The U.S. Court of Appeals for the Sixth Circuit recently reversed the entry of summary judgment in favor of a mortgagor in a breach of contract claim where the plain language of a settlement agreement did not prohibit a lender from reporting its transaction with the Internal Revenue Service (IRS).
Here, the mortgagor paid the taxes relating to the cancelled indebtedness, and the Court did not address the propriety of a hypothetical borrower’s attempt to prevent reporting to the IRS altogether.
A copy of the opinion is available at: Link to Opinion
On November 14, 2015, the mortgagor (“Mortgagor”) obtained a loan from the mortgagee’s (“Lender”) predecessor in interest. Mortgagor eventually defaulted on the loan, and Lender initiated foreclosure proceedings in the state court.
On June 1, 2010, the state court entered judgment in the amount of $524,478.87 (the “Judgment”), and ordered the sheriff to sell the property. Lender assigned its right to bid at the sheriff’s sale to a bidder (“Bidder”). Bidder purchased the property at the sheriff’s sale for $280,000. After accounting for fees and costs, the state court credited Mortgagor $269,557.90 toward the balance that he owed to Lender on the judgment.
On June 1, 2011, Mortgagor filed a motion in the state court to set aside the Judgment on the ground that Lender had failed to mitigate its damages. Mortgagor asserted that, prior to the sheriff’s sale, Lender had received two offers to purchase the property for $435,000 and $372,000, respectively. Mortgagor argued that: (1) Lender had unreasonably failed to pursue those offers; and (2) because the winning bid at the sheriff’s sale was substantially less than the other offers Lender had received, the credit that the state court applied toward the balance Mortgagor owed on the Judgment was too low.
Mortgagor and Lender ultimately agreed to resolve Mortgagor’s motion to set aside the Judgment. As part of the resolution, Mortgagor agreed to pay Lender $5,000 and Lender agreed to negate the portion of the Judgment reflecting amounts owed by Mortgagor (the “Settlement Order”).
The parties memorialized their agreement by stipulating to the entry of the Settlement Order, which contained the following terms:
1) For good and valuable consideration, the receipt of which Lender acknowledges, the deficiency judgment as to Mortgagor has been resolved and settled among the parties in total; and
2) Any such deficiency judgment as to Mortgagor is hereby released and/or vacated.
Following the entry of the Settlement Order, Lender issued a 1099 (likely a 1099-C) to both Mortgagor and the IRS. On that form, Lender indicated that it had cancelled $159,478.87 in debt owed by Mortgagor. Mortgagor included that amount in the gross income he reported in his 2011 federal tax return. Mortgagor claimed that the additional $159.478.87 reported income increased his 2011 tax liability by $68,660.
After paying his 2011 federal taxes, Mortgagor filed a breach of contract action against Lender in the state court. Lender removed the action to federal court. Both parties moved for summary judgment.
The district court granted summary judgment in favor of Mortgagor. The district court reasoned that resolution of the claim necessitated evaluation of income tax law and terms of art utilized in that area of law, particularly the contested liability doctrine. See, e.g., Zarin v. Comm’r of Internal Revenue, 916 F.2d 110, 115 (3d Cir. 1990) (“Under the contested liability doctrine, if a tax payer, in good faith, disputed the amount of a debt, a subsequent settlement of the dispute would be treated as the amount of debt cognizable for tax purposes. The excess of the original debt over the amount determine to have been due is disregarded [in calculating gross income].”).
The district court reasoned that because Mortgagor contested the amount of the debt that was negated by the Settlement Order, the order did not result in “income” to Mortgagor. Accordingly, the district court held that Lender breached the Settlement Order by issuing the 1099.
On appeal, the Sixth Circuit looked to Ohio contract law to determine the parties’ obligations under the Settlement Order. The Sixth Circuit noted that where “the parties following negotiations make mutual promises which thereafter integrated into an unambiguous contract duly executed by them, courts will not give the contract a construction other than which the plain language of the contract provides.” See Aultman Hosp. Ass’n v. Cmty. Mut. Ins. Co., f/k/a Hosp. Care Corp., 544 N.E.2d 920, 924 (Ohio 1989). A court may not “rewrite the parties’ contract” to give it a meaning other than and/or beyond that expressed in its unambiguous language.” Id.
The Sixth Circuit noted that the Settlement Order consisted in relevant part of two short, clear sentences. According to the Court, Lender only: (1) acknowledged that the deficiency judgment had been settled; and (2) it agreed that the deficiency judgment was “resolved and/or vacated” -- Lender had not made any effort to resuscitate Mortgagor’s debt, it had not taken any action that indicated to anyone or any entity that Mortgagor remained indebted to Lender, and Lender had not made any effort to collect any debt from Mortgagor. Thus, the Court held, the Lender had not breached the Settlement Order.
The Sixth Circuit concluded that the Settlement Order said nothing about how each party would treat the transaction memorialized in the Settlement Order for tax purposes nor about how each party would report the transaction the IRS. Given the complete absence of any reference to tax reporting issues, the Court held, the Settlement Order could not be read as precluding Lender from issuing the 1099. Indeed, the Sixth Circuit noted, a contrary ruling would violate Ohio’s fundamental rules of contract interpretation.
The Sixth Circuit likened the case to a South Carolina case in which the District of South Carolina granted summary judgment in favor of an insurance company because a similar agreement did not prohibit the insurance company from filing a Form 1099-MISC. See Ward v. Am Family Life Ins. Co. of Columbus, 444. F. Supp.2d 540 (D. S.C. 2006).
Next, the Court noted that the absence of any reference to tax treatment/reporting in the Settlement Order was significant because it is common practice for parties to address tax matters in settlement agreements when the parties have, in fact, agreed upon them. Consideration of tax law, however, would be appropriate where the language of the parties’ settlement agreement makes those laws relevant. See Duse v. Int’l Bus. Mach. Corp. 252, F.3d 151 (2d Cir. 2001) (consideration of tax law appropriate where settlement agreement provided that the settlement payment was “not subject to withholding taxes” and where defendant agreed not to disclose the amount of the settlement “except as may be required by law or business necessity”). As the Settlement Order contained no language tying Lender’s authority to report the settlement payment to federal tax law, the Court held there was no basis to resolve the contract claim by reference to federal tax law.
Accordingly, the Sixth Circuit reversed the entry of summary judgment in favor of Mortgagor and remanded for entry of judgment in favor of Lender.
Ralph T. Wutscher
McGinnis Wutscher LLP
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Email: rwutscher@mwbllp.com
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