United States v. First National Bank of Circle
48 A.F.T.R.2d (RIA) 5750, 32 Fed. R. Serv. 2d 114, 652 F.2d 882 (1981)
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Rule of Law:
A pretrial order, entered under Fed.R.Civ.P. 16, controls the subsequent course of litigation and may only be modified by the court to prevent manifest injustice after considering specific factors. Under 26 U.S.C. § 3505(b), liability for an employer's unpaid withholding taxes extends to "lenders, sureties, or other persons" who supply funds for specific wage payments, even if they act as an agent or through honoring overdrafts, provided they have actual knowledge of the employer's inability to pay taxes.
Facts:
- Fort Belknap Builders, Inc. (Builders), a corporation all of whose stock is held by the Fort Belknap Indian Community Council, borrowed funds from the First National Bank of Circle (Bank) and its affiliates in 1970 to finance the purchase of a contract with the Department of Housing and Urban Development (HUD) for 50 houses.
- Later in the same year, the shareholders of Builders borrowed funds from the Bank and its affiliates to finance the construction of a building for Builders.
- Builders assigned the lease of that building to the Bank as security, and also assigned the proceeds from the HUD contract, which were deposited directly into Builders’ account.
- Edward Towe, president of the Bank and also president of most affiliated lending banks, arranged all these loans and possessed blank forms of notes executed by Builders.
- During the latter part of 1971, Builders' account with the Bank was substantially overdrawn.
- From the fourth quarter of 1970 through 1971, Builders paid its employees but failed to pay withholding and F.I.C.A. taxes.
Procedural Posture:
- The United States initiated an action in district court against the First National Bank of Circle under Section 3505(b) of the Internal Revenue Code to collect unpaid withholding and F.I.C.A. taxes owed by Fort Belknap Builders, Inc.
- The Bank filed an answer consisting of a general denial.
- In 1976, the Bank moved for summary judgment, arguing the loans were ordinary operating loans for general expenses, not specifically for paying wages.
- The district court granted the Bank's initial motion for summary judgment.
- The United States appealed to the United States Court of Appeals for the Ninth Circuit, which reversed the district court's decision, holding that material issues of fact remained in dispute (556 F.2d 589), and remanded the case.
- On March 28, 1978, after remand, the United States (appellant) and the Bank entered into a pretrial order that included agreed facts, stating that "numerous loans and advances were made by the [Bank]," and listed the Bank's contentions, none of which asserted that it was not a supplier of funds.
- On the first day of the new trial, the Bank moved for summary judgment, contending for the first time that it had not been a supplier of funds, arguing it acted only as an agent for participating banks and that honoring overdrafts did not constitute supplying funds.
- The district court granted this second motion for summary judgment, ruling that the Bank acted only as an agent and that honoring overdrafts did not make it a supplier of funds.
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Issue:
1. Did the district court err by granting summary judgment to the Bank on a theory not included in the pretrial order and at variance with agreed facts, without formally modifying the order under Federal Rule of Civil Procedure 16? 2. Can a bank be held liable as an "other person" under 26 U.S.C. § 3505(b) for arranging loans through affiliates or honoring a borrower's overdrafts for wage payments, if it knew the employer could not pay withholding taxes?
Opinions:
Majority - Schwarzer, District Judge
Yes, the district court erred by granting summary judgment to the Bank on a theory not included in the pretrial order and at variance with agreed facts, without formally modifying the order under Federal Rule of Civil Procedure 16, and yes, a bank can be held liable as an "other person" under 26 U.S.C. § 3505(b) for arranging loans through affiliates or honoring a borrower's overdrafts for wage payments, if it knew the employer could not pay withholding taxes. The Ninth Circuit held that the district court improperly disregarded the pretrial order without exercising its discretion to modify it. Rule 16 of the Federal Rules of Civil Procedure states that a pretrial order controls the subsequent course of the action and limits the issues for trial. Parties generally cannot offer evidence or advance theories at trial that are not included in or contradict the order, unless modified "to prevent manifest injustice." The court emphasized that unless pretrial orders are honored, the objectives of simplifying issues and avoiding unnecessary proof will be jeopardized. To properly modify an order, a court must consider factors such as the degree of prejudice to both parties, the impact on the orderly conduct of the case, and any willfulness or neglect on the part of the moving party. The district court here departed substantially from the order to the prejudice of the United States without considering these relevant factors. Regarding the Bank's potential liability under Section 3505(b) as a "supplier of funds," the court rejected the district court's narrow interpretations. First, the court clarified that the regulatory definition of "other person" excludes those "acting only as agent of the employer or as agent of the employees," not any person who happens to be an agent. Therefore, the Bank's role in arranging funds for Builders, even if as an agent for affiliated banks, does not automatically absolve it from liability if it "supplies funds." The statute is not limited to persons supplying their own funds, but is intended to reach anyone who provides payroll financing, directly or indirectly. Second, the court held that honoring overdrafts can constitute a method for supplying funds under Section 3505(b) under proper circumstances, citing Fidelity Bank, N.A. v. United States. The determination depends on whether the evidence establishes that the overdrafts were honored "for the specific purpose of paying wages" with knowledge of the employer's inability to pay taxes, which requires a trial to resolve the factual issues based on several factors. The court also dismissed the Bank's other contentions, stating that whether loans were "ordinary working capital loans" is a factual issue for trial, that no separate assessment against the supplier is required for the statute of limitations under Section 3505(b), and that laches is not a defense to tax claims by the United States.
Analysis:
This case significantly reinforces the procedural importance of pretrial orders under Fed.R.Civ.P. 16, emphasizing their role in trial management and preventing "trial by ambush." Substantively, it broadens the scope of "supplier of funds" liability under 26 U.S.C. § 3505(b), clarifying that financial institutions cannot easily avoid liability by structuring transactions as agency arrangements or by routinely honoring overdrafts. This ruling makes it more challenging for third parties involved in payroll financing to escape responsibility for unpaid withholding taxes, thereby strengthening the IRS's ability to collect such taxes and encouraging greater due diligence from lenders.
