Spearing the Secured Creditor Sixth Circuit Applies Bluebook Rule to IRS Lien Notice Requirements

Once again highlighting the tension between
federal and state law involving lien priority disputes, the Sixth
Circuit recently held that federal law—including, not
insignificantly, federal policy considerations—essentially excused
what would have otherwise been an ineffective IRS notice of lien filing
under the Michigan Uniform Commercial Code. <i>United States v.
Crestmark Bank (In re Spearing Tool and Manufacturing Co. Inc.),</i> 412
F. 3d 653 (6th Cir. 2005). Reversing the district court and affirming
the bankruptcy court, the <i>Spearing Tool</i> ruling provides that the
appropriate test for determining the adequacy of an IRS notice of
lien—as it relates to the debtor name requirement—is whether a
"reasonable and diligent search would have revealed the existence of the
notices of the federal tax lien." <i>Id.</i> at 656 (<i>citing Tony
Thornton Auction Serv. Inc. v. U.S.,</i> 791 F.2d 635 (8th Cir. 1986)).

</p><p>The facts of <i>Spearing Tool</i> are relatively straightforward, and
the underlying case was decided on summary judgment. The procedural
history of the case and the well-reasoned analyses of the bankruptcy and
district courts, however, are particularly noteworthy. Both lower-court
opinions reflect differing approaches to the relevancy and remaining
vitality of more-dated decisional authority, viewed in context with
varying judicial recognition of the technical evolutions (and
limitations) of modern electronic filing and search techniques. Both the
lower courts explored the degree of deference, if any, to be given to
the resulting desire of the business community for increased
"uniformity" and standardization of such techniques manifested by the
framework of the revised Uniform Commercial Code. The Sixth Circuit's
opinion, in unfortunate contrast, pays little heed to these topical and
emergent issues, applying instead a more subjective and parochial
analysis, laced heavily with federal policy concerns, resting within the
precedential aegis of being "limited to these facts." <i>Id.</i>

</p><p>Turning to the facts, in April 1998 Crestmark entered into a loan
transaction with Spearing Tool and Manufacturing Co. Inc. (Spearing).
Crestmark properly perfected its security interest in all of Spearing's
assets by filing and recording appropriate notices and financing
statements under Spearing's precise legal name, as registered with the
Michigan Secretary of State. In April 2001, Crestmark entered into a
secured financing transaction with Spearing involving the purchase of
Spearing's accounts receivable, perfecting in the same manner and again
using Spearing's precise legal name.

</p><blockquote><blockquote>
<hr>
<big><center>
<i>It is not, quite frankly, too much to ask that the government get the
name right.</i>
</center></big>
<hr>
</blockquote></blockquote>

<p>On Oct. 15, 2001, the IRS filed two notices of federal tax lien with
the Michigan Secretary of State under the name "Spearing Tool &amp; Mfg.
Co. Inc.," which was neither Spearing's legal name nor any registered
fictitious name.<small>^{<a href="#1" name="1a">1</a>}</small>
On April 16, 2002, Spearing filed a voluntary chapter 11 petition. At
that time, Crestmark first discovered the IRS lien filings and
ultimately filed a declaratory action against the IRS to determine
priority to $153,058.33 remaining in a reserve account established under
a first-day cash collateral order.<small>^{<a href="#2" name="2a">2</a>}</small>

</p><p>The bankruptcy court began its analysis with a discussion of the
undisputed premise that federal law applies in determining the priority
of tax liens. The issue posed by that analysis, however, is this: What
law should apply to the federal requirement that the notice of federal
tax lien must "identify the taxpayer"? Crestmark argued that the
bankruptcy court should apply M.C.L.A. §440.9503 (UCC §9-503)
to that requirement, mandating that the IRS should have made all filings
and recordings under the debtor's name as it appears in the official
public record.

</p><p>Recognizing that federal law requires that the IRS look to state law
as to the <i>place</i> of filing its notices, the bankruptcy court
nevertheless rejected any notion that state law could have any bearing
on any other federal requirement, especially as to the form of the
notice, <i>citing U.S. v. Union Cent. Life Ins. Co.,</i> 368 U.S. 291
(1961). <i>Union Central</i> is a pre-UCC case premised on the concern
that permitting states to legislate the form of notice would result in
"radically differing forms" of notice: a result contrary to "the
principle of uniformity which has long been accepted in the field of
federal taxation."

</p><p>Accordingly, the bankruptcy court applied the "reasonably diligent
search" standard developed under federal common law. In that vein, the
bankruptcy court found that the IRS made no error in identifying the
taxpayer in the notice because the IRS used the accepted Bluebook
abbreviations for "manufacturing" and substituting an ampersand (&amp;)
in place of "and." The bankruptcy court also noted that Crestmark had
itself used such abbreviations when referring to Spearing Tool in its
internal credit memoranda. Thus, in granting summary judgment to the
IRS, the bankruptcy court applied purely federal statutory and common
law analyses to the notice-requirement issue.

</p><p>In reversing, the district court took a much different approach in an
attempt to harmonize the seemingly competing interests of state and
federal law in achieving a common policy goal: commercial certainty
through uniformity and accuracy. First, the district court qualified the
bankruptcy court's reliance on <i>Union Central,</i> finding the case to
control only the issue of whether states could prescribe the form of IRS
notices—not whether the IRS correctly completed those forms. As the
district court noted, "filling out a form correctly does not implicate
the same concerns as creating a different form for different states."

</p><p>Like the bankruptcy court, however, the district court framed the
issue as whether the lien in this case complied with federal law. The
IRS conceded that the most applicable test of compliance is one of
"reasonableness" (<i>i.e., </i>whether a reasonable search of the index
would have discovered the otherwise erroneous federal tax lien).

</p><p>Bridging that analysis, the district court opined that courts
applying the reasonableness test necessarily consider the recording
method used by the applicable state or county. The district court also
balanced the IRS's arguments that Crestmark had constructive notice of
Spearing Tool's abbreviated name against Crestmark's contention that the
search logic employed in Michigan is programmed, in accordance with UCC
§9-503, only to find the exact legal name of the debtor entity.
Weighing the respective burdens imposed on creditors to search every
possible version of a debtor's name, versus the burden on the IRS to get
the debtor's name right, the district court concluded that the burden on
the IRS would be slight by comparison. Thus, the district court reframed
the issue, in the context of state law, to address the question of who
should bear the burden of recording systems that use rigid computerized
search logic rather than physical, alphabetized indexes.

</p><p>The district court concluded that, given the relative weight of
burdens, the advent of modern electronic filing and the constraints
created by state law-based search mechanisms, fairness dictated that
inaccurate IRS liens should not have priority over secured lenders.

</p><p>The Sixth Circuit, however, took a slightly different approach,
applying a more subjective analysis than that of either lower court.
While the <i>Spearing Tool</i> court acknowledged that older federal
precedent regarding the reasonableness of a lien search held little
analogy in light of modern electronic searches, it nevertheless applied
similar principles. Affirming the bankruptcy court's reference to the
Bluebook, <i>Spearing Tool</i> found that "Mfg." and the ampersand are
"most common abbreviations" and should have been included in the search.

</p><p>In addition, the <i>Spearing Tool</i> court, in <i>Poirot</i>-like
fashion, revealed the existence of a February 2002 handwritten note from
the Michigan Secretary of State's office suggesting to Crestmark: "You
may wish to search using Spearing Tool &amp; Mfg. Company Inc."

<i>Id.</i> at 655. While the existence of such a note is admittedly
interesting, it is perhaps more significant that neither lower court
relied upon it—or even referred to it—in their respective
opinions. Further, the date of the note was approximately four months
<i>after</i> the IRS filed its notices of lien. Yet the <i>Spearing
Tool</i> court <i>twice</i> referred to the note as subjective evidence
of the unreasonableness of Crestmark's search.

</p><p>Moving to the relative policy concerns implicated by the district
court's opinion, the Sixth Circuit summarily dismissed any argument that
requiring secured creditors to conduct a multiplicity of searches under
various iterations of a debtor's name was in any way unreasonable.
Rather, the court opined that requiring the IRS to identify a taxpayer
"with absolute precision" would be "unduly burdensome to the
government's tax-collection efforts." Such a burden on the IRS,
speculated the court, "<i>might</i> burden the government <i>at least as
much</i> as Crestmark's claim it would be burdened by having to perform
multiple lien searches" (emphasis added).

</p><p>Hence, the <i>Spearing Tool</i> court rejected any contention that
the IRS should be required to meet the stringent standard imposed on
every other lien creditor pursuant to UCC §9-503. As additional
support for such a lower, non-uniform standard, the Sixth Circuit
pointed to the fact that the UCC applied only to contract transactions
and that federal policy favoring "prompt, effective tax collection"
effectively trumped any inconvenience to the entire nationwide body of
secured creditors. <i>Id.</i> at 656 (<i>citing U.S. v. Kimbell Foods
Inc.,</i> 440 U.S. 715, 734-35 (1979) (where the court stated, in
<i>dicta,</i> that national revenue policy justified the extraordinary
priority accorded tax liens through choateness and first-in-time
doctrines, but also qualified that federal policy opining that it must
be tempered so as not to be disruptive to credit markets and state
priority rules). Thus, the <i>Spearing Tool</i> court reversed the
district court and affirmed summary judgment for the government.

</p><p>While the holding of <i>Spearing Tool</i> is limited to its facts and
therefore of questionable precedent, from a policy perspective the
ruling is troubling for at least two reasons. This case presented an
excellent opportunity for the court to address the modern electronic
filing environment and keep tax-collection practices in pace with the
evolving changes in state law and private commerce. As it stands, the
ruling only serves to increase the disconnect between state and federal
law as the former struggles to adapt to technical evolution and the
latter appears intransigent and unmoved by the resulting dilemma to
secured creditors.

</p><p>To shield this anachronism within the bulwark of federal policy only
serves to question the limits of such doctrines. It is not, quite
frankly, too much to ask that the government get the name right. Such
judicial paternalism seems to go too far if it essentially says, "we
have to do everything in our power to save the government from itself
just to keep the lights on around this place." The district court should
be applauded for its efforts to reconcile these recurring tensions,
however ephemeral and unrewarded they might have been.

</p><hr>
<h3>Footnotes</h3>

<p>^{<small><a name="1">1</a></small>} Although it was the name
under which Spearing Tool filed some—but not all—of its tax
returns. <a href="#1a">Return to article</a>

</p><p>^{<small><a name="2">2</a></small>} "Notice" is significant
in this context, because despite having a prior filed financing
statement, the Internal Revenue Code provides an exception to state law
lien priority for any loans made more than 45 days after a notice of tax
lien has been filed. <a href="#2a">Return to article</a>