MARKEY, Chief Judge.
Appeal from a judgment of the United States Claims Court, 3 Cl.Ct. 595 (1983), holding Dudley J. Godfrey, Jr. (Godfrey) liable for $159,361.26 of unpaid accrued taxes of Career Academies, Inc. (Career) pursuant to Internal Revenue Code section 6672, the 100 percent tax penalty provision.
This case arises from the bankruptcy of Career Academies, Inc., a Delaware corporation headquartered in Milwaukee, Wisconsin, and authorized to provide homestudy and resident vocational training in such fields as radio broadcasting, medical and dental assisting, architectural and engineering drafting, hotel/motel training, and airline personnel and travel.
Career's shares were listed on the American Stock Exchange until August 14, 1972, after which they were traded in the over-the-counter market. On May 18, 1974, Career had 6,992 stockholders and 4,646,099 shares outstanding.
Dudley Godfrey was and is a partner in Godfrey and Kahn, S.C., a business law firm in Milwaukee with special tax expertise.
As Chairman of the Board, Godfrey never signed, and was never authorized to sign, the checks of Career or its subsidiaries. The Claims Court found that Godfrey never "signed any IRS 941 Forms submitted by the corporation or other payroll or tax returns of Career and [never] participated in any way in the preparation of such returns or in the preparation of any payrolls for Career." 3 Cl.Ct. at 598.
As a Director, Godfrey exercised the authority given him by the bylaws. He participated in electing officers, hired or approved the hiring of top level consultants, delegated authority to establish bank accounts, and designated signatories for those accounts. He also authorized borrowing by officers on behalf of the corporation, authorized major sales programs, ratified and approved settlements made by officers, and approved loan agreements made with various banks. Godfrey was also instrumental in negotiating a critical (but ultimately unsuccessful) recapitalization agreement with a potential investor. Finally, Godfrey authorized the filing of Career's Chapter XI bankruptcy petition.
Career had sustained substantial operating losses in each of the years 1967-1972. In November 1972, it defaulted on semiannual interest payments on a total of $12,000,000 of 5 1/2 and 6-percent convertible subordinated notes. Responding to this desperate situation, Godfrey and other members of Career's management entered financing negotiations with lenders, potential lenders, prospective buyers, and potential investors. Those efforts led to negotiation of a loan and recapitalization agreement with American Management Services, Inc. (AMS). Brian Gordon (Gordon), a financier/investor in the Washington, D.C., area, was the principal of AMS.
On August 30, 1973, Career executed a letter of intent with AMS, the Chemical Bank, and the United States Trust Company of New York. As part of the package, Gordon insisted on his choice of management to run the "new" Career. Godfrey agreed, and got the Career Board to select Gordon's candidates, Joseph P. Maher (Maher) as president and Joseph L. Ferrare (Ferrare) as executive vice-president on September 10, 1973.
Throughout the entire period in which the AMS package was being negotiated, and after Maher and Ferrare had been installed, Career had serious financial difficulties.
As president, Ferrare was in daily contact with Terrence J. Metzdorff (Metzdorff), Career's vice president/treasurer, concerning issuance of checks to creditors, including the Internal Revenue Service (IRS). Ferrare and Metzdorff ran the day-to-day operations of Career. Both were authorized to sign checks, including those in payment of withheld taxes, and to prepare Career's Form 941 (withholding tax returns). Unlike Ferrare, who was an inside director, Metzdorff was never elected to the Board, but did regularly attend its meetings as an advisor. Neither Ferrare nor Metzdorff owned stock, directly or beneficially.
In October 1973, in a meeting attended by Godfrey, Ferrare and Andrew Lauritzen (Lauritzen) (an attorney with Godfrey & Kahn and Career's outside legal counsel), Metzdorff expressed concern about unpaid withholding taxes (income and FICA) and threatened to resign unless relieved of responsibility for paying them. Ferrare gave Metzdorff an October 5, 1973 letter relieving him of that responsibility. Metzdorff testified that Godfrey met his concern with "no one ever goes to jail for not paying taxes, so I wouldn't be too concerned about that." 3 Cl.Ct. at 601.
Federal tax problems continued. Monthly reports prepared in Metzdorff's office showed that in October 1973 withholding taxes were accruing and were being paid late. The December 1973 report showed $9,095 (FICA) and $30,689 (income tax withholding) accrued and unpaid. Metzdorff distributed the reports to all corporate officers and the Board.
In the spring of 1974, Arthur Anderson & Company was asked to audit Career's books for the two fiscal years ending January 31, 1974, in connection with the proposed AMS recapitalization. In a general representation letter connected with the audit, Godfrey, Ferrare, and Metzdorff stated: "[t]he Company is presently past due in the remittance of Federal and State withholding taxes in the amount of approximately $250,000 as of May 31, 1974." 3 Cl.Ct. at 601. Though Godfrey stated at trial that when he signed that letter he knew of that delinquency, he also said he directed outside counsel Lauritzen to insure that the taxes were paid. The trial court concluded that, "aside from his comments to Mr. Lauritzen, Mr. Godfrey appears to have taken no subsequent affirmative action to investigate further and rectify the situation." 3 Cl.Ct. at 601.
On July 11, 1974, Arthur Anderson & Company sent Career's consolidated financial statements for 1973 and 1974 and their audit to Metzdorff, who distributed them to Career's executive officers and the Board. The financial statements included:
3 Cl.Ct. at 601.
IRS's Milwaukee office well knew of the deficiency and, in September, 1974, threatened to close the corporation down unless it paid withholding taxes for the first and second quarters of 1974. In the same month, Metzdorff contacted Ferrare, who called on the AMS revolving credit line for the required $250,000 and Metzdorff paid IRS the first and second quarter 1974 withholding taxes in full.
Career was walking a financial tightrope. Metzdorff paid only those bills authorized for payment by Ferrare. The Claims Court found that "[i]t was the practice during this time for Mr. Metzdorff and Mr. Ferrare to get together approximately once each week to decide which creditors would be paid and which bills would be deferred.
The Board met every two months. Ferrare would normally go over the financial picture and Metzdorff would fill in details when asked. In the September 1974 meeting, Ferrare presented an upbeat financial picture, indicating that the corporation would shortly turn the corner on profitability because of increased student enrollment contemplated with the start of the school year and the pending AMS recapitalization.
Ferrare's optimism proved to be unfounded. On or about November 12, 1974, Metzdorff resigned, precipitating a meeting of the Board on November 19, 1974, at which it directed a thorough review of the beleaguered corporation's assets. In late November, AMS withdrew from the proposed recapitalization. Godfrey sought other loans or sale of Career's subsidiary schools, without success.
On December 5, 1974, Godfrey wrote the IRS, seeking to forestall collection efforts on the delinquent third and fourth quarter withholding taxes. He said it would be advisable for all creditors (including the United States) to keep Career alive, and requested deferral of IRS enforcement action until December 11, 1974.
At Career's December 9 Board meeting, the directors concluded that insolvency proceedings were necessary if Career were to stay in business and increase the value of its assets.
Career filed for an arrangement under Chapter XI of the Bankruptcy Act on December 12, 1974. It was adjudicated bankrupt on April 15, 1975. The IRS filed a claim in the bankruptcy proceeding for employment taxes aggregating $210,925.65. After all assets were sold and the proceeds distributed, the IRS received nothing.
The Claims Court
The IRS assessed a 100 percent penalty on Godfrey and two other directors (Gerald J. Kahn and Gilbert Palay) for $191,734.68 in unpaid taxes.
The Claims Court held Godfrey liable for the full amount of the tax deficiency. The government does not on appeal contest the Claims Court's holding that Kahn and Palay were not liable because they were not "persons" within the meaning of the statute.
The Claims Court also found that the IRS failed to allocate certain undesignated taxes paid during the six month period before bankruptcy, resulting in a reduction of $32,213.42 in the judgment against Godfrey. The government cross-appealed that part of the judgment.
Section 6672 of title 26 states:
For the purposes of § 6672, "person" is defined in 26 U.S.C. § 6671:
Thus a person is subject to a 100 percent penalty if he satisfies two separate statutory requirements. First, he must be under a duty to "perform the act in respect of which the violation occurs," (§ 6671(b)) and that duty is "to collect, truthfully account for, and pay over" any taxes (§ 6672). Such a person is a "responsible person".
(A) Did the Claims Court err in determining that Godfrey was a "responsible person" under 26 U.S.C. 6671(b)?
(B) Did the Claims Court err in determining that Godfrey's conduct was "willful" under 26 U.S.C. 6672?
(C) Did the Claims Court err in reducing the judgment by $32,213.42?
The Claims Court held, 3 Cl.Ct. 605-06, that Godfrey satisfied the "responsible person" requirement of § 6672:
The purpose of the 100 percent penalty provision "is to permit the taxing authority to reach those [persons] responsible for the corporation's failure to pay the taxes which are owing." White v. United States, 372 F.2d 513, 516, 178 Ct.Cl. 765 (1967). Though the legislative history is uninformative, "it is evident from the face of the section that [§ 6672] was designed to cut through the organizational form and impose liability upon those actually responsible for an employer's failure to withhold and pay over the tax." See Pacific National Insurance Co. v. United States, 422 F.2d 26, 31 and n. 12 (9th Cir.), cert. denied, 398 U.S. 937, 90 S.Ct. 1838, 26
The overwhelming weight of case precedent requires the factfinder to look through the "mechanical functions of the various corporate officers", White v. United States, 372 F.2d at 516, to determine the persons having "the power to control the decision-making process by which the employer corporation allocates funds to other creditors in preference to its withholding tax obligations." Haffa v. United States, 516 F.2d 931, 936 (7th Cir.1975). The inquiry required by the statute is "a search for a person with ultimate authority over expenditure of funds since such a person can fairly be said to be responsible for the corporation's failure to pay over its taxes." White v. United States, 372 F.2d at 517. See also Barrett v. United States, 580 F.2d 449, 452, 217 Ct.Cl. 617 (1979); Bauer v. United States, 543 F.2d 142, 148, 211 Ct.Cl. 276 (1976). Whether the plaintiff is a "person" with ultimate authority "hinges upon the application of the relevant facts to the ... pertinent provisions of the Internal Revenue Code of 1954." Bauer v. United States, 543 F.2d at 144. As the Ninth Circuit commented in Pacific National Insurance Company v. United States, 422 F.2d at 30-31:
The mechanical duties of signing checks and preparing tax returns are thus not determinative of liability under § 6672. In White v. United States, 372 F.2d at 514-15, the president of the corporation was held liable because he directly controlled the secretary-treasurer in the latter's collecting, accounting for, and paying over the taxes. He was the president and 50 percent shareholder of a closely-held corporation. He actively conducted the day-to-day operations of the business: he came to the office daily, hired and laid off employees, ordered materials and supplies, conducted business correspondence, set the price of jobs, negotiated all contracts with customers, prepared invoices, disbursed corporate checks signed by him and the secretary-treasurer in payment of supplier's bills and other business expenses, and deposited the business receipts in the corporation's bank account. His address was used for receiving most business mail; his signature was required on all corporate checks. He also drew a weekly salary from the corporation. Under these circumstances, the taxpayer was held to clearly fall within the category of responsible person because "he had the authority to act, and did act, as fiscal manager of that company's affairs, and exercised authority over the general policy, affairs, and finances of the corporation." 372 F.2d at 517. Nothing remotely comparable to such control was here exercised by Godfrey.
The Claims Court effectively held that Godfrey's status as chairman cum advisor-negotiator — and the respect and deference accorded that status — amounted to "ultimate authority" or "power to control" for purposes of § 6672. The case law will not support that holding.
It is material, but not controlling, if Godfrey were the "single most important individual"
As the case law makes abundantly clear, a person's "duty" under § 6672 must be viewed in light of his power to compel or prohibit the allocation of corporate funds. It is a test of substance, not form. Thus, where a person has authority to sign the checks of the corporation, see White v. United States, 372 F.2d at 515, McCarty v. United States, 437 F.2d at 968, but cf. Barrett v. United States, 580 F.2d at 953-54, Marlowe v. United States, 2 Cl.Ct. 711, 716 (1983), or to prevent their issuance by denying a necessary signature, see Burack v. United States, 461 F.2d at 1291, Bolding v. United States, 565 F.2d at 671, or where that person controls the disbursement of the payroll, see White v. United States, 372 F.2d at 515, or controls the voting stock of the corporation, see White v. United States, 372 F.2d at 514, McCarty v. United States, 437 F.2d at 967-68, Burack v. United States, 461 F.2d at 1286, Feist v. United States, 607 F.2d at 960, cf. Marlowe v. United States, 2 Cl.Ct. at 716, he will generally be held "responsible".
In no case has an outside director of a publicly held corporation, who neither signed nor had authority to sign checks, who did not participate in the day-to-day fiscal management of the corporation, who did not control the payroll, who did not determine which creditors would be paid and which would not, and who did not own a significant fraction of the corporation's voting securities, been held a "responsible" person under § 6672.
That Godfrey took the lead in attempting to avoid Career's insolvency, negotiated emergency loans and recapitalization plans, helped to arrange for sale of corporate assets, and participated in the hiring and firing of top corporate management are factors insufficient alone to make Godfrey a "responsible person" under § 6672. "The courts recognize the normal division of and limitations on authority exercised by various representatives of a particular business." Bauer v. United States, 543 F.2d at 149. Those normal activities within the proper sphere of Godfrey's role as chairman of the board do not in themselves give rise to a "duty" under the statute, i.e. to "collect, account for, and pay over" taxes. Absent here is any evidence that Godfrey had or exercised control of the collection, accounting for, and payment over of taxes.
To hold Godfrey a "responsible person" on the present record would be to hold as a "responsible person" every board chairman who took an active interest in the solvency of the corporation he serves. Godfrey's activities were not those of a passive "above the fray" chairman, but they do not, without more, impose or create the "duty" expressly described in the statute.
The Claims Court also found Godfrey a "responsible person" because of his knowledge "as early as October 1973 that [Career] was running behind on the payment of its tax obligations to the IRS." 3 Cl.Ct. at 604. Godfrey's knowledge of nonpayment may be relevant to the issue of willfulness, Marlowe v. United States, 2 Cl.Ct. at 716, but it is irrelevant in considering the question of whether he was a "responsible person" under 26 U.S.C. § 6671(b).
The Claims Court erred in determining that Godfrey was a "responsible person".
Assuming, arguendo, that Godfrey were a "responsible person" under § 6672, the record supplies no basis for a determination that he "willfully" failed to collect, account for, pay over, or "willfully" evaded or defeated taxes.
Whether "the failure to pay the overdue taxes [is] willful has been seen ...
The Court of Claims in White defined willfulness as meaning "a deliberate choice voluntarily, consciously, and intentionally made to pay other creditors instead of paying the Government." 372 F.2d at 521. Willful conduct may also include a reckless disregard of an "obvious and known risk" that taxes might not be remitted. Feist v. United States, 607 F.2d at 961. "Mere negligence in failing to ascertain facts regarding a tax delinquency," however, "is insufficient to constitute willfulness under the code." Bauer v. United States, 543 F.2d at 150; see also Bolding v. United States, 565 F.2d at 672.
Willfulness must also be viewed in light of the "personal fault" of the plaintiff: "[t]he fact that the provision imposes a `penalty' and is violated only by a `willful failure' is itself strong evidence that it was not intended to impose liability without personal fault." Slodov v. United States, 436 U.S. at 254, 98 S.Ct. at 1788. Personal fault being a necessary element of willfulness, relevant evidence bearing on the element of personal fault may not be ignored. Feist v. United States, 607 F.2d at 962.
The Claims Court noted that Godfrey knew Career was behind in payment of withholding taxes as early as October 1973. 3 Cl.Ct. at 601. After a review of events of the first two quarters of 1974, it concluded that "[t]he evidence is simply overwhelming that Mr. Godfrey knew for many months about Career's withholding delinquencies and did not do anything to rectify the problem." 3 Cl.Ct. at 606. That statement is in this case directed to non-probative considerations in respect of the willfulness determination required by § 6672.
Following the IRS's demand and threat to close down the corporation, the delinquent withholding taxes for the first two quarters of 1974 were paid in full. 3 Cl.Ct. at 601. As the Claims Court noted, Godfrey had instructed Lauritzen as early as May 1974 "to check into the [withholding tax] delinquencies and to insure that the taxes were paid." Id. Thus the sole act of Godfrey in relation to taxes was an instruction looking to payment and not to evasion or defeat.
There is no evidence, and the Claims Court made no finding, that after Career's September 1974 payment of the $250,000 delinquency Godfrey actually knew of any continuing tax delinquency for the third or fourth quarter, or that Godfrey knew current withholding taxes were not actually being paid in a timely fashion.
The Government argues that whether Godfrey had actual knowledge during the October-December period is irrelevant to liability under the statute. The Government conceded at oral argument that, at the time it wishes to charge Godfrey with actual knowledge of continuing delinquencies (the November 19, 1974 emergency board meeting), there were little or no unencumbered funds to pay the taxes, even if Godfrey had so demanded. Ferrare testified that, if Godfrey had at that time asked him to withhold or pay the taxes, "that would have triggered off another question, saying fine, we're going to pay the taxes then tell me where I get the money from." The government's position would make failure to order the impossible the equivalent of willfulness.
Under the view urged to this court, Godfrey's knowledge of past delinquencies would alone have created a duty to affirmatively inquire into and cure any new deficiency which might arise, and his failure to carry out that duty would establish willfulness. That argument was apparently accepted by the Claims Court:
3 Cl.Ct. at 606.
The willfulness requirement is satisfied "if the responsible person acts with a reckless disregard of a known or obvious risk that trust funds may not be remitted to the Government, ... such as by failing to investigate or to correct mismanagement after being notified that withholding taxes have not been duly remitted," Mazo v. United States, 591 F.2d 1151 (5th Cir.), cert. denied, 444 U.S. 842, 100 S.Ct. 82, 62 L.Ed.2d 54 (1979); cf. Bolding v. United States, 565 F.2d at 672. The case law requires, however, at least actual notice of the current delinquency to establish an affirmative duty to act.
An important factor in the willfulness determination here is the period to which the assessment relates. The Government did not assess the 100 percent penalty for non-payment of withheld taxes during the first two quarters of 1974, of which Godfrey admits actual knowledge. It assessed the penalty for taxes left unpaid after Career's September 1974 payment, and there has been no showing that Godfrey had actual knowledge of that non-payment until the eve of bankruptcy.
To hold that Godfrey's knowledge of a past delinquency alone makes him a guarantor of future tax payments would be contrary to the logic of the Supreme Court's discussion of willfulness in Slodov v. United States, 436 U.S. 238, 98 S.Ct. 1778, 56 L.Ed.2d 251.
In Slodov, the government argued that a "responsible person" renders himself personally liable to the § 6672 penalty by using gross receipts to purchase inventory or pay wages, or even by using personal funds for those purposes, so long as any withholding taxes remain unpaid to the United States. 436 U.S. at 252, 98 S.Ct. at 1787. The Court said:
436 U.S. at 253-54, 98 S.Ct. at 1788.
Contrary to the representations of the government, § 6672 cannot be read as imposing here an absolute duty to "pay over" the amounts which should have been collected and withheld. See Slodov v. United States, 436 U.S. at 255, 98 S.Ct. at 1789. Nor may the provision be read as imposing in this case a risk of liability which would not further the overall deterrent and tax collection goals of the statute. Id. at 253 and n. 16, 98 S.Ct. at 1788 and n. 16. Moreover, as was noted in Slodov, "that the provision imposes a penalty and is violated only by a `willful' failure is itself strong evidence that the statute was not intended to impose liability without personal fault." Id. at 255, 98 S.Ct. at 1789.
As applied to Godfrey, it is clear that his conduct as Career's chairman, assuming,
Because Godfrey was not a "responsible person" as defined by § 6671(b) and did not fail willfully to execute a duty imposed by § 6672, that part of the judgment holding him liable for the unpaid taxes at issue must be reversed. In light of that reversal, that part of the judgment relating to the IRS's allocation of certain tax payments must be vacated as moot and the government's cross-appeal must be dismissed.
REVERSED IN PART, VACATED IN PART.
436 U.S. at 246 n. 7, 98 S.Ct. at 1784 n. 7.