The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
The United States District Court for the Southern District of Indiana (the Court) recently ruled that the bankruptcy removal statute did not permit taxpayers to remove the federal government’s suit seeking to reduce tax liabilities to judgment to the bankruptcy court, notwithstanding the debtors’ assertions that the tax liability was discharged in a prior chapter 7 case. United States v. Mikhov, 645 B.R. 609 (S.D. Ind. 2022).
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Debtors/defendants Vladimir and Angela Mikhov (the debtors) filed a chapter 7 bankruptcy case in April 2017 and received a discharge. They listed certain tax liabilities to the Internal Revenue Service (IRS) for tax years 2008-2014 in their schedules but no further action regarding those debts occurred while the case was open. In 2022, the federal government (referred to herein as the IRS) filed a civil action in the Court, seeking to reduce income tax liabilities to judgment pursuant to 26 U.S.C. § 7402. The debtors filed a “Notice of Filing of Notice of Removal” with the Court, referencing their filing of a Notice of Removal in the bankruptcy court and also seeking to remove the proceeding to the bankruptcy court pursuant to 28 U.S. C. § 1452(a). The IRS responded with a motion to dismiss the Notice of Removal as void because § 1452(a) only provides for removal of cases from state courts to federal courts, not from a district court to a bankruptcy court. In addition, the IRS asserted that the action did not fall within bankruptcy court jurisdiction provided by 28 U.S.C. § 1334 because it did not “arise under title 11” but rather arose under Title 26. That the debtors might raise dischargeability of the debt as an affirmative defense does not alter that jurisdiction.
Instead of responding to the IRS’s motion, the debtors filed a “Motion to Confirm Referral of Proceeding to Bankruptcy Court or, in the Alternative, to Refer Proceeding to Bankruptcy Court.” They asserted that the district court had already automatically referred the suit to the bankruptcy court pursuant to a local rule and sought confirmation of that fact or, if not already referred, they asked the Court to make the referral. The Court addressed the IRS’s motion and the debtors’ motion in one consolidated ruling, granting the IRS’s motion that the removal was void and denying the debtors’ motion that the matter was automatically referred under the relevant local rule.
The Court briefly examined the disputes at issue in the IRS’s lawsuit, which asserted the existence of income tax liabilities and explained in detail why none of the alleged liabilities had been discharged. Per the IRS, the earlier taxes were not subject to discharge because of the debtors’ numerous misleading and fraudulent activities which occurred over several years, and the last two years of taxes and penalties were not excepted from discharge because the relevant returns were not timely filed.
The Court next turned to the jurisdictional issues raised directly by the competing motions. It began by looking at the specific and limited grant of jurisdiction to the bankruptcy courts under 28 U.S.C. § 1334(b), which provides that the district courts have “original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11.” The district court may refer these Title 11 proceedings to the bankruptcy judges for the district, making the bankruptcy court’s jurisdiction solely derivative of the district court’s jurisdiction.
The Court then considered the removal language in § 1452, agreeing with the IRS that it is limited to removal from state courts to district courts, which may if appropriate refer such removed cases to the bankruptcy courts. This limitation of removal power is bedrocked in the principle that the bankruptcy courts only derive their jurisdiction from the district courts. Therefore, the debtors’ purported removal was void.
Addressing the debtors’ motion, which sought to confirm the applicability of a district court local rule which routinely referred cases arising under Title 11 to the bankruptcy courts, the Court found the debtors’ reliance on the local rule was misplaced. The IRS’s complaint did not arise under Title 11 but rather under Title 26, the Internal Revenue Code. The Court recounted the three types of bankruptcy proceedings over which bankruptcy courts may exercise jurisdiction: those arising under Title 11, those arising in a Title 11 case, and those related to a Title 11 case. It rejected the debtors’ argument that the IRS’s case arose under Title 11 because it was not created or determined by a statutory provision of Title 11. Furthermore, it did not arise in bankruptcy, a category “defined generally as ‘administrative matters that arise only in bankruptcy cases’” and limited to proceedings that “would have no existence outside of the bankruptcy.” The debtors had not asserted that the case “related to” a bankruptcy case, so the Court did not need to address that potential jurisdictional tie. Because the district court’s jurisdiction was founded in Title 26, the automatic referral by the local rule did not apply.
This case presents an excellent analysis of the basis for bankruptcy court jurisdiction and a reminder why local rules, which all district courts have adopted and which automatically refer cases arising under title 11 to the bankruptcy courts, came to exist. The amendments to the original jurisdictional statements in the Bankruptcy Reform Act of 1978 (the Bankruptcy Code as we know it) were compelled by the Supreme Court in Northern Pipeline Construction Co. v Marathon Pipe Line Co, 458 U.S. 50 (1982) “(holding the jurisdictional grant of the Bankruptcy Reform Act of 1978 violated the Constitution’s separation of power doctrine insofar as it purported to permit a bankruptcy court, which was not a court established under Article III of the Constitution and lacked the essential attributes of an Article III court, to exercise the judicial power of the United States.)” Mikhov, 2022 WL 17103970, at * 5. A party may not remove a matter from district court to bankruptcy court, as the bankruptcy court only derives its powers from that very court.
Reading the factual assertions of the IRS complaint as detailed by the Court, one can understand why the debtors attempted this misadvised maneuver. However, as the Court noted, if they truly had a legitimate defense that their tax debt was discharged in their 2017 bankruptcy case, they would have full ability to raise the defense in the Title 26 action in the district court.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.