VanDynHoven v. Bank of Kaukauna

Filing 9

DECISION AND ORDER RE BANKRUPTCY APPEAL, signed by Judge William C Griesbach on 05/10/2012. The decision of the Bankruptcy Court is reversed, and the case remanded for further proceedings consistent with this decision. See Decision and Order for full detail. (cc: all counsel)(Griesbach, William)

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF WISCONSIN
RICHARD W. VAN DYN HOVEN,
Appellant,
v.

Case No. 12-C-0076

BANK OF KAUKAUNA,
Appellee.

DECISION AND ORDER

This bankruptcy appeal raises the issue of whether that portion of the debt incurred by a
business over a seven-month period when its bank covered overdrafts for payment of payroll taxes
is excepted from the discharge of the owner of the business pursuant to 11 U.S.C. § 523(a)(14) and
(14A). The bankruptcy court held that it was and granted summary judgment in favor of the creditor
bank. For the reasons that follow, the Court disagrees and reverses the judgment of the bankruptcy
court.

FACTUAL AND PROCEDURAL BACKGROUND
Richard W. Van Dyn Hoven (Van Dyn Hoven) filed a petition for Chapter 7 bankruptcy on
May 18, 2010. One of his creditors, the Bank of Kaukana (“the Bank”), objected to discharge of
a portion of the debt owed by Van Dyn Hoven under a personal guarantee and instituted an
adversary proceeding. The parties stipulated to the following facts: Van Dyn Hoven was the sole
shareholder and in charge of the day-to-day operations of Action Electric, Electrical Contractors,

Inc. (Action Electric). Action Electric was a Wisconsin corporation engaged in business as an
electrical contractor. Action Electric had a business checking account and loans at the Bank since
2001, and Van Dyn Hoven guaranteed payment of Action Electric’s obligations to the bank,
pursuant to written continuing guarantee agreements. The Bank regularly covered Action Electric’s
checks and ACH drafts1 against its checking account, with Van Dyn Hoven’s knowledge and
consent. Between late 2006 and late 2007, Action’s loan classification slipped from “Satisfactory”
to “Watch,” and by October 2008, it had further slipped to “Substandard.”
By October 2008, Action Electric’s checking account was overdrawn by approximately
$254,000, and the overdrafts were rolled into one or more notes. Although Action Electric’s
checking account had a positive balance at the end of September 2009, the account showed a
negative balance beginning in October 2009 and never regained a positive balance thereafter.
Nevertheless, the Bank continued honoring some checks and ACH drafts (statements show many
were dishonored) in the overdrawn account. Van Dyn Hoven again was aware of the status of the
account and did not object to the Bank covering the checks.
Between October 7, 2009, and April 30, 2010, the Bank honored 45 ACH drafts directing
a total of $101,432.91 in payment to the IRS or the Wisconsin Department of Revenue. A list of
the payroll taxes paid through the account which the Bank contends are excepted from discharge
is included in the stipulated facts. (ECF No. 2 at 16.) During the same period, Action Electric
continued to operate and to generate revenue and accounts receivable. Deposits to the account over

1

Automated Clearing House (also referred to as ACH) is the network that processes
electronic financial transactions in the United States. ACH credit transactions include payments
to vendors or merchants made electronically or electronic check conversions where the merchant
scans a check and converts it to an ACH item.
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the same period of time totaled $460,858.91. Employee wages and other operating expenses were
also paid out of the account. By the time he filed for bankruptcy, Van Dyn Hoven owed the Bank
$885,000, $121,239.50 of which was attributed to overdrafts the Bank covered.
Based on these facts, the parties filed cross motions for summary judgment. In a
memorandum decision issued on November 3, 2011, the bankruptcy court concluded that the
$101,239.50 used to pay Action’s payroll taxes was not dischargeable and granted summary
judgment in favor of the Bank. It is from that decision that Van Dyn Hoven appeals.

LEGAL STANDARD
Federal district courts have jurisdiction to hear appeals of bankruptcy court orders under 28
U.S.C. § 158(a). A bankruptcy judge's “[f]actual findings are reviewed for clear error; [and] legal
conclusions are reviewed de novo.” In re Doctors Hosp. of Hyde Park, Inc., 474 F.3d 421, 426 (7th
Cir. 2007); accord In re Crosswhite, 148 F.3d 879, 881 (7th Cir. 1998); Meyer v. Rigdon, 36 F.3d
1375, 1378 (7th Cir. 1994). However, this is an appeal from a bankruptcy court’s decision granting
summary judgment. Granting a motion for summary judgment is a legal conclusion, meaning that
it is reviewed de novo. Monarch Air Service, Inc. v. Solow ( In re Midway Airlines, Inc.), 383 F.3d
663, 668 (7th Cir.2004). A district court will affirm a grant of summary judgment if there are no
genuine issues as to any material facts and if the moving party is entitled to judgment as a matter
of law. Id. (citing Fed. R. Civ. P. 56(c)). A district court can also affirm a summary judgment “on
any ground supported by the record, even if it was not relied upon by the court below.” Id. (citing
Johnson v. Gudmundsson, 35 F.3d 1104, 1115 (7th Cir. 1994)).

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ANALYSIS
Section 523(a)(14) and (14A) except from discharge of a debtor any debt incurred to pay a
tax to the United States or other governmental entity that would itself be nondischargeable to the
debtor. Congress enacted 11 U.S.C. § 523(a)(14) in 1994 to bar the dischargeability in bankruptcy
of ordinary loans “incurred to pay a tax to the United States that would be nondischargeable
pursuant to [§ 523(a)(1) ].” In re Francis, 226 B.R. 385, 396 (6th Cir. BAP 1998) (Lundin, J.,
dissenting); see also In re Barton, 321 B.R. 869, 875 (Bankr. N.D. Ohio 2004) (“This section was
added to the Bankruptcy Code through the Bankruptcy Reform Act of 1994, and was intended ‘to
impose a limitation on pre-bankruptcy substitution of a dischargeable obligation for a
nondischargeable obligation.’”) (quoting American Express Centurion Bank v. Gavin (In re Gavin),
248 B.R. 464, 465 (Bankr. M.D. Fla. 2000)). Once the IRS and other taxing authorities began
accepting credit card payments for taxes, it became a simple matter to substitute a dischargeable
debt (the charge on a credit card) for a nondischargeable claim (the pre-petition taxes). See The
Bankruptcy Amendments Act of 1993: Hearings on S. 540 Before the Subcomm. on Courts and
Admin. Prac. of the Comm. on the Judiciary, 103d Cong. 265 (statement of the American Bankers
Ass'n), 370–71 (statement of Mastercard Int'l Inc. and Visa U.S.A. Inc.) (March 31, 1993).
Subsection (14) of section 523(a) was added at least in part to address this problem. Subsection
(14A) was added in 2005 to extend the exception to include debt incurred to include taxes paid to
other taxing authorities as well. Pub. L. 109-8, § 314(a).

In this case, the Bank argued and the

Bankruptcy Court found that both exceptions applied to $101,239.50 of the debt Van Dyn Hoven
owed the Bank under his guarantee.

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Van Dyn Hoven argues that the Bankruptcy Court erred in denying his discharge for the
portion of his debt used to pay overdrafts for payroll taxes. Unlike the vast majority of cases in
which the exception has been applied, Van Dyn Hoven notes that the tax liability here at issue was
not paid with a personal credit card. More importantly, the tax liability paid by the Bank was that
of Action Electric, not Van Dyn Hoven, and because the taxes were timely paid, he could never
have been held liable for them. Given these facts, Van Dyn Hoven argues that the exceptions to
discharge do not apply.
Van Dyn Hoven’s argument rests largely on In re White, 455 B.R. 141 (Bankr. N.D Ind.
2011). In White, the debtor operated a business under the corporate name of New Era of
Educational Development, Inc. (“New Era”). DDC, the plaintiff creditor, paid New Era’s payroll
taxes to the IRS and the Illinois Department of Revenue under an Account Services Agreement.
When White later filed for Chapter 7, DDC claimed that the amount DDC paid for New Era’s
payroll taxes was excepted from discharge pursuant to 11 U.S.C. § 523(a)(14) and (14A). Based
on its analysis of the provisions of the tax code governing the liability of individuals involved in a
corporation for nonpayment of payroll taxes, the Bankruptcy Court rejected the plaintiff’s claims
and held that the debt would be discharged. In essence, the Bankruptcy Court noted that because
the payroll taxes were timely paid, the debtor cannot be said to have incurred debt to pay her tax
liability. Even if the taxes had not been timely paid, the court noted that it did not necessarily
follow that the debtor would have been personally liable for them. To impose personal liability on
the debtor for nonpayment of payroll taxes by the corporate employer, the IRS would have to show
not only that the payroll taxes were unpaid, but also that the debtor was a “responsible person” and
that she willfully failed to pay the taxes. 455 B.R. at 147. This led the bankruptcy court to observe
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that there was “many a drip between the cup and the lip before liability could be asserted against
an individual under 26 U.S.C. § 6672.” Id. (internal quotes omitted). In other words, the mere fact
that the payroll taxes were not paid did not mean that the business owner was personally liable.
Moreover, even if a responsible person is found liable, the liability is not for the unpaid taxes, the
court observed, but instead is in the form of a 100 % penalty intended as a kind of collection device.
Id. Thus, the most that could be said, according to the court, was that the debtor may have been
contingently liable individually for New Era’s payroll taxes had they not been paid. Given these
facts, the court concluded that DDC’s payments did not constitute a debt incurred to pay a federal
or state tax with respect to the debtor. The plaintiff’s request to except its payments from the
debtor’s discharge was therefore denied.
The bankruptcy court in this case found White “unpersuasive and contrary to the purpose of
the exceptions to discharge under 11 U.S.C. § 523(a)(14) and (14A).” (Mem. Dec. on Mot. for S.J.,
at 12.) Allowing a responsible person to avoid the exception by arranging for the business entity
to borrow the money to timely pay taxes, the court suggested, would circumvent the intent of the
exceptions by allowing the individuals responsible for payment to substitute dischargeable debt for
nondischargeable debt. Such a result is also inconsistent with the language of the code, the court
concluded. The court noted that the term debt in section 523(a) included contingent claims, and that
Van Dyn Hoven, as a responsible person, was at all times at least contingently liable for Action
Electric’s payroll taxes. See 11 U.S.C. § 101(5)(12). Likewise, the court noted, the contingent
guarantee of the Action Electric debt to the Bank made Van Dyn Hoven liable to the Bank for a
nondischargeable debt to the extent of taxes paid on his behalf.

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Instead of White, the bankruptcy court followed In re Cook, 416 B.R. 284 (Bankr. W.D. Va.
2009). In that case, the debtor used his American Express Card to pay certain payroll taxes and
penalties owed by his LLC. In response to American Express’ objection to his discharge of the
portion of his debt used to pay the payroll taxes, the debtor argued that the debt incurred in payment
for taxes did not fall within the exception set forth in section 523(a)(14) because the taxes paid were
a liability of his business and not his personal liability. The Cook court rejected this argument
noting that section 523(a)(14) excepts from discharge debt incurred for payment of taxes if the tax
would be nondischargeable under section 523(a)(1). One category of nondischargeable taxes under
section 523(a)(1), Cook noted, is specified in section 507(a)(8) of the Code, regardless of whether
a claim for the tax was filed or allowed. 11 U.S.C. § 527(a)(1)(A). Section 507(a)(8) includes taxes
which are “required to be collected or withheld and for which the debtor is liable in whatever
capacity.” 11 U.S.C. § 507(a)(8)(C). Since the debtor, as a responsible official, would have been
liable for nonpayment of payroll taxes in the form of a 100% penalty, the court concluded that the
exception from discharge set forth in section 523(a)(14) applied. “There is nothing in the
Bankruptcy Code,” the court held, “which requires that the IRS must have made an assessment
against the responsible official before the exception to the dischargeability is triggered.” Id., at 289.
I agree with Cook that the IRS need not make an assessment against the responsible official
before the section 523(a)(14) exception to discharge of debt used to pay a business’ payroll taxes
is triggered. But more is required than was shown here. There must be a showing of a willful
refusal to pay the withheld taxes on the part of the debtor. Otherwise, the debtor cannot be held
personally liable in any capacity for the unpaid payroll taxes. In Cook, the debtor had acknowledged
his responsibility for withholding and payment of taxes. Id., at 288. The liability he paid with his
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American Express Card was reflected in four tax payment notices that had been sent jointly to him
and his LLC. Id., at 286. Here, by contrast, Action Electric’s payroll taxes, like all of its expenses,
were paid in the normal course of business. Had the Bank refused to extend credit by honoring the
overdrafts, Van Dyn Hoven presumably would have ceased doing business at that point and used
whatever income the business had to pay its taxes. Instead, with the Bank continuing to honor his
overdrafts, he had no reason to suspect that he could be held personally liable for unpaid taxes.
Indeed, while the parties stipulated to the fact that “Van Dyn Hoven was aware of the status of the
account and did not object to the Bank’s covering Action Electric’s checks” (Stipulation of Facts,
¶ 10), there is no evidence that Van Dyn Hoven knew that his payroll taxes were being paid with
borrowed funds as opposed to the company earnings that were regularly deposited into the account.
It was only after he filed for Chapter 7 that the Bank claimed he had incurred debt to pay
undischargeable tax liability.
For the same reason, there is also no evidence that Van Dyn Hoven incurred the debt for the
purpose of paying taxes. To prevail on a claim under section 523(a)(14) or (14A), the creditor must
show that: (1) the debt was incurred to pay a tax to the United States; and (2) the tax owed to the
United States would have been nondischargeable under section 523(a)(1) if it had not been paid prepetition. In re Dinan, 425 B.R. 583, 586 (Bankr. D. Nev. 2010); In re Barton, 321 B.R. 877, 879
(Bankr. N.D. Ohio 2005). Statutory exceptions to discharge are strictly construed against the party
seeking the exception. In re Berman, 629 F.3d 761, 765 (7th Cir. 2011) (“Courts construe these
exceptions narrowly, in favor of the debtor, bearing in mind the goal of bankruptcy law to give the
debtor a fresh start.”). The petitioning party has the burden of proving the right to the exception by
a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279 (1991); Ojeda v. Goldberg, 599
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F.3d 712, 716 (7th Cir. 2010) (“A bankruptcy court applies a preponderance of the evidence
standard when making dischargeability determinations under § 523(a).”).
The phrase “incurred to pay a tax” as used in section 523(a)(14) and (14A) means that the
debt was incurred “for the purpose of paying Federal or state taxes.” In re Stephenson, Bankruptcy
No. 07-10778-SSM, 2007 WL 4268904, *2 (Bankr. E.D. Va. Nov. 30, 2007) (unpublished
decision). Otherwise, the exceptions would become open invitations to trace the use of all funds
loaned to a business, regardless of when, with a hope of tying them to payment of some sort of tax
liability. Here, for example, Action Electric paid its taxes in the ordinary course of business. The
taxes were paid from the same account as payroll and other operating expenses. There is no
showing that Van Dyn Hoven or any other employee of Action Electric ever applied for a loan to
pay the company’s tax liabilities. The fact that the Bank continued to honor overdrafts had the
effect of extending a line of credit to Action Electric which Action used to remain in business. In
fact, previous overdrafts were rolled into a series of notes to the Bank. (Stipulated Facts, ¶¶ 7,8.)
Under the Bank’s interpretation of the exceptions, any portion of the previous debt rolled into the
notes that it could trace to tax payments would also be excepted from discharge. This is far beyond
what the exceptions to discharge in section 523(a)(14) and (14A) were intended to accomplish.
It is also unfair to the debtor. Section 523(a)(14) and (14A) were added in order to prevent
individuals who failed to pay their taxes from obtaining a discharge from liability for such debt by
using unwitting creditors to substitute ordinary debt for nondischargeable tax liability. The Bank
has offered no evidence that Van Dyn Hoven did that here. Not only is there no evidence that Van
Dyn Hoven incurred debt for the purpose of paying taxes, but there is also no evidence that the Bank
acted unwittingly in continuing to extend credit. Instead, the evidence suggests that the Bank was
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fully aware of Action Electric’s financial circumstances. The Bank monitored Action Electric’s
checking account, apparently even deciding which overdrafts it would pay and which it would not.
This is a far cry from Cook where the responsible person used a presumably personal credit card to
pay the withholding taxes for his business three months before he and his wife file for a Chapter 7
bankruptcy.
The other cases cited by the Bankruptcy Court are similarly distinguishable. In re Francis
involved the issue of a novation upon two individuals and does not apply except to point out that
if the consideration fails, the release is voided. 226 B.R. 385, 396 (B.A.P. 6th Cir. 1998). In re
Gavin involved a debtor with direct liability who borrowed money from American Express on an
access check to pay his income taxes. 248 B.R. 464, 465 (Bankr. M.D. Fla. 2000). The debt in all
of these cases was not contingent but rather was direct and instant. Additionally, the debtors in all
of these cases borrowed money in their own names, whereas here Action Electric was named on the
account. In Re Dinan, also relied upon by the Bankruptcy Court, is another example of a debtor
directly owing taxes and borrowing money to pay for them. 425 B.R. 584 (Bankr. D. NV 2010).
In all of these cases, the debtor was aware of the direct tax liability to the taxing authority
which was immediately due and owing, and the debtor intentionally borrowed money in his own
name for the purpose of paying taxes that were otherwise nondischargeable. Not so here, where the
Bank extended credit to Action Electric — not Van Dyn Hoven himself — for a variety of
legitimate business purposes, including but not limited to the payroll taxes.
For all of these reasons, I conclude the Bankruptcy Court erred in granting summary
judgment in favor of the Bank excepting from Van Dyn Hoven’s discharge the sum of $101,432.98.

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The decision of the Bankruptcy Court is accordingly reversed, and the case remanded for further
proceedings consistent with this decision.
SO ORDERED this

10th

day of May, 2012.
s/ William C. Griesbach
William C. Griesbach
United States District Judge

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