We welcome back guest blogger Matthew Hutchens of the University of Illinois Gies College of Business. With co-author Erin Stearns, Hutch recently updated the lien and levy chapters of Effectively Representing Your Client Before the IRS. In today’s post, he examines the Fifth Circuit opinion on a niche question of Louisiana law after an attempted visit to the Louisiana Supreme Court. Christine
In a post last summer, I wrote about the 5th Circuit case of Goodrich et al. v. United States, No. 20-30422 (5th Cir. 2021). In that decision, the court defined what constituted “an interest” in property that would allow a third party to bring a wrongful levy suit under IRC. § 7426(a)(1). However, the court felt Louisiana law was unsettled as to whether such an interest existed in the present case.
Accordingly, we were left with the court certifying a question to the Louisiana Supreme Court regarding the property rights of naked owners of a usufruct of consumables. In November, the Louisiana Supreme Court denied certification of the question. And, in late January, the 5th Circuit—somewhat anti-climactically—resolved the case in an unpublished opinion.
In their initial opinion, the 5th Circuit adopted a definition of “an interest” used by several other Circuits; holding that “an interest” in the context of a wrongful levy suit requires a third party to hold “a fee simple or equivalent interest, a possessory interest, or a security interest in the property levied upon.” But, while determining what level of ownership interest is enough for a third party to bring a wrongful levy suit is a federal law question, determining what a third party actually owns is a state law matter. And here, the court was unable to determine—under Louisiana state law—what kind of ownership interest the third parties had at the time of the levy.
To briefly summarize the facts, Mr. Goodrich passed away with significant federal tax debt. After his death, a succession bank account was set up. The account included cash and later the proceeds from several post-death asset sales. This account was then levied upon by the Service.
At the time of his death, Mr. Goodrich had a lifetime usufruct over various properties. A usufruct being the legal right to enjoy the use of property during the term of the usufruct (similar to the common law life estate, but duration can be shorter than a lifetime). Mr. Goodrich’s three children were the naked owners of the property subject to his usufruct. A naked owner owns the property, but they do not have the full rights to use the property. At the end of the usufruct, all the rights to the property revert to the naked owner (similar to a remainder interest at common law).
At the district court, the children prevailed in showing they were—as naked owners—the rightful owners of cash proceeds from certain post-death asset sales of usufruct property. This resulted in a portion of the levied funds related to those assets being returned.
However, the issue facing the 5th Circuit on appeal revolved around what kind of state law property rights the children had in proceeds from a stock sale of usufruct property that had occurred years prior to Mr. Goodrich’s death. Or put another way, what rights the naked owners had in usufruct property that had already been consumed.
Under Louisiana law, when the usufruct ended, Mr. Goodrich was bound to “pay to the naked owner the value that the things had at the commencement of the usufruct or to deliver to him things of the same quantity and quality.” So, the children had some interest in the sales proceeds from the stock. But was it enough of an interest to sustain a wrongful levy claim?
The children argued that they were the actual owners of Mr. Goodrich’s cash funds up to the amount of the prior stock sale proceeds. However, the district court disagreed, finding under Louisiana law that the children were merely unsecured creditors. The 5th Circuit though found the answer to this question unclear, certifying the following tongue twister to the Louisiana Supreme Court: “[d]oes a usufructuary’s testamentary usufruct of consumables render naked owners unsecured creditors of the usufructuary’s succession?”
In November, the Louisiana Supreme Court denied certification of the question stating that “[t]he certified question may be resolved under existing law and jurisprudence.” The court pointed to the Louisiana Civil Code and two state court appellate court decisions—one of those appellate decisions being the same ruling the district court had relied on in making their initial determination.
When the case returned to the 5th Circuit, the court affirmed the district court’s decision that the children (as naked owners) had a claim against the father’s succession for the usufruct of consumables (the disposed stock). However, that claim under Louisiana law was only as unsecured creditors. Thus, the children were not the direct owners of the disputed funds in the bank account. And, as unsecured creditors, the children did not have an interest sufficient to sustain a wrongful levy claim related to those funds.
While this may seem like an ending that fizzled, the case shows the interplay of state and federal law upon lien and levy law under the Internal Revenue Code. The Supreme Court in Aquilino v. United States, 363 U.S. 509 (1960) made clear that state law plays a large role. Here, it’s hard to criticize the district or circuit court for the manner in which the case was handled. The district court properly looked to state law to find the answer and based its decision on the state law it concluded applied to the case. The Fifth Circuit, giving the children the full benefit of getting definitive state law precedent, sought guidance from the state Supreme Court and received a response that basically said the district court got it right.
Not many clients hold usufructs, but many have some type of state law property interest. Goodrich provides a great example of how the process should work while simultaneously making some of us glad we don’t practice in Louisiana having to tangle with this strange property creature called a usufruct.