Floyd v. Internal Revenue Service of United States

F I L E D
United States Court of Appeals
Tenth Circuit
PUBLISH
AUG 10 1998
UNITED STATES COURT OF APPEALS
PATRICK FISHER
Clerk
TENTH CIRCUIT

GREGORY F. FLOYD and DENISE
D. FLOYD, doing business as Medical
Information Services; HAROLD
DEAKINS and LYNNE DEAKINS,
doing business as K and L Computers;
RHONDA SIPPEL, doing business as
Statbilling; JERRY NEVONEN, doing
business as Network Facilities;
WILLIAM MUTH, doing business as
Electronic Billing Services; JACKIE
RAY, doing business as Medical
Billing Service; THOMAS PERRY,
No. 96-3166
doing business as TurboClaim,

Plaintiffs - Appellants,
v.

INTERNAL REVENUE SERVICE of
the United States of America; STATE
OF KANSAS ex rel. Carla Stovall,
Attorney General; 12424 ABERDEEN,
JOHNSON COUNTY, KANSAS, a
certain piece of real estate,

Defendants - Appellees.
GREGORY F. FLOYD, DENISE D.
FLOYD, doing business as Medical
Information Services; HAROLD
DEAKINS, LYNNE DEAKINS, doing
business as K and L Computers;
RHONDA SIPPEL, doing business as
Statbilling; JERRY NEVONEN, doing
business as Network Facilities;
WILLIAM MUTH, doing business as
Electronic Billing Services; JACKIE
RAY, doing business as Medical
Billing Service; THOMAS PERRY,
doing business as TurboClaim,

Plaintiffs - Appellees,
and

INTERNAL REVENUE SERVICE of
No. 96-3215
the United States of America,

Defendant - Appellee,

v.

STATE OF KANSAS ex rel. Carla
Stovall, Attorney General,

Defendant - Appellant,

and

12424 ABERDEEN, JOHNSON
COUNTY, KANSAS, a certain piece
of real estate,

Defendant.

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 Appeal from the United States District Court
for the District of Kansas
(D.C. No. 95-2177-JWL and 95-CV-2177)

Edward A. McConwell (Laura L. McConwell with him on the brief), McConwell
Law Offices, Overland Park, KS, for Gregory F. and Denis D. Floyd, Harold and
Lynne Deakins, Rhonda Sippel, Jerry Nevonen, William Muth, Jackie Ray and
Thomas Perry.

Martin J. Peck, Special Assistant Attorney General, Wellington, KS, for the State
of Kansas.

Theodore M. Doolittle (Kenneth L. Greene with him on the briefs), Department of
Justice, Washington, D.C., for the Internal Revenue Service.

Before HENRY, and LUCERO, Circuit Judges, and MILES-LaGRANGE,
District Judge. *

LUCERO, Circuit Judge.

Thomas Bridges and his associated companies are in debt to three parties:

the Internal Revenue Service (“IRS”), the State of Kansas, and a group of private

judgment-creditors, the “Floyd plaintiffs.” These three parties sought judicial

resolution of the priority of their claims to the assets of Bridges and his

companies. Following a bench trial, the District Court for the District of Kansas

held that the IRS claims primed those of the other two parties, and that, as to the

*
The Honorable Vicki Miles-LaGrange, United States District Judge for the
Western District of Oklahoma, sitting by designation.

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remaining assets, Kansas took priority over the Floyd plaintiffs. The district

court’s holding was premised in part on the IRS’s position that one of Bridges’s

companies was his alter ego. Because we find that the district court erred in

accepting the IRS’s alter ego argument, we reverse and remand.

I

In 1991, Thomas Bridges founded two corporations, Network Billing

Centers, Inc. (“NBC”) and Med-Net Technologies, Inc. (“Med-Net”), both in the

business of licensing and developing computer software. Bridges, who was the

sole shareholder and director of these companies, had complete control over them.

Bridges’s salary from NBC was paid into the account of Thomas Marketing, Inc.

(“TMI”), another corporation founded and controlled by him and of which he was

the sole shareholder and director.

The IRS’s claims against Bridges and his associated companies date from

Bridges’s failure to pay personal income tax in 1984. The IRS first filed a Notice

of Federal Tax lien against Bridges in 1990. In 1993, the IRS filed additional tax

liens against Bridges as a result of his failure to pay personal income tax between

1988 and 1991. The following year, the IRS filed two tax liens against Med-Net

for failing to pay employment taxes for the second and third quarters of 1993.

Kansas’s claims are based on a pre-judgment attachment of Med-Net, NBC, and

TMI accounts following the filing of an action by the State against Bridges, Med-

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Net, and NBC under the Kansas Consumer Protection Act (“KCPA”). Kansas

won this action in late March 1994, obtaining judgment for just under $1 million.

The Floyd plaintiffs’ claim is based on their successful suit against Bridges, NBC,

and Med-Net for fraud and breach of contract. They secured judgment in early

March 1994.

These three creditors dispute their priority to two groups of assets: first,

some $179,000, which constitutes proceeds from the sale of a house in Lenexa,

Kansas, held in the registry of the United States District Court for the District of

Kansas pursuant to a settlement between the three creditors; second, some

$84,000 from the Med-Net, NBC, and TMI accounts attached by Kansas, which is

held in the registry of the District Court of Johnson County. 1

The Lenexa house was purchased using primarily Med-Net funds in 1992.

Bridges’s daughter, Brooke Bridges McBride, filed an affidavit of equitable

interest in the property with the register of deeds in Johnson County; legal title

was apparently to pass from the construction company to McBride pursuant upon

1
The total amount seized was approximately $155,000. This sum was reduced
pursuant to an agreement in August 1994 between the Floyd plaintiffs and the State to
around $84,000.

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full payment under a contract for deed. 2 Both Bridges and McBride lived in the

house.

In April 1994, after obtaining judgment against Bridges, Med-Net, and

NBC under the KCPA, Kansas filed another state court action, which was

subsequently joined by the Floyd plaintiffs, alleging that McBride had received

the house through a fraudulent conveyance from Med-Net and NBC. Shortly

thereafter, the Floyd plaintiffs unsuccessfully attempted to collect on their

judgment against Bridges, Med-Net, and NBC by garnishing McBride, arguing

that Med-Net held its interest in her name. To resolve their claims to the house,

Kansas, McBride, and the Floyd plaintiffs entered into a settlement whereby the

house was to be sold, with the bulk of the proceeds to be contested among the

competing creditors. After filing a lien against the house naming McBride as

Bridges’s nominee, the IRS subsequently joined this settlement, and the house

was sold.

II

The district court accepted the IRS’s arguments that Med-Net was

Bridges’s alter ego and that McBride held the house as Bridges’s nominee. With

The handwritten version of this contract listed Bridges and McBride as
2

purchasers. A typed version prepared the same day lists only McBride. The district court
determined Bridges had his name removed because he did not want the IRS to put a lien
on the house.

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one exception, therefore, the federal tax liens had been filed against Bridges and

Med-Net before either of the other creditors had secured their judgments against

Bridges and his associated companies. 3 Consequently, acting on the principle that

“priority for purposes of federal law is governed by the common-law principle

that ‘the first in time is the first in right,’” United States v. McDermott, 507 U.S.

447, 449 (1993) (quoting United States v. New Britain, 347 U.S. 81, 85 (1954)),

the district court held that the IRS’s claims to the house proceeds primed the

claims of both Kansas and the Floyd plaintiffs. Because the IRS’s claims, which

amounted to some $186,000, exhausted the sale proceeds entirely, the district

court did not determine the relative priority of the other two creditors’ claims to

the house.

The district court further held that the remaining $7,000 still owing to the

IRS should be satisfied from the seized bank accounts, of which it concluded

some $136,000 was traceable to Bridges and his alter ego Med-Net. As to the

remaining bank account funds, the district court found that the State perfected its

attachment lien when it won a favorable judgment in its KCPA suit. Because the

State perfected its interest in the funds before the Floyd plaintiffs executed their

3
The exception is the federal tax lien filed against Med-Net for its failure to pay
employment taxes for the third quarter of 1993. The IRS does not appeal the district
court’s holding that both Kansas and the Floyd plaintiffs’ claims have priority over this
claim.

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judgment liens against those same funds, the district court concluded that Kansas

had priority over the Floyd plaintiffs to whatever funds remained. Kansas and the

Floyd plaintiffs both appeal.

III

Federal tax liens only arise in property as to which the defaulting taxpayer

has rights of ownership. See United States v. Wingfield , 822 F.2d 1466, 1472

(10th Cir. 1987). State law determines such rights. See United States v. Central

Bank of Denver , 843 F.2d 1300, 1303-04 (10th Cir. 1988). Federal law then

determines the priority of competing liens against a taxpayer’s property. See

Aquilino v. United States , 363 U.S. 509, 514 (1960).

Both Kansas and the Floyd plaintiffs argue that Bridges had no rights to the

Lenexa house, thus placing that property beyond the reach of the tax liens filed by

the IRS against Bridges. More specifically, the Floyd plaintiffs argue that the

house was properly owned by Med-Net, and because Med-Net was not Bridges’s

alter ego, the house is properly claimable only by Med-Net creditors. Kansas, for

its part, argues that Bridges fraudulently conveyed the house to McBride, leaving

him without a valid claim to the property under state law.

The district court determined that Med-Net was the alter ego of Bridges

based on Pemco, Inc. v. Kansas Dep’t of Revenue , 907 P.2d 863 (Kan. 1995). If

we accepted Pemco as the controlling authority in this case, we would review that

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determination deferentially. See G.M. Leasing Corp. v. United States, 514 F.2d

935, 939 (10th Cir. 1975) (district court’s finding of alter ego status

“presumptively correct and must be left undisturbed on appeal unless . . . clearly

erroneous”), rev’d in part on other grounds, 429 U.S. 338 (1977). And were we

to do so, we would conclude that the evidence before the district court manifestly

supported its conclusion that the “relationship” between Bridges and Med-Net

was “so intimate,” Bridges’s “control” over Med-Net “so dominating,” and “the

business and assets of the two are so mingled that recognition of [Med-Net] as a

distinct entity would result in an injustice to third parties.” Pemco, 907 P.2d at

867 (quoting Doughty v. CSX Transp., Inc., 905 P.2d 106, 111 (Kan. 1995)). We

also would not find error in the district court’s conclusion that crediting Med-Net

with a separate corporate identity would sanction Bridges’s unjust evasion of his

federal tax liability.

But Pemco does not appropriately govern this case. The Pemco court

considered a parent company’s request to be treated as a single unit with its

corporate subsidiary for sales tax purposes. Ultimately, the court refused that

request because “a corporation, having chosen the legal form in which to exist

and do business, should not be permitted to pierce its own corporate veil to gain a

tax advantage.” Id. at 866. That rule does not speak to the case of an outside

entity—here, the IRS—seeking to pierce the corporate veil.

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 True, Pemco does recite Kansas’s “substantial case law authorizing the

piercing of a corporate veil if to do otherwise would work an injustice on third

parties.” Id. at 867. Those precedents, however, are inapplicable here because

they consider the “standard” veil-piercing situation, in which corporate creditors

seek to disregard the corporate form in order to hold stockholder assets liable for

the corporation’s debts. In this case, we are presented with the reverse

phenomenon because the IRS seeks to pierce Med-Net’s veil and use corporate

assets to satisfy the obligations of an individual stockholder. Cf. Towe Antique

Ford Found. v. IRS , 999 F.2d 1387, 1390 (9th Cir. 1993) (“Ordinarily, courts are

called upon to apply the alter ego doctrine in cases where a party seeks to hold an

individual liable for a business entity’s debts.”); Cascade Energy & Metals Corp.

v. Banks , 896 F.2d 1557, 1575 (10th Cir. 1990) (stating that reverse-piercing

theory employed by district court “led to the peculiar result of holding the

corporation liable for the debts or torts of its controlling shareholder rather than

the other way around”) (emphasis added). The IRS’s claims, in which an outside

party seeks to meld the stockholder and the corporation into one, represent a

“variant” on the usual “reverse-piercing” claim, in which an insider asserts that

theory. See Cascade , 896 F.2d at 1575 n.17; see also Gregory S. Crespi, The

Reverse Pierce Doctrine: Applying Appropriate Standards , 16 J. Corp. L. 33, 37-

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38 (1991) (“Crespi”) (distinguishing between inside and outside reverse-piercing

claims).

The Floyd plaintiffs urge us to reject this outside reverse veil-piercing

theory, at least where third-party corporate creditors would thereby be harmed.

The government counters that numerous cases recognize such a practice in the

federal taxation context. See No. 96-3166, IRS’s Br. at 30 (citing, e.g., Towe ,

999 F.2d at 1390-91). But the question of whether Med-Net can be found to be

Bridges’s alter ego for purposes of reverse veil-piercing must be answered by

state law, see Towe , 999 F.2d at 1391; Terrapin Leasing, Ltd. v. United States ,

No. 79-1086, 1981 WL 15490, at *2 (10th Cir. Apr. 6, 1981), and none of the

authorities cited by the government are drawn from that body of jurisprudence.

Nor does the taxation context of the government’s claim dictate the outcome here.

“The IRS should be viewed as any other creditor seeking to pierce a corporate

veil that is allegedly defrauding it of its legitimate claim.” Terrapin , 1981 WL

15490, at *2.

In fact, there are significant reasons to resist application of the alter ego

doctrine in this case. The IRS has presented no authority suggesting that Kansas

does or would recognize an outside reverse-piercing claim, and our own review of

Kansas law provides no authoritative support for that proposition. See Cascade ,

896 F.2d at 1577 (holding that, “[a]bsent a clear statement” by state supreme

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court adopting outside reverse-piercing theory, federal court will not reverse

pierce). 4

In addition, “[t]he reverse-pierce theory presents many problems.” Id. In

Cascade , we noted two. First, the theory “bypasses normal judgment-collection

procedures whereby judgment creditors attach the judgment debtor’s shares in the

corporation and not the corporation’s assets.” Id. Second, third parties may be

unfairly prejudiced if the corporation’s assets can be attached directly. Although

in Cascade our particular concern was with non-culpable third-party shareholders

of the corporation being unfairly prejudiced, no greater culpability should attach

to the third-party corporate creditors harmed by reverse-piercing in this case. See

id. (“‘[A] necessary element of the [alter ego] theory is that the fraud or inequity

sought to be eliminated must be that of the party against whom the doctrine is

invoked, and such party must have been an actor in the course of conduct

4
The Kansas courts did once apply a variant of reverse piercing—but only in a
jurisdictional context. In Farha v. Signal Cos., 532 P.2d 1330, modified, 535 P.2d 463
(Kan. 1975), the Supreme Court of Kansas upheld a finding of personal jurisdiction
against a corporation, which was not otherwise reachable under the Kansas long-arm
statute, on the grounds that its co-defendant parent corporation transacted business within
the state. While that decision contains alter ego and veil-piercing language, it does not
contain any indication whatsoever that the subsidiary’s assets were reachable as a result
of the parent’s substantive liability. As in personam jurisdiction can be asserted
whenever a defendant has those “minimum contacts” with the forum state that will satisfy
“‘traditional notions of fair play and substantial justice,’” International Shoe Co. v.
Washington, 326 U.S. 310, 316 (1945) (quoting Milliken v. Meyer, 311 U.S. 457, 463
(1940)), the Farha decision is best understood as limited to the jurisdictional context;
these jurisdictional standards should not be presumed to translate into substantive
corporate law.

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constituting the abuse of corporate privilege— the doctrine cannot be applied to

prejudice the rights of an innocent third party .’”) (quoting 1 William Meade

Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations § 41.20, at

413 (1988 Supp.)) (emphasis added); see also Hamilton v. Hamilton Properties

Corp. , 186 B.R. 991, 1000 (Bankr. D. Col. 1995) (“The reverse piercing theory is

an aberration which, if invoked, would prejudice . . . the rightful creditors of the

corporation whose assets are subsumed for the benefit of the creditors of the

individual. What of the creditors of [the corporation] who relied on its separate

corporate existence in doing business with it?”); Cargill, Inc. v. Hedge , 375

N.W.2d 477, 479 (Minn. 1985) (holding that in considering propriety of reverse

pierce, “[a]lso important is whether others, such as a creditor or other

shareholders, would be harmed by a pierce”).

There are reasons beyond those identified in Cascade to deny an alter ego

claim of this kind. For one thing, the prospect of losing out to an individual

shareholder’s creditors will unsettle the expectations of corporate creditors who

understand their loans to be secured—expressly or otherwise—by corporate

assets. Corporate creditors are likely to insist on being compensated for the

increased risk of default posed by outside reverse-piercing claims, which will

reduce the effectiveness of the corporate form as a means of raising credit.

Furthermore, as Judge Learned Hand suggested in what may be the earliest case to

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consider such a claim, outside reverse piercing is only appropriate in the rare case

of a subsidiary dominating its parent. See Kingston Dry Dock Co. v. Lake

Champlain Transp. Co. , 31 F.2d 265, 267 (2d Cir. 1929); see also Crespi at 67

(“Kingston stands for the proposition that the highly unusual circumstance of a

subsidiary dominating its parent is a virtual prerequisite for finding the kind of

unity that would allow an outside[] reverse pierce . . . .”); id. at 57, 65-66. Here,

the premise of the IRS’s position is that the effective subsidiary—Med-Net—was

the dominated party, which makes it hard, if not impossible, to argue for

forfeiture of its assets through a reverse pierce. Additionally, disregard of the

corporate form is an equitable remedy. See McKinney v. Gannett Co. , 817 F.2d

659, 666 (10th Cir. 1987). As a consequence, it is appropriately granted only in

the absence of adequate remedies at law. See 1 William Meade Fletcher et al.,

Fletcher Cyclopedia of the Law of Private Corporations § 41.25, at 653 (perm. ed.

rev. vol. 1990). In cases where a corporation has been dominated by a controlling

stockholder, an agency or aiding and abetting theory may suffice to hold the

corporation liable for the actions of that stockholder. See Crespi at 65. Standard

judgment collection procedures may also suffice to cover shareholder liability

without expanding equitable theories of corporate liability. See Cascade , 896

F.2d at 1577. And, in taxation cases, the transfer of an economic benefit to a

shareholder may be reachable for tax purposes as a constructive dividend, again

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obviating the need for the more drastic remedy of corporate disregard. See

generally 10 Jacob Mertens, Jr. et al., The Law of Federal Income Taxation §

38B.33 (1991).

We recognize that the problems associated with reverse-piercing may be

viewed as less serious in cases where a corporation is controlled by a single

shareholder—there are, for instance, no third-party shareholders to be unfairly

prejudiced by disregarding the corporate form. Should the Kansas courts consider

adopting the doctrine of reverse-piercing, that factor may well influence the terms

of any rule they ultimately adopt. Consequently, we stress that in reciting the

litany of problems associated with the doctrine, we should not be understood as

seeking to dictate or influence the law of corporations in Kansas. Rather, we seek

only to lend additional weight to Cascade ’s federal law conclusion that, in the

absence of a clear statement of Kansas law by the Kansas courts, we will not

assume that such a potentially problematic doctrine already has application in that

state. See Cascade , 896 F.2d at 1577.

IV

The lion’s share of the district court’s analysis of this complex litigation is

premised on its finding that Med-Net was Bridges’s alter ego. The district court’s

conclusion that McBride held title to the house as Bridges’s nominee depends on

its underlying finding that Bridges purchased the house through his alter ego

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Med-Net. Similarly, the determination of priority to the bank account proceeds

assumes that the IRS satisfies the bulk of its claims by means of the proceeds

from the sale of the house. If that latter determination is undone, then the IRS’s

claims to the bank account funds, or the resolution of the other parties’ claims to

the house proceeds, may impact the district court’s determination that Kansas

would receive the bulk of the bank account funds.

However, the district court’s opinion need not inexorably unravel with our

holding here because the IRS also brought a constructive dividend claim. That

claim, if adjudged successful, might lead to the same conclusion as to the

ownership of the house and the court’s subsequent determinations flowing

therefrom. The district court did not rule as to whether Med-Net’s purchase of

the house was a constructive dividend to Bridges. As the record on appeal

contains no indication that the facts relevant to a constructive dividend

determination are undisputed, we cannot decide this question as a matter of law,

and it must instead be resolved in the first instance by the trial court below. Cf.

Dolese v. United States , 605 F.2d 1146, 1153 (10th Cir. 1979). We are therefore

obliged to remand for further proceedings.

REVERSED and REMANDED for further proceedings consonant with the

views herein expressed.

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