New York State Court of Claims

New York State Court of Claims

KEMPER v. THE STATE OF NEW YORK, #2009-032-101, Claim No. 108940, Motion Nos. M-75340, CM-75377


Synopsis



Case Information

UID:
2009-032-101
Claimant(s):
KEMPER INSURANCE COMPANIES
Claimant short name:
KEMPER
Footnote (claimant name) :

Defendant(s):
THE STATE OF NEW YORK
Footnote (defendant name) :

Third-party claimant(s):

Third-party defendant(s):

Claim number(s):
108940
Motion number(s):
M-75340
Cross-motion number(s):
CM-75377
Judge:
JUDITH A. HARD
Claimant’s attorney:
Ernstrom & Dreste, LLPBy: Theodore M. Baum, Esq.
Defendant’s attorney:
Hon. Andrew M. Cuomo, NYS Attorney GeneralBy: Frederick H. McGown, III, Assistant Attorney General, Of Counsel
Third-party defendant’s attorney:

Signature date:
January 9, 2009
City:
Albany
Comments:

Official citation:

Appellate results:

See also (multicaptioned case)



Decision
BACKGROUND

On March 1, 2000, Haseley Construction Co., Inc. (Haseley) contracted with the New York State Department of Transportation (Contract No. D258333) to provide certain services on a construction project on Military Road in the Town of Niagara (Military Road Project).[1] In connection with the project, Haseley was required to purchase a faithful performance bond and a labor and material bond, which were obtained from claimant insurer. In August 2001, Haseley voluntarily terminated its contract with the State; the State declared it to be in default; and claimant was called upon to complete the work pursuant to the performance bond. At the time of Haseley’s default, the State held a total of $783,823.67 in retainage and unpaid receivables for work that had already been performed.

In October 2001, claimant entered into a Takeover Contract (McGown Affirmation, Exhibit D) with the State, in which the State agreed to process payment for the benefit of claimant any monies that were due or would have become due to Haseley under the original contract:
All sums now due and payable and to become due and payable upon the Contract, including all retainage percentages, all outstanding unpaid progress estimates for work accomplished before termination and all money to be paid under the Contract as would have been payable to the Original Contractor, subject to applicable liens and setoffs, if any, shall be paid to Surety [claimant] as if there had been no declared termination of the employment of the Original Contractor.
(Takeover Contract, p 3.) On two occasions subsequent to signing the takeover contract, claimant reminded the State by letter that it was not to authorize any payment to Haseley from funds related to the Military Road Project.

Construction of the Military Road Project was completed on August 31, 2002; a final walk-through inspection occurred on September 10, 2002; and the agreement as to final quantities of materials installed and work performed was reached on June 5, 2003. Claimant paid off the claims of all laborers, suppliers, materialmen and others who had worked on the project. DOT authorized payment of all invoices submitted by claimant, and the remaining project funds were paid by the State to claimant, with the exception of $579,779.68. At the time of payment, claimant was not informed of the basis for this partial non-payment (Stipulation of Facts, ¶¶ 20, 21).

The sum that was withheld from claimant had earlier been paid by the Office of the State Comptroller (OSC) to the United States Internal Revenue Service (IRS), pursuant to two Notices of Levy that had been served which sought money allegedly owed by Haseley to the IRS. The first notice was served on June 5, 2002, (McGown Affirmation, Exhibit 2 to Exhibit L) and the second on January 8, 2003 (id. Exhibit 3; Stipulation of Facts). The second Notice of Levy directed the OSC to turn over to the IRS the sum of $579,779.68 from any wages or other income owed to Haseley in order to satisfy that firm’s outstanding delinquent tax liability, and on January 10, 2003, the OSC issued payment to the IRS from funds designated for the Military Road Project. The parties agree that at the time of this payment, the OSC “had no knowledge of whether the tax obligations owed by Haseley arose from the Military Road Project or other projects” and “did not inquire as to whether the tax obligations owed by Haseley arose from the Military Road Project or some other project” (Stipulation of Facts, ¶¶ 35, 36).

Although it was not been given formal notification of these Notices of Levy by either the IRS or the State (id. ¶¶ 26 - 28), claimant evidently had been aware that Haseley had or might have outstanding tax liabilities.[2] Because of this awareness, on May 6, 2002 (prior to service of the initial Notice of Levy at issue here and prior to completion of the Military Road Project) claimant had filed a complaint against the United States of America in the District Court for the Western District of New York seeking, inter alia, injunctive relief to prohibit it from “enforcing or pursuing wrongfully served levies” (id. ¶ 22). That federal action was dismissed after January 2003, because the only outstanding levy had been paid and the question of enforcement became moot, but claimant subsequently moved to reopen the case and to supplement its complaint to ask for judgment, inter alia, in the amount of $579,779.68. In other words, the federal action now sought to recover the Military Road Project funds that had been paid to the IRS by the OSC. In response to the motion to reopen and supplement, the United States argued that claimant’s supplemental claim was time-barred, however that argument was rejected and the action allowed to proceed (McGown Affirmation, Exhibit J [Corrected Decision and Order, 02-CV-6252, September 22, 2004]).

In September 2005, claimant moved for summary judgment in the federal lawsuit, specifically asserting that the IRS had wrongfully levied on the sum of $579,779.68. The United States again raised the Statute of Limitations defense in opposing the motion. This motion was resolved by a Stipulation for Judgment, executed May 3, 2006, which acknowledged that both the United States and claimant had a legal interest in the funds and that, at the time of the June 5, 2002 levy, claimant was entitled to $535,885.78 of the sum in question (Stipulation of Facts, Exhibit C). The difference of $43,893.90, it appears, was the amount that Haseley actually owed to the IRS in unpaid taxes (McGown Affirmation, ¶ 16).

The stipulation for judgment expressly provided that the parties retained the right to appeal the judgment. After judgment was formally entered, on June 30, 2006 the United States appealed, once again arguing that claimant’s supplemental complaint had been time-barred. Negotiations between the parties followed, and claimant ultimately agreed to accept the sum of $300,000.00 to settle its action against the United States.
APPLICABLE LAW AND DISCUSSION
Claimant now seeks summary judgment in its favor in the amount of $235,885.78 (the difference between the original sum claimed and the $300,000 received in settlement of the federal action), arguing that the money was wrongfully released by the OSC. The basis of this argument is claimant’s contention that at the time the money was paid over to the IRS, Haseley had no apparent interest in any funds related to the Military Road Project and that the OSC failed to make a good faith determination as to Haseley’s apparent interest, in violation of 26 CFR §301.6332-1(c)(2). Defendant argues that the OSC was obligated to turn over the funds to the IRS in response to a lawful levy (26 USC § 6332[e]) and, in any event, that claimant’s exclusive remedy to challenge the levy was to pursue a federal remedy. Defendant relies on §301.6332-1(c)(3) in support of its position.

Section 6332 of the Internal Revenue Code (26 USC § 6332) provides that a person[3] who has possession of property, or rights to property, that is the subject of an IRS levy “shall, upon demand of the Secretary, surrender such property or rights . . . to the Secretary,” except for any part of the property that is subject to an attachment or execution under a judicial process. A person who fails to surrender such property becomes liable to the United States for a sum equal to the value of the property, as well as a penalty equal to 50 percent of the value of the property (subd [d][1],[2]). If the property is surrendered, the statute provides protection to the property-holder in subdivision (e):
Any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which a levy has been made who, upon demand by the Secretary, surrenders such property or rights to property (or discharges such obligation) to the Secretary (or who pays a liability under subsection (d)(1)) shall be discharged from any obligation or liability to the delinquent taxpayer and any other person with respect to such property or rights to property arising from such surrender or payment.

(26 USC § 6332[e] [emphasis supplied]). Briefly stated, the property-holder who complies with an IRS levy cannot be held liable to the taxpayer or to any third party for having disposed of the assets in that fashion. The phrase “and any other person” was added to the statute in 1988 (Pub.L. No. 100-647 § 1015[t][1], 102 Stat. 334) in order to expressly provide the immunity with respect to third parties who claim that they had a legal interest in the property as well as to the taxpayer (see, Midwest Sports Medicine and Orthopedic Surgery, Inc. v U.S., 73 F Supp 2d 870 [SD OH 1999][amendment “extends immunity to a person or entity who mistakenly surrenders property of a third party, who is not subject to an IRS levy”]; Ollerdessen v U.S., not reported, 1993 WL 313159 [ND CA 1993], affd 52 F3d 334 [9th Cir 1995]).

The purpose of this statute and the 1988 amendment is to further a “policy of encouraging efficient collection of federal taxes and voluntary compliance with the tax laws” by penalizing noncompliance with a levy and discharging any person who honors an IRS levy from any obligation or liability to the taxpayer or a third party (Smith v Kitchen, 156 F3d 1025, 1029 [10th Cir 1997]). “Although there may be some disagreement between the circuits as to whether section 6332(e) creates a ‘defense’ or an ‘immunity,’ this provision clearly bars money damages against a person who has complied with an IRS levy” (id.)

Defendant contends that this statute provides it with a complete defense against a claim by claimant insurer in this action. Claimant disagrees, relying on an exception to the statute’s grant of immunity that is contained not in the statute itself but in a regulation, 26 CFR § 301.6332-1(c). Following a general provision (26 CFR § 301.6332-1[c][1])which echoes the language regarding immunity of 26 USC § 6332 (e), subdivision (2) creates the following exception:
(2) Exception for certain incorrectly surrendered property. Any person who surrenders to the Internal Revenue Service property or rights to property not properly subject to levy in which the delinquent taxpayer has no apparent interest is not relieved of liability to a third party who has an interest in the property. However, if the delinquent taxpayer has an apparent interest in property or rights to property, a person who makes a good faith determination that such property or rights to property in his or her possession has been levied upon by the Internal Revenue Service and who surrenders the property to the United States in response to the levy is relieved of liability to a third party who has an interest in the property or rights to property, even if it is subsequently determined that the property was not properly subject to levy.
Claimant interprets this regulation to require that in order for the State to take advantage of the statutory immunity of Section 6332(e) it must “show that it made a good faith determination as to Haseley Construction’s apparent interest in the property” (Claimant’s Memorandum of Law,

p 8).

Defendant focuses on another part of the regulation, not referenced by claimant, which sets forth the remedies that may be pursued by taxpayers or third parties who allege that they have been damaged by an improper levy:
(3) Remedy
. In situations described in paragraphs (c)(1) and (c)(2) of this section, taxpayers and third parties who have an interest in property surrendered in response to a levy may secure from the Internal Revenue Service the administrative relief provided for in section 6343(b) or may bring suit to recover the property under section 7426.[4]

Defendant contends that an action brought pursuant to 26 USC § 7426 is the only way in which a third party who claims interest in the subject property can challenge the propriety of an IRS levy.
It is undisputed that a third party in possession of property upon which a levy has been issued must surrender the property or rights to property subject to levy and that are two, and only two, possible defenses for a property-holder’s failure to comply with a tax levy: 1) that the property is already subject to judicial attachment or execution or (2) that the third party is neither “in possession of” nor “obligated with respect to” property or rights to property belonging to the taxpayer (United States v National Bank of Commerce, 472 US 713, 722 [1985]). It is also undisputed that in a tax levy case, the relevant property interests of the parties is controlled by state law while the determination of whether a custodian was obliged to surrender property in response to a levy is governed by federal law (United States v National Bank of Commerce, supra; United States v Ruff, 99 F3d 1559 [11th Cir 1996]; United States v Metropolitan Life Ins., 874 F2d 1497 [11th Cir 1989]). With respect to the second issue, whether the custodian was obliged to surrender the property, federal case law is clear: “even if others claim an interest in the property and the taxpayer's interest may be quantified as a mere modicum,” the property must be surrendered until ultimate ownership can be resolved (Congress Talcott Corp. v Gruber, 993 F2d 315, 319 [3d Cir 1993]).

The initial question presented here is what court or courts are authorized to rule on whether a property-holder can be liable to an injured party (either the taxpayer or a third party) for surrendering property in response to an IRS levy. If defendant is correct and 26 CFR § 301.6332-1(c)(3) provides the exclusive remedy available to claimant for challenging the propriety of the levy to which defendant responded, that fact would present a jurisdictional bar to the instant claim. Even if such a federal action is only one option and the issue can be litigated in State court, a second issue would be whether the fact that claimant has already pursued the federal remedy prevents the matter from being relitigated in this Court.

By far the majority of challenges to allegedly wrongful levies are brought in federal court (see e.g., United States v National Bank of Commerce, supra; In re Beam, 192 F3d 941 [9th Cir 1999]; Moore v General Motors Pension Plans, 91 F3d 848 [7th Cir 1996]), and a number of wrongful levy actions that were initially commenced in state court are removed to federal court, often because the lawsuit names both the United States and the property-holder (see e.g., United States v Triangle Oil, 277 F3d 1251 [10th Cir 2002]; Biegeleisen v Ross, 164 F3d 617 [2d Cir 1998]).

When taxpayers or third parties have sought to sue the person or entity that surrendered property in compliance with an IRS levy in state courts, the typical result is that the action has been dismissed on the ground that the property-holder was immunized by 26 USC §6332(e), with no discussion of whether the regulatory exception applied and no discussion of the availability of alternative remedies (Hufnagel v North Valley Bank, 2008 WL 1749038 [Cal App 2008]; Cross v USAA Federal Savings Bank, 2007 WL 3023227 [Tex App 2007]; Gavigan v Fleet Nat. Bank Corp., 2006 WL 279367 [Conn Super 2006]; Edwards v Swift Transp. Co., Inc.145 SW3d 443 [Mo App 2004]; Brown v Ford Motor Co., 154 Ohio App.3d 404 [Ohio App 2003]; Geiersbach v Blue Cross/Blue Shield of Kansas City, 58 SW3d 636 [Mo App 2001] [Section 6332(e) places no investigatory obligation on the property-holder]; Bennett v Southeastern Bank, 481 SE2d 830, 224 Ga App 714 [1997]).

Research has disclosed only two instances in which a State court has ruled on both the state law issue, whether the taxpayer had a legal interest in the subject property, and the federal issue, whether the property-holder had been obliged to honor the levy in light of the exception contained in 26 CFR § 301.6332-1(c)(2). In Victore Ins. Co. v City of Bowie (23 SW3d 499 [Tex App 2000]), the surety of a contractor had to assume some of the payroll and other expenses during the course of a public construction project and objected when the city paid funds for that project to the IRS, in response to a levy. A Texas Court of Appeals interpreted the relevant regulation in the same fashion as claimant’s in this action, as placing a burden on the property-holder to prove that its action was “based on a good faith belief that the property is subject to IRS levy.” In that case, the court concluded that in the situation presented there, Texas law did not recognize any property interest on the part of the contractor and there was no evidence to support a finding that the property-holder had paid the IRS in good faith. This, of course, is the result that claimant seeks in the instant case and great reliance is placed on this decision. In Victore Ins. Co. (supra), there is no reference to subdivision (3) of 26 CFR § 301.6332-1(c), which sets forth the remedies available to those who claim an interest in the subject property, and no discussion of whether state or federal courts, or both, have jurisdiction to determine whether a levy was proper.

In contrast to the result in Victore Ins. Co., (supra), the Supreme Judicial Court of Maine held in A.F.A.B., Inc. v Town of Old Orchard Beach (777 A2d 831[ME 2001]), that “[t]he appropriate remedy for one who believes a notice of levy to be wrongful is to surrender the property and bring an action against the federal government” (id at 835, citing to 26 CFR § 301.6332-1[c][3]). In that case, a town owed money to a corporation and turned over some of that money in response to a levy on the property of an individual who had some connection to the corporation. The corporation sued the town for breach of contract and unjust enrichment, contending that the property it turned over did not belong to the individual named in the levy. The court held that the town was statutorily immunized from liability and that, as noted, the issue of whether the levy was wrongful had to be resolved in a federal action.

The reasoning and authority of A.F.A.B., Inc. v Town of Old Orchard Beach, (supra), is persuasive. While state court actions may appropriately determine whether a property-holder’s surrender of property was in response to an IRS levy and thus entitled to statutory immunity, any further inquiry into the propriety of the levy or the diligence of the property-holder in making a determination of ownership must be decided in a federal action pursuant to 26 CFR § 301.6332-1(c)(3). In granting statutory immunity, Congress “balanced the interest of the Government in the speedy collection of taxes against the interests of any claimants to the property, and reconciled those interests by permitting the IRS to levy on the assets at once, leaving ownership disputes to be resolved in a post-seizure administrative or judicial proceeding” (United States v National Bank of Commerce, 472 US at 729, supra; see also Congress Talcott Corp. v Gruber, 993 F2d 315 [3d Cir 1993]). As another court has observed, the tax laws, specifically section 6332(e), “are designed to reach those [property] interests and to encourage third parties to turn over the interests when the government issues a demand for them” (Farr v United States, 990 F2d 451, 456 [9th Cir 1993]).

These purposes are defeated if the immunity conferred by section 6332(e) protects the property-holder in Federal court only, leaving it potentially liable in state court actions, actions that can be brought at any stage of the proceedings and that will inevitably result in widely differing standards and burdens of proof.[5] If claimant’s interpretation is accepted, a property-holder would be placed in a Catch-22 situation: it could turn over the property in response to the levy, thus avoiding the IRS penalties, but potentially be found liable in state court for failing to make a good faith determination or it could retain the property until any state challenge was resolved, only to be subjected to statutory penalties by the IRS. Since the real disputes in these situations are between the IRS, the taxpayer, and in some instances a third party claiming an interest in the property, a system that effectively and safely removes the property-holder from the center of the controversy benefits all concerned. 26 USC § 6332 establishes such a system.

Claimant’s motion is denied. Defendant’s cross motion is granted. Claim No. 108940 is dismissed.


January 9, 2009
Albany, New York

HON. JUDITH A. HARD
Judge of the Court of Claims


Papers Considered:


1. Notice of Motion and Supporting Affidavit of Theodore M. Baum, Esq. with annexed Exhibits and Memorandum of Law;


2. Notice of Cross Motion and Supporting Affirmation of Frederick H. McGown, III, AAG, with annexed Exhibits and Memorandum of Law;

3. Reply Affidavit of Douglas A. Bass, with annexed Reply Memorandum of Law

Filed papers: Claim, Amended Claim, Answer.


[1].Most of the facts giving rise to this claim are not in dispute, as the parties entered into an extensive Stipulation of Facts (Baum Affidavit, Exhibit A). Those facts are summarized here, supplemented in a few instances with information drawn from documents and affidavits submitted by the parties.
[2].It is likely that such awareness resulted from earlier Notices of Levy, in different amounts that had been served by the IRS in August 2001 and June 2002 (McGown Affirmation, Exhibit F). The submissions do not indicate if or how these levies were satisfied.

[3].For purposes of this statute, the term “person” is defined broadly and includes states (U. S. v Com. of Pa., Dept. of Highways, 349 F Supp 1370 [ED PA 1972]).

[4].26 USC §6343(b), captioned “ Authority to release levy and return property,” provides a basis for persons whose property has been obtained through a tax levy to submit a written request for the return of such property, as explained in Amwest Sur. Ins. Co. v U.S. (28 F3d 690 [7th Cir 1994]).

26 USC § 7426, captioned “Civil Actions By Persons Other Than Taxpayers” authorizes, inter alia, the following: “Wrongful levy. If a levy has been made on property or property has been sold pursuant to a levy, any person (other than the person against whom is assessed the tax out of which such levy arose) who claims an interest in or lien on such property and that such property was wrongfully levied upon may bring a civil action against the United States in a district court of the United States.”
[5].In Victore Ins. Co v City of Bowie, (supra), for example, the Texas court imposed on the property-holder the burden of proving that it had a good faith belief that under Texas law the taxpayer had an interest in certain property.