Jersey State Bank v. U.S.

• Decision Date: 21 February 1991
• Docket Number: 90-1730,Nos. 90-1522,s. 90-1522
• Citation: 926 F.2d 621
• Parties: -575, 59 USLW 2558, 91-1 USTC P 50,089 JERSEY STATE BANK, Plaintiff-Appellee, Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant, Cross-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 621

926 F.2d 621

67 A.F.T.R.2d 91-575, 59 USLW 2558, 91-1

USTC P 50,089

JERSEY STATE BANK, Plaintiff-Appellee, Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant, Cross-Appellee.

Nos. 90-1522, 90-1730.

United States Court of Appeals, Seventh Circuit.

Argued Jan. 14, 1991.

Decided Feb. 21, 1991.

Lee W. Barron, William H. Strang, Jerseyville, Ill., for plaintiff-appellee, cross-appellant.

Richard M. Prendergast, Charles M. Green, Dept. of Justice, Tax Div., Washington, D.C., Frederick J. Hess, U.S. Atty., Robert L. Simpkins, Asst. U.S. Atty., East St. Louis, Ill., Gary R. Allen, Murray S. Horwitz, Robert L. Baker, William S. Estabrook, Dept. of Justice, Tax Div., Appellate Section, Washington, D.C., for defendant-appellant, cross-appellee.

Before CUMMINGS, POSNER, and KANNE, Circuit Judges.

POSNER, Circuit Judge.

The Internal Revenue Service, having assessed (demanded) taxes due from Marion Price, served a notice of levy on the Jersey State Bank, in which Price had a demand deposit account--a notice, in other words, that the Service intended to seize the account in order to collect the assessment. 26 U.S.C. Sec. 6331. Price had borrowed money from the bank for his business in exchange for a note that not only promised to repay the loan but also purported to give the bank a security interest in the deposit account and a right to set off money in that account against Price's debt to the bank. The loan was in default, so after receiving the Internal Revenue Service's notice of levy the bank exercised its right of set off by seizing the balance in the deposit account, some $5,000. Later the Service filed a notice of tax lien, which it claims established its priority over the bank's right of set off. The district court disagreed and gave judgment for the bank in this suit for wrongful levy, and the Service has appealed. The bank has cross-appealed, arguing that it is entitled to reasonable attorney's fees under 26 U.S.C. Sec. 7430, which entitles the prevailing party in a suit for wrongful levy to attorney's fees unless the government's position was substantially justified. The cross-appeal must fail. The statute defines prevailing party to exclude not only the United States but also the taxpayer's creditor, Sec. 7430(c)(4)(A), which is what the bank is.

The making of the tax assessment against Price created a lien upon his property, and the lien arose on the date of the assessment. 26 U.S.C. Secs. 6321, 6322. If, however, the competing creditor, that is, the bank, obtained a "security interest" in the property (the money on deposit) before the Internal Revenue Service filed its notice of tax lien, the creditor prevails. Sec. 6323(a). (The notice of levy was not the assessment, was not a notice of tax lien, was not filed, and, in short, has no significance with respect to the question which lien had priority.) We must go therefore to section 6323(h)(1)(A), which defines "security interest," so far as pertinent here, as any interest in property "protected under local law against a subsequent judgment lien arising out of an unsecured obligation." This shunts us to Illinois law, where the controlling case is Pines Trailer Corp. v. Roaring Express Co., 127 Ill.App.2d 46, 261 N.E.2d 709 (1970). A bank was owed money by one of its depositors, who just as in this case had defaulted on an obligation to the bank. Another creditor of the depositor obtained a judgment entitling it to garnish the depositor's account. Before he could do so the bank exercised its right to set off the money in the account against the depositor's debt to it. The court held that this was a proper set off, and by so holding put the bank ahead of a subsequent judgment lienor, the garnishing creditor. This shows that the interest which a bank acquires in its depositor's account as a result of his defaulting is a security interest as defined by the federal statute. So even if the set off had been made after the Internal Revenue Service filed its notice of tax lien, the bank would have won, because the security interest that the set off enforced had been obtained before that filing. Indeed, it may have been obtained even before the promissory note came due by virtue of the default--may have been obtained when the loan was made in the first place. Bee Jay's Truck Stop v. Dept. of Revenue, 86 Ill.App.3d 7, 13, 41 Ill.Dec. 257, 262, 407 N.E.2d 755, 760 (1980).

It is arguable (though Jefferson Bank & Trust v. United States, 894 F.2d 1241, 1244 (10th Cir.1990), is to the contrary) that the bank's security interest was "inchoate" until the bank exercised its right of set off or took other steps to prevent the depositor from withdrawing the money in the account. But that is of no consequence. The set off was made before the notice of tax lien was filed, and a security interest that predates such notice takes priority over the federal tax lien. All this assumes, moreover--what is by no means clear--that the doctrine of...