City of Farrell v. Sharon Steel Corp.

Opinions of the United
1994 Decisions States Court of Appeals
for the Third Circuit

11-15-1994

City of Farrell v. Sharon Steel Corp.
Precedential or Non-Precedential:

Docket 94-3130

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 UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

No. 94-3130

CITY OF FARRELL,

v.

SHARON STEEL CORPORATION;
UNITED STATES OFFICE;
CREDITORS' COMMITTEE;
MUELLER INDUSTRIES, INC.;
CITIBANK, N.A.

The City of Farrell,

Appellant

On Appeal from the United States District Court
for the Western District of Pennsylvania
(D.C. Civ. No. 93-0736)

Argued August 30, 1994

BEFORE: STAPLETON and GREENBERG, Circuit Judges,
and ATKINS, District Judge*

(Filed: November 15, 1994)

P. Raymond Bartholomew (argued)
Cusick, Madden, Joyce
& McKay
One East State Street
P.O Box 91
Sharon, PA 16146

Attorneys for Appellant
* Honorable C. Clyde Atkins, Senior United States District Judge
for the Southern District of Florida, sitting by designation.

Herbert P. Minkel, Jr. (argued)
Fried, Frank, Harris, Shriver
& Jacobson
One New York Plaza
New York, NY 10004

Attorneys for Appellee
Sharon Steel Corporation

William H. Schorling (argued)
Klett, Lieber, Rooney &
Schorling
One Oxford Centre
40th Floor
Pittsburgh, PA 15219-6498

Attorneys for Appellee
Citibank, N.A.

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

This appeal involves a controversy over City of Farrell

municipal income taxes that Sharon Steel Corporation withheld

from its employees' wages. After withholding the amounts in

dispute, Sharon Steel filed for protection under Chapter 11 of

the Bankruptcy Code and thus did not remit the funds to the city.

The City of Farrell subsequently initiated this action in the

bankruptcy court to collect the unpaid taxes withheld. The

bankruptcy court and the district court denied the City's request

for an order requiring Sharon Steel to remit the withheld funds.

We will reverse the district court's order, and we will remand
the case to the district court for the proceedings we outline in

this opinion.

II. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

Sharon Steel has its main plant and principal place of

business in the City of Farrell, Mercer County, Pennsylvania. In

1967 the city, pursuant to section 13 of the Pennsylvania Local

Tax Enabling Act, as amended, Pa. Stat. Ann. tit. 53, § 6913

(1972), enacted a tax (Ordinance No. 0-17-66) on the earned

income and net profits of all residents and non-residents

employed or conducting business within the city. Under the

ordinance and Pennsylvania law, Pa. Stat. Ann. tit. 53, § 6913

IV, employers located in the City of Farrell must withhold taxes

on locally earned income from the wages of any employee subject

to the city income tax and must remit those taxes in quarterly

payments to the city.

For the fourth quarter of 1992, Sharon Steel withheld

$56,831.99 in City of Farrell income tax. On November 30, 1992,

Sharon Steel filed its petition under Chapter 11 of the

Bankruptcy Code in the United States Bankruptcy Court for the

Western District of Pennsylvania. After filing its petition,

Sharon Steel remitted $7,944.97 in withholding taxes to the City

of Farrell, which was the post-petition portion of the fourth-

quarter wages it withheld for payment to the City of Farrell.

But Sharon Steel retained the remainder of the withheld fourth-

quarter taxes.
 To obtain the remaining funds, the City of Farrell

filed a motion in the bankruptcy court to lift the automatic stay

and to compel the turnover of the funds. The bankruptcy court

denied the motion in a written opinion dated April 9, 1993,

rejecting the city's reliance on Begier v. IRS, 496 U.S. 53, 110

S.Ct. 2258 (1990). In re Sharon Steel Corp., 152 B.R. 450

(Bankr. W.D. Pa. 1993). The city contends that Begier held that

a trust is created for the benefit of the taxing authority

whenever an employer withholds a portion of an employee's wages

as income taxes. Thus, in the city's view, taxes withheld from

an employee but not paid to the city do not become "property of

the estate" when the employer files for bankruptcy even if the

employer had not segregated the "trust" funds from its other

assets. But the bankruptcy court distinguished Begier, primarily

because Begier requires that the taxing authority show "some

nexus between the trust and the assets sought to be applied to

the debtor's trust fund tax obligations" and, in the court's

view, the city could not "establish the required nexus with

regard to the commingled funds in [Sharon Steel's] possession."

Id. at 451-52. In other words, unlike in Begier, where the

debtor had paid the taxes withheld to the Internal Revenue

Service prior to filing its bankruptcy petition, thereby creating

a segregated fund, Sharon Steel commingled the funds with its

other assets and the funds remained commingled when Sharon Steel

filed its Chapter 11 petition.

The city appealed but the district court affirmed the

bankruptcy court's decision in a written opinion, agreeing with
the bankruptcy court that "the facts of this case are

distinguishable from [those in] Begier" and that the City "has

failed to demonstrate the required nexus between the taxes and

the commingled funds in the possession of the estate of Sharon

Steel." In re Sharon Steel Corp., Civ. No. 93-0736, at 3-4 (W.D.

Pa. Feb. 11, 1994). The district court also distinguished Begier

on the basis that the statutory "language establishing a 'trust

fund' in the withheld taxes in Begier is absent in the pertinent

statute and ordinance governing withholding taxes for Farrell."

Id. The district court entered its order on February 14, 1994,

affirming the bankruptcy court's order. The city has appealed to

us from that order.

The bankruptcy court had subject matter jurisdiction

under 28 U.S.C. § 157(b) and 11 U.S.C. § 362(d) as the City of

Farrell filed a motion to lift the automatic stay and compel

turnover of the trust fund taxes. The district court had

appellate jurisdiction under 28 U.S.C. § 158(a) over the

bankruptcy court's denial of the City's motion, as the bankruptcy

court's order denying the city relief was final. We have

jurisdiction under 28 U.S.C. § 158(d) over the district court's

final order affirming the bankruptcy court's order.

III. DISCUSSION

a. Introduction
The crux of this appeal is whether the remaining

portion of the funds Sharon Steel withheld from its employees'

wages for the fourth quarter of 1992 constitutes property of its
bankruptcy estate or whether it is excluded from the estate by 11

U.S.C. § 541(d), which excludes equitable interests of third

parties from a bankrupt's estate.1 If the funds are property of

the estate, then the bankruptcy court and district court

correctly rejected the city's claim; but if the funds are not

property of the estate, they should be paid to the city unless,

as we discuss below, Sharon Steel's pre-petition lenders have a

prior claim to the funds. The City of Farrell primarily contends

that because Sharon Steel retained the funds withheld in trust

for the city, the funds are not property of the estate, and that

therefore we should reverse the district court's order. In

considering this appeal we are exercising plenary review because

both the bankruptcy court and the district court decided the case

as a matter of law on facts which so far as considered by those

courts were not disputed. In re Brown, 851 F.2d 81, 84 (3d Cir.

1988).

1
. 11 U.S.C. § 541(a)(1) provides that the property of the
estate includes "all legal or equitable interests of the debtor
in property as of the commencement of the case." Section 541(d)
provides the following exception:

Property in which the debtor holds, as of the
commencement of the case, only legal title and not
an equitable interest . . . becomes property of
the estate under subsection (a)(1) of this section
only to the extent of the debtor's legal title to
such property, but not to the extent of any
equitable interest in such property that the
debtor does not hold.
 We start from the well-settled principle that debtors

do "not own an equitable interest in property . . . [they] hold[

] in trust for another," and that therefore funds held in trust

are not "property of the estate."2 Begier, 496 U.S. at 59, 110

S.Ct. at 2263; see also 11 U.S.C. § 541(d); Universal Bonding

Ins. Co. v. Gittens & Sprinkle Enters., 960 F.2d 366, 371 (3d

Cir. 1992). In general, "to establish rights as a trust

recipient, a claimant must make two showings: (1) demonstrate

that the trust relationship and its legal source exist, and (2)

identify and trace the trust funds if they are commingled."

Goldberg v. New Jersey Lawyers' Fund, 932 F.2d 273, 280 (3d Cir.

1991); In re Columbia Gas Sys. Inc., 997 F.2d 1039, 1063 (3d Cir.

1993) ("beneficiaries of trust funds bear the burden of

identifying and tracing their trust property"), cert. denied, 114

S.Ct. 1050 (1994). Goldberg teaches that we look to state law to

determine whether the claimant has shown a trust relationship,3

but that we look to federal law to determine whether the claimant

2
. The "classic definition of a trust . . . [is that] the
beneficiary has an equitable interest in the trust property while
legal title is vested in the trustee." In re Columbia Gas Sys.
Inc., 997 F.2d 1039, 1059 (3d Cir. 1993), cert. denied, 114 S.Ct.
1050 (1994).
3
. See Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914,
918 (1979) ("Congress has generally left the determination of
property rights in the assets of a bankrupt's estate to state
law."); see also In re Nejberger, 934 F.2d 1300, 1302 (3d Cir.
1991) ("Although section 541 defines property of the estate, we
must look to state law to determine if a property right exists
and to stake out its dimensions.").
has traced and identified the trust funds.4 Goldberg, 932 F.2d

at 280; see also Universal Bonding, 960 F.2d at 369; In re Markos

Gurnee Partnership, 163 B.R. 124, 129 & n.4 (Bankr. N.D. Ill.

1993); In re Visiting Nurse Ass'n v. Bowen, 143 B.R. 633, 641

(W.D. Pa. 1992) ("Once a bankruptcy court makes a determination

concerning whether a debtor has any legal or equitable interest

in property based upon applicable state law, whether the property

will come into the estate is a federal question.") (internal

quotations and citations omitted)), aff'd, 986 F.2d 1410 (3d Cir.

1993) (table).

In considering this case we naturally focus first on

Begier. In Begier, the trustee filed an adversary proceeding

against the United States, claiming that the debtor's pre-

petition payment of withheld federal income tax to the Internal

Revenue Service was a voidable preference under 11 U.S.C. §

547(b). The Supreme Court rejected the trustee's position,

holding that the payment of the taxes to the IRS was not a

voidable preference because the funds transferred were not

property of the debtor, but rather were held in trust for the

government. Begier, 496 U.S. at 66-67, 110 S.Ct. at 2267. In

finding that a trust existed, the Court relied on a section of

the Internal Revenue Code, which provided that persons

4
. Begier is not inconsistent with Goldberg's approach. In
Begier, the Court solely confronted federal issues, so it
naturally looked to federal law to determine whether the claimant
proved a trust relationship. Additionally, the Court looked to
federal law to determine whether the claimant identified and
traced the trust funds.
withholding taxes hold the withheld funds in trust for the IRS.5

The Court also found that the debtor's pre-petition payments of

withholding amounts to the IRS constituted a sufficient enough

nexus to take the funds out of the bankruptcy estate.

The city contends that Begier mandates that we reverse

the district and bankruptcy courts' orders denying the city's

motion to lift the automatic stay and compel turnover of the

remaining funds withheld. The district court found two

independent reasons for denying the city's motion: (1) the city

failed to show that a statutory trust had been created; and (2)

the city failed to show the appropriate "nexus" between the

debtor's assets and the withholding funds. Sharon Steel and

Citibank, as agent for certain of Sharon Steel's creditors,

contend that the district court correctly held that Begier is

distinguishable and that therefore we should affirm its order

affirming the bankruptcy court. Accordingly, we will discuss the

district court's two reasons for denying the City's motion.
b. Was a trust created in the taxes withheld?

The district court concluded that while there is no

"statutory authority . . . [for] Farrell's contention that these

taxes are held in trust," the statute involved in Begier, 26
U.S.C. § 7501, "expressly designates that taxes withheld by an

5
. The Court quoted: "'Whenever any person is required to
collect or withhold any internal revenue tax from any other
person and to pay over such tax to the United States, the amount
of tax so collected or withheld shall be held to be a special
fund in trust for the United States.'" 496 U.S. at 60, 110 S.Ct.
at 2263 (quoting 26 U.S.C. § 7501).
employer are held in trust for the United States." In re Sharon

Steel Corp., Civ. No. 93-0736, at 3-4. In response, the city

argues that Pennsylvania law demonstrates that Sharon Steel did

hold the taxes in trust for the city. See City of Philadelphia

v. Penn Plastering Corp., 253 A.2d 247 (Pa. 1969), and City of

Philadelphia v. B. Axe Co., 397 A.2d 51 (Pa. Commw. Ct. 1979).

We are satisfied that in determining whether a trust has been

created we look to the entire body of germane state law,

including the relevant case law, and that we should not be

confined solely by the applicable authorizing statute. See,

e.g., Goldberg, 932 F.2d at 280; In re Markos Gurnee, 163 B.R. at

129; In re Visiting Nurse Ass'n, 143 B.R. at 641-42; In re King,

117 B.R. 339, 341 (Bankr. W.D. Tenn. 1990).

We find that under Pennsylvania case law, when Sharon

Steel withheld the city income taxes a trust was created so that

Sharon Steel held the funds in trust for the city. Penn Plaster

is instructive in this regard. That case involved a suit by the

City of Philadelphia against a corporation doing business in

Philadelphia and its president to collect wage taxes withheld by

the corporation. As the corporation's president filed

"preliminary objections in the nature of a demurrer," the court

accepted Philadelphia's averments as true, finding that "the

taxes were collected by the corporation as agent for

[Philadelphia] and that [the president as] the active and

controlling officer . . . failed to pay the taxes so collected

over to the City." Penn Plaster, 253 A.2d at 248-49.
Philadelphia argued that when the corporation withheld the city
income tax, the corporation and its president as its controlling

officer and director became "trustees of those wage taxes" and

had "a duty to pay those funds over to [Philadelphia]." Id. at

248. The Pennsylvania Supreme Court agreed, holding that "[o]ne

who collects taxes as agent for a city and fails to pay the same

over to the city has long been held to be a trustee ex

maleficio." Id. at 249 (citing City of Philadelphia v. Heinel

Motors, Inc., 16 A.2d 761 (Pa. Super. Ct. 1940)); see also City

of Philadelphia v. B. Axe Co., 397 A.2d 51.

Penn Plaster's reference to the principle that the

party who "collects taxes as agent for a city and fails to pay

the same over to the city [is] . . . a trustee ex maleficio[,]"

does not somehow undermine our conclusion that when Sharon Steel

withheld the City of Farrell income tax, a trust was created.

Rather, the reference supports our result. After all, the

principle that Penn Plaster's reasoning recognized was premised

on the concept that a trust was created when the corporation

withheld the income taxes. The court stated that it is

undisputed "that corporations must act through individuals and

where the individuals are the active and controlling officers and

agents of the corporation and they fail to administer the trust
responsibilities of the corporation, those responsibilities are

imposed upon the individuals who are responsible for the

performance of the trust duty." Penn Plaster, 253 A.2d at 125

(emphasis added). Therefore, Penn Plaster clearly contemplated

that when a corporation withholds municipal income taxes,

Pennsylvania law imposes a "trust responsibility" and thus the
corporation retains the funds withheld as trustee for the

municipality.

Heinel Motors, cited in Penn Plaster, supports our

conclusion that, under Pennsylvania law, a trust is created when

an employer withholds city income taxes. Heinel Motors involved

the question of whether a trust is created when a vendor collects

sales tax from a purchaser of goods subject to the tax. In

making its analysis, the Heinel court extensively considered

precedent regarding the creation of trusts and concluded that the

"receipt of the tax money by the vendor operates to create a

constructive trust." Heinel Motors, 16 A.2d at 765. The court

reasoned, in part, that as the sales tax was imposed on the

purchaser and not on the vendor, the vendor collected the tax as

trustee for the state. Indeed, the court recognized the broad

principle that "[e]very person who receives money to be paid to

another or to be applied to a particular purpose is a trustee[.]"

Id. (citations and internal quotations omitted). Clearly,

therefore, the tax in Heinel Motors is similar to the withholding

tax at issue here, as in both instances the entity holding the

tax funds is not responsible for the burden of the tax but only

is responsible for collecting it. See also In re King, 117 B.R.
at 341.

We acknowledge that sales taxes are paid to the vendor

by a third party but when income tax is involved the employer had

possession of the funds it withholds prior to paying wages to the

employee. However, this distinction does not affect our result.

In substance, when the employer pays wages and withholds taxes it
is paying the employees' taxes to itself since the employee has

earned his or her entire gross wages. Indeed, the only reason

that the employer need not pay the funds withheld to the employee

is that the applicable law requires the employer to withhold the

wages for application on the employee's tax obligations. Thus,

it would be artificial to characterize the withholding tax

situation as simply creating a debtor-creditor relationship

between the employer and the city. The real debt is the

employees' tax liability to the city and the employer is merely

the conduit for its employees' tax payments. Consequently, we

hold that under Pennsylvania law Sharon Steel held the

withholding taxes in trust for the City of Farrell.6
6
. In re Markos Gurnee, 163 B.R. 124, does not conflict with
our conclusion. There, the Illinois Department of Revenue
claimed that it had a trust-fund interest in the debtor's general
assets to the extent of unpaid hotel occupation and use taxes.
Markos Gurnee, 163 B.R. at 127. The court held against the
state, reasoning that the statutes creating the hotel occupation
and use taxes did not "create a trust in favor of the state."
Id. at 130.

But as the Markos Gurnee court recognized, the hotel
occupation and use taxes differed from the type of trust-fund
taxes involved in Begier. The Markos Gurnee court stated that
the "theory of 'trust fund taxes' (like income tax withholding)
is that the tax is imposed on one party (for example, an
employee), but is collected and held by another party (for
example, the employer)." Id. The court held that this theory
was inapplicable to the occupation tax "since the tax is imposed
directly on hotel operators, not their customers." Id. As to
the use tax, the court held that the statute's plain language
shows that state is a creditor and "not in the position of a"
beneficiary. Id. at 131-32. Thus, Markos Gurnee is
distinguishable from this case, because the occupation tax is a
direct tax on the hotel while the City of Farrell income tax is a
direct tax on the employees and not on Sharon Steel, and because
the Illinois use tax statute's plain language merely creates a
debtor-creditor relationship between the taxing authority and the
party responsible for remitting the taxes.
c. Does the source of the trust distinguish this case from

Begier?

We must now decide whether the trust created under

Pennsylvania law warrants the same treatment as the trust created

under the statute in Begier, 26 U.S.C. § 7501. Section 7501

provides that "[w]henever any person is required to collect or

withhold any internal revenue tax from any other person and to

pay over such tax to the United States, the amount of tax so

collected or withheld shall be held to be a special fund in trust

for the United States." According to the Begier Court, this

statutory trust extends "only to 'the amount of tax so collected

or withheld,'" and that the trust is created "at the moment" the

employer paid its employees' wages. Begier, 496 U.S. at 60-61,

110 S.Ct. at 2263-64. Moreover, Begier rejected the argument

that segregation of the withheld funds was a prerequisite to the

creation of a trust. Id. at 60-61, 110 S.Ct. at 2264.

(..continued)

We also recognize the following additional point. It
is conceivable that an employer paying wages might not have the
funds to pay the gross wages in full, though it could pay the
employees their net wages after withholding. In that event it
reasonably could be argued that no trust has been created in the
"withheld" taxes as there were no funds to withhold. Clearly,
the larger the amount of taxes to be deducted the more plausible
would be the argument that a trust had not been created.
However, while we recognize the plausibility of this argument, we
do not address it because neither Sharon Steel nor Citibank
raises it. Furthermore, we doubt that there would be a factual
predicate for the argument because the City of Farrell income tax
rate was 1% when it was enacted, and we believe it was 1.5% by
1992.
 We find no significant distinction between the trust

created under section 7501 with respect to federal withholding

and the trust created under Pennsylvania law with respect

withholding of local income taxes. First, both statutory schemes

require that the employer withhold the appropriate portion of

income when it pays wages to its employees.7 Thus, as

Pennsylvania case law establishes that a trust is created when

the tax is withheld and as section 7501 creates an express trust

in funds withheld, it is clear that under both statutory regimes

the trust is created when the employer pays the wages.

Second, the Begier Court's primary reason for rejecting

the argument that segregation of the withheld funds is a

prerequisite to the creation of a trust applies with equal force

in this case. Begier stated that requiring segregation as a

prerequisite to the creation of the trust would "mean that an

employer could avoid the creation of a trust simply by refusing

to segregate." 496 U.S. at 61, 110 S.Ct. at 2264. Thus, if

we were to hold that a trust was not created under Pennsylvania

law because Sharon Steel did not segregate the withholding funds,

we would be eviscerating the concept expressed in Penn Plaster
that "[o]ne who collects taxes as agent for a city and fails to

7
. See Begier, 496 U.S. at 60, 110 S.Ct. at 2264 ("Section
3402(a)(1) requires that 'every employer making payments of wages
shall deduct and withhold upon such wages [the employee's federal
income tax].'") (emphasis added); and see City of Farrell
Ordinance No. 0-17-66, § 5(b) ("Every employer having . . . [a]
place of business within the City of Farrell . . . shall deduct
at the time of payment thereof, the tax imposed by this Ordinance
on the earned income due to his employe or employes.").
pay the same over to the city has long been held to be a trustee

ex maleficio." 253 A.2d at 249. This would occur because, then,

an employer could avoid creating a trust simply by commingling

the withholding funds with its other assets.

Moreover, we must recognize the city's equitable

interest in the funds withheld even though Pennsylvania law and

the city ordinance do not create an express trust in the withheld

funds. Whatever may be true in other contexts, the distinction

between a direct trust (i.e. one expressly created by the

parties) and a constructive trust (i.e. one imposed by law) has

no relevance to the issues on this appeal. As we recently

stated, "Congress clearly intended the exclusion [of trust funds

from the debtor's estate] created by section 541(d) to include

not only funds held in express trust, but also funds held in

constructive trust." In re Columbia Gas, 997 F.2d at 1059

(citing H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 368 (1977),

reprinted in 1978 U.S.C.C.A.N. 5963, 6324).

We are not alone in this approach. The Court of

Appeals for the Ninth Circuit, in In re Unicom Computer Corp., 13

F.3d 321, 324 (9th Cir. 1994), even more recently indicated,

"[a]lthough we have never expressly held that the same rule

(viz., funds held in trust are property neither of the debtor nor

of the bankruptcy estate) should apply as well to situations

involving funds held by a debtor in constructive trust, the rule

would seem to apply with equal force to both situations."

Therefore, since we have recognized that the crux of this appeal

is whether the withholding funds fall within section 541(d)'s
exception to "property of the estate," the fact that the trust at

issue is constructive rather than express has no bearing on our

decision. Accordingly, we find no reason not to analyze the

trust in this case in the same manner as Begier analyzed the

trust created by 26 U.S.C. § 7501. We hold that because a trust

was created under Pennsylvania law when Sharon Steel withheld the

income tax, the district court erred when it held that the City

of Farrell did not show a trust relationship.

d. Has the city satisfied Begier's "nexus" requirement?

In Begier, after the Court concluded that a trust was

created "at the moment" of wage payment, it analyzed whether "the

particular dollars that . . . [the debtor] paid to the IRS were

'property of the debtor.'" Begier, 496 U.S. at 61, 110 S.Ct. at

2264 (emphasis added). In other words, the Court wrestled with

how to determine whether the "assets transferred to the IRS .

. . were trust property." Id. at 62, 110 S.Ct. at 2265. This

inquiry mirrors the second part of our Goldberg test, i.e.

whether the claimant identified and traced the trust funds. See

932 F.2d at 280.

Because the statute creating the trust considered in

Begier, section 7501, provided no guidance on this issue, the
Court stated that it "might naturally begin with the common-law

rules that have been created to answer such questions about other

varieties of trusts." 496 U.S. at 61, 110 S.Ct. at 2265. The

Court, however, concluded that "[c]ommon-law tracing rules . . .

are unhelpful in this special context," reasoning that "[u]nlike

a common-law trust, in which the settlor sets aside particular
property as the trust res, § 7501 creates a trust in an abstract

'amount'-- a dollar figure not tied to any particular assets --

rather than in the actual dollars withheld." Id. at 62-63, 110

S.Ct. at 2265 (emphasis added). As we have concluded that we

should analyze the trust in this case as Begier analyzed a

section 7501 trust, we find that the common-law tracing rules

should not apply to our decision on whether the city has

satisfied Begier's nexus requirement.

Were it not for Begier, our task would be more

difficult because of the Supreme Court's opinion in United States

v. Randall, 401 U.S. 513, 91 S.Ct. 991 (1971). In Randall, the

Court confronted a situation very similar to this appeal. There,

the United States sought, in the bankruptcy proceeding, to

satisfy the debtor's pre-petition tax obligations from the

debtor's post-petition general assets. The United States argued

that the debtor held an amount representing the tax obligation in

trust for the government and that this amount could be traced to

the debtor's funds when the petition was filed. In response, the

trustee argued that no trust had been created because the debtor

did not segregate any funds for the tax obligation. The Court

did not accept either argument. Instead, it held that the IRS

could not recover the taxes ahead of administrative expenses,

reasoning that "the statutory policy of subordinating taxes to

costs and expenses of administration would not be served by

creating or enforcing trusts which eat up an estate, leaving

little or nothing for creditors and court officers whose goods

and services created the assets." Id. at 517, 91 S.Ct. at 994.
 Were we to apply Randall on this appeal, we probably

would affirm the district court's order on the basis that a

taxing authority's trust interest in a debtor's pre-petition tax

obligation does not justify granting the authority priority over

claims for administrative expenses. Begier, however, held that

the "strict rule of Randall . . . did not survive the adoption of

the new Bankruptcy Code" section 541. Begier, 496 U.S. at 65,

110 S.Ct. at 2266. The Court's reasons for holding that section

541 displaced the holding in Randall are helpful in shedding

light on the nexus requirement.

In reaching its decision, the Begier Court first

compared the Senate and House bills that led to the enactment of

section 541. Begier stated that the "Senate bill attacked

Randall directly, providing in § 541 that trust-fund taxes

withheld or collected prior to the filing of the bankruptcy

petition were not 'property of the estate.'" Begier, 496 U.S. at

63-64, 110 S.Ct. at 2265 (citing S. Rep. No. 95-1106, at 33

(1978)). As to the House bill, Begier stated that while the

"bill did not deal explicitly with the problem of trust fund

taxes, . . . the House Report stated that 'property of the

estate' would not include property held in trust for another."

Begier, 496 U.S. at 64, 110 S.Ct. at 2265-66 (citing H.R. Rep.
No. 95-595, at 368 (1977)). Congress's final compromise in

enacting the portion of section 541 that deals with post-petition

transfers, according to Begier, "explicitly provided that 'in the

case of property held in trust, the property of the estate

includes the legal title, but not the beneficial interest of the
property.'" Begier, 496 U.S. at 64, 110 S.Ct. at 2266 (citing

124 Cong. Rec. at 32,417 (remarks of Representative Edwards)).

Next, Begier took the unusual step of treating the

floor statements of a representative "as persuasive evidence of

congressional intent." Begier, 496 U.S. at 64 n.5, 110 S.Ct. at

2266 n.5. The Court quoted Representative Edwards for the

proposition that "the Senate language specifying that withheld or

collected trust-fund taxes are not part of the bankruptcy estate

was deleted as 'unnecessary since property of the estate does not

include the beneficial interest in property held by the debtor as

trustee.'" Id. at 64, 110 S.Ct. at 2266 (citing 124 Cong. Rec.

at 32,417).

Additionally, Begier placed great weight on

Representative Edwards' subsequent discussion of "the effects of

the House language on the rule established by Randall":
[A] serious problem exists where 'trust fund
taxes' withheld from others are held to be
property of the estate where the withheld amounts
are commingled with other assets of the debtor.
The courts should permit the use of reasonable
assumptions under which the Internal Revenue
Service, and other tax authorities, can
demonstrate that amounts of withheld taxes are
still in the possession of the debtor at the
commencement of the case.

Begier, 496 U.S. at 64, 110 S.Ct. at 2266 (citing 124 Cong. Rec.
at 32,417). From this statement, the Court concluded that "by

requiring the IRS to 'demonstrate that amounts withheld are still

in possession of the debtor at the commencement of the case'

[i.e. at the filing of the petition] . . . , Congress expected

that the IRS would have to show some connection between the §
7501 trust and the assets sought to be applied to a debtor's

trust-fund tax obligations." Begier, 496 U.S. at 65-66, 110

S.Ct. at 2266 (emphasis added). The Court continued by asking

just "how extensive the required nexus must be." Id. (emphasis

added). Answering that question, the Court held that in Begier

the pre-petition payment to the IRS satisfied the nexus

requirement.8 Id. at 67, 110 S.Ct. at 2267. Thus, as Begier

involved a pre-petition payment, while here we have no such

8
. In explaining this "nexus" requirement, Begier stated that
the "Bankruptcy Code provides no explicit answer, and
Representative Edwards' admonition that courts should 'permit
reasonable assumptions' does not add much." Begier, 496 U.S. at
66, 110 S.Ct. at 2266. Accordingly, the Court looked to the
following statement from the House Report for guidance:

'A payment of withholding taxes constitutes a
payment of money held in trust under Internal
Revenue Code § 7501(a), and thus will not be a
preference because the beneficiary of the trust,
the taxing authority, is in a separate class with
respect to those taxes, if they have been properly
held for payment, as they will have been if the
debtor is able to make the payments.'

Id. at 66, 110 S.Ct. at 2267 (quoting H.R. Rep. No. 95-595, at
368 (1977), 1978 U.S.C.C.A.N. at 6324). "In the absence of any
suggestion in the Bankruptcy Code about what tracing rules to
apply," the Court adopted a literal reading of the above quote.
Under this literal reading, the Court held that "any voluntary
prepetition payment of trust-fund taxes out of the debtor's
assets [satisfies the nexus requirement and therefore] is not a
transfer of the debtor's property." Begier, 496 U.S. at 67, 110
S.Ct. at 2267.

This holding does not control the situation before us,
because Begier involved a pre-petition payment to the taxing
authority, while here we confront the taxing authority's attempt
to collect the taxes from the debtor's post-petition general
assets. Of course, the holding that an actual pre-petition
payment will satisfy the nexus requirement does not mean that the
requirement cannot be satisfied in some other way.
payment, we cannot draw a conclusion from Begier as to whether

the City of Farrell has met the nexus requirement.

Nevertheless Sharon Steel argues that as "it is

undisputed that the [t]axes were not held in a segregated account

. . . [or] paid prepetition, . . . the required nexus cannot be

established." Brief at 13 (emphasis added). But its argument

misconstrues Begier's nexus requirement, because it contemplates

that the nexus requirement is met only if the employer had

segregated the trust fund taxes or transferred them to the taxing

authority before the petition. Yet Begier's reliance on

Representative Edwards' remarks shows that the taxing authorities

should be able to show that the nexus requirement is satisfied in

other ways.9
9
. The bankruptcy court cited In re Kulzer Roofing, Inc., 139
B.R. 132 (Bankr. E.D. Pa. 1992), aff'd 150 B.R. 134 (E.D. Pa.
1992), and In re Russman's, Inc., 125 B.R. 520 (Bankr. E.D. Tenn.
1991), for the proposition that the "City of Farrell cannot
establish the required nexus with regard to the commingled funds
in [Sharon Steel's] possession." In re Sharon Steel Corp., 152
B.R. at 451-52. Kulzer is readily distinguishable as it did not
involve a taxing authority, but involved private parties'
attempts to collect funds that were commingled in the debtor's
general assets. The bankruptcy court rejected the attempt
because the claimants had not established that the funds were
held in either an express or a constructive trust. 139 B.R. at
141. Of course, even if Kulzer were not distinguishable we would
not be bound to follow it.

Russman, however, though concerning sales taxes, raises
trust-fund issues similar to those in this case. Russman held
that a state taxing authority had satisfied Begier's nexus
requirement with respect to segregated funds but had not
satisfied the nexus requirement "with regard to the commingled
funds remaining on deposit in the trustee's general operating
account." Russman, 125 B.R. at 524. But the court reached its
conclusion with respect to the commingled funds without analysis
and in these circumstances we do not find the opinion persuasive.
 Because the Begier Court relied heavily on

Representative Edwards' remarks when deciding whether the pre-

petition transfer satisfied the nexus requirement, we will give

his remarks similar weight in considering whether the City of

Farrell has satisfied the nexus requirement. Specifically, as

partially quoted earlier, Representative Edwards stated that:
Where it is not possible for the Internal
Revenue Service to demonstrate that the amounts of
taxes withheld are still in the possession of the
debtor at the commencement of the case, present
law generally includes amounts of withheld taxes
as property of the estate. . . . Nonetheless, a
serious problem exists where 'trust fund taxes'
withheld from others are held to be property of
the estate where the withheld amounts are
commingled with other assets of the debtor. The
Courts should permit the use of reasonable
assumptions under which the Internal Revenue
Service, and other taxing authorities, can
demonstrate that amounts of withheld taxes are
still in the possession of the debtor at the
commencement of the case. For example, where the
debtor had commingled that amount of withheld
taxes in his general checking account, it might be
reasonable to assume that any remaining amounts in
that account on the commencement of the case are
withheld taxes.

124 Cong. Rec. at 11,047. Thus, Representative Edwards spoke

about a situation in which an employer commingles the trust-fund

taxes in its general checking account and subsequently files for

bankruptcy without having paid the taxes to the appropriate

taxing authority.

We, however, face an insurmountable hurdle barring us

from deciding whether the City of Farrell has satisfied the nexus

requirement, because neither the bankruptcy court nor the

district court made findings of fact on which we could predicate
such a determination. This omission is understandable, since the

bankruptcy court and district court believed that the city could

not satisfy the nexus requirement as Sharon Steel's funds were

commingled and Sharon Steel did not pay the taxes before it filed

its Chapter 11 petition. Nevertheless Representative Edwards'

example of what "might" constitute a reasonable assumption could

be applicable here.10

As we have indicated, Representative Edwards stated

that "where the debtor had commingled [the] amount of withheld

taxes in his general checking account, it might be reasonable to

assume that any remaining amounts in that account on the

commencement of the case are withheld taxes." Sharon Steel

concedes that before it filed for bankruptcy, Citibank

"controlled all monies coming into Sharon Steel through a lock

box account . . . [and] Citibank would authorize disbursement of

funds from the [l]ock [b]ox [a]ccount to Sharon Steel's operating

10
. We recognize that allowing courts to consider commingling in
deciding whether a sufficient nexus exists runs counter to our
holding above that a party should not be able to defeat a trust
"simply by commingling the withholding funds with its other
assets." See typescript at 15. Nonetheless, as the Supreme
Court held in Begier, the question of whether a trust exists is
analytically distinct from whether or not the trust funds are
traceable and identifiable. The first question involves an
inquiry into state law; the second does not. Therefore,
considerations relevant to the first question are not always
coextensive with considerations relevant to the second. To some
extent, however, Representative Edwards' comments were intended
to make equitable considerations part of the "nexus" inquiry as
well. Thus, when applying the guidelines we set forth to
determine whether a nexus exists, the bankruptcy court certainly
should keep in mind the broader policy against allowing a party
unilaterally to make a trust unenforceable by commingling assets.
accounts." Brief at 3. Thus, as Sharon Steel's funds were

placed in the lock box account, it would be reasonable to

conclude that the withheld funds were held in trust for the City

of Farrell in that account. Moreover, when Sharon Steel filed

its Chapter 11 petition the lock box account may have contained

an amount of funds exceeding the remaining withholding held in

trust for the City. If so, we have the exact set of facts that

Representative Edwards contemplated: i.e. pre-petition trust-

fund taxes commingled in the debtor's general checking account.11

Because it is manifest that we do not know sufficient

facts to determine whether the City of Farrell has met the nexus

requirement, we will remand the case to the district court which

in turn will remand it to the bankruptcy court for appropriate

fact finding. The district court and the bankruptcy court should

be cognizant of the factual findings necessary to apply the

"lowest intermediate balance test" ("LIBT"). The LIBT is a

judicial construct that some federal courts have applied to ease

a beneficiary's tracing burden when "a trustee commingles trust
funds with other monies in a single account." In re Columbia

Gas, 997 F.2d at 1063. The LIBT "allows trust beneficiaries to

assume that trust funds are withdrawn last from a commingled

11
. We reject any argument that because the City of Farrell is
not the IRS, it should not receive the benefits of Representative
Edwards' remarks. He specifically stated that "[t]he Courts
should permit the use of reasonable assumptions under which the
Internal Revenue Service, and other taxing authorities, can
demonstrate that amounts of withheld taxes are still in the
possession of the debtor at the commencement of the case." Thus,
we cannot limit the application of his statement to the IRS.
account. Once trust money is removed, however, it is not

replenished by subsequent deposits. Therefore, the lowest

intermediate balance in a commingled account represents trust

funds that have never been dissipated and which are reasonably

identifiable." Id.

At this time we do not decide definitively that the

district court and the bankruptcy court must apply the LIBT as

the parties have not briefed the issue and neither the bankruptcy

court nor the district court addressed the applicability of the

LIBT. But, as we recognize that the LIBT may constitute a

"reasonable assumption[] under which the Internal Revenue

Service, and other taxing authorities, can demonstrate that

amounts of withheld taxes are still in the possession of the

debtor at the commencement of the case[,]" we will instruct that

on remand, the bankruptcy court make factual findings sufficient

to support a conclusion as to whether the city may recover if, as

a matter of law, the LIBT is applied.

Sharon Steel also contends that the city did not

request discovery and relied exclusively on Begier in the

bankruptcy court. Thus, in Sharon Steel's view, the city has

waived its rights to discovery and we therefore should not remand

for additional fact-finding. Brief at 8-9. The city responds

that the procedural posture of the case in the bankruptcy court

precluded it from obtaining discovery. We need not linger on

this point as Sharon Steel's argument necessarily is predicated

on its contention that we must apply a clearly erroneous standard

of review to the bankruptcy court's finding that "[t]he City of
Farrell cannot establish the required nexus with regard to the

commingled funds in [Sharon Steel's] possession." Brief at 10.

The bankruptcy court made this finding on the basis of its

correct observation that "there is no allegation that there

exists a segregated trust fund and the amount in question has not

been paid." In re Sharon Steel Corp., 152 B.R. at 451. In view

of those legal conclusions drawn from undisputed facts it would

have been pointless for the city to request discovery as the

discovery would not have been directed to the issues which the

bankruptcy court thought were outcome determinative as a matter

of law. Rather, discovery could be germane only to determine the

status of funds that Sharon Steel had neither segregated nor paid

before filing its Chapter 11 petition. Accordingly, in light of

our legal conclusion that the bankruptcy court misstated the law,

it is only fair that the parties have an opportunity to develop

the facts relating to the broader method of satisfying the nexus

requirement which we recognize. Consequently, we reject Sharon

Steel's argument that we should not remand for additional factual

findings.

We deal with one final point. Citibank, as agent for

certain lenders, asserts that "the only source of funds available

to pay the taxes is the Cash Collateral Account which secures

[Sharon Steel's] obligations to the Lenders under" a prepetition

credit agreement on which the lenders have a prior lien.

Therefore in its view the taxes cannot be paid without the

lenders' consent. It concludes the taxes cannot be paid at all

as the lenders do not consent. Brief at 10-11. Neither the
district court nor the bankruptcy court considered this issue and

the parties have not briefed it on this appeal, though Citibank

has mentioned the point in a conclusory fashion. Furthermore,

the record is not clear as to exactly how Citibank and Sharon

Steel treated Sharon Steel's funds. In these circumstances we

are satisfied that we should not address Citibank's argument but

we reach our result without prejudice to Citibank's position on

this point which it may advance on the remand.

In sum, therefore, we will reverse the district court's

order of February 14, 1994, and will remand the case to the

district court for proceedings consistent with this opinion.

Specifically, on further remand, the bankruptcy court should make

factual findings about Sharon Steel's payment of wages and the

withholding, i.e. the accounts in which the withholding was

placed, the deposit and withdrawal history of those accounts, and

the amounts remaining in those accounts at the time Sharon Steel

filed its bankruptcy petition. Furthermore, Citibank may assert

that the lenders which it represents have a lien on the funds

from which the city seeks payment.