Matter of Community Hosp. of Rockland County, Bankruptcy No. 79 B 20074
| Decision Date | 07 December 1981 |
| Docket Number | Bankruptcy No. 79 B 20074,Adv. No. 81-6036. |
| Citation | 15 BR 785 |
| Parties | In the Matter of COMMUNITY HOSPITAL OF ROCKLAND COUNTY, Debtor. |
| Court | U.S. Bankruptcy Court — Southern District of New York |
Harvey S. Barr, Spring Valley, N.Y., Trustee.
John S. Martin, Jr., U.S. Atty., S.D.N.Y., New York City, for I.R.S.; Stuart M. Bernstein, Asst. U.S. Atty., New York City, of counsel.
DECISION ON NOTICE OF MOTION TO DISMISS THE TRUSTEE'S COMPLAINT
The United States Internal Revenue Service ("IRS") seeks to dismiss the claim asserted by the trustee in bankruptcy in this converted Chapter 7 case. The trustee charges that IRS received a preference when it collected certain taxes pursuant to a pre-petition notice of tax levy because the IRS tax lien should be subordinated to priority administration expenses and wage claims, as described in Code § 724(b)(2). IRS reasons that the trustee's claim should be dismissed because this court's prior determination in the aborted Chapter 11 case is res judicata, and also because Code § 106(c) does not provide for a waiver of its sovereign immunity with respect to the trustee's preference claim.
The debtor, Community Hospital of Rockland County, filed a petition under Chapter 11 of the Bankruptcy Code on December 4, 1979. Immediately prior to that time (between November 14, 1979 and December 5, 1979), IRS had served notices of tax levy on the debtor's obligors (various medical insurance institutions) in order to collect a tax indebtedness in excess of $700,000. The debtor commenced an adversary proceeding against IRS in order to recover sufficient monies to meet its impending payroll. The debtor's complaint asserted three causes of action. In the first cause of action the debtor sought a determination that the tax liens were subordinated to the wage claims pursuant to Code §§ 724(b) and 507 and that the debtor was therefore entitled to recover the amount necessary to meet the payroll. The second cause of action alleged that the levies were a preference within the meaning of Code § 547 which the debtor could recover. The third cause of action sought a determination that the levies did not reach claims which were authorized for payment after the dates of service.
The court conducted a trial on the following day, at which time the debtor proceeded solely on the subordination theory under Code § 724(b), as set forth in the first cause of action. In a decision the same day the court dismissed the complaint, ruling that Code § 103(b) made Code § 724(b) inapplicable to Chapter 11 reorganization cases. The court also concluded, alternatively, that since the Government had not filed any claim in this case, it could properly assert that the limited waiver of sovereign immunity with respect to compulsory counter-claims and offsets, as expressed in subsections (a) and (b) of Code § 106, did not strip it of sovereign immunity with respect to the subordination theory asserted in the debtor's first (and only litigated) cause of action. In re Community Hospital of Rockland County, 5 B.R. 7 (Bkrtcy.S.D.N.Y. 1979).
On the same day, the debtor filed a notice of appeal to the district court. The appeal was heard and determined the next day. The district court affirmed this court's dismissal of the first cause of action, declaring that Code § 724 was available only in liquidation cases under Chapter 7 and not in reorganizations under Chapter 11. The district court also affirmed this court's alternative ruling that since the Government did not file a claim it did not waive its sovereign immunity with respect to the subordination claim asserted in the debtor's first cause of action. In re Community Hospital of Rockland County, 5 B.R. 11 (Bkrtcy.S.D. N.Y.1980).
The debtor was unable to continue operations under Chapter 11 and therefore an order was entered by this court on June 4, 1980 converting this case to Chapter 7 for liquidation. The trustee in bankruptcy was then appointed by the United States Trustee, pursuant to Code § 15701(a). The trustee claims that since Code § 724 is now applicable to this Chapter 7 case, the IRS tax levies should be subordinated to the priority claims under Code § 507. Of the $87,876.68 covered by the levies, $38,502.89 was received during the month immediately prior to the filing of the Chapter 11 petition; $57,201.19 was received after the filing of the Chapter 11 petition, but before the conversion to a Chapter 7 case on June 4, 1980, and $2,172.60 was received after the conversion. The trustee further argues that levies prior to the filing of the Chapter 11 petition were preferentially in violation of the distribution scheme contemplated under Code § 724 and that the funds collected after the commencement of the Chapter 11 case are property of the estate held by IRS as a custodian and must be turned over to the trustee in accordance with Code § 543.
A final judgment on the merits bars further claims by parties or their privies based on the same cause of action. Montana v. United States, 440 U.S. 147, 99 S.Ct. 970, 59 L.Ed.2d 210 (1979). The doctrine of res judicata prevents litigation of all grounds for recovery or defenses that were previously available to the parties, regardless of whether they were asserted or determined in the prior proceeding. Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979). In the prior litigation between the debtor and IRS, this court ruled that the subordination theory underlying Code § 724 was not available to a debtor in a Chapter 11 reorganization case because it was expressly limited to a trustee in bankruptcy in a liquidation case under Chapter 7. Now that the trustee in bankruptcy seeks relief under Code § 724 in this Chapter 7 case, he is met with the defense that this court's prior decision precludes the trustee from asserting the subordination requirement under Code § 724. Manifestly, Code § 724 was not previously available to the trustee in the Chapter 11 case, nor was this section available to his predecessor in interest, the debtor-in-possession in that case. Although the trustee replaced the debtor-in-possession so that they are in privity to the extent that their interests coincide, their objectives, nevertheless, are different; the debtor-in-possession seeks to continue its economic life under the aegis of a reorganization, whereas the trustee in bankruptcy aims to terminate the estate's existence and distribute the property of the estate in accordance with the concept of equality of distribution. To the extent that tax liens are not subordinated to priority claims, as required under Code § 724, the statutory design for equality of distribution will be frustrated. Therefore the trustee in bankruptcy should not be barred from insisting upon compliance with Code § 724 merely because this court's previous determination between the debtor-in-possession and IRS dismissed the erstwhile debtor's improper attempt to utilize this same section in a reorganization case under Chapter 11.
The Government's reliance upon Teltronics Services, Inc. v. L.M. Ericson Telecommunications, Inc., 642 F.2d 31 (2d Cir. 1981) is misplaced. In that case the trustee in bankruptcy was bound by a prior dismissal of the debtor's antitrust claim and could not rely upon the inexperience of the debtor's former counsel. Judge Mulligan observed that "no case has been cited or discovered where relief from res judicata principles has been granted simply because the plaintiff was represented by inexperienced counsel" (Page 36). The emergence on the scene of a trustee in bankruptcy was also insufficient basis to liberate him from the res judicata effects of an assertable cause of action in the prior litigation. However, in this case the subordination claim under Code § 724 was not assertable in the Chapter 11 case. Thus, the operable facts are different and res judicata is not a bar to the trustee's obligation to liquidate and distribute in accordance with the statutory scheme mandated by Congress.
In this court's earlier decision on December 27, 1979, which was affirmed by the district court on January 2, 1980, it was ruled that the limited waiver of immunity expressed in subsections (a) and (b) of Code § 106 did not apply because the Government did not file a claim against which a compulsory counterclaim or offset could be asserted. Subsection (c) was not considered because the debtor sought to obtain the levied funds solely under Code § 724, which was held inapplicable. The Government's claim of sovereign immunity was sustained because the debtor did not seek a turnover under Code § 542. This point was explained in In re Hudson Valley Ambulance Service, Inc., 11 B.R. 860, 864 (Bkrtcy.S.D. N.Y.1981), where this court held that accounts receivable levied upon by the IRS were "property of the estate", within the meaning of Code § 541, which may be used by the debtor pursuant to Code § 363, subject to providing adequate protection as required under Code § 363(e). In the instant case the erstwhile debtor could not rely upon Code § 542 because it was in no position to offer adequate protection to the IRS. It, therefore, impermissibly relied upon Code § 724.
The debtor could not recover the pre-petition levied funds as a preferential transfer because Code § 547(c)(6) expressly excludes from the definition of preferences the fixing of statutory liens that are not avoidable under Code § 545. Tax liens, other than inventory, are not avoidable under Code § 545 because they are not the sort of liens that first become effective upon bankruptcy or insolvency, as proscribed under Code § 545. Therefore, since the IRS lien affords a validly secured status, the satisfaction of the lien by levying against the debtor's obligors did not constitute a preference in the Chapter 11 case. Payment to a secured...
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