IRS Can Pursue “Responsible Persons” for Unpaid Trust Fund Taxes and Automatic Stay Cannot Be Used to Enjoin Collection Against Non-Debtor Officers and Directors

The Bottom Line

The Puerto Rico Bankruptcy Court followed the Third Circuit in holding that the Anti-Injunction Act, which prohibits suits to restrain the assessment or collection of any tax, is not superseded by section 105(a) of the Bankruptcy Code.  The Court looked to the plain language and legislative history of section 105, and determined that Congress did not intend to overrule the application of the Anti-Injunction Act to protect non-debtor third parties from tax collection.  Section 105 does not exempt the principals of Chapter 11 debtors “by reason of their corporation’s bankruptcy.”  This decision directly affects certain directors and officers of a debtor as “responsible persons” for unpaid trust fund taxes (such as sale and withholding taxes) and the ability to stay the collection of these claims during the pendency of a Chapter 11 case.

What Happened

In In re Condado Restaurant Group Inc. and Restaurant Associates of PR Inc. No. 17-00050 (Bankr. D. P.R. June 7, 2017), Condado Restaurant Group and Restaurant Associates of PR (the “Debtors”) filed a complaint against the IRS, seeking to extend the automatic stay to non-Debtor principals and to enjoin the IRS from collecting taxes from the Debtors’ principal employees.  The Debtors had incurred penalties for late tax payments and had failed to make other tax payments.  The IRS had asserted that the Debtors’ principals were personally liable for all federal “Trust Fund” taxes owed by the Debtors, in the amount of approximately $150,000, and also for penalties associated with the Trust Fund taxes, as the principals had been aware that taxes were not being paid. 

The Debtors argued that the IRS’ persistent attempts to collect past-due taxes from the Debtors’ principals were in violation of the automatic stay and had distracted the Debtors’ principals to the point where they were having trouble operating the Debtors’ businesses.  The Debtors asked for a Temporary Restraining Order (“TRO”) and Preliminary and Permanent Injunctive Relief against the IRS, asserting that the Bankruptcy Court had the power to issue an injunction restraining the IRS under section 105(a) of the Bankruptcy Code.  Condado, 17-00050, at *2.  Section 105 gives the Bankruptcy Court the power to “issue any order, process or judgment that is necessary or appropriate to carry out the provisions of this title.”  11 U.S.C § 105(a).

The Court denied the TRO motion and the motions for injunctive relief, holding that the Anti-Injunction Act bars the Court from extending the automatic stay to non-debtor collection acts by the IRS.  Condado, 17-00050, at *2, 5.  In doing so, the Court noted that only one other court in the First Circuit had ruled on the issue, and had decided that the Bankruptcy Court was barred from “enjoining the IRS from making assessment or collections as against non-debtor principals.”  Condado, 17-00050, at *4. 

While the Eighth Circuit and courts in the Eleventh Circuit have interpreted the scope of section 105(a) broadly and have enjoined the IRS from pursuing collection actions against non-debtors, the Condado court found “nothing in the general language or legislative history to § 105(a) indicates that Congress intended it to supersede the proscription of the Anti-Injunction Act to protect third party non-debtors from tax collection proceedings.”  Condado, 17-0005, at *7 (internal citations omitted).  The statutory exceptions to application of the Anti-Injunction Act were irrelevant in this case, and the court found no basis for enjoining the IRS under other sections of the Bankruptcy Code.  The Court noted that “section 524 which applies in Chapter 11 cases, 11 U.S.C. § 103(a), specifically provides that the discharge of the debt of the debtor does not affect the liability of any other entity . . . on such debt.”  Condado, 17-00050, at *7 (internal citations omitted).

Why the Case is Interesting

This case represents the deepening of a circuit split between the Third Circuit, Eighth Circuit, and courts in the First Circuit regarding whether the bankruptcy court has the power to enjoin the IRS from pursuing collection actions against non-debtors.  The result is increased uncertainty over whether debtors’ principals may be shielded from IRS collection actions when a corporation files for bankruptcy, and may lead to forum shopping when companies with extensive tax liabilities decide where to file Chapter 11 petitions.  In addition, given the risk of non-payment upon the corporate officers and directors, this will likely lead to continued negotiation of sufficient funds to pay all outstanding “trust fund” taxes as part of “first day” motions.  As a practical matter, many debtors already include this type of relief in such “first day” motions and the Condado decision underscores the need (from a debtor’s view) of such relief.