H & H Beverage Distributors v. Department of Revenue of Com. of Pa.

• Decision Date: 19 July 1988
• Docket Number: No. 87-1695,87-1695
• Court: U.S. Court of Appeals — Third Circuit
• Parties: , Bankr. L. Rep. P 72,368 In re H & H BEVERAGE DISTRIBUTORS v. DEPARTMENT OF REVENUE OF the COMMONWEALTH OF PENNSYLVANIA. Appeal of COMMONWEALTH OF PENNSYLVANIA, PENNSYLVANIA DEPARTMENT OF REVENUE.

Page 165

850 F.2d 165

18 Bankr.Ct.Dec. 76, Bankr. L. Rep. P 72,368

In re H & H BEVERAGE DISTRIBUTORS v. DEPARTMENT OF REVENUE OF the COMMONWEALTH OF PENNSYLVANIA.

Appeal of COMMONWEALTH OF PENNSYLVANIA, PENNSYLVANIA

DEPARTMENT OF REVENUE.

No. 87-1695.

United States Court of Appeals, Third Circuit.

Argued April 15, 1988.

Decided June 24, 1988.

Rehearing and Rehearing In Banc Denied July 19, 1988.

Prince Altee Thomas, Com. of Pa., Pennsylvania Dept. of Revenue, Philadelphia, for appellant.

J. Raymond Munholland (argued), J.R. Munholland & Associates, Erdenheim, for appellee.

Before HUTCHINSON, SCIRICA and ROSENN, Circuit Judges.

OPINION OF THE COURT

SCIRICA, Circuit Judge.

In this appeal we must determine whether the Commonwealth of Pennsylvania violated the automatic stay in a Chapter 11 bankruptcy proceeding, 11 U.S.C. Sec. 362 (1982), by conducting a sales tax audit and issuing a notice of audit assessment to the debtor, H & H Beverage Distributors, Inc. ("H & H"). The district court affirmed the bankruptcy court and concluded that both the audit and the notice violated the automatic stay's prohibition against "any act to create, perfect, or enforce" a lien, see Secs. 362(a)(4), (a)(5), because the acts constituted "the statutory prerequisites to the creation of a lien under the Pennsylvania Tax Code...." H & H Beverage Distrib., Inc. v. Department of Revenue of Pennsylvania, 79 B.R. 205, 207 (E.D.Pa.1987).

Our review is plenary, In re Remington Rand Corp., 836 F.2d 825, 828 (3d Cir.1988), and for reasons that follow, we will reverse. We hold that the Commonwealth was entitled to audit H & H to ascertain the extent of any claim it may have. Moreover, although issuance of a notice of audit assessment was a step toward the creation of a lien, it was expressly permitted under Sec. 362(b)(9), which provides that issuance by a governmental unit of a notice of tax deficiency is not subject to the automatic stay.

I.

H & H filed a voluntary petition on January 20, 1984, under Chapter 11 of the Bankruptcy Reform Act of 1978 ("the Code"), 11 U.S.C. Sec. 1101 et seq., and was granted debtor-in-possession status. The Commonwealth received notice of the Chapter 11 filing and in August, 1984, undertook a sales tax audit for the period from January 1, 1981 to July 30, 1984. Upon completing the audit on August 27, 1984, the Commonwealth sent H & H a "notice of audit assessment," which read:

Final Assessment

A certificate of lien will be filed with the prothonotary of your county, unless this assessment is paid or a notice of intent to appeal is filed with the board of appeals within thirty (30) days of the assessment mailing date....

J.A. at 5. The notice stated that H & H owed $162,981.16 in unpaid sales tax.

H & H initiated the administrative appeal process in an effort to obtain a redetermination of the audit findings. Its state appeal is pending in the Pennsylvania Commonwealth Court. In addition, H & H filed a complaint on January 16, 1986 in the United States Bankruptcy Court, seeking to set aside the sales tax assessment, or in the alternative to have the bankruptcy court determine H & H's tax liability.

The bankruptcy court ruled that the audit and the assessment of tax liability against H & H violated the automatic stay under Sec. 362(a). Moreover, the court concluded, because the violations were made with knowledge of the bankruptcy petition, H & H was entitled to attorneys' fees and costs. Accordingly, the bankruptcy court declared the assessment null and void and held that any lien arising from the assessment must be stricken. The district court affirmed, reasoning that the audit, assessment, and notice were prerequisites to the creation of a lien, and under Pennsylvania law, a "lien would be automatically created absent action by the debtor." Therefore, the district court held, the Commonwealth willfully violated the automatic stay.

II.

An automatic stay under Sec. 362 of the Code "is one of the fundamental debtor protections provided by the bankruptcy laws." H.R.Rep. No. 595, 95th Cong., 1st Sess. 340 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 6296. Its essential purpose is twofold: (1) to protect creditors and thereby promote the bankruptcy goal of equal treatment, Hunt v. Bankers Trust Co., 799 F.2d 1060, 1069 (5th Cir.1986); and (2) to give the debtor a breathing spell. H.R.Rep. No. 595, at 340.

[The automatic stay] stops all collection efforts, all harassment, and all foreclosure actions. It permits the debtor to attempt a repayment or reorganization plan, or simply to be relieved of the financial pressures that drove him into bankruptcy.

Id.; S.Rep. No. 989, 95th Cong., 2d Sess. 50 (1978); see generally 2 Collier on Bankruptcy Sec. 362.04, at 362-31 (L. King ed. 1988).

In order to examine the issue of tax liability when a stay has been issued, we turn to Sec. 362(a), which prohibits:

(4) any act to create, perfect, or enforce any lien against property of the estate;

(5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;

(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; ....

Id.; see also S.Rep. No. 989, at 50 (1978) ("To permit lien creation after bankruptcy would give certain creditors preferential treatment...."). Despite Sec. 362(a)'s broad prohibitions, the Code provides that a Chapter 11 filing "does not operate as a stay ... of the issuance to the debtor by a governmental unit of a notice of tax deficiency." Id. Sec. 362(b)(9). Moreover, pursuant to Sec. 505 of the Code, the bankruptcy court is empowered under certain circumstances-- notwithstanding Sec. 362--to determine the amount or legality of a tax "whether or not previously assessed, whether or not paid, and whether or not contested...." Id. Sec. 505(a)(1), (c). When the bankruptcy court makes this determination, the governmental unit charged with collecting the tax may then assess the tax against the debtor. Thus, once a bankruptcy proceeding is instituted, and a Sec. 362(b)(9) notice of tax deficiency has been issued for prepetition taxes, the bankruptcy court has the option of referring the tax issue to the Tax Court or making its own determination.

The parties' positions in this matter are straightforward. H & H contends that the Commonwealth willfully violated the automatic stay's prohibition of any act to create a lien. The Commonwealth maintains that it must conduct an audit before filing a proof of claim, and before it can notify a debtor of any deficiency. It also contends that its notice of audit assessment is expressly permitted under Sec. 362(b)(9).

The bankruptcy court determined that the act of auditing was a per se violation of the automatic stay; the district court affirmed on different grounds, concluding that the audit violated the stay because it was followed by a tax assessment and the issuance of a tax assessment notice to the taxpayer. Under either theory, the district court's judgment must be reversed.

III.

Auditing a debtor's sales tax records does not by itself constitute an act to create a lien or collect a claim. The Commonwealth, like any other creditor, is entitled to determine whether it possesses a valid claim against the debtor. Cf. In re Remington Rand, 836 F.2d at 827, 832 (government audit of Chapter 11 debtor's records to determine whether it had a right to payment for breach of contract). In many cases, prohibiting a tax audit would prevent the Commonwealth from filing a proof of claim. See 124 Cong.Rec. H11110 (daily ed. Sept. 28, 1978) (remarks of Rep. Edwards explaining House amendments to Code) ("Where no proceeding in the Tax Court is pending at the commencement of the bankruptcy case, the tax authority can ... file a claim against the estate for a prepetition tax liability...."); accord Bankr.R. 3001. ¹ In addition, it would prevent governmental units from determining whether a tax deficiency exists, and thereby render meaningless Sec. 362(b)(9), which expressly permits taxing entities to issue notices of tax deficiency.

IV.

H & H contends that even if the automatic stay does not bar the audit, the district court correctly concluded that issuance of the notice of audit assessment was void because it would automatically result in imposition of a lien in favor of the Commonwealth.

As we have noted, Sec. 362(b)(9) of the Code provides that the automatic stay does not bar a governmental entity from issuing a "notice of tax deficiency." Thus, although a governmental unit may not collect taxes or create a lien during the stay, it may notify a debtor of a tax deficiency. This provision, which applies to governmental units, was based on the workings and terminology of the federal taxing scheme. See In re Hardy, 39 B.R. 64, 66 (Bankr.E.D.Pa.1984) (Internal Revenue Service ("IRS") notice of tax deficiency does not violate the automatic stay).

Congress exempted the notice of tax deficiency from the automatic stay to "permit the debtor to take his personal tax case to the Tax Court, if the bankruptcy judge authorizes him to do so (as explained more fully in the discussion of section 505.)" 124 Cong.Rec. H11110 (daily ed. Sept. 28, 1978) (remarks of Rep. Edwards); see also In re Community Hosp. of Rockland County, 15 B.R. 785, 790 (Bankr.S.D.N.Y.1981); 1 W. Norton, Norton Bankruptcy Law and Practice Sec. 20.21 & n. 2 (1981) (notice of tax deficiency is "condition precedent" to debtor's application to proceed in Tax Court should automatic stay be set aside); cf. H.R.Rep. No. 96-833, 96th Cong., 2d Sess. 43 & nn. 3, 4 (1980) (bill amending Internal Revenue Code to provide for tax treatment in bankruptcy--if a deficiency notice has been issued, bankruptcy court may lift automatic stay in case involving corporate debtor and permit tax issue to be...