Opinion
Civil No. A3-01-05, Bankr. Appeal No. 2000-10, Bankr. No. 99-31826, Adv. No. 00-7021.
June 13, 2001
MEMORANDUM AND ORDER
I. Introduction
Before the Court is an appeal by Superpumper from a partial summary judgment entered in favor of the United States by the Honorable William A. Hill, United States Bankruptcy Judge. For the reasons set forth below, the Court AFFIRMS the order of the bankruptcy judge and the judgment entered thereon.
II. Background
The essential facts are not much in dispute, though their legal effect obviously is. In the early 1990s, Nerland Oil failed to pay various federal taxes. The Internal Revenue Service therefore made assessments for unpaid taxes against it on several dates between August 1993 and September 1999, resulting in a number of tax liens. These assessments and liens total roughly 1.6 million dollars, $566,227 of which arose in 1993 and 1994. However, the IRS did not file any public notice of its liens until September 1998.
In June 1995, Nerland Oil sold the Dakota Fuel Stop, a gas station in Jamestown, North Dakota, to Superpumper. As part of the transaction, Superpumper executed a promissory note in favor of Nerland Oil for $350,000, securing it with a second mortgage on the property. Under the note, Superpumper was to make quarterly payments of $7,545, with the balance due September 30, 2000, or when Superpumper sold the station. The contract also included a supply and freight agreement with West Fargo Truck Stop (WFTS) — an entity apparently controlled by the same individual who owns Nerland Oil — by which Superpumper would purchase all of its fuel from WFTS and WFTS would haul Conoco fuel products to several different Superpumper stations.
Perhaps most significantly, these contracts enabled Nerland Oil to act as the "jobber" for the Dakota Fuel Stop, making it the conduit through which Superpumper submitted its credit card receivables to Conoco, which ultimately paid them. This arrangement was not expressed in the contracts, but it is widely understood in the industry — and unquestioned in this record — that a jobber, in this case Nerland Oil, remits credit cards for the stations it services. However, Nerland Oil fell behind in remitting these monies to Superpumper, and by October 31, 1996, Nerland Oil owed Superpumper $348,856.26 in receivables. At this time, Superpumper also owed Nerland Oil $359,790.18 under the note and mortgage.
On October 28, 1996, Superpumper cancelled its supply and freight contract with WFTS and directed Nerland Oil to offset the amount due it for credit card receivables against the promissory note and mortgage. It also sought to have Superpumper accept payment of the difference between the two amounts and satisfy the mortgage. Nerland Oil refused. Superpumper then sued Nerland Oil in state court, and the judge ultimately ruled that the contracts required the parties to arbitrate the dispute. The arbitration went forward without the IRS being made a party, and the arbitrators ultimately awarded setoff to Superpumper. The state court judge entered an order adopting the arbitration panel's ruling, but Nerland Oil filed a chapter 7 bankruptcy petition before judgment was entered.
This decision was affirmed by the North Dakota Supreme Court. Superpumper, Inc. v. Nerland Oil, Inc., 200o N.D. 220.
Superpumper and the United States then filed cross motions for summary judgment in the bankruptcy court, Superpumper to enforce the setoff and the United States to prevent it. The bankruptcy judge ruled for the United States, and Superpumper elected to pursue an appeal to this Court. The Court, having considered the briefs and submissions of the parties and having heard oral argument, now AFFIRMS the ruling below.
III. Analysis
A district court in a bankruptcy appeal reviews the bankruptcy court's factual conclusions for clear error and its legal conclusions de novo. See In re Westpointe, L.P., 241 F.3d 1005, 1007 (8th Cir. 2001). It is the Court's view that this case presents mainly questions of law, since the essential facts are mainly undisputed, allowing this Court to perform a de novo review. Id.
A. Superpumper's right to setoff
The bankruptcy judge's analysis proceeded on the assumption that this case is essentially a fight over lien priority, a position with which the United States agrees. Superpumper's efforts to characterize the events of the case and the legal issues before the Court as something different will be addressed below, but the Court is in essential agreement with the legal analysis performed by the bankruptcy judge. That analysis, in brief, proceeds as follows.
The Bankruptcy Code preserves the right of a creditor to offset a mutual debt under nonbankruptcy law. See 11 U.S.C. § 553(a). Thus, a court need not determine if the requirements for a setoff are met until it decides if a creditor has a general right to setoff in a given situation. The issue here is that, when Superpumper sought to setoff its debts with Nerland Oil, the United States had tax liens in place exceeding the amount Superpumper seeks to setoff. As explained below, this fact prevents Superpumper from having a right of setoff and obviates the need to determine if the elements of setoff are met.
Three elements are needed to effect a setoff: (1) The creditor is liable to the debtor on a prepetition debt; (2) the creditor has a prepetition claim against the debtor; and (3) the debts are mutual.
By the end of 1994, the IRS had assessed $566,227 in delinquent taxes against Nerland Oil. Under 26 U.S.C. § 6322, a tax lien arises in favor of the United States on the date delinquent taxes are assessed and continues in force until the delinquency is paid or the lien becomes unenforceable. See generally State of Minnesota, Department of Revenue v. United States, 184 F.3d 725, 728 (8th Cir. 1999). This statutorily-created lien extends to all the taxpayer's property then owned or subsequently acquired. 26 U.S.C. § 6321, 6322. Thus, there can be no question that, when Superpumper purchased the station and delivered the note to Nerland Oil in 1995, the United States obtained rights in the payments due under the promissory note through its tax liens, just as it had an interest in all of the property of Nerland Oil. Id.
The Court also notes that the rights of the United States in this case are determined solely by the rights given it by Congress, not by reference to any rights it might have had under the North Dakota U.C.C. as a holder in due course, as Superpumper seems to argue.
The Court reviews this history because Superpumper's effort to setoff its debt is subject to the rules which govern the priority of federal tax liens. The general rule is that the relative position of liens is determined by the principal "first in time, first in right": Whichever interest becomes choate first triumphs. See United States v. McDermott, 507 U.S. 447, 449 (1993). Though not a lien, a state-created right of setoff is subject to the choateness requirement. See Horton Dairy, Inc. v. United States, 986 F.2d 286, 291 (8th Cir. 1993). A right of setoff is choate when exercised. Id. Superpumper never attempted to exercise its setoff until 1996. At that point, the federal tax liens were already in place and choate. Thus, Superpumper's effort to exercise its setoff is prevented by the superior position the IRS liens enjoy under the priority rules, precluding summary judgment in its favor.
B. Superpumper's payment theory
The foregoing analysis, of course, depends on the premise that a setoff is analogous to a lien, a premise with which Superpumper takes issue. Rather than characterizing it is a species of lien, Superpumper argues that its setoff was in a fact a "payment," by which it directed application of its own unencumbered funds, which Nerland Oil held in trust, to its debt. Though it is highly sympathetic to Superpumper, the Court concludes that it must reject this argument.
Most importantly, this argument misses the fundamental distinction between a setoff and a payment: A true payment introduces new money into the equation, while a setoff works by applying debts against each other. See Black's Law Dictionary 1336 (7th ed. 1999) (defining "setoff" as "a debtor's right to reduce the amount of a debt by any sum the creditor owes the debtor"). A setoff is thus by nature unlike a payment, since it explicitly functions to avoid putting any "new" money into play. This distinguishes it fundamentally from a payment and explains why courts treat setoffs as liens.
This principle becomes clear when applied to the facts of this case. Here, Superpumper seeks to use its right of setoff to avoid its obligation to make payments under the note — payments which would accrue to the benefit of the IRS in its role as a superior lienholder. It does not intend to put any new money into the bankruptcy estate. Describing this set of affairs as a "payment" misses the point of what would actually happen. Rather, because no new money will enter the estate, the setoff must be treated as a lien, and, on those terms, it cannot beat the United States' tax liens. See Horton Dairy, Inc., 986 F.2d at 291 (holding that setoffs are subject to the choateness requirement). Though not required to do so for purposes of its holding, the Court notes that this theory is further complicated by the fact that the unencumbered trust funds Superpumper seeks to use for payment clearly do not exist in that form. All parties agree that the credit card receivables, when received and in the possession of Nerland Oil, were held in trust for Superpumper, and as long as they remained in that form, the IRS could not reach them. Thus, if there were an account containing money attributable to the credit card receivables, Superpumper could apply it against the debt by paying Nerland, and the IRS could then take the money from Nerland pursuant to its liens. Unhappily, however, it is clear that the trust funds were not preserved in that form, undercutting Superpumper's theory.
Essentially, Superpumper wishes to establish that its credit card receivables are not in the bankruptcy estate to be paid out in accordance with the general priority rules, but rather that it has a priority on them. The general rule is indeed that property a bankrupt holds in trust for the benefit of another does not become part of the bankruptcy estate. See 11 U.S.C. § 541. However, the burden is on the one seeking to establish such a trust; he or she "must identify the trust fund or property in the estate, and, if such fund or property has been mingled with the general property of the debtor, sufficiently trace the trust property." First Federal of Michigan v. Barrow, 878 F.2d 912, 915 (6th Cir. 1989) (quoting 4 L. King Collier on Bankruptcy, ¶ 541.13 (15th ed. 1988)). Failing to do so leaves the beneficiary in the position of a general creditor of the estate. Id.; see also Sender v. Nancy Elizabeth R. Heggland Family Trust, 48 F.3d 470, 474 (10th Cir. 1995); County of Orange v. Merrill Lynch Co., Inc., 191 B.R. 1005, 1015-16 (Bankr.C.D.Cal. 1996) (collecting and citing cases). These general rules have been adopted and applied in the Eighth Circuit. See Chiu v. Wong, 16 F.3d 306, 309-10 (8th Cir, 1994).
Unfortunately for Superpumper, this appears to be the case here. Though it urges that the record does not conclusively establish that the funds were dissipated or commingled at the time it made its setoff, there seems little doubt that this is the case. Thus, Superpumper likely has a claim against Nerland Oil for conversion or breach of fiduciary duty. However, for purposes of this bankruptcy, its claim is not superior to those already made choate, such as the tax liens at issue here. Thus, Superpumper's assertion that Nerland Oil is, under North Dakota law, liable for the trusts's "safety in all respects" is absolutely correct; this does not, however, give it a preferred claim in bankruptcy. See N.D. Cent. Code § 59-01-17 (establishing liability of a commingling fiduciary).
In conclusion, the Court emphasizes its sympathy with Superpumper's position. It is apparent that, for one reason or another, Nerland Oil failed to give Superpumper the almost $350,000 which it held in trust. It also seems apparent that this money was somehow commingled with Nerland Oil's other monies and, with Nerland Oil now insolvent and in bankruptcy, Superpumper is thus unlikely ever to recover it. Further, because the United States had tax liens -which were unfiled but still valid — Superpumper will be unable to offset the debt against its note. Thus, in addition to losing close to $350,000, it continues to owe a similar amount on the note. Despite the Court's sympathy, however, allowing this setoff is simply not supported by the law. The payments due under the note and the credit card receivables are separate issues, and Superpumper's effort to offset them, though logical on its face, unfortunately must fail, as the bankruptcy judge held.
C. Inapplicability of 26 U.S.C. § 6323
Finally, the Court rejects Superpumper's argument that it is protected from the the United States' tax liens by 26 U.S.C. § 6323. That section provides in part that "[t]he lien imposed by section 6321 shall not be valid as against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary." Superpumper below argued it was protected because it was the holder of a security interest, an argument the bankruptcy judge rejected. Superpumper now argues it is a purchaser.
Section 6323 defines "purchaser" as follows:
Purchaser. — The term "purchaser" means a person who, for adequate and full consideration in money or money's worth, acquires an interest (other than a lien or security interest) in property which is valid under local law against subsequent purchasers without actual notice. In applying the preceding sentence for purposes of subsection (a) [the section quoted above] of this section, and for purposes of section 6324 —
(A) a lease of property,
(B) a written executory contract to purchase or lease property,
(C) an option to purchase or lease property or any interest therein, or
(D) an option to renew or extend a lease of property, which is not a lien or security interest shall be treated as an interest in property.26 U.S.C. § 6323(6). Further, case law makes clear that the person asserting purchaser status must have acquired the interest at issue in a transaction having the indicia of a vendor/vendee relationship. See United States v. Scovil, 348 U.S. 218 (1955).
Here, there can be no doubt Superpumper is a purchaser of the Dakota Fuel Stop. The Court has no doubt that, if the United States sought to assert liens against the property, Superpumper would be protected, at least as long as it met its obligations under the note. This is not the factual context, however.
Rather, the asset at issue, in which both parties claim an interest, is the right to receive payments under the note. To the extent Superpumper has an interest in this asset through its credit card receivable balance, this is clearly not the interest of a "purchaser" as defined by the statute. 26 U.S.C. § 6323(6). Further, it did not acquire its putative interest in a transaction having any indicia of a vendor/vendee relationship. See Scovil, 348 U.S. 218. Thus, this argument must fail.
IV. Conclusion
For the reasons set forth above, the Court AFFIRMS the judgment of the bankruptcy court. The Court is sympathetic to Superpumper. Nevertheless, the law does not support its efforts to set off its debt under the circumstances of the case.
IT IS SO ORDERED.