The opinion of the court was delivered by: BUCKLO
On February 10, 1988, Lee N. Mortenson ("Mr. Mortenson") and James M. Fawcett ("Mr. Fawcett") were assessed a 100 percent penalty in the amount of $ 694,887.42 pursuant to 26 U.S.C. § 6672. Messrs. Mortenson and Fawcett subsequently brought these lawsuits against the United States government seeking a refund and abatement of the penalty, and the government brought counterclaims to recover the unpaid portion of the penalty. The government now brings this motion in limine to exclude evidence from the trial of these consolidated cases. For the reasons stated herein, the motion is granted.
The parties have stipulated to the following facts for purposes of this motion. Opeleika Manufacturing Corporation ("Opeleika") was a publicly-held Illinois corporation engaged in the business of manufacturing textiles. Opeleika maintained its headquarters in Chicago, Illinois, but had manufacturing plants and divisional headquarters in Alabama, Arkansas, Georgia, Illinois, Michigan, New York and the Barbados. During the relevant period, Opeleika employed several thousand persons at its various locations. Approximately 61 percent of Opeleika's outstanding stock was owned by Technical Equipment Leasing Corporation ("Telco"), another publicly-held company, during the relevant period. Opeleika filed for reorganization under the federal bankruptcy laws on May 23, 1985. Opeleika was unsuccessful in achieving a reorganization and was liquidated by the bankruptcy court without paying $ 694,887.42 in withholding taxes for its employees.
In January, 1984, Mr. Mortenson was hired as the President and Chief Operating Officer of Telco. On August 31, 1984, Telco named him President and Chief Executive Officer of Opeleika, which was then experiencing financial difficulties. Mr. Mortenson served as President and Chief Executive Officer through December, 1986. He was elected a director of Opeleika in March, 1985, and served in that capacity through December, 1986. He never owned any stock of Opeleika, nor was he a shareholder of Telco during the relevant period. As President of Opeleika, Mr. Mortenson had the authority to sign checks for Opeleika, hire and fire employees, make financial decisions, and sign loans and other documents authorized by the Board of Directors.
In June, 1977, Mr. Fawcett became a director of Telco. He served as director and Vice Chairman of Telco's Board through December, 1985. In June, 1983, Mr. Fawcett became a director of Opeleika, and on August 31, 1984, he was named Vice Chairman of Opeleika's Board of Directors. He remained a director and Vice Chairman of Opeleika's Board through March, 1986. Mr. Fawcett was employed by Opeleika to assist its President with special projects. He never served as an officer of Opeleika nor owned any Opeleika stock. As an Opeleika employee, Mr. Fawcett was an authorized signatory on some bank accounts but he never signed checks. He lacked the authority to hire and fire employees, make financial decisions, or determine which creditors were to be paid. His first and primary special project was the refinancing of Opeleika's debt, which occurred in November, 1984.
On November 28, 1984, Opeleika's debt was partially refinanced with a group of financial institutions headed by Congress Financial Corporation ("Congress"). As security for its loans, Congress obtained perfected security interests in all of Opeleika's accounts receivable, inventory, machinery and equipment, trademarks and patents, the stock of its subsidiaries, and the proceeds of all of such assets. Opeleika's real estate remained mortgaged to other lenders. Pursuant to the loan agreement, Opeleika was required to and did notify all of its customers to send their payments directly to a lock box under the sole control of Congress. Congress subsequently advanced funds on a daily basis on Opeleika's request. These funds were deposited in Opeleika's bank accounts and used to pay its bills. Under this arrangement, Opeleika had no funds available to pay bills except those funds advanced by Congress. Under the loan agreement, Congress agreed to extend to Opeleika a line of credit in an amount up to a specified percentage of the value of Opeleika's inventory and accounts receivable. The excess of this amount over the amount already advanced to Opeleika at any given time was referred to as Opeleika's "availability" of funds. If Opeleika had already borrowed an amount equal to or in excess of its maximum line (i.e., there was no availability), Congress was not required by its loan documents to advance any more funds and could apply the funds it received from Opeleika's customers to reduce its advances to the maximum that it was required to extend.
A few weeks before the Congress loan was funded, Congress informed Mr. Fawcett that employment taxes were delinquent. Messrs. Mortenson and Fawcett had previously been unaware of this delinquency. These taxes were paid from the proceeds of the Congress loan.
After the loan closing, Mr. Mortenson instructed Arthur J. Rabin ("Mr. Rabin"), the Assistant Treasurer, to treat the payment of employment taxes as a top priority. Neither Mr. Mortenson nor Mr. Fawcett were involved in the process of paying payroll or payroll taxes. Mr. Rabin, who was appointed Treasurer of Opeleika on January 29, 1985, was responsible for preparing, reviewing, filing and signing employment tax returns and depositing employment taxes. During the relevant period, Mr. Rabin reported to Roy Younger, Opeleika's Chief Financial Officer, who in turn reported to Mr. Mortenson. By letter dated December 12, 1984, Congress informed Mr. Rabin that he was required to provide Congress with copies of all depository slips or cancelled checks for all tax payments, including federal withholding taxes on a daily basis, under the terms of the loan agreement. After the closing of the Congress loan, federal withholding taxes were properly deposited and returns timely filed through the week of December 5, 1984. Nevertheless, beginning in mid-December, 1984, and continuing sporadically through January, 1985, Mr. Rabin failed to deposit federal withholding taxes, using the funds provided for this purpose to pay others instead. Withholding taxes for the period between February 12, 1985 and May 23, 1985, the date upon which Opeleika filed bankruptcy, were paid as required.
In January, 1985, Opeleika's auditors determined that Opeleika had an inventory shortage of approximately $ 3,000,000 and informed Messrs. Mortenson and Fawcett that Opeleika's December 31, 1984, inventory was overstated by approximately that amount. This decrease in Opeleika's inventory value caused the Congress loan to exceed the maximum availability. Messrs. Mortenson and Fawcett informed Congress of this shortage and scheduled a meeting with Congress representatives to discuss how to proceed under circumstances where Congress was no longer required to advance funds to Opeleika and could, if it desired, declare the loan immediately due and apply all funds received to reduce the amount due to Congress. The Congress loan was constantly over its limit and in default from the discovery of the inventory shortage until Opeleika filed bankruptcy in May, 1985.
On February 10, 1985, Mr. Rabin informed Mr. Fawcett about the unpaid withholding taxes which had accrued during the prior two months. Mr. Fawcett in turn informed Mr. Mortenson. Prior to February 10, 1985, neither Mr. Fawcett nor Mr. Mortenson were aware that such taxes were not deposited or had any reason to believe that Mr. Rabin was not carrying out Mr. Mortenson's prior instructions to deposit these taxes. Shortly thereafter, Mr. Mortenson asked Congress to fund additional amounts to pay the back withholding taxes and to enable Opeleika to continue to operate. Congress, however, refused to advance additional funds to pay the past due federal withholding taxes. Congress agreed to fund specific expenditures which it deemed necessary for Opeleika to continue to operate, such as current wages, raw materials, and utilities.
After February 12, 1985, Congress changed its funding practices because Opeleika had no loan availability and any additional advances by Congress were strictly voluntary. Congress began requiring that Opeleika representatives submit daily funding requests to Congress. Congress representatives subsequently determined which of these requests should be paid, reported its decisions to the Opeleika representatives, and advanced to Opeleika funds sufficient to pay only these amounts. These funds were transferred to Opeleika's accounts and Opeleika made the payments specified by Congress. Opeleika had no other funds except those advanced by Congress to pay its obligations. All payroll taxes due for periods after February 12, 1985, and prior to Opeleika's May 23, 1985 bankruptcy filing were paid with funds advanced by Congress.
After February 12, 1985, Opeleika requested and received funds from Congress in excess of the amount of the unpaid withholding taxes. These funds were advanced for the specific purpose of paying current wages, including current payroll taxes, buying raw materials, and covering other operating expenses approved by Congress. While Messrs. Mortenson and Fawcett did not personally make the daily requests to Congress for funds, they knew that other creditors of Opeleika were being paid from funds advanced by Congress after February 12, 1985, and that the payroll taxes for periods prior to February 12, 1985, remained unpaid.
Starting in March or early April, 1985, representatives of the Internal Revenue Service ("IRS") met with Mr. Fawcett and others at Opeleika to negotiate a plan to remit the unpaid payroll taxes. The IRS representatives emphasized the importance of keeping payroll taxes current and indicated their willingness to accept payment over time of the back taxes if Opeleika kept current. Since Congress was willing to fund current payroll taxes, Opeleika was able to comply with the requirement for current payment. Messrs. Mortenson and Fawcett hoped that they could obtain financing from either Congress or Telco to pay the unpaid withholding taxes if a reasonable payment plan could be negotiated. During April or May, 1985, Mr. Fawcett and other Opeleika representatives continued to negotiate with the IRS for a plan to pay the remaining December, 1984 and January, 1985 withholding taxes. They were not able to negotiate a plan acceptable to Congress before Opeleika declared bankruptcy on May 23, 1985.
Liability for Withholding Taxes Under the Internal Revenue Code
The Internal Revenue Code ("Code") requires employers to withhold federal income and social security taxes from their employees' wages. See 26 U.S.C. § 3102, 3402; United States v. Running, 7 F.3d 1293, 1294 (7th Cir. 1993). The withheld taxes are deemed to be a special fund held in trust for the benefit of the government. 26 U.S.C. § 7501(a); Slodov v. United States, 436 U.S. 238, 243, 56 L. Ed. 2d 251, 98 S. Ct. 1778 (1978). As such, they may not be used as working capital for the business. Cline v. United States, 997 F.2d 191, 194 (6th Cir. 1993) (citations omitted). If an employer withholds the taxes, the employee is credited with having paid them regardless of whether the employer turns the taxes over to the government. Bowlen v. United States, 956 F.2d 723, 726 (7th Cir. 1992). The government's only recourse for the payment of the ...