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Internal Revenue Service v. Murphy

United States District Court, D. Maine

September 7, 2016

INTERNAL REVENUE SERVICE, Appellant
v.
WILLIAM CHARLES MURPHY, Appellee Bankr. No. 05-22363 Bankr. Adv. No. 11-2020

          DECISION AND ORDER ON BANKRUPTCY APPEAL

          D. Brock Hornby, United States District Judge.

         This bankruptcy appeal presents two primary questions: (1) how to interpret the term "willfully" in a federal statute; (2) whether a lawyer's unrecognized cognitive impairment that comes to light only later can be used to upset an interlocutory ruling that may have resulted from the lawyer's inadequate representation during the cognitive impairment.

         The appellant Internal Revenue Service ("IRS")[1] argues that it should not be held liable for damages to a debtor-taxpayer under an Internal Revenue Code provision that allows a taxpayer to recover damages if the IRS "willfully violates" a bankruptcy court's discharge injunction under section 524 of the Bankruptcy Code. The IRS challenges the bankruptcy court's definition of "willfully" and the bankruptcy court's decision to use offensive collateral estoppel to establish the IRS violation. The IRS argues that the predicate judgment against the IRS confirming that the bankruptcy discharge wiped out the tax debts (thus generating the estoppel) resulted from an Assistant United States Attorney's (AUSA) then unknown cognitive impairment.

         After oral argument on August 22, 2016, I conclude that the bankruptcy court applied the proper definition of "willfully, " but that it acted contrary to law and abused its discretion in failing to consider the IRS's two motions for reconsideration under the interests-of-justice test that Federal Rule of Civil Procedure 54(b) requires.[2]

         Facts and Procedural Background

         The debtor-taxpayer William C. Murphy ("Murphy") filed for Chapter 7 bankruptcy protection in October 2005. Voluntary Pet., In re Murphy, Ch. 7 Case No. 05-22363 (Oct. 13, 2005) (Bankr. ECF No. 1). The majority of the debts Murphy listed on his Petition were for outstanding federal income taxes for various years. Id. at 11-14. The bankruptcy court granted his discharge on February 14, 2006. Order Discharging Debtor, In re Murphy, Ch. 7 Case No. 05-22363 (Feb. 14, 2006) (Bankr. ECF No. 5).

         Thereafter, the IRS informed Murphy that it considered his tax liabilities excepted from the 2006 discharge on the basis that Murphy had filed fraudulent returns or attempted to evade taxes. See 11 U.S.C.A. § 523(a)(1)(C). The IRS issued notices of levies to Murphy's bank and various clients.[3] See Debtor's Statement of Material Facts at 2-3, Murphy v. I.R.S., Adv. No. 09-2042 (May 4, 2010) (Bankr. ECF No. 41-1); Obj. and Resp. by IRS at 9-10, Murphy v. I.R.S., Adv. No. 09-2042 (May 25, 2010) (Bankr. ECF No. 44).

         In August 2009, Murphy reopened his bankruptcy case and began the first adversary proceeding in bankruptcy court seeking a declaration that his 2006 discharge covered taxes owing for 1993-1998, 2000, and 2001; challenging the IRS's attempts to collect taxes for the years covered by his bankruptcy discharge; and asking that the IRS be enjoined from all collection activities concerning the discharged tax liabilities. Compl., Murphy v. I.R.S.. Adv. No. 09-2042 (Aug. 14, 2009) (Bankr. ECF No. 1). Because the AUSA who handled bankruptcy proceedings in this District accepted service of the Complaint, Murphy's counsel did not mail a copy of the Complaint to the Attorney General, as Federal Rule of Bankruptcy Procedure 7004(b)(5) would otherwise require. Therefore, the Tax Division of the Department of Justice and the Boston IRS Office of Chief Counsel were unaware of the adversary proceeding until long after an adverse judgment.[4]U.S. Renewed Mot. to Recons. Order Granting Partial Summ. J. at 8-9, Murphy v. I.R.S., Adv. No. 11-2020 (Nov. 16, 2015) (Bankr. ECF No. 265).

         In this first adversary proceeding, Murphy bore the burden of proving that a bankruptcy discharge issued, but the IRS bore the burden of proving that Murphy's tax obligations were excepted from the 2006 discharge under Bankruptcy Code section 523 and therefore that the 2006 discharge did not prevent IRS collection efforts. See Pretrial Order at 6, Murphy v. I.R.S., Adv. No. 09-2042 (Oct. 20, 2009) (Bankr. ECF No. 19).

         Murphy moved for summary judgment in this adversary proceeding on May 4, 2010, seeking a final determination that his 2006 discharge embraced his tax debts. PL's Mot. for Summ. J. at 5, Murphy v. I.R.S., Adv. No. 09-2042 (May 4, 2010) (Bankr. ECF No. 41). The AUSA who had been handling bankruptcy proceedings in this District on behalf of the government for many years took only limited discovery to support the IRS's position; he served requests for production of documents but did not take Murphy's deposition. See Notice of Service of Disc, Murphy v. I.R.S., Adv. No. 09-2042 (Dec. 3, 2009) (Bankr. ECF No. 26). In opposing the motion on May 25, 2010, the AUSA failed to present evidence that would raise a triable issue of fact as to whether Murphy's tax liabilities were excepted-an opposition that presiding Bankruptcy Judge Haines described as falling "far short of applicable substantive and procedural standards" under Federal Rule of Civil Procedure 56.[5] Order Granting Summ. J. at 5, Murphy v. I.R.S., Adv. No. 11-2020 (Dec. 20, 2013) (Bankr. ECF No. 94). In June 2010, Judge Haines granted Murphy's motion for summary judgment from the bench, stating:

I've looked at the summary judgment record very carefully and frankly, somewhat surprisingly, I'm not-I'm not of the view that the IRS has put forth qualified, evidentiary-quality, by affidavit or otherwise, materials that create disputed issues of material fact. And therefore I'm going to enter summary judgment for the plaintiff.

         Tr. of Bench Ruling at 4-5, Murphy v. I.R.S., Adv. No. 09-2042 (June 22, 2010)[6](Bankr. ECF No. 99).

         In his ensuing order, Judge Haines declared Murphy's tax obligations for the years 1993-1998, 2000, and 2001 discharged by the 2006 bankruptcy discharge. Order Granting Mot. for Summ. J., Murphy v. I.R.S., Adv. No. 09-2042 (June 22, 2010) (Bankr. ECF No. 48). The IRS did not appeal.

         In February 2011, Murphy filed a second adversary Complaint against the IRS under Internal Revenue Code section 7433(e), which permits a taxpayer to recover damages if the IRS "willfully violates" a bankruptcy discharge under section 524 of the Bankruptcy Code.[7] Compl., Murphy v. I.R.S., Adv. No. 11-2020 (Feb. 28, 2011) (Bankr. ECF No. 1); see 26 U.S.C.A. § 7433(e). Murphy alleged that the IRS was liable under section 7433(e) of the Internal Revenue Code because the IRS had violated Bankruptcy Code section 524 by levying on his discharged tax liabilities. Compl., Murphy v. I.R.S., Adv. No. 11-2020 (Feb. 28, 2011) (Bankr. ECF No. 1). The period for discovery in the second adversary proceeding expired without the AUSA taking any discovery. U.S. Request for a Status or Pretrial Conference in Chambers at 1, 3, Murphy v. I.R.S., Adv. No. 11-2020 (Dec. 11, 2012) (Bankr. ECF No. 52).

         In 2012, the AUSA who had been handling this and other bankruptcy matters in this District stated his intention to retire by year's end. See Id. at 1. Around the same time, colleagues of the AUSA stated concerns about his physical demeanor and possible health problems. See R. Murphy Decl. at 2, Murphy v. I.R.S., Adv. No. 11-2020 (Feb. 28, 2014) (Bankr. ECF No. 142-1) (sealed document). In October 2012, the United States Attorney's Office disclosed to the Department of Justice's Tax Division that the AUSA had been potentially diagnosed with amyotrophic lateral sclerosis (ALS) and dementia. Id. at 6. Thereafter, the Tax Division informed the bankruptcy court that the AUSA was no longer assigned to Murphy's case due "to his imminent retirement and for personal reasons" and that the Tax Division would take over the defense of the second adversary proceeding. U.S. Request for a Status or Pretrial Conference in Chambers at 1, Murphy v. I.R.S., Adv. No. 11-2020 (Dec. 11, 2012) (Bankr. ECF No. 52). In this same filing, Tax Division counsel said that the IRS planned to file a motion to reopen discovery on damages in the second adversary proceeding based on excusable neglect under Bankruptcy Rule 9006 and/or good cause under Federal Rule of Civil Procedure 16(b)(4). Id. at 3.

         At that time, the parties agreed that the IRS would defer moving to reopen discovery pending cross motions for summary judgment on liability. See Parties' Am. Joint Pretrial Order at 5-6, Murphy v. I.R.S., Adv. No. 11-2020 (Mar. 27, 2013) (Bankr. ECF No. 63). The principal argument that the IRS made in its motion for summary judgment was that the IRS should be able to escape liability under section 7433(e) for "willfully violating]" the discharge injunction because it relied on a good faith belief that the statutory discharge injunction was inapplicable to the tax debts at issue. Br. in Support of Mot. for Summ. J. at 1-19, Murphy v. I.R.S., Adv. No. 11-2020 (May 1, 2013) (Bankr. ECF No. 69). Murphy argued, in turn, that the IRS "willfully violate[d]" the discharge injunction under section 7433(e) because the tax debt was discharged, the IRS had notice of the discharge, and the IRS intended the acts that violated the discharge injunction. Murphy Opp'n to Summ. J. & Cross-Motion for Summ. J. at 4-8, Murphy v. I.R.S., Adv. No. 11-2020 (June 28, 2013) (Bankr. ECF No. 80).

         On December 20, 2013, Bankruptcy Judge Haines granted partial summary judgment on liability to taxpayer Murphy in the second adversary proceeding. Order Granting Summ. J., Murphy v. I.R.S., Adv. No. 11-2020 (Dec. 20, 2013) (Bankr. ECF Nos. 94-95). Using the doctrine of offensive collateral estoppel, Judge Haines ruled that the preclusive effect of the June 2010 summary judgment order in the first adversary proceeding (determining that Murphy's tax debt was discharged) estopped the IRS from asserting that Murphy's tax debt was excepted from discharge for the purpose of escaping liability under 26 U.S.C.A. § 7433(e). Id. As a result, liability (not damages) was established. Id. At the time Judge Haines issued his ruling, he knew of the by-then-retired AUSA's impairment (it was brought to his attention in a 2013 status conference), but nothing in the record suggested that the AUSA's impairment had affected his competency during the first adversary proceeding in 2010. Although the IRS sought an interlocutory appeal from the partial summary judgment, I denied the request, Murphy v. I.R.S., No. 2:14-mc-24-DBH, ___ B.R. ___, 2014 WL 840255 (D. Me. Mar. 4, 2014), ruling that the appeal should await final judgment after a determination of damages.

         Thereafter, the IRS acquired the AUSA's medical records and learned that he had in fact been diagnosed with frontotemporal dementia in late 2011, coupled with ALS, and that three physicians all agreed that the AUSA's condition predated the May 2010 summary judgment proceedings in the first adversary proceeding. See U.S. Mot. to Revise Interlocutory Order Granting Partial Summ. J. on Issue of Liability at 6-10, Murphy v. I.R.S., Adv. No. 11-2020 (Apr. 11, 2014) (Bankr. ECF No. 155); Mem. in Support of Def.'s Mot. to Reopen Damages Disc, at 6-9, Murphy v. I.R.S., Adv. No. 11-2020 (Feb. 7, 2014) (Bankr. ECF No. 132) (sealed document); Exs. Medical R., Murphy v. I.R.S., Adv. No. 11-2020 (Apr. 1, 2014) (Bankr. ECF No. 152-2) (sealed documents). The IRS then filed three motions seeking relief.

         In the first adversary proceeding, the IRS moved the bankruptcy court under Federal Rule of Civil Procedure 60(b)(6) and 60(b)(4)[8] to vacate its 2010 final discharge order. Def.'s Rule 60(b) Mot. for Relief from the Final Order of June 22, 2010, Murphy v. I.R.S., Adv. No. 09-2042 (May 1, 2014) (Bankr. ECF No. 52). Judge Haines having retired, Bankruptcy Judge Kornreich denied the motion in June 2014, [9] see Order on Def.'s Rule 60(b) Mot. for Relief from Final Order, Murphy v. I.R.S., Adv. No. 09-2042 (June 26, 2014) (Bankr. ECF No. 78). The IRS appealed to this court, and I affirmed the bankruptcy court's denial of Rule 60(b) relief on February 24, 2015. See I.R.S. v. Murphy, No. 2:14-cv-340-DBH, ___ B.R. ___, 2015 WL 790075 (D. Me. Feb. 24, 2015).[10]

         The IRS also filed two motions in the second adversary proceeding: (1) the IRS moved to reopen discovery on damages based on its contention of excusable neglect and/or good cause because of the former AUSA's cognitive impairment during the second adversary proceeding, Def.'s Mot. to Reopen Damages Disc, Murphy v. I.R.S., Adv. No. 11-2020 (Jan. 27, 2014) (Bankr. ECF No. 114); and (2) the IRS moved to reconsider or revise the interlocutory order granting summary judgment on the issue of liability, U.S. Mot. to Revise Interlocutory Order Granting Partial Summ. J. on Issue of Liability, Murphy v. I.R.S., Adv. No. 11-2020 (Apr. 11, 2014) (Bankr. ECF No. 155). Again, Judge Haines having retired, Judge Kornreich denied both motions from the bench on May 8, 2014. Tr. of Bench Ruling at 8, 10, Murphy v. I.R.S., Adv. No. 09-2042 (May 8, 2014) (Bankr. ECF No. 65)[11]; see Order on Def.'s Mot. to Revise Interlocutory Order, Murphy v. I.R.S., Adv. No. 11-2020 (May 13, 2014) (Bankr. ECF No. 165); Order on Def.'s Mot. to Reopen Damages Disc, Murphy v. I.R.S., Adv. No. 11-2020 (May 13, 2014) (Bankr. ECF No. 166).

         With regard to the IRS's Rule 54(b)[12] motion to reconsider or revise Judge Haines's interlocutory order granting partial summary judgment on liability, Judge Kornreich stated that he was "uncertain as to the applicability of that rule, " did not apply it, and instead applied Federal Rule of Civil Procedure 60(b)[13]-which is applicable only to final judgments. Tr. of Bench Ruling at 9, Murphy v. I.R.S., Adv. No. 09-2042 (May 8, 2014) (Bankr. ECF No. 65). In applying Rule 60(b), Judge Kornreich denied the IRS's motion to reconsider, stating:

My denial of the motion has two prongs. First, that the disability was not the problem; that if there was a failure to adequately prosecute-that was attributable to a failure to supervise and as I have been told by the United States Attorney, supervision is not part of the game plan.[14] Second, I have reviewed the written decision and have determined, according to my own likes, that there was no error of law which would permit me as a trial judge of this court to set aside or reconsider the decision of [Judge Haines].

Id. at 9-10 (footnote added by this court).

         Thereafter, the parties entered into and submitted to the bankruptcy court a stipulation as to damages, with certain rights reserved, whereby they stipulated to $225, 000 in damages caused by the IRS's levies after the discharge. Settlement Agreement as to Damages (with Certain Rights Reserved), Murphy v. I.R.S., Adv. No. 11-2020 (Oct. 2, 2015) (Bankr. ECF No. 259-2). The parties also agreed that the damages were contingent upon the IRS being able to file a renewed motion to reconsider in the bankruptcy court and to appeal any final judgment including the liability decision of December 20, 2013, and the denials of any motions to reconsider that determination. Id. at 1-3, 5; see U.S. Renewed Mot. to Recons. Order Granting Partial Summ. J. on Issue of Liability, Murphy v. I.R.S., Adv. No. 11-2020 (Nov. 16, 2015) (Bankr. ECF No. 265).

         On December 14, 2015, Judge Kornreich also having retired and the two successor bankruptcy judges in this District being recused, Bankruptcy Judge Hoffman of the District of Massachusetts denied the renewed motion to reconsider the liability decision, determining on the willfulness issue that "[i]t is settled law in the First Circuit that damages are available for violation of the discharge injunction if a creditor had knowledge of the discharge and intended the actions which constituted the violation." Mem. & Order on Renewed Mot. of U.S. to Recons. at 3-4, Murphy v. I.R.S., Adv. No. 11-2020 (Dec. 14, 2015) (Bankr. ECF No. 266) (citing Pratt v. GMAC, 462 F.3d 14, 21 (1st Cir. 2006); Fleet Mortg. Grp., Inc. v. Kaneb, 196 F.3d 265, 268 (1st Cir. 1999)). As to the IRS's objection to the use of offensive collateral estoppel to determine liability, Judge Hoffman stated: "Applying the IRS's motion to the flexible standards of Fed.R.Bankr.P. 7054 [incorporating Federal Rule of Civil Procedure 54(b)], I find no basis to reconsider Judge Haines'[s] partial summary judgment ruling [on liability]." Id. at 5 (footnote omitted).[15]

         In accordance with the settlement agreement, final judgment entered in favor of Murphy in the amount of $225, 000 on December 23, 2015. Final Judgment, Murphy v. I.R.S., Adv. No. 11-2020 (Dec. 23, 2015) (Bankr. ECF No. 268). This timely appeal followed.

         Jurisdiction

         The district court has jurisdiction over Murphy's Chapter 7 case under 28 U.S.C.A. § 1334. The bankruptcy court had jurisdiction by reference from this court under 28 U.S.C.A. § 157. See Local Rule 83.6. If the adversary proceeding seeking damages was a core bankruptcy proceeding (I conclude that it was, see infra), the reference was under section 157(b). If the adversary proceeding was a noncore bankruptcy proceeding, the reference was under section 157(c)(1). Because the IRS elected to have this appeal from the bankruptcy court heard by the District Court instead of the Bankruptcy Appellate Panel, this court now has jurisdiction under 28 U.S.C.A. § 158(a)(1), (c)(1)(A).

         Standard of Review

         In core proceedings, conclusions of law reached by the bankruptcy court are subject to de novo review, and underlying factual findings are reviewed only for clear error. Monarch Life Ins. Co. v. Ropes & Gray, 65 F.3d 973, 978 (1st Cir. 1995). Discretionary decisions are reviewed for abuse of discretion. In re Gonic Realty Tr., 909 F.2d 624, 626 (1st Cir. 1990). In noncore proceedings the bankruptcy judge's findings of fact, conclusions of law, and discretionary decisions are reviewed de novo. See 28 U.S.C.A. § 157(c)(1); In re Sheridan, 362 F.3d 96, 99-100 (1st Cir. 2004).

         Analysis

         The IRS has raised two issues on appeal: (1) what kind of intent determines whether an IRS employee "willfully violates" the bankruptcy discharge injunction under section 7433(e); and (2) in refusing to reconsider or revise its order determining that the IRS was liable under section 7433(e) based upon offensive collateral estoppel, did the bankruptcy court improperly apply Federal Rule of Civil Procedure 54(b) when presented with evidence of the AUSA's previously unknown cognitive impairment.

         A. The Section 7433(e) Standard for When an Employee of the IRS "Willfully Violates" the Discharge Injunction

         Internal Revenue Code section 7433(e)[16] provides:

If, in connection with any collection of Federal tax with respect to a taxpayer, any officer or employee of the Internal Revenue Service willfully violates any provision of section 362 (relating to automatic stay) or 524 (relating to effect of discharge) of Title 11, United States Code (or any successor provision), or any regulation promulgated under such provision, such taxpayer may petition the bankruptcy court to recover damages against the United States.

         The IRS Restructuring and Reform Act of 1998 added subsection (e) as part of a significant bipartisan effort to address "abuses inflicted on taxpayers by unsupportable activity within the IRS" after a series of investigative hearings examining both the internal and public conduct of the agency. 144 Cong. Rec. S4251-01 (daily ed. May 5, 1998); S. Rep. No. 105-174, at 7-9 (1998); Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685 (1998). The Act added new "taxpayer protection and rights, " including the ability to collect civil damages if an IRS employee "willfully violates" sections 362 or 524 of the Bankruptcy Code, Pub. L. No. 105-206, § 3102(c), and expanded taxpayers' rights to collect damages for an IRS employee's reckless, intentional, or negligent disregard of any provision of the Internal Revenue Code, id. § 3102(a).[17] Although the legislative history of the entire Act is voluminous, it does not explain why Congress used "reckless, intentional, or negligent" in one subsection (7433(a) remedy for violations of the Internal Revenue Code), and used "willfully violates" in a different subsection (7433(e) remedy for violations of sections 362 and 524 of the Bankruptcy Code). It is a general principle, however, that Congress "legislated against a background of law already in place and the historical development of that law." Exxon Mobile Corp. v. Allapattah Servs., Inc., 545 U.S. 546, 587 (2005). I therefore address the interpretations of those terms at the time section 7433(e) was enacted.

         "Willfulness" appears a number of times in the Internal Revenue Code and is an element of several tax crimes in Title 26. See, e.g., 26 U.S.C.A. §§ 7201-07. In that context, the Supreme Court has defined the term as "requir[ing] the Government to prove that the law imposed a duty on the defendant, that the defendant knew of this duty, and that he voluntarily and intentionally violated that duty." Cheek v. United States, 498 U.S. 192, 201 (1991) (emphasis added). As a result, a taxpayer defendant may raise as a defense that he held a good faith belief that he was not violating any provision of the tax laws. Id. at 202; see United States v. Aitken, 755 F.2d 188, 191-93 (1st Cir. 1985); cf. Ratzlaf v. United States, 510 U.S. 135, 137 (1994) ("To establish that a defendant 'willfully violat[ed]' the antistructuring law, the Government must prove that the defendant acted with knowledge that his conduct was unlawful.").

         In contrast to these Internal Revenue Code provisions and interpretations, only one provision of the Bankruptcy Code contains the term "willful violation, " and that is the provision prohibiting any violation of the section 362 automatic stay, 11 U.S.C.A. § 362(k)(l).[18] However, courts have used "willful violation" as the standard for assessing violations of the discharge injunction as well, relying on the statutory contempt powers in section 105.[19]See, e.g., Crvsen/Montenay Energy Co. v. Esselen Assocs., Inc. (In re Crysen/Montenay Energy Co.), 902 F.2d 1098, 1105 (2d Cir. 1990); Cuffee v. Atl. Bus. & Cmty., Dev. Corp. (In re Atl. Bus. & Cmty. Corp.), 901 F.2d 325, 329 (3d Cir. 1990); Goichman v. Bloom (In re Bloom), 875 F.2d 224, 227 (9th Cir. 1989); David M. Holliday, Annotation, Willful Violation of Discharge Injunction Provisions of Bankruptcy Code § 524(a)(2) and (3), 9 A.L.R. Fed. 2d 431 (2016) (collecting cases). The term "willful violation" is not defined in the Bankruptcy Code. But courts have stated that a willful violation occurs if the defendant "(1) knew that the automatic stay was invoked and (2) intended the actions which ...


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