Taxing authorities have the supreme advantage of having direct legislative support for the imposition of taxes and the enforcement of liens to secure taxpayer obligations. There is ample evidence of this in state statutory schemes, the Internal Revenue Code and even the Bankruptcy Code. Thus, it is not surprising that statutory tax liens are often automatic and broad.

A statutory tax lien may be a lien in solido. In other words, the lien may attach to all of a tax debtor's property within the taxing authority's jurisdiction, enabling a taxing authority to pick and choose which property to pursue. Under such circumstances, there is no incentive for the taxing authority to pursue a debtor's property subject to the lien on a pro rata basis, or to make any effort to calculate proportionate shares of a debtor's tax obligation arising from specific items of property. On the contrary, the most efficient course of action for a taxing authority may well be to pursue a single item of property within the scope of the lien of sufficient value to satisfy the tax obligation at once and in full. Assuming such an item of property exists, chances are it is also encumbered by prior perfected, but by operation of statute, inferior liens.

Thus, a scenario may arise in which a creditor obtains an interest in a valuable item of a tax debtor's property and takes all necessary steps to document, record and timely perfect an interest in such property, but nonetheless finds that the encumbered property is the target of a taxing authority's efforts to satisfy the tax debtor's tax obligations.

Section 545(2) of the Bankruptcy Code provides a limited mechanism for challenging statutory tax liens. Successful use of §545(2) may depend on a strict application of the requirement that a "bona fide purchaser" be able to prime the statutory lien in the relevant jurisdiction. See, e.g., In re Janssen, 213 B.R. 558 (8th Cir. B.A.P. 1997) (examining whether a §542(2) "bona fide purchaser" may avoid a federal tax lien).

Assuming that the status as a "bona fide purchaser" does not suffice to avoid a tax lien pursuant to §545(2), or if a party is for other reasons unable to avail itself of the lien avoidance provisions of the Bankruptcy Code, what remedies remain? Marshaling may offer a party in interest an avenue of approach to minimize or defeat the otherwise potentially significant consequences of an unavoidable tax lien.

Marshaling

Marshaling is an equitable doctrine that provides that a senior secured creditor with an interest in a debtor's property may not gain satisfaction against such property also encumbered by another secured creditor, if doing so would defeat the second secured creditor's recovery, and if other property is available to the first secured creditor to satisfy its claim. See Meyer v. United States, 375 U.S. 233, 236, 84 S. Ct. 318, 11 L.Ed.2d. 293 (1963). Case law has distilled the doctrine of marshaling to three essential elements: (1) two secured creditors with claims against a common debtor, (2) the existence of two properties belonging to the debtor and (3) the senior secured creditor, which has a right to either of the properties, and the junior secured creditor, which has rights against only one of the properties.¹ See, e.g., In re Riverwood La Place Associates LLC, 234 B.R. 256, 259 (Bankr. E.D.N.Y. 1999); see, also, In re Vermont Toy Works Inc., 135 B.R. 762, 767 (D. Vt. 1991) (stating that a proponent of marshaling must establish the elements by clear and convincing evidence).

Marshaling may not be applied if the senior secured creditor or other parties are unduly prejudiced. See In re Pray, 242 B.R. 205, 209-10 (Bankr. D. Mass. 1999). Because the doctrine is designed to protect junior secured creditors, the majority view is that unsecured creditors may not invoke marshaling. See In re Craner, 110 B.R. 111, 123 (Bankr. N.D.N.Y. 1988). However, a trustee provided with the status of a secured creditor by virtue of §544 of the Bankruptcy Code may move the court to apply marshaling for the benefit of a debtor's estate. See In re America's Hobby Center Inc., 223 B.R. 275, 287 (Bankr. S.D.N.Y. 1998). In In re Bame, 279 B.R. 833 (8th Cir. B.A.P. 2002), the chapter 7 trustee invoked the marshaling doctrine against taxing authorities to the substantial benefit of the estate's unsecured creditors.

In Bame, a debtor was faced with unavoidable tax liens from the Internal Revenue Service (IRS) and the Minnesota Department of Revenue. Approximately $1 million was available for distribution to the estate's creditors. The taxing authorities held claims totaling approximately $300,000. In addition to the taxing authorities' general and sweeping liens against the debtor's estate, the taxing authorities possessed liens, for the same tax obligations, against certain real property owned by the debtor's non-debtor spouse. The estimated value of the real property far exceeded the value of the taxing authorities' liens. The chapter 7 trustee commenced an adversary proceeding against the taxing authorities to compel marshaling to force the taxing authorities to attempt to first satisfy their liens against the non-debtor spouse's real property before receiving any distributions from the debtor's estate.

The taxing authorities argued that the application of marshaling simply should not be available against governmental agencies collecting revenue. Such a per se prohibition is the law in the Ninth Circuit, based in part on a concern for the "considerable burden on the revenue collection process." In re Decker, 199 B.R. 684, 688 (9th Cir. B.A.P. 1996) (quoting Kovaks v. United States, 355 F.2d 349, 351 (9th Cir.); cert. denied, 384 U.S. 941, 86 S.Ct. 1460, 16 L.Ed.2d 539 (1966)). The Bame court declined to follow the Ninth Circuit rule, and stated that "marshaling must be evaluated on a case-by-case basis, regardless of whether a taxing authority is involved." Bame, 279 B.R. at 838.

The taxing authorities next argued that they would be unacceptably prejudiced by having to proceed against the non-debtor spouse's real property, largely due to the potential costs and time delay attendant to any foreclosure process. The bankruptcy court had determined that because the taxing authorities were so vastly oversecured, these factors would not cause "undue harm" and did not overcome the benefit to the estate's unsecured creditors that would follow the proposed marshaling.² The court also noted that in the unlikely event that the taxing authorities would be unable to satisfy the tax obligations from the non-debtor spouse's real property, the taxing authorities would still have allowed claims against the debtor's estate. The Bankruptcy Appellate Panel (BAP) for the Eighth Circuit agreed, and upheld the application of marshaling to the claims of the taxing authorities.³

Some courts outside the Ninth Circuit have followed the absolute prohibition against the application of marshaling against taxing authorities, especially if the taxing authority is the United States. See, e.g., First of America Bank West Michigan v. Alt, 848 F.Supp. 1343, 1351 (W.D. Mich. 1993) ("there exists no ‘right of marshaling' against the United States") (quoting United States v. Eshelman, 663 F.Supp. 285 (D. Del. 1987)). Courts adopting a more deliberative approach tend to focus on the extent to which the senior secured creditor would be burdened by marshaling, and the potential prejudice marshaling would impose upon other parties.

Subrogation

Section 509 of the Bankruptcy Code provides: "Except as provided in subsection (b) or (c) of this section, an entity that is liable with the debtor on, or that has secured, a claim of a creditor against the debtor, and that pays such claim, is subrogated to the rights of such creditor to the extent of such payment." Subrogation has been characterized as an equitable doctrine, and "one of the benevolences of the law" designed to provide for the transfer of the rights of a first party to a second party who has paid the obligations of a third party to the first party. In re Zoglman, 78 B.R. 213, 214 (Bankr. W.D. Wis. 1987) (quoting 17 Am. Jur. 2d Subrogation, §§1 and 7 (1974)).⁴ A co-debtor, guarantor or similar third-party element must exist; a debtor may not invoke subrogation to gain for itself the priority status of a governmental entity for the obligations the debtor voluntarily pays. See In re McCready, 255 B.R. 834, 836 (Bankr. M.D. Tenn. 1999); In re Tygrett, 72 B.R. 129, 130 (C.D. Ill. 1987).

Although §509 of the Bankruptcy Code arises from equitable principles, some courts have stated that it remains a remedy distinct from nonstatutory equitable subrogation. Wetzler v. Cantor, 202 B.R. 573, 577-78 (D. Md. 1996); In re Spritos, 103 B.R. 240, 244 (Bankr. C.D. Cal. 1989) (stating that Bankruptcy Code subrogation is an additional non-exclusive remedy). Courts recognizing the distinction between statutory and equitable subrogation note that traditional equitable subrogation requires that the claim for which subrogation rights are asserted must be paid in full, whereas §509 permits partial subrogation for partial payment of such a claim.⁵ See, e.g., In re Northview Motors Inc., 202 B.R. 389, 401 (Bankr. W.D. Pa. 1996); 11 U.S.C. §509(a) (subrogee "subrogated to the rights of such creditor to the extent of such payment") (emphasis added).⁶ Both species of subrogation have been invoked by debtors and other parties in interest seeking to limit the consequences of unavoidable tax claims.

Section 509 of the Bankruptcy Code has been successfully utilized by parties who have satisfied a debtor's tax obligations to challenge the dischargeability of the debtor's tax obligations, as the taxing authority itself would have been able to do pursuant to §523(a) of the Bankruptcy Code. See In re Fields, 926 F.2d 501, 504 (5th Cir.), cert. denied, 502 U.S. 938, 112 S. Ct. 371, 116 L.Ed.2d 323 (1991); In re Alloway, 37 B.R. 420, 423 (Bankr. E.D. Pa. 1984) ("[One] who has paid the tax liability of another, subject to the limitations of §509(a), may be subrogated to the claim of the taxing authority and may thus seek an exception to discharge based upon that claim.").⁷

A pair of late Bankruptcy Act cases held that equitable subrogation may be invoked by parties who satisfy tax obligations owed to the United States. In In re Co-Build Companies Inc., 21 B.R 635 (Bankr. E.D. Pa. 1982), the bankruptcy court permitted an officer of a debtor corporation to assert the priority claim of the IRS against the debtor after the government had intercepted the officer's tax refund to satisfy the debtor's tax obligations. In In re Metropolitan Metals Inc., 50 B.R. 685 (Bankr. M.D. Pa. 1985), the IRS had instituted a levy against a debtor's accounts receivable from a third party who owed a substantial amount to the IRS. The trustee in the case requested that the bankruptcy court apply marshaling to compel the United States to pursue the non-debtor's property to attempt to satisfy the tax obligation before obtaining a distribution from the bankrupt debtor's estate. The court declined to order marshaling because the property at issue—the receivable—was not owned by a common debtor, as required for the application of equitable marshaling. In large part because of the prejudice to the estate's creditors that would result from the United States's acquisition of the receivable, the bankruptcy court concluded that the debtor, "as one who has been compelled to pay the debt of another," was entitled to step into the shoes of the IRS and exercise all rights and remedies the IRS had against the non-debtor third party primarily liable for the tax obligation. Id. at 698.⁸

Conclusion

The determination that a tax claim or lien is unavoidable does not necessarily mean that the negative consequences of such a claim or lien are entirely unavoidable. Two remedies based in equity, marshaling and subrogation may offer some relief to a party who is forced to satisfy tax obligations on behalf of another.

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Footnotes

¹ The right to marshal is a property right derived from state law. See, e.g., In re High Strength Steel Inc., 269 B.R. 560, 572 (Bankr. D. Del. 2001). Return to article

² The bankruptcy court's decision is reported in In re Bame, 271 B.R. 354 (Bankr. D. Minn. 2001). Return to article

³ Because there was technically no "common debtor," the Bame court based its decision, in part, on more equitable considerations as permitted by case law developed in the Eighth Circuit. In re Bame, 271 B.R. 354, 361-62 (Bankr. D. Minn. 2001). Some courts have dispensed with the "common debtor" requirement entirely in certain circumstances involving inequitable conduct or alter-ego theories. See In re Borges, 184 B.R. 874, 879 & n. 3 (Bankr. D. Conn. 1995) (citing cases). Return to article

⁴ Subrogation may not be available to those who pay the obligations of another as a "volunteer." See In re Fischer, 184 B.R. 41, 43 (Bankr. M.D. Tenn. 1995); cf. In re Zogleman, 78 B.R. 213, 215 (Bankr. W.D. Wis. 1987) ("Persons who have an interest of their own to protect by making payment are not volunteers."). Return to article

⁵ Note that §509(c) of the Bankruptcy Code provides that a subrogated claim is subordinated until the claimant is paid in full. Return to article

⁶ Other courts have examined the considerations of both statutory and equitable subrogation simultaneously in reaching a result. See, e.g., In re Zogleman, 78 B.R. 213, 214-15 (Bankr. W.D. Wis. 1987). Return to article

⁷ Note that §507(d) of the Bankruptcy Code limits the rights of subrogees to assert priority claims based on subrogation, but such limitation does not affect a party's right to utilize subrogation to object to the dischargeability of a debt. See In re Cooper, 83 B.R. 544, 547 (Bankr. C.D. Ill. 1988). Return to article

⁸ More recently, in In re White Trailer Corp., 266 B.R. 390 (Bankr. N.D. Ind. 2000), the trustee sought, pursuant to §510(c) of the Bankruptcy Code, to equitably subordinate the sales tax claims of the IRS because the IRS could have sought payment for such taxes against another entity and did not do so. The court declined to subordinate the claims of the IRS, but suggested that the debtor could have subrogated to the rights of the IRS had it paid the tax claims instead. Id. at 394. Return to article