Bankruptcy Appellate Panel of the Sixth Circuit Rules Payment of Delinquent Trust Fund Taxes May Be Nondischargeable Under 11 U.S.C. § 523(a)(6)
December 18, 2008
Joseph Wells
In a recent opinion, the Bankruptcy Appellate Panel of the Sixth Circuit (the “Sixth Circuit B.A.P.”)1 held that payment of delinquent “trust fund taxes” from the proceeds of a corporation’s receivables, upon which a creditor holds a properly secured lien, constitutes a willful and malicious injury to property of that creditor which may be nondischargeable under 11 U.S.C. § 523(a)(6) in the corporate officer’s bankruptcy case.
The relevant background provides that the Debtors owned and operated J.M.S. Nursing Pool, Inc. (“JMS”), which employed nurses and contracted their services to various health care providers. JMS, as the nurses’ employer, was responsible for withholding federal and state taxes from the nurses’ weekly paychecks.
JMS obtained an installment loan and business line of credit from JP Morgan Chase Bank, N.A. (“Chase”), and executed two promissory notes, which were personally guaranteed by the Debtors, in connection with the loan. JMS also granted Chase a security interest in its assets. Chase automatically withdrew the monthly payments owed on the promissory notes from the checking account that JMS maintained at Chase.
Subsequent to obtaining the loan, JMS began experiencing financial difficulties and was unable to pay all of the taxes withheld from its employees to the Internal Revenue Service (“IRS”). JMS’s checking account at Chase also became significantly overdrawn. After unsuccessfully attempting to resolve JMS’s financial difficulties, the Debtors contacted an IRS Tax Advocate regarding the delinquent employment taxes, and were informed by the Advocate that the employment taxes owed to the IRS constituted a “trust fund” belonging to the IRS that must be paid.
Thereafter, JMS ceased business operations. However, the Debtors continued to collect the outstanding accounts receivable of JMS. Due to the automatic payments being withdrawn from JMS’s checking account at Chase relating to the promissory notes, JMS’s checking account was substantially overdrawn and JMS was unable to pay the outstanding amounts due to the IRS. Accordingly, JMS opened another account at First Financial Bank and began depositing JMS’s collected receivables in the new account. Ultimately, JMS deposited $57,971.15 into the First Financial Bank account, from which the Debtors paid the IRS a total of $36,485.95.
Eventually, the Debtors filed for bankruptcy, and Chase filed adversary complaints against the Debtors asserting that the Debtors defaulted under the terms of the promissory notes and guaranty agreement by failing to make payments, and by willfully and intentionally causing the proceeds from the accounts of JMS to be transferred to other creditors without the consent of Chase. The complaints sought judgments of nondischargeability pursuant to 11 U.S.C. § 523(a)(6) for willful and malicious injury to Chase’s property through the intentional depletion of is collateral. In response, the Debtors argued that Chase’s security interest could not attach to funds used to pay trust fund taxes.
The Sixth Circuit B.A.P. held that “no trust is automatically created in funds received by a debtor after trust fund taxes have been dissipated. Thus, the funds paid to the IRS in the present case were not in the first instance trust funds. While [some case law] advises that a trust in after-acquired funds may be created by the fact of payment to the IRS, [ other case law] instructs that the imposition of such a trust is subject to the pre-existing interest of a secured creditor in these funds. Because Chase was a perfected secured creditor with a valid security interest in the accounts receivable of JMS, its interest in JMS’s after-acquired funds was superior to that of the IRS, notwithstanding the Debtors’ payment of the funds to the IRS.”
Further, the Sixth Circuit B.A.P. held that “[t]o accept the Debtors’ argument in these cases would produce the anomalous result that mere payment by the Debtors of the accounts receivable proceeds to the IRS somehow destroyed Chase’s interest in these funds or elevated the interest of the IRS to a position superior to that of Chase, even though absent payment, and even if the IRS had filed a lien, its interest in the accounts receivable in question would have been inferior to that of Chase. We are not convinced that this the law.”
Accordingly, the Sixth Circuit B.A.P. held that Chase had an interest in the funds paid by the Debtors to the IRS and remanded the case to the Bankruptcy Court for further consideration of the other elements of 11 U.S.C. § 523(a)(6).
1 JP Morgan Chase Bank v. Zwosta (In re Zwosta), 395 B.R. 378 (B.A.P. 6th Cir. 2008).