A pair of recently decided cases address the validity and the amount of the claim of the IRS in bankruptcy. Each case offers a small lesson on such claims. In In re Yuska, No. 14-01504 (N.D. Iowa April 6, 2018), the debtor attacked the IRS claim because the bankruptcy specialist checked the wrong box on the claim form. In United States v. Austin, No. 17-6024 (B.A.P. 8th Cir. April 9, 2018), the court determined the value of the IRS secured claim, secured by virtue of a chose in action held by the debtor. Neither case reaches a surprising result, though the bankruptcy court’s decision in Austin, overturned by the Bankruptcy Appellate Panel in the case discussed here, did produce a surprising result and one which the IRS appealed on a valuation matter because of the legal issue involved.
In Yuska, the debtor owed the IRS over $1 million, which the court had previously determined in an adversary proceeding. From the court’s description of Mr. Yuska’s arguments, I believe he qualifies as a tax protestor. In this follow-up matter, he attacks not the validity of the underlying liability but the validity of the claim of the IRS filed in the proceeding. He argues that in preparing the claim, the IRS bankruptcy specialist checked the box on the claim indicating that she was the creditor rather than checking the box that she was filing the claim as an agent of the creditor.
The first argument of the IRS in the case sought a decision based on res judicata due to the prior adversary proceeding determining Mr. Yuska’s liability. The court did not base its decision on its prior determination regarding the amount of the liability but looked instead to the basis for objecting to a claim. It held that the following bases for objecting to a claim exist:
1) The claim is unenforceable against the debtor and property of the debtor;
2) The claim is for unmatured interest;
3) The claim is for a tax assessed against property of the estate and exceeds the value of the interest of the estate in such property;
4) The claim is for services of an insider or attorney of the debtor and exceeds the reasonable value of such services;
5) The claim is for a debt that is unmatured on the date of the filing of the petition and that is excepted from discharge under section 523(a)(5) of this title;
6) The claim is the claim of a lessor for damages resulting from the termination of a lease of real property and meets other criteria;
7) The claim is the claim of an employee for damages resulting from the termination of an employment contract and meets other criteria;
8) The claim results from a reduction due to late payment in the amount of an otherwise applicable credit available to the debtor in connection with an employment tax on wages, salaries, or commissions earned from the debtor; or
9) The proof of such claim is not timely filed…
The court found that unless the objecting party meets one of these objections, the court shall determine the amount of the claim and shall allow such claim in that amount. Here, the complaint of the debtor raises a technical issue related to the preparation of the claim form. The IRS agrees that the employee checked the wrong box but argues that this technical deficiency does not invalidate the claim. The court pointed out that Bankruptcy Rule 3001(a) requires that a claim conform substantially with the official form published by the rules. The court finds that the form filed by the IRS substantially complies with the rules, that common sense should not disallow a claim based on a small technical failure, and that the debtor himself recognized in his pleadings that the IRS employee was not the true claimant against the estate. So, it determines that the IRS has a valid and binding claim.
In Austin, the debtor had a workman’s comp lawsuit pending at the time of filing the bankruptcy petition. Prior to the filing of the petition, the IRS had filed a notice of federal tax lien. So, the IRS would have a secured claim in the value of the lawsuit (minus the attorney’s fees for bringing the suit.) The issue presented is the value of the suit. The issue can regularly arise in bankruptcy cases; however, cases attacking the value are not commonly reported.
In their schedules, the debtors listed the suits as contingent and unliquidated exempt property and valued the claims at $0.00. Debtors objected to the secured claim of the IRS assigning value to the lawsuits and argued initially that the value of the IRS lien in these suits was $0.00. The bankruptcy court determined that the suits had some value and overruled the objection. While that litigation was pending, the debtor negotiated a settlement netting $15,661.00 after attorney’s fees. The IRS learned of the settlement and amended its claim to reflect that amount as the value of its secured claim.
The debtors’ objected to the amended secured claim of the IRS, arguing that the value of the claim was not equal to the amount of the settlement. They attached an affidavit of their attorney who “opined that the worker’s compensation claims had a nuisance value of $3,000 on the petition date.” The IRS responded that this affidavit was not substantial evidence contradicting their claim and that under B.C. 502 the claim is presumed correct unless an objection to the claim is filed and supported by substantial evidence.
The court found that “substantial evidence means ‘more than a mere scintilla. It means such relevant evidence as a reasonable mind might accept as adequate to support a conclusion.’ Substantial evidence requires financial information and factual arguments. Here the Smallwood Affidavit does not contain the financial or factual information necessary to support Mr. Smallwood’s opinion of value.” Debtor’s attorney basically argued that they did not have much of a case and only by his skill did he obtain a settlement of over $20,000. The court points out that no matter how wonderful Mr. Smallwood was it was the debtors’ claim that formed the basis for the recovery. It also found that presenting evidence by way of affidavit prevented the IRS from its opportunity to cross examine. It stated that “allowing a valuation of a tort claim without a reasonable factual basis encourages abuse.”
So, the court found the debtors failed to present substantial evidence sufficient to overcome the presumption of validity in the claim. The court did not discuss the fact that a secured claim is not static in value. Even if the value of the tort claim was $3,000 at the outset of the case, the value of the claim could rise if the property to which the lien attach rises in value. The case provides an interesting glimpse at the amount of proof needed to win an objection regarding the value of property but I wanted it to also discuss the ability of a secured claim to rise or fall in value. That ability is why creditors seek to lock in value through cash collateral proceedings at the outset of a bankruptcy case.