Lilley, In re

• Decision Date: 31 July 1996
• Docket Number: No. 95-1782,95-1782
• Citation: 91 F.3d 491
• Parties: -5884, 65 USLW 2139, 96-2 USTC P 50,456, 36 Collier Bankr.Cas.2d 609, Bankr. L. Rep. P 77,147 In re Ernest R. LILLEY, Jr., Debtor. Ernest R. Lilley, Jr., Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 491

91 F.3d 491

78 A.F.T.R.2d 96-5884, 65 USLW 2139,

96-2 USTC P 50,456,

36 Collier Bankr.Cas.2d 609,

Bankr. L. Rep. P 77,147

In re Ernest R. LILLEY, Jr., Debtor.

Ernest R. Lilley, Jr., Appellant.

No. 95-1782.

United States Court of Appeals, Third Circuit.

Argued May 20, 1996.

Decided July 31, 1996.

John R. Crayton (Argued), Crayton & Belknap, Bensalem, PA, for Appellant.

Loretta C. Argrett, Assistant Attorney General, Gary R. Allen, Robert W. Metzler, David English Carmack, Annette M. Wietecha (Argued), Tax Division, Department of Justice, Washington, DC, for Appellee.

Before: SLOVITER, Chief Judge, SAROKIN and ROSENN, Circuit Judges.

OPINION OF THE COURT

SAROKIN, Circuit Judge:

This case raises the question of what constitutes "cause" for the purpose of dismissing a petition under Chapter 13 of the Federal Bankruptcy Code. The appellant, Ernest R. Lilley, Jr., filed a petition under Chapter 13 of the Federal Bankruptcy Act, 11 U.S.C. § 101 et seq., to discharge a debt incurred as a result of his willful failure to pay personal income taxes over a period of several years. The Internal Revenue Service filed a motion to dismiss the petition on the ground that Mr. Lilley's prepetition conduct was cause for dismissal under the statute. The bankruptcy court rejected the agency's argument, but on appeal the district court reversed, granting the motion to dismiss for cause.

Mr. Lilley now appeals the district court's holding.

I. Facts and procedural posture

The unusual chain of events that led to the instant case goes back a quarter of a century. In 1970, Ernest R. Lilley, Jr. formed Mintmaster, Inc., a corporation which minted and sold gold, silver and bronze medallions and jewelry. In January 1971, the United States Secret Service seized the assets of Mr. Lilley's business in the mistaken belief that Mr. Lilley was unlawfully engaged in counterfeiting activities. After several months, the Secret Service determined that Mr. Lilley, in fact, had not engaged in any unlawful activity, and returned his assets to him. Shortly thereafter, however, Mr. Lilley's business deteriorated and ultimately failed, a loss that Mr. Lilley attributed to the seizure of his assets.

Mr. Lilley was unable to obtain monetary redress from the Secret Service for the loss which he believed it had caused. He turned to self-help instead and, as he describes it, "decided to recoup his losses by refusing to pay his future federal income taxes." Appellant's Brief at 3. He secured employment as a night watchman in 1974, and became director of security for a shopping mall in 1977. In both positions, he filed federal tax withholding forms on which he falsely claimed that he was exempt from withholding, as a result of which no federal income tax money was withheld from his wages--though he did allow state income taxes and FICA taxes to be withheld. By 1980 he had become public relations and marketing manager for the mall and started his own business.

In 1983, Mr. Lilley was convicted in federal court of willful failure to file tax returns for 1976 through 1979, and served a one-year prison sentence. As part of his probation, he was required to file his delinquent tax returns for 1974 through 1984, but he did not do so until September 1985, when he was faced with a violation of his probation. By that point, he had amassed $178,000 in federal delinquent tax debt and additions. Mr. Lilley eventually filed a petition with the United States Tax Court arguing that his failure to file income tax returns was due to both mental illness and, for the years 1980 to 1984, advice of counsel. The court denied the petition on the ground that Mr. Lilley had acted with willful neglect, not reasonable cause, in failing to file his returns from 1980 to 1984, and that he had acted negligently with intentional disregard of IRS rules and regulations so as to warrant imposition of additions to taxes owed from 1974 through 1984.

On April 17, 1992, Mr. Lilley filed a Chapter 7 bankruptcy petition in the United States District Court for the Eastern District of Pennsylvania seeking discharge of his tax debt, and identifying the IRS as his only creditor. A year later, and after numerous legal maneuvers, the bankruptcy court found that Mr. Lilley had willfully attempted to evade or defeat his tax obligation and that 11 U.S.C. § 523(a)(1)(C) precluded discharge of the debt. In re Lilley, 152 B.R. 715 (Bankr.E.D.Pa.1993).

Subsequent statutory developments opened new avenues for Mr. Lilley to seek discharge of his tax debt. Section 108(a) of the Bankruptcy Reform Act of 1994, Pub.L. 103-394, 108 Stat. 4104, amended 11 U.S.C. § 109(e) to increase the unsecured debt limit in a Chapter 13 proceeding to $250,000 for cases filed after October 22, 1994. This change made Chapter 13 available to Mr. Lilley for the first time, and on November 21, 1994 he filed the instant petition seeking discharge of his federal income tax obligation.

At the time of his Chapter 13 bankruptcy filing, Mr. Lilley was 66 years old, in poor health and disabled. The schedules filed in this proceeding indicate that he had no real or personal property, that his sole creditor was the IRS, and that his sole income was monthly Social Security benefits of $904. He claimed, and the IRS did not dispute, that his monthly expenses amounted to $854. Mr. Lilley's plan proposed payments to the IRS of the balance--or $50 per month--for thirty-six months, for a total of $1800. The filings indicate total tax indebtedness to the IRS of $178,000. The IRS contends that "[m]ost of the proposed payments would be consumed by attorney's fees, with the IRS receiving very little on its claim." Appellee's Brief at 8.

The IRS filed a motion to dismiss Mr. Lilley's petition on the ground that it was filed in bad faith in violation of 11 U.S.C. § 1307(c). The IRS also objected to confirmation of Mr. Lilley's plan, asserting that the plan "has not been proposed in good faith" in violation of 11 U.S.C. § 1325(a)(3). Appendix at 39. In response, Mr. Lilley filed an adversary proceeding seeking a declaration that his indebtedness to the IRS for delinquent personal income taxes for the years 1976 through 1984, totalling $178,000, was neither a priority nor a secured debt and was totally dischargeable under 11 U.S.C. § 1328(a). The IRS subsequently conceded that Mr. Lilley's tax indebtedness was not a priority debt and was not secured at the time of the Chapter 13 filing.

The bankruptcy court issued its opinion and order on May 3, 1995. In re Lilley, 181 B.R. 809 (Bankr.E.D.Pa.1995) [hereinafter Lilley II ]. First, the court denied the IRS's motion to dismiss on the ground that there is no good faith filing requirement in Chapter 13 cases. Id. at 811. Second, the court denied the agency's objections to confirmation on the ground that Mr. Lilley was not in violation of the good faith or illegality requirement for plan confirmation found in § 1325(a)(3). Id. at 813. The court concluded that "[t]he Debtor's plan will therefore be confirmed." Id. at 814.

The IRS appealed the bankruptcy court's determination to the United States District Court for the Eastern District of Pennsylvania. The district court reversed, holding that Mr. Lilley's attempt "to defraud the Government by intentionally evading payment of his federal income taxes constitutes cause for dismissal of his Chapter 13 bankruptcy petition pursuant to 11 U.S.C. § 1307(c)." In re Lilley, 185 B.R. 489, 494 (E.D.Pa.1995) (mem.) [hereinafter Lilley III ]. The court further held that "the bankruptcy court's finding of good faith [under § 1325(a)(3) ] is supported by the record and cannot be deemed clearly erroneous." Id. at 495.

Mr. Lilley now appeals the district court's determination. He argues that the court erred when it considered his prepetition conduct under section 1307(c). He further argues, in the alternative, that if the debtor's prepetition conduct is relevant to a dismissal for cause under section 1307(c), it is only one factor which should be considered by the bankruptcy court in examining the totality of the circumstances.

II. Jurisdiction

The bankruptcy court issued an order disposing of Mr. Lilley's Chapter 13 petition and the IRS's various challenges to it on May 3, 1995. The IRS filed an appeal of the court's order, over which the district court had jurisdiction pursuant to 28 U.S.C. § 158(a).

The district court issued its final order in the case on August 22, 1995. We have jurisdiction over Mr. Lilley's appeal from the district court's order pursuant to 28 U.S.C. § 1291.

The issue presented on appeal is a question of law. Therefore, we exercise plenary review over the decision of the district court. In re Cohn, 54 F.3d 1108, 1113 (3d Cir.1995).

III. The IRS's motion to dismiss

The district court, on appeal from the bankruptcy court order confirming Mr. Lilley's Chapter 13 plan, found that Mr. Lilley "attempted to defraud the Government by intentionally evading payment of his Federal income taxes and such action constitutes cause for dismissal of his Chapter 13 bankruptcy petition pursuant to 11 U.S.C. § 1307(c)." Lilley III, 185 B.R. at 494. We conclude that tax fraud is not "cause" for dismissal of a Chapter 13 petition, and therefore that the district court erred in reversing the bankruptcy court.

Section 1307(c) states, inter alia:

Except as provided in subsection (e) of this section, on request of a party in interest or the United States trustee after notice and a hearing, the court ... may dismiss a case under this chapter ... for cause, including--

(1) unreasonable delay by the debtor that is prejudicial to creditors;

(2) nonpayment of any fees and charges required under chapter 123 of title 28;

(3) failure to file a plan timely under section 1321 of this title;

(4) failure to commence making timely payments under section 1326 of this title;

(5) denial of confirmation of a plan under section 1325 of this title and denial of a...