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TMG II v. UNITED STATES

September 27, 1991

TMG II, et al., Plaintiffs,
v.
UNITED STATES OF AMERICA, Defendant


Louis F. Oberdorfer, United States District Judge.


The opinion of the court was delivered by: OBERDORFER

From 1979 to 1983, through a series of limited partnerships that included plaintiffs' TMG Associates and TMG II (the "Partnerships" Edward Markowitz "created and marketed more than $ 445 million in false and fraudulent federal income tax deductions through sham, non-existent and pre-arranged transactions in United States Government securities and precious metals forward contracts." *fn1" Eventually, the Government uncovered the scheme and prosecuted Markowitz as well as several of his associates for filing and conspiring to file fraudulent tax returns. *fn2"

 This case arises out of a civil action brought against Markowitz. In 1983 and 1984, the Partnerships sued Markowitz for failing to account for partnership property before resigning as general partner. These claims were eventually settled, and in August, 1985, a judgment for nearly $ 900,000 was entered against Markowitz. *fn3" However, in January of that year, well before the Partnerships obtained their judgment, the Internal Revenue Service (IRS) filed over $ 5 million dollars in tax liens against Markowitz. *fn4" To establish the priority of their claims over the Government's, the Partnerships instituted this action.

 Currently before the Court, are cross-motions for summary judgment. For the reasons stated below, the accompanying order will grant the defendant's motion for summary judgment, deny the plaintiffs' motion for summary judgment, and dismiss plaintiffs' claims.

 I.

 The Partnerships were organized in 1979 and 1980 as limited partnerships under New York law with Markowitz either as the managing general partner or as the controlling stockholder of the corporation acting as the general partner. *fn5" Officially, the Partnerships were to operate "as broker-dealer and market maker in commodities and metals, and futures and option contracts therein," and perhaps as well to "trade in exempt securities and currencies." *fn6" In private, however, promoters promised that the Partnerships were excellent tax shelters and would produce four dollars in tax losses for every dollar invested. *fn7" Attracted by these promises, approximately 130 individuals and firms invested approximately $ 4.8 million in TMG Associates and TMG II, *fn8" and between 1980 and 1982 most of them did, in fact, take 4:1 writeoffs on their investments. *fn9"

 There were even then, signs, in addition to the promise of 4:1 write-offs, that Markowitz's activities might be questionable. In 1981, Markowitz, who had few assets before the formation of the limited Partnerships, *fn10" embarked on a massive buying spree. First, he purchased a home at 2323 Porter Street overlooking Rock Creek Park for $ 385,000. *fn11" Next, he bought a Rolls Royce. *fn12" Then, in short order, Markowitz purchased a house at 2329 Porter Street, for his sister, at a cost of nearly a half million dollars, established "Markowitz Stables" which eventually accumulated more than a million dollars in capital, and purchased a minority interest in the Washington Capitals hockey club for a quarter million dollars. *fn13"

 Markowitz appears to have financed this spree at least in part by diverting partnership opportunities to himself. Most of the funds used to exploit the opportunities came from two entities owned by Markowitz: the Monetary Group, N.V. ("N.V."), a Netherlands Antilles corporation, and the Monetary Group Government Securities ("GSI"), an American corporation. *fn14" These two entities in turn acquired most of their assets from securities transactions with Hillcrest Equities, Inc, an entity that had originally traded with TMG II and perhaps TMG Associates as well. *fn15" By July, Hillcrest was trading exclusively with N.V. and then with GSI. *fn16" Markowitz admits that he instigated this switch entirely "for purposes of [his] own enrichment." *fn17"

 Most importantly from the perspective of the Partnerships' limited partners, Markowitz's transactions failed to produce legitimate tax losses. As early as 1981, Price Waterhouse, TMG Associates' original auditor, suspected that the Partnerships were not engaged in bona fide transactions. *fn18" In fact, the only thing that Markowitz bought or sold was documentation. The Partnerships paid its so-called trading partners "for the fraudulent documentation . . . provided to substantiate the fictitious losses that TMG Associates passed on to its limited partners." *fn19" Similarly, the Partnerships, as well as N.V. and GSI, received commissions not for trading in securities but rather "for the fraudulent documentation" of "more than $ 350 million in false interest expenses." *fn20"

 By 1983, both the Government and the Partnerships were closing in on Markowitz. Early in the year, the IRS opened an investigation of Markowitz. *fn21" The partners in TMG II were, however, the first to institute legal action. On November 15, 1983, apparently in response to the IRS investigation, Markowitz resigned as general partner of both TMG Associates and TMG II. *fn22" A little less than a month later, Donald Weil, the remaining general partner in TMG II, sued Markowitz, alledging that Markowitz had breached his fiduciary duties to the Partnership by improperly appropriating the opportunity to trade with Hillcrest, by using Partnership employees for his own benefit, by converting Partnership funds to purchase, among other things, the stables and the houses for himself and for his sister, and by making improper loans to himself from the Partnership. A similar complaint, filed six months later by an ad hoc committee of TMG Associates limited partners, was consolidated with Weil v. Markowitz, and after a four month delay of the proceedings requested by the United States Attorney for the Southern District of New York and several more months of negotiation, the parties reached a compromise embodied in an Order of August 30, 1985. *fn23" According to the terms of the order, Markowitz and several of his wholly owned corporations agreed to the entry of a judgment against them in the amount of $ 897,177.96 representing a "full accounting, in equity, for specific Partnership property, including funds, that were entrusted to Mr. Markowitz in his fiduciary capacity as general partner." *fn24" TMG II and TMG Associates agreed in return to release all related claims against Markowitz and his corporations. *fn25" The agreement did not in any way affect the rights of limited partners, *fn26" many of whom would later claim to have lost both the equity they invested in the Partnerships and the tax deductions that they took between 1980 and 1982. *fn27"

 Although the Partnerships were able to file suit before the Government, the Government drew first blood: After filing its lien against Markowitz in January, the IRS was able, in the next six months, to seize approximately $ 450,000 from bank accounts owned or controlled by Markowitz. *fn28" After entry of the Order of August 30, 1985 and the filing of the instant complaint, Markowitz voluntarily surrendered to the IRS approximately $ 270,000, constituting the proceeds from the sale of his home at 2323 Porter Street, the Rolls Royce, the Ford Bronco, and his stock in TMG Securities, as well as $ 5,000 from a Swiss bank account. *fn29" Finally, in 1988, the IRS received, from an escrow account established in Weil v. Markowitz, over $ 500,000 from the sale of the house at 2329 Porter Street bought for Markowitz's sister. *fn30"

 The Partnerships filed the instant action on August of 1985 -- after the IRS filed its tax liens and levied upon Markowitz's bank accounts but before the surrender of the other assets. They alleged that their claims against Markowitz for fraud and for breach of fiduciary duty had priority over the IRS's claims against Markowitz for delinquent taxes. Plaintiffs also originally sought to recover any surplus from the tax levies and to estop the United States from denying the priority of their claims.

 In the six years since this action was filed, the latter two claims have been abandoned. It is now clear that the tax levies did not produce a surplus; while the IRS claims Markowitz owes over $ 5 million in back taxes, it has been able to recover less than a third of that amount. *fn31" The estoppel claim has also been resolved. The Partnerships contended that the Government should be estopped from denying the priority of their claims because it improperly delayed entry of judgment against Markowitz in Weil v. Markowitz.32 This claim was considered and rejected when the plaintiffs in Weil v. Markowitz sought to enter the Order of August 30, 1985 nunc pro tunc, to before the filing of the Government's liens in January of 1985. See Weil v. Markowitz, 283 App. D.C. 184, 898 F.2d 198, 201 - 02 (D.C. Cir. 1990), cert. denied, 110 S. Ct. 68 (1990); see also Revised Order of March 10, 1988 (consolidating this matter with Weil v. Markowitz for the limited purpose of resolving the motion for entry of the consent order nunc pro tunc).

 As a consequence, the only remaining issue in this action is whether the Partnerships' claims against Markowitz have priority over the Government's claims. This issue has also been confined since the filing of the original complaint. The Partnerships now claim that they have superior title to fourteen specific assets seized or recovered by the IRS. Even so limited, resolution of this claim is far from simple.

 II.

 Before considering the substance of the matter, it is first necessary to determine whether this Court has jurisdiction over all aspects of the claim. Congress has waived its sovereign immunity in suits alleging wrongful levies by the IRS. See 26 U.S.C. § 7426(a)(1) (1988). *fn33" As a consequence, this Court clearly has jurisdiction over the assets seized by the IRS from Markowitz's bank account during the early part of 1985. See supra p. 7. Congress has also consented to actions to "quiet title to . . . real or personal property on which the United States has or claims a mortgage or other lien." 28 U.S.C. § 2410(a)(1). *fn34" On August 2, 1985, when the instant complaint was filed, the United States had liens on all of the other assets now claimed by the Partnerships. It would, therefore, appear that this Court has jurisdiction over whose claims as well. The Government, however, contends that since those assets were later voluntarily surrendered to the IRS, this Court no longer has jurisdiction over claims concerning them. This contention is not persuasive.

 The Government correctly notes that the waiver of sovereign immunity in 28 U.S.C § 2410(a) does not apply when, at the commencement of litigation, the property at issue is in the possession of the United States. See. e.g., Trustees of the Puritan Church v. United States, 111 App. D.C. 105, 294 F.2d 734 (D.C. Cir. 1961) (per curiam). There is, however, no precedent for the claim that the IRS may strip a federal court of jurisdiction under § 2410 by the simple expedient of obtaining possession of the property. Quite to the contrary, all three circuits that have considered this contention have rejected it. See Kulawy v. United States, 917 F.2d 729, 734 (2d Cir. 1990); Delta Savings & Loan Assoc. v. Internal Revenue Service, 847 F.2d 248, 249, n. 1 (5th Cir. 1988); Bank of Hemet v. United States, 643 F.2d 661, 665 (9th Cir. 1981).

 Moreover, this rejection rests upon a sound reading of the statute. Simply put, there is "nothing in § 2410(a)(1) that permits the government to oust Ca] court of jurisdiction validly invoked." Kulawy v. United States, 917 F.2d at 733 - 34 (citation omitted). Nor is there any reason to suppose that Congress intended to give the Executive Branch such power. "The existence of federal jurisdiction ordinarily depends on the facts as they exist when the complaint is filed." Newman-Green, Inc. v. Alfonzo-Larrain, 490 U.S. 826, 109 S. Ct. 2218, 2222, 104 L. Ed. 2d 893 (1989) (citation omitted) (emphasis added). As a consequence, § 2410(a) is most naturally read to condition the waiver of sovereign immunity on the circumstances at the time the complaint is filed. Indeed, the Government's interpretation would defeat Congress' apparent purpose in consenting to quiet title suits. By consenting to such suits, Congress indicated that it wished title disputes to be resolved by law, not by brute force. The Government's interpretation would, however, give the IRS the power "to manipulate its position subsequent to the filing of the complaint" so as to bar potentially meritorious claims. Bank of Hemet v. United States, 643 F.2d at 665. Absent a clear indication to the contrary, Congress should not be presumed to have intended such an irrational and unjust result. See, e.g., Sunstein, Interpreting Statutes in the Regulatory State, 103 Harv. L. Rev. 405, 482 (1989).

 In the alternative, the Government contends that plaintiffs' claims are barred because § 2410 does not authorize the recovery of money damages. Cf. Lehman v. Nakshian, 453 U.S. 156, 161, 69 L. Ed. 2d 548, 101 S. Ct. 2698 (1980) (noting that "this Court has long decided that limitations and conditions upon which the Government consents to be sued must be strictly observed and exceptions thereto are not to be implied") (quotation and quotation marks omitted). Be that as it may, nothing bars plaintiffs from receiving a declaratory judgment of their rights which might serve as the basis for a claim of conversion or from seeking some form of equitable relief. So, even if it is assumed that the Partnerships' remedies are limited, nothing prevents them from establishing their right to the assets in question.

 III.

 The Government asserts that it has a superior claim to the assets claimed by the plaintiffs based, upon the tax liens filed in January, 1985. According to the Government, those liens have priority over the subsequent judgment obtained by TMG Associates and TMG II in Weil v. Markowitz. This contention is correct, but it does not resolve the case.

 "Federal tax liens are wholly creatures of federal statute," United States v. Brosnan, 363 U.S. 237, 240, 4 L. Ed. 2d 1192, 80 S. Ct. 1108 (1960), and under federal law such liens may, with several exceptions not applicable here, be "primed" only by a previously and properly filed lien. See, e.g., United States v. New Britain, 347 U.S. 81, 85, 98 L. Ed. 520, 74 S. Ct. 367 (1954). To be properly filed, a lien must be "choate." In other words, "the identity of the lienor, the property subject to the lien, and the amount of the lien" must all be established and nothing more left to be done to perfect the lien. Id. at 84. The judgment lien in Weil v. Markowitz clearly fails to satisfy this standard. Although the complaints consolidated into that action were filed fully six months before the United States filed its lien against Markowitz on January 14, 1985, the Partnerships did not obtain a judgment against Markowitz in a specific amount until August 30 of that year. See Order of August 30, 1985 at 4. Moreover, as noted above, the Partnerships' request to have that order entered nunc pro tunc has been denied. See supra p. 9. As a consequence, the United States is entirely correct in arguing that its tax liens have priority over the plaintiffs' judgment liens.

  It does not, however, follow that the Partnerships' claim to the fourteen assets at issue here must be dismissed. Tax liens may attach only to "property . . . belonging to [the taxpayer]." 26 U.S.C. § 6321. *fn35" They "cannot extend beyond the property interests held by the delinquent taxpayer." United States v. Rodgers, 461 U.S. 677, 690 - 91, 76 L. Ed. 2d 236, 103 S. Ct. 2132 (1983). Thus, if the Partnerships can show that at the time the Government filed its liens they, not Markowitz, were the true owners of the fourteen assets, they can establish their entitlement to those assets. See, e.g., United States v. Durham Lumber Co., 363 U.S. 522, 4 L. Ed. 2d 1371, 80 S. Ct. 1282 (1960). Moreover, in order to do so, the plaintiffs need not show that they had legal title to those assets. They need only show that they had a beneficial interest in those assets sufficient to give them equitable title under state law. See, e.g., Dennis v. United States, 372 F.Supp. 563 (E.D. Va. 1974); see also Aquilino v. United States, 363 U.S. 509, 513, 4 L. Ed. 2d 1365, 80 S. Ct. 1277 (1960) (noting that "state law controls in determining the nature of the legal interest which the taxpayer had in the property sought to be reached by the statute") (quotation, quotation marks, and footnote omitted).

 The Partnerships contend that in tax lien cases the burden of proof shifts to the Government. See Plaintiff's Opposition at 27; Plaintiff's Reply at 15. This contention is based primarily upon the authority of a Ninth Circuit decision, Flores v. United States, 551 F.2d 1169 (9th Cir. 1977). The contention is not persuasive. Both the facts and the reasoning in that case are easily distinguishable.

 As in this case, in Flores a third party challenged a tax lien filed upon what the IRS contended was the property of a delinquent taxpayer. However, in contrast to this case, in Flores the Government seized property from the possession of the third party. See id. at 1171. The Ninth Circuit reasoned that in such a situation the Government should for two reasons bear the burden of proving that the property belonged to the delinquent taxpayer. First "the Internal Revenue Service needs probable cause at the time assets are initially seized to connect these assets to a taxpayer with outstanding taxes due." Id. at 1174 - 75 (footnote omitted). It then reasoned that

 since the Internal Revenue Service has this obligation in any event, it seems highly appropriate for the Government to bear the burden of persuasion on what is really the identical question raised by the terms of the statute -- whether the levy is wrongful because the taxpayer has no interest in the property.

 Id. at 1175. Second, the Flores Court found that it would be unfair to force the third party to establish that the taxpayer did not own the property because of the difficulties of proving "a negative fact about which he had absolutely no information." Id. & n.7.

 Neither of these rationales applies to this case. Because the property seized from Markowitz was in his possession, the nexus between the delinquent taxpayer and the property is obvious, and there is no need for the IRS to present additional evidence in order to satisfy their constitutional obligations. More importantly, in this case, the Partnerships would not be prejudiced by assuming the plaintiff's normal burden of proof: "In most situations, the plaintiff has the burden of proving his case, so it is not exceptional to expect a plaintiff attacking a tax levy to prove that the property was his own." Minges v. United States, No. H-75-186, at *2 (D. Conn. March 30, 1991) (LEXIS, Genfed Library, District Court Library). Indeed, in Flores the Ninth Circuit recognized that its ruling did not extend to this situation. See Flores, 551 F.2d at 1176 n.8 (expressly reserving judgment on whether the burden of proof would shift to the Government where "the plaintiff makes a claim to the property derivatively from the taxpayer"). Indeed, when finally faced with a case like this one, the Ninth Circuit placed the burden of proof on the plaintiff challenging the tax lien. See Arth v. United States, 735 F.2d 1190, 1193 (9th Cir. 1984); see also Valley Finance, Inc v. United States, 203 App. D.C. 128, 629 F.2d 162 n.19 (D.C. Cir. ...


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