Slobodian v. U.S. Internal Revenue Serv. (In re Net Pay Solutions, Inc.)

• Decision Date: 10 May 2016
• Docket Number: No. 15–2833.,15–2833.
• Citation: 822 F.3d 144
• Parties: In re NET PAY SOLUTIONS, INC., d/b/a Net Pay Payroll Services, Debtor Markian R. Slobodian, Appellant v. United States of America Internal Revenue Service.
• Court: U.S. Court of Appeals — Third Circuit

822 F.3d 144

In re NET PAY SOLUTIONS, INC., d/b/a Net Pay Payroll Services, Debtor

Markian R. Slobodian, Appellant

v.United States of America Internal Revenue Service.

No. 15–2833.

United States Court of Appeals, Third Circuit.

Argued March 2, 2016.

Filed: May 10, 2016.

Markian R. Slobodian(Argued), Harrisburg, PA, for Appellant.

Ivan C. Dale(Argued), Michael J. Haungs, Ari D. Kunofsky, Esq., U.S. Department of Justice, Tax Division, Washington, D.C., for Appellee.

Before: SMITH and HARDIMAN, Circuit Judges.^*

OPINION OF THE COURT

HARDIMAN, Circuit Judge.

Markian Slobodian, in his capacity as trustee of debtor Net Pay Services, Inc., appeals the District Court's summary judgment in favor of the Internal Revenue Service.The District Court denied Slobodian's motion to avoid five alleged preferential transfers under 11 U.S.C. § 547(b) of the Bankruptcy Code.The District Court held that four of the five payments were not avoidable because of their minimal value.And although the fifth payment was sufficiently large to constitute a preference, it was not avoidable because the funds were not property of Net Pay's estate.For the reasons that follow, we will affirm.

I

The facts of this case are straightforward.Before it filed for protection under Chapter 7 of the Bankruptcy Code, Net Pay managed its clients' payrolls and handled their employment taxes pursuant to a form contract called a “Payroll Services Agreement,” which required clients to provide their employee payroll information so Net Pay could determine the taxes and wages they owed.The Agreement gave clients the option of authorizing Net Pay to transfer funds from their bank accounts into Net Pay's account and to remit those funds to the clients' employees, the IRS, and other taxing authorities.The Agreement also established an independent contractor relationship between Net Pay and its clients, disclaiming “any relationship of employment, agency, joint venture, partnership, or any other fiduciary relationship of any kind.”App. 189.

At issue in this appeal are five transfers Net Pay made on behalf of its clients to the Internal Revenue Service on May 5, 2011—almost three months before it filed its Chapter 7 petition.These transfers included: (1) $32,297 on behalf of Altus Capital Partners, Inc.; (2) $5,338 on behalf of HealthCare Systems Connections, Inc.; (3) $1,143 on behalf of Project Services, LLC; (4) $352.84 for an unknown client; and (5) $281.13 for another unknown client.The day after these transfers were made, Net Pay informed its clients that it was “ceasing business operations including all payroll processing.”App. 267.

As trustee for Net Pay, Slobodian sought to recover the monies represented by these five payments, arguing that they were avoidable preferential transfers.¹Slobodian and the IRS filed cross-motions for summary judgment.The District Court granted the IRS judgment as a matter of law.²

The District Court concluded that four of the five transfers were not subject to recovery as preference payments because they were less than the minimum amount established by law ($5,850).11 U.S.C. § 547(c)(9)(2013).Recognizing that four of the payments were beneath that threshold, the Trustee argued that because the payments exceeded $5,850 in the aggregate, the statutory threshold did not apply.The District Court disagreed, reasoning that distinct transfers may be aggregated for purposes of defeating the threshold only if they are “ ‘transactionally related’ to the same debt.”Slobodian v. U.S. ex rel. Comm'r,533 B.R. 126, 132–133(M.D.Pa.2015).Because the payments of $5,338, $1,143, $353, and $281 were “separate and unrelated transactions in satisfaction of independent antecedent debts” to different creditors, the Court held that they could not be aggregated to satisfy the statutory minimum.Id. at 133.

As for the $32,297 payment Net Pay made on behalf of Altus, which plainly exceeded the statutory minimum, the question remained whether it was a “transfer of an interest of the debtor in property.”11 U.S.C. § 547(b)(emphasis added).To evaluate that question, the District Court noted that section 7501(a) of the Internal Revenue Code creates a special statutory trust in favor of the United States for taxes withheld from employee paychecks (otherwise known as “trust fund” taxes).Informed by the Supreme Court's opinion interpreting that provision in Begier v. Commissioner,496 U.S. 53, 110 S.Ct. 2258, 110 L.Ed.2d 46(1990), the District Court held that Net Pay lacked an interest in the transferred funds because they were held in trust under § 7501(a) at the moment they were withheld.

Notwithstanding this evidence, the Trustee emphasized that $6,527.90 of the Altus payment was designated for employer, non-trust-fund tax obligations unaffected by § 7501(a).The District Court saw the evidence differently, finding that the payroll summary offered by Net Pay in support of this assertion failed to “identify what portion of Altus's non-trust fund and trust fund tax obligations were outstanding at the time.”Id. at 137(emphasis added).Because there was unrefuted evidence that the IRS applied the entire $32,297 toward Altus's trust fund tax obligations, the Court held that the payment was not avoidable as a preference.

This timely appeal followed.³

II

We begin with the Trustee's argument that the four smaller value transfers may be aggregated to exceed the Bankruptcy Code's minimum threshold for the avoidance of preferential transfers.⁴We have not had occasion to examine this provision, which states that the “trustee may not avoid ... a transfer ... if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $5,850.”⁵11 U.S.C. § 547(c)(9).

A

Although section 547(c)(9) is less than pellucid, it is clear that the “aggregate value” of “all property” that “constitutes or is affected by” a debtor's “transfer to or for the benefit of a creditor” must be at least $5,850 to be avoidable as a preference.11 U.S.C. § 547(b)(1), (c)(9).But this leaves unanswered the question whether small-value transfers for the benefit of different creditors and based on distinct debts can be aggregated and avoided as preferential.Citing an interpretive rule—“the singular includes the plural,”11 U.S.C. § 102(7) —the Trustee reads the Bankruptcy Code to allow the aggregation of transfers that individually fall below the threshold, as long as they were all to the same transferee.We reject the Trustee's reading.As we shall explain, when read in context, § 547(c)(9) precludes aggregation of multiple preferential transfers for the benefit of different creditors on distinct debts.

A “central policy” of the Bankruptcy Code is “[e]quality of distribution among creditors.”Begier,496 U.S. at 58, 110 S.Ct. 2258.“According to that policy, creditors of equal priority should receive pro rata shares of the debtor's property.”Id.The power of bankruptcy trustees to avoid preferential transfers that benefit certain creditors over others is critical to this system.“This mechanism prevents the debtor from favoring one creditor over others by transferring property shortly before filing for bankruptcy.”Id.The fear is that “[i]f preference law fails to preserve absolute equality in liquidation, those creditors who are aware of this failure will compete for position during insolvency rather than cooperating fully in an attempt to maximize the value of the firm.”Note, Preferential Transfers and the Value of the Insolvent Firm, 87 YaleL. J. 1449, 1455(1978);see alsoIn re Molded Acoustical Prods., Inc.,18 F.3d 217, 219(3d Cir.1994)(“[T]he preference rule aims to ensure that creditors are treated equitably, both by deterring the failing debtor from treating preferentially its most obstreperous or demanding creditors in an effort to stave off a hard ride into bankruptcy, and by discouraging the creditors from racing to dismember the debtor.”).

The Bankruptcy Code includes certain exceptions to the general preference rules.For example, a trustee may not avoid a transfer made “in the ordinary course of business,”11 U.S.C. § 547(c)(2), “because it does not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor's slide into bankruptcy.”Union Bank v. Wolas,502 U.S. 151, 160, 112 S.Ct. 527, 116 L.Ed.2d 514(1991)(internal quotation marks omitted).Indeed, it furthers bankruptcy policies by “encourage[ing] creditors to continue dealing with distressed debtors on normal business terms” and “promot[ing] equality of distribution by ensuring that creditors are treated equitably.”In re Pillowtex Corp.,427 B.R. 301, 306(Bankr.D.Del.2010)(citingIn re Molded Acoustical Prods., Inc.,18 F.3d 217, 219(3d Cir.1994) ).

The § 547(c)(9) minimum threshold is a relatively new addition to the Code.⁶SeeBankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. 109–8,119 Stat. 23(April 20, 2005).This provision was intended to benefit creditors who had to decide whether small-value preference actions were worth defending.SeeKevin C. Driscoll Jr., Bankruptcy 2005: New Landscape for Preference Proceedings, Am. Bankr. Inst. J., June 2005, at 1, 56.Given that “spending $10,000 in legal fees to defeat a $5,000 preference is a Pyrrhic victory,” many “defendants in these smaller preferences chose to settle otherwise defendable claims.”Id.Accordingly, as one court has observed, the essential function of the minimum threshold is to “discourage [ ] litigation over relatively insignificant transfer amounts” in order to “promote commercial and judicial efficiency, not only by reducing litigation over nominal amounts, but also by preventing creditors with smaller claims from waiving otherwise meritorious defenses simply because the costs associated with defending against trustees'...