United States v. Paolo (In Re Paolo)

             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).

                                -2-
           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

                                   -3-
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).

                                     -4-
            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.



                                        -5-
              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




                                            -6-
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).

                                    -7-
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.


                                         -8-