Wolff v. U.S.A. (In re Firstpay, Inc.)

No. 13-2116 (4th Cir. Dec. 12, 2014)
Affirming that the trustee in bankruptcy may not recover the approximately $28 million transferred by the debtor to the IRS during the 90 days preceding the filing of the bankruptcy petition where the debtor lacked an equitable interest in the funds because such funds were held in trust for payment of its clients' obligations.
Procedural context:
The United States Bankruptcy Court for the District of Maryland (the "Bankruptcy Court") granted summary judgment in favor of the United States government finding that, among other things, the funds withheld by the debtor for the purpose of paying the IRS on behalf of its clients were not "property of the debtor" and therefore payment to the IRS from those funds did not constitute avoidable preferences. Trustee appealed and District Court affirmed. Trustee appealed to Fourth Circuit.
FirstPay, Inc. (the "Debtor") provided payroll services pursuant to various agreements (the "Agreements") with its clients whereby it would withdraw funds from its client's accounts to cover the client's tax obligations, client's employee's wages and the Debtor's fees. The Debtor, however, transferred some of these funds to an account used to pay its business expenses and to cover "lavish personal expenditures". When this scheme came crashing down, FirstPay's creditors filed an involuntary Chapter 7 bankruptcy against it. The Chapter 7 Trustee filed a nine count complaint against the United States, seeking, among other things and pertinent to this opinion, to avoid and recover the Debtor's payments of its clients' payroll taxes to the IRS as preferences under 11 U.S.C. 547. After various summary judgment proceedings and appeals therefrom, the Fourth Circuit ultimately remanded to the bankruptcy court with an instruction to ignore the parties' stipulation that the transfers were transfers of the Debtor's own interest in property (the court need not accept the parties' stipulations as to conclusions of law). On remand, the bankruptcy court granted summary judgment in favor of the U.S. Government. On appeal from the District Court, the Fourth Circuit, in affirming the grant of summary judgment, held that the funds held by the Debtor were "held in trust" for its clients and, therefore, the Debtor did not have an equitable interest in the funds under Maryland law (the Agreements dictated that Maryland law govern). In short, the Debtor "was but an intermediary". In so holding, the Fourth Circuit rejected the Trustee's argument that the tax funds were a "debt" that the Debtor owed to its clients and not held in trust on their behalf. The Fourth Circuit held that the terms of the parties' Agreements left the Debtor with "no discretion as to how it could handle the funds". Accordingly, it was clear that a trust was the intended effect of the Agreements, and not the creation of a debt.
Davis, Motz and Diaz

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