Secured Creditors Beware: Liability Lurks in Lockboxes
Jill B. Bienstock, Cole Schotz P.C.
liability. A creditor using a lockbox may unwittingly expose itself to greater risk and liability than just a debtor’s default if it receives funds that were collected as sales tax on a debtor’s goods or services.
As a lender or secured creditor, how do you know if you are at risk? First and foremost, understand your debtor’s business and whether its goods or services are taxed. Second, know what the laws provide for in the jurisdiction where your debtor is conducting business – particularly with respect to third-parties that collect or receive sales tax.
By way of example, the State of Texas treats anyone who collects or receives money that is collected as a tax as a strict, statutory trustee, holding the collected tax for the benefit of the taxing authority. Recipients and holders of such proceeds may be liable for the full tax amount collected – plus any accrued interest and penalties. See Tex. Tax Code Ann. § 111.016 (2007).
A central issue in determining liability in your jurisdiction may be how your lockbox is structured, as is the case for Texas. If a debtor’s customers pay receipts with sales tax directly to a lockbox, in Texas such a creditor is a strict, statutory trustee. If, however, a debtor’s customers pay receipts with sales tax first to the debtor and then those funds are transferred to a lockbox, a creditor still risks being liable as a transferee if they have the requisite “knowledge.” In determining whether to impose liability on a third-party, Texas courts consider whether the recipient knew that it received sales tax funds. Knowledge is not just whether you had actual notice that the receipts contained sales tax funds. Instead, it is an “inquiry notice” standard, which requires a court to consider whether there was sufficient information available to cause you to inquire whether the funds received contained tax receipts. Courts consider a third-party as being on “inquiry notice,” and thus having the requisite knowledge to be held liable, where, if you pursued an issue, you would or could have ascertained the truth.
Do you have enough information to be on “inquiry notice?” Lenders and secured creditors often require that debtors provide various periodic reports and/or copies of invoices to monitor the financial health of their operations. As a careful and proactive creditor, you may already have sufficient information to be on “inquiry notice” that you are holding commingled funds in your lockbox.
Jill B. Bienstock
Lenders and secured creditors often require that debtor-customers direct all receivable collections into a lockbox, hoping to wrangle any available proceeds to apply to their debtors’ outstanding debt. In requiring a debtor or its customer to remit payments to a lockbox, however, creditors may be overlooking a potential source of significant liability. A creditor using a lockbox may unwittingly expose itself to greater risk and liability than just a debtor’s