Terns v. Whispell

• Citation: 227 F. Supp. 498
• Parties: Russell TERNS, Plaintiff, v. Kenneth J. WHISPELL and Louise Selderbeck, Defendants. UNITED STATES of America, Plaintiff-in-Intervention, v. Russell TERNS, Kenneth J. Whispell and Louise Selderbeck, Defendants.
• Decision Date: 16 March 1964
• Court: U.S. District Court — Southern District of New York

227 F. Supp. 498

Russell TERNS, Plaintiff, v. Kenneth J. WHISPELL and Louise Selderbeck, Defendants.

UNITED STATES of America, Plaintiff-in-Intervention, v. Russell TERNS, Kenneth J. Whispell and Louise Selderbeck, Defendants.

United States District Court S. D. New York.

March 16, 1964.

Robert M. Morgenthau, U. S. Atty. for the Southern Dist. of New York, for United States of America, Philip H. Schaeffer, Asst. U. S. Atty., of counsel.

Richter & Werbalowsky, Kingston, N. Y., for Russell Terns.

DAWSON, District Judge.

On or about October 5, 1962, Russell Terns (hereinafter referred to as "Terns"), a subcontractor, brought suit in the New York Supreme Court against Kenneth J. Whispell (hereinafter referred to as "Whispell"), Terns' contractor, and Louise Selderbeck (hereinafter referred to as "Selderbeck"), the property-owner for whom certain work had been done.¹ Thereafter, on or about November 21, 1962 the action was removed by the United States to the United States District Court for the Southern District of New York.

The action now comes before this Court on cross-motions seeking orders under Rule 56 of the Rules of Civil Procedure for summary judgment on the ground that there are no material issues of fact and that each party is, respectively, entitled to judgment as a matter of law. The competing claims of the subcontractor and of the United States are founded respectively on Section 36-a of the New York Lien Law and Section 6321 of the Internal Revenue Code of 1954.

The Facts

The material facts are not in dispute. They are as follows:

1. In July 1957, Whispell entered into a contract under which he agreed to do certain work for Selderbeck.

2. Thereafter Terns was engaged by Whispell for the Selderbeck job.

3. Work was completed on the Selderbeck job in January 1958.

4. Somewhat over a month later, on March 4, 1958, federal withholding taxes were assessed against Whispell in the amount of $5,285.63. A further assessment of $250.53 was made on May 16, 1958. Notice of tax liens for each assessment was filed on March 7 and August 29, 1958, respectively.

5. On or about March 10, 1958, the Internal Revenue Service served a levy upon Selderbeck for the debt owed by her to Whispell.

6. On March 22, Whispell filed a voluntary petition in bankruptcy. During the course of that proceeding the Referee in his report recommended that the claim against Selderbeck be abandoned to the Director of Internal Revenue. The Referee's report was confirmed on August 1, 1962.

7. Terns' complaint, dated October 5, 1962, alleges that the sum of $2,120 is due Terns from Whispell.

8. In an affidavit submitted by her attorney it is admitted that Selderbeck "owes someone the sum of $1,646.89."

9. The United States intervened in this action and demanded, in its complaint, "the sum of $1,517.82 plus interest and statutory thereon according to law." (Sic).

The Applicable Law

Sections 6321 and 6322 of the Internal Revenue Code of 1954 create a lien for unpaid taxes which runs in favor of the United States upon all property and rights to property belonging to the taxpayer at the time an assessment for taxes due is made. The lien arises upon failure to pay taxes due after demand and relates back to the date of assessment. 26 U.S.C. §§ 6321, 6322.

The pertinent portions of the tax lien statute read as follows:

"§ 6321. Lien for taxes

"If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount * * * shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person."

"6322. Period of Lien.

"Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed is satisfied or becomes unenforceable by reason of lapse of time."

Once the federal tax lien attaches, competing claimants have to satisfy vigorous federal tests if they are to obtain priority over the Section 6321 tax lien which is often reinforced by the federal government's priority in insolvency. Section 3466 of the Revised Statutes. See United States v. Pioneer Amer. Ins. Co., 374 U.S. 84, 83 S.Ct. 1651, 10 L.Ed. 2d 770 (1963); United States v. Buffalo Sav. Bank, 371 U.S. 228, 83 S.Ct. 314, 9 L.Ed. 283 (1963); United States v. R. F. Ball Construction Co., 355 U.S. 587, 78 S.Ct. 442, 2 L.Ed.2d 510 (1958); United States v. White Bear Brewing Co., 350 U.S. 1010, 76 S.Ct. 646, 100 L. Ed. 871 (1956); United States v. Liverpool & London & Globe Ins. Co., 348 U.S. 215, 75 S.Ct. 247, 99 L.Ed. 268 (1955); United States v. City of New Britain, 347 U.S. 81, 74 S.Ct. 367, 98 L.Ed. 520 (1953); United States v. Security Trust & Sav. Bank, 340 U.S. 47, 71 S.Ct. 111, 95 L.Ed. 53 (1950); United States v. Waddill, Holland & Flinn, Inc., 323 U.S. 353, 65 S.Ct. 304, 89 L.Ed. 294 (1945); United States v. Emory, 314 U.S. 423, 62 S.Ct. 317, 86 L.Ed. 315 (1941); United States v. Texas, 314 U.S. 480, 62 S. Ct. 350, 86 L.Ed. 356 (1941). For a discussion of the federal tax lien, the federal priority of insolvency and the status of various competing claims, see Myers, The Fall and Rise of the Security Interest, 6 Prac.Law. 60 (1960) and Myers, The Security of Security: Incursions of Federal Tax Liens, N.Y.L.J. (June 26-30, 1961).

However the question of the priority of the Government's tax lien over a competing lien becomes pertinent only after it has been determined that the taxpayer has "property" or "rights to property" to which the tax lien has attached.

"The threshold question in this case, as in all cases where the Federal Government asserts its tax lien, is whether and to what extent the taxpayer had `property' or `rights to property' to which the tax lien could attach." Aquilino v. United States, 363 U.S. 509, 512, 80 S.Ct. 1277, 1280, 4 L.Ed.2d 1365 (1960).

See United States v. Durham Lumber Co., 363 U.S. 522, 80 S.Ct. 1282, 4 L.Ed. 2d 1371 (1960); United States v. Bess, 357 U.S. 51, 55, 78 S.Ct. 1054, 2 L.Ed.2d 1135 (1958); Fidelity & Deposit Co. of Maryland v. New York City Housing Authority, 241 F.2d 142 (2d Cir. 1957); Central Sur. & Ins. Corp. v. Martin Infante Co., 272 F.2d 231 (3d Cir. 1959); Wolverine Ins. Co. v. Phillips, 165 F. Supp. 335 (N.D.Iowa 1958).

While the classification of rights is a matter of federal law, the question of property rights is one of state law. The Supreme Court made this specific finding in Aquilino v. United States:

"In answering that question the question of whether the taxpayer has "property" or "rights to property", both federal and state courts must look to state law for it has long been the rule that `in the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property * * sought to be reached by the statute.' Morgan v. Commissioner, 309 U.S. 78, 82, 60 S.Ct. 424, 84 L.Ed. 585." 363 U.S. at 513, 80 S.Ct. at 1280, 4 L.Ed.2d 1365.

See United States v. Durham Lumber Co., supra; United States v. Bess, supra; United States v. Herman, 310 F.2d 846, 848 (2d Cir. 1962).

Thus, the initial question before this Court in regard to Section 6321 is whether under New York law a contractor-taxpayer has any "property" or "rights to property" in funds due the contractor for improvements while a subcontractor remains unpaid.

The "property rights" of a contractor-taxpayer in "improvement funds" held by a property-owner² are determined by Section 36-a of the New York Lien Law³ which impresses a trust upon moneys paid or due for improvements to real property. The Section 36-a trust runs in favor of subcontractors, architects, engineers, surveyors, laborers and materialmen for claims arising out of those improvements. In pertinent part, the statute reads as follows:

"§ 36-a. Contractor who diverts funds guilty of larceny; civil remedy to enforce trust. The funds received by a contractor from an owner for the improvement of real property are hereby declared to constitute trust funds in the hands of such contractor to be applied first to the payment of claims of subcontractors, architects, engineers, surveyors, laborers and materialmen arising out of the improvement * * * and any contractor * * * who applies or consents to the application of such funds for any other purpose and fails to pay the claims hereinbefore mentioned is guilty of larceny * * *. Such trust may be enforced by civil action maintained as provided in article three-a of this chapter by any person entitled to share in the fund, whether or not he shall have filed, or had the right to file, a notice of lien or shall have recovered a judgment for a claim arising out of the improvement. For the purpose of a civil action only, the trust funds shall include the right of action upon an obligation for moneys due or to become due to a contractor, as well as moneys actually received by him."

Section 36-a was passed to prevent improper and irresponsible practices which were then prevalent in the construction industry. By enacting the "trust fund" provision, the Legislature prohibited contractors from diverting funds received for improvements to unrelated projects at the expense of the subcontractors and materialmen whose efforts were responsible for the improvement itself. In the earliest version of Section 36-a, criminal prosecution was the only means of enforcing the trust. The 1942 amendment made a civil action available to the subcontractors, materialmen, and the other listed categories for whose benefit the statute had been enacted. These matters are fully discussed by the New York Court of Appeals in Aquilino v. United States, 10 N.Y.2d 271, 219 N.Y. S.2d 254, 176 N.E.2d 826 (1961).

The 1942 amendment which provided a civil remedy for violation of the "trust fund" provisions also enacted certain enforcement provisions which included a one-year statute of limitations.

"ARTICLE 3-A

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