AQUILINO v. UNITED STATES

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Argument of Charles S. Friedman

Chief Justice Earl Warren: Number 1, Robert Aquilino and Joseph Spero, Home Maintenance Company, Incorporated, Petitioners, versus United States of America.

Mr. Charles S. Friedman: Mr. Chief Justice --

Chief Justice Earl Warren: Mr. Friedman.

Mr. Charles S. Friedman: -- may it please the Court.

For some three days, this Court which have listened to a contest between giants here, that it listened to the United States Government has one contest with five different States over property that amounts -- will eventually amount to billions of dollars.

We're engaged in a contest here between that -- one of those giants to wit, the United States and two small subcontractors from the State of New York.

The amount of money involved is small.

It's only $2200.

The Government tax reached that far.

It has been awarded to them and they claimed of it's -- and it's been awarded to them upon the basis that it was property of the taxpayer under 3670 of the Internal Revenue Code.

We claim that the property belongs to these subcontractors under the law of the State of New York.

Some brief reference of the facts is essential.

In 19 -- in December 1951, and again in March of 1952, the Government filed two assessment liens for small amounts with the collector of Internal Revenue in Albany, New York.

That lien may be -- what has been very amply described as the secret pernicious lien of the United States Government to wit, it's one of those liens that nobody, except the United States Government and the collector knows about it.

Justice John M. Harlan: Made so by the decisions of this Court, I suppose you might.

[Laughs]

Mr. Charles S. Friedman: That may be so, Your Honor.

Sometime thereafter, totally unaware of this lien and totally unconnected with the tax -- delinquent taxpayer, a Mrs. Bottone bought some rail property in Westchester County.

She bought this property in July of 1942.

Some seven months after the Government filed its first lien.

She intended to conduct a business thereon and have some remodeling work and intended to have some remodeling work done.

She employed the delinquent taxpayer here, Fleetwood Paving Company, to do that work.

Prior to that, Fleetwood Paving have no real business relationship with her, nor with the subcontractors, who I represent the petitioners herein.

Fleetwood Paving Corporation thereupon, entered into contracts with the two petitioners herein as subcontractors, to wit, Aquilino and Colonial Sand Company.

Both these subcontractors very promptly and quickly performed their subcontracts and completed their work.

They remain unpaid to this date.

Now, I mentioned these dates despite the fact that in our opinion, these dates are unimportant, unimportant for this reason.

The question is whether or not this is property of this -- of the delinquent taxpayer, the general contractor.

We say that that isn't.

And therefore, the time of filing by anybody is unimportant.

Now, we say it isn't because whether or not this is property of the taxpayer and therefore, reachable by the Government's lien, is a matter purely of state law.

And this Court has so set in the decision last June, United States versus Bess 357 U.S. 51.

Therein --

Chief Justice Earl Warren: Is there any difference of opinion between the parties on that score?

Mr. Charles S. Friedman: I'd -- I'm sorry.

Chief Justice Earl Warren: Is there any difference of opinion between the parties on that score?

Mr. Charles S. Friedman: No.

Chief Justice Earl Warren: As to what's --

Mr. Charles S. Friedman: No.

Chief Justice Earl Warren: Well --

Mr. Charles S. Friedman: I'm just getting to that.

[Laughter]

The point is that the Government agrees as they've stated in their brief on pages 13 and 7.

Petitioner recognized as indeed they must and then they cite U.S. versus Bess that whether Fleetwood had any property interest in the sum due from Bottone is a question of law.

And on page 7, they set forth the same recognition of that being the question.

Now, it's regrettable that this Bess case wasn't decided before the Aquilino case, on which we are here now.

Justice John M. Harlan: (Inaudible) no question of competing lien.

Mr. Charles S. Friedman: Your Honor, we do not consider that this is a question of competing liens.

We only give in to the question of competing liens, if and when you're discussing the question of property that's admittedly the tax --

Justice John M. Harlan: (Inaudible) words in your mouth that this follow the question of competition between creditors involved here?

Mr. Charles S. Friedman: No.

We say there is no question of competition.

We say that this property under the law of the State of New York belongs to these subcontractors.

Justice Charles E. Whittaker: When -- when you say property, as I understand, you limit yourself to the chosen action under this contract.

You pose to him be -- avail of the contract, is that it?

Mr. Charles S. Friedman: I don't say that we limit ourselves to that.

I say that all moneys due to the general contractor including his cause of action against the owner for the moneys that either, are due or are to be become due, are part of the trust under the New York law.

And as long as they are part of the trust and these sub -- subcontractors are the sole beneficiaries of that trust, that is not property of the -- of the general contractor and is not reachable by the tax lien.

Justice Charles E. Whittaker: In other words, this property of the trustee is not properly have been issued?

Mr. Charles S. Friedman: That's right.

It's just -- it's just as simple as that.

And we say that it is not the property of the trustee.

The -- most that could ever be said with respect to the trustee is that he held bare legal title.

He had no beneficial interest whatsoever.

Justice Charles E. Whittaker: Now, do you mean that interest -- you mean in your title -- in essence of title of the trustee, but in his individual capacity, he is only conditional, is that what you think?

Mr. Charles S. Friedman: No.

Not the -- not the general contractor --

Justice Charles E. Whittaker: No, the trustee.

Mr. Charles S. Friedman: Well, the trustee -- the general contractor would be the trustee.

But such title as he had would be solely a bare legal title as trustee for the benefit of the subcontractors or the beneficiaries as set forth in the statute in the State of New York.

Justice John M. Harlan: New York Court of Appeals (Inaudible)

Mr. Charles S. Friedman: No.

I don't agree with that, Your Honor.

I think that the New York Court of Appeals did not decide that and that's why the issue is here.We say that the Court of Appeal avoided a determination as to whether or not, this was property of the -- of the delinquent taxpayer, the general contractor herein.

And we say -- and we think it's crystal clear that they avoided it for this reason.

And I'd like to read you a part of their decision.

It's in the record on page 68, “It is by now exceedingly well settled that no state-created rule may defeat the paramount right of the United States to levy and collect taxes, uniformly throughout the land.”

With which we agree.

Then it goes on to say, “That being so, if powers of the provisions on this State's Lien Law to which the responded points that funds received by a contractor from the owner for the improvement of real property shall be deemed “trust funds” for the payment of the subcontractors, and then here's the key line, “May not be construed to affect the rights of the Government or the priority of its tax lien.”

Now, I don't think with that phraseology, there can be any question that they were deferring to the federal -- to federal decisions, which they cite as -- as precluding them from determining under the law of the State of New York, whether or not this was property of the general tax of the --

Justice William J. Brennan: I gather your point is that they, suppose if you have appreciated that this was the decision of the -- made on state law, whether the property --

Mr. Charles S. Friedman: That's right.

Justice William J. Brennan: -- the result (Inaudible) difficult.

Mr. Charles S. Friedman: That's exactly what we say and as a matter of fact, it's our contention that the Court's own footnote to that statement in their opinion, eliminates and accentuates that very question because in their footnote to that statement, they say, “To the extent that Cranford-Leopold, which was a Court of Appeals' decision earlier, just contrary to what it's contented they held here, to the extent that Cranford-Leopold suggest the contrary, it must give way to more recent federal decisions.

Now, we think that its -- that makes it very clear that they did not pass on the question as to whether or not, this was property of the general -- of the general contractor under New York State law.

Justice Felix Frankfurter: Well, the -- the utmost thing that you could ask from this Court or is it the utmost thing that -- which indicates back to the Court of Appeals to have them ascertain, it's a little presumptuous to tell, for us, to tell them they should have statements to New York law and so Judge Fuld and company wouldn't have pursued that.

Mr. Charles S. Friedman: That would -- that would be an alternative disposition, Justice Frankfurter, but --

Justice Felix Frankfurter: Another one is that we should decide what New York law is.

Mr. Charles S. Friedman: Well, we think that this Court has the power to decide what New York law and -- is and could therefore, reverse it rather than remand for --

Justice Felix Frankfurter: It would require for us to decide New York law which, for some reason or other, the New York Court of Appeals, in your point of view, it wouldn't do, is that right?

Mr. Charles S. Friedman: That may be so.

Of course, we contend -- we contend that if the Court of Appeals had to -- we contend exactly as was stated in the opinion in the Durham case, which is to be heard immediately following us.

In the Durham case there, the Court of Appeals for the Fourth -- Fourth Circuit there, I don't have that phraseology immediately at hand, but they -- but they said, “That had the Court of Appeals, in the Aquilino case, given further consideration or given proper consideration to the law of the State of New York, they probably would've disposed of it definitely.”

Justice John M. Harlan: (Inaudible)

Mr. Charles S. Friedman: Justice Harlan, I'm very -- I'm very happy that you -- that you've drawn attention of that for this reason.

Justice John M. Harlan: Which is then?

Mr. Charles S. Friedman: This is the reference that the Government makes to the fact that -- they -- they claim that the Government's lien attached to the contractual obligation of the owner to the general contractor and not for the real property.

And I think that that's immaterial, but in order to -- let's see how the Government gets away from that -- supports that question.

They say -- they say that two decisions of the Court of Appeals of the State of New York to wit, a so-called Raymond case, 288 N.Y. 452 and a Sulphur case, 290 N.Y. 903 held that the contractual obligation of an owner to a general contractor was -- was property of the general contractor was that and could therefore, be reached by judgment creditors or Federal Government lien or whatnot.

The fact remains that those decisions may have, despite the fact that I disagree with it, they may have been good law because -- but they were based and founded on a -- upon a construction of the law prior to the 1942 Amendment, which amendment -- which amendment included the contractual obligation as part of the trust.

So that -- I -- I'm quite surprised that those two cases have been cited by the Government here, because they have attention withdrawn to them.

They were criticized and they were explained in a dissenting opinion in the Gramatan-Koslow case just the year, 1957.

And it's very obvious that they don't apply at all.

Justice William O. Douglas: Well, we have -- we have your (Inaudible) state law, don't we?

That they -- they construe it this way because under the compulsion and reading the federal statute that it would be unconstitutional to construe it any the other way.

Mr. Charles S. Friedman: No, I -- I don't see it that way, Your Honor.

I don't think that the Court of Appeals of New York appreciated that they had the right to dispose of this on a basis of what the state law was.

They were under the impression that they were precluded from determining that.

And the -- the strange part of it is that another case in which this Court has just granted cert in a -- the so-called Coblentz case.

They decided on the basis of this law of the State of New York that an attorney's lien under the judiciary law of the State of New York did constitute property of Coblentz, the attorney and wasn't -- and was superior to the lien of the Government.

So, now, as to whether or not this is property of the -- whose property this is against which the Government has filed the lien or claim the lien?

Let's look to the law of the State of New York, both the legislative and judicial history of that law.

I happen to have been practicing prior to -- in New York prior to the time that this law was passed in 1929.

Prior to that time, there was nothing to stop a general contractor from performing a contract with an owner, collecting all the money that was due and then absconding, leaving the subcontractors and the materialmen high and dry.

We finally got pretty fed up with that situation and amend the Lien Law so as to provide that a contractor who collected money from an owner or an owner who collected money from a mortgagee -- from a mortgagee and who did not use the moneys for the purpose of paying subcontractors and materialmen, was guilty of a diversion and guilty of a crime.

I'll put a stop to a great deal of it, but then as usual, they found ways and means of avoiding that and so we have continuously amended the law right down to date, so that we believe that under the law of the State of New York, there was a complete valid trust for the benefit of subcontractors, materialmen and the few others mentioned of the statute.

Now, with respect to the elements of this trust, first of all, it identifies the trust assets, and I'm reading from the statute now.

It says that the funds received by a contractor from an owner, from an owner for the improvement of real property.

So we have no question as to the identification of the corpus of the trust.

Then it designates a place of beneficiaries and it specifically says subcontractors, laborers, materialmen and it list others.

Then it designates the trustee and it says, “That the funds constituting this trust shall -- are hereby declared to be trust funds in the hands of such contractor.”

So we now have a trustee.

Other sections of the statute which we inadvertently did not have pointed, specifically requires them to keep books and records and as a matter of fact, the statute very elaborately says why he shall keep in the books and records and how he shall keep that.

It requires him to furnish an accounting to anyone of the beneficiaries of this trust anytime upon 10 days notice.

Now, it has -- it -- it also authorizes any beneficiary to examine the books and records, to examine checkbooks, any of the ledger accounts, specifically set forth in the statute.

So that we have every single essential element of a vital trust in this situation.

Now --

Justice William J. Brennan: Mr. Friedman, may I ask what do you say about the State (Inaudible) if federal lien by a government inserted against factual obligation that is conformed with (Inaudible) I gather that some (Inaudible)

Mr. Charles S. Friedman: I say that that, Your Honor, at the misconstruction of the New York statute because the New York statute specifically says that that property is part of the trust here.

Justice William J. Brennan: No, it isn't.

What I meant here is whether (Inaudible) translation on the New York Court of Appeals (Inaudible) New York statute.

Mr. Charles S. Friedman: Well, the fact of the matter is that whether it is personal property or not, it's still part of the corpus of this trust for the benefit -- benefit of these beneficiaries and it's therefore, not reachable by the Government, if it isn't the taxpayer's property, if it isn't the delinquent taxpayer's property, whether it's personal property, whether real property, whether it's a hybrid.

Justice William J. Brennan: (Inaudible)

Mr. Charles S. Friedman: No.

But then we come to the 1942 Amendment, Your Honor.

And that 1942 Amendment specifically says that for the purposes of any action, “The trust fund shall include the right of action upon an obligation for moneys due or to become due to a contractor, as well as money actually received by him.”

So it would seem to me that the so-called contractual obligation referred to in -- in what you have just read, is part and partial of the trust for the benefit of these beneficiaries.

Justice Felix Frankfurter: Couldn't -- what the Court of Appeals what Justice Fuld said the (Inaudible) means that the kind of -- of interest that the subcontractor has or the kind of obligations which the contractor holds under the New York law is not competent or rather is proper that the -- that that (Inaudible) contractor had, although he may hold them in trust, as you say to the subcontractor in the -- into the labor and so on, is not called property under 3670.

And therefore, they're construing not the New York law, but they're construing the federal law as to what constitutes profit and they exclude therefrom ownership, title ownership though is subject to a trust, is not -- is nevertheless property in that sense, in the federal sense.

Is that what they are doing?

And thereby, construing a federal statute which is open to (Inaudible) here --

Mr. Charles S. Friedman: Frankly.

Frankly --

Justice Felix Frankfurter: (Voice Overlap) --

Mr. Charles S. Friedman: -- Your Honor, we're -- we're somewhat puzzled as to what the Court of Appeals are trying to say.

Justice Felix Frankfurter: It's unlikely.

Mr. Charles S. Friedman: And I think the Court of Appeals is somewhat puzzled and we're -- we're more convinced to that in reading two subsequent decisions of theirs in which they have circumvented this very -- this very question.

Justice William J. Brennan: Well, it has what Mr. Justice Frankfurter suggested (Inaudible) what they are opposing from is -- it's not the New York statute, possibly (Inaudible) Section 3670 of the United States Code.

Mr. Charles S. Friedman: Yes.

They're trying to define --

Unknown Speaker: (Voice Overlap) --

Mr. Charles S. Friedman: -- they're trying to define property not according to the state law, but according to the -- according to federal law which we say is wrong.

We say that this property, this --

Justice Felix Frankfurter: Whether it's wrong or not, it is not a determination which forecloses us from reconsidering it.

Mr. Charles S. Friedman: That's right.

That's right.

Now -- now, there is one single decision in the State of New York in which this trust has been denied full force and effect as a good and valid trust.

There was also -- I also direct your attention to the -- to some of the federal cases involved here, particularly, those in bankruptcy, one case to which Boiler versus Godfrey 121 F. -- F.2d 415 in which this Court 314 U.S. denied cert.

The question arose there as to where or not the property of a -- whether or not funds receivable by a bankrupt in connection with work performed under this same Lien Law, whether or not they were reachable by the trustee in bankruptcy for the benefit of general creditors and the Court held that they were not.

They were not reachable under -- under the Bankruptcy Act, the trustee had no title to them they had no right to them.

So that we have a good and valid trustee here and we have the Court of Appeals not determining what the subcontractors' rights were hereunder.

Thus, the legislature of the -- of the State of New York by statute and the judiciary of the State of New York have held by their decisions that -- and are not accepting Aquilino that this is a good and valid trust.

And that the only persons that have any right title or interest are the beneficiaries set forth in the statute.

Now, this brings us to one unusual situation.

The Government, in its brief, accedes to the fact that private individuals can avoid the consequences of this Act.

On page 22 in their brief, in commenting upon the decision of (Inaudible) in the Second Circuit which this Court cited with approval in U.S.-Bess, they said that for assuming the correctness of (Inaudible) it is not unusual that parties by contract may change their respective rights.

Now, would be anomalous to say the least, that parties to a contract could -- could prevent the United States Government from collecting taxes against to delinquent taxpayer by putting the proper clause in a contract, but that the State of New York with its sovereign power and through his judiciary, cannot protect the subcontractor from the Government coming in and taking its moneys as they have here.

I say that this is not property of the delinquent taxpayer.

It's solely the property of the subcontractors here not reachable by the Federal Government's lien under 3670 and that there should be either a reversal or that the case should be remanded to the Court of Appeals for further consideration on the basis of New York state law.

Justice John M. Harlan: (Inaudible) the State wants to characterize the first problem, the problem whether you can attach (Inaudible) and the owner in your case, the general contractor, it can defeat the lien priority which otherwise would attach if it's denominated his lien under our Bess decision as the practical effect to the lien --

Mr. Charles S. Friedman: I say that the --

Justice John M. Harlan: -- from your position.

Mr. Charles S. Friedman: Yes.

I say that the State has a right to do that within certain limitation.

It cannot, of course, be obvious that the purpose of it was to defeat the United States Government in any respect.

Justice John M. Harlan: Well, a State would never (Inaudible)

Justice Charles E. Whittaker: Well, do -- do you really concede that it's a matter of nomenclature, whether the State merely puts a trust label on it --

Mr. Charles S. Friedman: No.

Justice Charles E. Whittaker: -- or not?

Mr. Charles S. Friedman: I -- no, Your Honor.

I don't think it's a -- it's a question of the label that you put on it.

I say that under the law of the State of New York, it's very clear that this is a good and valid trust.

They have gone to extreme lengths to define the trust, the nature of it, the trust assets, the beneficiary, they've imposed criminal sanctions, civil sanctions.

Justice Charles E. Whittaker: You say, in other words, in the brief, that it's not a trust in label or form alone but it's the trust -- a true trust in facts.

Mr. Charles S. Friedman: That's right.

That's exactly what we contend and that this -- and that this general contractor has no right title or interest there except there legal title for the benefit of the beneficiaries, if and when, the money comes into his hands.

Justice Felix Frankfurter: But it wouldn't help you, and the New York Court of Appeals unambiguously had disagreed with.

But my reading of it, they do not unambiguously disagree with you, but they say this kind of interest is not property within the federal statute.

Mr. Charles S. Friedman: That's right.

They say, “We have no right to consider whether or not as property of the general contractor.”

Thank you, Your Honor.

Chief Justice Earl Warren: Mr. Heffron.

Argument of Howard A. Heffron

Mr. Howard A. Heffron: Mr. Chief Justice, may it please the Court.

We have here two creditors of a general contractor.

The creditors are competing for something.

They're competing for the proceeds of the construction contract.

One creditor, the United States, asserts that its tax lien which here arose prior to the proceeds of the construction contract becoming due, gives it prior rights to this fund.

The other group of creditors, subcontractors, asserts that the trust fund provisions of New York State law give them a prior right.

Now, the chronology, we submit, is important.

The tax lien arose first.

It was followed by the taxpayer entering into a contract to do some construction work.

He proceeded to complete that contract to the satisfaction of the owner.

Shows in action arose at that time.

This was property of the taxpayer, and it was this shows an action to which the tax lien attached.

A New York law provides that the funds which a contractor has due to him on a construction contract shall, to the extent that any subcontractors are unpaid at that time, be held in trust for their benefit.

And that is where the basis for the competing claims of the subcontractors derived from.

Now, what is it that we're dealing with?

The New York State statute provides that the subcontractors have this trust right only to the extent that there is any debt owing from the owner of the property to the general contractor taxpayer.

The effect of the decision below in which the owner turned into court the funds which was still owing to the contractor, was to discharge the owner from any further liability to the contractor.

The basis for the subcontractors' claims here is that there was money due and owing to the contractor which is held in trust.

This is the basis, the foundations with the trust under New York State law.

The trust does not arise unless moneys are owing to the contractor.

The complaint here, which was filed by each of these subcontractors in the lower court, alleges that as a necessary allegation of their cause of action.

Moneys were due to the contractor.

The contractor earned these moneys.

There is no defense to the contractors claim by the owner.

Therefore, under New York law, we have prior rights.

Now, we submit that in that context while the subcontractors here may choose to use a verbal variant of the contentions which have presented -- have been presented to this Court in previous cases that this is precisely the same kind of issue which this Court has had before, many times in the past.

In essence, the subcontractors are arguing here that because under the provisions of New York law, their rights are impregnable to those of any other creditors of the taxpayer.

For that reason, they must also come prior to the reach of the federal tax lien.

Now, that is precisely the kind of argument which this Court has rejected in the past.

It rejected it through in situations where the security which the subcontractor was asserting with a lien on real estate.

Here, the security which the subcontractor asserts is, in essence, a lien on a chose in action.

Under New York law, he has the right to reach this chose in action and apply it in satisfaction of his claim.

The Government submits that it makes no difference whether the property of the taxpayer be real estate or whether it be a chose in action.

The principle which this Court has defined in the past are equally applicable here.

Now, this Court has reached the issue of the rights of mechanic's liens as against those of the United States in many situations.

It has reached that, for example, in the White Bear case, where the mechanic's lien preceded was antecedent to the federal tax lien and where everything had been done under state law, which would render the mechanics' rights impregnable to attack.

Nevertheless, this Court held that the federal tax lien was superior.

It had reached --

Chief Justice Earl Warren: Mr. Heffron, may I ask you this.

If suppose the New York court had held against you, held that the taxpayer had no right in this property under this statute, would you be here?

Mr. Howard A. Heffron: Yes, we would.

Chief Justice Earl Warren: You --

Mr. Howard A. Heffron: Mr. Chief Justice.

Chief Justice Earl Warren: In other words, you feel that New York cannot -- does not have the constitutional right to so find.

Mr. Howard A. Heffron: Well, we -- we would -- we would submit this in answer to that --

Chief Justice Earl Warren: Yes.

Mr. Howard A. Heffron: -- question, sir.

That New York cannot adopt a statute which, in effect, is a priority statute and which gives a creditor of the taxpayer a preferred position.

And then under the guise of saying, “Well, since no other creditor under New York law can reach this property, the taxpayer has no property.

Therefore, the Government can't reach it.”

We submit to characterize it in term, what is, in essence, a preference statute in terms of property doesn't -- doesn't solve the question.

The realities of the situation would govern here and in terms of the rights and liabilities of the parties, we have here a situation where the subcontractors are seeking to reach a debt owed to the taxpayer.

Now, we would say that if New York law characterized the rights of the subcontractors as -- as so concrete and fixed that the taxpayer had no property interest, that that would not bind this Court because, in essence, the New York court would be saying that the security device which we've created to benefit the subcontractors is sufficient to defeat the federal tax lien.

Justice William J. Brennan: Do I understand the Government (Inaudible) the general contractor by agreement, a provision of their contract might have accomplished precisely this -- that the claim of the subcontractors would be honored as against something which the taxpayer (Inaudible)

Mr. Howard A. Heffron: No, Your Honor.

We -- we do not concede that.

We distinguish the case in our brief which had arisen in the Second Circuit, which involved a contract provision under which it was provided that if the contractor failed to comply with certain conditions, he would have no right to the balance due.

And we distinguish that case.

Justice William J. Brennan: Well, in that -- in that -- under such provision, you're saying that the Federal Government that brings out the subcontractors?

Mr. Howard A. Heffron: No, Your Honor.

We say that would be a harder case and the question would then arise whether this Court would characterize that device which would again be an essence of method for preferring a creditor of the taxpayer --

Justice William J. Brennan: (Voice Overlap) didn't held.

Mr. Howard A. Heffron: I beg your pardon, sir?

Justice William J. Brennan: The Government didn't held.

Mr. Howard A. Heffron: The Government did lose in that case, but that case, Mr. Justice Brennan, involved a surety who held.

Justice William J. Brennan: It did lose out (Inaudible)

Mr. Howard A. Heffron: No, we did not.

Now, that case involved a complicated contract with the City of New York.

A surety who had -- had an agreement with the contractor, performance bonds and payment bonds and complicated contractual provisions which were designed to protect the City of New York from litigation which might ensue over public housing project.

And in that case, the contractor couldn't complete his contract and the surety took over for him and on the facts of that case, the Government did not feel that the result was wrong.

Justice John M. Harlan: Judge Medina, in that case, rightly or wrongfully, thought it was distinguishable under the Kings County case, which was written by Judge Clark.

Mr. Howard A. Heffron: Yes, sir.

I was going to point out that --

Justice John M. Harlan: (Voice Overlap) he'd better not, he didn't think he was changing the law of a previous panel.

Mr. Howard A. Heffron: In -- in --

Justice John M. Harlan: The Kings County case is flattening in your favor.

Mr. Howard A. Heffron: That is right.

There is a case in the Second Circuit which involves precisely this issue.

In fact, it involves a better case for the subcontractors because in the Kings County case, the trust fund arose prior to the federal tax lien coming into existence.

Surely, if they were --

Justice John M. Harlan: (Voice Overlap) the Court of Appeals on (Inaudible)

Mr. Howard A. Heffron: Yes, it is.

But the Court of Appeals was well aware of the subsequent decision in the surety case, which Your Honor has alluded to.

Justice William J. Brennan: (Voice Overlap) the Second Circuit is that on this question.

Mr. Howard A. Heffron: None that I am aware of, sir.

Justice Felix Frankfurter: You have said some time that a device for avoiding the power to the Federal Government.

Does one have to characterize the protection of -- of the interest of people like subcontractors and laborers and devices may they not be -- didn't the question really whether, if a state court works how to scheme of fiduciary relations of a trust, thereon social interest which the State may protect, although in consequence, the Government priority maybe secondary.

Why do you call it a device?

Mr. Howard A. Heffron: It may be that the -- the word “device” was inappropriate.

Justice Felix Frankfurter: No, but that's in the back of your mind as to what these things are.

Mr. Howard A. Heffron: No.

What is in the back of my mind, sir, is that -- that semantics should not govern here.

Justice Felix Frankfurter: I'm not talking about semantics either.

I'm taking about the real social policy by a State to fix the dedicate trust interest upon funds like this in order to protect people, in the opinion of the legislature of a State, may need protection.

Mr. Howard A. Heffron: And -- I -- I would answer to that, sir, that precisely that kind of social interest was embodied in the various lien statutes of Mississippi, Colorado --

Justice Felix Frankfurter: I'm not talking about lien statute.

Doesn't -- that may be the purpose of the lien statute, but the question is, a construction whether on words, property, preclude honest to God, trustees that he could trust interest.

Mr. Howard A. Heffron: Well, I --

Justice Felix Frankfurter: It does in an ordinary trust, does it?

I mean, as I know of their trust, I mean a conventional trust.

Is the -- is the trustee's property of pure trust or naked trust, if you will?

Is that the trustee's property for -- for 3670 purposes?

Mr. Howard A. Heffron: No.

It probably would not be in the ordinary case.

Justice Felix Frankfurter: All right.

So we start from there and then the question is whether the -- a State like New York cannot create -- cannot impose all the interest and incidence of a trust relationship of moneys going through of -- of person like a contractor?

Mr. Howard A. Heffron: Well, I -- I would have -- I would have two answers for that, sir.

First, I think the question would be whether after the federal tax lien has arisen and a chose of action in favor of the taxpayer has come into existence, a State may, at that time, by a statute, provide that that cause of action shall be held in trust for a creditor of the taxpayer other than the United States.

Justice Felix Frankfurter: I'm not interested in that particular question.

That's -- that's a -- a minor question is referred to make a redraft of arrangements whether it creates retroacted community.

But suppose you have an outstanding state statute which governs by which even just the creating.

And if one couldn't say that either a device is by the State, but at least they're honest to God, need of creating an -- a conventional trust relationship.

Would that be -- the question would be where this property under 3670.

Mr. Howard A. Heffron: Of course, we -- we would not conceive that the relationship created by New York law here is a conventional trust relationship.

Justice Felix Frankfurter: I understand that.

Either to conceive, I don't know what -- I don't quite understand that close opinion.

That's my difficulty or in the language of the Minnesota tax case, it's obscure.

Mr. Howard A. Heffron: Well, we -- we read Judge Fuld's opinion as holding that the trust fund is, in essence, another method for assuring security to the subcontractors and that as a method which assures security, it must be tested by the rules which this Court has laid down in determining the validity of other state methods for assuring security to subcontractors.

And I've tried to point out --

Justice Hugo L. Black: Are you taking -- this is your view that if this New York statute should be held sufficient, it defies the Government of its lien?

Every State could adopt the same kind of law which would -- and substituted for that Lien Law for the same purposes and thereby, rendered the statute in effect, the federal statute in effect?

Mr. Howard A. Heffron: That certainly could be done, if -- if the statute --

Justice Hugo L. Black: Your view -- your view is that this is -- whatever it is, it's a method of trying to give security some credit, which defies the Government of the security which the federal statute has shared or given it when the States used the term “liens” instead of “trust”.

Mr. Howard A. Heffron: That is precisely our position, sir.

If we examined the nature --

Chief Justice Earl Warren: Then -- then it is your -- it is your position, I -- I take it, that -- that the States cannot determine who has property in this -- in these bonds.

That it must leave them with the contractor and that if Judge Fuld had decided otherwise, he would have been -- he would have been wrong and you'd be entitled to be here anyway then reverse.

Mr. Howard A. Heffron: We would say that under the New York statutes as they presently exist that Judge Fuld had decided that this was not property within the meaning of the federal statute that he would have erred as a matter of federal law.

Justice Hugo L. Black: But assume your fist argument is that he -- he assumed to decide -- interpret the state statute, we ought to follow it like you do in other case?

Mr. Howard A. Heffron: That would be our fist position, the argument which --

Justice Felix Frankfurter: I think you can get a unanimous court on that.

[Laughter]

Chief Justice Earl Warren: Well, I -- I --

Justice Felix Frankfurter: I'm not sure.

Chief Justice Earl Warren: I thought, Mr. --

Justice Hugo L. Black: (Inaudible) to that.

Chief Justice Earl Warren: I thought, Mr. Heffron, that -- that counsel said that you agree that the State did have the right to declare the property rights and I thought you cited Bess and other cases in your -- in your opinion or in your brief to that effect.

But I thought that you relied on -- on Judge Fuld's opinion to the effect that New York law did not confer this property right on the subcontractors --

Mr. Howard A. Heffron: No.

Chief Justice Earl Warren: -- and therefore, we should affirm him.

Mr. Howard A. Heffron: We agree with the petitioners here that New York law defines the rights and liabilities of the parties.

From there, we --

Chief Justice Earl Warren: No, does that mean property rights on the parties?

Mr. Howard A. Heffron: Well, we -- we would submit that whether the rights and liabilities which exist under state law is property within the meaning of the federal statute, is the federal question which is before this Court.

And we say that Judge Fuld examined the rights and liabilities of the parties under New York law, as he had the right to do.

He observed that the trust which New York law creates is predicated upon the existence of a debt to the taxpayer and that is his word in his opinion, “There is a debt to the taxpayer,” he said in the opinion, examining the nature of the rights and liabilities which are created under New York law and finding as he have to that there was a debt owing to the taxpayer, he came to the conclusion that the trust fund provisions of New York law just as the mechanic's lien provisions of New York law and the laws of the other States, was simply another way of preferring a class of creditors to the detriment of the Federal Government.

And he came to the conclusion that under the decisions of this Court, he could not give effect to the trust fund -- fund provisions where the federal tax lien had already attached to this debt, which was owing to the contractor, taxpayer here.

Chief Justice Earl Warren: And it's your position that he could arrived no other conclusion that if he had, you would have been wrong and should have been reversed by us.

Mr. Howard A. Heffron: Yes.

That would be our position, sir.

Chief Justice Earl Warren: Yes.

Does -- does your brief say that?

Mr. Howard A. Heffron: Well, I think it -- it's a --

Chief Justice Earl Warren: Doesn't your -- I thought your brief said in several places here which you call Bess case and other cases that the State had the right to determine in whom the property --

Mr. Howard A. Heffron: Well --

Chief Justice Earl Warren: -- was.

Mr. Howard A. Heffron: The State -- we -- we set in our brief and we intended to say, Mr. Chief Justice, that the State has the right to determine the rights and liabilities of the party.

But whether or not to characterize the resulting conglomeration of rights and liabilities as property or not is the federal question which is before this Court.

If we examine the trust fund provisions of New York law, we -- we find that what we have here is an animal which is very far from being related to a conventional trust.

The trust fund provisions of New York law provide, for example, that the trust shall arise --

Justice Hugo L. Black: What difference would that make?

That's not a conventional trust.

I thought you're arguing for is that they can't do this under the name of the lien, although a lien has a very high stakes in the law, mechanic, laborers and so forth.

Since they can't do it in the lien rather preference speaks now by the federal statute, if they do it on the name of the trust.

Mr. Howard A. Heffron: No.

I did not mean to detract from the force of that argument, sir.

I was really addressing myself now to an additional position which we have here and that is that even under New York law, the rights of the subcontractors are not fixed within the requirements of the decisions of this Court, so that this is an additional reason why they could not supersede the federal tax lien here.

Now, I --

Justice John M. Harlan: Your position doesn't involve attributing anything sinister and devious in New York, doesn't it?

Mr. Howard A. Heffron: No, it does not.

I -- that was inappropriate use of language.

I simply meant to suggest that -- that if an argument could prevail here to the effect that a security interest under state law had become so perfected and so fixed that the taxpayer no longer had any property to which the federal lien could reach, whether on the decisions of this Court could be undone in precisely the same situations where this Court has upheld the reach of the federal tax lien.

That is essentially what the argument of the petitioners comes down to.

This is a security provision of New York law.

Some of the courts have said the subcontractors in New York have a double security.

They have the lien on the real estate of the owner and they have the trust right to the debt owing to the contractor.

But in essence, these are both security methods by which the subcontractors can be assured of payment.

And what is he assured of payment from?

He is assured of payment from the chose in action which he holds against the owner.

The owner is discharged here.

Justice Charles E. Whittaker: I can assume that (Inaudible) power over the State to do, does not the State has such interest to continue of materialmen and mechanics before the parties have been taken for the initial payment of tax, that it can't be in trust by (Inaudible)

Mr. Howard A. Heffron: Well, we would say to that where the federal tax lien has attached to a debt which admittedly is owing to the taxpayer, that the State could not thereafter require that that fund be held in trust for another creditor of the taxpayer.

Justice Charles E. Whittaker: How can, in this case (Inaudible) were the tax lien had (Inaudible) of making a contract, then when the materialmen are not paid and the fund that it was set up by (Inaudible) is used by the Government in his (Inaudible) who are paying tax of the (Inaudible)

Mr. Howard A. Heffron: Well, of course, that is an equitable consideration which is involved.

I'd like to point out that we're here dealing with withholding and social security taxes which were withheld from the wages of employees of the taxpayer.

And we know in the enforcement of the revenue laws, the great delinquency is over $200 million which now exist in withholding and social security taxes and we know that the pattern in the construction industry is for contractors to take this withheld taxes, which themselves are trust funds under federal law and use them to operate there business.

Now, we can't trace these taxes into the hands of any particular subcontractors, but I don't think we're -- we're dealing with a situation were the Federal Government doesn't have some right to pursue tax dollars which the contractor withheld from his employees and to take them.

Chief Justice Earl Warren: Mr. Heffron, I understand that the Government made this assessment against the taxpayer -- against the contractor before he entered into this contract with Mrs. Bottone.

But that -- that fact was not known to anyone, but the Government.

And there was no way that materialmen or laborers could -- could determine whether that assessment had been made and that thereafter, this contractor entered into the contract for this improvement and these materialmen and laborers, put there materials and their labor into this job.

Now, if the federal assessment against this taxpayer was more than he had coming from the -- from the owner of the property or the judge.

Do you say is a practical matter that the State could not protect those workmen and those materialmen to such an extent that they could get that from that transaction, the value of the property and the value of the labor that they put into it that they'd be entirely wiped out?

Mr. Howard A. Heffron: Well, that is the result of this Court's decisions --

Chief Justice Earl Warren: Yes.

Mr. Howard A. Heffron: -- in a great --

Chief Justice Earl Warren: Do you believe that --

Mr. Howard A. Heffron: -- line of cases.

Chief Justice Earl Warren: Do you believe the State is deprived to that power to do that?

Mr. Howard A. Heffron: The -- the first case in which the secret lien which we're allegedly dealing with here arose with the Snyder case in 149 U.S., where a bona fide purchaser of the property without notice, was held to have rights inferior to the federal tax lien which was not recorded and which under state law as an unrecorded lien could have no effect.

Nevertheless, this Court held that the federal tax lien was superior.

Now, this prompted Congress to grant relief and Congress has provided that federal tax liens must be -- must be filed, if they are to be valid against four categories of claimants, judgment creditors, purchasers, mortgagees and pledgees.

And this Court has noted in the prior decisions that mechanic's lienors are not within the class of persons protected by the filing requirements of federal law.

Justice William J. Brennan: In those cases were usually a mechanic's lien holders (Inaudible) were they not only cases which there's any doubt taxpayer had property in the thing they thought -- which they thought to have liens?

The issue here is whether or not there was any property in the taxpayer with which the lien was taxed.

Mr. Howard A. Heffron: Well, of course, in this other cases, Justice Brennan, the mechanics were, in essence, claiming that lien had so fixed upon the property that there was nothing left for --

Justice William J. Brennan: The fact is --

Mr. Howard A. Heffron: -- the tax lien to reach.

Justice William J. Brennan: The fact is, however, no issue.

I impose there are a great number, but I don't believe there is any which was not in fact -- that there was property of the taxpayer and the thing in which the lien attached and the conflict then arose between other lien claimants and the federal claim.

Here, the basic question, as I understand it, is whether in fact there was any property at all of this taxpayer to which any lien could tax, isn't that it?

Mr. Howard A. Heffron: Well, that is the issue as formulated by the petitioners.

We submit that there clearly is property here.

Justice William J. Brennan: Well --

Mr. Howard A. Heffron: It is the debt owing to the contractor.

Justice William J. Brennan: (Voice Overlap) happens (Inaudible) property of course, that the issue is for us.

Mr. Howard A. Heffron: But just --

Justice William J. Brennan: But the New York Court of Appeals --

Mr. Howard A. Heffron: Of course --

Justice William J. Brennan: -- had finally decided.

Mr. Howard A. Heffron: In the other cases which this Court has passed on.

There was much language in the lower state court opinions which said, "Under our law, the mechanic's lien has divested the taxpayer of his interest.

Therefore, the federal tax lien can't attach." So, this argument has worked in the record of these cases, and it could've been pulled out at any time as the grounds for invalidating the federal tax lien.

It never was.

It lurked in the record in the Kings County case in the Second Circuit.

And the court there went on to say that although your -- the trust fund provisions of New York law apply first in time here, the trust had arisen first.

Justice William J. Brennan: But is that (Inaudible) where we have (Inaudible) tax lien on the state law, the property of the taxpayer?

Mr. Howard A. Heffron: Well, I think those were the first cases in the lien field which have held that property must be taken to refer to interest created and defined by provisions of state law.

Now, of course, the -- the thrust of petitioner's argument here is to place him in a position, theoretically, which is even more favorable than the position which Congress has placed judgment creditors, mortgagees, pledgees and purchasers.

Because if his argument should be accepted at anytime that the trust fund may arise even subsequent to the filing of the tax lien, a time when all the cases have assumed that at anytime the Government's rights were set, it was when the tax lien was recorded and filed.

If this argument is accepted, even those provisions will not support the reach of the tax lien, because the argument will be -- well, under federal -- under state law, you taxpayer have no property because your -- your creditor who is subsequent to the tax assessment and who is subsequent to the recording of the tax lien, has taken the property.

Now, we -- we submit that that result is foreclosed by the provisions of the statute itself, which indicate those classes of persons who are protected from unfiled federal tax lien.

Justice Hugo L. Black: What do you say if it's a very bad thing if we've decided and probably this much argument on that side.

Why shouldn't we overrule it, rather than to leave a system in existence, were some States can protect their mechanics and some cannot, until they changed their laws with reference to lien?

Mr. Howard A. Heffron: Well --

Justice Hugo L. Black: Would you say to the -- do you think the Court's opinions are right that have held that this secret right lien for the Government can be enforceable against a mechanic for his -- rather than to have a preference over mechanic's lien?

Do you think they're sound?

Mr. Howard A. Heffron: I think that under the logic of the decided cases, the Court could've come to know other conclusion in the mechanic's lien cases.

Justice Hugo L. Black: That's logical.

Mr. Howard A. Heffron: And we submit that it can come to know other conclusion in this case.

Justice Hugo L. Black: That you -- you're talking about the (Inaudible) case.

Justice John M. Harlan: I have to (Inaudible)

Mr. Howard A. Heffron: Well, I'd like to point out, Mr. Justice Black, that the criticism which has been levied against the federal tax lien as usually been -- been brought to bear in a situation where the lien under state law comes first.

And then the persons who've developed the expectancy are divested by a -- by a subsequently accruing lien.

We have here a case where the federal lien is antecedent to all the interests, which have been created under state law.

So that even the -- those --

Justice Felix Frankfurter: If the state law preceded the lien, then the interest is not antecedent.

And the lien is not antecedent as the practical proposition.

If the State has fabulous statute providing that all these moneys should go to the Farmers' Loan and Trust Company that -- or some other trust company, would you then say it was just like a lien?

Actually, there is a difference between creating a lien and creating a trust.

And you don't have to say that one equals the other.

Mr. Howard A. Heffron: No, they don't necessarily have to equal the other.

But when one is used to secure creditors of a taxpayer, the payment of his debt to them in addition to the lien it -- it -- in substance, reaches the same result.

Justice Felix Frankfurter: I know, but the law of property is full of different regards being reached for the same result than outward being reached by different method that condemn even assignments and creation of interest.

You can't just wipe out and say wherever a result is the same, therefore, all legal instrumentalities are the same.

Mr. Howard A. Heffron: No.

But this Court has pointed out that it will look at the realities of the situation --

Justice Felix Frankfurter: I know reality --

Mr. Howard A. Heffron: -- in the --

Justice Felix Frankfurter: -- is a big word.

Mr. Howard A. Heffron: Well, in the Gilbert Associates case --

Justice Felix Frankfurter: One of the realities -- these are -- the trust is a very --

Mr. Howard A. Heffron: Well --

Justice Felix Frankfurter: -- different thing from a lien.

That's one of the great realities in which the law has been doing business --

Mr. Howard A. Heffron: Well --

Justice Felix Frankfurter: -- for hundreds of years.

Mr. Howard A. Heffron: Of course --

Justice Felix Frankfurter: (Voice Overlap) --

Justice Hugo L. Black: (Voice Overlap) --

Mr. Howard A. Heffron: -- we --

Justice Hugo L. Black: -- to argue that the Court can't just wipe out all the decisions it did accept -- it made which is declined to give mechanics preference over the Government, under the government statute.

Mr. Howard A. Heffron: Well, I have -- I -- I hope that I have reached that point and if I may answer --

Chief Justice Earl Warren: You may answer.

Mr. Howard A. Heffron: If I may answer your question, Mr. Justice Frankfurter, in terms of the realities of interest under state law and the Gilbert Associates case, which dealt with the question of who was a judgment creditor within the meaning of the federal statute.

Your opinion says that we must not look to the label which is placed by state law in this interest.

We must look to the actual rights and liabilities as defined.

Justice Felix Frankfurter: Because Gilbert went that way, it doesn't mean that you say there's no difference, I repeat, that there's no difference between the creation of a lien and the creation of a bona fide trust.

Mr. Howard A. Heffron: Well, I would accept that statement because it's our position that this is not a bona fide trust.

Justice Felix Frankfurter: Very well, I understand that too.

Mr. Howard A. Heffron: Thank you.

Chief Justice Earl Warren: We'll recess now.