City of Farrell v. Sharon Steel Corp. , 40 F.3d 92 ( 1994 )

Opinions of the United
1994 Decisions States Court of Appeals
for the Third Circuit
11-15-1994
City of Farrell v. Sharon Steel Corp.
Precedential or Non-Precedential:
Docket 94-3130
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"City of Farrell v. Sharon Steel Corp." (1994). 1994 Decisions. Paper 188.
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 94-3130
CITY OF FARRELL,
v.
SHARON STEEL CORPORATION;
UNITED STATES OFFICE;
CREDITORS' COMMITTEE;
MUELLER INDUSTRIES, INC.;
CITIBANK, N.A.
The City of Farrell,
Appellant
On Appeal from the United States District Court
for the Western District of Pennsylvania
(D.C. Civ. No. 93-0736)
Argued August 30, 1994
BEFORE: STAPLETON and GREENBERG, Circuit Judges,
and ATKINS, District Judge*
(Filed: November 15, 1994)
P. Raymond Bartholomew (argued)
Cusick, Madden, Joyce
& McKay
One East State Street
P.O Box 91
Sharon, PA 16146
Attorneys for Appellant
* Honorable C. Clyde Atkins, Senior United States District Judge
for the Southern District of Florida, sitting by designation.
Herbert P. Minkel, Jr. (argued)
Fried, Frank, Harris, Shriver
& Jacobson
One New York Plaza
New York, NY 10004
Attorneys for Appellee
Sharon Steel Corporation
William H. Schorling (argued)
Klett, Lieber, Rooney &
Schorling
One Oxford Centre
40th Floor
Pittsburgh, PA 15219-6498
Attorneys for Appellee
Citibank, N.A.
OPINION OF THE COURT
GREENBERG, Circuit Judge.
I. INTRODUCTION
This appeal involves a controversy over City of Farrell
municipal income taxes that Sharon Steel Corporation withheld
from its employees' wages. After withholding the amounts in
dispute, Sharon Steel filed for protection under Chapter 11 of
the Bankruptcy Code and thus did not remit the funds to the city.
The City of Farrell subsequently initiated this action in the
bankruptcy court to collect the unpaid taxes withheld. The
bankruptcy court and the district court denied the City's request
for an order requiring Sharon Steel to remit the withheld funds.
We will reverse the district court's order, and we will remand
the case to the district court for the proceedings we outline in
this opinion.
II. FACTUAL BACKGROUND AND PROCEDURAL HISTORY
Sharon Steel has its main plant and principal place of
business in the City of Farrell, Mercer County, Pennsylvania. In
1967 the city, pursuant to section 13 of the Pennsylvania Local
Tax Enabling Act, as amended, Pa. Stat. Ann. tit. 53, § 6913
(1972), enacted a tax (Ordinance No. 0-17-66) on the earned
income and net profits of all residents and non-residents
employed or conducting business within the city. Under the
ordinance and Pennsylvania law, Pa. Stat. Ann. tit. 53, § 6913
IV, employers located in the City of Farrell must withhold taxes
on locally earned income from the wages of any employee subject
to the city income tax and must remit those taxes in quarterly
payments to the city.
For the fourth quarter of 1992, Sharon Steel withheld
$56,831.99 in City of Farrell income tax. On November 30, 1992,
Sharon Steel filed its petition under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the
Western District of Pennsylvania. After filing its petition,
Sharon Steel remitted $7,944.97 in withholding taxes to the City
of Farrell, which was the post-petition portion of the fourth-
quarter wages it withheld for payment to the City of Farrell.
But Sharon Steel retained the remainder of the withheld fourth-
quarter taxes.
To obtain the remaining funds, the City of Farrell
filed a motion in the bankruptcy court to lift the automatic stay
and to compel the turnover of the funds. The bankruptcy court
denied the motion in a written opinion dated April 9, 1993,
rejecting the city's reliance on Begier v. IRS, 496 U.S. 53, 110
S.Ct. 2258 (1990). In re Sharon Steel Corp., 152 B.R. 450(Bankr. W.D. Pa. 1993). The city contends that Begier held that
a trust is created for the benefit of the taxing authority
whenever an employer withholds a portion of an employee's wages
as income taxes. Thus, in the city's view, taxes withheld from
an employee but not paid to the city do not become "property of
the estate" when the employer files for bankruptcy even if the
employer had not segregated the "trust" funds from its other
assets. But the bankruptcy court distinguished Begier, primarily
because Begier requires that the taxing authority show "some
nexus between the trust and the assets sought to be applied to
the debtor's trust fund tax obligations" and, in the court's
view, the city could not "establish the required nexus with
regard to the commingled funds in [Sharon Steel's] possession."
Id. at 451-52. In other words, unlike in Begier, where the
debtor had paid the taxes withheld to the Internal Revenue
Service prior to filing its bankruptcy petition, thereby creating
a segregated fund, Sharon Steel commingled the funds with its
other assets and the funds remained commingled when Sharon Steel
filed its Chapter 11 petition.
The city appealed but the district court affirmed the
bankruptcy court's decision in a written opinion, agreeing with
the bankruptcy court that "the facts of this case are
distinguishable from [those in] Begier" and that the City "has
failed to demonstrate the required nexus between the taxes and
the commingled funds in the possession of the estate of Sharon
Steel." In re Sharon Steel Corp., Civ. No. 93-0736, at 3-4 (W.D.
Pa. Feb. 11, 1994). The district court also distinguished Begier
on the basis that the statutory "language establishing a 'trust
fund' in the withheld taxes in Begier is absent in the pertinent
statute and ordinance governing withholding taxes for Farrell."
Id. The district court entered its order on February 14, 1994,
affirming the bankruptcy court's order. The city has appealed to
us from that order.
The bankruptcy court had subject matter jurisdiction
under 28 U.S.C. § 157(b) and 11 U.S.C. § 362(d) as the City of
Farrell filed a motion to lift the automatic stay and compel
turnover of the trust fund taxes. The district court had
appellate jurisdiction under 28 U.S.C. § 158(a) over the
bankruptcy court's denial of the City's motion, as the bankruptcy
court's order denying the city relief was final. We have
jurisdiction under 28 U.S.C. § 158(d) over the district court's
final order affirming the bankruptcy court's order.
III. DISCUSSION
a. Introduction
The crux of this appeal is whether the remaining
portion of the funds Sharon Steel withheld from its employees'
wages for the fourth quarter of 1992 constitutes property of its
bankruptcy estate or whether it is excluded from the estate by 11
U.S.C. § 541(d), which excludes equitable interests of third
parties from a bankrupt's estate.1 If the funds are property of
the estate, then the bankruptcy court and district court
correctly rejected the city's claim; but if the funds are not
property of the estate, they should be paid to the city unless,
as we discuss below, Sharon Steel's pre-petition lenders have a
prior claim to the funds. The City of Farrell primarily contends
that because Sharon Steel retained the funds withheld in trust
for the city, the funds are not property of the estate, and that
therefore we should reverse the district court's order. In
considering this appeal we are exercising plenary review because
both the bankruptcy court and the district court decided the case
as a matter of law on facts which so far as considered by those
courts were not disputed. In re Brown, 851 F.2d 81, 84 (3d Cir.
1988).
1
. 11 U.S.C. § 541(a)(1) provides that the property of the
estate includes "all legal or equitable interests of the debtor
in property as of the commencement of the case." Section 541(d)
provides the following exception:
Property in which the debtor holds, as of the
commencement of the case, only legal title and not
an equitable interest . . . becomes property of
the estate under subsection (a)(1) of this section
only to the extent of the debtor's legal title to
such property, but not to the extent of any
equitable interest in such property that the
debtor does not hold.
We start from the well-settled principle that debtors
do "not own an equitable interest in property . . . [they] hold[
] in trust for another," and that therefore funds held in trust
are not "property of the estate."2 Begier, 496 U.S. at 59, 110
S.Ct. at 2263; see also 11 U.S.C. § 541(d); Universal Bonding
Ins. Co. v. Gittens & Sprinkle Enters., 960 F.2d 366, 371 (3d
Cir. 1992). In general, "to establish rights as a trust
recipient, a claimant must make two showings: (1) demonstrate
that the trust relationship and its legal source exist, and (2)
identify and trace the trust funds if they are commingled."
Goldberg v. New Jersey Lawyers' Fund, 932 F.2d 273, 280 (3d Cir.
1991); In re Columbia Gas Sys. Inc., 997 F.2d 1039, 1063 (3d Cir.
1993) ("beneficiaries of trust funds bear the burden of
identifying and tracing their trust property"), cert. denied, 114
S.Ct. 1050 (1994). Goldberg teaches that we look to state law to
determine whether the claimant has shown a trust relationship,3
but that we look to federal law to determine whether the claimant
2
. The "classic definition of a trust . . . [is that] the
beneficiary has an equitable interest in the trust property while
legal title is vested in the trustee." In re Columbia Gas Sys.
Inc., 997 F.2d 1039, 1059 (3d Cir. 1993), cert. denied, 114 S.Ct.
1050 (1994).
3
. See Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914,
918 (1979) ("Congress has generally left the determination of
property rights in the assets of a bankrupt's estate to state
law."); see also In re Nejberger, 934 F.2d 1300, 1302 (3d Cir.
1991) ("Although section 541 defines property of the estate, we
must look to state law to determine if a property right exists
and to stake out its dimensions.").
has traced and identified the trust funds.4 Goldberg, 932 F.2d
at 280; see also Universal Bonding, 960 F.2d at 369; In re Markos
Gurnee Partnership, 163 B.R. 124, 129 & n.4 (Bankr. N.D. Ill.
1993); In re Visiting Nurse Ass'n v. Bowen, 143 B.R. 633, 641
(W.D. Pa. 1992) ("Once a bankruptcy court makes a determination
concerning whether a debtor has any legal or equitable interest
in property based upon applicable state law, whether the property
will come into the estate is a federal question.") (internal
quotations and citations omitted)), aff'd, 986 F.2d 1410 (3d Cir.
1993) (table).
In considering this case we naturally focus first on
Begier. In Begier, the trustee filed an adversary proceeding
against the United States, claiming that the debtor's pre-
petition payment of withheld federal income tax to the Internal
Revenue Service was a voidable preference under 11 U.S.C. §
547(b). The Supreme Court rejected the trustee's position,
holding that the payment of the taxes to the IRS was not a
voidable preference because the funds transferred were not
property of the debtor, but rather were held in trust for the
government. Begier, 496 U.S. at 66-67, 110 S.Ct. at 2267. In
finding that a trust existed, the Court relied on a section of
the Internal Revenue Code, which provided that persons
4
. Begier is not inconsistent with Goldberg's approach. In
Begier, the Court solely confronted federal issues, so it
naturally looked to federal law to determine whether the claimant
proved a trust relationship. Additionally, the Court looked to
federal law to determine whether the claimant identified and
traced the trust funds.
withholding taxes hold the withheld funds in trust for the IRS.5
The Court also found that the debtor's pre-petition payments of
withholding amounts to the IRS constituted a sufficient enough
nexus to take the funds out of the bankruptcy estate.
The city contends that Begier mandates that we reverse
the district and bankruptcy courts' orders denying the city's
motion to lift the automatic stay and compel turnover of the
remaining funds withheld. The district court found two
independent reasons for denying the city's motion: (1) the city
failed to show that a statutory trust had been created; and (2)
the city failed to show the appropriate "nexus" between the
debtor's assets and the withholding funds. Sharon Steel and
Citibank, as agent for certain of Sharon Steel's creditors,
contend that the district court correctly held that Begier is
distinguishable and that therefore we should affirm its order
affirming the bankruptcy court. Accordingly, we will discuss the
district court's two reasons for denying the City's motion.
b. Was a trust created in the taxes withheld?
The district court concluded that while there is no
"statutory authority . . . [for] Farrell's contention that these
taxes are held in trust," the statute involved in Begier, 26
U.S.C. § 7501, "expressly designates that taxes withheld by an
5
. The Court quoted: "'Whenever any person is required to
collect or withhold any internal revenue tax from any other
person and to pay over such tax to the United States, the amount
of tax so collected or withheld shall be held to be a special
fund in trust for the United States.'" 496 U.S. at 60, 110 S.Ct.
at 2263 (quoting 26 U.S.C. § 7501).
employer are held in trust for the United States." In re Sharon
Steel Corp., Civ. No. 93-0736, at 3-4. In response, the city
argues that Pennsylvania law demonstrates that Sharon Steel did
hold the taxes in trust for the city. See City of Philadelphia
v. Penn Plastering Corp., 253 A.2d 247 (Pa. 1969), and City of
Philadelphia v. B. Axe Co., 397 A.2d 51 (Pa. Commw. Ct. 1979).
We are satisfied that in determining whether a trust has been
created we look to the entire body of germane state law,
including the relevant case law, and that we should not be
confined solely by the applicable authorizing statute. See,
e.g., Goldberg, 932 F.2d at 280; In re Markos Gurnee, 163 B.R. at
129; In re Visiting Nurse Ass'n, 143 B.R. at 641-42; In re King,
117 B.R. 339, 341 (Bankr. W.D. Tenn. 1990).
We find that under Pennsylvania case law, when Sharon
Steel withheld the city income taxes a trust was created so that
Sharon Steel held the funds in trust for the city. Penn Plaster
is instructive in this regard. That case involved a suit by the
City of Philadelphia against a corporation doing business in
Philadelphia and its president to collect wage taxes withheld by
the corporation. As the corporation's president filed
"preliminary objections in the nature of a demurrer," the court
accepted Philadelphia's averments as true, finding that "the
taxes were collected by the corporation as agent for
[Philadelphia] and that [the president as] the active and
controlling officer . . . failed to pay the taxes so collected
over to the City." Penn Plaster, 253 A.2d at 248-49.
Philadelphia argued that when the corporation withheld the city
income tax, the corporation and its president as its controlling
officer and director became "trustees of those wage taxes" and
had "a duty to pay those funds over to [Philadelphia]." Id. at
248. The Pennsylvania Supreme Court agreed, holding that "[o]ne
who collects taxes as agent for a city and fails to pay the same
over to the city has long been held to be a trustee ex
maleficio." Id. at 249 (citing City of Philadelphia v. Heinel
Motors, Inc., 16 A.2d 761 (Pa. Super. Ct. 1940)); see also City
of Philadelphia v. B. Axe Co., 397 A.2d 51.
Penn Plaster's reference to the principle that the
party who "collects taxes as agent for a city and fails to pay
the same over to the city [is] . . . a trustee ex maleficio[,]"
does not somehow undermine our conclusion that when Sharon Steel
withheld the City of Farrell income tax, a trust was created.
Rather, the reference supports our result. After all, the
principle that Penn Plaster's reasoning recognized was premised
on the concept that a trust was created when the corporation
withheld the income taxes. The court stated that it is
undisputed "that corporations must act through individuals and
where the individuals are the active and controlling officers and
agents of the corporation and they fail to administer the trust
responsibilities of the corporation, those responsibilities are
imposed upon the individuals who are responsible for the
performance of the trust duty." Penn Plaster, 253 A.2d at 125
(emphasis added). Therefore, Penn Plaster clearly contemplated
that when a corporation withholds municipal income taxes,
Pennsylvania law imposes a "trust responsibility" and thus the
corporation retains the funds withheld as trustee for the
municipality.
Heinel Motors, cited in Penn Plaster, supports our
conclusion that, under Pennsylvania law, a trust is created when
an employer withholds city income taxes. Heinel Motors involved
the question of whether a trust is created when a vendor collects
sales tax from a purchaser of goods subject to the tax. In
making its analysis, the Heinel court extensively considered
precedent regarding the creation of trusts and concluded that the
"receipt of the tax money by the vendor operates to create a
constructive trust." Heinel Motors, 16 A.2d at 765. The court
reasoned, in part, that as the sales tax was imposed on the
purchaser and not on the vendor, the vendor collected the tax as
trustee for the state. Indeed, the court recognized the broad
principle that "[e]very person who receives money to be paid to
another or to be applied to a particular purpose is a trustee[.]"
Id. (citations and internal quotations omitted). Clearly,
therefore, the tax in Heinel Motors is similar to the withholding
tax at issue here, as in both instances the entity holding the
tax funds is not responsible for the burden of the tax but only
is responsible for collecting it. See also In re King, 117 B.R.
at 341.
We acknowledge that sales taxes are paid to the vendor
by a third party but when income tax is involved the employer had
possession of the funds it withholds prior to paying wages to the
employee. However, this distinction does not affect our result.
In substance, when the employer pays wages and withholds taxes it
is paying the employees' taxes to itself since the employee has
earned his or her entire gross wages. Indeed, the only reason
that the employer need not pay the funds withheld to the employee
is that the applicable law requires the employer to withhold the
wages for application on the employee's tax obligations. Thus,
it would be artificial to characterize the withholding tax
situation as simply creating a debtor-creditor relationship
between the employer and the city. The real debt is the
employees' tax liability to the city and the employer is merely
the conduit for its employees' tax payments. Consequently, we
hold that under Pennsylvania law Sharon Steel held the
withholding taxes in trust for the City of Farrell.6
6
. In re Markos Gurnee, 163 B.R. 124, does not conflict with
our conclusion. There, the Illinois Department of Revenue
claimed that it had a trust-fund interest in the debtor's general
assets to the extent of unpaid hotel occupation and use taxes.
Markos Gurnee, 163 B.R. at 127. The court held against the
state, reasoning that the statutes creating the hotel occupation
and use taxes did not "create a trust in favor of the state."
Id. at 130.
But as the Markos Gurnee court recognized, the hotel
occupation and use taxes differed from the type of trust-fund
taxes involved in Begier. The Markos Gurnee court stated that
the "theory of 'trust fund taxes' (like income tax withholding)
is that the tax is imposed on one party (for example, an
employee), but is collected and held by another party (for
example, the employer)." Id. The court held that this theory
was inapplicable to the occupation tax "since the tax is imposed
directly on hotel operators, not their customers." Id. As to
the use tax, the court held that the statute's plain language
shows that state is a creditor and "not in the position of a"
beneficiary. Id. at 131-32. Thus, Markos Gurnee is
distinguishable from this case, because the occupation tax is a
direct tax on the hotel while the City of Farrell income tax is a
direct tax on the employees and not on Sharon Steel, and because
the Illinois use tax statute's plain language merely creates a
debtor-creditor relationship between the taxing authority and the
party responsible for remitting the taxes.
c. Does the source of the trust distinguish this case from
Begier?
We must now decide whether the trust created under
Pennsylvania law warrants the same treatment as the trust created
under the statute in Begier, 26 U.S.C. § 7501. Section 7501
provides that "[w]henever any person is required to collect or
withhold any internal revenue tax from any other person and to
pay over such tax to the United States, the amount of tax so
collected or withheld shall be held to be a special fund in trust
for the United States." According to the Begier Court, this
statutory trust extends "only to 'the amount of tax so collected
or withheld,'" and that the trust is created "at the moment" the
employer paid its employees' wages. Begier, 496 U.S. at 60-61,
110 S.Ct. at 2263-64. Moreover, Begier rejected the argument
that segregation of the withheld funds was a prerequisite to the
creation of a trust. Id. at 60-61, 110 S.Ct. at 2264.
(..continued)
We also recognize the following additional point. It
is conceivable that an employer paying wages might not have the
funds to pay the gross wages in full, though it could pay the
employees their net wages after withholding. In that event it
reasonably could be argued that no trust has been created in the
"withheld" taxes as there were no funds to withhold. Clearly,
the larger the amount of taxes to be deducted the more plausible
would be the argument that a trust had not been created.
However, while we recognize the plausibility of this argument, we
do not address it because neither Sharon Steel nor Citibank
raises it. Furthermore, we doubt that there would be a factual
predicate for the argument because the City of Farrell income tax
rate was 1% when it was enacted, and we believe it was 1.5% by
1992.
We find no significant distinction between the trust
created under section 7501 with respect to federal withholding
and the trust created under Pennsylvania law with respect
withholding of local income taxes. First, both statutory schemes
require that the employer withhold the appropriate portion of
income when it pays wages to its employees.7 Thus, as
Pennsylvania case law establishes that a trust is created when
the tax is withheld and as section 7501 creates an express trust
in funds withheld, it is clear that under both statutory regimes
the trust is created when the employer pays the wages.
Second, the Begier Court's primary reason for rejecting
the argument that segregation of the withheld funds is a
prerequisite to the creation of a trust applies with equal force
in this case. Begier stated that requiring segregation as a
prerequisite to the creation of the trust would "mean that an
employer could avoid the creation of a trust simply by refusing
to segregate." 496 U.S. at 61, 110 S.Ct. at 2264. Thus, if
we were to hold that a trust was not created under Pennsylvania
law because Sharon Steel did not segregate the withholding funds,
we would be eviscerating the concept expressed in Penn Plaster
that "[o]ne who collects taxes as agent for a city and fails to
7
. See Begier, 496 U.S. at 60, 110 S.Ct. at 2264 ("Section
3402(a)(1) requires that 'every employer making payments of wages
shall deduct and withhold upon such wages [the employee's federal
income tax].'") (emphasis added); and see City of Farrell
Ordinance No. 0-17-66, § 5(b) ("Every employer having . . . [a]
place of business within the City of Farrell . . . shall deduct
at the time of payment thereof, the tax imposed by this Ordinance
on the earned income due to his employe or employes.").
pay the same over to the city has long been held to be a trustee
ex maleficio." 253 A.2d at 249. This would occur because, then,
an employer could avoid creating a trust simply by commingling
the withholding funds with its other assets.
Moreover, we must recognize the city's equitable
interest in the funds withheld even though Pennsylvania law and
the city ordinance do not create an express trust in the withheld
funds. Whatever may be true in other contexts, the distinction
between a direct trust (i.e. one expressly created by the
parties) and a constructive trust (i.e. one imposed by law) has
no relevance to the issues on this appeal. As we recently
stated, "Congress clearly intended the exclusion [of trust funds
from the debtor's estate] created by section 541(d) to include
not only funds held in express trust, but also funds held in
constructive trust." In re Columbia Gas, 997 F.2d at 1059
(citing H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 368 (1977),
reprinted in 1978 U.S.C.C.A.N. 5963, 6324).
We are not alone in this approach. The Court of
Appeals for the Ninth Circuit, in In re Unicom Computer Corp., 13
F.3d 321, 324 (9th Cir. 1994), even more recently indicated,
"[a]lthough we have never expressly held that the same rule
(viz., funds held in trust are property neither of the debtor nor
of the bankruptcy estate) should apply as well to situations
involving funds held by a debtor in constructive trust, the rule
would seem to apply with equal force to both situations."
Therefore, since we have recognized that the crux of this appeal
is whether the withholding funds fall within section 541(d)'s
exception to "property of the estate," the fact that the trust at
issue is constructive rather than express has no bearing on our
decision. Accordingly, we find no reason not to analyze the
trust in this case in the same manner as Begier analyzed the
trust created by 26 U.S.C. § 7501. We hold that because a trust
was created under Pennsylvania law when Sharon Steel withheld the
income tax, the district court erred when it held that the City
of Farrell did not show a trust relationship.
d. Has the city satisfied Begier's "nexus" requirement?
In Begier, after the Court concluded that a trust was
created "at the moment" of wage payment, it analyzed whether "the
particular dollars that . . . [the debtor] paid to the IRS were
'property of the debtor.'" Begier, 496 U.S. at 61, 110 S.Ct. at
2264 (emphasis added). In other words, the Court wrestled with
how to determine whether the "assets transferred to the IRS .
. . were trust property." Id. at 62, 110 S.Ct. at 2265. This
inquiry mirrors the second part of our Goldberg test, i.e.
whether the claimant identified and traced the trust funds. See
932 F.2d at 280.
Because the statute creating the trust considered in
Begier, section 7501, provided no guidance on this issue, the
Court stated that it "might naturally begin with the common-law
rules that have been created to answer such questions about other
varieties of trusts." 496 U.S. at 61, 110 S.Ct. at 2265. The
Court, however, concluded that "[c]ommon-law tracing rules . . .
are unhelpful in this special context," reasoning that "[u]nlike
a common-law trust, in which the settlor sets aside particular
property as the trust res, § 7501 creates a trust in an abstract
'amount'-- a dollar figure not tied to any particular assets --
rather than in the actual dollars withheld." Id. at 62-63, 110
S.Ct. at 2265 (emphasis added). As we have concluded that we
should analyze the trust in this case as Begier analyzed a
section 7501 trust, we find that the common-law tracing rules
should not apply to our decision on whether the city has
satisfied Begier's nexus requirement.
Were it not for Begier, our task would be more
difficult because of the Supreme Court's opinion in United States
v. Randall, 401 U.S. 513, 91 S.Ct. 991 (1971). In Randall, the
Court confronted a situation very similar to this appeal. There,
the United States sought, in the bankruptcy proceeding, to
satisfy the debtor's pre-petition tax obligations from the
debtor's post-petition general assets. The United States argued
that the debtor held an amount representing the tax obligation in
trust for the government and that this amount could be traced to
the debtor's funds when the petition was filed. In response, the
trustee argued that no trust had been created because the debtor
did not segregate any funds for the tax obligation. The Court
did not accept either argument. Instead, it held that the IRS
could not recover the taxes ahead of administrative expenses,
reasoning that "the statutory policy of subordinating taxes to
costs and expenses of administration would not be served by
creating or enforcing trusts which eat up an estate, leaving
little or nothing for creditors and court officers whose goods
and services created the assets." Id. at 517, 91 S.Ct. at 994.
Were we to apply Randall on this appeal, we probably
would affirm the district court's order on the basis that a
taxing authority's trust interest in a debtor's pre-petition tax
obligation does not justify granting the authority priority over
claims for administrative expenses. Begier, however, held that
the "strict rule of Randall . . . did not survive the adoption of
the new Bankruptcy Code" section 541. Begier, 496 U.S. at 65,
110 S.Ct. at 2266. The Court's reasons for holding that section
541 displaced the holding in Randall are helpful in shedding
light on the nexus requirement.
In reaching its decision, the Begier Court first
compared the Senate and House bills that led to the enactment of
section 541. Begier stated that the "Senate bill attacked
Randall directly, providing in § 541 that trust-fund taxes
withheld or collected prior to the filing of the bankruptcy
petition were not 'property of the estate.'" Begier, 496 U.S. at
63-64, 110 S.Ct. at 2265 (citing S. Rep. No. 95-1106, at 33
(1978)). As to the House bill, Begier stated that while the
"bill did not deal explicitly with the problem of trust fund
taxes, . . . the House Report stated that 'property of the
estate' would not include property held in trust for another."
Begier, 496 U.S. at 64, 110 S.Ct. at 2265-66 (citing H.R. Rep.
No. 95-595, at 368 (1977)). Congress's final compromise in
enacting the portion of section 541 that deals with post-petition
transfers, according to Begier, "explicitly provided that 'in the
case of property held in trust, the property of the estate
includes the legal title, but not the beneficial interest of the
property.'" Begier, 496 U.S. at 64, 110 S.Ct. at 2266 (citing
124 Cong. Rec. at 32,417 (remarks of Representative Edwards)).
Next, Begier took the unusual step of treating the
floor statements of a representative "as persuasive evidence of
congressional intent." Begier, 496 U.S. at 64 n.5, 110 S.Ct. at2266 n.5. The Court quoted Representative Edwards for the
proposition that "the Senate language specifying that withheld or
collected trust-fund taxes are not part of the bankruptcy estate
was deleted as 'unnecessary since property of the estate does not
include the beneficial interest in property held by the debtor as
trustee.'" Id. at 64, 110 S.Ct. at 2266 (citing 124 Cong. Rec.
at 32,417).
Additionally, Begier placed great weight on
Representative Edwards' subsequent discussion of "the effects of
the House language on the rule established by Randall":
[A] serious problem exists where 'trust fund
taxes' withheld from others are held to be
property of the estate where the withheld amounts
are commingled with other assets of the debtor.
The courts should permit the use of reasonable
assumptions under which the Internal Revenue
Service, and other tax authorities, can
demonstrate that amounts of withheld taxes are
still in the possession of the debtor at the
commencement of the case.
Begier, 496 U.S. at 64, 110 S.Ct. at 2266 (citing 124 Cong. Rec.
at 32,417). From this statement, the Court concluded that "by
requiring the IRS to 'demonstrate that amounts withheld are still
in possession of the debtor at the commencement of the case'
[i.e. at the filing of the petition] . . . , Congress expected
that the IRS would have to show some connection between the §
7501 trust and the assets sought to be applied to a debtor's
trust-fund tax obligations." Begier, 496 U.S. at 65-66, 110
S.Ct. at 2266 (emphasis added). The Court continued by asking
just "how extensive the required nexus must be." Id. (emphasis
added). Answering that question, the Court held that in Begier
the pre-petition payment to the IRS satisfied the nexus
requirement.8 Id. at 67, 110 S.Ct. at 2267. Thus, as Begier
involved a pre-petition payment, while here we have no such
8
. In explaining this "nexus" requirement, Begier stated that
the "Bankruptcy Code provides no explicit answer, and
Representative Edwards' admonition that courts should 'permit
reasonable assumptions' does not add much." Begier, 496 U.S. at
66, 110 S.Ct. at 2266. Accordingly, the Court looked to the
following statement from the House Report for guidance:
'A payment of withholding taxes constitutes a
payment of money held in trust under Internal
Revenue Code § 7501(a), and thus will not be a
preference because the beneficiary of the trust,
the taxing authority, is in a separate class with
respect to those taxes, if they have been properly
held for payment, as they will have been if the
debtor is able to make the payments.'
Id. at 66, 110 S.Ct. at 2267 (quoting H.R. Rep. No. 95-595, at
368 (1977), 1978 U.S.C.C.A.N. at 6324). "In the absence of any
suggestion in the Bankruptcy Code about what tracing rules to
apply," the Court adopted a literal reading of the above quote.
Under this literal reading, the Court held that "any voluntary
prepetition payment of trust-fund taxes out of the debtor's
assets [satisfies the nexus requirement and therefore] is not a
transfer of the debtor's property." Begier, 496 U.S. at 67, 110
S.Ct. at 2267.
This holding does not control the situation before us,
because Begier involved a pre-petition payment to the taxing
authority, while here we confront the taxing authority's attempt
to collect the taxes from the debtor's post-petition general
assets. Of course, the holding that an actual pre-petition
payment will satisfy the nexus requirement does not mean that the
requirement cannot be satisfied in some other way.
payment, we cannot draw a conclusion from Begier as to whether
the City of Farrell has met the nexus requirement.
Nevertheless Sharon Steel argues that as "it is
undisputed that the [t]axes were not held in a segregated account
. . . [or] paid prepetition, . . . the required nexus cannot be
established." Brief at 13 (emphasis added). But its argument
misconstrues Begier's nexus requirement, because it contemplates
that the nexus requirement is met only if the employer had
segregated the trust fund taxes or transferred them to the taxing
authority before the petition. Yet Begier's reliance on
Representative Edwards' remarks shows that the taxing authorities
should be able to show that the nexus requirement is satisfied in
other ways.9
9
. The bankruptcy court cited In re Kulzer Roofing, Inc., 139
B.R. 132 (Bankr. E.D. Pa. 1992), aff'd 150 B.R. 134 (E.D. Pa.
1992), and In re Russman's, Inc., 125 B.R. 520 (Bankr. E.D. Tenn.
1991), for the proposition that the "City of Farrell cannot
establish the required nexus with regard to the commingled funds
in [Sharon Steel's] possession." In re Sharon Steel Corp., 152
B.R. at 451-52. Kulzer is readily distinguishable as it did not
involve a taxing authority, but involved private parties'
attempts to collect funds that were commingled in the debtor's
general assets. The bankruptcy court rejected the attempt
because the claimants had not established that the funds were
held in either an express or a constructive trust. 139 B.R. at
141. Of course, even if Kulzer were not distinguishable we would
not be bound to follow it.
Russman, however, though concerning sales taxes, raises
trust-fund issues similar to those in this case. Russman held
that a state taxing authority had satisfied Begier's nexus
requirement with respect to segregated funds but had not
satisfied the nexus requirement "with regard to the commingled
funds remaining on deposit in the trustee's general operating
account." Russman, 125 B.R. at 524. But the court reached its
conclusion with respect to the commingled funds without analysis
and in these circumstances we do not find the opinion persuasive.
Because the Begier Court relied heavily on
Representative Edwards' remarks when deciding whether the pre-
petition transfer satisfied the nexus requirement, we will give
his remarks similar weight in considering whether the City of
Farrell has satisfied the nexus requirement. Specifically, as
partially quoted earlier, Representative Edwards stated that:
Where it is not possible for the Internal
Revenue Service to demonstrate that the amounts of
taxes withheld are still in the possession of the
debtor at the commencement of the case, present
law generally includes amounts of withheld taxes
as property of the estate. . . . Nonetheless, a
serious problem exists where 'trust fund taxes'
withheld from others are held to be property of
the estate where the withheld amounts are
commingled with other assets of the debtor. The
Courts should permit the use of reasonable
assumptions under which the Internal Revenue
Service, and other taxing authorities, can
demonstrate that amounts of withheld taxes are
still in the possession of the debtor at the
commencement of the case. For example, where the
debtor had commingled that amount of withheld
taxes in his general checking account, it might be
reasonable to assume that any remaining amounts in
that account on the commencement of the case are
withheld taxes.
124 Cong. Rec. at 11,047. Thus, Representative Edwards spoke
about a situation in which an employer commingles the trust-fund
taxes in its general checking account and subsequently files for
bankruptcy without having paid the taxes to the appropriate
taxing authority.
We, however, face an insurmountable hurdle barring us
from deciding whether the City of Farrell has satisfied the nexus
requirement, because neither the bankruptcy court nor the
district court made findings of fact on which we could predicate
such a determination. This omission is understandable, since the
bankruptcy court and district court believed that the city could
not satisfy the nexus requirement as Sharon Steel's funds were
commingled and Sharon Steel did not pay the taxes before it filed
its Chapter 11 petition. Nevertheless Representative Edwards'
example of what "might" constitute a reasonable assumption could
be applicable here.10
As we have indicated, Representative Edwards stated
that "where the debtor had commingled [the] amount of withheld
taxes in his general checking account, it might be reasonable to
assume that any remaining amounts in that account on the
commencement of the case are withheld taxes." Sharon Steel
concedes that before it filed for bankruptcy, Citibank
"controlled all monies coming into Sharon Steel through a lock
box account . . . [and] Citibank would authorize disbursement of
funds from the [l]ock [b]ox [a]ccount to Sharon Steel's operating
10
. We recognize that allowing courts to consider commingling in
deciding whether a sufficient nexus exists runs counter to our
holding above that a party should not be able to defeat a trust
"simply by commingling the withholding funds with its other
assets." See typescript at 15. Nonetheless, as the Supreme
Court held in Begier, the question of whether a trust exists is
analytically distinct from whether or not the trust funds are
traceable and identifiable. The first question involves an
inquiry into state law; the second does not. Therefore,
considerations relevant to the first question are not always
coextensive with considerations relevant to the second. To some
extent, however, Representative Edwards' comments were intended
to make equitable considerations part of the "nexus" inquiry as
well. Thus, when applying the guidelines we set forth to
determine whether a nexus exists, the bankruptcy court certainly
should keep in mind the broader policy against allowing a party
unilaterally to make a trust unenforceable by commingling assets.
accounts." Brief at 3. Thus, as Sharon Steel's funds were
placed in the lock box account, it would be reasonable to
conclude that the withheld funds were held in trust for the City
of Farrell in that account. Moreover, when Sharon Steel filed
its Chapter 11 petition the lock box account may have contained
an amount of funds exceeding the remaining withholding held in
trust for the City. If so, we have the exact set of facts that
Representative Edwards contemplated: i.e. pre-petition trust-
fund taxes commingled in the debtor's general checking account.11
Because it is manifest that we do not know sufficient
facts to determine whether the City of Farrell has met the nexus
requirement, we will remand the case to the district court which
in turn will remand it to the bankruptcy court for appropriate
fact finding. The district court and the bankruptcy court should
be cognizant of the factual findings necessary to apply the
"lowest intermediate balance test" ("LIBT"). The LIBT is a
judicial construct that some federal courts have applied to ease
a beneficiary's tracing burden when "a trustee commingles trust
funds with other monies in a single account." In re Columbia
Gas, 997 F.2d at 1063. The LIBT "allows trust beneficiaries to
assume that trust funds are withdrawn last from a commingled
11
. We reject any argument that because the City of Farrell is
not the IRS, it should not receive the benefits of Representative
Edwards' remarks. He specifically stated that "[t]he Courts
should permit the use of reasonable assumptions under which the
Internal Revenue Service, and other taxing authorities, can
demonstrate that amounts of withheld taxes are still in the
possession of the debtor at the commencement of the case." Thus,
we cannot limit the application of his statement to the IRS.
account. Once trust money is removed, however, it is not
replenished by subsequent deposits. Therefore, the lowest
intermediate balance in a commingled account represents trust
funds that have never been dissipated and which are reasonably
identifiable." Id.At this time we do not decide definitively that the
district court and the bankruptcy court must apply the LIBT as
the parties have not briefed the issue and neither the bankruptcy
court nor the district court addressed the applicability of the
LIBT. But, as we recognize that the LIBT may constitute a
"reasonable assumption[] under which the Internal Revenue
Service, and other taxing authorities, can demonstrate that
amounts of withheld taxes are still in the possession of the
debtor at the commencement of the case[,]" we will instruct that
on remand, the bankruptcy court make factual findings sufficient
to support a conclusion as to whether the city may recover if, as
a matter of law, the LIBT is applied.
Sharon Steel also contends that the city did not
request discovery and relied exclusively on Begier in the
bankruptcy court. Thus, in Sharon Steel's view, the city has
waived its rights to discovery and we therefore should not remand
for additional fact-finding. Brief at 8-9. The city responds
that the procedural posture of the case in the bankruptcy court
precluded it from obtaining discovery. We need not linger on
this point as Sharon Steel's argument necessarily is predicated
on its contention that we must apply a clearly erroneous standard
of review to the bankruptcy court's finding that "[t]he City of
Farrell cannot establish the required nexus with regard to the
commingled funds in [Sharon Steel's] possession." Brief at 10.
The bankruptcy court made this finding on the basis of its
correct observation that "there is no allegation that there
exists a segregated trust fund and the amount in question has not
been paid." In re Sharon Steel Corp., 152 B.R. at 451. In view
of those legal conclusions drawn from undisputed facts it would
have been pointless for the city to request discovery as the
discovery would not have been directed to the issues which the
bankruptcy court thought were outcome determinative as a matter
of law. Rather, discovery could be germane only to determine the
status of funds that Sharon Steel had neither segregated nor paid
before filing its Chapter 11 petition. Accordingly, in light of
our legal conclusion that the bankruptcy court misstated the law,
it is only fair that the parties have an opportunity to develop
the facts relating to the broader method of satisfying the nexus
requirement which we recognize. Consequently, we reject Sharon
Steel's argument that we should not remand for additional factual
findings.
We deal with one final point. Citibank, as agent for
certain lenders, asserts that "the only source of funds available
to pay the taxes is the Cash Collateral Account which secures
[Sharon Steel's] obligations to the Lenders under" a prepetition
credit agreement on which the lenders have a prior lien.
Therefore in its view the taxes cannot be paid without the
lenders' consent. It concludes the taxes cannot be paid at all
as the lenders do not consent. Brief at 10-11. Neither the
district court nor the bankruptcy court considered this issue and
the parties have not briefed it on this appeal, though Citibank
has mentioned the point in a conclusory fashion. Furthermore,
the record is not clear as to exactly how Citibank and Sharon
Steel treated Sharon Steel's funds. In these circumstances we
are satisfied that we should not address Citibank's argument but
we reach our result without prejudice to Citibank's position on
this point which it may advance on the remand.
In sum, therefore, we will reverse the district court's
order of February 14, 1994, and will remand the case to the
district court for proceedings consistent with this opinion.
Specifically, on further remand, the bankruptcy court should make
factual findings about Sharon Steel's payment of wages and the
withholding, i.e. the accounts in which the withholding was
placed, the deposit and withdrawal history of those accounts, and
the amounts remaining in those accounts at the time Sharon Steel
filed its bankruptcy petition. Furthermore, Citibank may assert
that the lenders which it represents have a lien on the funds
from which the city seeks payment.