Fifth Circuit Gives IRS Priority in Lien and Levy Case (5/29/12)

In United States v. Boardwalk Motor Sports, Limited, ___ F.3d ___, 2012 U.S. App. LEXIS 17978 (5th Cir. 2012), here, the Court dealt with some nuances of the IRS collection process dealing with liens and levies. The majority and minority opinions are a bit obtuse in their holdings, but the opinions do offer an opportunity to step through the lien and levy process in a way that students should learn in a basic tax procedure course.  Hence, I provide a summary -- dealing with the big points and not getting into the details of some of the convoluted reasoning of the majority and the minority as to what the right result should be.

The facts:

1. The taxpayer had tax lien filings for over $3 million.  The IRS had filed the tax lien of public record.

JAT Comment:  Section 6321, here, creates a federal tax lien upon the assessment if the taxpayer fails to pay upon notice and demand.  Section 6322, here, makes the effective date of the lien the date of assessment.  The lien springs into operation by law, without any notice to the taxpayer or third party creditors.  Section 6326(a), here, says that the lien is not valid as to certain third party purchasers of the taxpayer's property before the lien is filed of public record (thus giving at least constructive notice, under familiar creditor's rights concept).  Certain third party purchasers during the period the lien is filed are not primed (e.g., purchasers of stock on a stock exchange, purchasers of merchandise from a regular retail vendor), but none of these exceptions apply here.  There is one exception, not applicable here, that should be mentioned.  Section 6323(b)(2) provides:

(2) Motor vehicles
With respect to a motor vehicle (as defined in subsection (h)(3)), as against a purchaser of such motor vehicle, if—
(A) at the time of the purchase such purchaser did not have actual notice or knowledge of the existence of such lien, and
(B) before the purchaser obtains such notice or knowledge, he has acquired possession of such motor vehicle and has not thereafter relinquished possession of such motor vehicle to the seller or his agent.

Note that this exception for automobile purchases has two conjunctive components.  The bottom line is that any person who acquires an interest in the taxpayer's property while the lien is filed is loses to the IRS unless an exception applies.
2. Plains Capital Corp., a bank ("the Bank"), knowing of federal tax liens, extended the taxpayer a line of credit of $200,000 and took possession of the title to the taxpayer's 2005 Ferrari to secure the obligation.  It does not appear that the line of credit was a loan for the taxpayer to purchase the Ferrari.

JAT Comment:  The Bank could not qualify for the Section 6323(b)(2) exception because (i) it did not purchase the automobile; (ii) it had actual notice of the lien; and (iii) did not acquire possession before notice (did not acquire possession of the automobile at all).  Hence, the bank's "security" in the form of possession of title was subject to the outstanding filed federal tax lien. Vis-a-vis the IRS, the bank did not have a perfected security interest in the Ferrari.

3.  The IRS could have seized the Ferrari immediately and sold it.  Such seizures often do not produce the best price, so IRS collection officers sometimes work with the taxpayer to allow him to make an alternative sale through normal channels in order to maximize the price and thus benefit both the IRS by applying to the tax and the taxpayer by reducing his tax liability.  In this case, in a three way deal, the taxpayer agreed to deliver the Ferrari to Boardwalk Motor Sports, Limited ("the Dealer") to arrange a sale and Boardwalk agreed that, upon the sale, the proceeds would be delivered to the IRS.

4.  In order to perfect the negotiated deal, after having been told that the Ferrari had been delivered to the Dealer, the IRS collections officer delivered an IRS levy to the Dealer on July 2.  On that date, however, the Ferrari was not in the possession of the Dealer.  Under the law, the IRS levy reaches only the taxpayer's property the party levied actually possessed on the date of levy.  Hence, the levy was legally meaningless.

5.  There are significant financial costs for failure to honor a valid levy.  The person receiving a levy is liable for the value of the property levied upon and not turned over, plus a penalty of 50%.  § 6332(d), here. The person can be relieved from the penalty for reasonable cause, which would be something beyond the person's control that prevents compliance (say, for example, the person was in a coma).  § 6332(d)(2).

6.  On July 3, the taxpayer delivered the Ferrari to the Dealer.

6.  On July 25, the Dealer sold the Ferrari for $210,454 and, consistent with the negotiated deal, tried to notify the IRS collection officer who was on vacation.   The Dealer had no interest in the proceeds, except for the Dealer's $10,000 commission on the sale which it had earned by that time.

7.  On August 7, apparently not having heard back from the IRS, the Dealer sent the Bank a check for $194,982 to pay off the Bank's lien and obtain title.  The Dealer retained the difference, $10,000, for its agreed upon commission.  Obviously, having sold the Ferrari and received payment, the Dealer was keenly interested in delivering a title to the purchaser.

JAT Comment:  The opinion is somewhat confusing on a key point.  The opinion says:

On August 7, Boardwalk [the Dealer] sent Plains Capital [the Bank] a check for $194,982 to pay off Plains Capital’s lien and obtain title.  Boardwalk [the Dealer] kept a commission, deducted costs, and gave the rest to the IRS, then applied the funds to Rand’s debt on August 16 and released its lien,

I think the majority opinion conflates the facts in the last sentence.  I think it was the Bank that applied the proceeds to the debt and released its lien.

8.  On August 21, the IRS served a final demand for payment on the Dealer.

9.  On August 28, the IRS served on the Bank a notice of levy. On October 18, the IRS served on the Bank a final demand for payment.

10.  Neither the Dealer nor the Bank responded to the final demands for payment.

11.  The IRS sued the Dealer and the Bank "for failure to honor a federal tax levy and for tortious conversion."

The majority held:

1.  There was no tortious conversion, thus reversing the district court on this issue.  Tortious conversion is a state law remedy that the IRS is entitled to rely upon in addition to or in lieu of other specific remedies provided in the Code.  The majority concluded that Texas law required that the person alleging the remedy for tortious conversion have actual possession or the right to possession at the time of the act of conversion.  Here, a valid levy on a person involved who actually possessed or had the right to possess the taxpayer's property would give the IRS at least the right to possess (if not a form of constructive possession in the third party's hands).  But the IRS had not made a valid levy on the Dealer (it was served before the Dealer took possession and thus was not a valid levy on the automobile.  And the IRS had not made a valid Levy on the Bank because it served the levy after the Bank had applied the proceeds to the debt and thus had no property of the taxpayer.  The actual reasoning for this is a bit convoluted, but I think that is the gravamen of the holding rejecting a tortious conversion remedy for the IRS.

2.  But, the court held, while there was no tortious conversion, there was a failure to honor the levy by the Bank.  The reasoning goes like this:  The federal tax lien applies to the taxpayer's property.  The lien applies by operation of law to any substitute property as a result of sale or otherwise.  Thus, the court reasoned, the sale of the property by the Dealer produced cash proceeds to which the lien applied.  So, when the Bank received the net cash proceeds $194,982, it took the cash proceeds subject to a lien.  Then, when it applied those cash proceeds to pay off the taxpayer's property it necessarily acquired something of equal value subject to the lien.  (This is a bit fuzzy.)  Hence, the Bank did have something treated as the taxpayer's property when the levy was served on August 28.  Hence, the Bank must (i) respond to the levy and (ii) suffer the consequences of not having done so.

JAT Comment:  Of course, allowing the IRS to prime the bank and get the benefit of the net cash proceeds is fair in an overall sense.  You will recall that, from the beginning, it was clear that the IRS had a prior interest to the Bank.  The Bank was just trying to seize victory from the jaws of the defeat that it had created for itself, through the fortuitous timing of the levy.  So, equitably, at least, that is the right result.

The Court's reasoning as to what taxpayer property the bank held after it applied the proceeds to repayment of the debt is a bit strained.  But, as noted, the right result is reached.

The dissent, by Judge Edith Brown Clement, would get to the right result -- the IRS primes the Bank -- but would get there a different way.  Judge Clement would (i) the IRS was entitled to the state law remedy of tortious conversion and (ii) the IRS was not entitled to the levy remedies.  I won't get into those details here.