SMALL BUSINESS ADM'N v. MCCLELLAN

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Argument of Morton Hollander

Chief Justice Earl Warren: Number 42, Small Business Administration, Petitioner, versus G. M. McClellan, Trustee.

Mr. Hollander.

Mr. Morton Hollander: May it please the Court.

This case arises out of a vague bankruptcy proceeding.

It's here on certiorari to the Court of Appeals for the Tenth Circuit.

The petitioner is the Small Business Administration which is here challenging the denial by the court below of a statutory right explicitly conferred upon the Government by the Congress more than 160 years ago, the claim of priority in the distribution of the assets of the estate of an insolvent debtor.

The priority actually was written into the statute purposes far back as 1797.

That is one of the two principal statutes with which we are here concerned.

We set forth the text of that statute on page 3 of our brief.

It provides -- it provides in -- in very broad unequivocal terms that whenever any person indebted the United States is insolvent, the debts due to the United States shall first be satisfied.

The other pivotal statute with which this case is concerned is the Bankruptcy Act’s priority provisions themselves.

Now in the Bankruptcy Act, the Congress has carried over this right of priority under the 1797 statute and actually converted it into a fifth class priority in a bankruptcy proceeding.

It is that fifth class priority, the Small Business Administration claims it is entitled to in this case and it is that fifth class priority that was denied to the Small Business Administration by the courts below.

I would like briefly to review the facts out of which this controversy emerges.

In the -- in November of 1956, Byquist, the bankrupt in this case, a small wholesaler of electronic supplies and radio equipment, needed additional working capital.

He solicited the aid of both the Small Business Administration and a local bank, a private bank, the Brookville State Bank of Kansas.

He filed applications with them under the Small Business Administration Act for a loan of $20,000.

The bank took the position that it wasn't ready to extend the full $20,000 credit to him but that if the United States Government would participate with the bank, the Brookville State Bank and advanced $15,000 of the entire $20,000 loan sought by Byquist, the bank would add the additional $5000 and the $20,000 loan could be extended to Mr. Byquist.

The bank took this matter up with the Small Business Administration.

The Small Business Administration agreed to enter into a participation agreement with the bank so that the United States would advance 75% of the loan or $15,000 with the bank advancing the remaining $5,000.

At the time the United States entered into this -- to the Small Business Administration -- entered into this participation agreement with the bank and notified Mr. Byquist directly that his application has been approved.

In the participation agreement, and I would like to invite Your Honors attention to page 5 of our brief because this is one of the crucial provisions in the participation agreement upon which the Court of Appeals seize in order to justify its forfeiture of this long standing priority dated back in 1797.

The -- on page 5, we set forth two of -- in quotes, two of the provisions of the participation agreement.

The first one, paragraph 12, points out in effect that whenever any collection is made under the loan from the borrower, the proceeds are to be shared proportionately with both lenders, and that is three-fourths of each collection has to go to the United States and the remaining one-fourth to the bank.

Paragraph 14, the particular paragraph that the Court of Appeals relied on, also points out that -- in the event that there should be a loss under the loan.

The loss should be shared in proportion to the investment of the United States in the one hand and the bank on the other.

In other words, if there's a loss, United States gets stock to the extent of three-fourths of its interest and the bank only to the extent of its 25% interest.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: The Government did not reduce its claim, Your Honor.

I will get to that.

I'll get to that in just one minute.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: The -- the Government -- what happened was this.

The -- the -- in order to answer Your Honors question, I'll have to explain exactly what happened with the -- with the amount in the loan.

No, I think it's crucial.

I think -- I think Your Honors question actually is crucial to the Government's position in this case.

As soon as -- as soon as the bank had agreed with the United States, United States agreed to supply $15,000.

United States sent its check drawn on the United States Treasury for $15,000 to the Brookville Bank.

Brookville Bank took the proceeds of that check, added $5,000 of its own money to it and made out a check to Byquist for $20,000, getting in exchange Byquist’s note for $20,000, made out payable to the bank.

About a year elapsed Byquist repaid about $4000 of the outstanding note, $3000 going to the United States, and $1000 going to the bank.

And he was thrown at the bankruptcy at that point, about a year after the note had been given to the bank.

When there was a balance of $16,000 due on the -- on the note.

After the bankruptcy, there was a formal assignment of the note itself from the bank to the United States Government.

And it was at that point, in answer to your question, that the United States filed on the bankruptcy proceeding in effect, a claim on its own behalf for the $12,000 due here on the note and also a claim on behalf of the bank for the $4000 due the bank on its share of the note.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: Yes.

It was --

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: -- it was.

No.

That's absolutely right.

In other words, the Government lump both of them together but has made it absolutely clear throughout this proce -- throughout the proceeding in the Court of Appeals and the District Court, the referee, that the only portion of that $16,000 obligation is to which the Government was insisting, it had a right to priority under 3466, the 19 -- 1797 statute and the pertinent provision of the Bankruptcy Act.

The only portion of that $16,000 loan as to which the Government claim that it had a right to priority was the $12,000 portion of the loan representing the federal government's investment in that loan.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: Absolutely, Your Honor.

It was -- it was for 75% of the outstanding balance just as it had been for 75% of the original face value.

Justice Charles E. Whittaker: The balance of the claim has started as a general claim, is that right?

Mr. Morton Hollander: Yes, Your Honor, $4000 was inserted as general.

Justice Charles E. Whittaker: If the signing of the note by the Kansas, in fact, the Small Business Administration, stand -- would you mind for a better word.

This participation (Inaudible) was it still outstanding?

Mr. Morton Hollander: It actually resulted in the termination of the participation agreement, in the sense that the United States had actually acquired from the bank at that point the bank’s 25% interest in the -- in the loan.

Justice Charles E. Whittaker: Is that right or did the Government just become a trustee.

Mr. Morton Hollander: With the understanding -- with the understanding of course that the Government was acting simply as a collection agent.

Under the participation agreement, it -- it in effect -- the participation agreement in effect permitted either the bank or the United States that the option of the United States to act as collection agent for any of the proceeds affected by way of recovery under the loan.

Up until --

Justice Charles E. Whittaker: (Voice Overlap) -- do say the parti -- participation agreement is still effective or not?

Mr. Morton Hollander: Well, to the extent -- to the extent that -- to the extent that the United States has to honor its contractual commitment under the participation agreement to share ratably or proportionately with the bank so far as any loss is incurred under the -- under this particular notice is concerned, of course, it's still -- we -- we believe it still retains its -- the full vitality it had at the time the arrangement itself was entered into.

And the United States of course stands ready to honor its commitment under the share ratably -- a share ratable over share proportional provision.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: The bank would have gotten thousand, yes, Your Honor.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: Yes, Your Honor.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: You're -- you're -- that's absolutely right, Your Honor.

Justice William J. Brennan: So that bank starts to hold that (Inaudible).

Mr. Morton Hollander: Yes, Your Honor.

I think that is right.

I don't know whether under those circumstances, some adjustment might have to be made in order to --

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: -- under the agreement to put the United States in the same position as the bank.

I'm not sure.

But --

Justice Charles E. Whittaker: (Inaudible)

Mr. Morton Hollander: I shouldn't think so, Your Honor.

I shouldn't think that it's a pertinent consideration to the bankruptcy court at all, just as much as if the United States had decided the very last minute to waive whatever rights it might have had under this agreement and to -- to leave the parties in the status quo.

The -- the Government after filing its claim in the bankruptcy proceeding, had the claim rejected by the referee on the ground that this claim was not one due to United States but was in fact due to some separate entity.

On appeal to the District Court, the District Court was dissatisfied with the reason the referee had given for rejecting the Government's claim and felt that the claim should be denied because the Government, the District Court thought was asserting a claim acquired by it for the first time after the petition of bankruptcy has been filed.

Now the Court of Appeals, apparently dissatisfied with both of those grounds, seized upon this third justification for denial of the Government's priority and that justification arises out of the language in Article 14 of the participation agreement.

The Court of Appeals was of the view that since the United States under this loss ratable provision and participation agreement would have to as Mr. Justice Brennan pointed out, turn over $3000 of the $12,000 it would recoup if its priority were recognized, it would have to turn over $3000 to that $12,000 to the private bank.

The Court of Appeals felt that this violated some long standing principle of interpretation under 3466, namely, that the United States was in effect collecting by exercising its right to priority for the benefit of a private party.

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: Under the agreement, I think -- under the agreement I think the parties, Your Honor, would have to strike a balance and after recoveries of --

Unknown Speaker: (Inaudible)

Mr. Morton Hollander: The -- the agreement does provide that -- that parties shall share ratably or proportionately.

All losses are sustained under the agreements.

So I think irrespectively meant the bank recovered in the other from one hand of the amount that the United States Government recovered on the other.

They would have to strike a balance and then a portion of the loss, 25% of the loss with the bank and three-fourths of the loss to the United States Government.

Now the -- the Court of Appeals, as I say, invoked the theory that since the United States at least impart had to turnover the part of the proceeds, it was going to recoup to the private bank that it was therefore not entitled to the priority established by 3466.

And the Court of Appeals in that connection relied, I think, exclusively on this Court's earlier decision in the Nathanson case, Nathanson against National Labor Relations Board.

Now, I have time I think to -- two minutes to just briefly describe the facts.

Tomorrow, I hope to be able to distinguish that case adequately but the facts in this case with which I would like to leave the Court this afternoon are simply these.

The -- in the Nathanson case.

The National Labor Relations Board issued a backpay order.

It directed an employer of certain bus company up in Massachusetts to pay several thousands of dollars in backpay to some employees with respect to only the employer is guilty of an unfair labor practice.

The bus company was thrown into bankruptcy, and at that point, the Board filed a claim on behalf of all of the employees in who is in favor of the backpay award has been made.

And it filed a claim under the Bankruptcy Act and it claimed the priority under 3466 and 64 -- Section 64 (a) of the Bankruptcy Act said that these claims should first be satisfied because of the Government's priority.

And this Court, I think quite properly in a case point that -- that after all, the whole underlying purpose of the federal priority statutes is to enable the federal government to secure it to any sufficient public revenue to sustain the public burden and to discharge the public debt.

And the Court pointed that quite naturally that any recovery or backpay in this bankruptcy proceeding were necessarily new or exclusively to the benefit of the employees in whose favor the backpay award has been made.

And the -- the Court by putting those two concepts together, I think came up to the inevitable conclusion that since the priority in that case sought to be asserted on behalf by the National Labor Relations Board, on behalf of the employees with not a single penny, that priority have recognized whatever intuitive benefit of the Federal Treasury can never be used to sustain any part of the public burden.

Well obviously, the Government was not entitled to the (Voice Overlap) --

Justice William J. Brennan: But here, the Government will get half?

Mr. Morton Hollander: Here, the Government would get 75%, Your Honor.

Justice William J. Brennan: 75%.

Mr. Morton Hollander: Yes, Your Honor.

Chief Justice Earl Warren: We'll recess now.

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Argument of Morton Hollander

Chief Justice Earl Warren: -- Small Business Administration, Petitioner, versus G. M. McClellan, Trustee.

Mr. Hollander, you may continue your argument.

Mr. Morton Hollander: May it please the Court.

Yesterday afternoon, I finished discussing the facts in the Nathanson case, the Labor Board case in which this Court denied, I think, quite properly, the National Labor Relations Board a priority in a bankruptcy proceeding for a backpay award.

The backpay award in that case had the priority been recognized, would have been -- you had exclusively to the benefit of each of the individual employees involved.

Now, it was exclusively on the basis of the Nathanson decision, as I read the opinion in the court below, that the -- a court below found a fatal infirmity in Small Business Administration's insistence that it was entitled to a priority in this case.

But the -- the obvious distinction that leaps to mind so far as the comparison of the Nathanson case with our case is concerned is that in our case, unquestionably, three-fourths, three-fourths of the priority, if recognized, will stay in the Federal Treasury.

Indeed, the entire recovery of the $12,000 which the Government insists it is entitled to by way of priority in this bankruptcy proceeding, will go to the Federal Treasury.

It is true that under this separate and contractual arrangement with the bank at sometime, the United States will have to pay over to the bank one-fourth of $12,000 and not, of course, necessarily any of these funds.

These funds are not earmarked to the bank.

All of the money collected by the Government, if its priority is recognized is turned into the Federal Treasury.

I think two-way, a -- a very significant, a very significant distinction between Nathanson and this case is the fact that in this case, we do have conclusive congressional manifestation that the general priority under 3466 recognized in favor of the Government and its agencies as far back as 1797, that this priority was to be preserved intact so far as the SBA was concerned.

After the Small Business Administration Act has been on the statute about five years, it was proposed by a Senator to strip the SBA of the priority everybody thought it had.

Indeed, the priority we all thought it had until the decisions of the court below challenged that priority.

And Senator Payne introduced in 1958, introduced into the Congress a bill which would, in expressed terms, have deprived the SBA of their priority under Section 3466, the 1797 statute.

Justice Felix Frankfurter: (Inaudible)

Mr. Morton Hollander: There was understandably considerable consternation when this bill was introduced.

The SBA objected vehemently and as a result, the bill, in the form of which is -- in which it was introduced, which would've wiped out the governmental priority, which would, in fact, have reached the -- have resulted in the same situation as that required by the decision of the court below in this case.

That bill was never reported out.

Instead, a much water down substitute was finally passed by Congress.

And in this 1958 Amendment, with the agreement of the Small Business Administration, Congress provided, in effect, that the Federal Government's priority under 3466 should be made to yield only to certain state and local tax lanes but not -- but not to the claims of the general unsecured creditors who are involved in this litigation.

We think too that a -- another -- a third -- a very vital distinction between Nathanson and this case is that in Nathanson, obviously, none of the moneys which would've been recovered by the Board, as I pointed out, would have possibly been enable to help sustain the public burden.

And because of that, the numerous admonitions of this Court that Section 3466 is to be liberally applied, this Court has pointed in -- in a host of decisions that the mandate of Section 30 -- of 30 -- Section 3466 is -- is broad.

It's clear, it's unequivocal.

And when it says that the text of the United States shall first be satisfied, that's -- that's expressly what it means.

And the reason for the broad interpretation, of course, was the need for assuring adequate public revenue to sustain the public burden and to discharge the public debt.

Well, in Nathanson this Court wasn't concerned with that broad policy of interpretation, which was essential to apply in order to help secure adequate public revenue because, as I pointed out in Nathanson, no public revenue at all was involved.

That's not true in this case.

As I pointed out in this case, every cent of that $12,000 goes into the Federal Treasury.

It is true that under our contractual arrangement with the bank, at some later date, the bank will get a part of the proceeds of that loan.

One other -- one other distinction, I don't want to belabor this point but I feel, I -- I have this --

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: A -- oh, well --

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: The -- the statute doesn't -- as -- probably as true of every other statute authorizing the Government to engage in a lending program of this sort.

It doesn't spell out the details of the arrangement but it definitely encourages the participation arrangement, the participation agreement arrangement.

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: There is no expressed provision requiring the Small Business Administration in its contract with the bank to say that of the proceeds recovered by the parties, there shall be -- they shall be distributed in accordance with their respective investment or interest in the loan.

No, that provision is not the -- the statute does make it very plain, however, that a participation agreement is to be encouraged and that if participation agreements are available, the Small Business Administration is not to lend --

Unknown Speaker: (Voice Overlap) --

Mr. Morton Hollander: That's set forth on page 22 of our brief in quotes from Section 636 (a) (2) of the statute.

The whole plan of the Small Business Administration Act, of course, is this, that to the extent that the would-be borrower can get the funds privately is, of course, encouraged to do so.

In fact, the Small Business Administration has to -- has to certify that a private loan is not available before the Small Business Administration Act's authority can be triggered into play.

After a demonstration of nonavailability of private loans is made, then the statute and that provision that Your Honor is reading, points out that the Small Business Administration shall try as -- a next step to arrange for a participation loan with the bank to have the bank come in at least to share in the making of the loan to the individual and failing that, then the Small Business Administration is allowed to loan 100%.

Now, again --

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: Oh, this is --

Justice William J. Brennan: (Inaudible) that you've got to find this (Inaudible)

Mr. Morton Hollander: So far as the Small Business Administration is concerned?

Oh, this is --

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: Insofar as the Small Business Administration program is concerned, oh, yes, Your Honor.

This is the typical agreement but this is the -- the type of agreement that right now, I think, covers over $500 million of Government funds disbursed under the Small Business Administration Act in participational loans.

I would like -- I -- I would like to -- to point out that there is this one last distinction between Nathanson and this case.

We filed a claim of the bankruptcy proceeding for $16,000.Of that $16,000, $4000 belongs to that bank.

That $4000, if we collect, we turn over to the bank or if we collect the dividend on it, that $4000, we're not asking for any priority.

In connection with that $4000, we're not asking for any priority at all.

We are asking and that's the $4000 which conceivably comes within the scope of the Nathanson decision.

We are asking for priority only with respect to the $12,000 representing the federal investment in this loan.

Now, for the -- for the reasons that --

Justice John M. Harlan: Both -- both claims, both claims are filed by the United States.

Mr. Morton Hollander: Yes, Your Honor.

It's filed --

Justice John M. Harlan: (Voice Overlap)-- the general creditor --

Mr. Morton Hollander: Yes.

Justice John M. Harlan: -- claim (Inaudible) were good.

Mr. Morton Hollander: Yes, Your Honor.

Now, for these reasons, we think the court below improperly relied on Nathanson.

We think that the District Court and the referees improperly relied on those recent that I've been able -- unable to get into and develop because of the limited time available.

Our arguments with respect to the two other grounds, that is those relied on by the District Court and those relied on by the referee are set forth in our brief.

And I, of course, have to submit in those arguments in the brief.

But for the reasons set forth in the brief, for those reasons I've tried to outline in my arguments here today, we respectfully submit that the judgment of the Court of Appeals was an error and should be reversed with instructions to that court to direct the lower courts to recognize the federal priority under 3466 and under the Bankruptcy Act's provision, Section 64.

Chief Justice Earl Warren: Mr. Royce.

Argument of John Q. Royce

Mr. John Q. Royce: Mr. Chief Justice, may it please the Court.

Yesterday, when Mr. Hollander was stating the facts, he said that the SBA sent a Treasury check to the Roopville State Bank in the amount of $15,000.

And that the bank added $5000 and lent back was $20,000.

That is not an accurate statement of the sequence of events.

I believe -- I don't think Mr. Hollander was trying to confuse anyone, but I think that the actual sequence of events is important, at least, is material to one of my arguments.

Actually, if you'll note from the record on page 4, paragraph 2, the participation agreement provides that the bank -- that SBA would purchase from the bank 75% of each disbursement made by the bank.

Paragraph 4 of the participation agreement provides that the bank will not cash the check until bank has disbursed to the borrower the amount it represents it will disburse to the borrower and the bank's requisition to SBA for such check.

You'll note also in the record at page 9 that the note is dated November 16, 1956.

The requisition to the bank which is found in the record at page 27, Exhibit F, shows that the bank on November 26 or on November 16 requested the funds.

The check from the SBA to the bank is dated November 23rd.

The sequence of events was that the bank lent back was $20,000 and then the SBA sent its check to the bank for $15,000.

I believe that is material in one of my arguments that I'll try to point out later.

Justice Charles E. Whittaker: Isn't that you understand the common way it's devised in its participation agreement?

Mr. John Q. Royce: That would be my understanding but that is the way that is supposed to be handled at least.

Now, Mr. Justice Brennan inquired twice I believe yesterday, what would be the result of a dividend on the common unsecured part of this claim and Mr. Justice Whittaker inquired whether or not the participation agreement from the assignment lost its validity.

I believe Mr. Hollander correctly answered those questions that the agreement is still operative.

It has been pointed out here today that there has -- there's only one claim applied.

The claim appears on page 2 of the record here.

Now that is one claim for 16,700 and some dollars.

In paragraph 4, it notes that the consideration is the $20,000 note executed and delivered to the bank and thereafter, assigned to the Small Business Administration.

You'll note on paragraph 6 that priority actually is claimed in the claim for the full $16,000.

Now, as a matter of fact, one of the grounds of objection filed with the referee initially in this case was that the Small Business Administration didn't have that much money coming.

And Mr. Farmer, who was then United States Attorney, said, "No, of course, that is conceded.

We are bringing this action for the SBA and the bank as their interest may appear."

We have attached the -- as Exhibit A, the participation agreement and as Exhibit B, the note.

So that it is from those documents that you determine what interests each of them do have in this loan.

Justice John M. Harlan: But there's no -- there's no dispute, is there, that the Government was claiming a priority only in respect of its -- of the -- of the 75% (Voice Overlap) --

Mr. John Q. Royce: That is what they say now.

Justice John M. Harlan: Was there any doubt --

Mr. John Q. Royce: Yes.

Justice John M. Harlan: -- is there any doubt about that?

Mr. John Q. Royce: I don't believe so.

We -- we accepted that at least as a partial victory initially that they were not claiming for the entire $16,000 notwithstanding their claim as file said so.

Justice Charles E. Whittaker: They never did amend this proof of that?

Mr. John Q. Royce: I beg your pardon.

Justice Charles E. Whittaker: They never did amend this proof of claim?

Mr. John Q. Royce: It has never been amended.

No, sir.

Now, we have three points.

The priority statute provides a priority for debts due to the United States.

We contend that in this case, there is no debt due to the United States as such.

That maybe a sort of a robust position but I believe, it's true.

The basis of that is that the Small Business Administration is a separate entity.

Our second contention is that even though the --

Justice Charles E. Whittaker: Are you really serious about that -- are you really serious about that point?

Mr. John Q. Royce: Yes, sir.

I -- and I --

Justice Charles E. Whittaker: Are you --

Mr. John Q. Royce: -- I'll develop it a little bit later.

Briefly, I -- I am dead serious --

Justice Charles E. Whittaker: Go on.

Mr. John Q. Royce: -- about it and as a matter of fact, that's what the referee found in this case.

The second one is that even though the SBA is the United States, then we contend that there was no debt due to the SBA at the time of bankruptcy.

That is the holding of this Court in the Marxen case.

Our third point is that this Court has said that where the allowance of the priority would be plainly inconsistent with other statutes and acts of Congress, it will not be enforced.

We believe that the priority here would be inconsistent with the priority statute itself with the Bankruptcy Act and inconsistent with the Small Business Act itself.

Now, I -- I will mention this proposition that the Small Business Administration is not the United States.

I might start that with the proposition that the -- the Government in its brief says it is now firmly established that a non-incorporated agency of the United States must be considered the -- to be the United States for the purpose of the priority statute.

If that's true, then I have no argument.

This Court, however, in the -- in the Marxen case, suggested the argument in connection with the FHA that the administrator had been given the power to sue and be sued and -- but the question is not raised as to whether or not that constitutes the Federal Housing Administration a separate entity.

In the Remund case, United States against Remund, which involved the Farm Credit Administration, the Court found that the Farm Credit Administration was the United States but they did it not on the basis it is not incorporated but on the basis that it did not bear any resemblance to the government corporations or actual separate entities.

Here, in addition to the power to sue and be sued in any court to handle its property to adopt the seal, Congress initially set up a revolving fund for the Small Business Administration.

We contend that the money -- that it also provides that the Small Business Administration shall pay interest to the Treasury on the money that it has drawn from its revolving fund.

In this case, if there is a recovery by the Small Business Administration, the money will not be paid to the Treasury of United States, it -- except insofar as it is the custodian, the bank in which Small Business Administration keeps its money.

It does not have to account annually for the funds that are drawn.

The revolving fund is set up without fiscal year limitation.

The Small Business Administration simply pays interest on the amount that it has drawn.

When this goes back in, it will serve to reduce the interest that Small Business Administration pays but it -- it's not, in fact, a payment to the Treasury of United States.

That is my argument on the proposition that this is a separate entity.

As I say, I -- I recognized that if it has to be incorporated, this one isn't.

I submit that it does have all of the powers and stands between the debtor and the United States as it is now set up.

Now, my second proposition is that there was no debt due to Small -- to the Small Business Administration at the time of bankruptcy.

At that time, the bank -- the bank was the only payee on the note.

It still held the note.

The only interest that Small Business Administration had was a right to participate with the bank.

This is the reason that I -- I think the order in sequence of events as to how the loan was made.

Small Business Administration had a contract with the bank.

It was not a party lender at all.

It said, "Bank, if you will lend this man $20,000, then we will purchase from you 75% of it."

The bank did lend the money and still held the note.

The debtor could not have made a payment direct to the United States if he wanted to at that time.

The only legal assignment of this note occurred subsequent to the date of bankruptcy.

Justice John M. Harlan: Could the Small Business Administration have asked for that note anytime it wanted to?

Mr. John Q. Royce: Yes, sir.

And that is my second point that there was no equitable assignment of any part of the note.

The Small Business -- or the participation agreement provides that on written demand, the bank will assign -- will transfer the word -- the word uses -- used as "transfer without recourse" not assigned.

We'll transfer without recourse within five days after written demand.

Now, an agreement to assign in the future does not constitute an equitable assignment.

An equitable assignment arises when there is an intention immediately to assign but for some reason, no -- the actual assignment does not occur.

Here, there was no intention to make any immediate assignment.

It was to be made five days after a written demand.

Justice Charles E. Whittaker: But isn't that, if I may ask, only of legal title to the monument of debt and isn't it true that whoever held the debt here is a mere trustee for the beneficiaries whose interests are fixed by the participation agreement.

Mr. John Q. Royce: That is not --

Justice Charles E. Whittaker: Your view?

Mr. John Q. Royce: Not -- not my reasoning, no, sir.

I -- the Small Business Administration in its brief takes the position the minute we parted with our money, we had an interest.

I say, "No, you were interested but you had no legal interest."

If you follow the distinction that I make between interested and interest.

Justice Charles E. Whittaker: Well, that was Judge Stanley's view too, wasn't it, that you -- you're advocating?

Mr. John Q. Royce: Yes, sir.

Now, that -- now, that is the one that Judge Stanley took in this case.

Justice Charles E. Whittaker: Yes, yes.

Mr. John Q. Royce: Well, that, as I say, I think that is my position in connection with that phase of this thing.

Now, I do not agree with Mr. Hollander that the Court of Appeals held only on the basis of the Nathanson case.

That case is similar.

It is not analogous to the situation here.

In that case, as has been pointed out, the -- none of the money sought to be recovered went to any agency of the United States.

In this case, it is true that 75% of the recovery incidentally, that is not an absolutely accurate statement, 75% of the amount of the recovery by SBA because it's 75% of the total recovery, if any -- any part of the common claim is allowed that.

Unknown Speaker: (Inaudible) just before the --

Mr. John Q. Royce: That's right.

That would have to be included as a total recovery on this note and then the parties will bear the loss "ratively" in accordance with their interest.

Unknown Speaker: (Inaudible)

Mr. John Q. Royce: Not -- no -- no.

I have set out in my brief.

Frankly, I think, the cost may have gone up since the original computation was made but the -- just what distribution they will get in this case.

Now, my -- my proposition that the allowance of the priority would be inconsistent with the priority statute is simply that.

To the extent of bank shares, the money recovers will not be available to sustain the public burdens or discharge the public debt, at least a part of it is going to a private party.

Now, it is for that same reason also inconsistent with the Bankruptcy Act.

We have a number of cases saying that the theme of the Bankruptcy Act is equality of distribution among creditors holding just demands.

Here, while the bank will not recover $4000, if the priority is allowed in this case, the bank will recover 75% of its debt, where the other common creditors will receive not more than 2%, if they receive any.

So that the allowance of the priority not only produces a preference or a priority to a common creditor without any superior equities over any of the other creditors but also to the extent that that money is paid over to the bank, it will not be available to sustain the public burdens and discharge the public debt.

Justice Charles E. Whittaker: Does it get that, if I may ask, do the bank -- does the bank get that by law or by a private contract of the United States?

Mr. John Q. Royce: It's by a contract with the Small Business Administration.

I'm careful not to say --

Justice Charles E. Whittaker: Yes, yes.

Move on.

Mr. John Q. Royce: -- United States.

It -- it gets it by its private contract.

Now, the provision, the only provision in the law, and I do not have the whole thing set out in my brief, appears at page 19 Section 636 (a) of the Small Business Act, 15 U.S.C. Section 636 (a)."

The administration is empowered to make loans of various varieties and such loans maybe made or affected either directly or in cooperation with banks or other lending institutions through agreements to participate on an immediate or differed basis."

That is the -- that's the only language of the statute which provides for the participation between the bank and small firm -- participation of Small Business Administration with banks and other commercial lending institutions.

Now, I also contend that the allowance of the priority here would be inconsistent with the purpose of the Small Business Act itself.

At page 22 of my brief, commencing at that bottom of the page, is Section 1 of the Small Business Act.

It says, "The essence of the American economic system of private enterprise is free competition only through full and free competition can free markets, free entry into business and opportunities for the expression and growth of personal initiative and individual judgment be assured.

The preservation and expansion of such competition is basic not only to the economic well-being but to the security of this nation.

Such security and well-being cannot be realized unless the actual and potential capacity of small business is encouraged and developed.

It is the declared policy of the Congress that the Government should aid, counsel, assist and protect insofar as possible the interest of small business concerns in order to preserve free competitive enterprise to ensure that a fair proportion of the total purchases and contracts for property and services for the Government including, but not limited to, contracts for maintenance, repair and construction be placed with small business enterprises to ensure that a fair proportion of the total sales of government property be made to such enterprises and to maintain and strengthen the overall economy of the nation."

In the United States v. Guaranty Trust Company case, which this Court has cited in or has been apparently cited to this Court, nearly every case where the priority statute was involved, which involved the Transportation Act of 19 -- 1820, long in there.

They said that the purpose of the Act was to strengthen the credit position of the railroads and that allowing a priority would defeat that purpose.

I believe the same thing is -- is true here.

Your ordinary supplier, materials and services, if he knows that his debt is going to come after a priority allowed, the United States is going to curtail his credit.

If the argument was made in connection with the FHA and the Emory case and in that case the Court said, "No, the purpose of the FHA was -- was not -- was to stimulate the building trades."

The building trades would not be embarrassed by the allowance of a priority against the borrower or the homeowner.

In this case, it is the borrower himself, whose credit we are attempting to bolster, the small business organization.

I believe that as a matter of -- as a practical matter, we have advised clients in our office to be a little weary of -- to extending very much credit to people who have these loans and I say that not -- that has been even after this case has arisen, notwithstanding the fact that I have been successful in every court by either the appellee or the respondent.

I still feel that I'm swimming upstream.

This is not -- I -- I can't say that this is the pure cut-and-dried proposition and until this Court speaks, we are kind of warning our clients that they might find themselves out if there is a small business loan.

So -- this thing is not just argument, it is a practical matter I think as --

Justice Charles E. Whittaker: You mean in the event of bankruptcy or --

Mr. John Q. Royce: Yes, sir.

Now, there was some suggestion yesterday that, why can we raise this question of the participation of the bank?

I don't recall just who it was except -- well, isn't that just the side agreement, can't I agree to do anything I want to do with the money I recover?

My answer to that is simply that this is one single claim by the United States -- by the Small Business Administration.

As their interest may appear, therefore, you must examine the participation agreement in order to determine how their interests do appear.

First, you determine how the -- how much has been paid, how much each has recovered.

But then, the -- it is also necessary to determine whether or not a priority is due since it has been claimed.

I submit that you have to examine the entire document, the whole document, to determine how much is going to be available to sustain the public burdens to discharge the public debt.

Mathematically, the only place where the -- everybody comes out even, where the -- all of the laws, the Bankruptcy Act, the priority statute and the agreement between the bank and the Small Business Administration, the only place that they come out even is that if everybody gets just an ordinary dividend without priority.

The minute you allow a priority, then the bank has got to get some of it or there is a violation of the participation agreement.

Justice Felix Frankfurter: May I suggest, Mr. Royce, with all -- what shall I say, friendly and nice but when -- when you said the United States and then changed to the Small Business Administration, I don't think that was a slip of the tongue.

I think it is a bit of unconscious reason.

Mr. John Q. Royce: I said, "I -- I realized, this is a -- a robust request."

Nevertheless, I -- I really am serious but I -- I --

Justice Felix Frankfurter: But I didn't -- I didn't feel your seriousness that's why I made the comment.

It was what they call -- what the modern call, the subconscious, I think, prevailed there.

Mr. John Q. Royce: I think there is a -- there are two kinds of agents, burdening question, but -- but that the Small Business Administration is an agent.

But my contention is that it deals with its own funds to perform the work of its master.

The Farm Credit Administration, which this Court said was not a separate agency, got an annual appropriation.

It was all cleaned up at the end of each year.

Here, the master said to the agent, "Use my money to perform your service."

I say that the Small Business Administration has been given some money and said, "Now, use your money, pay me interest on it."

Justice Felix Frankfurter: All I'm suggesting is that in my master's house, Uncle Sam, there are many managements.

Mr. John Q. Royce: Yes, sir.

I believe that is all of my argument.

I believe for all of the various reasons stated that each of the courts below was correct and that the judgment should be affirmed.

Chief Justice Earl Warren: Mr. Hollander.

Rebuttal of Morton Hollander

Mr. Morton Hollander: May it please the Court.

I -- I should like to clarify one thing so far as the sequence of events is concerned here.

I am not quite sure how important it is and what materiality it has.

But I did state in my affirmative argument that the United States Treasury check for $15,000 was advanced.

It was sent to the bank.

The bank added 50 -- the bank $5000, then it made its $20,000 loan.

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: Oh, yes.

Oh, yes, the --

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: The record in this case shows that the application to the bank was made on a loan provided by the Small Business Administration that before this Small Business Administration disbursed its 75% to the bank, the borrower, Mr. Barquist (ph) was personally advised by letter from the SBA.

Justice William J. Brennan: (Inaudible)

Mr. Morton Hollander: Oh, yes.

This is -- the -- the relations are made very clear.

Does the sequence to that -- the fact that what happened was that SBA or the Treasury sent its $15,000 check, the bank added $5000 and then the $20,000 loan was made, is made very clear in the opinion of the District Court in this case.

The record at page 39, the District Court's opinion says, "The facts are not disputed in compliance with the agreement.

Small Business Administration paid over to the bank the sum of $15,000 by a draft drawn on the Treasury."

The bank then loaned the money to the bankrupt.

The Court of Appeals opinion on page 46 says, "On November 21, the SBA sent the bank the check for $15,000 worth 75% interest."

The bank then loaned $20,000 to Barquist (ph).

The record also shows that in a memorandum submitted by my opponent, the very same sequence of events was set forth.

I -- I don't believe there's any question.

The only -- on that aspect of the case, the only crucial consideration is, did the SBA or did the SBA not disburse its interest in the funds before bankruptcy?

Clearly, it did.

It disbursed the funds in November 1956.

The petition of bankruptcy was filed the Barquist (ph) was adjudicated a bankrupt late in 1957.

The Marxen case can have no applicability under those circumstances because in the Marxen case, the Government's disbursement, the expenditure of federal funds so far as its guarantee of the -- the National Housing Administration contract was concerned and the note thereunder, the federal disbursement, the disbursement of federal funds in that place did not occur until sometime after the filing of the petition of bankruptcy.

Here, as I say, whatever investment the Government made occur, practically a full year before.

I would like to touch on -- on the argument that -- that somehow the -- there's a -- a violation of the end line principle of the Bankruptcy Act by allowing the bank to participate in the Federal Government's priority to the extent of 25%.

It's been suggested that this gives the bank an undue preference over the other general unsecured creditors.

But I do submit that what the United States does with the recovery, it effects and the interests of stimulating small business expansion is really a matter of concern between the United States Government and the private party.

There is absolutely no difference between that arrangement and the arrangement between one creditor and the second creditor under which the first creditor tells the second creditor, "Well, I'm going to turnover to you all of the general dividends I get to the distribution of the estate."

That no way, prejudice is credit to C, D, E and F.

They still get the same as they would have if the first creditor had kept his general dividend distribution to himself and he had not turned it over to the second creditor.

Whatever benefits the second creditor gets, he gets solely at the advantage of the first creditor, not at the other general unsecured creditors.

That's the -- the same situation in this case.

The general unsecured creditors are in no way prejudiced.

They still get the same.

For those reasons and for those that I pointed out earlier, we respectfully submit that the judgment below should be reversed.