This month's Supreme Court Update features Kontrick v. Ryan,¹ in which the Court will decide whether a debtor's delay waives the deadline for objection to discharge, as the Seventh Circuit held. We also have two short takes, cases the Court has agreed to hear on ERISA and partnership tax issues arising in bankruptcy. The first of these is Yates v. Hendon,² where the Sixth Circuit held that ERISA does not cover working owners/sole shareholders of small businesses. In bankruptcy, that means those debtors cannot rely on ERISA to exclude their interests in employee benefit plans from the estate. Second is United States v. Galletti,³ where the Ninth Circuit disallowed as time-barred IRS claims for partnership taxes against individual partners because the IRS had not assessed or filed suit against the partners within the three-year deadline.

Kontrick: The Dueling Doctors' Discharge Dispute

Bankruptcy Rule 4004 (a) requires objections to discharge under Code §727 to be filed "no later than 60 days after the first date set for the meeting of creditors," unless the court grants an extension for cause before the time has expired. Kontrick v. Ryan,⁴ on appeal from the Seventh Circuit, raises a fresh-start question impacting individual debtors, their creditors and trustees. Suppose a discharge objection is filed late, but the debtor fails to raise the time bar in his answer. Does the debtor get a discharge or is Rule 4004(a)'s deadline subject to waiver and other equitable defenses?

The Kontrick tale might be titled "Slow and Slower;" the problem would not have arisen had counsel been quick and quicker. Debtor Kontrick, a plastic surgeon, filed a chapter 7 petition. Creditor Ryan, a surgeon formerly in practice with debtor, held a half-million dollar judgment against him. The creditor waited until the final day of his third extension before finally filing an objection to discharge. Four months later, with no further extension, the creditor amended his complaint, adding the one count that eventually counted. The debtor answered, but waited almost a year, until the creditor sought summary judgment, to raise Rule 4004(a)'s time limit.

Prof. Jeff Morris has suggested that the debtor's surname alone doomed his discharge.⁵ All three courts, however, relied on other grounds. Judge John Schwartz of the U.S. Bankruptcy Court for the Northern District of Illinois agreed that the amended complaint was late, but held that the debtor's own delay waived the time bar. Judge Schwartz then denied discharge based on the late-added count. District Judge Harry Leinenweber, and then the Seventh Circuit, in an opinion by Judge Ripple, affirmed.

On appeal, Kontrick contended that Rule 4004(a)'s 60-day limit for objecting to discharge is "jurisdictional" in the sense that "a court has no authority to extend or alter [the deadline] with equitable exceptions such as waiver." The courts below held that the time limits are instead akin to statutes of limitations, which can be waived.

The Seventh Circuit began by quoting the Supreme Court's statement in United States v. Locke:⁶ "Statutory filing deadlines are generally subject to the defenses of waiver, estoppel and equitable tolling." Since, in the circuit's view, the text of the rules in question "yields no definitive answer," it examined the Code and §28 U.S.C. 157 on core proceedings to decide that the time limits are not jurisdictional. The Seventh Circuit followed the Second and Fourth Circuits, as well as the Ninth Circuit BAP,⁷ in holding that deadlines for objecting to discharge and dischargeability are affirmative defenses that are waived if not timely raised.

Kontrick's Supreme Court brief emphasizes the plain language of Rules 4004 and 4007 on exceptions to discharge under §523. Rules 4004 and 4007 are both listed in Rule 9006(b)(3), which allows a court to increase the time for filing under [the listed rules] "only [as] stated in those rules." Further, Kontrick relied heavily on Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), holding that Rule 4003's 30-day period for objecting to exemptions cannot be extended even if the debtor's claim is in bad faith, and on Carlisle v. United States, 517 U.S. 416 (1996), denying authority to consider a motion for acquittal filed just one day late due to attorney error. The Seventh Circuit said that Taylor did not hold "that the debtor had an unlimited time" to raise time bars, and that criminal appeals like Carlisle require greater finality than discharge matters.

The National Association of Consumer Bankruptcy Attorneys (NACBA), in its amicus brief, avoids characterizing the rules as jurisdictional. Instead, NACBA argues that the plain language of Rule 4004 provides that lack of a timely objection to discharge entitles the debtor forthwith to a discharge. NACBA emphasizes the importance of finality in the fresh start, as well as the burden on bankruptcy courts of late-filed complaints and consequent arguments for equitable extension of time limits.

Respondent Ryan denies that the time limits are jurisdictional, and emphasizes the long history of statutes of limitation as affirmative defenses, waived if not timely asserted. He also cites the Supreme Court's decision in Young v. United States,⁸ finding the three-year look-back for discharge of tax claims tolled by a prior chapter 13. The Court there said bankruptcy courts are courts of equity, and bankruptcy time limits may be extended by equitable defenses. The Executive Office of the U.S. Trustee filed an amicus brief supporting the creditor's arguments.

The moral of the story is this: File those complaints and raise those affirmative defenses on time. Don't let time play a Kontrick on your client.

Yates: May an Employer Shelter His Own Assets Under ERISA?

Another doctor-debtor on the docket is Tennessee physician Raymond Yates, sole shareholder of a professional corporation. Three weeks before an involuntary chapter 7 petition was filed against him, Yates repaid $50,000 borrowed years earlier from the corporation's profit-sharing plan. When Trustee William Hendon sought to recover the payment as a preference, Yates argued that the funds were excluded from the estate under Code §541(c)(2) by ERISA and Patterson v. Shumate.⁹ The trustee relied on Sixth Circuit precedent, holding that business owners, such as sole proprietors and sole shareholders, are not employees under ERISA10 and may not enforce its anti-alienation rules on their own behalf if they participate in employee benefit plans. The bankruptcy court granted summary judgment to the trustee allowing recovery of the payment. The district court¹¹ and the Sixth Circuit, bound by Sixth Circuit precedent, affirmed, and rehearing en banc was denied. The Supreme Court granted certiorari on the interpretation of ERISA.

Debtor Yates urged that working owners are eligible ERISA plan participants, provided the plan covers non-owner employees as well. The Sixth Circuit, he argued, misconstrues a regulation intended only to determine if a plan covers such non-owner employees as instead totally excluding owners from ERISA protection. That holding, he says, sets up an unworkable two-tiered system with regular employees protected by ERISA but limited by its preemption of state remedies, while owners can access state law remedies for their interests in the same plan.

The United States, as amicus, urges reversal. The solicitor general seconds Yates's interpretation of ERISA and Department of Labor (DOL) regulations. In addition, he points out that in 1998, more than 600,000 ERISA pension plans, covering millions of workers, included at least one working owner. Allowing owners to participate is a powerful incentive for them to offer pension and other benefit plans to their employees, an incentive undermined by the Sixth Circuit holding. Disability insurer UNUMProvident, another amicus urging reversal, emphasized congressional intent to regulate ERISA plans under uniform federal law, not inconsistent state law.

The Supreme Court briefs do not directly address bankruptcy, but affirmance would mean that small-business owners could exclude their interests in employee benefit plans from the estate only if and as state trust and exemption law allowed. Non-owner employees, on the other hand, could completely exclude their interests under ERISA's anti-alienation rules and Code §541(c)(2).

Galletti: What Must the IRS Do to Collect Partnership Taxes from Individual Partners?

That does it for doctors in debt, but we're not done with deadlines. United States v. Galletti¹² will determine what the IRS must do to collect partnership tax deficiencies from individual general partners. The debtors, two married couples, were general partners in a business that failed to pay federal employment taxes from 1992-95. The IRS timely assessed the taxes against the partnership, but did not individually assess or sue the general partners. Instead, when the partners filed chapter 13 cases in 1999 and 2000, the IRS just filed proofs of claim. The debtors objected that the claims should be disallowed as time-barred, and Bankruptcy Judge Ernest Robles agreed. Judge Virginia Phillips of the Central District of California affirmed,¹³ as did the Ninth Circuit, in an opinion by Judge Graber.

To collect tax deficiencies from a taxpayer, the IRS must either make an assessment or file suit against that taxpayer within three years after a return for the taxes was due. After a timely assessment, the IRS has 10 years to collect from the taxpayer.¹⁴ The Galletti partners filed chapter 13 petitions more than three years after the partnership taxes were due, but less than 10 years after assessment against the partnership. Before the Ninth Circuit, the IRS claimed that assessment of the partnership is enough to allow collection from individual partners.¹⁵ In the IRS's view, partners are not separate taxpayers from the partnership under the relevant statutes. The courts below all disagreed, holding that the individuals are taxpayers distinct from the partnership, and that the IRS's right to enforce their liability ended when the three-year period expired without assessment or civil suit against them. Since the three years expired before the debtors filed chapter 13, the tax claims were properly disallowed under Code §502(b)(1) as "unenforceable...under applicable law." Stay tuned to see if the IRS can persuade the Supreme Court to see it their way.

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Footnotes

¹ Kontrick v. Ryan (In re Kontrick), 295 F. 3d 724 (7th Cir. 2002), cert. granted, 123 S.Ct. 1899 (2003). Return to article

² Hendon v. Yates (In re Yates), 287 F. 3d 521 (6th Cir. 2002), cert. granted sub nom, Yates v. Hendon, 123 S.Ct. 2637 (2003). Return to article

³ United States v. Galletti, 314 F.3d 336 (9th Cir. 2002), cert. granted, 123 S.Ct. 2606 (2003). Return to article

⁴ See supra, note 1. Return to article

⁵ Morris, Jeff, "Recent Case Developments," 8, 2003 ABI Annual Spring Meeting. Return to article

⁶ 471 U.S. 84 (1985). Return to article

⁷ See European American Bank v. Benedict, 90 F.3d 50 (2d Cir. 1996); Farouki v. Emirates Bank Int'l. Ltd., 14 F.3d 244 (4th Cir. 1994); In re Santos, 112 B.R. 1001 (9th Cir. BAP 1990). See, also, Nardei v. Maughan (In re Maughan), ___ F.3d ___ (6th Cir. 8/14/03) (bankruptcy court may use equitable power to extend time for filing objection to discharge). Return to article

⁸ 503 U.S. 42 (2002). Return to article

⁹ 504 U.S. 753 (1992). Return to article

¹⁰ See, e.g., Agrawal v. Paul Revere Life Ins. Co., 205 F.3d 297 (6th Cir. 2000); Fugarino v. Hartford Life & Acc. Ins. Co., 969 F.2d 178 (6th Cir. 1992). Return to article

¹¹ Yates, supra note 2. The opinions of the bankruptcy and district courts are not reported. Return to article

¹² See note 3, supra. Return to article

¹³ In re Galletti, 2001 WL 752652 (C.D. Cal.). Return to article

¹⁴ 26 U.S.C. §§6203, 6501(a) and 6502(a). Return to article

¹⁵ The Supreme Court briefs in this case were not available online when this article was prepared. Return to article