United States v. Sterling National Bank & T. Co. of NY, 72 Civ. 1533.

• Decision Date: 05 June 1973
• Docket Number: 72 Civ. 1533.
• Citation: 360 F. Supp. 917
• Parties: UNITED STATES of America, Plaintiff, v. STERLING NATIONAL BANK & TRUST COMPANY OF NEW YORK, Defendant and Third-Party Plaintiff, v. Charles S. SMITH, Third-Party Defendant.
• Court: U.S. District Court — Southern District of New York

360 F. Supp. 917

UNITED STATES of America, Plaintiff, v. STERLING NATIONAL BANK & TRUST COMPANY OF NEW YORK, Defendant and Third-Party Plaintiff, v. Charles S. SMITH, Third-Party Defendant.

72 Civ. 1533.

United States District Court, S. D. New York.

June 5, 1973.

Whitney North Seymour, Jr., U. S. Atty., S. D. N. Y., New York City, for plaintiff; David P. Land, Milton Sherman, Asst. U. S. Attys., of counsel.

Harry Gurahian, New York City, for Sterling National Bank & Trust Co. of New York.

PALMIERI, District Judge.

This is a motion by the Government for summary judgment. Fed.R.Civ.P. 56. The material facts in the case are not in dispute.

The case involves a dispute relating to the obligations of the defendant Bank as the result of a tax levy affecting one of its depositors.

The United States brought this action against Sterling National Bank & Trust Company of New York (Bank) after the defendant failed to honor a tax levy made by the Internal Revenue Service (I.R.S.) upon the checking account of one of the Bank's depositors.

Since the chronology of events is of crucial importance it is set forth below.

On February 13, 1970, the I.R.S. made an income tax assessment and demand for payment against Charles S. Smith (taxpayer) and his wife, jointly and severally, for the taxable period ending December 31, 1968, in the amount of $8,211.38.

On June 23, 1970, the taxpayer borrowed $6,097.32 from the Bank as evidenced by his promissory note. Under the terms of the note the taxpayer gave the Bank a continuing lien and right of setoff upon any and all cash balances the taxpayer maintained with the Bank to be applied against any and all indebtedness, whether matured or unmatured.

On August 14, 1970, the I.R.S. made a second assessment and demand against the Smiths. This claim involved unpaid income taxes for the taxable period ending December 31, 1969, and amounted to $6,475.20.

The I.R.S. filed notices of lien with respect to the two assessments referred to above on November 5, 1970, and March 2, 1971, respectively.

On June 9, 1971, the I.R.S. served the Bank with a notice of levy. The levy indicated that the taxpayer was indebteded to the Government in the amount of $15,531.26 ($14,686.58 in assessed taxes, plus statutory additions). The levy directed the Bank to remit to the I.R.S. all of the taxpayer's property then in the Bank's possession. The taxpayer maintained a checking account with the Bank which on the day the levy was served had a balance of $5,132.36. Prior to service of the levy the Bank had not acted to restrict the taxpayer's right to withdraw funds from the account.

Because the Bank did not remit the funds in the taxpayer's account as the notice of levy had instructed, the I.R.S. served the Bank with a final demand on June 18, 1971. This instrument directed the Bank to honor the levy and set forth the provisions of law which govern dishonor.

On July 2, 1971, the Bank exercised its alleged right of setoff and applied $3,779.64 to satisfy the indebtedness of the taxpayer, remitting what was left in the taxpayer's account, the sum of $1,352.72, to the I.R.S.

On August 5, 1971, the I.R.S. advised the Bank by letter that the I.R.S. had a prior right to the entire $5,132.36 balance of the taxpayer's account and demanded payment of the remaining $3,779.64 within two weeks. The Bank did not comply with this demand.

On April 14, 1972, this action was brought by the Government to recover $3,779.64 (the amount collected by the Bank by way of setoff), $1,889.82 (half of the first amount as a 50 percent penalty pursuant to 26 U.S.C. §§ 6332(c)(1) and 6332(c)(2)), plus interest and costs of the action.

On September 26, 1972, the taxpayer died.

On December 5, 1972, his estate paid his tax indebtedness plus interest in full.

In the present posture of the case the claim for $3,779.64 has been rendered moot by virtue of the payment of the tax and interest by the taxpayer's estate subsequent to the motion for summary judgment. The Government presses its motion, however, on its 50 percent penalty claim, upon the premise that in exercising its setoff on July 2, 1971, the Bank dishonored the tax levy, notice of which was previously served on the Bank on June 9, 1971, and June 18, 1971; and that the Bank was without reasonable cause for its action.

Section 6332(c)(1)¹ provides that when one dishonors a tax levy, he is personally liable to the United States for the value of the property not surrendered, together with costs and interest. Section 6332(c)(2)² provides that when the dishonor is "without reasonable cause," such person shall be liable for a penalty equal to 50 percent of the "amount recoverable" under § 6332(c)(1). The amount sued for by the Government and claimed as the amount recoverable at the outset of its lawsuit was $3,779.64, plus interest and costs. This was the amount allegedly dishonored and collected by the Bank by way of setoff.

The government is now seeking half of this amount as its "additional" recovery by way of penalty. As already indicated, and because of the payment by the taxpayer's estate, the penalty amount is the only stake in this litigation in its present posture.

The issues presented by the motion are the following: (1) whether at the time of the Government's notice of levy on June 9, 1971, there were "property or rights to property subject to levy" within the purview of § 6332(a);³ (2) whether the Bank dishonored the levy; (3) assuming dishonor of the levy by the Bank, whether its action was "without reasonable cause" within the purview of § 6332(c)(2), and (4) whether in the present posture of the case the Bank is liable for the penalty under § 6332(c)(1).

The Bank Was Holding "Property or Rights to Property Subject to Levy"

Title 26 U.S.C. § 6331(a)⁴ provides for a levy "upon all property and rights to property (except such property as is exempt under § 6334) belonging to such a person or on which there is a lien provided in this chapter for the payment of such tax." The application of this language here turns on whether the funds on deposit with the Bank in the taxpayer's account were subject to the levy. The Government contends that they were and in claiming priority for its tax levy against the Bank's right to setoff it relies directly upon two Ninth Circuit decisions. They are Bank of Nevada v. United States, 251 F.2d 820 (9th Cir., 1958), cert. denied, 356 U.S. 938, 78 S. Ct. 780, 2 L.Ed.2d 813, and United States v. Bank of America National Trust & Savings Ass'n, 229 F.Supp. 906 (S.D.Cal., 1964), aff'd 345 F.2d 624 (9th Cir., 1965), cert. denied, 382 U.S. 927, 86 S.Ct. 534, 15 L.Ed.2d 340 (1965). The Government contends that since the depositor taxpayer had the right to withdraw and use the account until the Bank took action to foreclose this right by setoff, the balance in the account was subject to the tax levy at any time before the Bank asserted its right of setoff. The facts in the instant action are very similar to the facts in the Nevada case and the Bank of America case, supra, which held that a bank did not have a lien priority by exercising its right of setoff.

In the Bank of Nevada case, the I.R.S. made a tax assessment against a taxpayer on November 15, 1954. The taxpayer then borrowed money from the bank on April 16, 1955, and, based upon a pre-existing financial statement dated August 31, 1954, the bank had a right to accelerate repayment of the loan. If the loan was accelerated, the bank could use a right of setoff. On June 10, 1955, the I.R.S. served a levy on the bank with respect to the balance of the taxpayer's bank account, and subsequently the bank exercised its right of setoff. In a suit to determine lien priorities, the court held for the Government. In so holding, the court stated:

The Bank could not protect itself from a federal tax levy by the taxpayer's inchoate agreement, or by an asserted right of set-off arising from a debt that was not in existence at the time the tax liens arose . . . The liens came into being at the time the assessments were made. 251 F.2d, at 825.

In the Bank of America case, a factual pattern analogous to the Nevada case was present and the court held for the Government. In so holding the court stated:

It is inconceivable that, by Section 6323 old statute⁵ Congress meant to say if a bank or other entity became a purchaser or a mortgagee in one transaction, funds held by it as the result of another transaction (i. e., creation of a debtor-creditor relationship in respect to a bank deposit) would be beyond the reach of the Government in a proceeding such as this.

Nor do we find persuasive the bank's argument that the taxpayer himself, being indebted to the bank could not demand payment on his accounts and therefore the Government could not demand such payment. While the bank asserts it had a right of set-off, it had not exercised this right until after the tax assessment was made and the levy served. 229 F.Supp., at 909.

The controlling factor in both these cases appears to be that the I.R.S. made tax assessments prior to the time the banks obtained a right of setoff against the taxpayers' bank accounts. In consequence, any right the banks had to the taxpayers' properties was encumbered by the pre-existing tax lien.⁶ These Ninth Circuit decisions are accepted as persuasive authority that the Bank's right of setoff is not prior to the federal tax lien and hence cannot be asserted to defeat the federal tax levy. Additionally, a more recent decision of that circuit, United States v. First National Bank of Arizona, 348 F.Supp. 388 (D.Ariz., 1970), affirmed per curiam, 458 F.2d 513 (9th Cir., 1972), although not limited to the facts of the Bank of Nevada case, was thought by the Ninth Circuit to require the same result. In the Bank of Arizona case the District Court said (supra, 348 F.Supp. at p. 389):

Until a bank has notified its depositor and then exercised emphasis in original its right of set off,

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