The United States Court of Appeals for the Third Circuit recently addressed an issue of first impression – whether a Chapter 7 trustee (the “Trustee”) could avoid multiple small-dollar payments to the Internal Revenue Service (“IRS”) that the debtor (the “Debtor”) had made on behalf of multiple clients, on the basis that all of the payments were made to the same payee. The Court rejected the Trustee’s argument as one that would render 11 U.S.C. § 547(c)(9) superfluous and ineffective. The Court also rejected the Trustee’s argument with respect to the one remaining transfer that surpassed the Bankruptcy Code’s $5,850 preference action threshold*, finding the payment qualified as a “trust fund tax” that was not an interest of the debtor in property. In the context of the latter ruling, the Court provides a detailed analysis of the Supreme Court’s Begier v. Commissioner, 496 U.S. 53 (1990) decision.
*since the time the adversary proceeding was initiated, the threshold has been increased to $6,225
The Bankruptcy and District Court Cases
Debtor’s business involved managing its clients’ (the “Clients”) payrolls and employment taxes. The arrangement authorized Debtor to transfer funds from Client bank accounts into Debtor’s account and to remit those funds to the Clients’ employees, the IRS, and other taxing authorities. At issue in this case were five transfers (the “Transfers”) Debtor made to the IRS on behalf of the Clients in the ninety days leading up to August 2, 2011 (the “Petition Date”) – four of which were less than the $5,850 preference action threshold established by 11 U.S.C. § 547(c)(9). The fifth transfer was for $32,297 (the “Remaining Transfer”).
The Trustee sought to avoid the Transfers on the basis that, in the aggregate, the Transfers exceeded $5,850, and thus, the threshold was not a barrier. The District Court for the Middle District of Pennsylvania (“District Court”) disagreed, granting summary judgment to the IRS and finding the Transfers could only be aggregated if they are “transactionally related” to the same debt; in this case, the District Court found that the four sub-$5,850 Transfers were separate and unrelated transactions in satisfaction of independent antecedent debts to different creditors. The Remaining Transfer was found to fall outside the bounds of “property of the estate”, as it was protected by the Internal Revenue Code (“IRC”) provision which creates a statutory trust in favor of the United States for taxes withheld from employee paychecks. Trustee appealed.
The Trustee’s Arguments on Appeal
On appeal, the Trustee argued that the Bankruptcy Code allows the aggregation of transfers that individually fall below the threshold, as long as they were all to the same transferee, citing 11 U.S.C. § 102(7) for the concept that “the singular includes the plural” in interpreting 11 U.S.C. § 547(c)(9). The Trustee further argued that section 547(c)(9) is internally contradictory, because the term “aggregate” implies a summation of various transfers, while the language “such transfer” implies the defense should be applied on a payment by payment basis.
As to the Remaining Transfer, the Trustee contended that Debtor was an intermediary that withheld and paid taxes on behalf of the Client, and that the “obvious meaning of the statute is that in order for a trust to be created, a person who is required to collect the tax must actually withhold the tax.” Trustee argues that because the Clients, not Debtor itself, were required to withhold the taxes at issue, those withholdings escape the statute’s limitations.
The Third Circuit’s Opinion
The Threshold Dispute
The Court first noted that it had not yet had the opportunity to examine section 547(c)(9), which states that a “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*.”
*see note above regarding the revised threshold amount
As applied to the four sub-threshold Transfers, the Court found that Trustee’s argument made little sense. It held that by Trustee’s logic, an individual creditor’s ability to invoke the minimum threshold as a defense “would depend not only upon whether the transfer from which it benefitted was less than $5,850, but also on whether the debtor had made any transfers (large or small) for the benefit of other creditors, and whether all transfers taken together exceed the statutory threshold . . . this cannot be the law.” The Court found that the language of section 547(c)(9) requires a transfer by transfer analysis and that creditors be considered independently, meaning creditors who have received the benefit of a prepetition transfer less than the threshold may invoke the defense regardless of what other creditors have received. The Court noted that “ostensibly distinct transfers may nevertheless be aggregated if they are, in effect, a single transfer on account of the same debt.”
As to Trustee’s reliance on the “singular includes the plural” maxim, the Court found that it “simply means that (1) a creditor may invoke the defense for multiple, independently qualifying transfers (i.e., it’s not a “one-and-done” defense) and (2) a party may defeat the defense where the challenged transfers are strategically divided yet transactionally related.” Since each sub-threshold Transfer involved a different Client, unrelated antecedent debts, and distinct tax liabilities, they could not be aggregated to exceed the threshold.
The Property of the Estate Dispute
The Court next addressed whether the Remaining Transfer involved the transfer of an interest of the debtor in property, as required by 11 U.S.C. § 547(b). It began this analysis by a thorough review of the Begier decision, which established the benchmark for trust fund taxes. Importantly, that decision found that the trust was created at the moment the relevant taxes were withheld, and that “[w]ithholding … occurs at the time of payment to the employee of his net wages.” Furthermore, no common law tracing was required in these trust fund cases, as the applicable IRC provision “creates a trust in an abstract ‘amount’—a dollar figure not tied to any particular assets—rather than in the actual dollars withheld.” Ergo, “any voluntary prepetition payment of trust-fund taxes out of the debtor’s assets is not a transfer of the debtor’s property” and “the debtor’s act of voluntarily paying its trust-fund tax obligation … is alone sufficient to establish the required nexus between the ‘amount’ held in trust and the funds paid.”
Applying Begier to the instant case, the Court found that the fact that Debtor was an intermediary that withheld and paid taxes on behalf of the clients – the sole relevant distinction here from the facts of Begier – was irrelevant. To the contrary, the applicable IRC provision “does not say that clients themselves must be the only ones involved in the withholding process in order for trust principles to be implicated.” Nothing “suggests that an employer may avoid the fact that an amount required by law is being held in trust for the United States merely by outsourcing payroll processing to a third party.” The Court conceded that Trustee cited one non-jurisdictional bankruptcy court decision that directly supported his argument, but found that opinion to be “devoid of analysis”, a defect that was not corrected by a subsequent opinion from the pertinent Court of Appeals.
The Court adds, in an interesting footnote, that even without the preemption of federal law in this case, Pennsylvania law (which governed Debtor’s agreements with the Clients) would mandate that the Transfers be held in a resulting trust, as the IRS produced ample evidence to show that there was no intention by the Clients to give Debtor the beneficial interest in the Transfers.
Thus, the Court affirmed the District Court’s judgment in all respects.
Aside from this being a matter of first impression in the Third Circuit with respect to aggregation dispute, the Court provides a detailed breakdown of the Begier decision and its continued vitality in tax-related preference issues. Given the involvement of the IRC, the ultimate utility of this decision (as to its trust component) in other contexts remains to be seen.
A copy of the Net Pay Opinion can be found here.