Harker v. Cummings (In re GYPC, Inc.)

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IN RE GYPC, INC., Debtor.

DONALD F. HARKER, III, Trustee for GYPC, Inc., Plaintiff/Appellee, v. CHRISTOPHER F. CUMMINGS, et al., Defendants/Appellants.

No. 3:22-cv-66

Bankruptcy No. 3:17-bk-31030

United States District Court, S.D. Ohio, Western Division

May 26, 2022

Chapter 7

Guy R Humphrey, Bankruptcy Judge

ORDER: (1) DENYING DEFENDANTS'/APPELLATNS' MOTION FOR LEAVE TO FILE AN INTERLOCUTORY APPEAL (DOC. NO. 1) AND (2) TERMINATING THIS CASE ON THE DOCKET

Hon Michael J. Newman United States District Judge

This bankruptcy case is before the Court on Defendants'/Appellants' Christopher F. Cummings and Eric Webb's (collectively “Shareholders'”) motion for leave to file an interlocutory appeal. Doc. No. 1-2. Shareholders seek immediate district court review of Bankruptcy Judge Guy R. Humphrey's order denying their motion to dismiss an adversary proceeding filed against them by Chapter 7 Trustee Donald F. Harker, III (“the Trustee”). Doc. No. 1-3. The motion is fully briefed and now ripe for review. Doc. Nos. 7, 8-1.

I.

Shareholders own 100% of Debtor GYPC, Inc. Doc. No. 1-2 at PageID 102. GYPC's small-business status qualified it to be treated as an S-Corporation (“S-Corp”) for federal income taxes purposes starting in 2013. Id. at PagelD 103; see also 26 U.S.C §§ 1361(b) and 1362(a). S-Corps possess several attractive attributes. Principal among them is that S-Corps are not subject to federal income tax and their income and losses flow through to their shareholders. 26 U.S.C. §§ 1363(b) and 1366(a). An S-Corp's shareholders must report their S-Corp's income and losses on their individual tax returns. 26 U.S.C. §§ 1363(b) and 1366(a). C-Corporations (“C-Corp”)- the default corporate tax status-are subject to federal income tax and do not possess flow through attributes. In re GYPC, Inc., No. 3:17-bk-31030, 2021 WL 4618410, at *1 (S.D. Ohio Oct. 5, 2021).

In February 2017, Cummings released his rights to a revocable trust that no party disputes converted GYPC's tax status from an S-Corp to a C-Corp. Doc. No. 1-3 at PageID 120. GYPC filed a voluntary Chapter 11 petition in March 2017. Id. Despite the change in its tax status, GYPC still filed S-Corp federal tax returns for 2017 and 2018. Id.

GYPC's case was converted to Chapter 7 in August 2019. Id. The Trustee was appointed in September 2019. Id. The Trustee did not know it at the time, but in October 2019, GYPC filed amended C-Corp tax returns for the post-conversion period in 2017 (February through December 2017) and the complete 2018 tax year (the “Post-Conversion Returns”). Id. at PageID 120-21. The Trustee learned of the conversion when, in September 2020, he filed an S-Corp return on behalf of GYPC only to be told by the IRS that GYPC's S-Corp election was terminated in February 2017. Id. at PageID 121. In response, the Trustee filed amended Post-Conversion Returns that shifted deferred income from tax year 2017 back to GYPC's pre-petition 2016 S-Corp return. Id. The Trustee's amended returns-if accepted by the IRS-would eliminate the bankruptcy estate's tax liability and offload about $4 million in tax liability back to Shareholders. Id.

For its part, the United States, on behalf of the IRS, views the Post-Conversion Returns as operative. Harker v. Cummings etal., No. 3:21-ap-3025, Doc. No. 38 (Bankr. S.D. Ohio Mar. 21, 2022). In September 2021, the United States filed an amended proof of claim in GYPC's case for payment of excise taxes and penalties. Id. The United States lodged a second amended proof of claim against GYPC in March 2022-after this motion for leave to appeal was filed-seeking $7, 206, 098.05 in taxes, interest, and penalties for tax years 2017 and 2018. Id.

The Trustee believes the Post-Conversation Returns should be avoided and replaced by its amended S-Corp returns. Doc. No. 1-3 at PageID 120. To that end, the Trustee filed this adversary proceeding against Shareholders under 11 U.S.C. § 549 to avoid the Post-Conversion Returns as an unauthorized post-petition “transfer of property.” Id. The Trustee specifically seeks (1) a “declaration that the filing of [Post-Conversion Returns] are a transfer of property of the estate that was not authorized by the Bankruptcy Code” and a (2) “declaration that the Trustee is authorized to file a tax return for the 2017 Full Year and 2018 on behalf of the Debtor or, in the alternative, that the amended returns filed by the Trustee shall be considered the return.” Harker v. Cummings et al., No. 3:21-ap-3025, Doc. No. 1 (Bankr. S.D. Ohio Oct. 1, 2021). Seizing on the word “declaration, ” Shareholders filed a motion to dismiss arguing that the Declaratory Judgment Act (“DJA”), 28 U.S.C. § 2201(a), deprives the bankruptcy court (and this Court) of subject matter jurisdiction to hear the Trustee's § 549 claim. Doc. No. 1-3 at PageID 122. Shareholders also contended that Rule 12(b)(6) dismissal was appropriate because a change in corporate tax does not constitute transferrable “property.” Id.

The bankruptcy court disagreed with the Shareholders on both counts. Id. at PageID 12229. It first determined that the DJA did not bar the Trustee's claim. Id. The DJA provides that

In a case of actual controversy within its jurisdiction, except with respect to Federal taxes other than actions brought under section 7428 of the Internal Revenue Code of 1986, a proceeding under section 505 or 1146 of title 11, . . . any court of the United States, upon the filing of an appropriate pleading, may declare the rights and other legal relations of any interested party seeking such declaration, whether or not further relief is or could be sought.

28 U.S.C. § 2201(a) (emphasis added). In the bankruptcy court's view, the DJA was inapplicable because the Trustee is not seeking a declaratory judgment. Doc. No. 1-3 at PageID 125. True, the Trustee seeks a “declaration” that he was authorized to amend the Post-Conversion Returns. Id. But the bankruptcy court explained that all the Trustee really wants is an order voiding the PostConversion Returns. Id. Even if the DJA applied, the bankruptcy court continued, its federal-tax exception did not deprive the court of subject matter jurisdiction. Id. Rather, said the bankruptcy court, the DJA only precludes jurisdiction over “ordinary” federal tax collection matters. Id.

With its jurisdiction assured, the bankruptcy court then determined that a C-Corp's tax attributes fit into the broad definition of estate property. Id. at PageID 127-28. It explained that a debtor corporation's tax status has a “significant” effect on the estate's assets. Id. After all, tax liability can only be satisfied with proceeds from the estate. Id. The bankruptcy court was satisfied that the Trustee stated a plausible § 549 claim and denied Shareholders' motion to dismiss. Id. at PageID 131.

Shareholders now ask this Court to conduct an interlocutory review of the bankruptcy court's order. Doc. No. 1-2. They contend that the bankruptcy court erred in determining that the DJA's federal-tax exception did not strip the court of subject matter jurisdiction. Id. The Court will review the parties' arguments in turn.

II.

A district court may hear an appeal from a bankruptcy judge's interlocutory order with leave of court. 28 U.S.C. § 158(a)(3). But § 158 and Rule 8004 of the Federal Rules of Bankruptcy Procedure are silent on when interlocutory review is appropriate. To compensate, district courts apply the standards set forth in 28 U.S.C. § 1292(b) as they do for interlocutory appeals from district to circuit courts. See, e.g., In re Energy Conversion Devices, Inc., 638 B.R. 81, 88-89 (E.D. Mich. 2022). Interlocutory appeal is appropriate under 28 U.S.C. § 1292(b) if “(1) [t]he appeal ‘involves a controlling question of law,' (2) there is a ‘substantial ground for difference of opinion' about the answer, and (3) ‘an immediate appeal from the order may materially advance the ultimate termination of the litigation.'” In re Somberg, 31 F.4th 1006, 1008 (6th Cir. 2022) (quoting 28 U.S.C. § 1292(b)).

“Congress sets the jurisdiction of the federal courts” and prefers that only final orders be appealed. Page Plus of Atl., Inc. v. Owl Wireless, LLC, 733 F.3d 658, 659 (6th Cir. 2013). Interlocutory review is an exception to that finality requirement and, therefore, should be “sparingly” afforded. Kraus v. Bd. of Cnty. Rd. Comm 'rs, 364 F.2d 919, 922 (6th Cir. 1966). This rule “guards against piecemeal appeals that permit litigants to second-guess the [bankruptcy] court at each turn, harming the [bankruptcy] court's ability to control the litigation in front of it and consuming finite appellate court resources along the way.” Page Plus, 733 F.3d at 659. Interlocutory review is not merely meant to “refer difficult matters to a higher court for advance decision, ” U.S. ex rel. Elliot v. Brickman Grp. Ltd., 845 F.Supp.2d 858, 863 (S.D. Ohio 2012) (quoting Alexander v. Provident Life & Accident Ins. Co., 663 F.Supp.2d 627, 639 (E.D. Tenn. 2009)), but is reserved for “exceptional cases, ” In re City of Memphis, 293 F.3d 345, 350 (6th Cir. 2002). Even denials of motions to dismiss for lack of subject matter jurisdiction are “not immediately reviewable.” Catlin v. United States, 324 U.S. 229, 236 (1945).

A. Controlling Question of Law

An interlocutory appeal must both (1) present a legal question and (2) control the case's outcome. In re Trump, 874 F.3d 948, 951 (6th Cir. 2017). “[I]nterlocutory appeals are limited to questions that present ‘neat abstract issues of law.'” Hills v. Kentucky, 457 F.3d 583, 588 (6th Cir. 2006) (quoting Turner v. Scott, 119 F.3d 425, 428 (6th Cir. 1997)). “A legal issue is controlling if it could materially affect the outcome of the case.” City of Memphis, 293 F.3d at 351.

Shareholders...