HARDIMAN, Circuit Judge.
Markian Slobodian, in his capacity as trustee of debtor Net Pay Services, Inc., appeals the District Court's summary judgment in favor of the Internal Revenue Service. The District Court denied Slobodian's motion to avoid five alleged preferential transfers under 11 U.S.C. § 547(b) of the Bankruptcy Code. The District Court held that four of the five payments were not avoidable because of their minimal value. And although the fifth payment was sufficiently large to constitute a preference, it was not avoidable because the funds were not property of Net Pay's
The facts of this case are straightforward. Before it filed for protection under Chapter 7 of the Bankruptcy Code, Net Pay managed its clients' payrolls and handled their employment taxes pursuant to a form contract called a "Payroll Services Agreement," which required clients to provide their employee payroll information so Net Pay could determine the taxes and wages they owed. The Agreement gave clients the option of authorizing Net Pay to transfer funds from their bank accounts into Net Pay's account and to remit those funds to the clients' employees, the IRS, and other taxing authorities. The Agreement also established an independent contractor relationship between Net Pay and its clients, disclaiming "any relationship of employment, agency, joint venture, partnership, or any other fiduciary relationship of any kind." App. 189.
At issue in this appeal are five transfers Net Pay made on behalf of its clients to the Internal Revenue Service on May 5, 2011 — almost three months before it filed its Chapter 7 petition. These transfers included: (1) $32,297 on behalf of Altus Capital Partners, Inc.; (2) $5,338 on behalf of HealthCare Systems Connections, Inc.; (3) $1,143 on behalf of Project Services, LLC; (4) $352.84 for an unknown client; and (5) $281.13 for another unknown client. The day after these transfers were made, Net Pay informed its clients that it was "ceasing business operations including all payroll processing." App. 267.
As trustee for Net Pay, Slobodian sought to recover the monies represented by these five payments, arguing that they were avoidable preferential transfers.
The District Court concluded that four of the five transfers were not subject to recovery as preference payments because they were less than the minimum amount established by law ($5,850). 11 U.S.C. § 547(c)(9) (2013). Recognizing that four of the payments were beneath that threshold, the Trustee argued that because the payments exceeded $5,850 in the aggregate, the statutory threshold did not apply. The District Court disagreed, reasoning that distinct transfers may be aggregated for purposes of defeating the threshold only if they are "`transactionally related' to the same debt." Slobodian v. U.S. ex rel. Comm'r, 533 B.R. 126, 132-133 (M.D.Pa.2015). Because the payments of $5,338, $1,143, $353, and $281 were "separate and unrelated transactions in satisfaction of independent antecedent debts" to different creditors, the Court held that they could not be aggregated to satisfy the statutory minimum. Id. at 133.
As for the $32,297 payment Net Pay made on behalf of Altus, which plainly exceeded the statutory minimum, the question remained whether it was a "transfer of an interest of the debtor in
Notwithstanding this evidence, the Trustee emphasized that $6,527.90 of the Altus payment was designated for employer, non-trust-fund tax obligations unaffected by § 7501(a). The District Court saw the evidence differently, finding that the payroll summary offered by Net Pay in support of this assertion failed to "identify what portion of Altus's non-trust fund and trust fund tax obligations were outstanding at the time." Id. at 137 (emphasis added). Because there was unrefuted evidence that the IRS applied the entire $32,297 toward Altus's trust fund tax obligations, the Court held that the payment was not avoidable as a preference.
This timely appeal followed.
We begin with the Trustee's argument that the four smaller value transfers may be aggregated to exceed the Bankruptcy Code's minimum threshold for the avoidance of preferential transfers.
Although section 547(c)(9) is less than pellucid, it is clear that the "aggregate value" of "all property" that "constitutes or is affected by" a debtor's "transfer to or for the benefit of a creditor" must be at least $5,850 to be avoidable as a preference. 11 U.S.C. § 547(b)(1), (c)(9). But this leaves unanswered the question
A "central policy" of the Bankruptcy Code is "[e]quality of distribution among creditors." Begier, 496 U.S. at 58, 110 S.Ct. 2258. "According to that policy, creditors of equal priority should receive pro rata shares of the debtor's property." Id. The power of bankruptcy trustees to avoid preferential transfers that benefit certain creditors over others is critical to this system. "This mechanism prevents the debtor from favoring one creditor over others by transferring property shortly before filing for bankruptcy." Id. The fear is that "[i]f preference law fails to preserve absolute equality in liquidation, those creditors who are aware of this failure will compete for position during insolvency rather than cooperating fully in an attempt to maximize the value of the firm." Note, Preferential Transfers and the Value of the Insolvent Firm, 87 Yale L. J. 1449, 1455 (1978); see also In re Molded Acoustical Prods., Inc., 18 F.3d 217, 219 (3d Cir.1994) ("[T]he preference rule aims to ensure that creditors are treated equitably, both by deterring the failing debtor from treating preferentially its most obstreperous or demanding creditors in an effort to stave off a hard ride into bankruptcy, and by discouraging the creditors from racing to dismember the debtor.").
The Bankruptcy Code includes certain exceptions to the general preference rules. For example, a trustee may not avoid a transfer made "in the ordinary course of business," 11 U.S.C. § 547(c)(2), "because it does not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor's slide into bankruptcy." Union Bank v. Wolas, 502 U.S. 151, 160, 112 S.Ct. 527, 116 L.Ed.2d 514 (1991) (internal quotation marks omitted). Indeed, it furthers bankruptcy policies by "encourage[ing] creditors to continue dealing with distressed debtors on normal business terms" and "promot[ing] equality of distribution by ensuring that creditors are treated equitably." In re Pillowtex Corp., 427 B.R. 301, 306 (Bankr.D.Del.2010) (citing In re Molded Acoustical Prods., Inc., 18 F.3d 217, 219 (3d Cir.1994)).
The § 547(c)(9) minimum threshold is a relatively new addition to the Code.
In view of this statutory scheme, the Trustee's argument makes little sense. An individual creditor's ability to invoke the minimum threshold as a defense would depend not only upon whether the transfer from which it benefitted was less than $5,850, but also on whether the debtor had made any transfers (large or small) for the benefit of other creditors, and whether all transfers taken together exceed the statutory threshold. As the following hypothetical demonstrates, this cannot be the law.
Assume a debtor has 1,000 creditors to whom it paid $5,000 each during the preference period. If we accepted the Trustee's argument, the debtor's estate would be able to recover this $5,000,000 and none of those creditors would be able to invoke the $5,850 minimum threshold as a defense. This would render § 547(c)(9) ineffective. In fact, the statute's only effect would be to apply in the very few bankruptcies where creditors were paid, in the aggregate, less than $5,850 during the preference period. Because this construction would render the minimum threshold an "empty promise,"
The Supreme Court has recognized that "[a] provision that may seem ambiguous in isolation is often clarified by the remainder of the statutory scheme ... because only one of the permissible meanings produces a substantive effect that is compatible with the rest of the law." United Sav. Ass'n of Tex. v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 371, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988) (internal citation omitted). Section 547(c)(9) is such a provision. And close inspection of the statutory scheme reveals that an interpretation of the minimum threshold that fails to distinguish between creditors is incompatible with the preference regime.
Unlike the Trustee's argument, the District Court's reading of § 547(c)(9) is faithful both to the text of the statute and the law as a whole. To reiterate, the defense provides that a debtor's "transfer to or for the benefit of a creditor" may not be avoided if the "aggregate value" of "all property" that "constitutes or is affected by such transfer" is "less than $5,850." 11 U.S.C. § 547(b)(1), (c)(9). In context, this language requires that creditors be considered independently. Hence, a creditor who has received the benefit of a prepetition transfer less than that threshold may invoke the defense regardless of what other
The text and context of § 547(c)(9) also demonstrate that the minimum threshold contemplates a transfer-by-transfer analysis. In this respect, the Trustee is wrong to describe the threshold as internally inconsistent. See Net Pay Br. 15 ("The language of [§ 547(c)(9)] is internally contradictory or at best ambiguous because the term `aggregate' implies a summation of various transfers, while the language `such transfer' implies the defense should be applied on a payment by payment basis.") (quoting In re Carter, 506 B.R. 83, 87 (Bankr.D.Ariz.2014)). In fact, the provision anticipates that a single transfer might be composed of more than one type of property and instructs that "all property that constitutes or is affected by" that transfer should be aggregated for purposes of determining whether the threshold is met. 11 U.S.C. § 547(c)(9) (emphases added).
This does not mean, of course, that courts must apply the minimum threshold in a mindless way that would permit wily debtors to thwart the law by structuring multiple transfers in amounts less than the threshold. Although § 547(c)(9) envisions creditor-by-creditor and transfer-by-transfer analyses, both the statutory scheme and the rule that the singular includes the plural require that ostensibly distinct transfers may nevertheless be aggregated if they are, in effect, a single transfer on account of the same debt. See 4 Norton Bankr. L. & Prac. 3d § 66:33 ("Courts look behind the form of multiple transfers to avoid [strategic separation of transfers on the same underlying obligation]. When a number of less than [$5,850] transfers occur between two parties, it is appropriate to treat the transfers as one transaction if they are, in fact, conducted pursuant to a single, common plan."); Commercial Bankruptcy Litigation § 11:20 n. 3 ("Multiple transfers to a single creditor may be aggregated where the underlying facts and circumstances indicate the transfers were part of a common plan.") (emphasis added); Andrea Coles-Bjerre, Bankruptcy Theory and the Acceptance of Ambiguity, 80 Am. Bankr. L. J. 327, 354 n. 85 (2006) (recognizing that "aggregation within a transfer — whatever those bounds may be — is different from aggregation across transfers").
In sum, the Trustee's reliance on § 102(7) ("the singular includes the plural")
In light of our interpretation of § 547(c)(9), we hold that Net Pay's four small-value transfers may not be aggregated to exceed the minimum threshold for avoidable preferences. Each payment involved a different creditor (i.e., a different Net Pay client), unrelated antecedent debts, and distinct tax liabilities. Accordingly, the District Court did not err when it held that the payments of $5,338, $1,143, $353, and $281 to the IRS are not avoidable preferences.
We now consider Net Pay's $32,297 payment to the IRS on behalf of Altus, which obviously is not subject to the minimum threshold defense of § 547(c)(9). The question presented with respect to this payment is whether it was "an interest of the debtor in property." 11 U.S.C. § 547(b). The District Court held that because Altus's funds were held by Net Pay in a special statutory trust pursuant to 26 U.S.C. § 7501(a), Net Pay had no interest in them. We agree.
The Internal Revenue Code 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." 26 U.S.C. § 7501(a). This "any
The Supreme Court interpreted § 7501(a) in Begier, which involved an airline that declared bankruptcy after paying certain withholding taxes to the IRS. 496 U.S. at 55-56, 110 S.Ct. 2258. The airline had commingled some of the trust fund taxes that it withheld from its employees with money in its general operating account, and then transferred funds to the IRS in satisfaction of its trust fund tax obligations from both the commingled general account and a segregated tax-fund-only account. Id. When the airline tried to avoid all these payments as preferential transfers, the IRS countered that the airline never had an interest in the funds because of § 7501(a). Id. at 56-57, 110 S.Ct. 2258.
The Court began its analysis by defining "interest of the debtor in property." Noting that "the purpose of the avoidance provision is to preserve the property includable within the bankruptcy estate," the Court reasoned that "`property of the debtor' subject to the preferential transfer provision is best understood as that property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings." Id. at 58, 110 S.Ct. 2258. The Court then turned to the Code's definition of "property of the estate," which includes "all legal or equitable interests of the debtor in property as of the commencement of the case" but excludes property in which the debtor holds "only legal title and not an equitable interest." Id. at 59, 110 S.Ct. 2258 (quoting 11 U.S.C. § 541(a), (d)). Because a debtor "does not own an equitable interest in property he holds in trust for another," the Court concluded that such property is not subject to § 547(b). Id.
Having established the legal framework, the Court articulated a two-pronged inquiry for deciding whether a prepetition transfer from a debtor to the IRS is unavoidable under § 7501(a): (1) whether a special statutory trust was created with respect to a certain dollar amount in the first place; and (2) if so, whether the assets used to pay the IRS were assets belonging to that trust. Id. at 57-67, 110 S.Ct. 2258. On the first question, the airline argued that even though § 7501(a) creates a statutory trust extending to "the amount of tax ... collected or withheld," a trust fund tax is not "collected or withheld" until specific funds are either sent to the IRS with the relevant return or placed in a segregated fund. Id. at 60, 110 S.Ct. 2258. The Supreme Court disagreed, holding that the trust was created at the moment the relevant taxes were withheld, and that "[w]ithholding ... occurs at the time of payment to the employee of his net wages." Id. at 60-61, 110 S.Ct. 2258. It followed that the airline created a special trust for the benefit of the United States once it withheld the funds from its employees' paychecks. Id. at 60-62, 110 S.Ct. 2258.
The Court then considered the second prong of the trust inquiry: whether the assets the airline used to pay the IRS belonged to that trust. Id. at 57-67, 110 S.Ct. 2258. Absent statutory guidance on this tracing question, the Court first considered the common law. Id. at 62, 110 S.Ct. 2258. But the Court found that unhelpful because, "[u]nder common law principles, a trust is created in property; a trust therefore does not come into existence until the settler identifies an ascertainable interest in property to be the
Having rejected the strict tracing rule of the common law, the Court was faced with a dilemma. "Congress," the Court surmised, "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." Id. at 65-66, 110 S.Ct. 2258. The question was how much of a connection? Relying on legislative history as "persuasive evidence of Congressional intent,"
Our rather detailed exposition on Begier is necessary here because there is only one meaningful difference between that case and this appeal: here, the debtor is an intermediary that withheld and paid taxes on behalf of its client-employers. According to the Trustee, this distinction makes all the difference because the "obvious meaning of the statute is that in order for a trust to be created, a person who is required to collect the tax must actually withhold the tax." Net Pay Br. 11. Because Net Pay's clients, not Net Pay itself,
Section 7501(a) 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." 26 U.S.C. § 7501(a). Net Pay's clients indisputably were persons "required to collect or withhold any internal revenue tax from [their employees] and to pay over such tax to the United States." 26 U.S.C. § 7501(a). And the provision does not say that clients themselves must be the only ones involved in the withholding process in order for trust principles to be implicated. It simply says that whenever an employer is required to withhold employee taxes, the "amount of tax" that is "so collected or withheld shall be held to be a special fund in trust for the United States." 26 U.S.C. § 7501(a). Nothing there suggests that an employer may avoid the fact that an amount required by law is being held in trust for the United States merely by outsourcing payroll processing to a third party. In fact, reading the statute that way would contravene Begier, which instructs that "[n]othing in § 7501 indicates ... that Congress wanted the IRS to be protected only insofar as dictated by the debtor's whim." 496 U.S. at 61, 110 S.Ct. 2258. In effect, Net Pay's construction amends the statute to read: 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 by the person so required, and only if by that person alone, shall be held to be a special fund in trust for the United States. Such a limit is present neither in the statute's text nor in the Supreme Court's opinion in Begier.
The Trustee cites various cases in support of its interpretation, but none carry the day. He quotes seemingly helpful language from In re Warnaco Group, Inc., but omits crucial details. Warnaco involved a staffing company (Pro Staff) that provided the debtor with employees in exchange for fees and reimbursements. 2006 WL 278152, at *1 (S.D.N.Y. Feb. 2, 2006). Rejecting Pro Staff's argument that certain payments from the debtor to Pro Staff represented employees' withheld taxes and were not avoidable, the District Court distinguished Begier because "[i]n that case, the employer, and no one else, withheld taxes." Id. at *5. Although this snippet appears to support the Trustee's argument that third-party involvement vitiates trust status, the real reason the situation was distinguishable from Begier was that the transfers the debtor sought to avoid were not payments of withholding taxes, but rather, reimbursements to Pro Staff "for monies already paid by Pro Staff to employees for salaries, taxing authorities and insurance premiums." Id. at *5 (emphasis added). As the court explained, "none of the amount paid to Pro Staff was specifically and directly reserved for withholding taxes. Rather, Pro Staff could do with that money as it saw fit." Id. Thus, the arrangement in Warnaco differed markedly from the one at issue in this case, where the amount paid to the IRS was reserved by the employer (Altus) for withholding taxes.
The bankruptcy court's decision in In re U.S. Wireless Corp. is similarly inapposite. Net Pay cites that case for the proposition that trust status is dependent upon the identity of the person who does the withholding. But U.S. Wireless says no such thing. Rather, it merely held that no statutory trust was created when the debtor-company
Section 7501(a)'s language is broad enough to cover the facts of this case. It makes no difference that Net Pay's customers used the company as an intermediary to withhold and pay its employees' taxes. The Altus payment represented an amount it was "required to ... withhold," 26 U.S.C. § 7501(a), and that was so withheld pursuant to the contract between Altus and Net Pay. The Tax Code thus deems the amount to have been "held to be a special fund in trust for the United States." 26 U.S.C. § 7501(a). And because the amount was paid out of Altus's assets, the traceability nexus is met. See Begier, 496 U.S. at 66-67, 110 S.Ct. 2258. Accordingly, the District Court did not err when it held that Net Pay lacked any interest in the property and may not avoid the transfer.
The Trustee argues that even if the statutory trust provision applies, $6,527.90 of the Altus payment may be avoided as a preference because it was marked for employer, non-trust-fund tax obligations. An internal payroll summary indicates that Altus had generated $25,769.90 in trust fund taxes and $6,527.90 in non-trust-fund taxes during the period covered by the summary: April 1-May 31, 2011. Accordingly, the Trustee argues that it's unclear that the entire $32,297 sum was applied to Altus's trust fund tax obligations.
The District Court did not err in holding that there is no genuine issue of material fact as to whether the entire Altus payment was applied to Altus's trust fund obligations. The record shows that on April 28, 2011, Net Pay withdrew $114,335 from Altus's bank account, of which $32,297 was designated for payment to the IRS on or before May 6, 2011. Both trust-fund and non-trust-fund portions of federal employment taxes were generated throughout the quarter as Altus's employees earned wages. See Donelan Phelps & Co. v. United States, 876 F.2d 1373, 1374-75 (8th Cir.1989); Calabrese, 689 F.3d at 316. Critically, the moment when taxes accrue is irrelevant to which portion of the tax liability is actually paid. Consistent with standard IRS practice, non-trust-fund taxes are deemed to be paid first, even though they may accrue later in that quarter. In re Ribs-R-Us,
Stated differently, Altus was required to withhold $137,521 from its employees' wages during the relevant period, and that "amount of tax so collected or withheld [was] held to be a special fund in trust for the United States." 26 U.S.C. § 7501(a). This is further demonstrated by the consequence of Net Pay's logic: were some portion of that amount to revert to Net Pay's estate, Altus would be on the hook for that exact amount in unpaid trust fund taxes. Because what matters for purposes of the statutory trust is the overall "amount" withheld, and because there is unrebutted evidence that the full $32,297 was withheld by Altus and paid over to the IRS, the District Court correctly held that there is no genuine issue of material fact as to whether the entire Altus payment was applied to Altus's trust fund obligations and was held in trust by Net Pay for the United States.
Our legal analysis is supported by common sense. It is hard to fathom that Net Pay's clients intended anything other than to "transfer only bare legal title" to Net Pay with respect to the funds meant for payment to the IRS. Galford v. Burkhouse, 330 Pa.Super. 21, 478 A.2d 1328, 1334 (1984). Of course, "[w]hether the money is held in trust must be determined... not merely by reliance on common sense, but also by application of traditional legal doctrines." In re Penn Cent. Transp. Co., 486 F.2d 519, 524 (3d Cir. 1973). Here, as we have explained, those legal doctrines cohere with common sense.
Net Pay is not entitled to recoup the money it transferred to the IRS on behalf of its clients. Four of its transfers may not be challenged as preferences because they did not meet the statutory threshold of 11 U.S.C. § 547(c)(9), and the Altus payment may not be avoided because Net Pay lacked an equitable interest in the property by operation of 26 U.S.C. § 7501(a). For these reasons, we will affirm the judgment of the District Court.
Moreover, even if we were to determine that Pennsylvania law conflicts with an important federal interest such that federal law governs the "interest of the debtor in property" inquiry, we would conclude that Net Pay held the funds in trust pursuant to federal common law. In re Columbia Gas Sys. Inc., 997 F.2d 1039, 1056 (3d Cir.1993) ("Federal common law imposes a trust when an entity acts as a conduit, collecting money from one source and forwarding it to its intended recipient."); see also In re Penn Central Transp. Co., 486 F.2d 519, 523-27 (3d Cir.1973) (en banc).
As for the tracing requirement — which in either case calls for application of federal rather than state tracing rules, see City of Farrell v. Sharon Steel Corp., 41 F.3d 92, 95-96 (3d Cir.1994) — we agree with the Fourth Circuit that "the law will presume that any funds received, held, and ultimately transferred by a trustee in accordance with the trust purpose are indeed trust funds." FirstPay, 773 F.3d at 595. As stated, the Trustee has not rebutted this presumption; the funds paid to the IRS are clearly traceable to the funds deposited into Net Pay's account just days before the transfers at issue.
