Chapter 11 Debtors Are Prohibited From Paying Taxes… Without a Notice and Hearing!
Before people worry too much, this is not as bad as it sounds but it is still pretty awful.
Under Bankruptcy Code section 102, “notice and hearing” is a due process safeguard: “after such notice as is appropriate in the particular circumstances, and such opportunity for a hearing as is appropriate in the particular circumstances.” In other words, there are circumstances where notice and hearing means just notice or notice and an opportunity to object. Hopefully local bankruptcy rules are modified to make these notice only requests.
This article is going to discuss IN THE MATTER OF CLOOBECK which is a 9th Circuit Court of Appeals decision decided on June 12, 2015 and its impact on Chapter 11 Bankruptcy practice. You can find a copy of the decisionhere.
Cloobeck is a case where the Chapter 7 Trustee paid the Bankruptcy Estate’s $340,000 tax liability. This is a no brainer right? Just look at all the authority for doing so:
Under IRC § 6012(b)(4), taxes returns must be filed by the Trustee:
“[r]eturns of an estate, a trust, or an estate of an individual under chapter 7 or 11 of Title 11 of the United States Code shall be made by the fiduciary thereof.”
28 U.S.C. § 960(a) makes it clear that taxes will continue to accrue, even with a Trustee appointed and § 960(b) requires payment to be made.
Furthermore, the Trustee is authorized to make the payment via § 726 which states in pertinent part:
(a) Except as provided in section 510 of this title, property of the estate shall be distributed—
(1) first, in payment of claims of the kind specified in, and in the order specified in, section 507 of this title, proof of which is timely filed under section 501 of this title
Following Section 507 leads us to:
“(2) Second, administrative expenses allowed under section 503 (b) of this title”
Following Section 503(b), we get to this gem:
“(1)(B) any tax— (i) incurred by the estate, whether secured or unsecured, including…”
Not only that, but the code goes even further; the taxing agency does not even have to file a proof of claim!
“(1)(D) notwithstanding the requirements of subsection (a), a governmental unit shall not be required to file a request for the payment of an expense described in subparagraph (B) or (C), as a condition of its being an allowed administrative expense;”
For those of us paying attention, the Trustee has to file returns on time. The taxes found to be incurred are then administrative expenses that must be paid by the Trustee even if the IRS does not file a proof of claim. WRONG.
I forgot something. Section 503(b) starts out like this, “After notice and a hearing,…”
According to the 9th Circuit Court of Appeals, the taxes are not administrative expenses until notice and a hearing. So the Chapter 7 Trustee, despite all the authority in the world to file and pay taxes, must also give creditors an opportunity to object before making those payments.
Chapter 7 Trustees are now on notice and will go this extra step. But wait, this was about Chapter 11 Debtors.
A Chapter 11 Bankruptcy case may be converted or dismissed if the Debtor does not timely pay postpetition taxes. See § 1112(b)(4)(I):
(I) failure timely to pay taxes owed after the date of the order for relief or to file tax returns due after the date of the order for relief;
The same analysis above applies to these taxes. They are potentially administrative claims, but only after notice and hearing. So before the tax may be paid, there must be notice and a hearing. Until local rules provide otherwise, a Debtor must notify all parties that it intends to pay taxes, wait the requisite 17 days to lapse, then file a declaration of non-opposition and lodge an order. That is a lot of work just to pay taxes as they come due.
Some other thoughts…
What if your client has already paid those taxes without notice and hearing? Will the DOJ require the Debtor to file a turnover action against the IRS? Should we go back and notice all prior paid taxes to see if anyone objects? There are more problems for individual debtors as well. Unless and until an individual filing Chapter 11 is considered as “operating a business (the business of living?),” an individual cannot technically buy food without a motion. This is the rationale behind having to file budget motions. If this is how it is, then how can taxes be paid without a § 363(b) motion — or quarterly fees for that matter?