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Attorney's Affidavit Insufficient to Rebut IRS's Proof of Claim in Bankruptcy

(Parker Tax Publishing April 2018)

The Bankruptcy Appellate Panel for the Eighth Circuit Court of Appeals reversed a bankruptcy court's decision that a worker's compensation attorney's affidavit stating his opinion on the value of the debtor's pending claim for worker's compensation on the petition date was substantial evidence to rebut the IRS's proof of claim. The Eighth Circuit found that the affidavit was not substantial evidence of value because it did not contain the financial or factual information necessary to support the attorney's opinion and the IRS never had the opportunity to cross examine the attorney. In re Austin, 2018 PTC 100 (B.A.P. 8th Cir. 2018).

Scott and Anna Austin filed for Chapter 13 bankruptcy in 2014. In their bankruptcy schedules, the Austins listed two pending worker's compensation claims as contingent and unliquidated exempt property. The Austins valued the claims at $0 or an unknown value.

The IRS was listed as a secured creditor. It filed a proof of claim asserting in part a secured claim resulting from a tax lien. The Austins filed an objection to the IRS's claim in January 2015. They objected to the amount of the IRS's priority claim and the amount of the claim listed as secured. The Austins said that no value should be attributable to their worker's compensation claims in determining the secured portion of the IRS's claim. They also argued, in the alternative, that since there were neither settlement offers nor a basis to determine the value of the worker's compensation claims, the present value of the worker's compensation claims should be $0.

After a hearing on the objection, the bankruptcy court held that the Austins had failed to rebut the IRS's claim. The court reasoned that, because the Austins' worker's compensation claims were being pursued at the time the petition was filed, they must have had some value.

In the meantime, the Austins negotiated a settlement of their worker's compensation claims for approximately $21,000 and received a net settlement after attorney's fees of around $15,000. The IRS learned of the settlement and filed an amended claim, which included as part of its secured claim the $15,000 net value of the settlement.

The Austins again objected to the value of the IRS lien against their worker's compensation claims. In support, they filed an affidavit of their worker's compensation attorney, Michael Smallwood, who opined that the worker's compensation claims had a "nuisance" value of $3,000 on the petition date. The IRS responded that the affidavit was not sufficient to overcome the prima facie validity of its claim. The IRS also argued that the value of the worker's compensation claims should be the settlement amount, although the settlement occurred several months after the petition date.

The bankruptcy court heard oral arguments on the second objection. In July 2017, the bankruptcy court ruled that the affidavit was substantial evidence of the value of the worker's compensation claims, sufficient to rebut the presumption of validity of the IRS's claim. The bankruptcy court reasoned that the affidavit was from the attorney who litigated the matter. Further, the bankruptcy court stated that the IRS had not provided additional evidence to prove why it believed the true value of the claim should be the actual settlement amount. The bankruptcy court sustained the objection and valued of the worker's compensation claims at $3,000. The IRS appealed to the Eighth CIrcuit.

Under 11 U.S.C. Sec. 506(a)(1), a claim is a secured claim to the extent of the value of the creditor's interest in the bankruptcy estate's interest in the property. When a creditor files a proof of claim, it is deemed allowed unless a party in interest objects. The filing of an objection does not deprive the proof of claim of its presumption of validity unless the objection is supported by substantial evidence. The objecting party bears the burden of producing substantial evidence as to the value of the collateral securing any portion of the claim. Substantial evidence means relevant financial and factual information that a reasonable person would accept as adequate.

On appeal, the IRS argued that Smallwood's affidavit did not constitute substantial evidence of the value of the claims. According to the IRS, the affidavit contained uncorroborated and self-serving hearsay statements. The IRS also pointed out that it never had the opportunity for cross examination. The Austins argued that no particular method of valuation was required, and valuation questions were for the judge to decide on a case-by-case basis. The Austins said that the affidavit was sufficient proof of the value of the claim because Smallwood handled the case and was an experienced worker's compensation attorney who was in the best position to value the claims as of the petition date.

The Bankruptcy Appellate Panel for the Eighth Circuit reversed the bankruptcy court and held that the Smallwood affidavit was not substantial evidence. First, the court found that the affidavit contained Smallwood's personal opinion of value. The court noted that Smallwood admitted in the affidavit that as of the petition date he did not know the full extent of Mr. Austin's injuries; Mr. Austin had not had any independent medical exams and needed further treatment and analysis.

The court also found that Smallwood provided no evidence of what he did to increase the value of the claims. As the court explained, the claims were for losses due to the injuries Mr. Austin sustained at work. The evidence supporting the losses would be determined by the extent of the injury and worker's compensation schedules. The court reasoned that Smallwood's work had no impact on these factors. While Smallwood's work helped establish the extent of Mr. Austin's injuries and helped to recover the worker's compensation insurance benefits, it had no impact on the value of the claims themselves, as Smallwood did not increase the extent of Mr. Austin's injuries. His efforts simply made the facts known and aided in recovery.

Smallwood stated in the affidavit that at the time of the filing of the petition, no offers in settlement had been made. The court found that Smallwood did not state what demands had been made on Mr. Austin's behalf, nor did he provide any documentation to corroborate his statement that the claim was worth only $3,000 on the petition date, despite settling it for over $21,000 just seven months later. The court noted that Smallwood did not present copies of the actual worker's compensation claims filed, evidence of the statutory scheme for valuing such claims, or evidence of past awards for similar claims.

The court also noted that, because the bankruptcy court did not hold an evidentiary hearing, the IRS had no opportunity to cross examine Smallwood or take testimony, and nothing was admitted into evidence.

The court explained that substantial evidence could have included such things as lost wages, medical bills or worker's compensation schedules. Allowing valuation without a reasonable factual basis, in the court's view, would encourage abuse and allow debtors to avoid a secured creditor's interest in claims simply by failing to obtain the facts necessary to support the claims.

For a discussion of bankruptcy estates, see Parker Tax ¶16,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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