In one opinion, the Third Circuit broke ground on two issues at the appeals court level by holding: (1) contemporaneous transfers on behalf of several creditors are not aggregated to surmount the minimum for recoverable preferential transfers, which is now $6,225; and (2) trust fund taxes are not the debtor’s property and therefore cannot be grounds for a preference claim against the Internal Revenue Service.
On both issues, the Third Circuit disagreed with lower court opinions from other circuits. On multiple grounds, the appeals court insulates the IRS from preference claims arising from payment of trust fund taxes.
The case involved a payroll services provider that took money from its customers and in turn paid the customers’ workers’ payrolls while remitting taxes to the IRS. On one day within 90 days of bankruptcy, the payroll provider made five wire transfers to the IRS. One transfer for about $32,000 was for one customer. The other four transfers aggregated more than $5,850, which was the minimum at the time, but each was for less than $5,850.
The payroll provider’s chapter 7 trustee sued the IRS for receipt of preferences. The district court withdrew the reference and granted the IRS summary judgment dismissing the preference claims. The trustee appealed and lost in an opinion on May 10 written by Circuit Judge Thomas M. Hardiman.
For non-consumer debts, Section 547(c)(9) provides a defense if the “aggregate value of all property that constitutes or is affected by such transfer is less than” $5,850. The trustee contended that the four smaller payments should have been aggregated since they were all paid to the defendant (IRS). Judge Hardiman disagreed, holding that subsection (c)(9) “precludes aggregation of multiple preferential transfers for the benefit of different creditors on distinct debts.”
Judge Hardiman relied in large part on the policy behind the defense. He said it was adopted by Congress in 2005 to prevent “creditors with smaller claims from waiving otherwise meritorious defenses simply because the costs associated with defending against trustees’ avoidance actions exceed any anticipated benefits.” To carry out the purpose of the statute, he said the recipient of a small transfer “may invoke the defense regardless of what other creditors have received.”
Judge Hardiman disagreed with bankruptcy court decisions from other parts of the country that allowed aggregation to surmount the statutory minimum.
To prevent clever debtors from protecting favored creditors, the appeals court qualified its holding by saying that “ostensibly distinct transfers may nevertheless be aggregated if they are, in effect, a single transfer on account of the same debt.”
The Third Circuit’s opinion upheld dismissal of the $32,000 preference claim because it was not a transfer of the debtor’s funds.
Relying on 26 U.S.C. Section 7501(a), which creates so-called trust fund taxes, the circuit court held that the monies paid to the IRS were trust funds and not the debtor’s property.
The case on appeal was indistinguishable from the Supreme Court’s 1990 decision in Begier v. IRS except that the payment came from an intermediary. Judge Hardiman said that the distinction was of no moment because the trust fund concept applies to the “amount of tax,” not to specific dollars in a specific location.
A bankruptcy court from another circuit held to the contrary in a case also involving a payroll services provider. The appeals court said that decision was “virtually void of analysis.”
The circuit court upheld dismissal of the large and smaller transfers on two alternate grounds. Under Pennsylvania law, there was a resulting trust, meaning that the transfers were not the debtor’s property. Under federal common law, there also would have been a trust to defeat the preference claim.
The circuit court’s opinion could be criticized for ruling on the aggregation issue when the case could have been decided purely on trust fund grounds. Also on the aggregation issue, the appeals court used an analysis applicable to multiple transferees when there were transfers to only one transferee, the IRS.