United States District Court, Central District of Illinois, Springfield Division
June 3, 1985
BRH BUILDERS, INC., PLAINTIFF,
UNITED STATES OF AMERICA, ET AL., DEFENDANTS.
The opinion of the court was delivered by: Baker, Chief Judge.
This matter is before the court on the parties' cross-motions
for summary judgment. The parties do not dispute the facts
underlying this action. Thus, summary judgment is appropriate.
Fed.R.Civ.P. 56(c). Plaintiff has sought oral argument on the
contested questions of law. The court, however, has determined
that oral argument would not aid in the consideration of this
On May 16, 1983, "Raymur" (a nationwide developer of classroom
buildings) entered into a lease agreement with Sangamon State
University (SSU or University), the terms of which provided that
Raymur would construct metal classroom buildings to SSU's
specifications and lease the buildings to SSU for five years,
granting SSU an option to purchase the buildings at the end of
the lease period. On the same day Raymur contracted for
Plaintiff, BRH Builders, to assemble the prefabricated
classrooms. As part of its financing arrangement, Raymur assigned
the SSU lease to the Continental Illinois National Bank (the
Bank). The assignment was recorded with the county clerk and
acknowledged by the lessee (SSU) on November 14 and 15, 1973. At
that time, the University had already made its first rental
payment to the bank on August 20, 1973. BRH continued
construction, the Bank remitted checks payable to BRH and Raymur,
and Raymur assigned to BRH the amounts owed on completed
construction. The Bank's final payment, due October 15, 1973, was
made directly to Raymur without obtaining a lien waiver from BRH.
Raymur did not pay BRH the balance then owing.
The record does not so indicate, but it is assumed that BRH
attempted to secure payment and in the process learned that
Raymur was unwilling or unable to pay the amount due. BRH then
faced several unattractive options:
1. Record and enforce a mechanic's lien against
Raymur. Raymur still held title to the improvements
BRH had constructed but the title was subject to a
lease with a purchase option and thus was
2. Record and enforce a mechanic's lien against the
bank. The bank as leaseholder could be said to have
benefited from BRH's improvements. It certainly had
knowledge of the improvements. But the bank had not
requested the improvements. Having already paid the
$115,000 final installment to Raymur, the bank
could be counted on to resist strenuously BRH's
equitable claims for relief.
3. Record and enforce a mechanic's lien against the
(a) as lessee or owner of the underlying land (if
SSU was the owner of the underlying land, a fact
not alleged here) on the theory that the University
knew about, acquiesced in and stood to benefit from
the improvements. (A few courts have recognized
this theory, but the University would certainly
resist this equitable claim.)
(b) as a public entity for which improvements had
been constructed. Illinois law provides that a
subcontractor may file a lien directly against a
public entity where the prime contractor holding a
contract to construct a "public improvement" for
the public entity has failed to pay the
work performed. Ill.Rev.Stat. ch. 82 § 23. The
statute's applicability to BRH was doubtful since
Raymur, the prime contractor, held a lease not a
construction contract with SSU and the buildings —
technically belonging to Raymur — were not clearly
BRH determined that a claim under Ill.Rev. Stat. ch. 82 § 23 had
the best chance of succeeding and accordingly filed a lien
against the University on January 3, 1974 (the tax year in
question). To comply with the state statute's requirements BRH
filed an action for an accounting against Raymur on March 1,
1974. It is not clear what response Raymur made to this claim.
The University, uncertain as to whom its second annual lease
payment should be paid, instituted an interpleader action naming,
among others, the bank, Raymur, and BRH as defendants.
The stipulated facts do not indicate but the Court may assume
that BRH's tax year 1974 ended on December 31, twenty-two days
after the University filed its interpleader action.
BRH claims that as of December 31, 1974, it assessed the
likelihood of recovering its $115,000 on its ch. 82 § 23 theory
and determined to write off the debt. The IRS contends that at
the end of 1974 the debt was not completely worthless as
demonstrated by subsequent events:
1. On March 10, 1975, BRH entered a motion for
summary judgment on its ch. 82 § 23 claim under
Ill.Rev.Stat. ch. 82 § 23.
2. On March 15, 1975, BRH filed its 1974 tax return
claiming the $115,000 as a bad debt deduction.
3. On April 10, 1975, the circuit court granted
summary judgment to BRH in its action for an
accounting, and ordered Raymur to pay to BRH the
$115,000 owing. Raymur did not appear at the
hearing on the motion.
4. On June 3, 1975, BRH moved to amend the order
granting summary judgment so as to require the
bank to pay BRH from the University's escrowed
lease payments. Essentially this was a motion to
enforce ch. 82 § 23.
5. On November 4, 1975, the circuit court approved a
settlement of BRH's claim whereby the bank would
pay to BRH from escrowed funds $90,000 in
satisfaction of BRH's $115,000 claim. The court
never ruled on BRH's motion to amend the order
granting summary judgment. The bank and the
University later apportioned their liabilities in
respect to the settlement payment.
The IRS granted Plaintiff a $25,000 bad debt allowance for the
tax year 1975 (the $115,000 debt less the $90,000 settlement) and
required Plaintiff to adjust its 1974 tax filings to erase the
$115,000 bad debt deduction. Plaintiff complied with the IRS'
directive and brought this suit claiming a $11,865.66 tax refund
resulting from vagueries in the rules for computing tax
liabilities which are not at issue here. This Court is asked to
decide whether BRH's claim against Raymur was a bad debt as of
December 31, 1974.
The Internal Revenue Code provides for the deduction from
income of all "wholly worthless debts," I.R.C. § 166(a)(1)
(1984). A taxpayer must claim a bad debt deduction in the year it
becomes worthless. See, e.g., H.W. Findlay v. Commissioner,
236 F.2d 959 (3d Cir. 1956). The burden of proving worthlessness
rests with the taxpayer, Redman v. Commissioner, 155 F.2d 319
(1st Cir. 1946), who must overcome a presumption in favor of the
IRS' determination, Lundsford v. Commissioner, 212 F.2d 878 (5th
The worthlessness of a debt must be determined by "an
examination of all the circumstances." W.A. Dallmeyer v.
Commissioner, 14 T.C. 1282, 1291 (1950). Relevant "circumstances"
may exist before or after the end of the tax year for which the
deduction is claimed. The strength of the creditor's claim, the
solvency of the
debtor, and efforts to collect the debt (before and after the end
of the relevant tax year) have been considered in determining a
debt's worthlessness. Ultimately, "[t]he date of worthlessness is
fixed by identifiable events which form the basis of reasonable
grounds for abandoning any hope for the future." Id. at 1291.
The IRS' position is essentially: Where there is a law suit
there is hope. This bright line definition of worthlessness does
have intuitive appeal. No one sues over a worthless debt.
The Commissioner cites a tremendous amount of precedent for the
standard he seeks, but the cases he offers appear to support a
slightly different proposition: A debt is not worthless, if the
parties continue to sue over it, and there appears to be some
chance for recovery. See, e.g., Appalachian Trail Company v.
Commissioner, ¶ 73, 119 P.H. Memo T.C. (continuing to do business
with debtor establishes debt not worthless); J.B. Reilly v.
Commissioner, ¶ 55,007 P.H. Memo T.C. (Some hope that taxpayer,
creditor in bankruptcy proceedings, would recover some portion of
his debt); Prescott v. United States, 4 AFTR 2d 5387 (S.D.Tex.
1959) ("So long as the taxpayers were attempting to collect a
claim . . . which, if allowed, would result in the taxpayers
receiving a substantial sum of money," the debt is not
In the instant case, as of December 31, 1974, the taxpayer,
even if his suit for an accounting was successful, was likely to
collect nothing. (Raymur was insolvent and a mechanic's lien
against Raymur as title holder of the building would be worth
nothing since the title was subject to the lease with option to
buy). The validity of the taxpayer's claim to protection under
Ill.Rev.Stat. ch. 82 § 23 was never reached by any court —
although taxpayer did broach it by filing in May of 1975 his
motion to order the Bank to pay the accounting Raymur owed BRH.
As indicated above, the statute's applicability was doubtful.
The mere existence of a suit at the time a debt is claimed to
be worthless does not establish that the debt has value. See,
Zeeman v. United States, 275 F. Supp. 235 (S.D.N.Y. 1967)
(Claimant in the Great Salad Oil Swindle was unlikely to recover
a dime). The continued prosecution of a suit to quell rumors,
Kugal v. Ryan, 289 F.2d 329 (2d Cir. 1961), or to obtain a
worthless judgment, Redfield v. Eaton, 53 F.2d 693 (D.Conn.
1931), does not jeopardize a claim that the debt was worthless
for tax purposes. Here, Plaintiff's prosecution of his request
for an accounting might well be seen as merely an attempt to
obtain a worthless judgment. However, his subsequent effort to
require the bank to pay the accounting out of the escrowed lease
payments indicates that Plaintiff felt more sanguine about the
collectibility of his debt than would be consistent with a bad
debt deduction in 1974. Plaintiff's subsequent recovery of
$90,000 by way of settlement agreement demonstrates the judgment
of all parties that Plaintiff's claim was not worthless.
Rather than challenge the IRS' brightline definition of
worthless debts, Defendant seeks to distinguish the lien he filed
pursuant to 82 § 23 and the lawsuit he prosecuted for an
accounting from a lawsuit to collect the debt. He cites Revenue
Rule 80-24 in which a purchaser of worthless promissory notes,
deducted the value of the notes from his taxable income and then
filed suit against the sellers alleging securities fraud and
claiming damages equal to the amount paid for the notes. The
ruling is inapposite. Ill.Rev.Stat. ch. 82 § 23 was designed as
an alternative means to ensure payment of subcontractors, not as
any kind of anti-fraud provision. The statute creates a lien and,
by implication, an action on the debt itself, not some
alternative substantive right to fair dealing.
In light of Plaintiff's continued pursuit of his claim — a
claim that subsequent events demonstrate was not frivolous — this
Court cannot adjudge the debt worthless as of the end of 1974.
cannot have it both ways. A well prosecuted effort to collect the
debt cannot now be overlooked in this well prosecuted effort to
declare the debt worthless.
As of December 31, 1974, it appeared unlikely that BRH would
collect the money due. Nevertheless, BRH continued its suit
beyond the end of 1974. Continuing to pursue a debt where there
is a likelihood of at least partial collection establishes that a
debt is not worthless. Here, the taxpayer continued to pursue a
debt where there was little chance of success yet did receive
satisfaction of the claim. The strength of BRH's claim against
the University argues for declaring the debt worthless in 1974,
but the taxpayer's pursuit of the claim and subsequent recovery
convinces this court that the claim was not worthless until 1975
and then only as to the $25,000 in excess of the amount received
in the settlement agreement.
IT IS THEREFORE ORDERED that Defendants' motion for summary
judgment is hereby GRANTED.
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