UNITED STATES v. WHITING POOLS, INC.
Legal provision: Bankruptcy Code, Bankruptcy Act or Rules, or Bankruptcy Reform Act of 1978
ORAL ARGUMENT OF STUART A. SMITH, ESQ., ON BEHALF OF THE PETITIONER
Chief Justice Burger: We will hear arguments next in United States against Whiting Pools.
Mr. Smith, I think you may proceed when you are ready.
Mr. Smith: Mr. Chief Justice, and may it please the Court, this bankruptcy tax collection case comes here on writ of certiorari to the Second Circuit.
It presents an important question under the new Bankruptcy Code, whether a Bankruptcy Court in a reorganization proceeding under Chapter 11 may compel the government under Section 542(a) of the Bankruptcy Code to turn over to the debtor in possession property which the government had seized by levy to satisfy the debtor's delinquent federal tax liabilities prior to the filing of the bankruptcy petition.
The facts are relatively simple, and can be summarized as follows.
Respondent is a corporation engaged in the business of servicing swimming pools.
In 1979 and 1980, it had unpaid assessments for withholding, employee withholding and social security taxes amounting to some $92,000.
These liabilities had gone unpaid for almost as much as two years, and on January 14th, 1981, the Internal Revenue Service exercised its statutory rights to levy on Respondent's inventory equipment and other tangible property.
This was done by placing a padlock on the premises, and the property therefore was seized pursuant to Section 6331(a) of the Internal Revenue Code.
The very next day, January 15th, 1981, Respondent filed a petition for reorganization under Chapter 11 of the Bankruptcy Code.
Unidentified Justice: What was the value of the property seized when the adjustment, $20,000 adjustment was made?
Mr. Smith: Well, the value of the property was found by the Bankruptcy Court to have a liquidating value of $35,000.
Unidentified Justice: What was the amount of the government's claim?
Mr. Smith: The amount of the government's claim is $92,000.
The $20,000 adjustment, Mr. Chief Justice, is somewhat of a... well, it is really not before the Court, because it involves the adequate protection question, but let me simply say in passing that the government took the position, correctly, we think, below, that that $20,000 did not constitute adequate protection because that was $20,000 in the bank account that the government had exercised its seizure rights.
So what was being done essentially was saying... was the Bankruptcy Court saying, well, you have adequate protection here because I am going to take this $20,000.
You have got $20,000 already.
That was with respect to another seizure.
But in any event, it is not before the Court.
By doing this, by filing this petition, the Respondent became a debtor in possession, and one month later, in February, the Internal Revenue Service sought to exercise its statutory rights under Section 6335 of the Code to sell the seized property and to reduce it to cash and to apply it against the tax liability.
It then, because of that, because it wished to do that, it went into bankruptcy... it went into the Bankruptcy Court on February 18th and sought an order from the bankruptcy judge that the automatic stay provisions of Section 362 did not bar its sale of the property, principally because the property was seized.
It was not part of the bankruptcy estate.
Respondent counterclaimed and sought an order which is at issue here, the propriety of which is at issue here, requiring the government to turn over the seized property under Section 542(a) of the Bankruptcy Code.
The Bankruptcy Court upheld the government on the issue that is before the Court.
It held that Respondent was not entitled to compel a turnover order... to a turnover order under 542(a), and the District Court on review likewise upheld the government.
It basically held, in accordance with our submission here, that the seized property was not property of the estate within the meaning of the pertinent provisions of the Bankruptcy Code, and was hence not subject to turnover.
Unidentified Justice: Do you think the District Court or the Bankruptcy Court based that view on the... analogizing the government's position here to that of any seizing secured creditor, or on the basis of peculiar to the government's position?
Mr. Smith: I think on the basis of peculiar to the government's position, that the government is not simply seizing secured credit, but operates, as the Court... as we point out in our brief, and the Court recognized in Phelps, the government... the government's position as tax collector is really quite different and distinct, and Congress has so made it different and distinct because of the involuntary nature of the government's creditor relationship.
In other words, we did not... unlike a bank, we did not enter into a voluntary relationship with Respondent to lend it money, and hope, you know, and take collateral.
We basically... Here we are in the position where, as the Court of Appeals itself recognized, the Respondent helped itself to the government's money.
This was... these were with principally employee withholding taxes.
So the Respondent paid net payrolls, never paid over the money that the... you know, in a timely way that you are supposed to.
Unidentified Justice: Mr. Smith, would your position be any different if it were just the income tax liability?
Mr. Smith: No, no.
Unidentified Justice: It would be the same?
Mr. Smith: I think the aspect of employee withholding taxes gives this case peculiar force.
I mean, I think what it does is show that, you know, essentially this was an involuntary... essentially Respondent was borrowing money from the government in an involuntary way.
Unidentified Justice: Well, it wasn't the Respondent's money.
You could take that position.
Mr. Smith: Exactly.
Unidentified Justice: Which makes, I suppose--
Mr. Smith: And indeed, the Court of Appeals recognized that that was something of somewhat peculiar force because of that fact.
Unidentified Justice: --But you don't restrict your case to that.
Mr. Smith: Again, I think it would be the same with respect to income taxes, and the Code suggests that, you know, once taxes are delinquent and owing, the full panoply of statutory authority rests in the Commission to take these steps.
Unidentified Justice: Mr. Smith, in all these bankruptcy situations, there obviously isn't enough money to go around or we wouldn't be having bankruptcy proceedings filed, and isn't... if the government were able to sell the property, it would only recover part of the taxes.
The theory of these reorganizations, of course, is to get the bankrupt back on its or his feet to be able to pay the creditors perhaps in full.
Is the government not better off if your security is adequate waiting it out with the rest of the creditors and getting more of the tax money?
Mr. Smith: Justice O'Connor, that may well be the case in a particular case.
I don't think that in hindsight any of us can sit back and say what the government ought to have done here.
This was a situation in which these taxes went unpaid for almost two years.
I can assure you and the Court on the basis of how the Internal Revenue Service behaves that levies do not occur gladly or with alacrity.
They are done really as a last resort, and I would... and the instruction--
Unidentified Justice: Well, the concern I have... the concern I have is that probably in almost every case of a bankruptcy reorganization there are taxes owed the government, and if the government is going to take the position on all these cases that it wants its levy and its money out, then probably the reorganization aspects will not be able to proceed in many cases, and so I was curious why--
Mr. Smith: --Yes.
Well, I would simply... I would simply suggest... suggest that the government exercises its levy rights only, I am sure, when it is satisfied that the debtor in possession or the bankrupt corporation is not going to be able to survive.
Unidentified Justice: --Yes, but that may be against the judgment of the Bankruptcy Court.
The Bankruptcy Court lets the reorganization petition be filed.
It survives motions to dismiss.
There is... That requires a judgment that there is a possibility of reorganization.
Mr. Smith: Indeed, but I suggest to the Court that the exercise of these statutory rights of levy are rights which Congress has vested in the Commissioner to take, notwithstanding--
Unidentified Justice: You have only got Phelps to defend your position under the previous Chapter 10, haven't you?
Mr. Smith: --Well, I would not say only got Phelps.
Unidentified Justice: Well, that wasn't even a Chapter 10 case.
Give me a Chapter 10 case.
I mean the old Chapter 10.
Give me one of those.
Mr. Smith: There is no... there are no Chapter 10 cases.
Unidentified Justice: The bankruptcy law... Chapter 10 had been on the books a long time.
Mr. Smith: Um-hm.
Unidentified Justice: And did you think the government regularly or even often got away with levying on property that... or saying that they didn't have to turn over property that had been levied on in that Chapter 10 proceeding?
Mr. Smith: Let me... as we point out in our brief, Justice White, there have been... there are no decided cases--
Unidentified Justice: That isn't what I asked you.
I asked you what the practice was--
Mr. Smith: --The practice--
Unidentified Justice: --that you were able to get away with it.
Mr. Smith: --The practice, as I understand it, is that the government exercised its rights of levy when it felt that they were necessary and appropriate.
Unidentified Justice: Well, all right, they exercised them.
And did Bankruptcy Courts always say, yes, if you have levied before a Chapter 10 petition is filed... that's the old Chapter 10... that you may keep the property?
Mr. Smith: I'm aware... I'm aware of no decisions forbidding the government from doing that.
Unidentified Justice: --Or approving it.
Mr. Smith: Or approving it.
And the point we are simply making is that here--
Unidentified Justice: Every other secured creditor could be required to turn it over, in the old Chapter 10.
Mr. Smith: --Indeed.
But I think the government is--
Unidentified Justice: You are saying now that one of your arguments is that the new bankruptcy law has permitted all creditors to seize property before the petition and keep it.
One of your arguments would--
Mr. Smith: --Indeed it is, although I think that, you know, our primary and principal argument is that the government stands in a very distinct position.
Unidentified Justice: --Well, that is one of your arguments in your brief.
I am not sure it is the principal one.
Mr. Smith: Well, it is the argument that we make, you know, and basically it is an argument based on this Court's recognition in Phelps, a unanimous recognition--
Unidentified Justice: It's a Chapter 11.
That was an old Chapter 11 case.
It wasn't a bankruptcy... it wasn't a Chapter 10 case, was it?
Mr. Smith: --No.
No, but the point--
Unidentified Justice: Well, that was a completely different operation with respect to secured creditors.
Mr. Smith: --But we think that Phelps is persuasive on this, and let me explain why.
Phelps dealt with the situation that the Court had to decide who had possession of this fund that was in the hands of an assignee for the benefit of creditors.
The government had served notice of seizure which the Court recognized was tantamount to a levy in that situation.
Now, once the government... once the government did that, then after that the debtor filed a petition for reorganization, and the--
Unidentified Justice: Yes, under Chapter 11.
Mr. Smith: --Under Chapter 11.
The government... the question before the Court was whether this was subject to the summary jurisdiction of the Bankruptcy Court or whether it was subject to plenary jurisdiction, but in deciding whether it was subject to summary or plenary jurisdiction, the Court necessarily had to determine who had possession of this property--
Unidentified Justice: Exactly.
Mr. Smith: --and the Court held that the assignee was holding the property in constructive possession for the government.
It's as if, really, what the Court said, and I would like to quote it, the Court said--
Unidentified Justice: Do you think the case would have come out any differently in Phelps if it had been a non-government creditor?
I don't... Don't you think any other secured creditor who would seize property ahead of the bankruptcy would have been able to hold it under Chapter 11?
Mr. Smith: --That may well be, but I think the important--
Unidentified Justice: Well, then, Phelps couldn't have rested on the special position of the government.
Mr. Smith: --I beg to differ with the Court, only because the middle part of the opinion discusses at great length the effect of a levy.
"Here we are concerned not with the priority of tax liens, but with the effect of a tax levy. "
Unidentified Justice: Right.
Mr. Smith: "Historically, service of notice has been sufficient to seize a debt, and notice of levy and demand are equivalent to seizure. "
Unidentified Justice: What if a mortgagee, what if a mortgagee in a case just like that had taken possession of the property before the Chapter 11 petition had been filed?
Mr. Smith: Well--
Unidentified Justice: Do you think they could have turned, been--
Mr. Smith: --There is authority that is cited by the Court of Appeals below that suggests that that would have been subject to a turnover.
Unidentified Justice: --In a Chapter 11?
Not in the old--
Mr. Smith: No, under a Chapter 10.
Unidentified Justice: --Well, that is a different thing, old Chapter 10.
Mr. Smith: Well, the point... I think the essential point of Phelps is, no matter what kind of proceeding existed under the old bankruptcy law, Phelps turns on the recognition as to what the effect of a levy is, and I think the important thing about the effect of a levy is that for all intents and purposes, it means that the government has virtually all rights to the property except a few narrow rights.
Unidentified Justice: All Phelps had to decide for purposes of deciding whether a plenary hearing was required or summary jurisdiction under the old Bankruptcy Act was that the government had reduced this property possession prior to the filing of bankruptcy.
So that is all the case can stand for.
Mr. Smith: That is all the case could have... could have said, but the Court went on and discussed what the effect of a levy was, and it said basically that the levy therefore gave the United States full legal right to the $38,000 levied upon as against the claim for the petitioner receiver.
Now, that to us is very significant, and when you take that recognition as to what the effect of a levy is, and you consider it against... in the context and in the perspective of the new Bankruptcy Code provisions, I think the answer is very clear that the Court of Appeals below erred, because what you had... I would like to refer the Court, if I may, to the pertinent provisions of statutory the language needs to be construed.
On Page 52-A, and 53-A, and 54-A of the appendix to our petition, the pertinent provisions are set forth, and basically we start, if I may, on Page 54-A, with the turnover provision, the very provision that the Court of Appeals thought was applicable here.
It says here,
"Except as provided in Subsection C or D of this section, an entity in possession, custody, or control during the case of property that the trustee may use, sell, or lease under Section 363 of this title shall deliver to the trustee. "
Now, the question... the IRS is an entity, and the question is, what is property that the trustee may use, sell, or lease, and we have to go to Section 363.
Unidentified Justice: May I interrupt you right there?
Is it not true that in a withholding case, as Phelps was, you've got cash involved that should have been paid out, you know, the withholding money, that that would not be property that the trustee could use.
Mr. Smith: That's right.
Unidentified Justice: Whereas in this case, the physical assets would be property that could be used?
Mr. Smith: Yes, but the point... the point--
Unidentified Justice: Isn't that true?
Mr. Smith: --Well, let me go on.
We then have to say to ourselves... we have to ask ourselves, what is the property that the trustee can use, and the question is, under Section 363(b), cited on... you know, set out on Page 52-A, it says,
"The trustee, after notice in hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate. "
So the question boils down to, what is... if this is not property of the estate, it is not subject to a turnover order.
And Section 541(a) finally defines what property of the estate is, and it says--
Unidentified Justice: --Let me back you up a little bit, Mr. Smith.
If this party had done what they should have done, this $92,000 would have been in a separate account, an agency or a trust account separate and apart from all the other assets of the employer.
Mr. Smith: --Precisely, and it would have been paid over.
Unidentified Justice: Well, at least it would have been set aside if it hadn't been paid over.
Mr. Smith: Right.
Unidentified Justice: Well, then, in this rehabilitation concept of Chapter 11, could that $92,000 have been used for any of the purposes of restoring this business?
Mr. Smith: No.
It belongs to the government.
Unidentified Justice: Of course not.
Mr. Smith: Of course not.
Unidentified Justice: Well, then, it is in a separate category--
Mr. Smith: Well, indeed--
Unidentified Justice: --and are you asserting that what was left of the... what was available is subject to a constructive trust?
Mr. Smith: --Well, that requires, you know, questions of tracing that the record is opaque on, and I am not suggesting that this property was in a constructive trust.
What I am suggesting, Your Honor, is that this is not property of the estate.
That is, you know, that is the critical aspect.
Unidentified Justice: But that is no different than a mortgagee seizing the day before.
I mean, you said that you thought your argument was primarily based on the unique position of the government, but this argument you are making it seems to me just for open to all secured creditors generally.
Mr. Smith: Well, we don't... we are not putting ourselves, Justice Rehnquist, in the same category as all secured creditors generally.
Unidentified Justice: Yes, but you are--
Mr. Smith: We are resting... we are resting on the exercise of our rights to levy.
Unidentified Justice: --But what you are saying, Mr. Smith, is that property of the estate refers to the debtor's interest in property and not to property in which the debtor has an interest.
Mr. Smith: That's right.
Unidentified Justice: And if that is your theory, it makes reorganization impossible in any case, because every creditor would be the same.
It is impossible.
Mr. Smith: It makes... let me suggest that it makes reorganization... it makes reorganization impossible in a case in which the debtor, like in this case, waits, you know, and does not pay tax obligations, and then finally the Internal Revenue Service exercises its statutory rights to levy, and then it goes into Bankruptcy Court.
I would suggest that that sequence of events wouldn't possibly make reorganization impossible.
But the chronology in this case is critical, because--
Unidentified Justice: But your theory that you have just been talking about would apply to all creditors.
That is the one argument that you make in your brief, and it would seem to me like you backed off from that argument in your reply brief.
Mr. Smith: --The point is that the Court of Appeals here began its analysis by saying that there was this turnover authority under the old bankruptcy law, and that somehow it was carried forward.
We don't think that is true, but that is not critical to our case, because even if it were carried over, we don't think that, you know, that the settled rule that permit... that insulated the Internal Revenue Service from turnover with respect to prepetition tax levied property has been altered by the codification of the Bankrupty Code.
We regard that rule as settled, and we regard the... I mean, it would be a drastic and radical departure from old law for the--
Unidentified Justice: Well, it is not very well settled if you can't give me any cases under Chapter 10, on the old law, if you can't even give me a case one way or the other.
Mr. Smith: --I think the point--
Unidentified Justice: How settled is that?
Mr. Smith: --I think it is settled because no one ever challenged the authority.
I think there would never be any--
Unidentified Justice: As far as I know, the Internal Revenue Service never attempted it before.
Mr. Smith: --Well, I can--
Unidentified Justice: And you can't tell me that it did.
Mr. Smith: --I can tell you that in investigating the history of this case, the Internal Revenue Service assured me that its right to do this had never been challenged, and that it had done it on a... it had done it on innumerable cases.
Unidentified Justice: That hardly answers my question.
Mr. Smith: Well, I would simply suggest that the absence of authority suggests that the... that the right was well settled.
After all, the statutory authority to levy, these are very old statutes, and the--
Unidentified Justice: Well, you wouldn't think that it had been settled with respect to other secured creditors under Chapter 10, would you?
Mr. Smith: --Well, apparently, there is--
Unidentified Justice: Would you?
Mr. Smith: --No.
Unidentified Justice: The rule is quite the contrary.
Mr. Smith: Well, there was some decisional law to the contrary, but that really--
Unidentified Justice: Then that is not well settled.
A lot more decisional law than there was in the case of the IRS.
Mr. Smith: --Well, indeed, but our point is that the government occupies quite a different position than an ordinary secured creditor.
An ordinary secured creditor simply has a security interest.
Take a mortgagee.
Unidentified Justice: Mr. Smith, all of your tracing through these statutory sections that you very helpfully took us through a few minutes ago, there is nothing peculiar to the government about any of that argument.
The only thing peculiar to the government is your heavy reliance on the Phelps case.
Mr. Smith: Well, let me say this.
But it is more than the Phelps case, because Section 541 defines property of the estate as all legal or equitable interests of the debtor in property as of the commencement of the case.
Now, the question is, what were the debtors' interests in this property as of the commencement of the case, the day that it filed its petition for reorganization, and under Section 6331(a) the levy had already taken place and the provisions of the Internal Revenue Code are absolutely clear that under those circumstances the only... the only property interests that the debtor had in that property was the right to receive notice of sale, was the right to receive possible surplus.
Unidentified Justice: Well, that is not much different than the chattel mortgagee.
Seizing chattel mortgagee.
Mr. Smith: Well, under--
Unidentified Justice: Or chattel mortgagor, I should say.
Mr. Smith: --Well, now, I--
Unidentified Justice: Right to receive notice of sale.
Right to receive surplus.
Mr. Smith: --Well, ultimately that is true, but I would suggest to the Court that the government is different in the sense that Congress has armed the government with statutory authority to conduct administrative sales without any... without any further ado.
A chattel mortgagee, I would suggest, has to get the sheriff to come and seize the property.
It can't engage in self-help.
Unidentified Justice: Well, take a conditional vendor then, who can... the sale--
Mr. Smith: --Well, let me simply say this, that the end result with respect to a secured creditor and the government may be the same at the bottom line in the sense that the debtor will be entitled to surplus, but the point is that Congress has made a determination that the Internal Revenue Service and its prerogatives are to be treated differently, and I think the Court has recognized that in Phelps, because what the Court said there was that the service of a notice of seizure takes the property... takes the legal interest of the property and puts it in the hands of the government.
The government then can sell it.
A chattel mortgagee or a real property mortgagee has to start a foreclosure action.
The government is not simply limited in tax collection proceedings to starting a... to commencing a suit to foreclose.
Unidentified Justice: --Well, neither a chattel mortgagee nor a conditional vendor in most places has to start suits to foreclose.
Mr. Smith: That's... that may be the case, but I am simply suggesting to the Court that in enacting the Bankruptcy Code, there is just... there is no statutory language that supports the notion that in a situation like this when the IRS has engaged in a free petition levy, that such property is subject to turnover.
It is a drastic change from what we regard as the settled rule for the contrary, as... and we think that Phelps recognizes that there was such a--
Unidentified Justice: I suppose one argument that the government might make that says that the tax claim is different from other secured creditors is that... at least you submit that the government's interest under a levy is determined by the code, whereas other secured creditors' interests very likely would be determined under state law.
Mr. Smith: --Under state law.
Unidentified Justice: Did the corporation here ever acquire any title to these tax moneys?
Mr. Smith: These tax moneys?
Unidentified Justice: Yes, the money that was put into these accounts, that he did not put into the accounts but should have put into the accounts.
Mr. Smith: Well, the corporation had title, and ultimately, you know, there is no money now in the account, where there are... are inventory.
Unidentified Justice: Well, let me go back to my other question.
If it had done what it should have done with its trust money, it would have had a separate account, would it not?
Mr. Smith: Indeed.
Unidentified Justice: And the $92,000 would be there.
Would the creditors be entitled to one penny of that?
Mr. Smith: No.
Unidentified Justice: You are arguing that equity presumes that should be done?
Mr. Smith: Absolutely not, but our argument, as I suggested to Mr. Justice Blackmun, you know, is with respect to all taxes, because Section 6331 empowers the Internal Revenue Service to levy on assets of the delinquent taxpayer any time there is unpaid assets, and here is a situation where these... unpaid tax liabilities.
Here is a situation where these things went unpaid for several years.
The government finally realized that it was not going to get paid unless it took these involuntary measures, and it did that, and the fact that the bankruptcy proceeding was commenced thereafter to us is critical, because it suggests that under the pertinent provisions, this property that was seized, this inventory was not property of the estate.
I would like to save the remaining time for rebuttal.
Chief Justice Burger: Mr. Relin.
ORAL ARGUMENT OF LLOYD H. RELIN, ESQ., ON BEHALF OF THE RESPONDENT
Mr. Relin: Mr. Chief Justice, and may it please the Court, it is the view of the Respondent that the decision reached by the Court of Appeals below was not only based on sound statutory analysis, but that of equal importance, it was grounded in common sense.
On the other hand, we believe the government's proposed plain language interpretation of turnover under the Bankruptcy Code--
Unidentified Justice: Let me put to you the question I put to your friend, Mr. Relin.
If this corporation had done what it should have done, put this money in a separate account, there would have been $92,000 in that account at the time of the bankruptcy, would it not?
Mr. Relin: --Yes, indeed.
Unidentified Justice: Now, could it use any part of that money for its corporate affairs?
Mr. Relin: It would not be property of the estate.
Unidentified Justice: It would be an embezzlement if they did so, would it not?
Mr. Relin: Well, perhaps--
Unidentified Justice: Perhaps?
Mr. Relin: --but it certainly would be a violation of trust, and--
Unidentified Justice: Well, that is sometimes called embezzlement--
Mr. Relin: --Yes.
Unidentified Justice: --when trustees take the money and use it for their own affairs and then lose it, especially if they lose it.
Now, when did the right of the creditors, the general creditors or the secured creditors, ever attach to any part of that, as we find it, a mythical fund, a fund that by his own default was not created?
When did they ever acquire any rights to share in that $92,000?
Mr. Relin: Your question, Mr. Chief Justice, presumes that there was in fact such a fund in existence at some point in time.
In fact, withholding taxes--
Unidentified Justice: Sometimes the law, especially on the equity side, assumes what that was done what should have been done.
Mr. Relin: --That's true.
Unidentified Justice: Now, that would be true if the $92,000 were there, wouldn't it?
Mr. Relin: No question about it.
And we do not mean to suggest in any way that it was inappropriate that it was not there.
Of course, the money should have been accumulated and paid.
Unidentified Justice: Why should the general creditors profit by the embezzlement or at least the default, to use a kinder word, of the debtor?
Mr. Relin: Well, I think the way the statutory construction is of the Bankruptcy Code is that if in fact a fund exists and can be traced, and the sponsors of the legislation indicate that tracing should be allowed a fairly liberal course--
Unidentified Justice: The predicate for that statutory provision is that the money belonged to the debtor, is it not?
Mr. Relin: --No, that the money does not belong to the debtor if it can be traced, and the sponsors make it clear that the government is to be given leeway by the Court to attempt to do such a tracing, if at all possible, but that was not attempted to be done here.
As a matter of fact, counsel has indicated that this tax had accrued over a period of a couple of years.
So there was no fund in existence.
As a matter of fact, the only cash or fund in existence was $15,000, not $20,000, that was on deposit in a bank account, and that had in fact been levied upon by the government prior to the levy on the tangible property, which, incidentally, was primarily construction equipment and vehicles, by and large, and the company had owned those for a substantial period of years.
So there is no direct relation between the unpaid tax liabilities and the property itself that was seized.
Unidentified Justice: Mr. Relin, did the government's levy count the filing of the petition for reorganization?
Mr. Relin: Well, it did, Justice Blackmun, at least on the day that it was filed.
However, the fact that we were able to file it within one day occurred because it had already been planned, but simply not put into execution.
The government pre-empted us in that regard.
The government's plain language interpretation assumes or argues that turnover applies only to interest rather than to the items of property which are subject to such interest and a basis--
Unidentified Justice: May I ask just one question before you get into your argument?
Mr. Relin: --Yes, Justice Stevens.
Unidentified Justice: The assets in dispute, as I understand it, are primarily physical assets.
Mr. Relin: That's correct.
Unidentified Justice: And you have a statement in your brief they had a going concern value of $162,000 or something of that--
Mr. Relin: The court did so find.
Unidentified Justice: --That is what I wanted to know.
There was a finding to that effect.
Mr. Relin: Oh, yes.
There was an evidentiary hearing with testimony as to values.
Unidentified Justice: Which is, of course, in excess of the government's claim.
Mr. Relin: Only by $70,000.
Unidentified Justice: Yes.
Mr. Relin: Yes.
The argument that turnover only applies to possessory interest or to interests in property rather than property would mean that the trustee would be entitled to obtain turnover under Section 542(a) of the possessory interest in property which he already has, assuming he does have such an interest, but not the item of property itself if that item happened to be held by someone else.
Clearly, such an interpretation of the statute is absurd and could not be seriously advanced by the government in this case.
Unidentified Justice: Then it would apply to all creditors.
Mr. Relin: Absolutely.
As you indicated in your questioning, Justice White, and we do agree that these sections are of general application to all cases in bankruptcy.
The word "turnover" implies in most instances a physical act with respect to a particular item of property.
Therefore, it seems logical that Section 542(a) must deal with the item of property itself, not merely with interests of various parties in that item of property.
However, the government says that the remedy of turnover is not available unless the debtor would have had the right of possession absent the pendency of the bankruptcy proceeding.
In other words, the government believes that Section 542(a) has no independent remedial function, but merely codifies the power of the court to compel a third party to turn over to the trustee property which the third party is not otherwise legally entitled to retain, even absent the pendency of the bankruptcy proceeding.
Under the Bankruptcy Act, such a turnover power existed as a judicially created adjunct to the Bankruptcy Court's summary jurisdiction, but it was not available for use against a creditor adversely in possession under a claim of right except in reorganizations, as I will subsequently discuss.
On the other hand, under the Bankruptcy Code, it would appear that the turnover power extends to property adversely held at the time of the filing of the petition.
Such an interpretation is supported by the legislative history, where property of the estate is interpreted according to the House and the Senate reports as including
"property recovered by the trustee under Section 542, if the property recovered was merely out of the possession of the debtor, yet remained property of the debtor. "
Unidentified Justice: Mr. Relin, do you understand the Second Circuit to have taken the position that you have just now been describing of this generally expanded availability of the turnover order even for property in possession of an adverse creditor?
Mr. Relin: I understand them to have taken that position with respect to a reorganization.
I don't think they--
Unidentified Justice: That they reserved as to ordinary?
Mr. Relin: --Yes, and I don't think it's necessary to reach that because, of course, we are dealing with a reorganization case here, but I think because the section itself, 542(a), is one of the sections of general application, then, Justice Rehnquist, I believe that such an interpretation would be possible.
Unidentified Justice: That is really a fairly important and rather broad question under the new Bankruptcy Act, isn't it?
Mr. Relin: It absolutely is, and I don't really purport to give an overall response to that, although it may be--
Unidentified Justice: What do you think the law was under Chapter 10, the old Chapter 10, with just an ordinary secured creditor who has taken possession immediately prior to the filing of the petition?
Isn't that subject to summary turnover?
Mr. Relin: --Yes.
There was a fairly extensive developed body of law.
Unidentified Justice: And if it wasn't subject to summary turnover, it might have been subject to turnover in a plenary suit?
Mr. Relin: It certainly might have been.
Unidentified Justice: I thought the trustee in the old Chapter 10 could collect those kinds of assets.
Mr. Relin: --Absolutely could, and there is no question that the developed law that--
Unidentified Justice: And do you know of any cases dealing specifically with property held... prior to a Chapter 10 reorganization held by the government under a levy?
Mr. Relin: --Absolutely not.
Unidentified Justice: There just weren't any?
Mr. Relin: No, there never were, and I would like to correct you, Justice White, in one minor respect, if I might.
Unidentified Justice: Yes, you certainly may.
Mr. Relin: Phelps was a liquidation case.
It was not a Chapter 11 case.
The only Chapter 11 case that I am aware of whatsoever was the case of Pittsburgh Penguin Partners.
Unidentified Justice: Well, it was a case... was it started out a Chapter 10 case?
Mr. Relin: Phelps?
Unidentified Justice: Yes.
Mr. Relin: No.
Unidentified Justice: It started out a straight bankruptcy case.
Mr. Relin: It was not only straight, but it was an involuntary bankruptcy.
Unidentified Justice: Well, that is even... that is a fortiori then from a Chapter 11.
I mean, an ordinary bankruptcy, if some secured creditor had taken possession, the trustee could never get it back.
Mr. Relin: Yes.
In a straight bankruptcy--
Unidentified Justice: Which it was.
Mr. Relin: --or in Chapter 11.
Which it was.
Unidentified Justice: Which Phelps was.
Mr. Relin: Absolutely was, and that certainly is our position with regard to Phelps.
I think that in order to understand the significance of Section 542, it is necessary to bear in mind Section 543 as well as Section 542, because they are companion sections.
The case law which had developed under the Act had distinguished between equity receivers holding property for creditors generally and for closure receivers holding property for a particular creditor.
Although both types of receivers were required to turn over such property in a Chapter 10 reorganization, only equity receivers were required to turn over to a straight bankruptcy liquidation trustee.
Section 543 of the Bankruptcy Code applicable to custodians by its terms clearly seems to encompass both equity and foreclosure receivers.
Unidentified Justice: Where is 543 set out in the briefs, if you know right off?
Mr. Relin: Well, it would be, I am fairly certain, in the government's appendix.
Unidentified Justice: It is in Judge Friendly's opinion in the footnote on Page 6-A.
It is on 6-A.
It is not in the other materials.
Mr. Relin: Now, the essence of 543 seems to be that there must be turnover by any party holding property which was once the debtor's or proceeds of that property if the party holding the party or the proceeds holds it for the benefit of some other party, and it doesn't matter whether that other party is just one creditor or all creditors of the debtor.
Section 542(a), on the other hand, provides for turnover from parties other than custodians.
If both traditional equity and foreclosure receivers are custodians, obviously, Section 542(a) applies to someone else.
In our opinion, and in the opinion of the Court of Appeals, that someone else includes a creditor who is in self-possession of assets of the debtor's property.
Under the Bankruptcy Act, Section 257, in corporate reorganizations, and Section 507, in real property arrangements--
Unidentified Justice: Excuse me.
Before you go on--
Mr. Relin: --Yes.
Unidentified Justice: --542(a) after the... other than custodian in possession language, is followed by what appears to be limitation of property that the trustee may use.
Mr. Relin: Yes, may use, sell, or lease under Section 363.
Unidentified Justice: Now, if, as I had suggested in my earlier question, this company had done what they should have done legally, put it in a separate account identified as withholding tax, then would that have been property that the trustee may use?
Mr. Relin: Not that property, but the property that was seized here by the government, absolutely.
Just because we are dealing with a certain dollar amount for one category and a tax of $92,000 does not mean equipment that had been purchased years earlier by the debtor would do that.
Unidentified Justice: What about bank accounts?
What about taxing--
Mr. Relin: Well, there is an indication in the legislative history that perhaps the courts should assume that the last money in bank accounts is in fact trust funds.
Unidentified Justice: --Is impressed with a constructive trust.
Mr. Relin: Yes, that is really a constructive trust argument, or resulting trust, perhaps, in a traditional sense, but not in the case of tangible property.
In any event, both 257 and Section 507 of the Act require turnover by a trustee under a trust deed or a mortgagee under a mortgage.
Both creditors were creditors who were in self-possession of the debtor's property.
Unidentified Justice: If the trustee... if the government could show that some of this $92,000 was used to purchase the physical, tangible assets that were seized, would the constructive or resulting trust follow?
Mr. Relin: Absolutely.
I don't think that there's a real dispute about that, Your Honor.
They may trace as far as they possibly can and--
Unidentified Justice: But that hasn't been undertaken.
Mr. Relin: --Not in this case.
It is our belief that the cases that have developed under Chapter 10 and under Chapter 12 and primarily, of course, the case of Reconstruction Finance Corporation, on which the Second Circuit placed great reliance, that those cases have been carried forward into the Bankruptcy Code, and those cases would not appear in Section 543.
We believe they were carried forward into Section 542(a).
The reason for this can be seen from the historical analysis that we have set out in our brief, and which the Court of Appeals followed.
There was considerable testimony adduced in the House and also in the Senate where many parties testifying expressed concern that the original custodial provision, turnover from a custodian under the earlier drafts of the Bankruptcy Code did not provide for turnover by a creditor in self-possession of the debtor's assets.
Following that testimony, the redrafted House bill, H.R. 6, was introduced which contained Section 542(a) in its present form.
And we believe that this was done for the purpose of incorporating the decisional rule of law that had developed in many cases, not just Reconstruction Finance, but In Re Prudence Bonds, Grand Boulevard Investment, Third Avenue Transit, Colonial Realty, and so on.
Unidentified Justice: Mr. Relin, to your knowledge, was Judge Magruder's opinion in Reconstruction Finance the only Court of Appeals opinion treating the particular issue that it did under the old bankruptcy law?
Mr. Relin: Well, that particular issue was dealt with in various other cases in other categories, although I think, as far as I know, Reconstruction Finance was the only case that actually dealt with inventory, which was the seized assets in that particular case.
We believe that by keying Section 542(a) to the sale, use, or lease of property under Section 363, Congress intended to enable a trustee or reorganizing debtor to acquire possession of needed property in which the interest of the estate is not inconsequential, so long as the interests of the party in possession of the property can be judicially determined to be adequately protected.
Section 363(e) mandates an adequate protection hearing upon the request of the affected creditor, and in the case of the proposed turnover of cash collateral, Section 363 mandates such a hearing.
In either case, the trustee has the burden of proving the protection offered is adequate.
Turnover is required under Section 542(a) of property that the trustee can use, sell, or lease... it is a disjunctive that is used... under Section 363.
Although the government has concentrated its analysis on Subsections (b) and (c), Subsection (f)(5) of Section 363 permits a trustee to sell property either in the ordinary course of business or out of the ordinary course of business free and clear of the interest of any other entity in the property if
"such entity could be compelled in a legal or equitable proceeding to accept a money satisfaction of such interest. "
Clearly, this is the case with respect to the interest of the IRS in all of the property that it seized from Whiting, as the government has no interest in the property except to get paid.
Therefore, as Whiting could sell the property under Section 363 at (5), it is entitled to turn over under Section 542(a).
Conceding that Section 542 might require turnover by a private creditor in possession of assets, the government nonetheless attempts to exclude itself from the application of that rule.
In essence, the government's argument takes the following pattern.
There existed pre-Bankruptcy Code prior decisional law governing the effect of pre-bankruptcy tax levies.
Nothing in the Congressional history specifically indicates that Congress intended to change that prior law.
Therefore, Congress did not change the prior law.
The government's syllogism fails, however, of its own accord, because it is based on a false major premise.
According to the government's argument, pre-Bankruptcy Code decisional law held that the government was not required to surrender to the trustee for inclusion in the bankruptcy estate property seized prior to bankruptcy to satisfy delinquent taxes.
That is the wording in the government's reply brief.
But there is no case cited by the government as prior law under the Bankruptcy Act which held that the government could not be compelled to turn over to a reorganization trustee tangible property seized in a pre-petition tax levy which had not been sold at the time of the petition.
With the sole exception of the Pittsburgh Penguin Partners case, all of the prior law cases concerned the government's seizure of intangible property and its right to retain that property against a liquidation trustee.
Pittsburgh Penguin Partners, however, which was a Chapter 11 case, is not even prior law as it was decided by the Third Circuit in 1979, one year after the Bankruptcy Code had been enacted.
Moreover, the decisions in American Acceptance Corporation versus Glendora and In Re Chantler Baking Company, both cited by them as part of this prior law, were published on March 30, 1977, and July 18, 1977, respectively, several months after the introduction of H.R. 6 on January 4, 1977, which already contained Section 542(a) in its present form.
Recognizing as it must that all of the prior cases arose in liquidations where the existence of a bona fide adverse claim to the property defeated summary jurisdiction of the Bankruptcy Court and would have done so for a private creditor in adverse possession as well as for the government, the government seeks to extend the ratio decidendi of the liquidation cases to broader application by arguing that the prior cases really held that a tax levy in and of itself effected a transfer of ownership to the government of the property levied upon.
But in actuality, the only cases which would be prior law that dealt with that particular subject are only three cited by the government, United States versus Eiland, a Fourth Circuit 1955 case, United States versus Sullivan, a Third Circuit 1964 case, and this Court's decision in Phelps versus United States.
Eiland concerned a prepetition levy on an account receivable which belonged to the bankrupt.
The court analogized the levy to a private creditor's attachment and garnishment, and held that the effect of the federal taxing statutes was to create a statutory attachment and garnishment resulting in a "virtual transfer" to the government of the right to receive payment of the debt.
Clearly, the court would have held the same way for a private attaching creditor.
United States versus Sullivan concerned a prepetition levy on two insurance companies to obtain the benefits under the policies of a living tax delinquent policyholder.
Although the court on the authority of Eiland states that a validly invoked seizure is
"tantamount to a transfer of ownership. "
and those words have been carried on in the subsequent decisions dealing with this issue under the Bankruptcy Code, the court nonetheless goes on in Sullivan to hold just the opposite.
It held that by the mere act of levying, the government was not entitled to have the insurance policies cancelled for their cash values, as the levy did not dress the government with all of the rights of the policyholder.
In so holding, the court stated,
"But implicit in the statute, the Internal Revenue Code, is the principle that the Commissioner acts pursuant to the collection process in the capacity of lienor as distinguished from owner. "
"Moreover, nowhere in the code is there a provision granting to the Commissioner power over property interests of delinquents comparable to that given the trustee in bankruptcy. "
The last case that is left is Phelps, and we have already discussed that to some extent.
Most significantly, and the only thing I would like to comment on Phelps to the Court at this time, is that it is difficult for me to understand the government's overreliance on Phelps when one considers that the holding most likely would have been the same, in favor of a secured creditor who had taken steps to recover the funds at issue from the assignee for benefit of creditors had the funds been the proceeds of the sale of assets, subject to the creditor's security interest, rather than proceeds of the sale of assets subject to the government's unfiled tax lien.
Unidentified Justice: Certainly that would have been the case if the non-tax secured creditor had seized physical assets and were holding them pursuant to a lien.
Mr. Relin: Yes.
And the rationale in Phelps is identical.
Although the language may appear somewhat overbroad taken out of context, in context, it makes absolute good sense.
All in all, then, it is our opinion that prior decisional law did not establish a rule that property seized by prepetitioned tax levy was never subject to post-bankruptcy turnover.
Rather, the cases simply held that the government did not have to turn over seized assets in circumstances where a private creditor exercising equivalent lien rights would not have had to do so.
The true intent of Congress with respect to the treatment of the Internal Revenue Service as a creditor under the Bankruptcy Code can best be seen by the provisions of Section 106(c)(1), which in waiving the government's sovereign immunity makes it clear that any provision of the Code applicable to an entity such as Section 542(a), which specifically applies to entities, applies to "governmental units".
As the IRS is by far the federal governmental unit most frequently involved in bankruptcy cases, it is clear that Congress intended the IRS to be included in Section 542(a) turnovers, not excluded, as the government here suggests.
In conclusion, we would respectfully submit that a statute should be construed so as to achieve its purpose, that a reform act, such as the Bankruptcy Reform Act of 1978, should be permitted wherever possible to simplify and modernize the law of bankruptcy in conformity with the developing law in the field, and that effect should be given to the avowed intent of the legislative sponsors to enact legislation that
"encourages business reorganizations by a streamlined new commercial reorganization chapter that will protect the investing public, protect jobs, and help save troubled businesses. "
We believe that the position taken by the government in this case is regressive and in conflict with the intent of Congress in enacting the Bankruptcy Code.
We respectfully submit that a decision in this case in favor of the government will thwart the independent functioning of the bankruptcy system in reorganization cases by constituting the IRS a censor of prospective Chapter 11 cases in which it might be involved as a creditor, with the power to virtually veto reorganization by seizing assets before petitions can be filed.
It will encourage the IRS to seize first and negotiate later.
Bankruptcy Courts will be powerless to preserve the assets of debtors under their jurisdiction against forced liquidation even if the value of the assets at fair market exceeds the tax debt many times over.
Such a result, we believe, could not have been intended by Congress.
We trust it will not be permitted by this Court.
Chief Justice Burger: Do you have anything further, Mr. Smith?
ORAL ARGUMENT OF STUART A. SMITH, ESQ., ON BEHALF OF THE PETITIONER -- REBUTTAL
Mr. Smith: Yes, I do.
I think that the scheme of the law that Respondent has described and the Court of Appeals has held was simply not enacted by Congress when it codified the Bankruptcy Code in 1978.
Our critical point here is that this property was not property of the estate.
Section 541, the precise words that Congress used, talked about all legal or equitable interests of the debtor in property as of the commencement of the case.
The legislative history is absolutely clear that the sponsors determine that this provision was not to expand the debtor's rights in property as of the commencement of the case.
The question before the Court is, what were the debtor's rights in this property as of the commencement of the case.
To that... property rights are not defined under the Bankruptcy Code, but are defined either under state law or in this case under the Internal Revenue Code, and to that, I submit, the Court must refer to Section 6331(a), et cetera, the levy provisions, and it is absolutely clear that under those situations the debtor... under that situation the debtor had very limited rights under this to this property.
He could receive notice of seizure.
He could receive surplus property, et cetera, et cetera.
He could not use, sell, or lease this property within the meaning of Section 363(b) of the Bankruptcy Code.
There... his right, simply, to get the property back, he had to pay the tax, and if he didn't do that, the IRS, without any further ado, without resort to any judicial proceeding, could sell the property.
The fact that this may thwart the rehabilitation of the debtor is a sorry circumstance in this case, but it proceeds on the basis of the explicit statutory words enacted by Congress in the legislative history.
What the Court of Appeals has done here is to prescribe a rule that was neither enacted by Congress with respect to secured creditors but at all events hardly enacted with respect to the Internal Revenue Service's statutory collection authority.
Chief Justice Burger: Thank you, gentlemen.
The case is submitted.