Update From The State Bar Business Law Section's Insolvency Law Co=
Posted: Wed Nov 05, 2014 11:23 am
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To: Bus. Law Insolvency Constituency List
Sent: Wed, Nov 5, 2014 9:11 am
Subject: Update From The State Bar Business Law Section's Insolvency Law Committee - William M. Hawkins, KKK v The Franchise Tax Boad of CA, USA, IRS
November 5, 2014
Insolvency Law Committee
Insolvency Law e-Bulletin
BUSINESS LAW SECTION
STATE BAR OF CALIFORNIA
Insolvency Law Committee
Co-Chair
Uzzi Raanan
Danning Gill Diamond & Kollitz LLP
Co-Chair
Diana Herman
McKenna Long & Aldridge LLP
Co-Vice Chair
Monique Jewett-Brewster
Bryan Cave LLP
Co-Vice Chair
Van Durrer
Skadden, Arps, Slate, Meagher & Flom LLP
Business Law Section Coordinator
John Buelter
415-538-2341
Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:
Summary:
On September 15, 2014, the United States Court of Appeals for the Ninth Circuit (the Ninth Circuit) issued its decision inWilliam M. Hawkins, III, aka Trip Hawkins, Appellant, v. The Franchise Tax Board Of California; United States Of America, Internal Revenue Service, Appellees, BKCase No. 11-16276, D.C. No. 3:10-cv-02026-JSW. In a well-reasoned published opinion, the Ninth Circuit reversed the lower court ruling denying the discharge of taxes under Bankruptcy Code Section 523(a)(1)(C) because there was no finding that the taxpayer had acted with the specific intent to nkruptcy court and the District Court that affirmed, the Ninth Circuit held that proof that a taxpayer spent more than his income but did not pay known taxes was not sufficient to prove the requisite intent to except the tax from discharge. The Ninth Circuits opinion can be read by clicking HERE:[http://cdn.ca9.uscourts.gov/datastore/o ... -16276.pdf].
Facts:
The debtor in this case, William H. Hawkins (better known as Tripof the Silicon Valleys most successful computer-games companies. In the mid 90s, Hawkins began to sell off his EA stock to fund a second company, 3DO. Around that time, Hawkinss tax advisors at KPMG advised him to invest in two complex off-shore investments designed to create large losses to offset capital gains. 3DO was not a success and ultimately filed bankruptcy. In 2001, the IRS began investigating the KPMG transactions and started an audit of Hawkins taxes. In 2005, the IRS and the Franchise Tax Board, together, assessed $36 million in taxes, penalties and interest. The Hawkinses were unable to pay the tax debt.Mr. and Mrs. Hawkins filed bankruptcy under Chapter 11 in 2006, and negotiated a plan of reorganization with the IRS and the FTB that was confirmed without objection. Including a distribution of $3.4 million through the plan, the taxing authorities together received over $19 million. The Hawkinses received a discharge through the plan under Bankruptcy Code section 1141(d), but the taxing authorities did not waive their right to assert that the remaining taxes (which had continued to increase with interest) were excepted from discharge.
After confirmation, the Hawkinses therefore sued the IRS and FTB to determine the dischargeability of the remaining taxes. The bankruptcy court discounted or entirely rejected all of the taxing authorities claims other than that Hawkinses had continued to live in a luxuriousadditional taxes. The bankruptcy court held that paying expenses in excess of income while not paying known taxes amounted to a willful attempt to evade or defeat the tax under Bankruptcy Code Section 523(a)(1)(C) and, thus, that the remaining unpaid taxes had not been discharged. The District Court affirmed, holding expressly that specific intent to evade or defeat the tax was not needed for this section to apply.
The Ninth Circuits Analysis:
The Ninth Circuit rejected the standard stated in the bankruptcy court opinion that was reiterated in the District Courts affirming opinion, as well as the cases from other circuits on which they relied. These cases generally state that taxes can be excepted from discharge under Section 523(a)(1)(C) even where no particular action is taken with the intent to evade or defeat the tax. The Ninth Circuit found that the analysis of the section turns on the meaning of willful, and whether it means simply a willful act (choosing not to pay a tax), or whether it requires some showing of deception or dishonesty.
Acknowledging that the word willful can have different meanings depending on the context, the Ninth Circuit first looked to the structure of the statute and the policies of the Bankruptcy Court as a whole. The Ninth Circuit noted that within Section 523(a) there are three sections describing taxes to be excepted from discharge: Section 523(a)(1)(A) for taxes incurred within particular time periods, Section 523(a)(1)(B) for taxes for which no return was filed, and Section 523(a)(1)(C) for taxes ttempted in any manner to evade or defeat such tax. The Ninth Circuit found that, while the first two categories impose liability where intent is not considered, the last section does not. Rather, it found that, because the statute groups willfully . . . evade or defeat such taxe filing of a fraudulent return clearly requires showing specific intent, proving a debtor willfully attempted to evade a tax must also require showing such intent. The Ninth Circuit also considered the identical language in Section 7201 of the Internal Revenue Code, which describes felonious action and clearly requires specific intent, as well as considering the general policy in bankruptcy law of reading exceptions to discharge narrowly.
Having established that in order to except taxes under this section a court must find that the debtor took action with the specific intent to evade or defeat the taxes, the Ninth Circuit determined that the lower court had not made such a finding in the Hawkins case. The Ninth Circuit reversed and remanded to the District Court for further determination and application of the proper standard applicable to actions to deny discharge under Bankruptcy Code section 523(a)(1)(C).
Authors Commentary:
The Ninth Circuit has put a halt, at least in this circuit, to decisions suggesting that taxes can be excepted from discharge solely on finding that taxpayers have spent more than they earned. The Ninth Circuit correctly observed that with such a rule, there would be few personal bankruptcies in which taxes would be dischargeable. The Ninth Circuit noted that, although statements in cases from other Circuit Courts had suggested that no intent to evade or defeat a tax need be shown under this section, none of the cases actually denied a tax discharge without such a finding, as had the opinions of the courts below.
There is an argument that maintaining spending at levels consistent with prior lifestyle may now be defensible in the Ninth Circuit, particularly when a substantial effort is made to pay the taxes owed. However, a debtorayers and the practitioners who counsel them are well advised to tread carefully as the law in this area continues to develop.
Procedural Update:
On October 29, 2014, the United States filed a Petition for RehearingEn Banc.
This e-Bulletin was written by Corey Weber of Ezra Brutzkus Gubner LLP, Co-Vice Chair of the Insolvency Law Committee.
Thank you for your continued support of the Committee.
Best regards,
Insolvency Law Committee
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