Sixth Circuit nixes suit against bankruptcy trustees

It’s not often that the United States government, as a plaintiff, uses its sovereign immunity as a sword against lawsuit defendants, in this case the bankruptcy trustees of the Eastern District of Michigan.

More typically, the government raises sovereign immunity as a shield after being sued for transgressions, real and imagined.

And, if the government wields sovereign immunity as a sword, the thrust, as the 6th U.S. Circuit Court of Appeals explains in United States v. Carroll, et al., must be against the correct parties.

Our story: In 2008, the clearance rate for Eastern District Chapter 13 bankruptcy cases was among the lowest in the country — 79th out of 90 judicial districts.

Some of the Eastern District bankruptcy judges devised a plan to improve the situation. When a debtor was due a tax refund, the bankruptcy court would order the IRS to send the refund directly to the trustee overseeing the debtor’s case. That way, the trustees could directly disburse funds to Chapter 13 creditors while eliminating the debtor, who might find other uses for the money, as a middleman.

At first, the IRS went along with this, even though redirecting the refunds to the trustees required the IRS to hand-process the affected tax returns. But the number of affected returns grew from an initial 400 to almost 5,000. And, because Chapter 13 reorganizations typically last three to five years, the refund-redirect orders were creating a significant headache for the IRS.

So, the IRS asked the United States to sue the trustees, claiming that the redirect orders violated the government’s sovereign immunity.

The government’s argument was that the bankruptcy code abrogates sovereign immunity “to the extent set forth” in 11 U.S.C. § 106. Section 106 requires that debts owed to the bankruptcy estate must be paid to the trustee. But, according to the government, this language does not clearly waive sovereign immunity with respect to the refund-redirect orders.

The federal district court thought this was a pretty good argument. The court enjoined the trustees from enforcing existing redirect orders and issued a writ of mandamus to prohibit the bankruptcy court from issuing redirect orders in future Chapter 13 cases.

The trustees appealed to the Sixth Circuit. Judge Jeffrey S. Sutton set the stage:

Even though both sets of parties would prefer that we resolve this lawsuit on the merits, we lack the jurisdiction to do so. The government sued the wrong parties, depriving it of standing to bring this lawsuit.

Of the three “irreducible constitutional minimum[s]” of standing — injury in fact, causation and redressability, Lujan v. Defenders of Wildlife, 504 U.S. 555, 560 (1992) — the government satisfies just one of them. Given the administrative burden to the United States of complying with the bankruptcy court’s orders, to say nothing of the alleged violation of sovereign immunity underlying them, the government has suffered the requisite injury.

But, Sutton said, causation and “redressability” are much more problematic.

The government sued a group of bankruptcy trustees, but the harm it suffered — administrative costs associated with processing tax refunds — flows not from the trustees’ actions but from the bankruptcy court’s orders.

When an entity does not like a court order, the answer is not to sue the lawyer or party who recommended the order; it is to appeal the order or, if utterly necessary, to sue the court. Bankruptcy trustees do not control bankruptcy courts.

Redressability, too, is a problem. The question is whether the requested relief would fix the problem at hand … . Even if the trustees have a role in enforcing these orders, that does not mean a judgment against the trustees will eliminate the problem. Trustees are not the only parties to Chapter 13 bankruptcies. Other parties, including the debtor and creditors, have an interest in ensuring that tax refunds make their way to the trustees.

Nothing prevents these entities from asking the bankruptcy court to issue the same order. …

This lawsuit was apparently born of three good intentions: (1) a need to resolve the government’s sovereign-immunity defense to the redirection orders; (2) a timing exigency in view of the growing administrative burden of the orders; and (3) a desire not to sue federal judges — thank you — unless absolutely necessary.

Yet the government’s unusual vehicle for handling these concerns was not the only one available. The government could have filed a direct appeal from the entry of a redirection order in one (or more) of the cases in which the IRS is a party.

Good intentions, yes; good trial strategy, no

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Eastern District Bankruptcy Court refines tax refund procedure

Debtors who have bankruptcy cases in the Eastern District are sometimes required to surrender income tax refunds to the trustee overseeing their cases.

The court has expended considerable effort to set up this procedure. See, The Michigan Lawyer, “Bankruptcy court has more to say about debtors’ tax refunds.”

The latest wrinkle in the matter concerns debtors, nondebtor spouses and joint tax returns that generate jointly payable refunds.

Here’s the latest directive from Chief Judge Philip Shefferly on the matter:

When only one spouse files a chapter 13 case, but the debtor and the non-debtor spouse file a joint tax return, the debtor must provide the trustee, if requested by the trustee, the appropriate IRS forms signed by the debtor and by the non-debtor spouse.

For example, if a trustee requires the debtor to execute an IRS form 2848, power of attorney, such form must be signed both by the debtor and by the non-debtor spouse as a condition for confirmation of the debtor’s chapter 13 plan. This is to ensure that any refund with respect to a joint tax return will be transmitted by the IRS to the trustee so that the debtor’s share of such joint tax refund will be applied to the debtor’s obligations under the debtor’s chapter 13 plan.

In each case where the debtor and the non-debtor spouse file a joint tax return, the order confirming plan in the debtor’s chapter 13 case must contain a formula or mechanism for allocating any joint tax refunds between the debtor and the non-debtor spouse to avoid unnecessary litigation in the future.

In each case where the debtor and the non-debtor spouse file a joint tax return, and a joint tax refund is received by the chapter 13 trustee, the trustee must promptly remit to the non-debtor spouse his or her share of the joint tax refund.

Bankruptcy court has more to say about debtors’ tax refunds

The Bankruptcy Court for the Eastern District of Michigan used to require Chapter 13 confirmation orders to include a provision ordering the IRS to pay debtors’ tax refunds directly to bankruptcy trustees.

The problem was, the IRS didn’t like being told to do that. It sued to prevent the bankruptcy court from including the requirement in the confirmation orders.

U.S. District Court Judge Denise Page Hood last month shot down the direct payment provisions. See, The Michigan Lawyer: Bankruptcy court can’t order IRS to give trustees debtors’ refunds

Bankruptcy Chief Judge Phillip Shefferly has responded with a new directive.

To continue facilitating compliance with the obligation to pay tax refunds to the trustee, notice is hereby given that in each case in which an order confirming the plan has not yet been entered and in which the debtor’s plan provides for the payment of tax refunds to the trustee, the debtor shall sign, as requested by the trustee,

(1) any appropriate IRS forms that authorize the IRS to forward the debtor’s tax refunds directly to the trustee, whether by check or direct deposit, and,

(2) any appropriate form that will authorize the trustee to endorse, negotiate and deposit the debtor’s tax refund check for the debtor’s chapter 13 account.

Shefferly’s directive applies to Chapter 13 cases in which the meeting of creditors or the confirmation hearing is on or after Friday, March 26, 2010.

Bankruptcy court can’t order IRS to give trustees debtors’ refunds

It seemed like such a good idea.

A couple of years ago, the Bankruptcy Court for the Eastern District of Michigan approved a standardized confirmation order for Chapter 13 cases, which, in part, attempted to cut out the middleman by ordering the IRS to send debtors’ tax refunds directly to the bankruptcy trustees overseeing their cases.

Well, nobody, and we mean nobody, tells the IRS what to do.

The IRS sued to stop the tax refund redirects. It later withdrew the suit and the parties tried to mediate a solution. Those efforts failed.

As the IRS made plans to file another suit, the court’s six judges sent the IRS a letter insisting they had the authority to issue the redirect order.

The IRS responded by reinstituting its suit.

Last week, U.S. District Court Judge Denise Page Hood, in United States v. Carroll, delivered the bad news to the trustees and the Bankruptcy Court

The Court finds that sovereign immunity has not been waived as to proceedings against the IRS redirecting tax refunds to be paid to chapter 13 Trustees instead of to the debtors. The Bankruptcy Court, therefore, had no jurisdiction and authority to enter chapter 13 confirmation orders ordering the IRS to redirect tax refunds to be paid to chapter 13 Trustees instead of to the debtors.

Accordingly, IT IS ORDERED AND DECLARED that the chapter 13 Trustees for the Eastern District of Michigan may not seek to enforce any provisions of chapter 13 plan confirmation orders entered by the United States Bankruptcy Court for the Eastern District of Michigan that compel the IRS to pay future tax refunds claimed by chapter 13 debtors to the chapter 13 Trustees instead of to the debtors.

IT IS FURTHER ORDERED that a writ of mandamus is issued prohibiting the United States Bankruptcy Court for the Eastern District of Michigan from entering any further orders containing redirection provisions of chapter 13 confirmation orders that compel the IRS to pay future tax refunds claimed by chapter 13 debtors to the chapter 13 Trustees instead of to the debtors.

Yesterday, Bankruptcy Court Chief Judge Phillip J. Shefferly issued a Notice Regarding Tax Refunds In Chapter 13 Cases. The notice recapitulates the relief ordered in Carroll and contains a stern reminder.

It is important to note that if a Chapter 13 plan or an order confirming a plan require the payment of tax refunds by a debtor to the Chapter 13 trustee, the debtor remains fully responsible to comply with such provision.

The District Court Order only addresses whether the Internal Revenue Service can be ordered to send tax refunds to the Chapter 13 trustees, not whether the debtors must send tax refunds to the Chapter 13 trustees.