In re White Trailer Corp.
| Decision Date | 30 November 2000 |
| Docket Number | Bankruptcy No. 96-40623. Adversary No. 00-4013. |
| Citation | 266 BR 390 |
| Parties | In re WHITE TRAILER CORPORATION, White Trailer Inc., Debtors. Daniel L. Freeland, Trustee, Plaintiff, v. Internal Revenue Service, Defendant. |
| Court | U.S. Bankruptcy Court — Northern District of Indiana |
Sheila A. Ramacci, Highland, IN, for Trustee.
Jennifer Gazaille, Washington, DC, for I.R.S.
DECISION
The complaint in this adversary proceeding asks the court to equitably subordinate a portion of the Internal Revenue Service's priority tax claim because it has failed to pursue the collection of those taxes from a third party who, allegedly, is also responsible for their payment. The United States contends that the complaint fails to state a claim upon which relief can be granted and seeks dismissal pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The matter has been submitted to the court for a decision on the briefs of counsel.
The debtor was a manufacturer of semitrailers. A 12 percent tax is imposed upon the first retail sale of these trailers, see, 26 U.S.C. § 4051(a), which the debtor failed to pay. As a result, the IRS has filed a priority claim for more than $2,230,0001 on account of this excise tax. There has been no objection to this portion of the IRS's claim, so that it is deemed allowed. 11 U.S.C. § 502(a). By this adversary proceeding, the trustee seeks to equitably subordinate the amounts due the IRS on account of the § 4051 taxes to the claims of the debtor's other creditors. The Trustee argues that the claim should be subordinated because the IRS has refused to pursue the collection of those taxes from a third party, Congress Financial, who the trustee contends is also liable for their payment.
Congress Financial loaned money to the debtor under a lockbox arrangement. This arrangement required all the proceeds from the debtor's sales to be remitted to a lockbox controlled by Congress Financial. The collections would be applied to the outstanding balance on the debtor's loan and the resulting reductions in the loan balance would produce an increase in the available credit. It had been the debtor's practice to pass the § 4051 excise tax on to its customers. Consequently, when the customers remitted the invoiced amount to the lockbox, Congress Financial would receive not only the purchase price of the trailers but also the additional excise tax. Congress Financial did not forward any of the amounts collected on account of the excise tax on to the IRS (or remit them to the debtor so that it could do so); instead, it applied all the funds it received to the debtor's outstanding loan balance.
Dismissal under Rule 12(b)(6) is appropriate if, after accepting all of the plaintiff's well pleaded allegations as true2 and drawing all reasonable inferences in the light most favorable to the plaintiff, Bethlehem Steel Corp. v. Bush, 918 F.2d 1323, 1326 (7th Cir.1990), "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." McLain v. Real Estate Board of New Orleans, Inc., 444 U.S. 232, 246, 100 S.Ct. 502, 62 L.Ed.2d 441 (1980) (citing Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). Consequently, for the purposes of the defendant's motion, the court accepts as true the trustee's allegations that the debtor imposed a 12% surcharge upon the buyers of its trailers on account of the § 4051 tax, that these customers remitted this amount to Congress Financial under the lockbox arrangement, and that Congress Financial applied the amounts collected to the debtor's outstanding loan balance. The court also accepts as true the fact that the IRS has not pursued Congress Financial for these funds, but has, instead, filed a claim to collect the taxes from the estate. The issue for the court to decide is whether these facts state a claim for equitable subordination.
The Trustee argues that once the proceeds of Debtor's sales were remitted to Congress Financial a trust was created under § 7501 of the Internal Revenue Code, with the result that Congress Financial held the tax portion of the sale proceeds as trustee for the benefit of the United States. The Trustee contends that this caused Congress Financial to become a responsible party, see, 26 U.S.C. § 6672(a), whose duty it was to pay the collected funds to the IRS. Under these circumstances, the Trustee believes that the IRS has a separate avenue for the collection of the amounts due it, apart from its claim against the estate, which it has failed to pursue and that this inaction constitutes inequitable conduct such that the claim should be subordinated to the claims of the debtor's other creditors, who can look only to estate for payment of their debt.
The Bankruptcy Code authorizes the court, "under principles of equitable subordination, to subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim. . . ." 11 U.S.C. § 510(c)(1). Congress did not identify what the "principles of equitable subordination" might be because it intended that the courts would be allowed to continue to develop the doctrine. See, United States v. Noland, 517 U.S. 535, 539, 116 S.Ct. 1524, 1526-27, 134 L.Ed.2d 748 (1996). It is clear, however, that equitable subordination must be "justified by particular facts," id., 517 U.S. at 540, 116 S.Ct. at 1527, so that the determination must be made on a case-by-case basis.
The fundamental principle upon which this action rests is the proposition that a creditor's failure to pursue the collection of its claim from a third party, who may, along with the debtor, also be liable for the obligation, constitutes a sufficient reason to equitably subordinate the creditor's claim against the estate. The validity of this proposition seems to be a question of first impression. Although both the trustee and the IRS have extensively briefed issues such as "categorical" subordination, whether subordination without fault continues to exist, and how much or how little the creditor must do for there to be fault, neither of them has directed the court's attention to a single decision which has discussed the proposition on which this case turns. This dearth of authority is surprising since the basic scenario giving rise to the issue will, at least potentially, exist any time a third party may also be liable for payment of a creditor's claim against the debtor. Given the frequency with which there are guarantors, sureties, co-makers, responsible parties and potentially responsible parties who may also be liable for the payment of a debtor's obligation, one would have thought that someone would have raised the issue before now. Apparently not.
Because of conflicting decisions on the issue, the parties differ over whether the possibility of subordination without fault still exists in the Seventh Circuit. Compare In re Virtual Network Services Corp., 902 F.2d 1246, 1250 (7th Cir.1990) ()3with Matter of Lifschultz Fast Freight, 132 F.3d 339, 349 (7th Cir.1997) (). The court does not need to enter this particular debate because misconduct (or the lack thereof) is only one of several factors the court is to consider in deciding whether subordination is appropriate. In addition to the issue of misconduct, "equitable subordination . . . must not be inconsistent with the provisions of the Bankruptcy Code." In re Mobile Steel Co., 563 F.2d 692, 700 (5th Cir.1977). See also, Matter of Vitreous Steel Products Co., 911 F.2d 1223, 1237 (7th Cir.1990); Lifschultz, 132 F.3d at 344. Virtual Network and similar decisions concluded only that misconduct was not required; it left the other considerations intact. See, Vitreous Steel Products, 911 F.2d at 1237. Indeed, in Noland the Supreme Court reaffirmed the vitality of this particular requirement when it noted that:
This last requirement that subordination not be inconsistent with the requirements of the Code has been read as a reminder to the bankruptcy court that although it is a court of equity, it is not free to adjust the legally valid claim of an innocent party who asserts the claim in good faith merely because the court perceives that the result is inequitable. Noland, 517 U.S. at 539, 116 S.Ct. at 1526 (citations and internal quotation marks omitted).
Consequently, subordination is inappropriate when it is based, "not on individual equities," but, instead, "on the supposedly general unfairness of satisfying" a claim in the manner prescribed by the Bankruptcy Code. Noland, 517 U.S. at 541, 116 S.Ct. at 1528. In other words, "the circumstances that prompt a court to order equitable subordination must not occur at the level of policy choice at which Congress itself operated in drafting the Code." Noland, 517 U.S. at 543, 116 S.Ct. at 1528.
The Court's admonition that the circumstances prompting subordination may not include the same type of policy considerations Congress would have evaluated in drafting the Bankruptcy Code is of significance here because Congress has already considered how to deal with claims on which an entity other than the debtor is also liable and its solution does not contemplate subordinating the primary creditor's claim. Quite to the contrary, the Bankruptcy Code specifically contemplates allowing the claim of the primary creditor. It is the claim of the codebtor that must be disallowed or subordinated.
Claims for contribution or reimbursement asserted by codebtors are not allowed unless the codebtor has actually paid something to the primary creditor, either before or after the petition. 11 U.S.C. § 502(e)(1)(B), (e)(2). Until then they are contingent. To the extent the codebtor actually pays the primary creditor, either in whole or in...
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