This article examines the decision of the United States Bankruptcy Court for the Southern District of New York in Stephen S. Gray v. The Williamsburg Hotel BK, LLC, Toby Moskovits, and Michael Lichtenstein, Adversary Proceeding No. 22-07049, which addressed whether Employee Retention Tax Credit (ERTC) refunds claimed and received by a non-debtor manager constitute property of the Debtor’s estate and must be turned over to the Liquidation Trustee.

Factual Background

The dispute centered on 96 Wythe Acquisition, LLC (the "Debtor"), a New York limited liability company that owned the Williamsburg Hotel. The Williamsburg Hotel BK, LLC (the "Manager"), another New York LLC, managed the Hotel’s operations. Defendants Toby Moskovits and Michael Lichtenstein owned and controlled both the Debtor and the Manager.

The relationship between the Debtor and the Manager was partially governed by an Assignment of Hotel Management Agreement and Subordination of Hotel Management Fees (the "December Agreement"), executed in 2017. This agreement stipulated that the Manager’s compensation was 3% of gross rent collected. Crucially, the Manager acknowledged in the December Agreement that all Rents and revenues generated by the Hotel were the sole property of the Debtor.

All parties agreed that the Manager used the Debtor’s Hotel revenues (referred to interchangeably as cash flow, funds, or revenue) to satisfy the payroll obligations, including employment taxes, for the employees who worked at the Hotel. The Manager, acting as the employer, reported these taxes to the Internal Revenue Service ("IRS") on Forms 941 and 941-X.

Following the enactment of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), which established the ERTC program, the Manager claimed $2,305,503.80 in ERTC refunds for the first, second, and third quarters of 2021. The ERTC is a refundable employment tax credit available to eligible employers affected by the COVID-19 pandemic who paid qualified wages. Excess credits are treated as an overpayment refundable under Internal Revenue Code Sections 6402(a) and 6413(b).

The Debtor filed for Chapter 11 relief in February 2021. The IRS subsequently paid the First Quarter Refund ($408,263.92) and the Third Quarter Refund ($1,132,423.18) to the Manager post-petition. The Second Quarter Refund ($475,448.94) was being held in escrow by Defendants’ counsel, resulting in a total disputed ERTC Refund amount. The Court noted that the Manager disbursed over $500,000 of the ERTC Refund to Moskovits and Lichtenstein personally.

Stephen S. Gray was appointed as the Chapter 11 Trustee and later became the Liquidation Trustee following the confirmation of the liquidation plan in April 2023.

Trustee’s Request for Relief

The Trustee, Stephen S. Gray, moved for summary judgment seeking the following relief:

A declaration that the proceeds of the ERTC Refund claimed by the Manager are property of the Debtor’s estate.
A conclusion that the Defendants were unjustly enriched by their retention of the refunds.
An order directing the Defendants to turn over the ERTC Refund to the Trustee for the estate’s benefit.
An order directing the Defendants to provide a written accounting of the disposition of the ERTC Refund.

Court’s Analysis of Applicable Law

The Court addressed the Trustee’s claims under three primary legal frameworks: Bankruptcy Estate Property, Turnover, and Unjust Enrichment.

Property of the Estate

The Court noted that upon commencement of a bankruptcy case, the estate is broadly created, comprising all legal or equitable interests of the debtor in property. This definition includes proceeds, product, offspring, rents, or profits of or from property of the estate (11 U.S.C. §541(a)(6)). Furthermore, any interest in property that the estate acquires after the commencement of the case is included (11 U.S.C. §541(a)(7)) if it is "sufficiently rooted in the pre-bankruptcy past" (citing Chartschlaa v. Nationwide Mut. Ins. Co., 538 F.3d 116, 122 (2d. Cir. 2008) and Segal v. Rochelle, 382 U.S. 375, 380 (1966)). Congress intended this definition to be interpreted broadly, encompassing "every conceivable interest of the debtor" (citing United States v. Whiting Pools, Inc., 462 U.S. 198, 204 (1983)). While state law determines the nature of the debtor’s interest, bankruptcy law determines if that interest is sufficient to bring the property into the estate.

Turnover

Turnover actions are governed by 11 U.S.C. §542(a). A party seeking turnover must establish three elements: (1) the property is or was in the possession, custody, or control of the entity during the case; (2) the property may be used under Section 363 or exempted under Section 522; and (3) the property has more than inconsequential value or benefit to the estate (citing In re Celsius Network LLC, 664 B.R. 85, 103 (Bankr. S.D.N.Y. 2024)).

Unjust Enrichment

Under New York law, a plaintiff asserting an unjust enrichment claim must demonstrate three elements (citing In re Pretty Girl, Inc., 644 B.R. 298, 311 (Bankr. S.D.N.Y. 2022) and Kaye v. Grossman, 202 F.3d 611, 616 (2d Cir. 2000)):

The defendant benefitted.
At the plaintiff’s expense.
Equity and good conscience require restitution.

Unjust enrichment is a quasi-contractual claim available only when no valid, enforceable written contract governs the specific subject matter (citing Sama v. Mullaney (In re Wonderwork, Inc.), 611 B.R. 169, 217 (Bankr. S.D.N.Y. 2020) and Clarke-Fitzpatrick, Inc. v. Long Island Rail Road Co., 70 N.Y.2d 382, 388-89 (1987)).

Tax Law Implications (26 U.S.C. §6402(a))

The Court discussed 26 U.S.C. §6402(a), which states that the Secretary shall refund any overpayment balance to "the person who made the overpayment". The Trustee argued that this phrase refers to the party who funded the taxes. Although United States v. Williams, 514 U.S. 527 (1995) was noted as having been superseded by statute, its reasoning supports the idea that the refund recipient under Section 6402 is the person who made the overpayment, which "expressly contemplate[s] refunds to parties other than the one assessed". The Court found that Section 6402(a) does not bar the Trustee from asserting a superior claim to the ERTC Refund in the adversary proceeding, even if the Manager was viewed as the nominal "person who made the overpayment" (citing Thompson v. United States, 429 F. Supp. 13, 15 (E.D. Pa. 1977)). Ultimately, the Court determined that the specifics of tax law were irrelevant to the unjust enrichment analysis.

Application of Law to the Facts

The Court applied the legal standards, finding that the Trustee established all necessary elements for summary judgment.

Debtor Ownership of Funds

The Court established that the Hotel revenue belonged entirely to the Debtor, a fact the Defendants did not dispute based on the December Agreement. Because the taxes that generated the ERTC refunds were paid exclusively from the Debtor’s revenue, the ERTC refunds are property of the Debtor’s estate under 11 U.S.C. §541(a). The Defendants’ attempt to classify the refund as "profit" belonging to equity holders failed, as profits from the Hotel are an asset of the Debtor’s estate.

Absence of Governing Contract

The Defendants argued that a contract barred the unjust enrichment claim. However, the Trustee asserted that the Manager’s use of the Debtor’s funds to pay its employees and related employment taxes was not governed by any contractual agreement. The Defendants failed to produce or cite a separate agreement covering this specific subject matter. Thus, the unjust enrichment claim was not barred (citing Scotto v. Almenas, 143 F.3d 105, 114 (2d Cir. 1998)).

Unjust Enrichment Analysis

The Court found all three elements of unjust enrichment were satisfied:

Enrichment: The Defendants were enriched when they received, retained, and disbursed the ERTC Refund, which originated from the Debtor’s property.
At the Estate’s Expense: The funds were property of the estate and, had they been paid to the Debtor, would have been used to pay administrative expenses or claims of prepetition creditors. By retaining and disbursing the funds, the Manager engaged in impermissible self-help, paying itself outside the priority scheme established by the Bankruptcy Code (citing In re Microvideo Learning Sys., Inc., 232 B.R. 602, 609-10 (Bankr. S.D.N.Y. 1999)).
Equity and Good Conscience: Restitution is required because the Defendants used the Debtor’s property to pay the Manager’s tax obligations and then unjustly kept the refund. The fact that the Manager paid the taxes and applied for the credit is irrelevant; as the revenue belonged to the Debtor in the first instance, the tax refund arising from that revenue belongs to the estate.

Conclusions

The Court concluded that the Trustee satisfied the burden of proving that the Defendants were unjustly enriched by retaining the ERTC Refund, which resulted from taxes paid with property of the estate.

Consequently, the Court also found that the Trustee established the claim for turnover of the ERTC Refund by the Defendants.

The Court therefore granted the Trustee’s Motion for Summary Judgment, requiring the Defendants to turn over the remaining ERTC Refund and account for any amounts already disbursed. The Court noted that the Defendants’ retention and disbursement of the ERTC Refund was consistent with their prior improper conduct during the bankruptcy case.

Prepared with assistance from NotebookLM.