Internal Revenue Serv. v. Murphy

892 F.3d 29

INTERNAL REVENUE SERVICE, Defendant, Appellant,

v.William Charles MURPHY, Plaintiff, Appellee.

No. 17-1601

United States Court of Appeals, First Circuit.

June 7, 2018

Peter Sklarew, with whom David A. Hubbert, Acting Assistant Attorney General, Paul A. Allulis, Gilbert S. Rothernberg, Thomas J. Clark, Attorneys, Tax Division, Department of Justice, and Halsey B. Frank, United States Attorney, were on brief, for appellant.

John H. Branson, with whom Branson Law Office, P.A., Portland, ME, was on brief, for appellee.

Before Lynch, Circuit Judge, Souter, Associate Justice,^* and Stahl, Circuit Judge.

STAHL, Circuit Judge.

In this case, we need to determine whether an employee of the Internal Revenue Service ("IRS") "willfully violate[d]" an order from the bankruptcy court discharging the debts of debtor-taxpayer William C. Murphy, as that term is used in 26 U.S.C. § 7433(e). After careful consideration, we hold that an employee of the IRS "willfully violates" a discharge order when the employee knows of the discharge order and takes an intentional action that violates the order. Under § 7433(e), the IRS's good faith belief that it has a right to collect the purportedly discharged debts is not relevant to determining whether it "willfully violate[d]" the discharge order. Because the IRS's actions in this case meet this standard, we affirm.

I.

On October 13, 2005, Murphy filed a Chapter 7 petition in the United States Bankruptcy Court for the District of Maine. On Schedule E of his bankruptcy petition, Murphy listed his income tax obligations to the IRS for the years of 1993-1998, 2000, 2001, and 2003, as well as a 2003 tax obligation to the Maine Revenue Services. Murphy's tax obligations were by far the largest liabilities he sought to discharge. In his petition, Murphy listed total liabilities of $601,861.61, of which $546,161.61 were tax obligations. On January 20, 2006, Assistant U.S. Attorney Frederick Emery, Jr. ("AUSA Emery") filed an appearance on behalf of the IRS in the bankruptcy proceeding.

On February 14, 2006, the bankruptcy court granted Murphy a discharge. The discharge order, which appears to be a standard form, reads:

It appearing that the debtor is entitled to a discharge,

IT IS ORDERED:

The debtor is granted a discharge under section 727 of title 11, United States Code, (the Bankruptcy Code).

Beneath the bankruptcy judge's signature, there is a notice that states, in bold and capital letters, "SEE THE BACK OF THIS ORDER FOR IMPORTANT INFORMATION. " The back of the order provides an explanation of bankruptcy discharge in a Chapter 7 case, stating that "[t]he discharge prohibits any attempt to collect from the debtor a debt that has been discharged." The order lists "[s]ome of the common types of debts which are not discharged" and specifically notes that "[d]ebts for most taxes" are not discharged.

It does not appear that the IRS objected to Murphy's discharge prior to the bankruptcy court entering its discharge order. On February 16, 2006, the IRS received notice of the discharge order.

The IRS did not believe that the discharge relieved Murphy of his tax obligations. Rather, the IRS viewed Murphy's taxes as excepted from discharge under 11 U.S.C. § 523(a)(1)(C), which excepts from discharge any tax if "the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax." Based on its earlier investigations into Murphy, the IRS believed that Murphy had willfully attempted to evade taxes during all of the years in question.

From February 2006 to February 2009, the IRS repeatedly informed Murphy that it did not view his tax obligations as discharged and that it planned to collect what it believed was owed. On February 20, 2009, the IRS issued levies against several insurance companies with which Murphy then did business in an attempt to collect on these tax obligations. Margurite Gagne, a revenue officer for the IRS, signed the levy notices sent to the insurance companies.

On August 14, 2009, Murphy filed an adversarial proceeding seeking a declaration that his tax obligations from 1993-1998, 2000, and 2001 had been discharged. In this proceeding, AUSA Emery represented the IRS. According to the IRS, AUSA Emery "took only minimal discovery in the case" and failed to submit evidence to the bankruptcy court that the IRS had developed during its investigation into Murphy's tax obligations. Instead, the IRS claims that AUSA Emery merely filed a summary of the IRS's allegations of Murphy's tax evasion, without submitting any admissible evidence to support the allegations.

On June 22, 2010, the bankruptcy court granted summary judgment in Murphy's favor and declared that Murphy's tax obligations had been discharged. The bankruptcy court later noted that it granted summary judgment in large part because the IRS's opposition to summary judgment "fell far short of applicable substantive and procedural standards." Murphy v. IRS (In re Murphy ), No. 05-22363, 2013 WL 6799251, at *2 (Bankr. D. Me. Dec. 20, 2013). The IRS did not appeal the bankruptcy court's 2010 summary judgment ruling.

Subsequently, AUSA Emery was diagnosed with frontotemporal dementia ("FTD"). According to the IRS, symptoms of FTD include "impairment of executive function, such as the cognitive skill of planning and organizing." Based on AUSA Emery's medical records and the opinions of three physicians, the IRS believes that AUSA Emery was already experiencing the symptoms of FTD in 2010.

In February 2011, Murphy filed a complaint against the IRS under § 7433(e), alleging that an employee of the IRS willfully violated the bankruptcy court's 2006 discharge order in February 2009 by issuing levies against the insurance companies with which he did business and thereby attempting to collect on his discharged tax obligations.¹ The IRS responded that it did not willfully violate the order because it reasonably believed his tax obligations were excepted from discharge under § 523(a)(1)(C) based on its investigation into his alleged tax evasion.

On December 20, 2013, the bankruptcy court granted summary judgment for Murphy for his § 7433(e) claim. The court found that the term "willfully violates" has an established meaning in the context of violations of automatic stays and discharge orders issued in bankruptcy proceedings: a willful violation occurs "when, with knowledge of the discharge, [a creditor] intends to take an action, and that action is determined to be an attempt to collect a discharged debt." In re Murphy, 2013 WL 6799251, at *7. The court further found that the 2010 summary judgment ruling collaterally estopped the IRS from relitigating whether Murphy's tax obligations were discharged, whether the IRS knew they were discharged, and whether it took actions which violated the discharge order. Id. at *8.

After the bankruptcy court denied the IRS's motion for reconsideration, the IRS appealed to the district court, which vacated the bankruptcy court's decision. IRS v. Murphy, 564 B.R. 96, 98 (D. Me. 2016). The district court concluded that the bankruptcy court should have considered AUSA Emery's impairment before finding that the 2010 summary judgment ruling collaterally estopped the IRS from relitigating issues related to Murphy's discharge. Id. at 112.

However, the district court agreed with the bankruptcy court's definition of "willfully violates" as used in § 7433(e). Id. at 106. The district court found that, by 1998, the term had an established meaning in the context of violations of both automatic stays and discharge injunctions, and under this established meaning, a creditor's "good faith belief in a right to the property is not relevant to a determination of whether the violation was willful." Id. (quoting Fleet Morg. Grp., Inc. v. Kaneb, 196 F.3d 265, 269 (1st Cir. 1999) ).

On remand, the parties entered into a settlement agreement, whereby the IRS waived its collateral estoppel arguments and accepted that the 2010 summary judgment ruling conclusively determined that Murphy's tax obligations had been discharged. The IRS reserved the right:

for further appeal(s) only its arguments that that [sic] a debtor is not entitled to damages where a creditor's violation of the discharge reflects a reasonable belief that the debt involved was excepted from discharge, and/or that the "willfully violates" language in IRS § 7433(e) should be construed to permit the IRS to defend against liability for violating the discharge on the basis that its employee reasonably believed that the tax involved is excepted from discharge [hereinafter "the willfully violates issue"].

As part of the settlement, the IRS agreed to pay $175,000 as Murphy's damages once it had exhausted the reserved right to appeal if the appeal was lost. The settlement did not "resolve whether or not the deficiencies in in [sic] the United States' response to plaintiff's motion for summary judgment ... were caused by any mental disability of the former Assistant United States Attorney at the time of the summary judgment proceedings." Based on this agreement, on January 4, 2017, the bankruptcy court entered final judgment against the United States, and the district court affirmed the judgment on appeal. The IRS timely appeals to this court.²

II.

We are, at this stage, confronted solely with the bankruptcy court's resolution of a legal question, which we review de novo. Wilding v. CitiFinancial Consumer Fin. Servs., Inc., (In re Wilding ), 475 F.3d 428, 430 (1st Cir. 2007). The parties' settlement agreement reserved for the IRS the right to appeal only the bankruptcy court's construction of the phrase "willfully violates" as used in § 7433(e).

The IRS argues it does not "willfully violate" an automatic stay or discharge order if it has a good faith belief that its actions do not violate the bankruptcy court's order. In support of its position, the IRS presents two somewhat conflicting arguments. First, it claims that, before Congress enacted § 7433(e) in 1998...