State of Ill., Dept. of Revenue v. Schechter, 95 C 3684.
| Citation | 195 BR 380 |
| Decision Date | 11 March 1996 |
| Docket Number | No. 95 C 3684.,95 C 3684. |
| Court | U.S. District Court — Northern District of Illinois |
| Parties | STATE OF ILLINOIS, DEPARTMENT OF REVENUE, Appellant, v. Joel SCHECHTER and The Continental Insurance Company, Appellees. |
Howard L. Adelman, Brad Arnold Berish, Adelman, Gettleman & Merens, Ltd., Chicago, IL, for Joel A. Schechter.
James Douglas Newbold, Illinois Attorney General's Office, Chicago, IL, for State of Illinois, Department of Revenue.
This is an appeal by the State of Illinois, Department of Revenue ("Department") from a summary judgment entered by the Bankruptcy Court in favor of appellees, Joel Schechter ("Schechter") and the Continental Insurance Company ("Continental") and from a denial of the Department's cross motion for summary judgment. The Department raises two issues: first, whether the Bankruptcy Court had jurisdiction to hear the case, and, second, whether Schechter, a trustee operating the bankrupt hotel during reorganization under Chapter 11 of the Bankruptcy Code ("Code"), can be held personally liable for failure to pay certain taxes levied by the State of Illinois on hotel operators.
The relevant material facts are not disputed. In 1991, Markos Gurnee Partnership and a hotel and restaurant it operated, filed voluntary petitions under Chapter 11 of the Bankruptcy Code which were later consolidated. Schechter was appointed operating trustee. In connection with his operation of the hotel and restaurant he collected a total of $18,605.93 in hotel and use taxes from customers. These proceeds were deposited into the general accounts of the estates but were not remitted to the State of Illinois.
On December 17, 1992, the estates ceased operations and the bankruptcies were converted to Chapter 7 liquidation proceedings. At the time of conversion the estates were administratively insolvent, i.e., the administrative expenses, including the taxes in question incurred after filing of the petition for Chapter 11, exceeded the assets available for payment of administrative claims. Schechter turned over approximately $82,000 in cash plus receivables with a face value of between $38,000 to $48,000 to the new Chapter 7 trustee. At that time the administrative claims totalled approximately $315,000. He did not pay the taxes due the State of Illinois, nor have they as yet been paid by the Chapter 7 trustee, and it is a virtual certainty that they will not be paid in full at the conclusion of the liquidation.
The Department filed a complaint in Bankruptcy Court against the Chapter 7 trustee during the course of her administration to determine whether the State had an equitable interest in the funds turned over by Schechter. Cross-motions for summary judgment were filed. The Bankruptcy Court determined that this suit was a core proceeding under 28 U.S.C. § 157(b) since it sought to determine ownership of property in possession of the debtor. Summary judgment was entered in favor of the debtor (by the Bankruptcy Court) because the two taxes in issue, the Hotel Operators' Occupation Tax (35 ILCS 145/1) and the Use Tax (35 ILCS 120/1-120/14), were taxes imposed directly on the hotel and restaurant businesses and not on the customers, although the statutes permitted the operator to bill the customers for reimbursement. Consequently, the relationship between the trustee and the Department was that of debtor-creditor rather than constructive trustee-beneficiary. Therefore, the State possessed no equitable interest in the collected but unpaid tax proceeds. In re Markos Gurnee Partnership, 163 B.R. 124 (N.D.Ill.1993). This decision was not appealed by the Department.
Subsequent to that decision, the Department advised Schechter that it intended to hold him personally liable for the taxes collected during his administration that remained unpaid after final distribution by the Chapter 7 trustee. In response Schechter filed a complaint for declaratory and injunctive relief in the Bankruptcy Court seeking a determination that he had no personal liability for these unpaid taxes. The Department filed a motion to dismiss for want of jurisdiction which was denied. The Department then filed an answer, a counter-claim against Schechter, and a third party complaint against Continental, the issuer of Schechter's trustee's bond. Cross-motions for summary judgment ensued: Schechter contending that the Bankruptcy Court did have jurisdiction because the State's claim had to be against him in his official capacity, and the Department contending that there was no jurisdiction because its claim was against Schechter personally and did not implicate the estate.
The bankruptcy judge concluded that he did have jurisdiction of the complaint because it was a "core proceeding" under 28 U.S.C. § 157(b)(1) and (b)(2)(A) as matter concerning the administration of the estate and that Schechter was not personally liable for the unpaid taxes. Amended Memorandum Opinion, 182 B.R. 211, April 27, 1995. The Department appeals to this court pursuant to 28 U.S.C. § 158(a). The parties agree that there are no disputed questions of fact. Under Rule 8013 of the Federal Rules of Bankruptcy Procedure, questions of law are subject to de novo review. In re Newman, 903 F.2d 1150, 1152 (7th Cir.1990).
The Department's position in this appeal is that the Bankruptcy Court did not have jurisdiction to hear Schechter's case because the Department is claiming money due from Schechter in his personal capacity so that ipso facto his claim does not arise in nor is it related to the bankruptcy proceeding. It argues that, since Schechter as the operator of the businesses had a duty to comply with applicable tax statutes, he is personally responsible for his failure to do so because he had a duty not to engage in the operation of a business giving rise to tax liabilities when he knew they could not be paid1. It cites two statutes in support of its position: 28 U.S.C. § 960 and 11 U.S.C. § 346(f). Section 960 unremarkably makes a bankruptcy trustee, among others conducting a business under the authority of an United States court, subject to federal, state, and local taxes. Section 346(f) requires a trustee to collect and pay withholding taxes from wages and other forms of remuneration.
The first issue to be tackled is whether the Bankruptcy Court had jurisdiction to hear the case in the first instance. Jurisdiction of course depends on the claim at issue. Here Schechter, at least before the bankruptcy judge, was defending against two alternative theories propounded by the Department as to why he is personally liable for the unpaid state taxes. The first theory was that he was entrusted with money due the State and he therefore owed a fiduciary duty to pay it over. The second is that he had no right to withhold payment, which seems to be a claim that Schechter acted ultra vires (although in its opening brief the Department avoids using that term). A claim for breach of fiduciary duty can only "arise" in a bankruptcy case and under the Bankruptcy Code since the fiduciary status of a trustee is created by the Code and his duties are described in the Code. Mosser v. Darrow, 341 U.S. 267, 71 S.Ct. 680, 95 L.Ed. 927 (1950). The Department argues that Schechter cannot make this argument because he claims that he breached no fiduciary duty. However federal jurisdiction can exist to determine in a declaratory judgment suit that a party sued does not have a federal right. 10A Charles A. Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice and Procedure Civil 2d § 2767, p. 739. Accordingly the Bankruptcy Court had jurisdiction to hear this case as it arose out of the provisions of the Bankruptcy Code.
The bankruptcy judge's decision on the merits was based on his finding that the taxes were incurred as a result of Schechter's operation of the businesses pursuant to authority granted by the Bankruptcy Court. He cited three principles of bankruptcy law as controlling. First, an estate is a distinct entity but not a legal person and can only be sued in the name of its trustee; the trustee is a party to such a suit in his official capacity only so the estate and not the trustee is liable. Second, the trustee is generally immune from suit for actions arising out of the operation of the estate; he is the legal representative of a separate entity, the estate. Third, the immunity is not unlimited; he can be held liable under two circumstances: when he operates ultra vires and when he breaches a fiduciary duty. He noted that since the operation of the hotel had been authorized by the Bankruptcy Court his actions were not ultra vires. The state taxes arising from the operations became administrative expenses under § 503(b)(1)(B) of the Code and owed by the estate only. He also found that the claim for violation of fiduciary duty foundered because the Department had previously lost that fight when it unsuccessfully sought to have an equitable interest declared in the estate assets, which was not appealed.
The Department's main argument is that Schechter can be held personally liable for a willful or negligent breach of the statutory duty to pay taxes under 28 U.S.C. § 9602. The Department cites U.S. v. Hemmen, 51 F.3d 883 (9th Cir.1995) for this proposition. However Hemmen did not involve a breach of a statutory duty to pay taxes, but the breach of a statutory duty to turn over property in which the IRS had a property interest pursuant to a tax levy. This is an application of the principle that a trustee can be personally liable for seizing or failing to turn over property in possession of the estate but owned by someone else, which is classified as an ultra vires act. See, e.g., Leonard v. Vrooman, 383 F.2d 556 (9th Cir.1967, cert. den., 390 U.S. 925, 88 S.Ct. 856, 19 L.Ed.2d 985 (1968)). This comports with the rule articulated by the bankruptcy judge that a trustee can be held personally liable for...
To continue reading
Request your trial
-
In re Carvalho, Case No. 15–00646
...that he owed as the trustee to some claimant.' " Lassman v. Reilly , 393 B.R. at 50 (quoting State of IIIinois, Dept. of Revenue v. Schechter , 195 B.R. 380, 384 (N.D. Ill. 1996) ). "[F]ederal courts have uniformly held that bankruptcy trustees are subject to personal liability for the will......