United States v. Henshaw

F I L E D
United States Court of Appeals
Tenth Circuit
PUBLISH
NOV 2 2004
UNITED STATES COURT OF APPEALS
PATRICK FISHER
Clerk
TENTH CIRCUIT

UNITED STATES OF AMERICA,

Plaintiff-Appellee,

v. No. 03-5165

TODD HENSHAW,

Defendant-Appellant.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF OKLAHOMA
(D.C. No. 00-CV-236-K)

Submitted on the briefs:

Todd Henshaw, Pro Se.

Eileen J. O’Connor, Assistant Attorney General, Charles Bricken, Attorney, and
Sara Ann Ketchum, Attorney, Tax Division, Department of Justice, Washington,
D.C., for Plaintiff-Appellee.

Before KELLY , HARTZ , and TYMKOVICH , Circuit Judges.

TYMKOVICH , Circuit Judge.
 Defendant Todd Henshaw appeals from a judgment entered against him in

favor of the Government for $20,000 and interest. The district court found that

Henshaw, an attorney, had converted the $20,000 by knowingly collecting his fee

from proceeds his client had derived from the sale of property encumbered by tax

liens. Because the proceeds were commingled with other funds when Henshaw

received the $20,000, the resolution of this case turns on the selection of an

appropriate equitable method for tracing money that has lost its separate identity.

“[A]dherence to specific equitable principles, including rules concerning tracing

analysis[, is] subject to the equitable discretion of the court,” and our review is

limited to an abuse-of-discretion standard. United States v. Durham , 86 F.3d 70,

72 (5 th Cir. 1996); see McKinney v. Gannett Co. , 817 F.2d 659, 670 (10 th Cir.

1987) (“[A]pplication of equitable doctrines rests in the sound discretion of the

district court; absent a showing of abuse of discretion, the district court’s exercise

thereof will not be disturbed on appeal.”). We hold that the district court did not

abuse its discretion in tracing the $20,000 Henshaw received to the encumbered

proceeds and, accordingly, affirm the judgment for the Government. 1

1
After examining the briefs and appellate record, this panel has determined
unanimously that oral argument would not materially assist the determination of
this appeal. See Fed. R. App. P. 34(a)(2); 10th Cir. R. 34.1(G). The case is
therefore ordered submitted without oral argument.

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 Factual and Procedural Background

After a trial to the bench, the district court found the following pertinent

facts. Henshaw’s client, Robert Lowrance, filed for Chapter 11 bankruptcy and

opened a debtor-in-possession account (DIPA). In the course of the proceeding,

he was ordered to open a separately-segregated account (SSA), which he did with

the same bank, to be the repository of proceeds from court-authorized sales of

property subject to federal tax liens. The order prohibited Lowrance from taking

any funds out of the SSA both during and after the bankruptcy proceeding without

the court’s prior approval and notice to the Government. On February 29, 2000,

the court orally granted Lowrance’s motion to dismiss the bankruptcy proceeding,

but with the condition that the dismissal would not affect its order regarding the

sale of assets and disposition of SSA funds. A written order memorializing this

ruling was entered on March 13, 2000.

By December 1999, however, Henshaw was aware that Lowrance had put

SSA funds into the DIPA. Despite knowing that the DIPA was thus tainted by

improperly commingled funds, Henshaw asked Lowrance to pay a portion of his

fee from the DIPA instead of submitting an application to the bankruptcy court

for payment of his fee under 11 U.S.C. § 330. In late February 2000, Lowrance

wrote five checks totaling $664,903.24 on his DIPA. The checks were cleared on

March 1, 2000, the same day that Lowrance wrote a $700,000 check on the SSA

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and deposited the money in the DIPA to cover the withdrawals. One of the five

checks was written to the Bank of Oklahoma for a $20,000 cashier’s check, and

had Henshaw’s name in the memo line. Henshaw accepted the cashier’s check in

payment for his services in the bankruptcy case.

Shortly thereafter, the Government brought this action against Lowrance to

reduce certain tax assessments to judgment and to foreclose on its tax liens. The

Government later added a claim against Henshaw, alleging that he had converted

its property, i.e., proceeds in the SSA that it was entitled to by virtue of its liens,

when he accepted the $20,000 from Lowrance. By way of defense, Henshaw

argued that there was no direct demonstrable link between any SSA funds and the

$20,000 he received from Lowrance and, therefore, he could not have converted

the Government’s money.

Equitable Tracing Issues

Recognizing that commingling of funds in the DIPA made straightforward

legal attribution of particular sums impossible, the district court properly turned

to equitable tracing principles, which are means “used by courts in many different

areas of law to identify and segregate property that has been mingled with other

property in such a manner that it has lost its identity.” William Stoddard, Note,

Tracing Principles in Revised Article 9 § 9-315(B)(2): A Matter of Careless

Drafting, or an Invitation to Creative Lawyering , 3 Nev. L.J. 135, 135 (Fall

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2002). “[T]he goal of ‘tracing’ is not to trace anything at all in many cases, but

rather [to] serve[] as an equitable substitute for the impossibility of specific

identification.” Id. at 142. There are several alternative methods, none of which

is optimal for all commingling cases; courts exercise case-specific judgment to

select the method best suited to achieve a fair and equitable result on the facts

before them. Id. at 139-40, 149.

The district court chose the “last in-first out” (LIFO) method that relates

deposits and withdrawals based on temporal contiguity. The court deemed this an

appropriate approach given the obvious relationship in time and amount between

the deposit from the SSA and the series of checks, including the $20,000 for

Henshaw, written on the DIPA. We agree; “LIFO is an accepted accounting

method and its use was appropriate here.” United States v. Intercontinental

Indus., Inc. , 635 F.2d 1215, 1220 (6 th Cir. 1980).

Henshaw argues, unpersuasively, that equities weigh against the use of any

tracing method, such as LIFO, that would favor the Government’s position here.

He insists that both parties bear responsibility for failing to respond earlier to

Lowrance’s misconduct and asserts that, between the two, the Government should

bear the loss. We cannot agree. The Government may have been in a position at

some point to discover and object to Lowrance’s misuse of the SSA and DIPA,

but Henshaw–Lowrance’s attorney –was in a position to do something about it

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from the outset. Instead, as Henshaw admits, he left Lowrance to police himself,

without professional legal or accounting oversight. Further, after Henshaw knew

that the DIPA had been tainted with commingled SSA funds, he nevertheless

sought and secured the direct payment of his fee out of the account, an expedient

that bypassed proper bankruptcy code procedure. Henshaw insists that he was not

aware of the specific $700,000 SSA-to-DIPA transfer when he obtained his fee,

but this merely attenuates the degree of impropriety involved (he admits he knew

of prior instances of Lowrance commingling SSA and DIPA funds).

Henshaw argues that it is inconsistent for the Government to invoke LIFO

tracing to tie his fee to the $700,000 deposit from the SSA, when that tracing

method would not work to tie the fee to other instances of commingling that had

occurred, which could only be reached, rather, by use of a “lowest intermediate

balance” (LIB) method. Even conceding Henshaw’s point about the contrasting

reach of the LIFO and LIB methods, it does not show that inconsistent tracing

methods have actually been used. All it shows is that the Government had

alternative approaches available to it for addressing the tracing question here,

each better suited to a different source of funds commingled in the DIPA, and the

one it chose to pursue was properly used by the district court to tie Henshaw’s fee

to the immediately preceding deposits from the SSA. There is no evidence in the

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record demonstrating any instance in which the Government actually employed a

different accounting method in this case to trace money in the DIPA to the SSA.

Henshaw also attempts to invoke the notion of ratification to undercut the

Government’s effort to reclaim its property. Specifically, Henshaw asserts that

the Government ignored earlier instances when Lowrance used tainted DIPA

funds to pay other obligations during the bankruptcy proceeding and contends that

it thereby “ratified” the subsequent use of commingled funds to pay his fee, citing

Davis v. Jones , 254 F.2d 696, 700 (10 th Cir. 1958). Even assuming the factual

premise, this argument clearly fails. Davis does not stand for the proposition that

tolerance of a prior breach of trust grants some kind of general license to

disregard fiduciary duties in the future. On the contrary, Davis explains that to

ratify a breach of trust, the beneficiary must “hav[e] knowledge of all the facts, ”

id. at 700 (emphasis added); see also Restatement (Second) of Trusts § 216(2)(b)

(1959) (beneficiary’s consent is ineffective if not based on knowledge of material

facts)–something inherently lacking in the generic, prospective notion of

ratification Henshaw seeks to invoke. The Government may have known of some

past misuse of funds, but Henshaw does not suggest that it was aware of any of

the material facts here, i.e., Lowrance’s transfer of $700,000 from the SSA to the

DIPA and coincident payment of Henshaw’s fee out of the DIPA. And when the

Government did learn of these facts, it took legal action to enforce its rights.

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 Legal Ownership Issues

In addition to his equitable arguments, Henshaw advances two contentions

challenging Government ownership of the converted funds that are more strictly

legal in nature. First, he contends that the cashier’s check used to pay his fee

constituted the funds of the issuing bank, not Lowrance’s, and thus use of the

check severed any legal connection to the Government funds Lowrance had

withdrawn from the SSA. This disingenuous contention–that the mere purchase

of a cashier’s check detaches a tax lien from the funds used for the purchase–is

plainly belied by the general principle that after a transaction involving property

encumbered by a tax lien, “[t]he lien reattaches to the thing and to whatever is

substituted for it .” Phelps v. United States , 421 U.S. 330, 334 (1975) (quotation

omitted and emphasis added). And the case law contains numerous examples in

which cashier’s checks are traced back to their sources for various purposes, often

to establish criminal liability or forfeiture based on the illegal derivation of the

funds used to purchase the check. See, e.g. , United States v. Benjamin , 252 F.3d

1, 8 (1 st Cir. 2001) (following United States v. Butler , 211 F.3d 826, 830 (4 th Cir.

2000)); United States v. 42.5 Acres , 834 F. Supp. 912, 920-21 (S.D. Miss. 1992).

Second, Henshaw notes that the deduction for the $700,000 check was not

reported on the SSA statement until March 2, 2000, the day after the money was

deposited in the DIPA to underwrite the five DIPA checks (including the one used

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to purchase the cashier’s check for his fee). Without elaboration or supporting

authority, he concludes from this that the $700,000 from the SSA was not in his

account when the cashier’s check was purchased and, therefore, the SSA funds

had no connection to the payment of his fee. We disagree.

The parties stipulated to the fact that the $700,000 SSA check was

deposited in the DIPA on March 1, 2000, see Aplt. App. at 51 (Joint Pretrial

Order), and that fact is corroborated by the DIPA monthly statement, which

clearly credits the $700,000 SSA check to the account on that date. See Aplt.

Addendum at 193 (reflecting $700,000 deposit on March 1) and 194 (specifying

March 1 “daily account balance,” derived by adding $700,000 to starting balance

and then subtracting checks cashed that day). Henshaw cannot now disavow or

circumvent that stipulated, substantiated fact simply by pointing to a day’s delay

in the notation by the bank (which held both accounts) to record the withdrawal

on the SSA statement. 2

2
Even if, contrary to the plain thrust of the stipulation and corroborating
bank records, we were to suppose that the $700,000 deposited in the DIPA on
March 1 reflected the bank’s own funds, provided in exchange for the $700,000
subsequently withdrawn from the SSA, that would just mean that the deposit was
“substituted for [SSA funds]” and therefore encumbered with the tax lien tied to
those funds, Phelps , 421 U.S. at 334 (quotation omitted), on the same analysis set
out above in connection with the cashier’s check given to Henshaw.

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 Availability of Cause of Action for Conversion

Finally, Henshaw argues that the IRS cannot, in any event, recover its

property from him through assertion of a conversion claim. He insists that the

sole remedy here is a levy under 26 U.S.C. § 6332, from which he is insulated

because, even if the $20,000 he got from Lowrance belonged to the Government,

he has spent that money and levies are effective only against a “person

in possession of ” the property subject to the levy. Section 6332(a) (emphasis

added). We reject this attempt to use an inapplicable statutory remedy as a shield

against an otherwise proper and effective common law remedy.

The Government has a well-established right to bring common law causes

of action, including tortious conversion, and in such cases the district courts

properly exercise jurisdiction under 28 U.S.C. § 1345. United States v. Moffitt,

Zwerling & Kemler, P.C. , 83 F.3d 660, 667 (4 th Cir. 1996) (following United

States v. Texas , 507 U.S. 529 (1993), and citing United States v. Butt , 203 F.2d

643 (10 th Cir. 1953), and United States v. Union Livestock Sales Co. , 298 F.2d

755 (4 th Cir. 1962), as specific examples of conversion). Henshaw must

therefore argue that this right to sue for conversion was abrogated when Congress

afforded the IRS the various levying powers set out in § 6332.

“We start from the premise that federal statutes do not, by implication,

abrogate the government’s right to bring common law suits.” Moffitt, Zwerling &

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Kemler, P.C. , 83 F.3d at 667. In other words, “common law actions are available

to the government to supplement those remedies found in federal statutes, as long

as the statute does not expressly abrogate those rights.” Id. ; see id. at 668

(collecting numerous cases reaffirming principle).

Far from such a situation of express abrogation, here we have statutory and

common law remedies that easily complement each other. Under the statute, the

Government can demand the surrender of a taxpayer’s property found in the hands

of a third party, see § 6332(a), and can recover the value of the property from the

third party if he or she refuses to surrender it, see § 6332(d). But given the

statute’s narrow focus on surrender of the taxpayer’s property, it does not apply if

the third party “can show that it was not, pursuant to the language in 26 U.S.C.

§ 6332(a), ‘in possession of’ any of the delinquent taxpayer’s property . . . at the

time that it received the notice of levy.” United States v. Ruff , 99 F.3d 1559,

1563 (11 th Cir. 1996); see Kane v. Capital Guardian Trust Co. , 145 F.3d 1218,

1221-22 (10 th Cir. 1998). That, of course, is the remedial gap Henshaw seeks to

escape through by having converted and dissipated the funds the Government

would otherwise have demanded he surrender under § 6332(a). The conversion

claim neatly supplements the statutory remedy by filling this gap with a tort

liability that, having its own distinct and fairly onerous elements, neither

contravenes nor nullifies the levy procedure.

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 Henshaw’s convert-and-dissipate defense is evidently fairly novel, as there

are few cases explicitly addressing the relationship between conversion claims

and § 6332(a) levies. There appear to be two primary district court decisions. In

Nomellini Construction Co. v. United States , 328 F. Supp. 1281 (E.D. Cal. 1971),

the court analyzed the question in abrogation terms similar to those discussed

above, and concluded, as do we, that “[t]he statutory and common law remedies

redress different evils” and “that the creation of one narrow remedy [in § 6332]

was [not] meant to eradicate all other established [common law] forms of relief.”

Id. at 1285-86. 3
In Fritschler, Pellino, Schrank & Rosen, S.C. v. United States ,

716 F. Supp. 1157 (E.D. Wis. 1988), the court took an opposing view, holding

that “[c]onversion is outside the scope of section 6332, and would require the

court to create or imply a remedy that Congress could have created had it been of

a mind to do so.” Id. at 1161. But this stands the analysis on its head; the

question is not whether Congress expressly or impliedly created a conversion

remedy in conjunction with § 6332, but whether it abrogated the Government’s

traditional right to invoke existing common law conversion remedies in passing

§ 6332. In our view, Nomellini asked and correctly answered the right question.

3
Nomellini was more recently followed in an unpublished decision issued
by another federal district court in California. See United States v. Smyers ,
No. CV 98-2603 MMM(MCX), 1998 WL 681461, at *8 (C.D. Cal. Aug. 24,
1998).

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Accordingly, we hold that the Government was not precluded from asserting a

claim for tortious conversion in this case.

The judgment of the district court is AFFIRMED.

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