Opposition Brief — California Franchise Tax Board v. MacFarlane, 117 S. Ct. 1243 (1997) (No. 96-235)
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SEP 11 1995
No. 96-235 CLERK
In The
Supreme Court of the United States
October Term, 1995
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FRANCHISE TAX BOARD OF
THE STATE ©F CALIFORNIA,
Petitioner,
iyS>
STEPHEN B. MACFARLANE,
Respondent.
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On Petition For Writ Of Certiorari
To The United States Court Of Appeals
For The Ninth Circuit
¢
RESPONDENT’S BRIEF IN OPPOSITION
+
E_mMerR DeaN Martin III
(Counsel of Record)
Gateway Corporate Center
21660 East Copley Drive, Suite 220
Post Office Box 4070
Diamond Bar, California 91765
(909) 861-6700 (Telephone)
(909) 860-3801 (Facsimile)
edmiii@worldnet.att.net (E-Mail)
Attorneys for Respondent
Stephen B. Macfarlane
COCKLE LAW BRIEF PRINTING CO., (800) 225-6964
OR CALL COLLECT (402) 342-2831
v\
QUESTIONS PRESENTED
If the allocation of burden of proof in litigation of
bankruptcy tax claims is important, why did the only two
circuits who have addressed the issue since 1898 have to
resort to dicta to decide it?
Should this Court review the judgment of the Ninth
Circuit Court of Appeals for the question posed by Peti-
tioner even though the judgment should be affirmed
because:
(a) Petitioner presented no evidence and therefore
affirmance of summary judgment is proper; and
(b) The claim of the Petitioner was not entitled to
presumptive validity because it was based solely on an
IRS report which was withdrawn by the United States
Department of Justice; and
(c) The claim of the petitioner was not entitled to
presumptive validity because assessment was barred by
11 U.S.C. § 362(a); and
(d) All Circuits are unanimous that a claimant
asserting a claim for taxes incurred after commencement
of a bankruptcy case has the burden of proving all ele-
ments of its claim; and
(e) It is well settled that any claim in bankruptcy is
entitled only to rebuttable presumption validity under
F.R.B.P. 3001(f); and
(f) Any result other than the result in the Ninth
Circuit would result in potentially at least 53 different
burdens of proof applicable in determining tax claims in
bankruptcy cases contrary to the uniformity intended by,
il
QUESTIONS PRESENTED - Continued
among other provisions, 11 U.S.C. §§ 346, 505, 728, 1146
and F.R.B.P. 3001(f); and
(g) The burden of proof rule in a controversy
between a tax claimant and a taxpayer is not applicable to
the controversy in a bankruptcy case between the tax
claimant and other claimants who seek to share the tax-
payer’s estate; and
(h) The question asserted by Petitioner is not raised
by the facts; and
(i) The decisions claimed to be in conflict are not in
conflict because one dealt with a federal tax claim and the
case at hand deals with a state tax claim in which issues
of uniformity are more germane.
iii
TABLE OF CONTENTS
Page(s)
Tee ee hk KKS SMG ab eb 0 cess sansecn iii
EEE een iv
RUGS Was wa 6 0 UW05 46600 c0crenese cus 1
Ea 1
Constitutional Provisions, Statutes and Rules
EE OI ee 1
eS anaes ena b ees eaneccennans 2
REASONS FOR NOT GRANTING THE WRIT...... 4
NEITHER THE NINTH CIRCUIT NOR THE
FOURTH CIRCUIT HAD TO DECIDE WHO HAD
UU MNUEPUEE GA ROE occa ncccccccnscedes 4
THERE ARE GROUNDS FOR AFFIRMING THE
JUDGMENT OF THE NINTH CIRCUIT INDE-
PENDENT OF ITS PRONOUNCEMENT ON BUR-
ecco nb 4h a6 50064 565 esc easceeane 4
THE ISSUE PRESENTED IS NOT ONE OF PRESS-
ee AA cae ACCRA CON CAS SAS ea eae 6
THE DECISION OF THE NINTH CIRCUIT WAS
CORRECT, FAIR AND ANY OTHER ALTERNA-
cave Wwwew CREATE CHAOS..............:5. 7
TSC CC. Cea GARE NG KA A4 cd sen eseens cease 10
iv
TABLE OF AUTHORITIES
Page(s)
CASES
American Dredging Co. v. Miller, 510 U.S. 443, 114 S.
ee ey se SS F Fi. | Peer rerrereeerre 6
Blum v. Bacon, 457 U.S. 132, 102 S. Ct. 2355, 72 L.
ee 8. ki. |: eee rer reer rT ere ye eer ae 5
California State Board of Equalization v. Official
Unsecured Creditors Comm. (In re Fidelity Holding
Co., Lid.), $37 F.2d 696 (Sth Cir. 1968).............. 4
Dayton Board of Education v. Brinkman, 433 U.S.
406, 97 S. Ct. 2766, 53 L. Ed. 2d 851 (1977)........ 5
Grogan v. Garner, 498 U.S. 279, 111 S. Ct. 654, 112
es SO Ol Fare MEET iin bh che haa CARN ENSE Seba eR Rees 9
Guidry v. Sheet Metal Workers Pension Fund, 493
U.S. 365, 110 S. Ct. 680, 107 L. Ed. 2d 782 (1990) ..... 8
IRS v. Levy (In re Landbank Equity Corp.), 973 F.2d
BOS COU EA FG vn cv iveccccewtalitesscany a, 4, 6, 7
Patterson v. Shumate, 504 U.S. 753, 112 S. Ct. 2242,
i ee me 8 Et erent rh Te ror 8
United States v. Johnson, 268 U.S. 220, 45 S. Ct. 496,
69 L. Bd. 925 (1925) .. «2.6... [suse GOES Riadee ss ca 5
United States v. New York Telephone Co., 434 U.S.
159, 98 S. Ct. 364, 54 L. Ed. 2d 376 (1977) ......... 5
Washington v. Yakima Indian Nation, 439 U.S. 463,
99 S. Ce. 700, SB L. Be. Sa FOO CIG79). o.oo cos cess 4
STATUTES
PURE GUROER skin MN Ay wAn kee shwEGA es eeweseeaeees 1, 3, 4
We We Bic ee cen icc eoeee ieee 1,9
TABLE OF AUTHORITIES - Continued
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Ma USA
1. Vos.
ak US.
ik USC.
li U.SA.
Page(s)
EE ar Cha ints s RK ULAR COO oe oe Oa
RT Ges tg Ee RR Se ps Ne a 9
SP eae c ad Gets wi get ae ee oe ak 1, 8
ER a ER OE a ee ee nen 3
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i SES rehire re a eee 1,9
OPINIONS BELOW
Respondent adopts the Petitioner’s Statement of
Opinions Below.
JURISDICTION
Respondent adopts the Petitioner’s Statement of
Jurisdiction.
+
CONSTITUTIONAL PROVISIONS,
STATUTES AND RULES INVOLVED
Respondent adopts the Petitioner’s Statement of
Constitutional Provisions, Statutes and Rules Involved
noting that although F.R.B.P. Rule 3001(f) is referenced in
Petitioner’s Statement, it is not included in Petitioner’s
Appendix as Petitioner represents at page 2 of its brief.
Rule 3001(f) states:
(f) Evidentiary Effect. A proof of claim exe-
cuted and filed in accordance with these rules
shall constitute prima facie evidence of the val-
idity and amount of the claim.
Respondent suggests that the following statutes are
also relevant:
11 U.S.C. § 346
11 U.S.C. § 362(a)
11 U.S.C. § 507(a)(8)
11 U.S.C. § 728
11 U.S.C. § 1107(a)
11 U.S.C. § 1146
STATEMENT OF THE CASE
Respondent commenced his bankruptcy case in 1990.
The Internal Revenue Service subsequently asserted a
claim for income taxes based on an audit report it issued
on June 25, 1991. Respondent objected to this claim and
the United States Department of Justice accepted as set-
tlement a minor portion of the amount claimed.
Petitioner asserted a claim on April 3, 1992 based
solely on the Internal Revenue Service report abandoned
by the United States Department of Justice. Respondent
objected to Petitioner’s claim and filed depositions and
declarations of witnesses and 849 pages of documentary
evidence. Petitioner submitted no evidence. Respondent
also contended that the issue of who has the burden of
proof was irrelevant because inasmuch as no assessment
had been made because it was barred by 11 U.S.C.
§ 362(a)! and the claim was based solely on an IRS report
which had been withdrawn, no state presumption of val-
idity arose and also because no controverted fact was in
issue.
Respondent contended that the language in IRS v.
Levy (In re Landbank Equity Corp.), 973 F.2d 265 (4th Cir.
1992) (hereafter “Levy”) was dicta and irrelevant because
_ in that decision no evidence was presented to rebut the
tax claim and accordingly the decision was proper under
' 362. Automatic stay
(a) Except as provided in subsection (b) of this section, a
petition filed under section 301, 302, or 303 of this
title . . . operates as a stay. ...
F.R.B.P. 3001(f) without application of any other burden
of proof rule.
The facts to be reviewed are not those with which
Petitioner takes considerable license in its statement but
rather those found at pages 37 through 42 of Petitioner’s
Appendix as determined by the bankruptcy court. These
facts were found by the Ninth Circuit to be wncon-
troverted and sufficient under applicable law to support
judgment in favor of Respondent. Petitioner’s Appendix
at 11.
The Petitioner filed a notice of appeal, and the matter
was ultimately heard by the district court. On June 29,
1994, the district court entered its judgment and mem-
orandum decision affirming the bankruptcy court’s
denial of the state’s proof of claim and reversing the
bankruptcy court’s summary determination, holding that
genuine issues of material fact existed. Respondent filed a
motion for reconsideration of this self-contradictory deci-
sion which was denied.
The Petitioner timely appealed to the United States
Court of Appeals for the Ninth Circuit and the Respon-
dent filed a cross-appeal. The matter was argued on
March 6, 1996. That decision affirmed the holding of the
district court which denied the Petitioner’s proof of claim
and reversed the holding of the district court which had
held that genuine issues of material fact existed and
remanded to the bankruptcy court for entry of judgment
for Respondent on all issues. To obtain a review of that
decision the Petitioner has filed its petition with this
Court.
REASONS FOR NOT GRANTING THE WRIT
NEITHER THE NINTH CIRCUIT NOR THE FOURTH
CIRCUIT HAD TO DECIDE WHO HAD THE BURDEN
OF PROOF
In Levy the bankruptcy estate presented no evidence.
Under F.R.B.P. Rule 3001(f) the claimant therefore wins.
That was all that was required.
In the case at hand the estate presented almost a
thousand pages of documents and depositions and decla-
rations. The decision to be reviewed found both that
there was no controverted fact and that the facts neces-
sary to support a determination of nonliability had been
determined.
There is no conflict in decision, only in principle,
perhaps due to a failure of advocacy in the Fourth Cir-
cuit.
Furthermore, Levy recognized that its decision may
apply only to federal tax claims inasmuch as it distin-
guished California State Board of Equalization v. Official
Unsecured Creditors Comm. (In re Fidelity Holding Co., Ltd.),
837 F.2d 696, 698 (5th Cir. 1988), which held that as to
California state tax claims the federal standard of F.R.B.P.
Rule 3001(f) alone applied. Respondent's Appendix at 38.
THERE ARE GROUNDS FOR AFFIRMING THE JUDG-
MENT OF THE NINTH CIRCUIT INDEPENDENT OF
ITS PRONOUNCEMENT ON BURDEN OF PROOF
A prevailing party may “defend its judgment on any
ground properly raised below. ...”, Washington v. Yakima
Indian Nation, 439 U.S. 463, 476 n. 20, 99 S. Ct. 740, 749 n.
20, 58 L. Ed. 2d 740 (1979); Dayton Board of Education v.
Brinkman, 433 U.S. 406, 419, 97 S. Ct. 2766, 53 L. Ed. 2d
851 (1977); Blum v. Bacon, 457 U.S. 132, 137 n. 5, 102 S. Ct.
2355, 2359 n. 5, 72 L. Ed. 2d 728 (1982); United States v.
New York Telephone Co., 434 U.S. 159, 166 n. 8, 98 S. Ct. 364,
369 n. 8, 54 L. Ed. 2d 376 (1977).
As noted at Respondent’s Appendix 2-25, Respon-
dent urged that there was no burden of proof issue raised
by the record because:
(a) no fact was controverted;
(b) no presumptive validity arose because no
assessment was made and the claim was based solely on
an IRS audit report abandoned by the United States
Department of Justice (Respondent’s Appendix 25);
(c) the Petitioner never cited any applicable state
standard for burden of proof which applied in the pres-
ence of such facts (Respondent’s Appendix 24).
As this Court has held, “We do not grant a certiorari
to review evidence. ... ” United States v. Johnson, 268 U.S.
220, 227, 45 S. Ct. 496, 497, 69 L. Ed. 925 (1925). Petitioner
is asking this Court to determine that the burden of proof
matters in a decision in which no fact is controverted and
in which several independent grounds for affirmance
exist. Respondent does not believe that the issue con-
tended to exist is apropos.
THE ISSUE PRESENTED IS NOT ONE OF PRESSING
IMPORTANCE
The two decisions contended by Petitioner to be in
conflict are the only two on the issue since 1898 to reach
the merits and only then when they did not have to.
Furthermore Levy ignores the clear historical treat-
ment of claims in bankruptcy as chronicled by the
Respondent in the Ninth Circuit.
As Respondent noted before the Ninth Circuit, the
law on this issue has been clear for a long time:
The FTB’s ubiquitous citations to Vanston Bond-
holders Protective Comm. v. Green, 329 U.S. 156, 67 S.
Ct. 237 (1946) in support of its position fail to quote
the most relevant passage from the opinion: “In
determining what claims are allowable and how a
debtor’s assets shall be distributed, a bankruptcy
court does not apply the law of the state where it
sits.” Id. at 329 U.S. 162. It should also be noted
that in addition to the substantive decisions regard-
ing the paramount nature of federal law in bank-
ruptcy cases, a strong argument can be made that
the FTB in filing its claim consented to a federal
burden of proof rule. See also, E. Martin, Consent:
The Constitutional Basis for Bankruptcy Judge Author-
ity, 19 Cal. Bankr. J. 1 (1991).
Respondent’s Appendix at 29.
Ironically, in American Dredging Co. v. Miller, 510 U.S.
443, 114 S. Ct. 981, 988, 127 L.Ed. 2d 285 (1994), cited by
Petitioner, this Court noted that the federal burden of
proof rule in admiralty has preempted contrary state
rules since before 1942. Admiralty and bankruptcy have
often been noted to have comparable considerations of
uniformity and purpose.
THE DECISION OF THE NINTH CIRCUIT WAS COR-
RECT, FAIR AND ANY OTHER ALTERNATIVE
WOULD CREATE CHAOS
As argued in the Ninth Circuit, Respondent's Appendix
27-28, the burden of proof rule which applies between a
taxpayer and a tax claimant does not apply when the contro-
versy is between the tax claimant and other creditors of the
taxpayer competing for a portion of the assets of the bank-
ruptcy estate of the taxpayer. All should be similarly situ-
ated.
The invalidity of Petitioner’s allegation that the bur-
den should be placed on the estate because it has access
to evidence is demonstrated by Levy in which the estate
lost because the trustee of the estate could present no
evidence to rebut the claim in issue. Respondent's
Appendix 27-28. Petitioner’s assertion that trustees in
bankruptcy have greater access to information than a
taxing agency when the trustees assume control over the
chaotic affairs of a bankrupt is generally not a reality.
This circumstance in Levy supports Respondent's position
that burden of proof rules applicable outside of bank-
ruptcy do not apply in bankruptcy because the parties in
interest are different. In a bankruptcy case the other
creditors, rather than the debtor, are the persons in inter-
est in the claims allowance process. Either a trustee, or a
debtor in possession acting as a trustee pursuant to 11
U.S.C. § 1107(a),? represents the other creditors in this
21107. Rights, powers, and duties of debtor in possession
(a) [A] debtor in possession shall have all the rights
. and powers, and shall perform all the functions and
duties . . . of a trustee serving in a case under this chapter.
process. This Court has always looked to the real parties
in interest in controversies. For instance, in Guidry v. Sheet
Metal Workers Pension Fund, 493 U.S. 365, 110 S. Ct. 680,
107 L. Ed. 2d 782 (1990), this Court noted that “the
malefactor often is not the only beneficiary of the pen-
sion” in precluding an equitable exception to ERISA pro-
hibition of alienation of a pension plan account. This
result was subsequently applied in a bankruptcy context
in Patterson v. Shumate, 504 U.S. 753, 112 S. Ct. 2242, 119 L.
Ed. 2d 519 (1992). This issue was raised in the Ninth
Circuit. Respondent’s Appendix 40-43.
Whenever the tax claimant was intended to have an
advantage, as in priority of a claim once established, the
Code has stated the advantage. 11 U.S.C. § 507(a)(8).° It
3 507. Priorities
(a) The following expenses and claims have priority in the
following order:
(8) Eighth, allowed unsecured claims of
governmental units, only to the extent that such
claims are for -..
(A) a tax on or measured by income... .
(B) a property tax assessed before the
commencement of the case and last payable without
penalty after one year before the date of the filing of
the petition;
(C) a tax required to be collected or withheld and
for which the debtor is liable in whatever capacity;
(D) an employment tax on a wage... .
(E) an excise tax on-....
(F) a customs duty....
(G) a penalty... for actual pecuniary loss.
eS
is well established that the burden of proof in establish-
ing nondischargeability of a tax is on the taxing agency.
Grogan v. Garner, 498 U.S. 279, 111 S. Ct. 654, 112 L. Ed. 2d
755 (1991). Since it is clear that a tax claimant has the
burden of proof as to both priority and non-
dischargeability, it would be inconsistent to hold that it
should be treated any differently as to other merits of its
claim.
The Bankruptcy Code was intended to provide for
uniformity of state taxation determination in many ways,
see, e.g., 11 U.S.C. §§ 346,4 505,5 728° and 11467 in order to
provide for uniformity throughout the country. The rule
argued by Petitioner could conceivably require tax claims
to turn on 50 state standards and each of the three federal
standards each of which are slightly different from each
other.
As Respondent argued to the Ninth Circuit, the deci-
sion of the Ninth Circuit is also consistent with the unani-
mous decisions of all Courts regarding taxes incurred
* 346. Special tax provisions
(a) Except to the extent otherwise provided in this section,
subsections (b), (c), (d), (e), (g), (h), (i), and (j) of this section
apply notwithstanding any State or local law imposing a tax....
° Petitioner’s Appendix 44-45.
© 728. Special tax provisions
(a) For the purposes of any State or local. . . .
(b) Notwithstanding any State or local law imposing a tax
on or measured by income. ...
7 1146. Special tax provisions
(a) For the purposes of any State or local law imposing a
tax on or measured by income... .
10
after the commencement of the bankruptcy case which
are clearly governed solely by a federal standard.
Respondent’s Appendix 26-27.
¢
CONCLUSION
The Petition for Writ of Certiorari should be denied
because the conflict claimed does not exist, the question
contended is not raised by the facts, there is no showing
that there is any state standard of proof rule applicable to
these facts, the decision sought to be reviewed is correct
and fair and a contrary decision would be contrary to
orderly national administration of bankruptcy law.
Respectfully submitted,
ELMER Dean Martin III
Attorneys for Respondent
Stephen B. Macfarlane
App. 1
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
In re STEPHEN B.
MACFARLANE
CASE NOS. 94-56064
Debtor. 94-56065
FRANCHISE TAX BOARD OF [DC # CV-93
THE STATE OF CALIFORNIA, 01435-JSR
Appellant/Cross So. Dist. San Diego]
Appellee/Creditor,
-VSsS-
STEPHEN B. MACFARLANE,
Appellee/Cross
Appellant/ Debtor
ee eee ee ee ee ee ee a ee —
COMBINED CROSS APPEAL OPENING AND
APPEAL REPLY BRIEFS OF
STEPHEN B. MACFARLANE
APPEAL FROM A JUDGMENT OF THE UNITED
STATES DISTRICT COURT FOR THE SOUTHERN
DISTRICT OF CALIFORNIA
Honorable John S. Rhoades
United States District Judge
ELMER DEAN MARTIN III
A Professional Corporation
1081 Grand Avenue, Suite G
P.Q. Box 4670
Diamond Bar, California 91765
(909) 861-6700
(909) 860-3801 (Facsimile)
edmiii@usa.net (E-Mail)
Special Counsel for Cross-
Appellant and Appellee
Stephen B. Macfarlane
App. 2
TABLE OF CONTENTS
[Deleted]
TABLE OF AUTHORITIES
[Deleted]
STATEMENT OF SUBJECT MATTER AND
APPELLATE JURISDICTION
[Deleted]
STATEMENT OF ISSUES
Cross Appeal
1. Did the district court erroneously characterize
the judgment of the bankruptcy court as a summary
judgment? This is reviewed de novo.
2. If the district court correctly characterized the
judgment of the bankruptcy court as a summary judg-
ment, was there any controverted material issue of fact
which prevented a valid summary judgment? This is
reviewed de novo.
Reply to FTB Appeal
3.. Was William Cheng (“Cheng”) obligated to repay
to Debtor the amounts of $1,400,000 and $2,028,141
advanced by Debtor to Cheng during 1988 and 1989
respectively? This is reviewed under the clearly erro-
neous standard.
4. Did Cheng’s obligations to repay the 1988 and
1989 advances become worthless in 1988 and 1989 respec-
tively? This is reviewed under the clearly erroneous stan-
dard.
App. 3
5. Since FTB never made an assessment of the tax in
question, is there any presumption of validity under state
law? This is reviewed de novo.
6. Is a FTB proposed assessment based on an IRS’
audit report which was abandoned by the U.S. Depart-
ment of Justice entitled to presumptive validity? This is
reviewed de novo.
7. Should a tax claimant be treated differently from
any other claimant in the absence of any bankruptcy law
or rule giving it special treatment? This is reviewed de
novo.
STANDARD OF REVIEW
Normally review of disposition of summary judgment
motions is de novo. The issue of whether a judgment is a
summary judgment is reviewed de novo. This Court
reviews such matters de novo because it is in as good a
position to do so as was the district court. In re Marquam
Inv. Corp., 942 F.2d 1462, 1465 (9th Cir. 1991) (function of
this court in reviewing district court reversal of bank-
ruptcy court); In re Dominguez, 51 F.3d 1502, 1506 (9th Cir.
1995).
The district court noted that on July 12, 1993 the
bankruptcy court had before it both an objection and a
motion for summary judgment. Supp. ER9 and DCR11 at
6. At the hearing on the FTB’s claim on March 15, 1993,
the bankruptcy court continued the hearing to July 12,
1993 in order to allow the FTB an opportunity to conduct
discovery and offer evidence and stated that an evidenti-
ary hearing would be held. Supp. ER4 and DCR4 at 170.
App. 4
On June 11, 1993 the Debtor filed a motion for summary
determination of the claim by either evidentiary hearing
or by summary judgment as the court considered appro-
priate. ER5 and DCR4 at 121-122. At the hearing on July
12, 1993 the court comprehensively addressed the merits
of the evidence without addressing the motion for sum-
mary judgment. ER7; DCR4 at 71-81. The Debtor also
noted in brief that the de novo standard of review should
not be applied in reviewing the judgment of the bank-
ruptcy court based on an uncontested evidentiary hearing
to which no objection was made after an opportunity for
discovery had been afforded. Supp. ER8 and DCR7 at 3.
Finally the Debtor urged the bankruptcy court to hold
that the Debtor had supported its objection by a prepon-
derance of the evidence. ER5 and DCR4 at 128.
The characterization by the district court of the judg-
ment of the bankruptcy court should be reviewed de novo.
However, the findings of fact of the bankruptcy court
should be reviewed under the clearly erroneous standard
whether or not they were pursuant to the summary judg-
ment motion. In reviewing a summary judgment, this
Court in Ojai Unified School District v. Jackson, 4 F.3d 1467,
1472 (9th Cir. 1993) stated: “[T]he district court essentially
conducted a bench trial based on a stipulated record.
Accordingly, we conclude that, because the district court
already has performed a de facto bench trial, a remand for
trial would serve no useful purpose in this case. The
parties concede that the district court had before it all of
their evidence regarding the issues in dispute; the record
before us is therefore complete.”
Ojai involved a review of an agency determination
and applied the standard of review appropriate for that
App. 5
review rather than a de novo standard. On facts more
similar to Debtor’s case, this Court in Kreisner v. City of
San Diego, 988 F.2d 883, 887n.3 (9th Cir. 1993) applied the
clearly erroneous standard in an appeal from a summary
judgment:
The dissent states because we are reviewing
the district court’s grant of summary judgment
we should view the evidence in the light most
favorable to Kreisner, rather than adopt the
findings of fact of the district court... . . Here,
the district court made findings of fact after
holding an evidentiary hearing and taking testi-
mony in open court..... Kreisner did not object
to the holding of an evidentiary hearing, nor is
there any indication that he did not have suffi-
cient notice to present his case. . . . [T]here is no
reason to depart from the clearly erroneous
standard of review that we apply to findings of
fact following an evidentiary hearing.
The rationale for such appellate review is stated in
the Federal Judicial Center monograph on summary judg-
ment which explains the procedure for summary judg-
ment in a bench trial as follows:
[W]hen the question for decision concerns draw-
ing inferences from undisputed evidence, or
interpreting and evaluating evidence to derive
legal conclusions, a trial may not add to the
judge’s ability to decide. Thus, when the dis-
puted issue is one of ultimate fact, a bench trial
is often unnecessary; the considerations that
militate in favor of trial if it is to a jury do not
apply. ... A court may determine that a full trial
would add nothing to the paper record and,
after proper notice, decide a case on that record,
App. 6
making a decision on a “trial without witnesses”
rather than on summary judgment.
W. Schwarzer, et al., The Analysis and Decision of Summary
Judgment Motions 39-40 (1991).
Debtor notes that the application of the clearly erro-
neous standard obviates the necessity to resolve the Bon-
ner and Vylene finality issue noted in the statement of
jurisdiction here.
The findings of fact of the bankruptcy court should
be affirmed, as they were by the district court, unless this
Court is left with “the definite and firm conviction that a
mistake has been committed.” If the bankruptcy court’s
“account of the evidence is plausible in light of the record
viewed in its entirety, the court of appeals may not
reverse it even though convinced that had it been siting
as the trier of fact, it would have weighed the evidence
differently.” Wolf v. C.I.R., 4 F.3d 709, 712-713 (9th Cir.
1993).
STATEMENT OF THE CASE
On June 25, 1991 the IRS issued an audit report which
determined that deductions for uncollectible debts due
from William Cheng in the amount of $1,400,000 for 1988
and $2,028,141 for 1989 should be disallowed and Debtor
should pay income taxes, penalties and interest as of that
date in the amount of $1,239,750 for 1988 and 1989. Supp.
ER6 and DCR4 at 597-610. The court may take judicial
notice that interest on this amount as of October 16, 1992
would add approximately $100,000 to the amount due to
the IRS in addition to the 1991 amount. Accordingly as of
App. 7
October 16, 1992 the amount due to the IRS was about
$1,339,750.
The debtor contested the IRS claim in the bankruptcy
court. On October 16, 1992 the U. S. Department of Justice
conceded all but $250,000 of the IRS’ $1,339,750 claim.
Supp. ER6 and DCR4 at 612-614. In the meantime, on
April 3, 1992 the FTB issued its notice that debtor owed
$410,838 to the FTB for 1988 and 1989 income taxes,
interest and penalties based solely on the IRS audit
report. Supp. ER6 and DCR4 at 576, 595-596. This notice
was expressly based solely upon the IRS audit report. Id.
The FTB filed its claims in the bankruptcy tourt begin-
ning in June 1992 based on that notice. Supp. ER6 and
DCR4 at 576. :
On January 6, 1993 Debtor’s Chapter 11 plan was
confirmed. ER15 at page 19 docket entry 180. On January
11, 1993 the debtor filed his objection to the FTB’s claim.
ER3(partial); DCR4 at 672-1154. On February 3, 1993 the
FTB filed its response and set’a hearing for March 15,
1993. ER4; DCR4 at 579-671. On March 2, 1993 the Debtor
filed his response to the FTB’s response for the hearing
on March 15, 1993. Debtor raised a number of evidentiary
issues. Supp. ER4 and DCR4 at 209-210.
On March 15, 1993 the bankruptcy court conducted a
hearing on the Debtor’s objection to the FTB claim. Supp.
ER4 and DCR4 at 169-173. The court ruled that the FTB’s
claim was prima facie valid but that.the Debtor had
provided competent evidence that debts existed in 1988
and 1989 and that the debts were worthless in 1988 and
1989 rebutting the presumption of validity of the FTB
claim. The court then adjourned the hearing to July 12,
| | erent
App. 8
1993 for an evidentiary hearing to allow the FTB to con-
duct discovery and offer evidence.
The FTB chose to forego discovery and offered no
evidence. On June 11, 1993 the Debtor filed a motion for
summary determination of the claim noting the lack of
any activity by the FTB, ER5 and DCR4 at 122, and in the
alternative requested that the objection to the claims of
the FTB be determined on the merits on the evidence
submitted. ER5 and DCR4 at 122 lines 1-3. The FTB did
not respond with a statement of controverted facts or
conclusions of law. It responded with a memorandum
which dealt primarily with burden of proof issues. ER5
and DCR4 at 88. Debtor’s position was that he had
proved that loans were made to William Cheng, that they
became worthless in the years claimed, that he did not
have to prove that there was no evidence in existence
which could lead to an alternative factual result which is
apparently what the FTB argues, and that although he
raised the burden of proof issue in his opening pleadings
as the case had progressed the issue had become irrele-
vant because there were no reasonably controverted facts.
At the hearing on July 12, 1993 the bankruptcy court
comprehensively addressed the issues on the merits of
the evidence on the basis of the objection without
addressing the summary judgment motion. ER7; DCR4 at
70-83. The court went on to criticize the FTB for failing to
conduct any discovery to obtain evidence which contro-
verted the evidence offered by the Debtor. Id. In neither
the bankruptcy court, the district court nor here has the
FTB contended that William Cheng did not obtain from
Debtor $1,400,000 in 1988 and $2,028,141 in 1989. The FTB
has contested only characterization of these amounts as
App. 9
debts and the time of their worthlessness. The bank-
ruptcy court’s judgment, findings and conclusions were
entered August 10, 1993.
The FTB filed its notice of appeal August 19, 1993.
ERY. On June 29, 1994 the district court filed its mem-
orandum decision and judgment reversing the judgment
of the bankruptcy court which the district court charac-
terized as a summary judgment, affirmed the bankruptcy
court’s findings as not clearly erroneous, and affirmed
the court’s conclusions of law. Supp. ER9. Both parties
timely appealed. ER9 and Supp. ER3.
ARGUMENT
Summary
The proper standard of review of a judgment result-
ing from an evidentiary hearing in which all of the facts
are developed is the clearly erroneous standard whether
or not the hearing resulted from a motion for summary
judgment. The district court was wrong when it applied a
de novo standard of review. It was also wrong in charac-
terizing the judgment as a summary judgment.
Even if the bankruptcy court’s judgment was a sum-
mary judgment, the four aspects of evidence cited by the
district court were taken out of context. The inferences
drawn by the district court were not reasonable in light of
all of the evidence before it. Accordingly even after a de
novo review the district court should have affirmed.
It is uncontested that the amounts in issue were
advanced to Cheng from Debtor in 1988 and 1989. All of
the testimony of percipient witnesses corroborated by
App. 10
inches of checks which bear notations that they are
“loans”, loan documents and agreements the composition
and execution of which was supervised by Cheng’s law-
yer and statements under oath by Cheng admitting his
obligation to debtor indicate the existence of a debt. The
testimony of Cheng’s personal bookkeeper and his office
manager who managed both his affairs and debtor's
affairs corroborated by his bankruptcy and subsequent
valuation of his most significant asset at $2,500 amply
demonstrate that at the end of 1988 and 1989 Cheng could
not repay the loans. The evidence also indicates it would
have been useless to pursue collection.
The Court need not resolve the issue raised by the
FTB regarding the holding by the bankruptcy and district
courts that the FTB is held to the same burden of proof in
proving its claim which is applicable to all creditors in
bankruptcy cases. The evidence is clear that even if the
debtor had the burden of persuasion, he carried it. The
FTB introduced no evidence and made no evidentiary
objections. It cites no relevant state standard of burden of
proof after devoting more than half of its brief to an analysis of
why the state standard is not preempted by federal law. Fur-
thermore, inasmuch as no state assessment was ever
made, there is no presumptively valid assessment, and
since the FTB claim was based only on an IRS report
abandoned by the U.S. Department of Justice, the claim
has no presumptive validity.
If the Court does decide the burden of persuasion
issue, then it should note that the Supreme Court has
held that the burden of proof imposed on anyone, includ-
ing a tax claimant, to prove fraud in an objection to
dischargeability proceeding, is different from, and less
App. 11
than, the burden of proof imposed on a tax claimant
outside of bankruptcy court in the assertion of fraud. The
fulfillment of federal objectives mandates burdens of
proof in bankruptcy cases different from other civil cases.
In some instances, this burden on the government, as in
the case of fraud, is lighter, and in others, as in the
determination as to how the debtor’s assets are to be
divided among his creditors, it is heavier because all
claimants should conduct their contest on a level playing
field. No contrary rule is explicitly ordained. The Fifth
Circuit has twice so held. The Fourth Circuit's decision to
the contrary does not withstand close scrutiny and in any
event was a dictum. This Court should also note that all
courts agree that the holder of a tax claim arising during
a bankruptcy case is not entitled to the benefit of the
burden of proof applicable outside of bankruptcy court.
It is perfectly consistent with bankruptcy policy to
require a tax claimant to prove entitlement in a bank-
ruptcy case for a payment of tax from the estate, yet to
the extent it is not collected from the estate and not
discharged, it can be collected from the bankrupt debtor
in a proceeding in which the bankrupt has the burden of
proof.
Did the district court erroneously characterize the
judgment of the bankruptcy court as a summary
judgment subject to de novo review?
Debtor has briefed this issue of his cross a> peal at
pages 8 and 9 of this brief.
App. 12
If the district court correctly characterized the
judgment of the bankruptcy court as a summary
judgment, was there a controverted material issue of
fact which prevented a valid summary judgment?
The district court in reviewing the record concluded
that four aspects of debtor’s evidence indicated a genuine
issue for trial. Supp. ER9 and DCR11 at 18-20. These are:
debtor’s statement Cheng did not have permission to use
the debtor’s money for the purposes for which it was
used; debtor discussed tax shelters with Cheng; debtor
couldn’t distinguish loans from investments; some of the
loan documents don’t have repayment dates, don’t bear
interest rates and are not secured.
The inferences to be drawn from the evidence in
favor of the FTB to defeat summary judgment must be
reasonable. The permission and investment out of context
statements were from two lines in 126 pages of testimony.
Considering the deposition as a whole it was apparent
that the debtor had loaned money to Cheng during 1988
and 1989 and that the debtor considered a loan an invest-
ment. Debtor testified that even if a bank loaned money
to him the bank would be investing in him. ER6 at
135-136; DCR4 at 356-357. The only tax shelter discussion
related to 1981 and 1983. ER6 at 35; DCR4 at 255-257.
Neither the district court nor the FTB cited any evidence
regarding tax shelters relating to the 1988 or 1989 loans.
The bankruptcy court expressly noted that there was no
connection shown between the tax shelters and the loans
in question. ER7 and DCR4 at 77 lines 17-21. The misrepre-
sentation of the facts in this regard at pages 25-26 of the FTB's
brief was recognized by the bankruptcy court. The loan docu-
ments criticized by the district court, Supp. ER9 and
App. 13
DCR11 at 20, were addendums to a letter loan agreement
from Cheng’s lawyer which clearly specified all indicia of
a loan required by any criteria. Supp. ER5 and DCR4 at
549-550. The only effect of these addendums was to
change one term in the letter agreement. They also
related to an extensive loan agreement. Supp. ER7 and
DCR4 at 1004-1017.
Arrayed against these four out of context references
was all of the other evidence regarding existence of debt
and worthlessness discussed infra.
Debtor suggests that construing the entirety of the
record the only reasonable conclusion one can come to is
that Cheng borrowed during 1988 and 1989 not only the
amounts in issue, but more than that amount, and that
the loans made during 1988 and 1989 were worthless at
the end of each of these years. Also, as pointed out infra,
even if these loans were investments, they clearly were
made for profit and if worthless would result in a capital
loss which is what debtor claimed. This issue was raised
in bankruptcy court by the debtor. ER5 and DCR4 at 128.
Whether the loss occurs under I.R.C. 165 or 166 is not a
distinction with a difference here. Because a judgment
may be affirmed on any basis which appears from the
record, the district court should have affirmed the judg-
ment of the bankruptcy court.
App. 14
Was William Cheng (“Cheng”) obligated to repay to
Debtor the amounts of $1,400,000 and $2,028,141
advanced by Debtor to Cheng during 1988 and 1989
respectively? Did Cheng’s obligations to repay the
1988 and 1989 advances become worthless
in 1988 and 1989 respectively?
The evidence offered by the Debtor, to which no
evidentiary objections from the FTB were made notwith-
standing the FTB’s complaints about hearsay in its brief,
included:
1. Leslie Szutenbach worked with Debtor and
Cheng in all aspects of their business affairs during 1988
and 1989 and is a percipient witness with personal
knowledge of such affairs and is the custodian of the
documents offered and the person in the course of whose
business the documents were prepared on the dates
shown on them. Supp. ER6 and DCR4 at 736-778, 837-
838, 852, 854(top), 855, 857, 868(top); Supp. ER7 and
DCR4 at 874, 877, 882(top), 884(top), 887(top), 888-891,
892(top), 896, 897, 907, 914-918, 1017 and 1027.
2. By December 31, 1988 Cheng had obtained at
least $1,632,500 from Debtor and promised to repay this
amount. Supp. ER6 and DCR& at 701, 712, 737, 753, Supp.
ER7 and DCR4 at 916-918, 1028-1030, 1033 and 1038.
3. In 1989 Cheng obtained at least $2,224,077 from
Debtor and promised to repay this amount. Supp. ER6
and DCR4 at 701, 702; Supp. ER7 and DCR&4 at 1028 and
1038.
4. On December 31, 1988 and December 31, 1989
Cheng’s promises to pay were worthless. Supp. ER6 and
DCR4 at 701 and 702.
App. 15
5. Cheng knew when he prepared Debtor’s 1988
and 1989 federal income tax returns that he could not
repay these amounts and therefore caused Debtor’s 1988
and 1989 federal income tax returns to report bad debt
losses for $1,400,000 for 1988 and $2,028,141 for 1989.
Supp. ER6 and DCR&4 at 743-744 and 702.
6. In April 1991 Cheng commenced a bankruptcy
case under Chapter 13 of Title 11 U.S.C. and his case was
converted to Chapter 7 in May 1991. Supp. ER6 and
DCR4 at 702 and 703.
7. Cheng’s bankruptcy estate has little or no value.
Supp. ER6 and DCR4 at 702, 723 and 725.
8. The primary asset of his estate was stock in Cheng
Information Systems, Inc., all of the property of which
was sold by CIS’ bankruptcy trustee for $2,500. Supp. ER6
and DCR4 at 702 and 725.
9. As of December 31, 1988 and December 31, 1989
Macfarlane had no realistic prospect of recovery from
Cheng of any of the amounts then due to Macfarlane.
Supp. ER6 and DCR&4 at 702.
10. John Haegen and Leslie Szutenbach assisted in
the preparation of Debtor’s 1988 and 1989 tax returns.
Supp. ER5 and DCR4 at 316-317; Supp. ER7 and DCR&4 at
1026 and 1028. John Haegen was a custodian of the
records which evidence the loans and summarized them.
Supp. ER7 and DCR4 at 1026-1034. Summary at Supp.
ER7 and DCR&4 at 1038 with detail appended. Supp. ER5
and DCR4 at 316-317, 332 line 1.
11. Debtor gave Cheng a general power of attorney
in 1983, Supp. ER5 and DCR4 at 290-294, and 418 to 421,
App. 16
and numerous special powers of attorney. Supp. ER5 and
DCR4 at 275-289.
12. Cheng signed Debtor’s 1988 and 1989 returns as
their preparer. Supp. ER5 and DCR4 at 272, 312, 325, 423,
and 471.
13. Debtor claimed a $1,400,000 bad debt for 1988,
Supp. ER5 and DCR4 at 433, and a $2,028,141 bad debt for
1989. Supp. ER5 and DCR4 at 516.
14. Leslie Szutenbach was a percipient witness for
all of the circumstances surrounding the loans from
Debtor to Cheng. Supp. ER5 and DCR4 at 262-264, 266,
267, 274.
15. Debtor and Cheng signed documents evidenc-
ing an intent to enter into a debtor and creditor relation-
ship. Supp. ER5 and DCR4 at 350, 351, 358 through 364,
and 547 through 559. See also Supp. ER6 and DCR4 at
772, 775 and Supp. ER7 and DCR4 at 1000-1018.
16. Cheng was in dire financial straits in 1988 and
by the end of 1989 was living off loans. Supp. ER5 and
DCR4 at 560-564.
17. Cheng managed all of Debtor’s property and
affairs and Debtor trusted Cheng for all financial advice.
Supp. ER5 and DCR&4 at 252-254, 275, and in particular,
298 through 311. Debtor had a mental breakdown in 1980
or 1981, and after that Debtor relied on Cheng to conduct
his affairs. Supp. ER5 and DCR4 at 245-248.
18. Debtor loaned $2,047,232 to Cheng in 1989.
Supp. ER5 and DCR4 at 337-338.
App. 17
19. Debtor loaned a total of $4,529,349 to Cheng.
Supp. ER5 and DCR&4 at 412.
The substantive tax law issues have been decided
based on federal law because of California’s conformity
to federal law on this subject. In this regard it is impor-
tant to note the Debtor has noted that the loss claimed by
Debtor was a nonbusiness bad debt, or capital, loss. Con-
sequently the FTB’s emphasis on characterizing the loan
in question as an “investment” does not change the
income tax result if worthlessness nevertheless occurred
in 1988 and 1989 as contended by Debtor. The tax in
question arose from capital gains which were offset by
the capital loss at issue. Supp. ER6 and DCR4 at 598-610;
ER5 and DCR4 at 128. The bankruptcy court at the July
15, 1993 hearing systematically addressed the criteria for
deductibility of bad debt losses listed by the FTB in-the
context of the evidence offered by the Debtor. As the
court noted, the amounts involved were not in issue. The
bankruptcy court started its analysis with the letter of
January 12, 1987, Supp. ER5 and DCR4 at 547-548, which
clearly reflected a secured loan transaction in the amount
of $250,000. On February 26, 1987 there is memorializa-
tion of an offer by Debtor to lend to Cheng an amount of
$500,000 witnessed by Leslie Szutenbach. Supp. ER5 and
DCR4 at 549. This was increased to $750,000 on May 6,
1987. Supp. ER5 and DCR4 at 550. Debtor wrote checks to
Cheng for the loans. Supp. ER5 and DCR4 at 551-556.
Cheng signed promissory notes. Supp. ER5 and DCR4 at
557-559. Some of these same documents, and additional
documents, are at Supp. ER7 and DCR4 at 1004-1018. On
July 31, 1988 Debtor and Macfarlane entered into a loan
agreement which acknowledged loans of up to $1,250,000
App. 18
and granted Debtor the right to exchange his right to
repayment from Cheng to a right of repayment from a
corporation upon the occurrence of events which never
transpired and expressly acknowledged that the agree-
ment did not require the Debtor to enter into such an
exchange or to limit Cheng’s obligation to repay the debt
to Debtor. Supp. ER7 and DCR4 at 1004-1017. At Supp.
ER7 and DCR4 at 1009 is a letter from Cheng’s lawyer
who characterized the transactions involved as loans by
Debtor to Cheng. In addition to these documents are the
checks all of which were designated as loans to Cheng by
Debtor and Cheng and summarized by Szutenbach in her
declaration and deposition and by John Haegen in his
summary of the net checks written to Cheng as loans
from Debtor. As to Haegen, see Supp. ER7 and DCR4 at
1038. As noted, the amounts are not in issue and the
intent to create a debtor-creditor relationship is well
established by Cheng’s bankruptcy schedules which
show him indebted to Debtor in the amount of $2,939,722
and as owning all of the stock of Cheng Information
Systems, by the declaration of Szutenbach and by her
deposition and by the Debtor’s deposition which include
as exhibits the many documents which evidence a debtor-
creditor relationship and by the Debtor’s tax returns pre-
pared by Cheng and by Cheng’s own statements reflected
in the depositions and declarations in the record. Cheng’s
bankruptcy schedules also indicate that there were other
lenders loaning money to him during the periods in issue
contrary to the FTB’s argument that Macfarlane was the
only lender. Supp. ER6 and DCR4 at 708-714.
App. 19
The evidence regarding Cheng’s inability to repay
these loans as of the end of 1988 and 1989 is uncon-
tradicted. His personal bookkeeper’s declaration substan-
tiates his inability to repay. Supp. ER6 and DCR4 at
560-564. He repeatedly stated to Szutenbach than [sic] he
could not repay. Supp. ER6 and DCR4 at 743 lines 19-20
and 744 lines 2 and 13. The assets of his only significant
asset, Cheng Information Systems, sold for $2,500. Supp.
ER6 and DCR4 at 702 and 725. He prepared and signed as
preparer the Debtor’s tax returns in which he admitted
the existence of the debts at issue here and their worth-
lessness. Supp. ER5 and DCR4 at 423 and 471. Cheng’s
admissions in this record are uncontradicted. The FTB’s
inordinate reliance on the circumstance that Cheng had
Debtor’s power of attorney doesn’t contradict any evi-
dence offered by Debtor; it simply confirms, as the bank-
ruptcy court indicated, that Cheng had the authority to
carry out the agreements or otherwise to loan the
Debtor’s funds. As to the FTB’s argument that the loans
had to have value when made, the Debtor argued that
loans can become worthless when made as indicated by
the IRS’ policy because debts are created both by law and
by contract. Supp. ER4 and DCR4 at 214-216. The bank-
ruptcy court stated that was not a problem because at
least at the time the loan was made it could have been
repaid with the loan proceeds.
As to the FTB’s statement on page 28 (bottom) of its
brief, that there is “absolutely no evidence . . . that Cheng
ever attempted to repay Macfarlane,” this is not abso-
lutely true. John Haegen’s summary of loans to Cheng
was a summary of “net” loans because Cheng did make
payments to Macfarlane in 1988. Supp. ER6 and DCR4 at
App. 20
788; Supp. ER7 and DCR&4 at 1038, 1041. This misrepre-
sentation is similar to statements such as the one on page
29 (bottom) of the FTB brief that “the only evidence to
support Cheng’s inability to repay Macfarlane’s cash
advances was a hearsay statement from Szutenbach, a
former Cheng employee. ...” As the record amply
shows, Szutenbach was Cheng’s office manager and her
initials are on many of the significant documents in evi-
dence. She also was in charge of Macfarlane’s affairs. The
FTB made no hearsay objection. But her statement is not
the only evidence. The FTB overlooks the declaration of
Cheng’s personal bookkeeper who had percipient per-
sonal knowledge of his financial affairs, the inferences
one can gather from Cheng’s bankruptcy schedules, and
his admissions. See discussion in the preceding para-
graph.
The FTB’s reliance on a requirement of an “identifia-
ble event” rendering the loan worthless in making the
claim, Supp. ER6 and DCR&4 at 576 lines 27-28, and in its
brief, is simply not the law. There does not have to be an
identifiable event; the taxpayer must simply persuade the
court that the debt became worthless at the necessary
time.
Debts are wholly worthless when there are reason-
able grounds for abandoning any hope of repayment in
the future, Dallmeyer v. Commissioner, 14 T.C. 1282, 1292
(1950), and it could thus be concluded that they have lost
their “last vestige of value.” Bodzy v. Commissioner, 321
F.2d 331, 335 (5th Cir. 1963). But a taxpayer need not be
“an incorrigible optimist.” United States v. S.S. White Den-
tal Manufacturing Co., 274 U.S. 398, 403, 47 S. Ct. 598, 600
(1927). This will usually entail proof of the existence of
App. 21
identifiable events which demonstrate the valuelessness
of the debts. Riss v. Commissioner, 478 F.2d 1160 (8th Cir.
1973); Crown v. Commissioner, 77 T.C. 582, 598 (1981);
Hubble v. Commissioner, 42 T.C.M. 1537, 1544 (1981). Estate
of Mann, 731 F.2d 267, 276 (5th Cir. 1984). However, when
or whether a debt becomes worthless is a question of fact,
the answer to which lies in an examination of all the
circumstances. Boehm v. Commissioner, 326 U.S. 287, 293
(1945); Estate of Mann, 731 F.2d 267, 275 (5th Cir. 1984);
Dallmeyer v. Commissioner, supra at 1291. When a debt
becomes worthless is to be decided by the trier of fact.
Cole v. Commissioner, 871 F.2d 64, 66 (7th Cir. 1989), aff’g.
T.C. Memo. 1987-228. A bad debt is deductible only in the
year it becomes worthless. Denver & Rio Grande Western
Railroad Co. v. Commissioner, 32 T.C. 43, 56 (1959), aff'd.
279 F.2d 368 (10th Cir. 1960); Feinstein v. Commissioner, 24
T.C. 656, 658 (1955). Worthlessness is determined by
objective standards. Perry v. Commissioner, 22 T.C. 968, 973
(1954). Some factors that have been considered by courts
in determining worthlessness include the subordinated
status of the debt (Cole v. Commissioner, supra at 67); a
decline in the debtor’s business (Continental Illinois
National Bank & Trust Co. of Chicago v. United States, 81-1
USTC par. 9185 (N.D. Ill. 1981)); the decline in value of
the property secured by the debt (Meurer Steel Barrel Co.,
Inc. v. Commissioner, 7 B.T.A. 64, 66 (1927)); claims of prior
creditors far in excess of the fair market value of all assets
available for payment (Hadley Falls Trust Co. v. United
States, 110 F.2d 887, 890-891 (1st Cir. 1940)); the overall
business climate, the debtor’s earning capacity, the
debtor’s serious financial reverses, guarantees on the
App. 22
debt, events of default, whether major or minor, insol-
vency of the debtor, the obligor’s refusal to pay, abandon-
ment of assets or business, ill health, death, or
disappearance of the principals, bankruptcy or receiver-
ship, actions of the obligee in pursuing collection, i.e.,
whether the obligee unreasonably failed to take collection
action and then claimed the deduction, subsequent deal-
ings between the obligee and obligor, and lack of assets
(Cole v. Commissioner, supra).
No single factor is conclusive as there are no abso-
lutes in this area. See 2 B. Bittker & L. Lokken, Federal
Taxation of Income, Estates and Gifts, sec. 33.3.1, pp. 33-10
to 33-11 (2d ed. 1990). Default is a factor considered in
deciding whether an obligation is worthless. Cole v. Com-
missioner, supra. However, the fact that a debt had not
matured does not prevent a finding of worthlessness.
Bonynge v. Helvering, 117 F.2d 157, 158 (2d Cir. 1941), aff'g.
41 B.T.A. 84 (1940); Robert Smith Corp. v. Commissioner, 21
B.T.A. 1400, 1405 (1931). Similarly, the fact that a bad debt
is not due at the time of deduction does not of itself
prevent its allowance under section 166. Sec. 1.166-1(c)(7),
Income Tax Regs. A taxpayer need not wait for a default
before taking a bad debt deduction if the debt is clearly
worthless before any payments are due. Bonynge v.
Helvering, supra at 158.
Legal action is not required before a bad debt deduc-
tion is allowable where the surrounding circumstances
indicate that a debt is worthless and uncollectible and
that legal action to enforce payment would in all proba-
bility not result in the satisfaction of execution on a
judgment. However, a showing of these facts will be
sufficient evidence of the worthlessness of the debt for
— = lm ~~~ -megeigglls ly pees
——_s
App. 23
purposes of the deduction under section 166. Sec.
1.166-2(a) and (b), Income Tax Regs.; Exxon Corp. v. United
States, 785 F.2d 277, 279 (Fed. Cir. 1986). In determining
worthlessness, no one factor is controlling.
It is obvious that there is no precise test for determin-
ing worthlessness within the taxable year and neither the
statutory enactment, its regulations, nor the decisions
attempt such an all-inclusive definition. Furthermore, it is
often impossible to select a single factor or “identifiable
event” which clearly establishes the time at which a debt
becomes worthless and thus deductible. Minneapolis, St.
Paul Railroad Co. v. United States, 164 Ct. Cl. 226, 240
(1964). All pertinent evidence should be considered. Sec.
1.166-2(a), Income Tax Regs. See also Estate of Mann, 731
F.2d 267, 276-277 (5th Cir. 1984):
Subsequent events may only be used to
evaluate the soundness of the belief that a debt
became worthless in a certain year, and not as
evidence of the fact of worthlessness. . . . The
fact that a debt reasonably determined to be
worthless in a given taxable year, is subse-
quently recovered in part or in full, is not in
itself sufficient to prevent the deduction. . . .
If and when such a debt becomes wholly
worthless must be determined from the facts
and circumstances known or which reasonably
could have been known at the end of the year of
asserted worthlessness. . . . Of course, proof of
subsequent events may be allowed, as they were
here, insofar as they may be relevant to the
reasonableness of a conclusion that a debt
became worthless in the particular year... .
Id. at 278 and n. 19. (Emphasis added)
App. 24
In this case we have percipient witnesses’ testimony.
Also subsequent events, such as the demonstrable worth-
lessness of Cheng’s bankruptcy estate, can be taken into
account under Mann to assess the reasonableness of a
determination of worthlessness in 1988 and 1989.
The findings of the bankruptcy court are not only not
clearly erroneous, but are clearly supported by uncon-
troverted evidence. The conclusions are appropriate
under the law.
Since the FTB never made an assessment of the tax in
question, is there any presumption of
validity under state law?
The FTB notice of proposed assessments were issued
on April 3, 1992, almost two years after the Debtor com-
menced his bankruptcy case in 1990, at a time when the
FTB knew that the IRS audit report was being contested
in the bankruptcy court. Supp. ER6 and DCR4 at 576-577,
595-596, 612-613 (attachment to FTB pleading). The FTB
did not, and because of the automatic stay under 11
U.S.C. § 362, could not, assess the tax in question.
Accordingly there is no assessment by the FTB to which
presumptive validity can attach. Although most of the
FTB’s brief is dedicated to arguments why state law relat-
ing to burden of proof should govern in this case, the
FTB’s brief never tells this Court what state law governs.
At page 12 of its brief the FTB cites two decisions holding
that in refund claim litigation in state court the taxpayer
has the burden of proving the right to repayment of a tax
the taxpayer has paid. Nowhere does the FTB tell this Court -
what state law imposes upon the taxpayer the burden of pro-
ving the lack of validity of an unassessed state tax based on an
a
App. 25
abandoned IRS report. This Court may hold that the FTB
has waived its argument on this issue.
Is a FTB proposed assessment based on an IRS audit
report which was abandoned by the U.S. Department
of Justice entitled to presumptive validity?
The FTB’s attempt to make this a test case to establish
in this circuit whether or not the procedural bankruptcy
claims allowance rules applicable by their terms to every-
one apply to tax collectors fails if the claim of the FTB is
not entitled to presumptive validity. As noted above all
that the FTB did was adopt an IRS audit report which was
being contested in bankruptcy court and which was later
replaced by a stipulation in bankruptcy court settling the
IRS claim essentially for the costs of litigation. Even after
the audit report had been abandoned by the U.S. Depart-
ment of Justice the FTB continued to rely on it for its
proof of claim. The FTB admitted that it conducted no
audit or investigation or made any inquiry beyond the
IRS audit report. Supp. ER6 and DCR4 at 576-577. On
these facts the presumptive validity of the FTB’s claim
would be subject to doubt in any court. In Portillo v.
C.I.R., 932 F.2d 1128 (5th Cir. 1991) the court held that the
IRS’ assessment based on an information return filed by a
person who paid the taxpayer money was not a “deter-
mination” and the assessment was not entitled to pre-
sumptive validity. The FTB relied on information received
from another person without making any independent
determination as did the IRS in Portillo and the result
should be the same; the FTB claim should have no pre-
sumptive validity. This is particularly true on the facts of
this case which include the repudiation of the informa-
tion upon which the FTB relied.
App. 26
Should the determination of the validity of the claim
of a tax claimant be conducted differently from the
determination of the validity of the claim of any
other claimant in the absence of any bankruptcy law
or rule giving it special treatment?
If this Court concludes, as Debtor contends, that even
if he had the burden of proving his entitlement to the
deductions, he has carried it, then most of the FTB’s brief
is not material to the issues which have to be resolved in
this appeal.
It is apparent that the FTB, and other commentators,
have not analyzed ail of the possible consequences of the
contention that the allocation of burden of proof outside
of bankruptcy court should govern allocation of burden
of proof in bankruptcy court. For example, outside of
bankruptcy court the government must prove civil fraud
by clear and convincing evidence. Ackland v. C.I.R., 767
F.2d 618 (9th Cir. 1985). But in bankruptcy court the
government must prove civil fraud only by a prepon-
derance of evidence. Grogan v. Garner, 111 S.Ct. 654
(1991). It is clear that federal objectives modify for bank-
ruptcy purposes burden of proof rules otherwise applica-
ble. Regarding fraud, the modification is to the
government’s benefit; regarding competing with other
creditors for a debtor’s assets in the claims allowance
process, the modification creates a level playing field. The
tax claimant, as well as all other claimants, should have
to prove entitlement to priority and amount by a prepon-
derance of the evidence.
The Court should be aware that all courts who have
addressed the issue agree that a tax claim arising during
a bankruptcy case is not entitled to any presumptive
App. 27
validity. In re Fullmer, 962 F.2d 1463, 1467 (10th Cir. 1992);
In re Glen Eden Hosp., Inc., 172 B.R. 538 (Bk. E.D. Mich.
1994); In re Allen Care Centers, Inc., 163 B.R. 180 (Bk. D. Or.
1994). In these cases the courts held that absent the appli-
cation of F.R.B.P. 3001(f), tax claimants are not entitled to
the burden of proof allocation applicable outside of bank-
ruptcy court. If the FTB’s argument is correct, then these
decisions are wrong.
The Fifth Circuit in In re Placid Oil Co., 988 F.2d 554
(5th Cir. 1993) held that tax claims were to be determined
just like any other claim insofar as burden of proof was
concerned. While tax claims are granted priority when
allowed, the bankruptcy code does not specify any spe-
cial advantage which tax authorities have in the claims
allowance process. Accord, California State Board of Equal-
ization v. Official Unsecured Creditors Comm. (In re Fidelity
Holding Co., Ltd.), 837 F.2d 696 (5th Cir. 1988).
In addition to the absence of any express statutory
advantage, it has been argued, and it is true, that it is not
the taxpayer and the tax collector who are at issue in a tax
claim contest in bankruptcy court, but rather the estate
and the tax collector. It happens that in this case the
Debtor is the representative of the estate. As provided by
11 U.S.C. § 1107(a) he acts as trustee for the estate. If the
estate were represented by a trustee, as happens in every
Chapter 7 case and many Chapter 11 cases, who was not
the Debtor most of the arguments made by the FTB
relating to access to information here would be ground-
less. The bankruptcy code does not allocate burdens of proof
dependent on whether one person or the other is trustee of an
estate. The primary authority relied on by the FTB indeed
did involve a trustee who was not the debtor. Internal
App. 28
Revenue Service v. Levy (In re Landbank Equity Corporation),
973 K.2d 265 (4th Cir. 1992). In that case neither the tax
collector nor the trustee had access to the relevant factual
evidence. This distinction with a difference exists even in
refund claim litigation in federal district courts in which
substantive law is disregarded in some contexts because
the parties before the court are different from the parties
between whom the law regulates substantive relations.
It is apparent that Levy overstated the authorities
upon which it relied and that its holding regarding bur-
den of proof is a dictum. In that case the claim was prima
facie valid, as it is here, and the trustee offered no evi-
dence in opposition. No new law needed to be pro-
nounced by the Fourth Circuit to hold for the tax
collector. Furthermore, the references to legislative his-
tory and interpretations of the court in Levy were simply
wrong. The erroneous statements of the court in Levy
simply do not detract from the result required by the
difference in parties before the court and outside the
court, the language of the bankruptcy code which states
that there shall be a priority for certain claims when they
are allowed but specifies no advantage for the tax collec-
tor in the allowance process, the interpretation of United
States Supreme Court decisions relating to claims
allowance and determinations in the bankruptcy court
summarized and analyzed hereafter, and two decisions of
the Fifth Circuit which do expressly address this issue
one of which involves a California state tax collector. It is
well established that although state law determines prop-
erty rights, federal bankruptcy law determines both the
manner and the time in which such rights are to be
determined and the tederal consequences to be attached
App. 29
to such property rights. The FTB’s argument first that the
burden of proof under state law in state courts is akin to a
property right and second that it is governing in deter-
mining whether another creditor of a bankruptcy estate
gets less simply because a tax claim rather than a nontax
claim of the same amount is asserted doesn’t seem to be
consistent with the federal bankruptcy policy reflected in
the statutes and Supreme Court decisions which bear on
this subject. The FTB’s ubiquitous citations to Vanston
Bondholders Protective Comm. v. Green, 329 U.S. 156, 67 S.
Ct. 237 (1946) in support of its position fail to quote the
most relevant passage from the opinion: “In determining
what claims are allowable and how a debtor’s assets shall
be distributed, a bankruptcy court does not apply the law
of the state where it sits.” Id. at 329 U.S. 162. It should
also be noted that in addition to the substantive decisions
regarding the paramount nature of federal law in bank-
ruptcy cases, a strong argument can be made that the FTB
in filing its claim consented to a federal burden of proof
rule. See also, E. Martin, Consent: The Constitutional Basis
for Bankruptcy Judge Authority, 19 Cal. Bankr. J. 1 (1991).
Debtor contends that the FTB must bear the ultimate
burden. In re Federated Department Stores, Inc., 135 B.R.
950, 957-58 (Bk. S.D. Ohio 1992): “This Court finds that
the better reasoned cases are those that treat the govern-
ment as any other creditor in bankruptcy, and accord-
ingly, place the burden on the IRS to establish its
claim. . . . These decisions hold that the government must
be treated like any other claimant in bankruptcy court
and is not entitled to any special exception.” See also In re
Premo, 116 B.R. 515 (Bk. E.D. Mich. 1990); In re Compass
App. 30
Marine Corp., 146 B.R. 138 (Bk. E.D. Pa. 1992); In re Rasb-
ury, 130 B.R. 990 (Bk. N.D. Ala. 1991), aff'd 141 B.R. 752
(N.D. Ala. 1992); In re Dakota Industries, 131 B.R. 437 (Bk.
S.D. 1991) (“The Court concludes that 11 U.S.C. § 502(a)’s
allocation of the burden of proof applies in tax assess-
ments.”); In re Imperial Corporation of America, 91-2 USTC
{ 50,342, [1990-1991 Transfer Binder] Bankr. L. Rep.
(CCH) { 74,096 at 99,759 (Bk. S.D. Cal.).
In a claims contest it is the objection which is heard,
not the claim, Controller of California v. Lockwood, 193 F.2d
169, 171 (9th Cir. 1952) citing Whitney v. Dresser, 26 S. Ct.
316, 317 (1905), yet the burden of persuasion is on the
claimant. Furthermore, the Debtor may file a claim and
object to it. Kilen v. United States (In re Kilen), 129 B.R. 538
(Bk. N.D. Ill. 1991).
In Internal Revenue Service v. Levy (In re Landbank
Equity Corporation), 973 F.2d 265 (4th Cir. 1992), the issue
was whether the trustee of a Chapter 7 estate had the
burden of proving that the estate was entitled to a bad
debt deduction from income of the estate. The issue arose
in the context of a claim by the IRS for prepetition taxes
which was first agreed to by the trustee but which he
later sought to have disallowed. The factual issue
involved was the year in which debts became worthless.
It was impossible for either the trustee or the IRS to show
in which years the debts became worthless; accordingly
the issue of who had the burden of proving the timing of
the worthlessness was determinative of the controversy.
The court in Levy in very broad terms held that the
burden of proof rules which would have applied in a
App. 31
nonbankruptcy forum, should also apply in the bank-
ruptcy forum and there existed no equitable reason why
the nonbankruptcy forum rule should not be applied.
The Debtor here argues that the result in Levy was
arguably correct because the IRS’ claim was entitled to
prima facie validity under F.R.B.P. Rule 3001(f) and there
was no evidence to rebut the prima facie validity of the
claim. However, the additional reasons for its decision
stated by the court were dicta, and the court clearly failed
to accurately apply governing precedents and erro-
neously characterized the historical treatment of tax
claims in bankruptcy, since the 1938 Chandler Act first
obligated tax authorities to file claims in bankruptcy
cases. The burden of proof rule is in any event a rule
which by its terms applies only in a controversy between
a taxpayer and a taxing agency and in this case and in
every bankruptcy case the controversy is between the
taxing agency and other creditors of the Debtor. The
equitable objective of equality in treatment in bankruptcy
distributions requires that the taxing agencies and other
creditors compete on an equal footing governed by only
the rules in bankruptcy cases and not by presumptions
and burdens of proof which apply in controversies which
are not in a bankruptcy context.
The customary IRS burden of proof argument outside
of a bankruptcy case is set forth in United States v. Molitor,
337 F.2d 917, 922-923 (9th Cir. 1964):
When, therefore, an assessment has been
made by this officer it is to be presumed until
such presumption is overcome by proof to the
contrary that it was made upon sufficient evi-
dence. . . . Such an assessment is not, however,
App. 32
conclusive evidence of the liability of the dis-
tiller; it is open to attack; it is prima facie proof
only of such liability, and prima facie evidence
is such evidence as is sufficient, when
unassailed, to establish a given fact, and it
remains sufficient for that purpose until it is
rebutted and overcome.
And upon it being so made to appear, the
burden of proof then shifts to the plaintiffs [the
IRS], and it then becomes incumbent on the
plaintiffs to maintain and establish the correct-
ness of the assessment... .
This prima facie validity standard is not different
from the bankruptcy standard under F.R.B.P. Rule 3001(f)
which the court could have chosen to apply in Levy rather
than expound as it did on issues which were not germane
to the decision. In United States v. Sampsell, 224 F.2d 721,
722-23 (9th Cir. 1955), the Ninth Circuit disposed of a
controversy similar to that in Levy by simply saying: “[A]
sworn proof of a tax claim in proper form establishes a
prima facie case for the allowance of the claim. The
burden of proof is on the claimant, but the burden of
going forward and introducing evidence to rebut the
prima facie case is on the objecting party. The trustee has
not met this burden.”
It should also be noted that procedural burden of
persuasion differs somewhat in each of the three federal
courts with jurisdiction in tax matters. If a uniform bur-
den of persuasion standard is to be adopted, which is
more appropriate than another? To paraphrase Cheng v.
Gill (In re Cheng), 943 F.2d 1114, 1117 (9th Cir. 1991), the
rule applied should be one which is most apparent and in
this case it is the standard simply of F.R.B.P. 3001(f).
App. 33
Accordingly, it appears that if the Levy court had
limited its holding to the holding dispositive of the case,
the same result would have obtained from merely the
application of F.R.B.P. 3001(f) without the verbal embroid-
ery to which most of the opinion is devoted and since
F.R.B.P. 3001(f) most specifically applies to this issue, it
should govern.
The opinion in Levy states that substantive law
applies in determining the validity of claims against a
bankruptcy estate. Again, the Debtor in the case at bar
agrees with the rule but not how it has been applied. Levy
cites Dick v. New York Life Ins. Co., 359 U.S. 437, 446 (1959)
as holding that burden of proof rules are “substantive”
and that therefore they are applicable in tax determina-
tions in bankruptcy court. Dick was an accidental death
diversity jurisdiction case, not a federal jurisdiction case
in which substantive law, state or federal, was sought to
be applied. Dick merely held at the cited page that
“{ujnder the Erie rule, presumptions (and their effects)
and burden of proof are ‘substantive’ and hence respon-
dent was required to shoulder the burden during the
instant trial.”
Perhaps a more appropriate starting point for the
analysis of the applicability of the “outside of bankruptcy
court” burden of proof rule in bankruptcy court would
have been Grogan v. Garner, 111 S.Ct. 654, 657-658&n.9
(1991) in which the court said:
At the outset, we distinguish between the stan-
dard of proof that a creditor must satisfy in
order to establish a valid claim against a bank-
ruptcy estate and the standard that a creditor
who has established a valid claim must still
App. 34
satisfy in order to avoid dischargeability. The
validity of a creditor’s claim is determined by
rules of state law. See Vanston Bondholders Protec-
tive Comm. v. Green, 329 U.S. 156, 161, 67 S.Ct.
237, 239, 91 L.Ed. 162 (1946). Since 1970, how-
ever, the issue of nondischargeability has been a
matter of federal law governed by the terms of
the Bankruptcy Code... .
In Vanston, cited in Grogan as announcing the ulti-
mate rule governing the issue in the case at bar, the Court
did what the Levy court said it was not empowered to do:
it denied the allowance of a claim without regard to state
law because state law could not contravene the overrid-
ing bankruptcy objective of equality and equity in distri-
bution.
A purpose of bankruptcy is so to administer an
estate as to bring about a ratable distribution of
assets among the bankrupt’s creditors. What
claims of creditors are valid and subsisting obli-
gations against the bankruptcy at the time a
petition in bankruptcy is filed, is a question
which, in the absence of overruling federal law,
is to be determined by reference to state law. ...
[A]ssuming, arguendo, that the obligation for
interest on interest is valid under the law of
New York, Kentucky, and the other states hav-
ing some interest in the indenture transaction,
we would still have to decide whether
allowance of the claim would be compatible
with the policy of the Bankruptcy Act.... In
determining what claims are allowable and how a
debtor’s assets shail be distributed, a bankruptcy
court does not apply the law of the state where it
sits... . Bankruptcy courts must administer and
enforce the Bankruptcy Act as interpreted by
App. 35
this Court in accordance with authority granted
by Congress to determine who and what claims
shall be allowed under equitable principles. . . .
It is manifest that the touchstone of each deci-
sion on allowance of interest in bankruptcy,
receivership and reorganization has been a bal-
ance of equities between creditor and creditor or
between creditors and the debtor. . . . (emphasis
added)
Id. at 67 S. Ct. 239-241 and note 5. Ironically, the Fourth
Circuit held that “Vanston’s vitality has not diminished,”
In re Twin Parks Ltd. Partnership, 720 F.2d 1374, 1377 (4th
Cir. 1983), and it applied the preemption standard of
Vanston to define a “claim” in Grady v. A.H. Robins Co.,
Inc., 839 F.2d 198, 201-202 (4th Cir. 1988), again to do
what it said in Levy it could not do. And an examination
of the decisions relied on in Vanston indicates that Van-
ston was not the first decision to determine the
allowability of a claim by reference to the equitable objec-
tives of the bankruptcy laws. Judge Ryan in In re DWS
Investments, Inc., 121 B.R. 845 (Bk. C.D. Cal. 1990) likewise
applied Vanston to achieve a equitable distribution and in
Southwest Bank v. Parsons (In re Parsons), 124 B.R. 818 (Bk.
S.D. Cal. 1991) the court cited both Grogan and Vanston in
deciding the issue before the court. The Ninth Circuit in
Official Cattle Contract Holders Committee v. Commons (In re
Tedlock Cattle Company, Inc.), 552 F.2d 1351, 1352-1353 (9th
Cir. 1977) did likewise in declining te follow California
law in allowing a claim applying instead equitable bank-
ruptcy principles and in United States v. Robinson (In re
D.C. Sullivan & Co., Inc.), 929 F.2d 1, 6 (1st Cir. 1991) the
court noted that the Ron Pair decision adopted the Van-
ston approach.
App. 36
Accordingly it is apparent that although state sub-
stantive law must be applied to determine the “substan-
tive rights” of the claimant, it is not so apparent whether
the burden of persuasion rule should be applied if it
causes a deviation from the objective that all claimants
should be treated alike. Levy asserts that because govern-
ment claimants have always been given the burden of
proof in bankruptcy cases which they would have had
outside of the bankruptcy case, Congress did not intend
to change such application. However, the authority cited
by Levy for the proposition that governments have been
given the benefit of more than a prima facie validity of
their claims consists of decisions in which the issue
wasn’t raised, Resyn Corp. v. United States, 851 F.2d, 660,
662-63 (3rd Cir. 1988); United States v. Uneco, Inc. (In re
Uneco, Inc.), 532 F.2d 1204, 1207 (8th Cir. 1976), followed
by a “but see” signal to California State Bd. of Equalization
v. Official Unsecured Creditors Comm. (In re Fidelity Holding
Co., Ltd.), 837 F.2d 696, 698 (Sth Cir. 1988) in which the
issue was raised and in which it was held that a Califor-
nia taxing agency should be treated just like any other
claimant without the benefit of any special advantage
available to it under state law. Consequently one must
look elsewhere to ascertain what the historical treatment
of tax claims has been in bankruptcy cases to ascertain
what it was that Congress did or did not intend to
change.
The standard treatise on the Bankruptcy Act, 3A J.
Moore, Collier on Bankruptcy { 64,409 at 2244 (14th ed.
1988) states: “As in the case of other types of claims, a
filed proof of a tax claim in proper form establishes a
prima facie case for the allowance of the claim. The
App. 37
burden of proof is on the claimant, but the burden of
going forward and introducing evidence to rebut the
prima facie case is on the objecting party. In Nicholas v.
United States, 86 S. Ct. 1674, 1679 n.4 (1966) the Court
notes that “in 1938, however, Congress amended the
Bankruptcy Act by reducing tax debts to the status of a
fourth priority . . . and by requiring tax claims to be
proved in the bankruptcy proceeding like ordinary debts
... In Saper, the Court held that, in light of these amend-
ments, tax debts had become sufficiently clothed with the
characteristics of other bankruptcy debts to justify the
application of the general rule... . “
Similarly see Heiser v. Woodruff, supra, 66 S. Ct. at 860
n.1 (1946) which was relied on by Vanston and Note,
Taxation During Bankruptcy Liquidation, 55 Harv. L. Rev.
1141, 1146 (1942).
There is very little to indicate that tax claims were
given the benefit historically of more than the prima facie
validity accorded to all claims when the issue was rele-
vant. As noted in United States v. Sompsell, 224 F.2d 721
(9th Cir. 1955), it appeared that the court assumed the
customary bankruptcy standard applied. In Dickinson v.
Riley, 86 F.2d 385 (8th Cir. 1936) the court expressly held
that presumptive validity under state law would not gov-
ern the allowability of a tax claim in a bankruptcy case.
New Jersey v. Anderson, 27 S. Ct. 137, 140 (1906) held that
state law characterization of a state exaction as a tax was
not governing for purposes of classifying the exaction as
a tax entitled to priority. In Industrial Commission of Ohio
v. Highway Const. Co. of Ohio, 105 F.2d 863, 866 (6th Cir.
1939), the state argued that its state statute should govern
the prima facie validity of its claim. The court rejected
App. 38
that position and stated that the customary bankruptcy
standard applied to determine the validity of the claim.
Likewise in In re Hotel Martin Co. of Utica, 41 F. Supp. 392
(N.D.N.Y. 1941) the court dealt with a claim for taxes as if
only the bankruptcy procedures for claim allowance gov-
erned and restrained recourse to any state procedures for
determination of the claim. These authorities are consid-
erably more persuasive than the authorities cited by Levy
except for the “but see” reference in Levy to the Fifth
Circuit decision which holds against Levy and which Levy
attempted to distinguish in passing by implying that it
only applied to state taxes. California State Bd. of Equaliza-
tion v. Official Unsecured Creditors Comm. (In re Fidelity
Holding Co., Ltd.), 837 F.2d 696, 698 (5th Cir. 1988).
There are three commentaries contemporaneous with
the period after the 1938 adoption cf the Federal Rules of
Civil Procedure and the changes to the Bankruptcy Act
and the Erie decision when the consequences of these
three events were being hotly debated: Hill, The Erie
Doctrine in Bankruptcy, 66 Harv. L. Rev. 1013 (1953)
(herein “Hill — Erie”); Hill, State Procedural Law in Federal
Nondiversity Litigation, 69 Harv. L. Rev. 66 (1955) (herein
“Hill — State”); and Note, Tax Claims in Bankruptcy, 29
Virginia L. Rev. 206 (1942). Hill — Erie’s reference to the
Vanston rationale at page 1017 and at pages 1038 and 1039
states:
“The theme of the Bankruptcy Act,” the
Supreme Court has said, “is equality of distribu-
tion.” But this theme is only barely suggested by
the express terms of the Act. The Act does not,
as it cannot, say what constitutes equality of
distribution; the determination is left to the
App. 39
bankruptcy court, as a “court of equity,” on a
case to case basis. But, in the light of what has
been said earlier, the equity power of the bank-
ruptcy court is essentially the power to carry
out bankruptcy objectives. . . . It would there-
fore seem to be a safe working hypothesis that,
in pursuance of the bankruptcy objective of
equality of distribution, the bankruptcy court is
free to apply overriding federal law in deter-
mining the consequences of acts of a claimant
which created equities in other claimants of a
character having relevance only in the context of
distribution in insolvency.
Hill - State is a lengthy analysis of the general subject
matter involved here and at pages 67, 69, 74, 90, 92 and 97
to 98 has much to say about the general consideration of
the issue at bar noting in general that
in cases where effect is given to state-created
substantive rights the courts should be alert to
the possible existence of overriding federal poli-
cies adopted by Congress in pursuance of a
valid legislative object. Thus, however impor-
tant presumptions may be in the devolution of
title to property under state law, the federal tax
scheme may shift the burden of proof, for tax
purposes, to the taxpayer. And in pursuance of
valid bankruptcy objectives Congress may
establish presumptions without regard to the
presumptions which may arise from the transac-
tions under state law.
As noted in Vanston, the court is required to strike an
equitable balance between “creditors and creditors” in
the distribution process. The district court in the Levy
case thought that all creditors should be on an equal
footing and that the presumption which applied between
App. 40
a taxpayer and the IRS should not apply between one
creditor and another creditor. In Re Levy, 130 B.R. 28 (E.D.
Va. 1991). Perhaps the validity of that observation is
apparent from the analysis of an analogous issue — the
applicability to a bankruptcy contested matter of state
parole evidence rules and statutes of fraud when the
contested matter involves a trustee and the IRS or a state
taxing agency.
The parole evidence rule and statutes of frauds are
not rules of evidence, rather they are rules of substantive
law founded upon the substantive rights of the parties
similar for this purpose to burden of proof rules. Vickery
v. Fisher Governor Co., 417 F.2d 466, 468 (9th Cir. 1969).
When the parole evidence rule or a statute of frauds
is at issue in a bankruptcy proceeding, the bankruptcy
court generally must apply the law of the state in which it
sits to resolve the issue. In re Beverly Hills Bancorp, 649
F.2d 1329, 1334-1335 (9th Cir. 1981); In re California Pump
& Mfg. Co., Inc., 588 F.2d 717 (9th Cir. 1978).
Notwithstanding the rule regarding applicability of
substantive law, however, it is clear that in a contested
matter in bankruptcy court between a trustee and the IRS,
the IRS could not assert the rule or the statute as a bar to
the admission of evidence. In Mustard v. U.S., 155 F. Supp.
325 (Ct. Cl. 1957) the taxpayer transferred an interest in a
promissory note to a charitable beneficiary under a writ-
ten assignment transferring absolute ownership on the
face of the instrument of transfer as compensation for
services rendered by the transferee. The IRS disallowed
the deduction on the grounds that the transfer was for
App. 41
services rendered by the trustee as specified in the instru-
ment of transfer. The taxpayer contended that the transfer
was subject to an oral trust under which the transferee
was to hold the property transferred in trust and apply
the payments on the note to purposes specified in the
terms of the oral agreement. The taxpayer was allowed to
prove the existence of an oral trust contrary to the terms
of a written instrument unambiguous on its face because
the IRS is not a party who can raise either the parole
evidence rule or the statute of frauds as a defense in a tax
controversy because it was not a party to the transaction
at issue. Id. at 332-33.
In keeping with the rationale that a bankruptcy pro-
ceeding is a division of a res in the custody of the court
and that claimants consent to the rules and authority of
the court when they file a claim, Martin, Consent: The
Constitutional Basis for Bankruptcy Judge Authority, 19 Cal.
Bk. J. 1 (1991), it does not seem too far fetched to con-
clude that rules which may apply when contestants are
the taxpayer vs. the goverment need not apply when the
contestants are somebody else. As noted in Hunt, Tax
Claims in Bankruptcy Proceedings, 14 J. of the National
Assoc. of Referees in Bankruptcy 3, 5 & 8 (1939) (cata-
loged in libraries as the first volumes of the current
American Bankruptcy Law Journal):
It seems to me that when bankruptcy intervenes
a new element enters upon the scene, viz., the
creditors. . . . Once bankruptcy intervenes, how-
ever, the creditors are put in the saddle through
their trustee. . . . [I]t is settled that the power of
the state officials. . . . to determine and levy
taxes must yield to the constitutional power of
the federal government to establish what it
App. 42
reads as just rules for liquidation in bank-
ruptcy. ... The bankruptcy act was drafted with
the principle that “equality is equity” in mind,
but there has been a tendency in recent years for
the typical bankruptcy proceeding to resolve
itself into a process in which one preferred party
after another slices off a portion of the available
assets with little or no remaining for distribu-
tion to general creditors. This process ought not
to be extended beyond the clear requirements
and control of the statutes.
It is useful to ascertain from other decisions whether
there are any clues to how this issue will be decided by
the Supreme Court. Certainly the court has followed a
policy of treating the government claimant the same as
any other claimant. Thus in United States v. Ron Pair
Enterprises, Inc., 109 S.Ct. 1026 (1989), this equality of
treatment was to the benefit of the government while in
United States v. Whiting Pools, Inc., 103 S. Ct. 2309 (1983)
this equality was to the government's detriment. (“We see
no reason why a different result should obtain when the
IRS is the creditor.” Id. at 2315.). More recently the deci-
sion in Patterson v. Shumate, 112 S. Ct. 2242 (1992) was
presaged by the Court’s decision in Guidry v. Sheet Metal
Workers Nat. Pension Fund, 110 S:Ct. 680 (1990) in which
the Court stated “[u]nderstandably, there may be a natu-
ral distaste for the result we reach here. The statute,
however, is clear. In addition, as has been noted above,
the malefactor often is not the only beneficiary of the
pension”, id. at 688, thus indicating, with important
implications here, that one must look to the real parties in
interest in a bankruptcy case to determine issues. Patter-
son also emphasized the desirability of uniform treatment
App. 43
of pension plans unaffected by state law variations. There
is an indication in 11 U.S.C. § 346, 728 and 1146 that the
same uniformity in state tax claims was intended by
Congress.
As noted, the real parties are the creditors and the
equitable objectives of the Bankruptcy Code would be
best served by adopting what Grogan referred to as “a
roughly equal allocation of the risk of error between
litigants . . . ” Grogan v. Garner, 111 S. Ct. 654, 659 (1991).
As Grogan also noted, adoption of this standard would
simplify determination of claims because it is well estab-
lished that the tax claimant has the burden of persuasion
as to priority and dischargeability. “Requiring the credi-
tor to establish by a preponderance of the evidence that
his claim is not dischargeable reflects a fair balance
between these conflicting interests.” Id.
The only other authorities cited by Levy not replied to
above are the quotes from the 1973 Report of the Com-
mission on the Bankruptcy Laws of the United States,
H.R. Doc. No. 137, which can be found in Volume 2 of the
Appendix to L. King, Collier on Bankruptcy (15th ed. 1993).
Levy states the report recognizes “the need to create a
bankruptcy system which obviates criticism based on the
ground which involves the different results likely to be
obtained in bankruptcy courts and nonbankruptcy
courts” 973 F.2d 265, 270 (4th Cir. 1992). The context of
the report from which this quotation was taken dealt with
the desirability of having bankruptcy judges removed
from administration of cases so that they could be more
impartial in adversary proceedings and hardly is relevant
to the issue in Levy. The same report, however, in the
App. 44
more germane portion of it which deals with “Determina-
tion of Tax Liability by the Bankruptcy Courts” states
that: “[t]he customary procedures of litigation of tax lia-
bilities, through the Tax Court or by suit for refund, have
in large part been abrogated in cases of bank-
ruptcy . . . Ever since the Chandler Act of 1938, it has
been required that the government file its claim for pre-
bankruptcy taxes, whether previously assessed or not,
within the same period required of other creditors... ”
H.R. Doc. No. 137 at 292-293. Perhaps more importantly,
the Report cites to Bailey v. Glover, 88 U.S. (21 Wall) 342,
346 (1875) which stated: “It is obviously one of the pur-
poses of the Bankrupt Law, that there should be a speedy
disposition of the bankrupt’s assets. This is only second
in importance to securing equality of distribution. The
Act is filled with provisions for quick and summary
disposal of questions arising in the progress of the case,
without regard to usual modes of trial... . ”
REQUEST FOR RELIEF
Debtor requests that the court affirm the district
court’s affirmance of the bankruptcy court’s findings of
fact on the grounds that they are not clearly erroneous,
affirm the district court’s affirmance of the bankruptcy
court’s conclusions of law as correct, and reverse the
district court’s reversal of the bankruptcy court’s judg-
ment.
App. 45
STATEMENT OF RELATED CASES
Pursuant to Circuit Rule 28-2.6, counsel certifies that
to the best of his knowledge there are no related cases
pending at this time in this Court.
Dated: June 27, 1995
Elmer Dean Martin III
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.