IRS Had No “Substantial Justification” for Challenging Jurisdiction

Posted by NCBRC - March 30, 2022

The IRS had no reasonable basis for challenging the bankruptcy court’s exercise of personal jurisdiction, where it consented to jurisdiction when it filed a claim in the debtor’s chapter 7 bankruptcy, and the debtor notified it of his objection to the claim using the address the IRS provided. For that reason, the debtor was entitled to recover fees and costs associated with litigation of the IRS’s claim. Nicolaus v. United States of America, No. 21-3010 (N.D. Iowa March 8, 2022).

The IRS submitted a claim for $92,877.89 in the debtor’s chapter 7 bankruptcy, listing a post office box in Philadelphia as its address for receipt of notices. The debtor objected to the IRS’s claim and sent notice of the objection to that address. The IRS did not respond to the objection and the bankruptcy court disallowed the claim. The IRS later moved the court, under Rule 60(b)(4), to vacate the order disallowing the claim, arguing that the debtor had failed to serve the United States according to the Bankruptcy Rules and therefore the court did not have personal jurisdiction over the IRS.

The bankruptcy court resolved a conflict among the courts as to the issue of whether Rule 3007 requires a debtor to serve the IRS according to Rule 7004(b)(4) which provides that service be made by mail “addressed to the civil process clerk at the office of the United States attorney for the district in which the action is brought and by mailing a copy of the summons and complaint to the Attorney General of the United States at Washington, District of Columbia.” Because the debtor did not serve the IRS at that address, the bankruptcy court vacated its earlier judgment and overruled the objection. In so holding, the bankruptcy court also rejected the debtor’s argument that the IRS submitted to personal jurisdiction when it filed its claim.

The district court affirmed.

The debtor appealed to Eighth Circuit which found that, under the version of Rule 3007 in effect at the time, a debtor need only serve the IRS at the address provided in the claim to establish personal jurisdiction. The court did not address the debtor’s additional argument that jurisdiction was established when the IRS filed its claim. It reversed and remanded with instructions to reinstate the order disallowing the claim.

Back in the bankruptcy court, the debtor moved for an award of fees and costs in the amount of $39,206.75. The bankruptcy court denied the motion on the basis that the IRS’s position was “substantially justified,” within the meaning of 26 U.S.C. § 7430(c)(4)(B).

The debtor appealed to the district court.

Section 7430 permits a prevailing party in an action involving collection of taxes to seek to recover litigation fees and costs from the losing party. Section 7430(c)(4)(B)(i), however, provides that no party is a “prevailing party” against the United States if the United State’s position was “substantially justified.” In Center for Fam. Med. v. United States, 614 F.3d 937 (8th Cir. 2010), the Eighth Circuit stated that “[t]he position of the United States is substantially justified if it has a reasonable basis in both law and fact, a determination made on a case by case basis.” The United States bears the burden of establishing substantial justification.

The court on appeal found the IRS’s position in its motion to vacate the order disallowing its claim was two-fold: First, it argued that Rule 3007 required the debtor to serve process on the government (not merely the IRS), and second, that service on the government was required for the court to have personal jurisdiction over the IRS.

The court noted that Wiswall v. Campbell, 93 U.S. 347 (1876), established the general principle that by filing a claim in bankruptcy, a party submits to the jurisdiction of the court. Gardner v. State of New Jersey, 329 U.S. 565 (1947) and Katchen v. Landy, 382 U.S. 323 (1966), reaffirmed that principle, notwithstanding the subsequent creation of various procedural rules.

The parties disagreed over the impact of United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010). That case involved the debtor’s treatment of his student loans in his chapter 13 plan without having filed an adversary proceeding as required by the Bankruptcy Code. The Court found that the student lender had received notice of the plan and did not object and was therefore bound by the terms of the confirmed plan despite the procedural irregularity. In so holding, the Court found that “Rule 60(b)(4) applies only in the rare instance where a judgment is premised either on a certain type of jurisdictional error or on a violation of due process that deprives a party of notice or the opportunity to be heard.” The Court found that the rule requiring a debtor to file an adversary proceeding to challenge the dischargeability of student loans was a procedural rather jurisdictional requirement.

Significantly for purposes of this case, the Espinosa Court stated: “Rule 60(b)(4) does not provide a license for litigants to sleep on their rights. United had actual notice of the filing of Espinosa’s plan, its contents, and the Bankruptcy Court’s subsequent confirmation of the plan. In addition, United filed a proof of claim regarding Espinosa’s student loan debt, thereby submitting itself to the Bankruptcy Court’s jurisdiction with respect to that claim. See Langenkamp v. Culp, 498 U.S. 42, 44, 111 S. Ct. 330, 112 L.Ed.2d 343 (1990) (per curiam).”

Where, as here, the IRS did not claim a lack of due process but relied solely on the argument that the court lacked personal jurisdiction over it, the court found the case law to be clear: when a party files a claim in a bankruptcy case, it consents to the court’s equitable jurisdiction. The court found that mailing an objection to the address provided by the IRS was not so fundamental an “infirmity” as to justify vacating the order of disallowance under Rule 60(b) and the bankruptcy court erred in finding that it was. For the same reasons, the IRS had no reasonable basis for challenging the order of disallowance.

The court reversed the bankruptcy court’s order denying the debtor’s motion for fees and costs. It remanded.

Nicolaus ND Ia March 2022

Tags: ,

Post a Comment

You must be logged in to post a comment.