Opinion
Bk. No. 17-00138-LA7
04-15-2021
In re: PECK JEEP EAGLE INC., Debtor.
WRITTEN DECISION - NOT FOR PUBLICATION
Chapter 7
MEMORANDUM DECISION
I.
INTRODUCTION
The matter before the Court is the chapter 7 trustee's objection to Claim No. 2-1 filed by the Department of Treasury, IRS ("IRS"). At the conclusion of the March 25, 2021 hearing on the claim objection, the Court took the matter under submission to consider the IRS' procedural argument that a claim objection is not the proper vehicle to challenge the IRS' lien or to subordinate its allowed claim. Based upon the evidence provided, arguments made, relevant law, and for the reasons more fully set forth below, the Court agrees that: (1) a claim objection, or a contested matter, is not a proper vehicle to determine the validity, priority, or extent of a lien or to subordinate an allowed claim; and (2) if the parties are unable to settle their dispute, the Trustee must file an adversary proceeding to challenge the IRS' lien and/or to subordinate its claim.
II.
FACTUAL BACKGROUND
Debtor filed this voluntary chapter 7 bankruptcy case on January 12, 2017, and the Trustee was appointed. In response to the Trustee's notice of the need to file proofs of claims, the IRS filed Proof of Claim No. 2-1 in the amount of $415,871.96, indicating that $299,446.67 is unsecured and $117,425.29 is secured ("Claim"). The Debtor objected to the unsecured portion of the Claim, and by prior uncontested order the unsecured portion of the Claim was disallowed in its entirety [ECF No. 58].
The unsecured portion asserted liability for failure to withhold payroll taxes; however, the Debtor owed no payroll taxes because it had closed its business and had no employees and had filed its final tax return confirming the same.
Thereafter, the Trustee filed her claim objection to the $117,425.29 asserted to be secured ("Secured Claim"). The Trustee's objection asserted that portions of the Secured Claim are for penalties, or interest on penalties, so the lien securing these amounts is avoidable and/or the amounts are subject to subordination pursuant to 11 U.S.C. §§ 724(a) and 726(a)(4). The IRS filed opposition to the Trustee's objection contending, inter alia, that proceedings to determine the validity, priority, or extent of a lien, and proceedings to subordinate any allowed claim, cannot be brought by filing a claim objection. The IRS contends that these matters are properly brought through the filing of an adversary proceeding, per Federal Rules of Bankruptcy Procedure 7001(2) and 7001(8). The Trustee responded that she routinely resolves these types of disputes with the IRS without the necessity of filing an adversary proceeding, and the IRS' filing of its Claim submits the IRS to this Court's jurisdiction to determine the Claim's validity. However, the Trustee indicated her willingness to file an adversary proceeding if necessary. / / / / / /
The Secured Claim is comprised of $3,903.68 (taxes); $101,332.70 (prepetition penalties); and $12,188.91 (prepetition interest). [POC 2-1, Attachment]
Hereinafter, all references to the Rules refer to the Federal Rules of Bankruptcy Procedure, unless otherwise specified.
Prior to the claim objection hearing, the Court issued her Tentative Ruling that: (1) the IRS had conceded that $103,332.70 of its Secured Claim is for "penalties" and thus, this portion of the Secured Claim may be avoided pursuant to § 724(a) and the lien preserved for the benefit of the estate; (2) the Court was unclear whether the $12,188.91 "interest" component of the Secured Claim represented interest on taxes, or interest on the penalties, and resolution of this remaining dispute would require supplemental evidence and a continued hearing; and (3) that this remaining dispute could be resolved as a contested matter through the claim objection without filing a formal adversary proceeding [ECF No. 86].
The Trustee submitted on the Tentative Ruling and withdrew her objection to the characterization of $12,188.91, conceding that this amount represented interest on the taxes which she could not avoid or subordinate. [ECF No. 87] The IRS did not challenge the Court's substantive ruling. However, it was unwilling to submit on the procedural portion of the Tentative Ruling that the Trustee's challenges to its Secured Claim could be resolved in a claim objection. The IRS argued that permitting parties to resolve disputes regarding the nature/priority of liens and subordination of allowed claims in the procedural context of a claim objection, without proceeding by an adversary proceeding, would cause material prejudice to the government and to private creditors.
At the close of the hearing, the Court took this procedural issue under submission.
III.
LEGAL ANALYSIS
Rule 3007 governs claim objections. Per Rule 3007(b), "[a] party in interest shall not include a demand for relief of a kind specified in Rule 7001 in an objection to the allowance of a claim." Rule 7001 sets forth the types of matters to be brought via an adversary proceeding, including proceedings to (i) determine the validity, priority, or extent of a lien or other interest in property; and (ii) subordinate any allowed claim or interest. See Fed.R.Bankr.P. 7001(2) and 7001(8).
Here, Trustee's objection to the Claim asserts that a portion of the Secured Claim can be subordinated and/or the lien avoided because it is for a penalty or interest on a penalty. The Court agrees that disputes of this nature are not properly decided in the context of a claim objection because they are adversary proceedings. The Court made a pragmatic procedural ruling because the IRS' opposition had conceded that $103,332.70 of its Secured Claim is penalties. As a matter of law, a lien for penalties can be avoided and the penalties claim subordinated, which the IRS did not appear to dispute. Thus, it appeared that only $12,188.91 of the Secured Claim was truly contested. The Court weighed the expense and delay of proceeding by formal adversary proceeding, and the relatively small amount in dispute, with the fact that the IRS had already appeared and was vigorously defending the claim objection. The Court made the decision that it would be more efficient to resolve the remaining dispute in this claim objection and, if necessary, by evidentiary hearing. The Court stated in her Tentative Ruling that an adversary proceeding is generally required; however, in this case, resolving the remaining dispute over the classification and treatment of roughly $12,000 in a contested matter is not inconsistent with substantial justice. Doing so would not affect the IRS' due process rights where the IRS has vigorously defended the claim objection and has had the opportunity to be heard on the matters in dispute. See In re Downey Regional Medical Center-Hosp., Inc., 441 B.R. 120, 127 (9th Cir. BAP 2010) (if the absence of a formal adversary proceeding did not cause prejudice, form should not be elevated over substance).
Additionally, the IRS' opposition indicated that the parties were discussing settlement. [ECF 77-1, Pg. 4] --------
However, the IRS in oral argument expressed concern that the Court's ruling sets a precedent for future disputes that prejudice the government, or other creditors, by waiving the benefits and formalities of an adversary proceeding and forcing them to defend future Rule 7001 disputes through a less formal claim objection or other contested motion. The Court acknowledges the IRS' concern. The Court had no intention of setting a precedent that a claim objection is a procedural substitute for a formal adversary to determine the validity, priority, or extent of a lien, or to subordinate an allowed claim. The Court has reviewed the applicable Rules, and they clearly provide that a demand for this type of relief cannot be made in a claim objection because they are adversary proceedings. See Fed. R. Bankr. P. 3007(b); Fed. R. Bankr. P. 7001(2) and 7001(8).
However, the Court does not foresee that a formal adversary proceeding will change the substantive outcome. In the interests of economy, the Court encourages the parties to settle this dispute. If the parties are unsuccessful, then the Trustee must proceed by adversary proceeding to avoid/subordinate the IRS' Secured Claim.
IV.
CONCLUSION
For the foregoing reasons, the Court vacates her Tentative Ruling that permitted this dispute to proceed by way of a claim objection, or as a contested matter, and instead holds that an adversary proceeding is the proper vehicle to avoid/subordinate the IRS' secured claim in this matter. The IRS is directed to prepare and lodge an order in accordance with the revised holding contained in this Memorandum Decision. DATED: April 15, 2021
/s/_________
Louise De Carl Adler, JUDGE
United States Bankruptcy Court
Notice Recipients
District/Off: 0974-3 User: Admin. Date Created: 4/15/2021 Case: 17-00138-LA7 Form ID: pdfO1 Total: 6 Recipients of Notice of Electronic Filing: tr Leslie T. Gladstone candic@flgsd.com aty Christin A. Batt christinb@flgsd.com aty Jack Fitzmaurice jackf@fitzmauricelaw.com aty Leslie T. Gladstone candic@flgsd.com aty Leslie T. Gladstone leslieg@flgsd.com TOTAL: 5 Recipients submitted to the BNC (Bankruptcy Noticing Center): db Peck Jeep Eagle Inc. 4370 Colling Rd. East Bonita, CA 91902 UNITED STATES TOTAL: 1