In the Matter of Pittsburgh Penguins Partners, Debtor.appeal of Equibank, N.a., in Behalf of Frank Sklar, Receiver, 598 F.2d 1299 (3d Cir. 1979)

This case presents the issue whether property seized by a tax levy pursuant to 26 U.S.C. 6331¹  prior to the date of bankruptcy is within the summary jurisdiction of a Chapter XI bankruptcy court. The district court concluded that seized property was not within that jurisdiction. We affirm.

On June 12, 1975, the Internal Revenue Service (IRS) served a notice of levy on holders of tangible personal property and bank accounts belonging to the Pittsburgh Penguins Partners (PPP). Among those items seized were approximately $90,000 worth of property located at the offices of PPP, and two bank accounts listed in PPP's name at Pittsburgh National Bank (PNB). The total sum claimed as of June 12, 1975 was $587,260.78.

On June 13, 1975, PPP filed a petition for an arrangement under Chapter XI of the Bankruptcy Act, and a receiver was appointed. On June 16, PNB received a letter from counsel for the Receiver demanding that the two PPP bank accounts be turned over to the court. That same day, Equibank, N.A., the Debtor's largest unsecured creditor, caused a writ of execution in the amount of $1,096,562.50 to be served on PNB, also purporting to seize the two contested bank accounts.

On June 25, 1975, PNB filed a complaint in interpleader in the Chapter XI proceedings, naming as defendants the United States and the Receiver. The complaint was subsequently amended to include Equibank as a defendant. Subsequent to the filing of the interpleader action, the United States and the Receiver resolved their dispute over the contested bank accounts. By stipulation the Receiver agreed to pay to the United States $547,271.41, in full payment of the principal, pre-petition interest, and costs of PPP's tax liability. In addition, the parties agreed to place in escrow the sum of $39,989.37, representing penalties and post-petition interest to July 15, 1975. These funds, to be drawn from the sale of the debtor's tangible assets, were to be held 'pending a final determination as to jurisdiction of the court and whether such amounts are payable, in whole or in part, to the Internal Revenue Service as a result of its levy and seizure on June 12, 1975.'²  In return the government agreed to release its claim of a lien on the assets of the debtor so as to permit their sale. By a separate stipulation, the Receiver also negotiated the release of Equibank's garnishment upon the PNB accounts. PNB's amended complaint in interpleader was then dismissed and the two PNB accounts were turned over to the Receiver. Following a successful sale of the tangible assets of the debtor, a final Plan of Arrangement was adopted, and approved by the creditors. This Plan was confirmed on January 5, 1976.

The government and the Receiver (represented below and in this proceeding by counsel for Equibank) then turned to the litigation in the Bankruptcy Court of the government's entitlement to penalties and interest. That issue turned on the effect of the levy upon the summary jurisdiction of the Chapter XI court. If the property seized was within that jurisdiction, then at the date of bankruptcy it became part of the debtor's estate, and §§ 57j and 63a(1) of the Bankruptcy Act operated to bar the payment of penalties and post-petition interest to the government. If, on the other hand, the levy had removed the property from the court's summary jurisdiction, then by the terms of the stipulation, the government was entitled to possession of the $39,000 in the escrow account, and the Receiver's remedy was a plenary proceeding against the IRS to contest title to the funds. On October 28, 1977, the Bankruptcy Court ruled in favor of the government, holding that the levy was effective to divest the Chapter XI court of summary jurisdiction. The district court affirmed in an unpublished opinion, and this appeal followed.

Section 311 of the Bankruptcy Act, 11 U.S.C. § 711, gives a Chapter XI bankruptcy court 'exclusive jurisdiction of the debtor and his property, wherever located.' Courts and commentators are divided on the proper interpretation of the statutory language. One school holds that the scope of Chapter XI jurisdiction is the same as in straight bankruptcy, where the exercise of summary jurisdiction depends on a finding that the debtor had actual or constructive possession of the property at the time of the filing of the petition in bankruptcy. Bayview Estates, Inc. v. Bayview Estates Mobile Home Owners Ass'n, 508 F.2d 405, 407 (6th Cir. 1974); In re Barasch, 439 F.2d 1393, 1394 (9th Cir. 1971); 9 Remington, Bankruptcy § 3574 at 217 (6th ed. 1955). If the bankruptcy court determines that the property is held by a third party with an adverse claim thereto, then it is divested of summary jurisdiction. Bayview Estates, Inc. v. Bayview Estates Mobile Home Owners Ass'n, supra; cf. Cline v. Kaplan, 323 U.S. 97, 98, 99, 65 S. Ct. 155, 89 L. Ed. 97 (1944).

A second line of authority reads § 311 as conferring jurisdiction based upon ownership rather than possession. On this view, the court acquires jurisdiction over all of the debtor's property in its possession as it would in straight bankruptcy. In addition, it may assume jurisdiction over property in the possession of a third party who makes no claim to ownership of the property, or whose claim or ownership is merely colorable. Where, however, the property is in the possession of a third party with a substantial adverse claim of ownership, the court is without summary jurisdiction. Slenderella Systems of Berkeley v. Pacific Tel. & Tel. Co., 286 F.2d 488, 490 (2d Cir. 1961); In re Gunder, 88 F.2d 284 (7th Cir.), cert. denied sub nom. 164 East 72nd Street Corp. v. Gunder, 301 U.S. 701, 57 S. Ct. 931, 81 L. Ed. 1356 (1937); 8 Collier on Bankruptcy § 3.02 at 162-63.

This Circuit has never had occasion to choose between the competing views of § 311, see In re Rubin, 378 F.2d 104 (3d Cir. 1967), although in In re Copeland, 391 F. Supp. 134, 140 (D. Del. 1975), aff'd in part, vacated in part, 531 F.2d 1195 (3d Cir. 1976), Judge Schwartz adopted Collier's broader view.

We need not resolve that issue here, however, for under either theory we think that the levy was effective to remove the property from the court's jurisdiction. Phelps v. United States, 421 U.S. 330, 95 S. Ct. 1728, 44 L. Ed. 2d 201 (1975), makes that clear. In Phelps, a straight bankruptcy, the government served a notice of levy upon cash assets of the debtor held by an assignee for the benefit of creditors. Thereafter an involuntary petition was filed against the debtor. The Supreme Court held that the service of the notice of levy was a transfer of possession sufficient to oust the summary jurisdiction of the bankruptcy court. That notice, the Court stated, was 'equivalent to seizure' and gave the United States 'full legal right to the (sums) levied upon as against the claim of the . . . receiver.' 421 U.S. at 387, 95 S. Ct. at 1732. In a further dictum, the Court suggested that the prebankruptcy levy effectively 'displaced any title of (the debtor).' Id. at n. 8, 95 S. Ct. 1728 n. 8.

Appellants concede that Phelps is direct authority for the proposition that service of a notice of tax levy is a seizure of the property levied upon that transfers constructive possession to the government. Under Remington's narrow interpretation of § 311, that fact alone would deprive the court of jurisdiction. Moreover, Phelps' further indication that service of a levy effectively transfers 'full legal right' to the property levied upon is, we think, sufficient to give the government a 'substantial adverse claim' of ownership as well. Even accepting Collier's broader view of § 311, that adverse claim deprives the Chapter XI court of summary jurisdiction. Resthaven Psychiatric Hospital v. United States, 426 F. Supp. 516 (C.D. Cal. 1977); In re Walsh, 38 A.F.T.R.2d 6206 (D. Alaska 1976), appeal pending, No. 77-3631 (9th Cir.). Contra, In re VanDeVeer, 2 Bankr.Ct.Dec. 1590 (W.D. Va. 1976).³  We need not decide, therefore, the further question whether the levy was effective to transfer full title to the assets to the United States.

Because the Bankruptcy Court was without summary jurisdiction over the assets levied upon, we hold that the district court properly ordered that the funds placed in escrow for payment of penalties and post petition interest be released to the government. If the Receiver has any further objections to the government's claim they must be pressed in a plenary action.