Peoples Nat. Bank of Washington v. United States, C83-680R.

• Decision Date: 31 December 1984
• Docket Number: No. C83-680R.,C83-680R.
• Citation: 608 F. Supp. 672
• Parties: PEOPLES NATIONAL BANK OF WASHINGTON, a national banking association, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Western District of Washington

608 F. Supp. 672

PEOPLES NATIONAL BANK OF WASHINGTON, a national banking association, Plaintiffs, v. UNITED STATES of America, Defendant.

No. C83-680R.

United States District Court, W.D. Washington, at Seattle.

Bernard H. Friedman, Karr, Tuttle, Koch, Campbell, Mawer & Morrow, P.S., Seattle, Wash., for plaintiffs.

Gene S. Anderson, U.S. Atty., Seattle, Wash., for defendant.

ORDER DENYING PLAINTIFF'S MOTION FOR RECONSIDERATION

ROTHSTEIN, District Judge.

THIS MATTER comes before the court on plaintiff's motion for reconsideration of the court's order of June 13, 1984, dismissing plaintiff's action for wrongful levy under 26 U.S.C. § 7426 (1982). The court has carefully considered the memoranda and other materials submitted in support of and in opposition to the motion. The court declines to order oral argument, which the court feels would not be helpful.

Plaintiff is People's National Bank of Washington (Peoples). Defendant is the United States. This case involves a federal tax levy on a taxpayer's bank account, in which Peoples claims a right of setoff and a security interest. The facts are undisputed.

On March 5, 1980 and April 6, 1981, the Internal Revenue Service (IRS) assessed income taxes against Jerry L. and Susan M. Redwine (the Redwines). The Redwines failed to pay the full assessment upon notice and demand.

On March 7, 1983, the Redwines borrowed money from Peoples to finance their farming activities. Exhibit A to Affidavit of Versil Brixey in Support of Plaintiff's Motion for Summary Judgment. The Redwines executed a promissory note for $193,989.29 that was due "on demand, or if no demand on 12-30-83." Id. The noted and accompanying Farm Security Agreement granted Peoples a security interest in, among other things, funds on deposit with Peoples and general intangibles. Exhibits A & B to Affidavit of Versil Brixey in Support of Plaintiff's Motion for Summary Judgment.

On March 25, 1983, the IRS issued a Notice of Levy for $5,125.36 on Peoples to satisfy the delinquent tax assessment from the Redwines' deposit account. Exhibit C to Affidavit of Versil Brixey in Support of Plaintiff's Motion for Summary Judgment. As of the time the Notice of Levy issued, Peoples had not taken any positive action to setoff the funds in the account or otherwise restrict the Redwine's ability to withdraw the funds. Approximately four months later, in July of 1983, the IRS filed notices of the tax lien pursuant to 26 U.S.C. § 6323(f) (1982). Exhibit A to Affidavit of Bernard H. Friedman in Support of Plaintiff's Motion for Summary Judgment. Peoples responded by delivering a cashier's check for $5,125.36 to the Clerk of this Court and commencing this action for wrongful levy under 26 U.S.C. § 7426 (1982).

On June 13, 1984, this court dismissed Peoples' action on the grounds that a federal tax lien had attached to the Redwines' property interest in the deposit account in question, and Peoples possessed no prior security interest in this account.

Now Peoples has moved for reconsideration of the Order of Dismissal. Peoples presents two arguments. First, Peoples argues that the Redwines' property interest in the deposit account is "limited by" Peoples' right of setoff and that the government can claim no interest greater than that which could be claimed by the Redwines themselves. Second, Peoples argues that it has a common-law security interest in the deposit account and that this security interest takes priority over the tax lien.

In light of these arguments, the court believes that greater explanation of its position is warranted.

I. THE REDWINES' INTEREST IN THE DEPOSIT ACCOUNT WAS PROPERTY TO WHICH A FEDERAL TAX LIEN COULD ATTACH

A. The IRS Has Authority to Levy on the Redwines' Property.

When a taxpayer fails to pay an income tax on demand, a lien is created on "all property and rights to property" belonging to the taxpayer. 26 U.S.C. § 6321 (1982). This includes after-acquired property. Bank of America Nat'l Trust & Savings Ass'n v. Mamakos, 509 F.2d 1217 (9th Cir.1975). For the purpose of determining priority among liens, a federal tax lien arises on the date of the assessment of taxes. 26 U.S.C. § 6322 (1982). In this case, a tax lien on all the Redwines' property and rights to property arose when, in 1980 and 1981, the IRS assessed taxes against the Redwines. Unless provided otherwise by statute, this tax lien takes priority over any lien arising after the date of assessment. See United States v. City of New Britain, 347 U.S. 81, 85-86, 74 S.Ct. 367, 370-371, 98 L.Ed. 520 (1954); United States v. Pioneer American Ins. Co., 374 U.S. 84, 87-89, 83 S.Ct. 1651, 1654-1656, 10 L.Ed.2d 770 (1963).

To recover delinquent tax assessments, the IRS may levy upon "all property and rights to property" that belong to the taxpayer or are subject to a federal tax lien. 26 U.S.C. § 6331(a) (1982). On March 25, 1983, the IRS levied on the Redwines' deposit account. The threshold question with respect to the lawfulness of this levy is whether the Redwines' interest in their account is property or rights to property. If the answer to this question is affirmative, then the levy is lawful. See 26 U.S.C. §§ 6331, 6332 (1982). The levy operates as a seizure of property. American Acceptance Corp. v. Glendora Better Builders, Inc., 550 F.2d 1220, 1222-23 (9th Cir.1977). The only way to overcome such a levy is to establish an interest prior to that of the government. See United States v. Citizens & Southern Nat'l Bank, 538 F.2d 1101, 1105-7 (5th Cir.1976), cert. denied, 430 U.S. 945, 97 S.Ct. 1579, 51 L.Ed.2d 792 (1977).

B. The Redwines' Interest in the Account Was Property.

State law determines the nature of the legal interests the IRS seeks to reach by levy. Aquilino v. United States, 363 U.S. 509, 512-14, 80 S.Ct. 1277, 1279-81, 4 L.Ed.2d 1365 (1960); United States v. Stonehill, 702 F.2d 1288, 1298 (9th Cir. 1983). In other words, 26 U.S.C. § 6321 (1982) creates no property rights but merely attaches consequences to the existence of property rights under state law. 363 U.S. at 513, 80 S.Ct. at 1280.

Under Washington law, "once money is deposited in a general bank account, title to the money passes to the bank, and the bank and the depositor assume the relationship of debtor and creditor, respectively." Peters v. Sjoholm, 95 Wash.2d 871, 875, 631 P.2d 937, 940 (1981), cert. denied, 455 U.S. 914, 102 S.Ct. 1267, 71 L.Ed. 2d 455 (1982). While the bank has title to the account, the depositor "does have an ownership interest in the indebtedness created by the deposit...." Id. Such a state-recognized interest has been treated as "property" to which a tax lien may attach. Bank of America Nat'l Trust & Savings Ass'n v. Mamakos, 509 F.2d 1217 (9th Cir. 1975); MacKenzie v. United States, 109 F.2d 540, 542 (9th Cir.1940).

Peoples had the right to setoff the Redwines' account against payments due on the Redwines' promissory note. See Allied Sheet Metal Fabricators, Inc. v. Peoples Nat'l Bank of Washington, 10 Wash.App. 530, 537, 518 P.2d 734, 739, cert. denied, 419 U.S. 967, 95 S.Ct. 231, 42 L.Ed.2d 183 (1974). As the court explained in its Order of Dismissal, however, a bank's unexercised right of setoff does not extinguish the depositor's interest in a deposit account. Such extinguishment requires positive action by the bank.

Washington case law indicates that setoff is an optional remedy. Bank of California v. Starrett, 110 Wash. 231, 236, 188 P. 410, 412 (1920); Allied Sheet Metal, 10 Wash.App. at 537-38, 518 P.2d at 739 (holding that a bank may choose among multiple remedies). By implication, therefore, setoff does not occur automatically or by operation of law whenever a person becomes both a depositor and a delinquent debtor with respect to a single bank. If a bank declines to exercise its right of setoff, then the depositor's interest in his account remains undiminished. In this case, Peoples did not exercise its right of setoff before the IRS issued the Notice of Levy. Therefore, the Redwines still owned an interest in the account at the time of the levy.

Where a deposit account is currently vulnerable to a bank's right of setoff under state law, but the bank has chosen not to exercise this right, the depositor's interest in the account is still "property" or "rights to property" for the purposes of 26 U.S.C. §§ 6321 and 6331. United States v. Citizens & Southern Nat'l Bank, 538 F.2d 1101, 1105-7 (5th Cir.1976), cert. denied, 430 U.S. 945, 97 S.Ct. 1579, 51 L.Ed.2d 792 (1977); United States v. Sterling Nat'l Bank & Trust Co., 494 F.2d 919, 921-22 (2d Cir.1974). Therefore, the Redwines' interest in the account at issue in this case was "property" or "rights to property" and subject to levy by the IRS.

II. PEOPLES' RIGHT OF SETOFF DOES NOT DEFEAT THE TAX LEVY

A. Peoples' Right of Setoff was not "Choate" When the Tax Lien Arose

In order to attain priority over a federal tax lien a state-created lien must become "choate" before the tax lien arises. United States v. City of New Britain, 347 U.S. 81, 85-86, 74 S.Ct. 367, 370-371, 98 L.Ed. 520 (1954). Under 26 U.S.C. § 6322 (1982), a federal tax lien arises on the date of assessment of taxes. In the present case, therefore, Peoples' interest in the levied property would have to have been "choate" on March 5, 1980, and April 6, 1981, in order to attain priority over the entire tax lien.

The "choateness" doctrine is part of a judicial gloss on 26 U.S.C. § 6321 (1982) (Section 6321), which creates federal tax liens on the property of delinquent taxpayers. New Britain, 347 U.S. at 85-86, 74 S.Ct. at 370-371 (discussing former codification of Section 6321, Section 3670 of the Internal Revenue Code of 1939). As a general rule, a lien created by Section 6321 takes priority over all liens arising subsequently. Id. The "choateness" doctrine serves to determine when a state-created lien may be considered to have arisen for the purpose of this rule. Id. In order for a lien to be "ch...