United States v. de Cespedes has a horrible back story involving the realization of the American dream, followed by a meteoric fall (I think both Bill Nye and Neil deGrasse are okay with that usage of the term meteoric) from grace due to defrauding various health care companies, along with the IRS, and eventually lien priority questions for one offender. The specific lien issues revolved around which creditor should be paid first from the sale of a homestead; the IRS for a tax lien, a third party creditor with a prior lien, or the federal government for non-tax restitution that was filed after both? In the end the federal government won, with the non-tax restitution trumping, followed by the tax lien. This was the optimal result for the government, and a bad deal for the offender’s ex-spouse, who was in possession of the home and only liable for the tax lien.
In 1980, Carlos and Jorge de Cespedes started Pharmed Group, growing it to over $60MM in revenue a year, becoming a large distributor of medical, surgical and pharmaceutical supplies working with large health systems and major pharma companies. The brothers came from humble beginnings, coming to the United States as young boys from Cuba without their parents, and growing up in an orphanage (I took this back story from the Pharmed Group Wikipedia page here).
Unfortunately, in the early 2000s, business started to falter, and various lawsuits sprung up, which you can read about here. As business got worse, it became evident the brothers were defrauding just about everyone and were evading taxes. Although they both pled guilty to a multitude of offenses, the rest of the post focuses on some of the difficulties Carlos faced following his conviction.
On January 7, 2009, Carlos was convicted of wire fraud in violation of 18 USC 1349, and ordered to pay joint restitution with the other defendants of about $7MM. On March 13, 2009, Carlos and his then wife, Martha, entered into a closing agreement with the Service, agreeing to an assessment of tax, penalties and interest of around $4MM for tax years 2001 through 2003. Presumably tax was assessed shortly thereafter, liens automatically arose at that point, and were filed on March 24, 2010, May 13, 2010 and June 23, 2010. On February 20, 2009, a civil suit was brought against the de Cespedes, which was finalized on August 7, 2009, wherein the plaintiff obtained a judgement of about $17.6MM. In February of 2009, Martha filed for divorce against Carlos. On December 15, 2010, Carlos transferred his interest in their primary residence, which was a homestead under Florida law, to Martha pursuant to the divorce settlement. To summarize:
- January 7, 2009 wire fraud conviction with restitution (no lien filed).
- February 20, 2009 civil suit brought.
- March 13, 2009 closing agreement with Service.
- August 2009 judgement and lien in civil suit.
- In March, May and June of 2010 tax liens filed.
Eventually, the homestead was sold, and there were a lot of creditors with their hands out, but nowhere near enough funds to pay everyone. This obviously matters to the creditors, who may have had limited other opportunities to collect. But, it also mattered to the ex-Ms. de Cespedes, who was a joint debtor with her husband on only one of the debts- the taxes owed. Two issues arose before the courts. In 2014, the District Court for the District of Southern Florida (can’t find a free link – sorry) focused on whether the government, specifically the tax claims, had priority over the civil plaintiff. Here, it was clear the civil plaintiff won the race to the court house, but in a surprising twist based on Florida homestead law, discussed below, the Service took priority. In 2015, the Eleventh Circuit reviewed the priority of the non-tax restitution payments compared to the tax lien, and found that the restitution had priority over the tax lien. This hinged on the treatment of the non-tax restitution as a tax lien.
Focusing first on the tax lien priority over the civil liability, the Court indicated the tax lien occurs at the time of assessment and applies to all property owned by the taxpayer, but under Sections 6323(a) and (f) the lien is not valid against another “judgement lien creditor” until notice of the tax lien has been field. This is a rule most of us know, and one that makes sense. In de Cespedes, the civil plaintiff filed its judgement on August 7, 2009, months before the IRS liens were recorded in May and June of 2010, which would seem to indicate the civil plaintiffs won the race to the court house, and therefore should get paid.
Under Florida law, however, there was question of whether the civil creditor was a “judgment lien creditor” in August of 2009, and, unfortunately for it, the Court found it was not. Under the Florida Constitution, “[t]here shall be exempt from forced sale under process of any court, and no judgement, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon…the following property owned by a natural person: (1) a homestead…” Fl. Const. art. X, §4(a)(1). Quoting the District Court for the Middle District of Florida, the Court stated this homestead exemption was to be liberally contributed, and shields the home from all claims of creditors, with limited exceptions (one of which is taxes). See Dowling v. Davis, 2006 WL 2331070 (MD Fl. 2006). The Court found that the house retained the homestead status until at least December of 2010, which was after the lien filings by the Service. When the home was sold, the government was to get paid since it had a valid lien, and the civil plaintiff was stuck empty handed.
Following the 2014 decision, the home’s equity was not all applied to the tax liability. Of the remaining funds, fifty percent of the home’s equity value was paid towards the restitution owed by only Carlos de Cespedes. The other fifty percent was paid towards the jointly owned tax debt. It is understandable to question how this could have occurred, because the non-tax lien of one spouse would seem to be precluded by the homestead exemption above. Martha appealed that allocation, arguing the tax lien had priority and all the remaining equity should have been applied towards the joint tax debt.
Specifically, Martha argued that the tax liens were created upon the assessment of the tax liability by the Service, or, in the alterative, the liens arose at the time of the closing agreement being signed. Second, Martha also argued that the non-tax restitution lien could not attach to the property because it was tenants by the entireties property owned jointly by them.
The Court did not find these arguments persuasive. Pursuant to the applicable federal statute, the restitution order was treated as “a liability for tax assessed under the [IRC]”. See 18 USC 3613(c). When the restitution order was recorded and notice of the lien was provided, the lien was treated as a federal tax lien. See 18 USC 3613(d)&(f). This allowed the lien to attach to the property regardless of the homestead exemption. The statute found in 18 USC 3616 is a federal criminal procedure statute that assists in the federal government collecting restitution for various non-tax crimes. The treatment of that restitution as “tax” creates an interesting anomaly in this case where there are competing government claims on co-owned property, and also can have an interesting impact in other areas (e.g. garnishment of qualified plans, see US v. Sawaf, 74 F3d 119 (6th Cir. 1996)). If the restitution is payable to the victims in some manner, it also creates a priority right in someone other than the government, possibly defeating the government in a situation like de Cespedes.
Likewise, the Court did not agree with the argument that the restitution order could not attach to the joint property, following United States v. Craft, and holding entireties interests are property or rights to property that can be attached. 535 US 274 (2002). The Court did note that Florida law exempts entireties property from execution of the debts of one spouse, but held this was trumped by federal law. See United States v. Ryals, 480 F3d 1101 (11th Cir. 2007).
In terms of timing, the Court stated a restitution lien arose in favor of the United States upon the entry of the judgement on January 7, 2009, which attached to all property and rights to property and was treated as a tax lien. It further stated that this put the lien on equal footing with the tax debt, and it received priority under the general rule of first in time, first in right under Griswold v. United States, 59 F3d 1571 (11th Cir. 1995). The tax lien would not have arisen until the assessment, which would have followed the execution of the closing agreement. The Court noted that the signing of the closing agreement itself did not cause assessment, which is correct, but doesn’t really seem to matter, since even the signing of the closing agreement was after the January 7th date when the restitution judgment was recorded and the federal tax lien type of lien came into existence.
This case presents the interesting competition between a real federal tax lien and a faux federal tax lien. Because the faux federal tax lien created by the restitution judgment has all of the characteristics of the real federal tax lien, the creation of the faux federal tax lien prior to the creation of the actual federal tax lien allows the faux FTL to come first in a priority fight between the two federal tax liens. See also US v. Vermont, 377 US 351 (1964)(“first in time is first in right”). Here, the payment of the restitution was to the detriment of the Service, but probably provided more benefit to the federal government as a whole, since two people remained liable for the tax debt, one of whom was not in jail (this assumes the restitution amount remained with the government).
Overall, the case was not groundbreaking, but showed two interesting quirks in lien law with one created by the impact of the Homestead exemption on judgment lien creditors, and the other with the interplay of the faux federal tax lien created by certain non-tax restitution orders versus the real federal tax lien.