United States Court of Appeals
For the First Circuit
No. 09-2083
IN RE: DAVID PAOLO,
Debtor.
__________
UNITED STATES OF AMERICA (INTERNAL REVENUE SERVICE),
Appellee,
v.
DAVID PAOLO,
Appellant.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. Mary M. Lisi, U.S. District Judge]
Before
Boudin, Gajarsa* and Thompson,
Circuit Judges.
James J. Lombardi III for appellant.
Ivan C. Dale, Tax Division, Department of Justice, with whom
John A. DiCicco, Acting Assistant Attorney General, Peter F.
Neronha, United States Attorney, and Bruce R. Ellisen, Tax
Division, Department of Justice, were on brief for appellee.
September 8, 2010
*
Of the Federal Circuit, sitting by designation.
BOUDIN, Circuit Judge. David Paolo appeals from a
district court's decision to abstain from deciding his tax dispute
with the government as an adjunct to his personal bankruptcy
proceeding. Paolo claims that Congress intended bankruptcy court
to be an available forum to determine a debtor's tax liability even
where the debtor's estate has no assets whose administration the
tax issues might affect; the government argues otherwise. We do
not decide whether the district court has power to do what Paolo
wants, concluding that the district court's decision to abstain
from doing so is not reviewable.
In early 2008, the Internal Revenue Service proposed an
assessment of tax penalties against Paolo for allowing more than
$217,000 in employment taxes to go unpaid by his former company,
Log on America, Inc.1 Paolo then filed for Chapter 7 bankruptcy,
claiming $11,870 in exempt personal property and listing $682,812
in unsecured claims--including the disputed tax penalty. The
bankruptcy trustee found no assets available to satisfy creditors,
so no claims were determined or distributions made. Paolo was
discharged of all non-exempt debts on October 6, 2008.
1
Employment taxes withheld from employee paychecks are held in
trust for the United States, 26 U.S.C. § 7501(a) (2006), and
persons responsible for collecting or paying over the taxes who
"willfully" fail to do so may be personally liable for the unpaid
amounts, id. § 6672(a). See Jean v. United States, 396 F.3d 449,
453-54 (1st Cir. 2005).
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In the meantime, Paolo had filed an adversary proceeding
in the bankruptcy court, which is the source of the present appeal.
In it, Paolo argued that the tax penalty was improper for various
reasons, including a claim that (despite being chief executive
officer) he lacked authority to pay over the withholding taxes at
his company. Paolo's complaint sought a determination of tax
liability under section 505 of Title 11, which provides that
the court [in bankruptcy proceedings] may
determine the amount or legality of any tax,
any fine or penalty relating to a tax, or any
addition to tax, whether or not previously
assessed, whether or not paid, and whether or
not contested before and adjudicated by a
judicial or administrative tribunal of
competent jurisdiction.
11 U.S.C. § 505(a)(1) (2006).
Debts owed the government for unpaid withholding taxes
are exempt from discharge in bankruptcy, see 11 U.S.C. §§
507(a)(8)(C), 523(a)(1)(A), so the validity of the tax penalty
remains a live issue. Paolo missed the initial ninety-day window
of time to challenge the IRS's proposed assessment of penalties in
Tax Court, see 26 U.S.C. § 6213(a), and so faced the requirement of
prepayment and a delay before bringing a new federal court suit to
challenge the penalty, see id. §§ 6532(a)(1), 7422(a). Resolution
in the bankruptcy proceedings offered a route to bypass both
requirements.
The government sought dismissal of, or abstention as to,
the adversary proceeding. It argued--and this is uncontested--that
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determining Paolo's liability for a non-dischargeable tax penalty
would not affect the administration of his bankruptcy estate
precisely because the estate had no assets to administer. Had the
estate held any non-exempt assets, then settling liability for the
non-dischargeable tax penalty could have reduced the funds
available to distribute to other creditors, as the tax penalty
would be paid out first. See 11 U.S.C. § 507(a)(8)(C) (priority of
withholding tax debt).
Accordingly, the government asserted that section 505 did
not apply in this case because Congress intended it only for
situations where the tax determination would affect the bankruptcy
estate. Further, even if section 505 could apply, the government's
position was that hearing Paolo's tax dispute would exceed the
jurisdictional limits of 28 U.S.C. § 1334 (2006), which requires
that the proceeding be (at least) "related to" bankruptcy2--a
status that the government disputes for Paolo's claim.
2
Proceedings are "related to" a Title 11 case within the
meaning of 28 U.S.C. § 1334(b) if they have some potential effect
on the bankruptcy estate. Boston Reg'l Med. Ctr., Inc. v. Reynolds
(In re Boston Reg'l Med. Ctr., Inc.), 410 F.3d 100, 105 (1st Cir.
2005). Section 1334(b) also confers jurisdiction over proceedings
arising under Title 11 or arising in a Title 11 case. These latter
categories are "core" proceedings, whereas those merely related to
the bankruptcy are "non-core." 28 U.S.C. § 157(b)-(c). For
further overview, see New England Power & Marine, Inc. v. Town of
Tyngsborough (In re Middlesex Power Equip. & Marine, Inc.), 292
F.3d 61, 68 (1st Cir. 2005); 1 Collier on Bankruptcy ¶ 3.01 (A.
Resnick & H. Sommer, eds., 16th ed. 2010).
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Alternatively the government argued that no "bankruptcy
purpose" would be served by hearing a dispute about a non-
dischargeable tax liability in a no-asset bankruptcy, so abstention
"under 28 U.S.C. § 1334(c)" was appropriate. Section 1334 affords
district courts wide discretion to decline to hear bankruptcy
proceedings:
Except with respect to a case under chapter 15
of title 11, nothing in this section prevents
a district court in the interest of justice,
or in the interest of comity with State courts
or respect for State law, from abstaining from
hearing a particular proceeding arising under
title 11 or arising in or related to a case
under title 11.
28 U.S.C. § 1334(c)(1). The argument for abstention parallels the
rationale for its jurisdictional claim--namely, that the
administration of Paolo's bankruptcy estate would not in any way be
affected by determining his tax liability.
Paolo has consistently countered with two "bankruptcy
purposes" that he says would be advanced by hearing his claim:
first, the general aim of bankruptcy law to afford a fresh start to
the "honest but unfortunate debtor," Local Loan Co. v. Hunt, 292
U.S. 234, 244 (1934); and second, section 505's aim to speed
resolution of debtor tax liability. Conversely, says Paolo, the
government's approach would force him and similar debtors without
assets to engage in new tax suits when they are least able to bear
the costs of litigating in multiple courts.
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The bankruptcy court refused to dismiss or abstain, but
the government sought and was granted leave for an interlocutory
appeal to the district court. The parties reprised their
positions, with the government bolstering its argument for
abstention by claiming that it would be prejudiced in various ways
if forced to litigate the tax claim in bankruptcy court--for
example, by its inability to implead other responsible persons from
Log on America.
On July 23, 2009, the district court granted the
government's appeal "with respect to the abstention issue,"
concluding that the "policy reasons underlying Section 505 are not
applicable" to Paolo's no-asset bankruptcy. Accordingly, the
district court held that the bankruptcy court should have exercised
its discretion to abstain; the bankruptcy court in turn entered an
order of abstention and closed the adversary proceeding.
Paolo now appeals, renewing the arguments he made in the
district court, while the government offers--in addition to its
prior positions--a new argument made possible by the district
court's decision to abstain: it contends that this court lacks
jurisdiction to hear an appeal of a discretionary decision to
abstain and it relies on 28 U.S.C. § 1334(d), which pertinently
says: "Any decision to abstain or not to abstain made under
subsection (c) . . . is not reviewable by appeal or otherwise by
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the court of appeals under section 158(d), 1291, or 1292 of this
title."3
Whether the district court abstained "under subsection
(c)" of section 1334 of Title 28, rather than section 505 of Title
11, see Cody, Inc. v. Cnty. of Orange (In re Cody, Inc.), 338 F.3d
89, 97 n.8 (2d Cir. 2003), might perhaps be debated, although it is
hard to imagine that Congress' limit on appellate review would turn
on such hairsplitting. In any event, the district court framed the
government's position as requesting abstention "pursuant to 28
U.S.C. § 1334(c)(1)," we read its decision as granting abstention
under that provision, and Paolo does not claim otherwise.
On this premise, the "not reviewable by appeal or
otherwise" language of section 1334(d) reads directly on the
district court's decision to order abstention. One might argue,
although Paolo does not, that subsection (d) should not apply where
the district court is acting in a quasi-appellate capacity vis-à-
vis the bankruptcy judge; but subsection (d) draws no such
distinction, accord Goradia v. O'Connor (In re O'Connor Int'l,
Inc.), 174 F. App'x 209, 212 (5th Cir. 2006) (per curiam), and the
3
Paolo's federal tax dispute implicates only discretionary
abstention under section 1334(c)(1). The omitted text in the
quotation refers to section 1334(c)(2), which makes abstention
mandatory in limited circumstances involving state law; the current
version of section 1334(d) permits appellate review only of
refusals of mandatory abstention. See Geruschat v. Ernst Young LLP
(In re Seven Fields Dev. Corp.), 505 F.3d 237, 248-49 (3d Cir.
2007).
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power of the bankruptcy court to abstain at all ultimately derives
from its status as a "unit" of the district court, 28 U.S.C. § 151.
Cf. Fed. R. Bankr. P. 5011 Advisory Committee's note.
Even through we agree with the government's view that the
order is not reviewable, the government urges us to decide whether
the courts below themselves had jurisdiction to abstain. To do so
might not amount to forbidden review of the merits of the
abstention order, cf. Ill. Mun. Ret. Fund v. Citigroup, Inc., 391
F.3d 844, 848-49 (7th Cir. 2004), and in general both we and the
district court have an obligation to notice true jurisdictional
defects, see Steel Co. v. Citizens for a Better Env't, 523 U.S. 83,
94-95 (1998).
But the rationale for considering jurisdiction before all
else is to avoid exercising unauthorized judicial power, and that
principle is not offended by dismissing on other non-merits
grounds, like abstention. Ruhrgas AG v. Marathon Oil Co., 526 U.S.
574, 585 (1999) (federal courts may "choose among threshold grounds
for denying audience to a case on the merits"); see also New
England Power, 292 F.3d at 66 n.1. The section 505 issue is one of
some difficulty, and we decline to pursue it where as here nothing
turns on it.
Accordingly, we dismiss the appeal as barred by section
1334(d).
So ordered.
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