Opinion
Case No. 96-15044-RGM.
January 12, 2007
MEMORANDUM OPINION
THIS CASE is before the court on the debtor's motion to hold the Internal Revenue Service in contempt for violating the terms of his confirmed chapter 11 plan. The court finds that the Internal Revenue Service did not properly comply with the terms of the confirmed chapter 11 plan and that sanctions are appropriate.
Background
Jeffrey M. Sherman filed a voluntary petition in bankruptcy pursuant to chapter 11 of the United States Bankruptcy Code in this court on September 16, 1996. The Internal Revenue Service timely filed its proof of claim on December 26, 1996. It asserted a secured claim in the amount of $85,374.32; a priority claim in the amount of $1,720.72; and an unsecured non-priority claim in the amount of $464.87. The debtor filed his chapter 11 plan on January 13, 1997. It did not provide for the payment of the secured claim of the Internal Revenue Service. It provided in Article IV that all "Tax Claims" would be paid in accordance with § 1129(a)(9)(C). This section provided that priority tax claimants would be paid the present value of their claim as of the effective date of the plan over a period not exceeding six years after the date of the assessment of the taxes. The debtor's disclosure statement stated that the Tax Claims were about $30,000.00 and that none of the claims of the IRS were secured because there was no equity in the real estate that he owned.
The secured claim was for the tax periods ending December 31, 1992 and December 31, 1993. The taxes were assessed on November 29, 1993 and August 21, 1995, respectively. The claim for priority taxes was for the tax period ending December 31, 1995. The tax was assessed on September 30, 1996.
The IRS objected to confirmation noting that the debtor had not objected to its proof of claim and that the plan made no provision for the treatment of its secured claim. After negotiations, the debtor and the IRS agreed upon a confirmation order which was entered on the docket on November 19, 1997. The order provided, as to the IRS, that the IRS' secured claim would be paid within six years of the date of the assessment of the taxes together with interest from the petition date. Payments were to commence on or before the effective date of the plan. The order preserved the debtor's right to object to the IRS' proof of claim. It is clear that the resolution was an interim solution permitting confirmation and giving the parties an opportunity to resolve the matters arising from the IRS' proof of claim.
The parties did not resolve their differences with respect to the proof of claim and on February 27, 1998, the debtor filed an objection to the IRS' proof of claim. He asserted that the claim was an unsecured claim; that the IRS had obtained a preference and was not entitled to any distribution until the preference had been discharged; and that the amount of the claim was incorrect in light of amended returns that he had filed. The United States filed an answer to the objection. It was represented by Melissa A. Holton in the Tax Division of the Department of Justice. The answer was, in essence, a general denial. Ms. Holton and the debtor engaged in negotiations to resolve the differences between the debtor and the government. The negotiations culminated in a consent order entered on the docket on April 7, 2000. The consent order provided that the IRS would file an amended proof of claim, that a post-confirmation set off in the amount of $12,026.35 would be retained by the IRS and credited against the debtor's priority tax claim, and that the amended proof of claim would be paid in 72 installments commencing on the first day of the first full calendar month after entry of the consent order. The IRS reserved the right to further examine the debtor's tax returns and the debtor reserved the right to object to the amended proof of claim. In fact, the debtor and the IRS had agreed on the amended proof of claim which had been filed on March 22, 2000. It asserted an unsecured priority tax claim in the total amount of $36,210.08 and a general unsecured claim in the amount of $12,402.56. This proof of claim was never challenged and constitutes the IRS' allowed claim. On May 17, 2000, the IRS wrote to the debtor referencing the consent order settling the objection of the claim. It properly acknowledged that the priority tax claim was to be paid with interest over a period of 72 months. It computed the monthly payment of $448.86. The payment computed by the IRS is the amount necessary to amortize the priority tax claim together with interest at the rate of ten percent per annum over 72 months.
The chapter 11 plan also provided that the unsecured general claim would be paid no later than 60 days after entry of the order which was also acknowledged by the IRS. The plan provided that unsecured claims would be paid five percent of the amount of the allowed unsecured claim. In this case, the payment to the IRS was in the amount of $620.13. The court finds that the payment was made, giving weight to the debtor's testimony and not the IRS' documentation.
The May 17, 2000 letter did not state the interest rate used by the Internal Revenue Service. The court requested the parties determine the interest rate used by the Internal Revenue Service. The government computed the interest rate at ten percent asserting that interest commenced on May 1, 2000. The debtor computed the interest rate at 10.07 percent. The court finds that the IRS used a ten percent annual interest rate, but that interest was computed from April 1, 2000. The first payment was, in accordance with the IRS letter, due on May 1, 2000. Interest on an amortized loan is paid in arrears unless otherwise provided. The IRS statutory interest rate at that time was nine percent. See debtor's Exhibit U, IRS response to debtor inquiry stating interest rate under Internal Revenue Code § 6601.
In 2003, long before the debtor was required to have completed the payments under the plan, he sought to pay off the debt to the IRS by refinancing his real property. In doing so, he discovered that the IRS had filed a lien against his property which asserted a claim for more than the claim allowed in the bankruptcy case. He was successful in refinancing the property and paid the IRS the balance believed due. This, however, did not end the matter. The IRS asserted that a balance was still due. After much discussion between the debtor and the IRS, it was determined that the IRS was asserting that the debtor owed interest on the tax claim for the date of the filing of the petition until the confirmation of the debtor's chapter 11 plan (or perhaps to the effective date of the plan) which it calls "gap interest". The amount claimed was substantial. The debtor was unable to convince the IRS that its allowed claim had been satisfied in full in the bankruptcy proceeding. When all other avenues of redress had been exhausted, he turned to this court and filed the motion presently under consideration.
Discussion
The Internal Revenue Service asserts in its answer that notwithstanding the confirmed chapter 11 plan, the debtor is obligated to pay gap interest which had a balance as of December 15, 2006 of $4,588.50. It previously offset refunds from the debtor's 2002 return, 2004 return, and 2005 return in the amounts of $5.76, $7.24 and $9,131.00, respectively. See U.S. Exhibit U. Thus, it has collected and seeks to collect a total of $13,732.50 for gap interest. The government relies upon Bruning v. United States, 376 U.S. 358, 84 S.Ct. 906, 11 L.Ed. 2d, 772 (1964); Banks v. Sallie Mae Servicing Corporation (In re Banks), 299 F.3d, 296 (4th Cir. 2002); and Mooreshead v. Educational Credit Management Corporation (In re Mooreshead) 2000 W.L. 4532236 (Bank. E.D. Va. Jan. 4, 2000). It is not necessary, and the court does not decide, whether gap interest, that is, the interest that accrued on the tax claim from the date of the filing of the petition until confirmation of the chapter 11 plan or the effective date, whichever may be appropriate, is discharged in an individual chapter 11 case. This argument is a red herring because it is quite clear that the government may compromise its claims, or agree to a treatment other than provided in § 1129(a)(9)(C). In fact, in this case, it did so. Here, although § 1129(a)(9)(C) provides that priority tax claims will be paid over a period of six years after the date of the assessment of the claim, the consent order, which modified the chapter 11 plan, provides for a six-year payment period commencing on the first day of the first full calendar month after entry of the order, that is, May 1, 2000. The question in this case is the extent of the settlement and the terms of the debtor's obligation to the IRS arising from the taxes in question in this case.
The gap period ran from the filing of the petition on September 16, 1996 and ended on either November 19, 1997, the date of entry of the confirmation order, or January 31, 1998, the effective date of the date. (The effective date of the plan was the last day of the first full month after the confirmation order became final. Because the tenth day after the entry of the confirmation order fell on a weekend, the confirmation order did not become final until December 2, 1997).
The court notes that both Moorehead and Banks were student loans cases. Priority tax claims are provided specific treatment in chapters 11 and 13. See Bankruptcy Code § 1129(a)(9)(C). Chapter 11 provides that the claim, which is determined as of the date of the filing of the case and which does not include gap interest, is to be paid in full on the effective date of the plan. Alternatively, the present value as of the effective date of the plan of the claim may be paid over a period of time. Prior to the 2005 amendments, that period of time was six years from the date of the assessment of the tax claim. The 2005 amendments extended it to a six-year period independent of the date of assessment. In chapter 13, the chapter 13 plan must provide for the payment in full of the tax claim. 11 U.S.C. § 1322(a)(2). There are no similar provisions for payment of student loans or other non-dischargeable claims. Moreover, Banks confirms that a chapter 13 plan may provide that less than payment in full of a student loan discharges the student loan. In Banks, the Court of Appeals in applying Bruning stated that a student loan is not generally dischargeable and, if not paid in the chapter 13 plan, is payable by the debtor at the conclusion of a chapter 13 plan. That would have been enough to have decided Banks. What concerned the Court of Appeals was the procedure a debtor must follow to obtain a full or partial discharge of a student loan debt. These issues of due process have been addressed by the court in other cases. See Cen-Pen Corp. v. Hanson (In re Hanson) 58 F.3d 89 (4th Cir. 1995); Piedmont Trust Bank v. Lincus (In re Lincus) 990 F.2d 160 (4th Cir. 1993).
Section 1129(a)(9)(C) begins: Except to the extent that the holder of a particular claim has agreed to a different treatment of such claim . . ."
The court finds that the consent order entered by the court on April 7, 2000, resolved all outstanding issues between the debtor and the IRS including the payment of gap interest. The order itself reflects that more than the proof of claim was resolved. It resolved the $12,026.35 set off to which the debtor objected. It resolved the assertion of the preferential transfer made by the IRS. It resolved the issues raised by the proof of claim, that is, whether the claim was a secured claim or an unsecured priority claim. It resolved the amount of the claim. Importantly, it provided a comprehensive manner in which the debtor's obligations to the IRS would be paid and contemplated that they would be paid in full.
The government asserts that the confirmation order controls, that the consent order merely fixes the amount of its claim. The confirmation order provides that interest will be paid from the petition date. Thus, the debtor owes gap interest by virtue of the terms of the plan. The government is mistaken in this regard. Interest is required to be paid on an oversecured claim such as the IRS asserted in this case. Bankruptcy Code § 506(b); United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 109 S.Ct. 1026, 103 L.Ed. 2d 290 (1989). The confirmation order which was intended to be a temporary resolution of the matter did not provide for a payment of gap interest on the secured portion of the debt, but rather the interest required to be paid to an oversecured creditor under Bankruptcy Code § 506(b). In fact, the confirmation order did not address the IRS' priority claim at all. Priority tax claims are addressed in Article IV of the Chapter 11 plan. They were to be paid within six years of the date of assessment, with interest at the applicable statutory rate from the confirmation of the plan.
If there were an ambiguity as to the meaning of the order, the correspondence between the debtor and Ms. Holton during the course of negotiations makes clear that the consent order resolved all matters in the case. Ms. Holton's letter to the debtor dated July 30, 1999, U.S. Exhibit I, states:
We understand that your compromise offer is made in full settlement of all issues in this case, and, if accepted, will result in the filing of a stipulation for dismissal with prejudice, the parties to bear their respective costs, including any possible attorneys' fees or other expenses of this litigation.
Please advise us in writing whether or not the foregoing comports with your understanding.
By letter dated August 2, 1999, from the debtor to Ms. Holton, the debtor confirmed this understanding. Debtor's Exhibit I. While there was no testimony of any express discussion between the debtor and Ms.Holton as to gap interest, it is inextricably intertwined with the debtor's tax obligations and their resolution in this chapter 11 plan. The entire purpose of the chapter 11 plan was to liquidate the obligation to the IRS and pay it in full. Both the debtor and the IRS wanted the claim to be fully and completely resolved. Neither wanted to resolve a portion of the claim and leave a portion for a later date.
The IRS acted on this understanding as reflected by its letter to the debtor of May 17, 2000, which immediately followed the entry of the consent order. This letter set out the terms of payment, the amount of the payment, and the commencement date for the payments. The interest rate chosen by the IRS was ten percent. The statutory rate applicable at that time was nine percent. The chapter 11 plan provided in Article IV that priority claims would be paid at the statutory rate. The letter reflects several things. First, there is no capitalization of the gap interest. The amortization payment is based only on the amount of the allowed claim, the interest rate of ten percent, and the amortization period of 72 months. The letter also provides for the payment of the unsecured portion of IRS' tax claim. It does make any demand for payment of gap interest. All of this is in accordance with the chapter 11 plan, the consent order, and the intention of the parties to fully and finally resolve all matters.
Johanna Trevino, an IRS employee, testified at the hearing. She has been a bankruptcy specialist for 27 years. The case was assigned to her in June, 2003, when the debtor requested a payoff. She prepared U.S. Exhibit U. She was also the individual who computed the payoff amounts for the debtor and computed the gap interest. She testified that when she prepared the payoff, she recognized that the gap interest had not been included in the IRS account, caused the account to be recomputed, and assessed gap interest. She did not, apparently, review the chapter 11 plan, the confirmation order or the consent order. It is clear that when the consent order was originally entered in April, 2000, it was transmitted to the IRS which processed it. The IRS employee processing it at that time did not assess the gap interest. He clearly had the consent order and access to Ms. Holton. Three years later, Ms. Trevinoassessed the gap interest, thereby changing what had been the understanding of the consent order accepted by both the IRS and the debtor. The court places greater weight on the IRS' conduct at the time the consent order was entered than its conduct more than three years later.
Ms. Holton may have forwarded the consent order to the IRS. The record is silent on how the IRS got the consent order.
The court is satisfied from the face of the consent order that this was a comprehensive settlement which included the claim to gap interest. If the consent order is itself ambiguous, the correspondence between the debtor and Ms. Holton relating to the completeness of the settlement and the actions of the IRS immediately upon conclusion of this settlement as reflected in its letter of March 17, 2000, reflect the understanding of the parties that this was a complete settlement.
The court finds that the debtor's tax obligations to the IRS including all gap interest were fully and finally resolved by the consent order entered on the docket on April 7, 2000. The obligation of the debtor was to pay the amount in the allowed proof of claim that was filed by the IRS on March 22, 2000, which was in the amount of $36,210.08 for priority taxes. Against this amount, he was entitled to a credit of $12,026.35 leaving a balance to be amortized of $24,183.73. This was to be amortized over a period of 72-months with an interest rate of ten percent. The amortized payment was $448.86. The debtor sought to pre-pay this obligation and discharged the obligation early. The amount of the payoff was a simple amortization. In order to compute the payoff amount, the outstanding principal accrued interest at the rate of ten percent from April 7, 2000, the date of entry of the consent order, until paid. The debtor has now overpaid this amount and the government must refund his overpayment with interest at the statutory rate.
Sanctions are appropriate in this case. The debtor spent significant time endeavoring to resolve this issue, entirely without success. He was met by an unresponsive IRS that at that time simply ignored the chapter 11 case and blindly adhered to Bruning v. U.S. A reasonable sanction would be to award the debtor compensation for the time and effort that he devoted to this effort. He is a professional and the time that he devoted must have been taken from his professional endeavors and he must have suffered an actual pecuniary loss as a result thereof. There is, however, no evidence in the record to determine the extent of this loss and the court cannot make an award without some basis. The court notes, however, that the IRS in its response to the debtor's December 3, 2004 inquiry, computed the obligation in accordance with the prevailing statutory rate as it changed over the applicable period of time. Debtor's Exhibit U. The agreement of the parties was to pay interest at the rate of ten percent per annum. The sanction in this case will be that the amount to be refunded to the debtor will be increased by the difference between the interest rate the IRS was statutorily entitled to charge and ten percent. The parties should compute the amount due under the settlement agreement on the adjustable rate as provided by the IRS in Debtor's Exhibit U and not at the rate of ten percent.
Debtor's Exhibit U was prepared in December, 2004, and does not purport to be a transcript of the debtor's tax accounts. It appears to have been computer generated in December, 2004. Ms. Trevino testified as to how such computations were made. The court does not accept it as reflecting the IRS' understanding of the account as of May 17, 2000. For example, the interest assessed for the period from March 31, 2000 to June 19, 2000, was $285.41 which is interest at the nominal rate of 9 percent, but compounded daily, the proper rate under 26 U.S. § 6601 at the time but not under the chapter 11 plan. The May 17, 2000 letter used 10 percent.