see In re Graham, 131 B.R. at 278-79 & n. 5, held that claim preclusion (res judicata) did not apply in dischargeability proceedings in bankruptcy. Both courts cited to Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979) without discussion. Claim preclusion applies to claims that "were or could have been raised" in a prior action involving the "parties or their privies" when the prior action had been resolved by "a final judgment on the merits." Allen v. McCurry, 449 U.S. 90, 94, 101 S.Ct. 411, 414, 66 L.Ed.2d 308 (1980). Claim preclusion thus bars relitigation of any claim that could have been raised in the prior action even if it was not so raised.

The key dispute between IRS and the Grahams over claim preclusion is whether Felsen applies and if it does, whether it completely eliminates claim preclusion as a defense to the Grahams' adversary proceeding in this case. In Felsen, Brown guaranteed a bank...