CHRISTOPHER S. SONTCHI, Chief Bankruptcy Judge.
This matter comes before the Court following an evidentiary hearing conducted on January 15, 2019. The matter arises from the motion of the current chapter 7 trustee, George L. Miller ("Trustee Miller"), to disgorge fees paid to the former trustee, Montague Claybrook, over 14 years ago. Trustee Miller alleges that Mr. Claybrook's negligent handling of the Debtor's tax obligations in 2006 caused certain Internal Revenue Service ("IRS") penalty and interest assessments against the Debtor's estate. Whether Mr. Claybrook did or did not mishandle the Debtor's tax obligations in 2006 is ultimately less consequential, however, than the question of whether the IRS assessments were accurate. Having considered the legal arguments and the evidence presented, the Court concludes that Mr. Miller has not satisfied his burden of proving by a preponderance of the evidence that the IRS assessments were accurate. Accordingly, Mr. Claybrook will not be held liable for such assessments against the Debtors' estate, and Trustee Miller's motion will be denied.
1. On January 12, 2004 (the "Petition Date"), Bake-Line Group, LLC and its affiliates (the "Debtors") commenced voluntary petitions for relief under chapter 7 of the Bankruptcy Code.
2. On the Petition Date, Montague Claybrook was appointed as the chapter 7 trustee for the Debtors' bankruptcy estate (the "Estate").
3. On July 18, 2013, Mr. Claybrook resigned from his appointment in all pending bankruptcy proceedings, including the Debtors' cases.
4. On July 26, 2013, Trustee Miller was appointed as successor chapter 7 trustee of the Estate.
5. On May 8, 2018, Trustee Miller filed the Motion of George L. Miller, Successor Chapter 7 Trustee, for Entry of an Order Disgorging Certain Compensation Paid to the Former Chapter 7 Trustee, Montague S. Claybrook (the "Disgorgement Motion").
6. On October 17, 2018, Mr. Claybrook filed the Objection of Montague S. Claybrook to the Motion of George L. Miller, Successor chapter 7 Trustee, for the Entry of an Order Disgorging Certain Compensation Paid to the Former Chapter 7 trustee, Montague S. Claybrook ("Objection").
7. On December 28, 2018, Trustee Miller filed the Successor Chapter 7 Trustee's Reply to the Objection of Montague S. Claybrook to the Motion of George L. Miller, Successor Chapter 7 Trustee, for Entry of an Order Disgorging Certain Compensation Paid to the Former Chapter 7 Trustee, Montague S. Claybrook.
8. On January 15, 2019, the Court held an evidentiary hearing regarding the Disgorgement Motion.
9. Prior to his resignation, Mr. Claybrook administered the assets of the Debtor as the chapter 7 trustee. Among other things, Mr. Claybrook was tasked with: (1) collecting property of the Debtor; (2) closing the Debtor as expeditiously as is compatible with the best interests of parties in interests; (3) being accountable for all property received; (4) furnishing information concerning the Debtor and its administration if requested by a party in interest; and (5) abiding by the Handbook for Chapter 7 Trustees issued by the Department of Justice, Executive Office for United States Trustees, which includes the duty to file appropriate tax returns and pay tax liabilities on behalf of the Debtor.
10. On November 18, 2005, the Court entered an order (the "Settlement Order")
a. Within 30 days of the Court's entry of a final non-appealable order approving this Stipulation, the Trustee shall: (a) issue in each Plaintiff's name a check in the amount of $1,136.36 less $378.78 for Plaintiffs Counsel's fees and less appropriate taxes and withholdings; (b) issue to Plaintiffs' Counsel a check for $66,665.92; and
b. Within 30 days of the date on which the total amount of funds that the Trustee has received from settlement of or judgment in adversary actions brought by the Trustee in these bankruptcy cases exceeds $2.5 million, the Trustee shall (a) issue a check in the name of each Plaintiff in the amount of $2,215.91 less $738.64 in attorney's fees and less appropriate taxes and withholdings; and (b) issue to Plaintiffs' Counsel a check in the amount of $130,000.
11. On December 8, 2005, Mr. Claybrook issued two checks to each Plaintiff for the amounts required to be paid in paragraphs 1(i) and 1(ii) of the WARN ACT Settlement Stipulation. The total amount of these checks was $261,515.78.3.
12. On December 8, 2005, Mr. Claybrook also issued the following checks to the IRS in connection with the WARN Act Settlement Stipulation:
a. a check to the IRS for Federal Withholding in the amount of $78,666.72 (check no. 227);
b. a check to the IRS for the WARN Plaintiffs' portion of FICA in the amount of $24,386.56 (check no. 228); and
c. a check to the IRS for the WARN Plaintiffs' portion of Medicare in the amount of $5,702.40 (check no. 229).
The total amount of these checks issued to the IRS on December 8, 2005 was $108,755.68.
13. On January 9, 2006, based on a motion filed by Mr. Claybrook, the Court awarded him interim compensation in the amount of $232,500.90.
14. On March 1, 2006, Mr. Claybrook issued a check to the IRS for the Debtor's portion of Medicare in the amount of $5,702.40 (check no. 589).
15. On March 8, 2006, Mr. Claybrook issued a check to the IRS for the Debtor's portion of FICA in the amount of $24,386.56 (check no. 558).
16. All five checks issued to the IRS relating to the WARN Act Settlement (check nos. 227, 228, 229, 558, and 589), totaling $138,844.64, cleared the Debtor's bank account on March 21, 2006 (collectively, the "2006 Claybrook Payments").
17. The Debtor's IRS Form 940 for 2005 was due no later than January 31, 2006, but the IRS did not receive it until March 30, 2006.
18. The Debtor's IRS Form 941 for the fourth quarter of 2005 was due no later than January 31, 2006, but the IRS did not receive it until March 10, 2006.
19. Mr. Claybrook testified that the reason he did not timely file Forms 940 and 941 is because he was waiting to pay approximately twenty of the WARN Plaintiffs in accordance with the WARN Act Stipulation, which required determining their appropriate addresses. The amount actually paid to the WARN Plaintiffs would ultimately determine the amounts to be properly reported on Forms 940 and 941. After making several attempts, using several databases, the checks paid to a number of the Plaintiffs were returned undeliverable. Mr. Claybrook ultimately was able to obtain the Plaintiffs' information from their class counsel by March of 2006, after the due date for the Forms 940 and 941, at which point he filed the relevant Forms. Mr. Claybrook did not seek an extension or otherwise contact the IRS regarding the late filing.
20. Form W-2s were due to the Social Security Administration by February 28, 2006, in connection with the issuance of payments made under the WARN Act Settlement Stipulation.
21. According to the IRS Account Transcripts for Forms 940, 941, and Civil Penalty (W-2), the IRS assessed the following penalties and interest against the Debtor (collectively, the "IRS Tax Obligation"):
a.
b.
c.
22. After Trustee Miller succeeded Mr. Claybrook as trustee in 2013, he requested tax refunds from the IRS in the amount of $66,767.37 for certain payroll tax overpayments (the "Overpayment Refund" or "Refund"). The source of the Overpayment Refund was Trustee Miller's filing of payroll tax returns associated with interim distributions made to former employees of the Debtor. Specifically, Trustee Miller made the payroll tax deposits at the time the interim distributions were made, but several of the distributions were not delivered and were returned to Trustee Miller, and several other distribution checks were never cashed. As a result, Trustee Miller sought the Overpayment Refund from the IRS.
23. The IRS processed the Overpayment Refund but retained and applied the entirety of it ($66,767.37) to the Debtor's IRS Tax Obligation ($109,392.50). The Debtor's Form 941 IRS Account Transcript for the period ending December 31, 2005, indicates that the Overpayment Refund was applied to obligations outstanding on the Debtor's Form 941 for the period ending December 31, 2005.
24. As set forth above, on May 8, 2018, Trustee Miller filed the Disgorgement Motion seeking entry of an order directing disgorgement of compensation paid to Mr. Claybrook from his time as the chapter 7 trustee in this case, with such disgorgement to equal no less than $109,329.50 (plus accruing interest), corresponding with the total amount of the IRS Tax Obligation, which Trustee Miller alleges arises from Mr. Claybrook's failure to timely remit payroll taxes, failure to timely file payroll tax returns, and failure to submit the required W-2s to the Government for the period ending December 31, 2005.
25. The Court heard testimony regarding Trustee Miller's Disgorgement Motion and his claim that the IRS Tax Obligation arises from Mr. Claybrook's failure to timely remit payroll taxes, failure to timely file payroll tax returns, and failure to submit the required W-2s to the Government for the period ending December 31, 2005:
26. William Homony is a Partner with the accounting firm Miller Coffey Tate LLP, with whom he has been since 2000. Mr. Homony has a bachelor's degree in accounting and is a certified insolvency and restructuring advisor. For over 18 years, Mr. Homony has dealt with hundreds of cases performing various financial and consulting assignments, including dealing with WARN Act claimants, making distributions to wage claims, and the tax related matters that are involved in paying employees and former employees. Miller Coffey Tate LLP are Trustee Miller's retained accountants and bankruptcy consultants in this case, having been retained for such roles in July 2013. Mr. Homony has worked on this case since that time.
27. Mr. Homony was asked by Trustee Miller where the IRS applied the Overpayment Refund that was due to the Debtor and how Mr. Homony made this determination.
28. On March 14, 2016, the IRS sent Trustee Miller a notice indicating that a $8,189.54 portion of the Refund was applied to the IRS Tax Obligation for the period ending December 31, 2005.
29. On March 21, 2016, the IRS sent Trustee Miller a notice indicating that another $47,368.55 portion of the Refund was applied to the IRS Tax Obligation for the period ending December 31, 2005.
30. On March 21, 2016, the IRS sent Trustee Miller another notice indicating that another $11,208.28 portion of the Refund was applied to the IRS Tax Obligation for the period ending December 31, 2005.
31. Mr. Homony thereafter searched for the relevant tax returns for the period ending December 31, 2005, including requesting a copy of the same from the IRS. To date, Mr. Homony has not found a copy of the tax returns in the Debtor's files, despite Mr. Claybrook's testimony that he did turn them over to Trustee Miller along with all of the Debtor's files, at the end of his term as trustee. Also, because the relevant tax returns were for a period longer than 10 years old, the IRS is no longer in possession of returns pertaining to that period. Mr. Homony has, therefore, had no occasion to review the filed tax returns for the period ending December 31, 2005.
32. Mr. Homony reviewed the IRS account transcripts of the Debtor's Forms 940, 941, and W2s (collectively, the "IRS Account Transcripts") for the period ending December 31, 2005 and concluded:
a.
b.
c. Form W-2s. The Civil Penalty Account Transcript for the tax period ending December 31, 2005, reflects that a civil penalty was assessed in the amount of $39,333.30 on December 29, 2008 for a failure to file Form W-2s with the Social Security Administration. Interest was subsequently assessed on November 17, 2014 ($8,909.77), and November 23, 2015 ($1,493.68). The total amount due to the IRS just prior to the application of the Overpayment Refund was $49,736.75. After application of a $7,716.81 portion of the Overpayment Refund, the balance due was $42,562.13, including $542.19 in ongoing interest charges.
33. Regarding the 2006 Claybrook Payments, Mr. Homony testified that $78,000 in checks from the Claybrook Payments were cashed and credited by the IRS, as reflected on the From 941 for that period.
34. Significantly, the Form 941 IRS Account Transcript for the period ending December 31, 2005, reflects a tax deposit penalty of $3,009.00, which is 5 percent of $60,177.92, which is the amount that was cleared to the IRS but not reflected on this transcript.
35. To date, Mr. Homony has not inquired with the IRS about the $60,177.92 in checks that were cashed but not reflected as credited in that exact amount on the Form 941 for the period of ending December 31, 2005.
36. Mr. Homony testified that he speculates that approximately $5,000 of the $60,177.92 was used by the IRS to pay down an outstanding balance due from the Debtor's 941 for the period ending December 31, 2002, as refenced earlier. Mr. Homony further speculates that the credited amount of $55,909.60 that is reflected on the Form 941 Account Transcript for the period ending December 31, 2005, is the remainder of the $60,177.92 Mr. Claybrook deposited to the IRS.
37. If the $60,177.92 deposit was not credited to the Debtor's 941 Account, then the current balance of the Debtor's IRS Tax Obligation ($42,562.13) is an incorrectly calculated amount. That is, an additional $60,177.92 credit to the Form 941 for the period ending December 31, 2006, after recalculating the relevant penalties and interest, would result in a remaining IRS Tax Obligation of approximately $14,000.
38. Mr. Homony testified that there are no records from which to definitively determine whether the $60,177.92 was in fact credited to the Debtor's IRS Tax Obligation.
39. Mr. Homony received the IRS Account Transcripts in March of 2016. Within a few months, he determined that the penalties were reasonable and the IRS setoff was valid.
40. The Court finds that Mr. Homony's determination regarding the accuracy of the IRS Tax Obligations is replete with speculation and inconsistencies. Therefore, the Court finds that Mr. Homony's determination in this regard is unreliable.
41. To date, Trustee Miller has not sought to avoid the IRS setoff, nor has an avoidance action been considered regarding the IRS setoff.
1. This Court has jurisdiction to consider and determine this matter pursuant to 28 U.S.C. § 1334. This is a core proceeding pursuant to 28 U.S.C. § 157(b). Venue is proper before this Court pursuant to 28 U.S.C. §§ 1408 and 1409.
2. The amount of compensation that can be awarded to trustees appointed in a case under chapter 7 is governed by sections 326(a) and 330.
3. Under section 330, a trustee may be awarded "reasonable compensation for actual, necessary services rendered . . . and . . . reimbursement for actual, necessary expenses."
4. Compensation of trustees in chapter 7 cases bypasses the typical considerations of section 330(a)(3). Instead, such compensation is governed by the percentages contained under section 326, which establishes a rebuttable presumption that the maximum percentage allowed under section 326 is reasonable.
5. Section 330(a)(2) explicitly allows for the reduction of a fee requested by a trustee based on a motion of the court, the United States Trustee, the trustee for the Debtor, or any party in interest.
6. A chapter 7 trustee serves as a representative of the estate and as a fiduciary of the estate for the benefit of the creditors.
7. If a trustee fails to timely file tax returns or pay taxes on behalf the Debtor, the IRS may impose penalties on the Debtor, "unless it is shown that such failure is due to reasonable cause and not willful neglect, "
8. The IRS has instructed employers who file late returns or make late deposits to attach an explanation of their "reasonable cause," if any, in order to potentially avoid late penalties.
9. Courts have found reasonable cause in such instances where a taxpayer relied on the IRS's inaction in conjunction with IRS audits,
10. Willful neglect has been found where a debtor knowingly and repeatedly failed to file tax returns or pay its tax debts in order to satisfy other obligations instead.
11. To succeed on the Disgorgement Motion, Trustee Miller must prove by a preponderance of the evidence that (i) Mr. Claybrook failed to perform his duty to appropriately satisfy the Debtor's tax-related obligations, (ii) that such failure resulted in the IRS Tax Obligation, and (iii) the IRS accurately calculated the amounts associated with the IRS Tax Obligation. If Trustee Miller satisfies his burden, then Mr. Claybrook carries the burden of proving he had reasonable cause and lacked willful neglect.
12. Mr. Claybrook's duties as the chapter 7 trustee included the timely filing of IRS tax returns and submission of all relevant tax forms on behalf of the Debtor. No one disputes that Mr. Claybrook did not timely file Forms 940 and 941 for the period ending December 31, 2005, despite knowing the appropriate due date (January 31, 2006). Mr. Claybrook testified that the reason he did not timely file the Forms 940 and 941 was because he was waiting to pay approximately twenty of the WARN Plaintiffs in accordance with the WARN Act Stipulation, which required contacting the relevant Plaintiffs and determining their appropriate addresses.
13. No one disputes that Mr. Claybrook failed to ever file Form W-2's with the Social Security Administration. Mr. Claybrook never provided these Form W-2s because he was not able to comply with the Social Security Administration's instructions on sending them. Sending these Forms in compliance with the Social Security Administration's instructions required a software that Mr. Claybrook did not have. Mr. Claybrook sought to use the software of other businesses, but no one he contacted was willing to provide their software to him. Ultimately, Mr. Claybrook made a business judgment to not make any further efforts to send the Form W-2's to the Social Security Administration.
14. In Refco, Judge Shannon did not find "willful neglect" where a Debtor was fully aware of its filing obligations and made repeated efforts to obtain the information necessary for making the appropriate tax filings but ultimately could not file a timely return.
15. Considering, however, that Mr. Claybrook did not seek an extension, did not otherwise contact the IRS regarding the late filings, and did not attach an explanation as to any reasonable causes, the Court finds that Mr. Claybrook did not exercise ordinary business care and prudence in filing the Forms and making the deposits. Mr. Claybrook could have potentially avoided any penalties by simply attaching an explanation of his reasons causing the Forms 940 and 941 late filings and deposits and for not filing Form W2s. Therefore, the Court concludes that Mr. Claybrook's conduct in this instance was a breach of his duty to timely file the relevant IRS returns and make timely deposits and he has not shown "reasonable cause" for breaching this duty.
16. That is not the end of the inquiry, however, as there remains the question of what damages, if any, exactly resulted from Mr. Claybrook's failure to file the relevant returns with the IRS. The IRS Account Transcripts indicate that penalties were assessed against the Debtor resulting from the late filing of the Forms for the period ending December 31, 2005. It is unclear, however, whether the penalties were correctly calculated and whether certain of the 2006 Claybrook Payments were accounted for in the penalty assessments. Particularly significant is the absence of a clear explanation as to why $60,177.92 in checks from the 2006 Claybrook Payments is not accounted for in that exact amount on the Debtor's Form 941 IRS Account Transcript for the period ending December 31, 2005. Mr. Homony speculates that approximately $5,000 of the $60,177.92 was applied to another delinquent tax obligation pertaining to the period ending December 31, 2002, prior to the Petition Date, and that a $55,909 credited amount that is reflected on the Form 941 for the 2005 period is the remainder of the $60,177.92. Mr. Homony does not provide any evidentiary support for this conclusion, however, as he has neither reviewed the tax return for the 2002 period nor is there an IRS Account Transcript available from that period to corroborate his speculation. Additionally, this explanation seemingly conflicts with the IRS's stated policy of applying deposits to the most recent tax liability within a quarter. According to that policy, the $60,177.92 that Mr. Claybrook deposited in 2006 should have been applied to the IRS Tax Obligation for that quarter (2005) before applying any amounts to the outstanding amount from 2002. Casting even greater uncertainty on Mr. Homony's speculation, the 941 Account Transcript reflects a $3,009.00 "Federal tax deposit penalty," which is approximately 5 percent of $60,177.92, assessed on June 5, 2006. This may indicate that the IRS did not account for $60,177.92 in checks that the Debtor's bank account record shows were cleared to the IRS on March 21, 2006. Ultimately, without the relevant records, Trustee Miller cannot establish that the penalties and interest were properly assessed. Therefore, the Court concludes that Trustee Miller has not satisfied his burden of proving that the IRS Tax Obligation was accurately calculated and that any damages incurred to the Debtor resulted from Mr. Claybrook's failure to timely file the relevant Forms or remit payments.
17. Even if the IRS Tax Obligation was properly calculated, the IRS was not entitled to a setoff.
18. Code section 503(b)(1)(B)(i) grants administrative expense priority to "any tax incurred by the Debtor, whether secured or unsecured, including property taxes for which liability is in rem, in personam, or both, except a tax of a kind specified in section 507(a)(8) of this title,"
19. The Plaintiffs' WARN Act wage claims arose and were earned upon termination without notice prior to the Petition Date.
20. Similarly, the Debtor's portion of FICA and Medicare are priority tax claims pursuant to section 507(a)(8)(D), which provides eighth priority treatment to "an employment tax on a wage, salary, or commission of a kind specified in paragraph (4) of this subsection earned from the debtor before the date of the filing of the petition, whether or not actually paid before such date."
21. Because the taxes Mr. Claybrook paid pursuant to the WARN Act Settlement Stipulation are priority claims, the penalties assessed are general unsecured claims not entitled to priority.
22. Finally, the IRS does not have an allowed claim for interest pursuant to sections 502(b)(2) and (i). Section 502(i) provides as follows:
Section 502(b)(2) provides that claims for unmatured interest that accrue after the bankruptcy filing cannot be allowed claims.
23. Therefore, the Court concludes that the IRS's application of the Refund to the IRS Tax Obligation was an impermissible setoff.
24. Mr. Claybrook asserts that the doctrine of latches should bar Trustee Miller's Disgorgement Motion. Laches bars an action in "extraordinary cases" where the plaintiff unreasonably delayed bringing an action, with such delay resulting in unfair prejudice to the defendant.
25. Trustee Miller was appointed in 2013 and knew about the IRS Tax Obligation since at least March 2016 but did not file the Disgorgement Motion until more than two years later. During a portion of this time, however, Mr. Homony investigated the grounds for the IRS Tax Obligation, including contacts with the IRS and Mr. Claybrook to obtain the relevant underlying tax returns and IRS Account Transcripts. Therefore, Trustee Miller did not unreasonably delay bringing the Disgorgement Motion. The Court concludes such delay was not unreasonable given Trustee Miller's various duties in administering the Estate. But even if the delay were found to be unreasonable, Mr. Claybrook was not unduly prejudiced by it. There is no reason to believe that any evidence that was unavailable when the Disgorgement Motion was brought would have been available when Trustee Miller first had knowledge of the IRS Tax Obligation in 2016. Among the missing documents that are particularly significant are the tax returns for the period ending December 31, 2005, and the returns and IRS Account Transcripts for the period ending December 31, 2002. Both sets of documents are outside the 10-year period which the IRS retains such documents. And Mr. Claybrook does not assert that the documents were accessible to him or any other party in 2016. Accordingly, the two-year delay in bringing the Disgorgement Action did not prevent Mr. Claybrook from further investigating the IRS's setoff. The Court, therefore, concludes that laches does not apply here.
26. Mr. Claybrook's final argument is that he should not be required to disgorge funds because he was theoretically entitled to receive $325,51154 in additional compensation pursuant to the trustee compensation formula under section 326. The Court rejects this argument. Even if Mr. Claybrook was theoretically entitled to further compensation, he ultimately did not seek such additional compensation, and the Court will not now retrospectively consider compensation that Mr. Claybrook never requested.
For the reasons set forth herein, the Trustee Miller's Disgorgement Motion will be denied.
An order will be issued.