Hartford Underwriters Ins. Co. v. Magma Bank, N.A.
In theUnited States Court of AppealsFor the Seventh CircuitNo. 98-3590In Re: William Stoecker,Debtor,Appeal of: State of Illinois, Departmentof Revenue.Appeal from the United States District Courtfor the Northern District of Illinois, Eastern Division.No. 97 C 414--Wayne R. Andersen, Judge.Argued April 16, 1999--Decided June 2, 1999 Before Posner, Chief Judge, and Bauer and Rovner,Circuit Judges. Posner, Chief Judge. This bankruptcy appeal hasa complicated procedural history that we shallignore; the curious are referred to 151 B.R. 989(Bankr. N.D. Ill. 1992); 179 B.R. 532 (N.D. Ill.1994), and 202 B.R. 429 (Bankr. N.D. Ill. 1996).All that matters is that the bankruptcy courteventually disallowed Illinois's claim againstthe debtor's estate for some $900,000 in unpaidIllinois use tax (including interest), Ill. Rev.Stat. ch. 120, para. 439.12 (1989), which wasowed on the purchase of a corporate aircraft.(The current statute, 35 ILCS 105/12, has anarrower scope, but we shall cite to it becausethe provisions that we discuss are materially thesame.) The district court affirmed thedisallowance, precipitating this appeal by thestate against the trustee in bankruptcy. The plane had been bought by ChandlerEnterprises, Inc., an Illinois company (nowdefunct) of which Stoecker was president. Thestate claims that Stoecker is liable for the taxas a "responsible officer" of Chandler. 35 ILCS735/3-7. If this is right, the liability is adebt of the estate in bankruptcy. Chandler had asked Jack Prewitt & Associates(JPA), an established buyer and seller ofcorporate jets, to find one for it. JPA located asuitable jet that was for sale by BezwadaInvestments and agreed with Chandler to brokerthe purchase. But Chandler did not have the cashto pay the plane's full purchase price, which wasin excess of $12 million, right away; so JPAturned to an affiliate, Prewitt Leasing, Inc.(PLI), which does airplane leasing and financing,for help with the sale. JPA bought the plane fromBezwada and transferred the title from itself toPLI. PLI then entered into an "Aircraft/LeasePurchase Agreement" with Chandler under whichChandler agreed to pay PLI $2.4 millionimmediately to be "applied to the final purchaseprice of the aircraft" and $10 million more (plusinterest denominated "lease payments" on the $10million) in 90 days if it decided to buy. Untilthe purchase option was exercised, title wouldremain in PLI. But during the 90-day optionperiod, Chandler would have the full use of theplane and indeed could modify it as it saw fit.In June 1998, Chandler took delivery of the planeand transported it to Illinois and in Septemberit exercised the option and PLI transferred titleto it. Thus the transaction was Bezwada-JPA-PLI-Chandler. The Illinois use tax is a sales-tax substituteimposed on Illinois residents (which Chandler isconceded to be, or rather to have been, since itis now defunct) who buy from out-of-statesellers. If the seller doesn't pay the tax, thebuyer must file a return and pay the tax and inthe case of aircraft the return must be filed andthe tax paid within 30 days after the aircraftenters the state. 35 ILCS 105/10. When no returnis filed--and Chandler filed no return--theIllinois Department of Revenue determines theamount of tax due and issues a Notice of TaxLiability to the taxpayer. 35 ILCS 105/12, 120/4.Unless the taxpayer protests the notice withinthe time provided, it become a final assessmentalthough it is still subject to judicial reviewin the Illinois circuit court. 35 ILCS 120/4, 12. The taxpayer may not be the only one liable fora tax. Under Illinois law, any corporate officer"who has the control, supervision orresponsibility of filing returns and makingpayment of the amount of any . . . tax . . . whowillfully fails to file the return or make thepayment . . . shall be personally liable for apenalty equal to the total amount of tax unpaidby the [corporation]." 35 ILCS 735/3-7. TheDepartment determines the penalty, and itsdetermination is "prima facie evidence of apenalty due." Id. It embodies this determinationin a Notice of Penalty Liability which is sent tothe officer. The procedures for challenging aNotice of Penalty Liability are similar to thosefor challenging a Notice of Tax Liability. Chandler not only failed to file a use-taxreturn; it failed to register the plane with theIllinois Department of Aviation, as it wasrequired to do. As a result, it took theDepartment of Revenue years to discover thatChandler owed use tax and by that time thecompany was defunct and Stoecker, its president,was in bankruptcy. The Department issued both aNotice of Tax Liability, futilely, againstChandler and a Notice of Penalty Liabilityagainst Stoecker. There are two principal issues. The first, whichthe district court resolved in favor of thestate, is whether Chandler owed use tax on thepurchase of the plane. The second, which thecourt resolved in favor of the trustee, iswhether, if Chandler did owe use tax, Stoecker isliable for that tax as a responsible officer.Since Chandler, now a ghost, cannot pay the tax,the court's second ruling spelled defeat for thestate. The trustee defends the second ruling butattacks the first, arguing that no use tax wasowed, in which event Stoecker had no responsible-officer liability regardless. The district court thought itself and thebankruptcy court barred by the Tax InjunctionAct, 28 U.S.C. sec. 1341, from reexaminingChandler's liability for use tax. The Act forbidsfederal courts to enjoin the assessment orcollection of state taxes unless the taxpayer hasno adequate remedy in the state courts. ButIllinois is not trying to extract taxes fromChandler. It is trying to get a penalty in lieuof taxes from Stoecker's estate in bankruptcy.Its right to do so depends on whether Chandlerowed use tax, and the district judge thought thata federal court cannot decide an issue of statetax law. That is incorrect. The Bankruptcy Codeexpressly authorizes bankruptcy courts to decidetax issues, 11 U.S.C. sec. 505(a)(1), andalthough state taxes are not specified, thecourts have interpreted the statute to coverthem. Adams v. Indiana, 795 F.2d 27, 29 (7th Cir.1986); City Vending of Muskogee, Inc. v. OklahomaTax Comm'n, 898 F.2d 122, 123-24 (10th Cir. 1990)(per curiam). The Act is anyway addressed only toinjunctive remedies (or a declaratory judgmentviewed as a preliminary to an injunction,National Private Truck Counsel, Inc. v. OklahomaTax Comm'n, 515 U.S. 582, 586 (1995)), and no oneis seeking an injunction against the state'sgoing after Chandler for the taxes that the statebelieves Chandler owes it. If federal courtscould not determine the debtor's liability forstate taxes--if they had to abstain pending adetermination of that liability in state court--bankruptcy proceedings would be even moreprotracted than they are. So we can consider the trustee's argumentagainst that liability, and it is that PLI's saleof the aircraft to Chandler was an "isolated oroccasional sale of tangible personal property atretail by a person who does not hold himself outas being engaged (or who does not habituallyengage) in selling such tangible personalproperty at retail." 35 ILCS 105/2. An examplewould be a good bought at a garage sale; no usetax would be due. See 86 Ill. Admin. Code sec.130.110(b) (1991); cf. Knowledge Data Systems v.Utah State Tax Comm'n, 865 P.2d 1387 (Utah App.1993); Nevada Tax Comm'n v. Bernhard, 683 P.2d 21(Nev. 1984) (per curiam). PLI, unlike its affiliate JPA, was not engagedin the regular sale of aircraft at retail (or atwholesale, for that matter). In fact the sale toChandler was apparently the first sale of anaircraft that PLI had made. The trustee thuswants us to confine our attention to the transferof title from PLI to Chandler. But that would bemyopic. PLI is the financing arm of JPA, which isa retailer of aircraft. JPA found the plane forChandler, took title to it from its previousowner, Bezwada, and brought PLI in to financeChandler's purchase of it. Bezwada was (so far aswe can tell) not a retailer. But JPA was and itacted as the intermediary in the sale toChandler, at one point actually holding title, asin the ordinary retail sale where the retailerbuys from a supplier and resells to a consumer.The fact that title passed from the retailer toits affiliate before coming to rest with Chandlerdid not make PLI the real seller. Otherwisetransactions would be easily structured to avoiduse tax by having an out-of-state retailertransfer title to its nonretailer affiliate forretransfer to the in-state purchaser. The"substance over form" doctrine of tax law, onwhich see Gregory v. Helvering, 293 U.S. 465(1935); Segal v. Commissioner, 41 F.3d 1144, 1148(7th Cir. 1994); Yosha v. Commissioner, 861 F.2d494 (7th Cir. 1988); ACM Partnership v.Commissioner, 157 F.3d 231, 246-47 (3d Cir.1998), would presumably allow the state to defeatthe bankruptcy trustee's attempt to invoke the"isolated or occasional sale" exemption byrecharacterizing the transaction as a sale by JPAto Chandler. Cf. Continental Illinois LeasingCorp. v. Department of Revenue, 439 N.E.2d 118(Ill. App. 1982). But this analysis is incomplete, because thereis another and equally good way of playing"substance over form" in this case, and that isto treat the "real" sale as Bezwada to Chandler,with JPA and PLI holding title merely as securityfor financing the sale. See UCC sec.sec. 1-201(37), 9-102, 810 ILCS 5/1-201(37), 5/9-102;Orix Credit Alliance, Inc. v. Pappas, 946 F.2d1258 (7th Cir. 1991); Tilghman Hardware, Inc. v.Larrimore, 628 A.2d 215 (Md. 1993). Thisparticular application of the "substance overform" doctrine, however, is nixed by Illinoislaw, which expressly treats a transfer of titleto a retailer as a sale even if the purpose ismerely to grant a security interest. 86 Ill.Admin. Code sec. 130.1060(a); Illinois Dept. ofRevenue Private Letter No. 92-0113, 1992 WL154376 (Feb. 27, 1992). JPA took title; JPA is aretailer; therefore use tax was due on thesubsequent transfer of title by JPA to Chandler. So Chandler was liable for the tax and the nextquestion is whether Mr. Stoecker was liable toounder the "responsible officer" rule. The recordcontains no evidence about the structure, scale,or operations of Chandler--even about whatbusiness it was engaged in--except that we doknow that it had an officer named Pluhar whoacted as the company's financial officer. Thereis no evidence concerning Stoecker's role in thefiling of Chandler's tax returns or the paymentof any taxes due, and so no proof either that hewas responsible for these corporate functions orthat he willfully evaded the payment of the usetax. But just as under the corresponding federallaw of responsible-officer liability for unpaidtaxes, 26 U.S.C. sec. 6672; United States v.Running, 7 F.3d 1293, 1297 (7th Cir. 1993);United States v. McCombs, 30 F.3d 310, 318 (2dCir. 1994), Illinois shifts the burden of proof--both production and persuasion--to the officeronce a Notice of Penalty Liability is issued,Branson v. Department of Revenue, 659 N.E.2d 961,968 (Ill. 1995); and the trustee has not carriedit. He may have satisfied his burden ofproduction by identifying Pluhar as Chandler'scorporate financial officer, but he has notsatisfied the burden of persuasion. Stoecker wasthe president and as far as we know he and Pluharwere the only officers and both deeply involvedin the tax affairs of their corporation. It is true that, just as under the correspondingfederal law, Wright v. United States, 809 F.2d425, 427 (7th Cir. 1987), the failure to pay mustbe willful, implying at least gross negligence.Branson v. Department of Revenue, supra, 659 F.2dat 965. Chandler had an opinion letter from areputable lawyer that no tax was due because JPAreally had just a security interest; and relianceon a reputable lawyer's opinion letter can negatewillfulness, Marrin v. Commissioner, 147 F.3d147, 152 (2d Cir. 1998); cf. Hall v. Aqua QueenMfg., Inc., 93 F.3d 1548, 1555 (Fed. Cir. 1996);Westvaco Corp v. International Paper Co., 991F.2d 735, 743-44 (Fed. Cir. 1993), though it'snot an automatic safe harbor. Marrin v.Commissioner, supra, 147 F.3d at 152-53; O'Connorv. United States, 956 F.2d 48, 52 n. * (4th Cir.1992); Smith v. United States, 894 F.2d 1549,1554 (11th Cir. 1990). But no evidence waspresented that Stoecker ever saw the letter, letalone that he relied on it. There is no otherevidence bearing on the issue of willfulness. So the burden of proof is critical, and thetrustee argues that whatever the rule under statelaw, the burden is on the state when the issue ofresponsible-officer liability is adjudicated in abankruptcy proceeding. This shift is necessary,he contends, to promote "equality" amongcreditors in bankruptcy. Bankruptcy is anequitable procedure, and "equality is equity"(and vice versa), Cunningham v. Brown, 265 U.S.1, 13 (1924); Scott v. Armstrong, 146 U.S. 499,511 (1892); United States v. Real Property, 89F.3d 551, 554 (9th Cir. 1996); DownriverCommunity Federal Credit Union v. Penn SquareBank, 879 F.2d 754, 761 (10th Cir. 1989); Whitev. Carolina Paperboard Corp., 564 F.2d 1073, 1087(4th Cir. 1977), as numerous bankruptcy casesintone. E.g., In re Elcona Homes Corp., 863 F.2d483, 484 (7th Cir. 1988); In re Joliet-WillCounty Community Action Agency, 847 F.2d 430, 434(7th Cir. 1988). These truisms have a particularappeal for those bankruptcy judges who would liketo administer the bankruptcy laws in accordancewith their personal notions of fairness. But itis now well settled that although the origins,procedures, and many of the remedies ofbankruptcy are indeed equitable, a bankruptcyjudge has no authority to cut down theentitlements that creditors seek to enforce inbankruptcy, except (see, e.g., United States v.Whiting Pools, Inc., 462 U.S. 198 (1983)) asprovided by the Bankruptcy Code itself. UnitedStates v. Noland, 517 U.S. 535, 543 (1996);Butner v. United States, 440 U.S. 48, 55-56(1979); In re Carlson, 126 F.3d 915, 920 (7thCir. 1997); In re FBN Food Services, Inc., 82F.3d 1387, 1396 (7th Cir. 1996); In re Lapiana,909 F.2d 221, 223 (7th Cir. 1990); In re LandbankEquity Corp., 973 F.2d 265, 271 (4th Cir. 1992). Bankruptcy is not a "free-for-all equitybalancing act." In re Lapiana, supra, 909 F.2d at2224. It is a forum in which creditors prove theentitlements that state or federal law confers onthem, and these entitlements are then enforcedconsistently with the provisions of the Codegoverning preferences, priority, and other issuesthat arise in the marshaling and collection ofdebts from a bankrupt debtor, none of whichaffects a state's tax claim. An equity free-for-all would engender confusion and uncertainty andincrease the strategic incentives to petition forbankruptcy either of debtors, if the bankruptcycourt curtailed entitlements, or of creditors, ifit expanded them. The closest to the power hereasserted of a free-wheeling equitable discretionto cut down entitlements when they are sought tobe enforced in a bankruptcy proceeding is thepower of equitable subordination. 11 U.S.C. sec.510. But it must be exercised case by case andnot over a whole class of claims. United Statesv. Reorganized CF&I Fabricators of Utah, Inc.,518 U.S. 213, 228-29 (1996); United States v.Noland, supra, 517 U.S. at 543; cf. In reEnvirodyne Industries, Inc., 79 F.3d 579, 581(7th Cir. 1996). Burden of proof is rightly classified as a partof the creditor's entitlement, implying that itis not shifted in bankruptcy. In re LandbankEquity Corp., supra, 973 F.3d at 270, so holds,though In re Macfarlane, 83 F.3d 1041, 1045 (9thCir. 1996), is to the contrary. We acknowledgedthe division of authority in In re Carlson,supra, 126 F.3d at 921, without having to choose.Today we choose, and we choose Landbank. It issupported by the general pattern of American taxlaw, in which "payment precedes defense, and theburden of proof, normally on the claimant, isshifted to the taxpayer," Bull v. United States,295 U.S. 247, 260 (1935), and by the countlesscases which hold that burden of proof is"substantive" for purposes of the Erie doctrine,e.g., Director v. Greenwich Collieries, 512 U.S.267, 271 (1994); American Dredging Co. v. Miller,510 U.S. 443, 454 (1994); Dick v. New York LifeIns. Co., 359 U.S. 437, 446 (1959); Koppers Co.v. Aetna Casualty & Surety Co., 98 F.3d 1440,1446 (3d Cir. 1996), in recognition of thecritical importance of burden of proof to aperson's rights. Illinois has given its taxingauthorities an entitlement to collect a penaltytax pursuant to a Notice of Penalty Liabilitythat is defeasible only if the taxpayer canpersuade the adjudicator that the tax is not due.That is different from an entitlement to collectthe taxes listed in the notice upon proof by thestate that the tax is due. On the latter view,the Notice of Penalty Liability really is just anotice, conferring no rights, adding nothing tothe Notice of Tax Liability; on the former view,which seems to us the sound view, the Notice ofPenalty Liability creates a defeasible right. Congress can alter entitlements in bankruptcy,and sometimes does so, but there is no indicationthat it meant to shift the burden of proof fromtaxpayer to tax collector. Rather the contrary.The Code itself grants a favored position toclaims of unpaid taxes, 11 U.S.C. sec.sec.507(a)(8), 523(a)(1) (we're about to see anotherexample); and the close attention that thedrafters of the Code paid to issues of burden ofproof, e.g., 11 U.S.C. sec.sec. 362(g), 363(o),364(d)(2), 547(g), 1129(d), makes their silenceon the burden of proof in tax cases eloquent. Theposition for which the trustee contends has nomore basis in the Code than in the law ofIllinois, and it would create a new incentive todeclare bankruptcy. We have enough bankruptcies. The last string to the trustee's bow is theargument that the state's tax claim was untimely.Bankruptcy Rule 3002(c) requires, with immaterialexceptions, that a proof of claim be filed withthe bankruptcy court within 90 days after thefirst date set for the meeting of creditors,which in this case would have been by June 26,1990. See also Bankr. R. 9006(b)(3). The state'sclaim was not filed until 18 months later and itwas therefore untimely. But in a conflict betweenthe Code and the rules, the Code controls, 28U.S.C. sec. 2075; In re Pacific Atlantic TradingCo., 33 F.3d 1064, 1066 (9th Cir. 1994), and itpermits--without even a loss of priority--thefiling of certain untimely claims (other than bythe debtor, In re Danielson, 981 F.2d 296 (7thCir. 1992)), including the state's tax claims inthis case. See 11 U.S.C. sec.sec. 507(a)(8)(E),726(a)(1). This is crystal clear under thecurrent version of section 726(a)(1), but wasclear enough under the old version, e.g., Cooperv. Internal Revenue, 167 F.3d 857 (4th Cir.1999), the one applicable to this suit, thoughsome courts disagreed. See cases cited in id. at859. The exception for instances of inexcusabledelay, in which the tardy claim may be equitablysubordinated to timely claims, 11 U.S.C. sec.726(a) (incorporating sec. 510), is not availableto Stoecker. Chandler's failure to register theaircraft or file a tax return prevented the statefrom discovering Stoecker's liability until longafter the bankruptcy proceeding was commenced, anexpress purpose of the requirement ofregistration being to make sure that "allapplicable fees and taxes shall be paid." 620ILCS 5/42. We conclude that the state has a valid claimagainst Stoecker's estate and that the decisionof the district court must therefore be reversed. We wish in closing to commend counsel for bothparties (Benjamin Goldgar for the state andRobert Radasevich for the trustee) for theirexcellent briefs and argument.Reversed and Remanded.