Perfection of Federal Tax Lien By Operation Law Stayed by Bankruptcy
 
December 1, 1999
 

A decision by the Fourth Circuit United States Court of Appeals issued in June addressed a matter of first impression in the circuits. In In re Avis, 178 F.3d 718 (4th Cir. 1999), the Fourth Circuit held that the automatic stay provisions of the United States Bankruptcy Code prevented the perfection of an IRS tax lien in a debtor's after-acquired property received after the filing of the bankruptcy petition. The court held that the attachment of a federal tax lien by operation of law to property acquired after a bankruptcy petition is filed is an "act" stayed under § 362(a) of the Bankruptcy Code. This decision is of interest to debtors and secured creditors alike, although the extent of the implications of this decision is not yet clear. At this time, no other decisions have been issued which rely upon or reference the Avis decision.

The Facts

The debtor, Dwight Avis, was placed in an involuntary Chapter 7 bankruptcy. On his bankruptcy schedule of personal property, Avis disclosed a contingent interest in a potential inheritance under trusts of family members. Avis listed the value of this contingent interest as "unknown." Approximately four months after the filing of the involuntary bankruptcy petition, the last of the relevant family members died, leaving 3% of the trust's assets to Avis. The Chapter 7 trustee eventually liquidated Avis' interest in the trust's assets for $149,669.

The Internal Revenue Service timely filed its proof of claim in the bankruptcy in the amount of $127,306 for taxes, interest and penalties that Avis owed for previous tax years. The IRS alleged that $108,819 of its claim was secured by a lien it had obtained almost a year prior to the commencement of Avis' bankruptcy case.

The Fourth Circuit's Analysis of General Bankruptcy Principles

To reach the ultimate issue in this case, the Fourth Circuit discussed the applicable general bankruptcy and commercial transaction principles. First, the court recognized that all of a debtor's property becomes part of the bankruptcy estate upon the filing of a bankruptcy petition. Accordingly, all of the property becomes subject to the provisions of the Bankruptcy Code. Section 541 of the Bankruptcy Code states that property of the estate includes all legal and equitable interests of the debtor in property as of the petition date wherever located and by whomever held. See 11 U.S.C. §541(a)(1). This definition of estate property is broad and all embracing. See In re Cordova, 73 F.3d 38, 42 (4th Cir. 1996).

As stated by the Avis court and courts around the country, the date of the bankruptcy petition is generally controlling for defining estate property. Property acquired by a debtor after the petition is filed may belong to a debtor free and clear of all claims that will ultimately be discharged through the bankruptcy case. However, this general rule is subject to an exception for certain types of property, including inheritances.

Section 541 of the Bankruptcy Code includes in a bankruptcy estate "[a]ny interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date by bequest, devise, or inheritance." 11 U.S.C. §541(a)(5)(A). Thus, if a debtor acquires an inheritance within 180 days of the filing of the bankruptcy petition, the inheritance is subject to the provisions of the Bankruptcy Code and will be administered accordingly.

The next general bankruptcy principle addressed by the court was the automatic stay. Property of a bankruptcy estate is protected from the post-petition reach of creditors through the automatic stay provisions of the Bankruptcy Code. Pursuant to §362, the filing of a bankruptcy petition "stays" any litigation, lien enforcement or other efforts by creditors or third parties to enforce or collect prepetition claims, except those acts specifically exempted under the Bankruptcy Code. See 11 U.S.C. §362(a). The purpose of the automatic stay is to protect the relative position of creditors and to shield a debtor from financial pressure during a bankruptcy case. The automatic stay represents "one of the fundamental debtor protections provided by the bankruptcy laws." Midatlantic National Bank v. New Jersey Department of Environmental Protection, 474 U.S. 494, 106 S.Ct. 755, 88 L.Ed.2d 859 (1986).

Third, the court addressed the creation of liens in after-acquired property and the effect of the automatic stay on such liens. As provided for in the Uniform Commercial Code adopted by most states, the law generally recognizes the creation of liens in after-acquired property; however, the applicability of the automatic stay to the attachment of such liens to assets acquired post-petition is not uniform. See UCC §9-204. For example, when a lien is created in after-acquired property under the terms of a consensual security agreement entered into pre-petition, the Bankruptcy Code generally will not recognize the attachment of the lien to property acquired post-petition. See 11 U.S.C. §552(a). There are exceptions to this general rule. See 11 U.S.C. §552(b) (this section provides a list of specific exceptions).

The IRS lien at issue in Avis was created by 26 U.S.C. §6321, which provides for the creation of liens for taxes, interest and penalties owed in favor of the United States, "upon all property and rights to property, whether real or personal belonging to the taxpayer." 26 U.S.C. §6321. Third parties are subject to these liens when the IRS files notices of the lien in any recording office within the state in which the property is located. Furthermore, liens created by this section apply to after-acquired property. See United States v. McDermott, 507 U.S. 447, 113 S.Ct. 1526, 123 L.Ed.2d 128 (1993).

After discussing these generally accepted principles, the Fourth Circuit applied the principles and discussed certain public policy issues in order to reach its ultimate conclusions.

Relevant Public Policy Issues

"The public policy favoring enforcement of statutorily created tax liens is important to the national tax collection effort." Avis, 178 F.3d at 722. The public policy underlying the automatic stay provisions of the Bankruptcy Code is also of significant importance. To resolve the tension between these public policy issues, the Fourth Circuit looked closely at the nature of the IRS' lien compared to the reach of the automatic stay.

According to the Supreme Court of the United States, the IRS tax lien is similar to security agreement liens regulated by Article 9 of the UCC. United States v. McDermott, 507 U.S. 447, 448, 113 S. Ct. 1526 (1993). Therefore, a tax lien in after-acquired property does not attach to such property until a debtor actually acquires the property. Until the lien attaches it is a "floating lien" or what is referred to as an "inchoate" lien. Id. at 452 n.5, 113 S. Ct. 1526.

There is no dispute that in Avis, the IRS had a properly perfected lien at the time of the bankruptcy petition and an "inchoate" lien in property that Avis may subsequently acquire, such as the inheritance. Although an "inchoate" lien existed, it could not be perfected until Avis actually received the inheritance. In this case, at the same time the inheritance came to Avis, it also became property of the bankruptcy estate, subject to the automatic stay.

Applicable sections of the automatic stay provision provide that the bankruptcy petition stays "any act to create, perfect or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under [the Bankruptcy Code]." 11 U.S.C. §362(a)(5). The Fourth Circuit did not accept the IRS' argument that its lien became perfected by operation of law and not by any act by it or on its behalf. Applying such reasoning would, according to the court, overlook a chief aim of the automatic stay provision which is to prevent the post-petition perfection of interests in a debtor's bankruptcy estate unless one of the exceptions contained in the Bankruptcy Code applies. Avis, 178 F.3d at 723.

For further support of its conclusion, the court referred to a 1994 amendment to the automatic stay provision - the exemption of the perfection of liens resulting from state or local property taxes which come due post-petition. According to the court, "if the perfection of statutory liens resulting by operation of law were generally excluded from the automatic stay . . . Congress would not have found it necessary to . . . [exempt] the perfection of liens created by state or local law. Because that section applies only to state and local tax liens, it must be inferred that Congress did not intend to exempt the perfection of federal tax liens." Id. The court ultimately concluded that the attachment of a federal tax lien to property acquired during the bankruptcy case as a matter of law is an "act" that is prevented by the automatic stay.

Future Impact of the Avis Decision

The Avis court's holding that automatic attachment of a statutory lien to after acquired property is an "act" prohibited by the automatic stay is the first such conclusion reached by any of the circuits. As of the preparation of this article, there have not been any subsequent cases relying upon or referencing the Avis decision. Although the court was concerned specifically with the attachment of a federal tax lien as a matter of law, the Fourth Circuit's reasoning would apply to the "automatic" attachment of other statutory and nonconsensual liens in after-acquired property when the property comes into the estate after the bankruptcy was filed, except as may be excepted under § 362(b). Only time will tell if the Fourth Circuit's view will be adopted by any of the other circuits.

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