Cases by Issue - Bankruptcy

Hamilton v. Lanning - Oral Argument

Sun, 19 Dec 2010 15:33:57 +0000

Case:

Hamilton v. Lanning

Media File:

08-998_20100322-argument.mp3

Related Transcript:

08-998_20100322-argument.xml

Transcript:

ORAL ARGUMENT OF JAN HAMILTON ON BEHALF OF THE PETITIONER

Chief Justice John G. Roberts: We will hear argument first this morning in Case 08-998, Hamilton, the Chapter 13 Trustee, v. Lanning.

Mr. Hamilton.

Mr. Hamilton: Mr. Chief Justice, and may it please the Court:

The Tenth Circuit and Stephanie Lanning were wrong in ignoring the new Chapter 13 means test contained in the 2005 amendments to the Bankruptcy Code.

The amendments to the 2005 Bankruptcy Code were intended to reduce judicial discretion by inserting a formula rather than the judicial discretion that had previously been accorded to judges and to the litigants.

Stephanie Lanning fell afoul of the means test because during the first 2 months of a 6-month lookback period, which I will explain in a moment, she had more income than what she had in the rest of the 6-month lookback period.

That income was from a buyout from her former employer, Payless, and distorted what her income appeared to be during that 6-month period of time.

Because of that, the amount which the means test showed that she would be required to pay to her creditors was more than she could actually pay.

Justice Ruth Bader Ginsburg: Which means -- which means what?

What is the consequence of that?

You concede that on the strict application of the 6 months she -- her income is much too high for her possibly to pay the creditors.

So what happens to her?

Mr. Hamilton: What happens to her and what could have happened to her may be two different propositions, Justice Ginsburg.

In the first place, there are two parts to that 6-month lookback period, which are found in 101(10A) of the United States Bankruptcy Code -- and the statutes, by the way here, are found at pages 83 through 96 of the petition appendix.

101(10A) has a first part which defines the 6-month lookback period as being 6 months prior to the filing of the date of the petition -- actually, the end of the month prior to the filing of the petition.

Congress's thought was, it seems, that that would be more representative of what an individual's actual income would be.

There is a second part to that 6-month lookback period which says essentially that the debtor can move that 6-month lookback period by not filing certain papers with the court.

Justice Ruth Bader Ginsburg: That's -- can you explain that?

It seems very odd.

It says she can do that if she doesn't do what the statute requires her to do.

I mean, she's supposed to file that schedule.

She's required, the statute says, to file it.

But she gets an advantage if she doesn't do what she's instructed to do?

Mr. Hamilton: The part of the statute that you are referring to is under 523, and it essentially says that debtor shall file -- 521, excuse me -- shall file certain schedules and that would include the income and expense schedules, Schedule I and Schedule J.

And certainly the court has the ability, under that statute, to extend the time or to excuse the performance of a debtor in that regard.

So there's nothing incongruous about that wording in the statute.

Justice Sonia Sotomayor: What do you -- what do you do with the contention that the court is bounded by other requirements such as the timing of the meeting of creditors and the plan confirmation, that that binds the district court from resetting it?

Mr. Hamilton: Certainly all of those time frames can be moved, Justice Sotomayor.

There is -- again, the actual timing of the confirmation hearing in a Chapter 13 case may be fluid, although there are certain time limits for the first meeting of creditors and for when the first -- when the confirmation hearing is held.

They can be extended, just as the confirmation hearing would be in a Chapter 12 or in a Chapter 11 case.

So the idea is the second part of 101(10A) allows the debtor to say: Your Honor, my 6-month time frame immediately prior to the filing of the bankruptcy petition is not representative of my income; I would like to have that time frame moved.

And that time frame would appear to be moveable up to the confirmation hearing.

Justice Ruth Bader Ginsburg: Moveable to where?

What -- what would be -- you say -- this time period, the statutory -- the 6-month lookback, she has these 2 extraordinary months.

So now she's going to say: Court, please change the period.

Change it to what?

Anything she wants?

Mr. Hamilton: No, Your Honor.

That would be up to the court.

It would be discretionary with the court, as the language suggests in the second part of 101(10A).

Justice Samuel Alito: But isn't it the case that before the 2005 amendments, bankruptcy courts were recognized as having discretion in calculating projected disposable income to take into account changes in the debtor's income after the filing of the plan, and shouldn't we presume that -- that Congress intended to continue essentially the same regime, unless Congress provided some clear indication that they wanted to depart from it?

Mr. Hamilton: Certainly prior to the 2005 amendments, your assessment is correct.

The court had the discretion to be able to assess the debtor's situation, use its discretion to determine what income and expenses should be calculated in determining whether or not a debtor was paying his or her best efforts under 1325(b)(1).

Here, there is a clear formula.

And if you read these -- there are three, three key statutes that form a triangle in order to give me the conclusion that I make and that I suggest to Your Honor.

And that is, we start with 1325(b)(1), which is the statute that brings into play the disposable income and projected disposable income requirements.

"Disposable income" is now defined as "current monthly income".

Justice Samuel Alito: It is odd that Congress provided this very detailed formula and -- and that they would provide such a detailed formula and then say: But the bankruptcy court can modify that based on a projection.

But still we have the word "projection -- projected".

And your interpretation leads to very strange, really absurd results; isn't that true?

And you have to devise some really elaborate escape strategies in order to allow a debtor to avoid those very strange results.

Mr. Hamilton: Respectfully, Justice Alito, I don't any agree with the assessment that -- of what you just stated.

Essentially, this formula allows the bankruptcy court to move that 6-month period of time, not to ignore the formula.

The formula's there.

The formula defines "current monthly income".

From the current monthly income then is subtracted reasonable and necessary expenses.

And formerly, under the old law, the '78 code, those reasonable and necessary expenses contained a few specifics, but largely it was up to the court to determine them.

Justice Samuel Alito: But you say that that can be done only if the debtor fails to file a form that the debtor is required to file; isn't that right?

Mr. Hamilton: In -- under 101(10A), the second part, yes.

But I think there are -- there are some other -- other avenues for the debtor that are statutory.

Justice Samuel Alito: What do you do with the situation in which the change that is projected to occur and in fact may be almost certain to occur is one that causes an increase in the debtor's income?

Let's say the debtor was unemployed through almost all of the lookback period and then just before the filing of the plan gets a job with a good salary.

You would say that the -- if you just look at the lookback period, the debtor would be required to pay practically nothing.

Mr. Hamilton: No, Your Honor, I would not agree with that.

Justice Samuel Alito: What is a creditor to do in that situation?

Mr. Hamilton: Well, there -- there are a couple of avenues.

There is a new statutory provision under 1325(a)(7) that says the plan must be filed in good faith and -- I'm sorry, the petition must be filed in good faith.

1325(a)(3) provides that the petition must be filed in good faith.

So we still have the good faith analysis that the debtor's actions may be subjected to even after the plan is filed.

And that would be as trustee the avenue that I would approach is that, even though the schedule formula may have been complied with, that if there had been a drastic increase in income post-petition, then that -- that should need to be accounted for.

Justice Sonia Sotomayor: Counsel, why -- what commends going through all these machinations, all of these alternative ways of avoiding absurd results?

Isn't the answer simply that we just narrow the circumstances in which a court can deviate from the statutory formula?

I mean, it's not -- even before this change, it wasn't that the district courts could at whim change the projected income.

They have to have a clear ground to do so.

Why is that inadequate to protect the interests that Congress had in creating this new formula for income and expenses?

Mr. Hamilton: My answer, Justice Sotomayor, is that Congress provided the formula, and it's not up to the courts, I suggest, to modify that formula.

Part of the--

Justice Sonia Sotomayor: There was a formula before.

It was somewhat ambiguous, and that's what led to the more defined terms for income and expense.

But that says nothing about changing the court's power to act in a situation where the formula's clearly not going to work.

That was the standard before.

Mr. Hamilton: --Two points, Justice Sotomayor.

One is that there was no formula before.

There was some general guidance that was given in the statute.

It's much like the proposition of good faith.

Good faith is almost incapable of definition, yet every circuit in the United States has a laundry list of factors that are taken into account for good faith.

Here, reasonable and necessary expenses under the old law had a few suggestions as to what needed to be involved with them.

Now we have a portion of another part of the triangle, which is under 707(b).

Justice Anthony Kennedy: But in a sense that cuts against you.

As I was -- when I was reading your opening brief, it seemed to me the tone was, well, if you accept the Respondent's position Congress did nothing at all.

Well, they did do something very important.

They had a formula for disposable income.

The question is, does that formula apply to projected?

Can that formula be modified altered or projected for projected?

So it's not as if Congress did nothing or it's not as if the amendment accomplishes nothing even under the Respondent's view.

It accomplished something very important.

Mr. Hamilton: My answer, Justice Kennedy, is that the definition of the word, quote, "projected", end of quote, has -- there's never has been one in the code.

That was a term that was in the 1978 code and is carried over into the present code.

How it was applied is vastly different.

The dispute under the prior law was over whether or not the court could take into account changes in circumstances which were likely to occur post-confirmation.

And so we had cases like the Anderson v. Satterlee case out of the Ninth Circuit and the Midkiff case out of the Tenth Circuit that disagreed as to how that ought to be applied.

In the Anderson v. Satterlee case the Chapter 13 trustee requested that the debtor sign essentially a pledge that they would devote their excess income to the plan, and the Anderson court said: Wait a minute; there is another statute at issue here and that is 1329.

1329 allows for the modification of the plan after the plan has been confirmed.

Prior to the confirmation of the plan, the debtor still has the ability -- and this ties in with some of the comments made by Justice Alito -- the debtor still has the ability to amend the plan under 1323.

So all of these statutes need to be read together to show what the result is.

Now the question is not whether or not changes should be taken into account for post-confirmation that may be likely to occur, but whether or not the court may deviate from the statute where Congress has said this is how we want you to determine current monthly income, therefore disposable income and consequently projected disposable income.

Justice Ruth Bader Ginsburg: But you already told us that there could be a deviation through this 101(10A)(ii).

And why, if that was all that needed to be done, did the trustee recommend, did the trustee say, bankruptcy judge, let's move the period, let's use this provision and we will get another period that doesn't have those 2 months with the extraordinary income?

Mr. Hamilton: No, Justice Ginsburg, and the reason is, is that that privilege is accorded only to the debtor to move that 6-month period.

Neither the unsecured creditors nor the trustee have the ability to request that that 6-month period be moved.

Justice Ruth Bader Ginsburg: Well, it could have been suggested to the debtor: You can accomplish what you want by using this provision.

Mr. Hamilton: The record is silent as to whether or not that occurred.

Justice Anthony Kennedy: What -- where can you move it?

I don't really -- this is the same line of inquiry as Justice Ginsburg.

What's the -- what has to be the ending date if you move the -- you can't move it any -- much beyond the date of what, the hearing?

Mr. Hamilton: It would be up to confirmation, but the confirmation hearing could be continued as the court saw fit.

Chief Justice John G. Roberts: The review of the determination or the request to move the period is -- is what?

Up to the total discretion of the -- of the judge?

Mr. Hamilton: It appears to be so under the statute, Chief Justice Roberts.

Chief Justice John G. Roberts: So your objection to the fact that the judge has more discretion with respect to defining "projected disposable" -- you don't mind the discretion on the other side.

Mr. Hamilton: No, Your Honor, I believe the discretion is not in determining the income, only in determining the time period.

Chief Justice John G. Roberts: Right, but the only purpose of moving the time period is to change the income.

Mr. Hamilton: That's true.

And there are other options that the debtor had available in addition to that, that we have referred to as the four options, which would be the debtor could have here just delayed filing the case for a couple of months and these problems would not have occurred.

Justice Antonin Scalia: There is another discretion that you don't seem to object to.

You say that one -- one way the debtor can get out of the bind that he's put in by the fixing of the confirmed plan is simply to move for a revision of the confirmed plan.

Mr. Hamilton: Absolutely, Justice Scalia.

Justice Antonin Scalia: What constrains the judge in allowing or not allowing the revision?

Doesn't he have the same kind of discretion with regard to the revision that you're objecting to with regard to his establishing the payments?

Mr. Hamilton: Justice Scalia, I don't think so.

1329 has been subject to quite a bit of litigation, but the argument that we make in our reply brief is that it would be simply necessary to plug in and plug out whatever the change in circumstance is.

So the debtor would be able to say, my wife's income is now gone, so we want to take that out of the formula.

Justice Antonin Scalia: But that's the same thing that's being argued here, that -- that you start with the fixed calculation based on the 6 months before and then you have to show that there were some extraordinary circumstances that justify a change.

I don't see that there's any difference.

Mr. Hamilton: There may not be, except that there is a statutory requirement as to how that is accomplished and that's where the 101(10A)(ii) comes into play.

It's not so much that there is a problem with--

Justice Antonin Scalia: What your case comes down to is the bankruptcy court can do this, but it has to do it by simply revising the plan, not by establishing the plan initially but by revising it.

Mr. Hamilton: --Not necessarily, Your Honor.

That certainly is one way.

Justice Antonin Scalia: Maybe?

Mr. Hamilton: It may be, yes.

It depends on the facts of the case.

Chief Justice John G. Roberts: Well, that's a good answer, isn't it, because your point would be the statute does not allow that exercise of discretion with respect to projected disposable income, but it does in the other areas.

Mr. Hamilton: Well, again I respectfully disagree, Chief Justice Roberts.

1329--

Justice Antonin Scalia: That was a friendly question.

Mr. Hamilton: --I'm sorry?

I'm sorry, I didn't hear.

Chief Justice John G. Roberts: No, my -- my point and what I thought your point would be is that the fact that there is exercise of discretion in two different areas is not the problem.

The problem is that in one area the discretion is specifically permitted and in the other area, projected disposable income, it's not.

Mr. Hamilton: I agree.

[Laughter]

Justice Samuel Alito: But can the -- can the plan be modified based on -- can the plan be modified based on something that was known before the plan was confirmed?

Mr. Hamilton: That depends on which jurisdiction one would be in, Justice Alito.

The most current example--

Justice Samuel Alito: Well, if it can't, then how is this modification remedy going to work?

Mr. Hamilton: --I think it should be.

For example, a good example of this would be debtor is expected 2 years from now to no longer have to repay a 401(k) loan.

And so one view would be that you ought to take that into account as of that date and figure those calculations, which becomes extremely unwieldy.

You are guessing at that point.

The debtor may say: Well, I may be losing that, but I don't know what my actual circumstances are going to be 2 years from now.

Chapter 13 is a fluid process.

Justice Samuel Alito: Your argument is that the Court has to confirm a plan that is really not confirmable because the debtor can't possibly make the payments under the plan, but then can turn around immediately and modify the plan so that it does call for payments to be made.

Mr. Hamilton: No, Your Honor.

That is not my argument.

Justice Samuel Alito: Well, I thought that -- explain it, then?

Mr. Hamilton: Well, what we are saying is that this plan cannot be confirmed as it stands because the debtor would have to be able to make those payments and the debtor obviously is not capable of making those payments.

But it's because she chose the wrong options.

If she had chosen the--

Justice Ruth Bader Ginsburg: But let me just stop you there, because then the answer you gave to the Chief and to Justice Scalia doesn't fit.

Chief -- you can not -- the bankruptcy judge is not going to confirm the plan was she has to pay over $1,000 a month, because she could never do that.

So you are not going to get that confirmed plan which could be amended later.

Mr. Hamilton: --Well, I agreed with that.

I may have misunderstood the question that I was asked.

But what I'm saying is that the statute needs to be followed and if the debtor had followed the statutes here then the debtor likely could have obtained a confirmed plan by moving that 6-month time frame.

Justice Ruth Bader Ginsburg: Well, what in addition to -- you brought up the 101 solution that she doesn't do what the statute tells her to do, so she's able to move it if the judge agrees.

And you said she has other options.

Mr. Hamilton: Yes.

Well, the other options -- and I referred to them as the four options and the 101(10A)(ii) is one of those options.

As I said, she could have delayed filing the case.

There is nothing in the schedules that would indicate that she was filing this bankruptcy under exigent circumstances.

There is no foreclosure, there is no repossession, there's no garnishment, there's no lawsuit.

So delay would have been a possible, and a debtor is always able to determine the date of the filing of the petition.

The second thing that she could have done is file a Chapter 7, and this is the anomaly between Chapter 13 and Chapter 7, is that she would have qualified in all likelihood for a discharge under Chapter 7 because she would have met the special circumstances test in 707(b).

Justice Ruth Bader Ginsburg: But then the creditors would have been a lot worse off, would they not have been?

Mr. Hamilton: That's very possible, but it's a formula that Congress thought to place into effect and it's not--

Justice Ruth Bader Ginsburg: Well, why would -- why would the trustee be urging the possibility that it would be okay for her to file under Chapter 7, in which case the unsecured creditors would get very little, but it's not okay for her to use chapter 13 with a plan that would give the unsecured creditors substantial payments?

Mr. Hamilton: --Here, Justice Ginsburg, the reason is plain and simple, and that was I sought to enforce the rule of law in order to have the courts determine how the rules were supposed to be interpreted.

By my view, it seemed like that had she followed the rules maybe she would have gotten there, but the way she did it she can't.

It's kind of like driving a car.

You can't expect that a the car is going to perform well if you don't turn the engine on.

Justice Antonin Scalia: Can I--

Mr. Hamilton: And here she didn't turn the engine on.

Justice Antonin Scalia: --Can I come back to Justice Ginsburg's question about whether there would ever be the opportunity to adjust the confirmed plan?

Because as you say, the plan here would not have been confirmed, but that -- that isn't the case always.

I mean, in many cases a plan would be confirmed because the -- the bankrupt could -- could barely make the payments that it requires; and then when it -- it is clear that, because of the extraordinary event in the preceding 6 months, the bankrupt is -- is not going to have that -- that amount of money, there would be the opportunity to adjust.

Mr. Hamilton: Maybe not -- I'm sorry.

Justice Antonin Scalia: In other words, is your response to Justice Ginsburg "always", that it will always be the case that where there would be an adjustment under this theory, there would not have been a confirmation in the first place?

Mr. Hamilton: If the plan is not confirmable by an analysis of Schedules I and J, which are the income and expenses statutes, I am not going to recommend confirmation, and nor do I think any trustee would.

Any events that are in the equation before the date of confirmation would likely be then subject to 1327, the res judicata provisions of chapter 13.

So if the plan is confirmed, say in Stephanie Lanning's case, with these facts known, then she would not be able to come in afterwards and ask for the court to modify under 1329 because that's part of the confirmation order.

The other options that were available -- we discussed briefly the ability to file this as a Chapter 7.

She also could have converted this case to a Chapter 7 post-petition with the same result, or she could have dismissed this case and refiled.

Justice Ruth Bader Ginsburg: Isn't that -- wouldn't that amount to just a -- a waste of everybody's time, to dismiss it and then refile it, and then she gets a time period that doesn't -- why -- why not just drop out those 2 months that are not representative of her income?

Mr. Hamilton: Because, Justice Ginsburg, the statute does not permit that.

It's not within the formula, and that's the question: Is the formula binding or is it not binding?

If it is binding then this -- obviously.

Congress intended a more rule-bound statute.

It got that.

It was obvious that it intended to reduce judicial discretion, and the statute seems to accomplish that.

Justice Ruth Bader Ginsburg: But the thing is -- but you have explained, your number one solution for her is this 101 route, which is -- gives lots of discretion in the court.

Mr. Hamilton: Only in moving the 6-month period, Justice Ginsburg.

Justice Ruth Bader Ginsburg: Yes.

Mr. Hamilton: That would be the only discretion that the statute would appear to accord to the court.

Chief Justice John G. Roberts: Where is that, by the way, the provision that allows it to move the 6-month period?

Mr. Hamilton: It's in 101(10A) and it provides that the term 6-month period ending on -- and then we come to subsections (i), little (i) -- or (ii).

And those are -- that's the disjuncture; it's the 6-month period prior or some other time frame, and the language is important.

Justice Samuel Alito: What do you say about cases in which moving the 6-month period can't solve the problem?

For example, if the debtor had good income for many years going back, but then slight -- shortly before the filing of the plan loses his or her job, and there is no prospect that the debtor is going to get another job?

Or it could be the converse, has very low income for a long period and then right before gets a job.

So you are not going to be able to cure those problems by moving the 6-month period.

What do you do then?

Mr. Hamilton: Well, Justice Alito, I think I would tie in 1323 with respect to the first proposition, and that is if the debtor's circumstances have markedly changed, then the debtor has the ability to file an amended plan; and that amended plan could ask the court to move that time frame forward to a confirmation hearing that would take into account the drop in income.

With respect to the second part of your proposition, and that is an increase in income, then I as Chapter 13 trustee would have the ability to object to it on the basis of -- of good faith under either 1325(a)(3) or 1325(a)(7), either the plan or the filing of the case itself.

And those -- the filing of the 1325(a)(3) was the primary way in which all of these disputes were resolved before the 1984 amendments which brought in subsection (b) to 1325 which introduced the concept of disposable income.

Justice Sonia Sotomayor: How do you file an amended plan and have the court restart the clock, when 101(10A) says only if the debtor has not filed a schedule of current income?

If there's been a plan confirmed or a plan proposed, then the income schedule had to have been filed.

Mr. Hamilton: Those are--

Justice Sonia Sotomayor: You don't do one without the other.

Mr. Hamilton: --Those are two different propositions, Your Honor.

One is if the plan is confirmed and one if it is not confirmed.

If it is not confirmed, then you are correct; at some point the trustee and the court are going to want to see a Schedule I and J to see what the actual income and expenses are.

If the plan has already been confirmed, then the ability to change the plan has to be done under 1329, which is--

Justice Sonia Sotomayor: Forget about 1329.

I'm going to the situation where the plan has been proposed, let's say.

The courts -- if a schedule of income has been filed, then it's without any jurisdiction to change the 6-month lookback period, correct?

Mr. Hamilton: --I don't agree with the word "jurisdiction", Justice Sotomayor.

Justice Sonia Sotomayor: Well, it can't under 101(10A).

Mr. Hamilton: The debtor would certainly have the ability to ask the court to be excused from that requirement given a change in circumstances.

But again it would be the formula that would be honored, rather than the court substituting judicial discretion.

If there--

Justice Antonin Scalia: Can I ask -- yes, there is one more question.

Mr. Hamilton: --Okay.

Justice Antonin Scalia: Can I ask whether 1323, which you have now invoked, does not provide the same kind of discretion to the court that you are objecting to?

What -- what standards are there for granting or not granting modification of the plan?

Is it pretty much up to the judge?

Mr. Hamilton: No.

I believe again the court is bound, Justice Scalia, by the 101(10A) formula.

It's obvious that Congress intended the formula.

It would not make much sense to read the statute to have some other formula.

Justice Antonin Scalia: Well, then -- then -- okay.

You are between a rock and a hard place.

Either 1323 gets you out of that formula, which is what you've said, it's one way out, or it isn't.

Which is it?

Mr. Hamilton: I haven't said that it gets me out of the formula.

It gets me out of the time frame issue, because certainly the statute doesn't take into specific account what happens if the debtor loses a job, say, post-petition?

Obviously -- example, husband loses the job at Goodyear after the bankruptcy petition is filed.

And I think 1323 is broad enough to allow an amendment which would involve only moving the time frame.

Justice Antonin Scalia: Okay.

So any -- any amendment has to relate to a period--

Mr. Hamilton: I believe so, Justice Scalia.

Justice Antonin Scalia: --subsequent to the filing.

Mr. Hamilton: If there are no other questions I would like to reserve the remainder of my time, Chief Justice Roberts.

Chief Justice John G. Roberts: Thank you, counsel.

Mr. Goldstein.

ORAL ARGUMENT OF THOMAS C. GOLDSTEIN ON BEHALF OF THE RESPONDENT

Mr. Goldstein: Mr. Chief Justice, and may it please the Court:

The Court, I think, has the parties' arguments very well in hand.

I think the -- the one point that I can hopefully address, and it is I think the hardest part of our case, is to address the issue that Justice Alito raised, and that is, is there an anomaly in the fact that in BAPCPA Congress added the 6-month period, which would suggest perhaps that Congress was trying to lock in a particular period that we would look at.

And the answer to that question is no, and I want to take you to the relevant statutory provisions.

Everything is going to be in the cert petition.

I am going to start in the petition appendix at 91, which is 1325, which is the operative provision here.

And 1325(b)(1) tells us that if the trustee or a creditor objects, then as of the effective date of the plan it's only going to be confirmed in subsection (b), which is the third full paragraph on page 91 is going to control.

The plan has to provide that all of the debtor's projected disposable income to be received in the applicable commitment period beginning on the date the first payment is due under the plan will be applied to make payments to unsecured creditors under the plan.

And the thing to note first about that provision is that it, too, sets a timetable.

It's not just projected disposable income, but it's projected disposable income of a very particular type, to be received in the applicable commitment period.

So unless there is something particularly strange about the definition of "disposable income", Congress specified a period that the income is going to be measured in, and that's over the course of the plan; the word "projected" tells us to get a realistic estimation of what that amount of money's going to be.

Now, my friend makes the point that disposable income after BAPCPA is a defined term; the definition comes in the next paragraph; it's subsection (2), 1325(b)(2).

For purposes of this subsection the term "disposable income" means current monthly income received by the debtor subject to some deductions and then the expenses.

So then we have to go to the definition of "current monthly income".

Current monthly income is in 101; it's at page 83.

That's where we get the 6-month period.

And it tells us that current monthly income is the average monthly income from all sources, so it's very encompassing, without regard to whether such income is taxable income derived during the 6-month period.

So, my friend's argument is that, well, Congress said 6 months.

The answer to that point is a couple fold.

First, as was suggested in the first half-hour, Congress was addressing a very specific problem there.

Before BAPCPA courts didn't know what the -- didn't agree on what the baseline was for determining someone's income.

Some courts would say, all right, you are a Chapter 13 debtor, right away I'm going to look at the latest month.

Some courts said 6 months.

We have a court in our brief that said 4 years.

So, we have to have a starting point to project from.

But the second point is that this term 13 term at all.

So, my friend's argument is that Congress stuck this 6-month period into Chapter 13, so it would be very anomalous if we could just -- in effect, he says we are throwing it out, we are giving the district judges discretion.

It's not quite right.

The place to look is in section 707, which is two pages later.

707 is a Chapter 7 provision.

And my friend started out by saying the problem with our position is that we were not following the Chapter 7 means test.

That's the key.

This term is really a -- borrowed from Chapter 7.

So 707(b)(2)(A)(i) is at the beginning of page 85 of the appendix.

And, so, we are in a Chapter 7 case here.

And this is the means test.

It tells us that: 1> ["], so we are trying to figure out if there is a presumption of abuse under Chapter 7 --

"whether the granting of relief would be an abuse of the provisions of this chapter, the court shall presume abuse exists if the debtor's current monthly income, reduced by the amounts determined under clauses 2, 3, and 4. "

--those are expense clauses --

"and multiplied by 60 is not less than. "

a certain amount.

So what happened is Congress in BAPCPA created this presumption of abuse in Chapter 7 and it then borrowed that concept, as my friend pointed out, in Chapter 13.

So that 6-month period has real force and effect in the Bankruptcy Code in Chapter 7.

So it's not like Congress in Chapter 13 fixed the 6-month period, which would give -- have a sort of a gravitational pull.

You wouldn't want to throw that out too lightly.

Justice Sotomayor, I do agree that we ought to be pretty -- we ought to stick to it.

It indicates Congress is concerned with the 6-month period.

But it's not like Congress added to Chapter 13 this 6-month concept.

It added it to Chapter 7, where it's in full force and effect.

Can I make one other point about that language, just to repeat it again?

Justice Antonin Scalia: You -- you -- you have lost me.

Mr. Goldstein: --Okay.

Justice Antonin Scalia: Where is the 6-month--

Mr. Goldstein: Sure.

It's back.

We have to go back two pages.

Justice Antonin Scalia: --No, I got -- I got it there.

Mr. Goldstein: Okay.

Sure.

I'm sorry.

The term is "current monthly income".

So we are in Chapter 7, so four lines down.

"The court shall presume abuse exists if the debtor's current monthly income. "

--that's the 6 months, current monthly income.

That's the 6-month period of income.

Justice Antonin Scalia: I -- I -- I see.

I see.

Mr. Goldstein: See, that's mostly where it matters.

Then Congress borrowed it in Chapter 13.

But it didn't get rid of, as was pointed out before, the term -- "projected"; it didn't get rid of the period, the commitment period.

But I do want to point out something very particular about this language.

Here's the phrase:

"Current monthly income, reduced by the amounts determined under clauses 2, 3, and 4. "

--those are expenses -- 60> ["].

That's what my friend says the phrase

"projected disposable income to be received over the applicable commitment period is. "

Our point is that if Congress intended that mechanical formulation, it would have used the exact words that I have just read from you in Chapter 7, because that's mechanical.

Justice Anthony Kennedy: Without the word "projected"?

Mr. Goldstein: I'm sorry?

Justice Anthony Kennedy: Without the word "projected"?

Mr. Goldstein: That's exactly.

They used "multiplied".

And Congress did that several times in BAPCPA and before BAPCPA.

When Congress wanted, look, we are going to have a mathematical formula, it used a mathematical formula.

Chief Justice John G. Roberts: Why don't you follow his suggestion and just move the 6-month period, because the statute specifically grants that authority to the judge?

Mr. Goldstein: Sure.

Let me make a few points about that, sir.

So I'll again read the language again.

So we are on 83.

It says that -- little (ii) is going to be -- it's going to be

"6 months ending on the date on which current income is determined by the court for purposes of this title if the debtor does not file the schedule of current income. "

A couple OF points about that.

Justice Alito, you were right, this is a one-way prodebtor ratchet, right.

The creditor and the trustee, if the debtor a month before confirmation gets a new job or their expenses go down -- let's say you had a car, but you know that the car payments are going to be done.

Under the trustee's view, then you still get to count the car payments which are totally pretend, or if you got a much higher paying job.

In fact, in this case she did get a higher paying job.

Towards the end of the period, she got a raise.

And we say that has to be counted, too.

We have to have a debtor and creditor-neutral provision.

In a statute that's designed to make sure the debtor pays a much as possible to her creditors, it's very strange to put this entirely in the debtor's hands.

Justice Samuel Alito: Can I ask you this?

There seems to be at least a subtle difference between your position and the government's position.

You say that the projected disposable income will be different from the disposable income calculated during the lookback period when it is known or virtually certain that there will be differences in income or expenses.

And the government says that there is a difference when something is likely to occur in the future.

Where do you -- where do you get from the statute your known or virtually certain differences?

Mr. Goldstein: The contrast between 1325 and 1329.

What I tried to do in my brief, and I have laid it out at the beginning of the argument section.

That's where we try to articulate our rule.

What we have done is we have looked at the cases.

As you pointed out, this is pre-BAPCPA practice.

Courts have set a pretty high bar, both in terms of the level of certainty and the degree of deviation.

And courts have said -- I will give you an example that will illustrate the difference perhaps.

You have times when someone expects to get a raise.

They don't know that they are going to get it, or they expect to get a promotion.

And courts will say, even if that's pretty likely, until you have actually got it we are not going to count it for purposes of 1325(b); come back under 1329.

And we point out in our merits brief that in fact, it's not quite on point, but she got a settlement post-confirmation here, and under 1329 that money was applied.

So, Justice Scalia, there are post-confirmation events, but if you know ahead of time -- and this case is a perfect example, it -- we know she is not going to get another buyout from Payless Shoe Stores.

When it's known or virtually certain, we think that is sufficient -- akin to Justice Sotomayor's point about, you know, making it hard.

Let me make one other point.

I wanted to finish off my answer to the Chief Justice about 101.

This provision has taken on greater significance in the oral argument and the reply brief of the Petitioner.

I did want to point out to the Court a provision that is not reproduced in the parties' briefs, but if the Court were to go this route it would want to be aware of, and that's 521(i).

And 521(i) tells us that you do have to file the forms at the beginning or you have to file them within 45 days, but upon request of the debtor made within 45 days after the date of filing the petition, the court may allow the debtor an additional period of not to exceed 45 days.

So it does seem to constrain the power of the bankruptcy court to shift this period all around.

So, I have made two points.

One is it's a one-way ratchet for the debtor; second, it's not unlimited.

The third is it just doesn't make any sense.

Why would Congress design a system that would have all of these machinations.

If we agree that Congress wants -- it seems my friend and I agree that Congress believes that she shouldn't have to make the payments that would be required under the trustee's reading of "projected disposable income".

The question is how we get there.

The trustee's answer is that you are required by the text; I'm sorry, Congress took this option away.

And I think that, as I have explained, the term

"projected disposable income to be received in the applicable commitment period. "

really is not language that you would ordinarily construe to ignore changes that--

Chief Justice John G. Roberts: Well, I think -- I think that's exactly right when you look at term "projected disposable income".

Mr. Goldstein: --Yes.

Chief Justice John G. Roberts: But if you look as "disposable income"--

Mr. Goldstein: Yes.

Chief Justice John G. Roberts: --as a defined term and then add "projected", I think it's a different -- different -- different argument, different kettle of fish.

I mean, because particularly in a statute intended to restrict discretion, it's a way to do it.

You look at it in the abstract, "projected disposable income", it doesn't achieve that objective.

Mr. Goldstein: And that is exactly, Mr. Chief Justice, why I started with the definition of

"current monthly income in the 6-month period. "

I agree that it is an important point.

It is their strongest argument.

My only point is that I have explained, I think, why Congress put the 6-month period in for purposes of Chapter 7 and also to have the starting point.

If I -- to give you an example, take inflation.

If we were to define inflation as the amount in the rise in prices over the previous 6 months, if Congress did that in a statute and then told us to look at projected inflation, we would still not ignore things that will tell us that there are going to be -- there has been an oil price spike or an increase in health care costs.

It would take a pretty firm, firm period that told us to only look into the past and not look into the future, particularly when the whole point of the statute is to make sure that the money goes into the creditor's hands that the debtor is able to pay.

On the point of discretion, I should also say BAPCPA as a whole was intended to reduce discretion.

And, so, it's kind of odd to say that the answer to our position is to turn to all of these other discretionary provisions--

Chief Justice John G. Roberts: What if you -- you wanted to achieve your friend's result and you had a definition of disposable income, and you wanted the court to -- you don't want to say project that forward, what -- what word would be more natural than saying projected?

Mr. Goldstein: --I -- I -- I would use the language that Congress did in 707.

Remember, the current monthly income reduced by the amounts determined under clauses 2, 3, and 4 and multiplied by 60.

Chief Justice John G. Roberts: No, that's altering disposable income -- the definition of disposable income.

I'm asking isn't the most natural word to achieve your friend's result to use projected.

What other word would you say when you say this is the period you look at and you want to take it forward?

Mr. Goldstein: Multiply.

And Congress did that a bunch of times.

Projected -- if we try to project something, we try and make the -- and everybody agrees on the definition, so really, it's not an unusual term.

It is: You make your best estimate of the future based on the data you have now.

My friend is right.

One piece of data we have now is her previous 6 months' income.

Another piece of data is we know that she's not going to have the same income in the future.

If there are no further questions.

Chief Justice John G. Roberts: Thank you, Counsel.

Ms. Harrington.

ORAL ARGUMENT OF SARAH HARRINGTON ON BEHALF OF THE UNITED STATES, AS AMICUS CURIAE, SUPPORTING RESPONDENT

Ms Harrington: Mr. Chief Justice, and may it please the Court:

In bankruptcy, as in many areas of the law, Congress has tried to balance on the one hand, doing case-specific justice, and on the other hand, ensuring that the statutory scheme is administrable.

Now, Congress certainly could have chosen to elevate simplicity over accuracy by telling bankruptcy courts to take a debtor's current disposable income and multiply that number by the number of months in the plan in assessing whether the plan is confirmable.

But there are several strong signals in the code that that is actually not what Congress intended courts to do.

Justice Samuel Alito: But do you think bankruptcy courts are supposed to be economic forecasters?

For example, if you -- after calculating the debtor's income during the 6-month period, the 6-month lookback period, should the bankruptcy court said, well -- say: Well, it's -- inflation is projected to be such-and-such over the term of this plan, so I am just going to increase it by the amount of inflation; or: This person works in a particular industry where historically, over the last five years or ten years, there's been a 3 percent increase in salary per year, so I'm going to multiply it by -- multiply the disposable income figure like that?

Ms Harrington: Certainly not, Justice Alito.

Bankruptcy--

Justice Samuel Alito: Well, why not?

You say that the bankruptcy courts should take into account things that are likely to occur in the future.

Ms Harrington: --Well, bankruptcy courts -- we are not saying that bankruptcy courts should ever speculate about what might happen in the future.

What we are saying is that bankruptcy courts should take into account what they know, in this case, already has happened, but also what they know will happen.

And so to give an example of a change that would benefit creditors, if as -- as I mentioned earlier, if a debtor has secured a higher-paying job just before or just after she filed her petition, a Court should be able to take into account the fact that her income going forward would be greater than would be reflected in the calculation of her current disposable income.

Justice Antonin Scalia: Well, "know will happen" is quite different from "likely to happen", and I thought your test was likely to happen.

Ms Harrington: Well, likely to happen based on what you know now.

I think -- we haven't suggested a particular burden of proof.

I think--

Justice Antonin Scalia: Not -- not likely, based on what you know.

Well, that's quite different from you know it will happen.

Ms Harrington: --Right.

So there is an example mentioned earlier: If the debtor is repaying a loan to her 401(k) program, that is the type of loan that can't be extended time-wise.

And so she will keep making those payments, which will be deducted as an expense in the calculation of her current disposable income, but -- but you know at a certain point, she is likely to stop making those payments.

Justice Antonin Scalia: Is there a difference between your test and the Respondent's test?

Ms Harrington: Not according to what I heard Mr. Goldstein say at the argument.

Again, we do not mean to suggest that a court should use--

Justice Sonia Sotomayor: His words were "known to a virtual certainty", which are -- likely to happen is different than likely to happen.

Ms Harrington: --I think, in part, it depends on what type of change you are talking about.

Again, we would never say that a court should speculate about what should happen.

But, for instance, to take another example on the expense side, if a debtor when she proposes her plan owns a second home, a vacation home that is secured by a mortgage, then that secured debt payment is an expense that would be deducted from her income in the calculation of her current disposable income.

But if she proposes to surrender that property as a condition of her plan, she will no longer have that debt payment going forward.

And so that's the type of -- so it will no longer be an expense going forward.

Under Petitioner's view, a court would not be able to take into account the fact that that current expense--

Justice Antonin Scalia: That's -- that's "know will happen".

That is "know will happen".

But I don't know how you can, at one and the same time, say: Courts shall not speculate, and then say that the test is "likely to happen".

Ms Harrington: --Well, again, in this--

Justice Antonin Scalia: I mean, to -- you know, to look forward and say: Is it likely or not likely?

That's speculation.

I don't know a better definition of speculation, to tell you the truth.

Ms Harrington: --Okay.

But then, we wouldn't -- we are not trying to advance that view of "likely".

And again, in this case the change had already occurred, so there is no uncertainty about what her situation is now and what we can project it to be going forward.

Chief Justice John G. Roberts: It seems to me that, particularly since you are adopting a fairly broad -- well, depending on how broad a theory you are adopting of what's projected and what's not, that you are taking into account a lot of things that are more properly taken into account when it comes to whether the plan should be confirmed or not.

Ms Harrington: Well, this is--

Chief Justice John G. Roberts: What's going to happen?

What's the situation going to be?

What should, you know, the creditors get?

What should the debtor get?

There is no reason to kind of shoehorn those into the projected disposable income.

Ms Harrington: --Well, except that if the creditor or a trustee objects, then the calculation of projected disposable income is one of the conditions of confirmability of the plan.

The court can't confirm it unless it can--

Chief Justice John G. Roberts: Well, is that -- I mean, let's say your friend wins up to the point and somebody else, when it gets to confirmation, can say: Well, look, you know, there was this big payout before the filing.

So don't confirm it.

We know she has got all this -- all this other money.

That -- it could do it that way, couldn't it?

Ms Harrington: --I'm sorry, if she got a higher-paying job just before?

Is that what you're suggesting?

Chief Justice John G. Roberts: Well, whatever the situation is, can't that be taken into account when it comes to confirmation?

Ms Harrington: Well, it could affect the -- well, one thing that is important to note that hasn't been brought up is under Section 1325(a)(6), the court is actually -- which is the feasibility provision -- the Court is actually required to think about what is going to happen in the future, whether a debtor is going to be able to repay her creditors.

And so it doesn't make very much sense to, on the one hand, require a court to consider what it knows will happen in the future in determining feasibility, and then on the other hand, if there's an objection by the creditor or the trustee and 1325(b) comes into play, to prohibit a court from considering the same facts it knows about what is going to happen in the future--

Justice Samuel Alito: What if the debtor is a waiter and during the last month of the 6-month period, because of some change of the economy the waiter's tips have gone up either way up or way down?

What's the court supposed to do then?

Ms Harrington: --Well, I think one purpose of having the 6-month lookback period in the calculation of current income is exactly to take into account those situations.

There are many people who are gainfully employed full time, but whose -- whose income fluctuates over time.

And so requiring that courts use the 6-month lookback period, I think, gives creditors a better sense of whether the current income figure provided by the debtor is accurate.

It reduces the chance for strategic filing because it sort of takes some of the significance away of the time of filing.

And so it seems fairer in that case to consider that 6-month average in a case where income fluctuates up and down as an accurate sense of what the -- what the debtor's current income is.

And again, in many -- in a significant number of cases the calculation of a current disposable income will be a good prediction of what the debtor's disposable income will be going forward.

Justice Ruth Bader Ginsburg: How do you deal with the Petitioner's -- the two arguments Petitioner makes?

One is that on the expense side, Congress provided for special circumstances, exceptions, and it didn't on the income side?

Ms Harrington: Well, the special circumstances exception comes in, in the calculation of the debtor's current disposable income, but it doesn't tell you what to do in terms of projecting that disposable income.

And so you can adjust what you think the current disposable income is based on an expense that isn't accounted for in the standard expenses or an expense that is accounted for, but is higher than is accounted for in those expenses.

But again, it doesn't tell you what to do -- how to project that number going forward.

Justice Ruth Bader Ginsburg: What about the argument that this is a simple thing; she didn't have to file the plan -- she didn't have to file the petition at a time when those two months would be in the 6-month lookback.

She could have waited.

Ms Harrington: Well, that is certainly true of this debtor, of the Respondent in this case.

That is not an option available to all debtors, many of whom are facing foreclosure proceedings or imminent foreclosure proceedings.

Delay is simply not an option.

And if I could address Section 101(10A)(A)(ii) option that the Petitioner offers -- I mean, one thing to note is it doesn't give the Court the discretion to set any other -- to just pick any other 6-month lookback period.

They pick a date and go 6 months back from whatever that date is.

So if a change occurs very soon before the filing of the petition, it makes it very hard for a court to use that provision to change the lookback period because you would have to wait 6 months, essentially, after the filing of the petition to set it back.

But again, the biggest problem with using that section as a workaround is that that is an option that is available to debtors, but not to creditors.

If a debtor files a Chapter 13 petition along with all the Schedules that are required under Section 521 of the code, then the debtor has no option for -- excuse me, the creditor has no option and the trustee has no option--

Chief Justice John G. Roberts: Well, the creditor has the option of objecting the confirmation of the plan.

Ms Harrington: --They can object to confirmation of the plan, but on what -- what basis?

If the Petitioner argues that the calculation of projected disposable income is merely a mechanical multiplication of the current disposable income times 60 or 36, then they have no way of allowing the court to take account of a change that has happened just before or after the time of the petition that would inure to the creditor's benefit.

Chief Justice John G. Roberts: They can't say: I object because the 6-month period is unrepresentative because of this particular event?

Ms Harrington: They could say that, but it's not clear in the code that that is a basis for refusing to confirm a plan.

I think they would have to make the argument that--

Chief Justice John G. Roberts: Does the government have a position on that?

Ms Harrington: --I think unless there were bad faith it's not clear how that can be a basis for not confirming a plan, and that was the -- the reason that my friend on Petitioner's counsel suggested.

But again, it's not clear how that would be bad faith, if a debtor proposes a plan that -- that commits all of her projected disposable income under the trustee's view of what that number is, it's hard to see how you could say that that was a plan that was proposed in bad faith.

So again, I just want to -- just to respond to the -- the argument that the government in Respondent's view reads the 6-month period totally out of the code--

Chief Justice John G. Roberts: You can finish the sentence.

Ms Harrington: --Okay.

The calculation of a -- a debtor's current disposable income will often be a reliable predictor of her future disposable income and when that's the case, then a reliable way of projecting is simply be multiplying.

Chief Justice John G. Roberts: Thank you, Ms. Harrington.

Ms Harrington: Thank you.

Chief Justice John G. Roberts: Mr. Hamilton, you have two minutes remaining.

REBUTTAL ARGUMENT OF JAN HAMILTON ON BEHALF OF THE PETITIONER

Mr. Hamilton: Thank you, Mr. Chief Justice.

First of all, I want to note that the plan is not confirmed in this case; this was an interlocutory appeal.

There is an amended order at the BAP level that allows it as an interlocutory appeal.

So the debtor still has preconfirmation options, rather than having to rely upon 1329 or something else in the record.

Secondly I want to point out that 1325 as has been suggested by Justice Ginsburg only incorporates a part of 707(b), and the part it doesn't incorporate is the special circumstances on the income side.

It only incorporates special circumstances on the expense side.

The significance of that is that what has been substituted for special circumstances on the income side is the 101(10A) formula minus certain expenses from 707(b).

The certain expenses from 707(b) are not a wild card.

They are IRS standards in certain other specially defined circumstances.

The idea that this would allow a phantom car payment -- no, we don't think so.

There is language in that section that says that the expenses have to be applicable and actual.

And one case recently decided in the Ninth Circuit, the Ransom case, says that.

You have to look at the language in 707(b) in order to determine the propriety of the expenses, which has nothing to do with the applicability of the 6-month time frame.

What the government and what the Respondent choose to do here is to basically gut the entire means test based upon one word, and that's "projected".

And they choose to use an undefined term "projected" over the statutory language that Congress chose to determine what debtors should pay to their creditors, and it's a congressional choice.

And as many commentators have suggested, if there is a remedy here, it is a congressional remedy and not a judicial remedy.

Thank you.

Chief Justice John G. Roberts: Thank you, counsel.

The case is submitted.

Featured:

Howard Delivery Service v. Zurich American Insurance Company - Oral Argument

Fri, 09 Jan 2009 14:48:59 +0000

Case:

Howard Delivery Service v. Zurich American Insurance Company

Media File:

05-128_20060321-argument.mp3

Related Transcript:

transcript.xml

Transcript:

Argument of Paul Farrell Strain

Chief Justice Roberts: We'll hear argument first today in 05-128, Howard Delivery Service v. Zurich American Insurance Company.

Mr. Strain.

Mr. Strain: Mr. Chief Justice, and may it please the Court--

We are hear about a bankruptcy priority, and bankruptcy priorities must be clearly granted by statute or they are not granted at all.

That's the first principle of bankruptcy law that this Court has laid down, that equal priority, that equal distribution is the first principle, and every priority is a deviation from that first principle, and therefore, they must be clearly set out in the statute.

This Court has been very clear over and over on those bedrock principles.

Applying them here, Zurich must demonstrate that its workers' comp insurance policy receivables are clearly included within the statutory phrase of 507(a)(4), contributions to an employee benefit plan arising from services rendered within 180 days.

Judge Niemeyer... Judge Niemeyer followed those principles, those bedrock principles of this Court.

The two concurring opinions below did not follow nor even mention those principles, and that led them to err, we... we submit.

Chief Justice Roberts: Can I get you to step back just... the presumption that you began with.

What... what's your strongest authority for that?

The first thing you cite in your brief is a dissenting opinion of two justices.

Mr. Strain: The strongest authority for that, Your Honor, is the opinion in Kothe, K, o, t, h, e, a 1930 opinion, followed by Nathanson, followed by Embassy Restaurant, and it is the--

Chief Justice Roberts: Nathanson is the... you cite the dissenting opinion for this proposition?

Mr. Strain: --No.

It is... Nathanson... the... the citation, the page citation, is to the majority... is to the majority opinion.

The principle is laid out in the majority opinion, Mr. Chief Justice.

And Nathanson majority opinion relied on Kothe, and Nathanson majority opinion was followed in 1959 by this Court in Embassy Restaurants, and followed in 1968 by this Court in Joint Industries Board also dealing with bankruptcy priorities.

That is the bedrock principles in the... of the majority decisions of... of this case... of this Court.

And what we have here, Your Honor and members of the Court, is that a... an insurance policy... what we're talking about here is an insurance policy, and the statutory language refers to an employee benefit plan.

We don't even have a plan here.

We have a policy.

There's a citation in the Zurich brief at page 20 to this Court's opinion in Pegram v. Herdrich, which I think drives that point home.

It is an incomplete citation.

The omitted language from the Zurich is as follows.

From page--

Justice Scalia: Where... where is the unomitted language?

What... what page of the brief are you quoting from?

Mr. Strain: --It's on page 20, Your Honor, of Zurich.

Citing to page 223 from this Court's opinion in Pegram, the omitted language, which comes in the middle of the quotation given at page 20, is as follows.

Thus, when employers contract with an HMO to provide benefits to employees subject to ERISA, the provisions of documents that set up the HMO are not, as such, an ERISA claim.

Now, that is what our case is, an insurance policy that incorporates a duty to pay benefits subject to workers' comp laws of the different States.

So even under the citation in... the full citation in Pegram, it is seriously questionable whether this insurance policy is a plan at all.

The statute requires an employee benefit plan.

The... this Court requires that it be clear from the statute that this insurance policy is itself a plan.

Justice Scalia: Now, ERISA... ERISA makes it very clear that... that a plan to pay insurance for employee benefits, whether it's disability or retirement or whatever else, is an employee benefit plan and... and explicitly excludes workmen's comp because otherwise it would fall within that definition of an employee benefit plan.

Mr. Strain: I believe that is... is correct, Justice Scalia.

Justice Scalia: I know that's a different statute.

I'm not saying that the... that the definitions of that statute have to apply here, but the definitions of that statute at least demonstrate that it is a permissible use of the... of... of the term employee benefit plan.

Mr. Strain: I disagree with you, Justice Scalia--

Justice Scalia: All right.

Tell me why.

Mr. Strain: --to this... to this extent.

The definition of employee benefit plan under ERISA is in two parts, a section (a), which is a... which is a listing; and a section (b), which is incorporation of provisions of the Taft Hartley law.

And it's under the section (b), the incorporation of provisions of the Taft Hartley law, that workers' compensation comes in.

And, of course it is then excluded by... by ERISA.

But a... the ERISA definition does not demonstrate that a... an insurance policy is a plan.

This Court has dealt with the issue under ERISA of whether everything scheduled in ERISA is a plan or not.

In the Massachusetts v. Morash decision, this Court determined whether a vacation... unpaid vacation policy was a plan under the definition of ERISA, and this Court held that it was not.

So it is clear from this Court's precedent that whether or not something is listed in ERISA, even if it applied... in that case, ERISA applied; in this case it does not... even if it applied, would not qualify as a plan.

Justice Ginsburg: Would it... would it if the employer were self insured?

Can you be self insured for workers' comp?

Mr. Strain: The employer can be self insured for workers'--

Justice Ginsburg: Would that be a plan then?

Mr. Strain: --I think it would not, Your Honor, because the self insurance for workers' comp, as I understand them, what they normally do is, just as the Court referred to in that omitted section of the Pegram opinion, is it simply is... is an agreement that it will provide the necessary wherewithal and bonding to pay the benefits as specified, as they may change from time to time in a State statute.

There is none of the other things, as I understand it, that the Court dealt with in Pegram which would make it a plan that are present in either a workers' compensation insurance policy or a self insurance program, as is permitted and--

Justice Ginsburg: So it would be an employee benefit program, but not a plan.

Mr. Strain: --It would be, Your Honor, or in the case of our case, an employee benefit policy.

And I would like to pick up on that, if I may, because it is not--

Justice Scalia: Before you... before you go on, could you satisfy a curiosity of mine?

Maybe Mr. Verrilli should be the one I should ask this, but you must have your... your version of it.

How do you decide whether an insurance premium is for work that was done within the last 180 days?

How... how do you calculate it, whether that characteristic of the... of the statute is complied with?

Mr. Strain: --Your Honor, I don't know that there is any good way to do that, and I think that's one of the anomalies in trying to superimpose an insurance policy under the rubric of an employee benefit plan.

Now, premiums... premiums, of course, there is a... there is a mechanism--

Justice Scalia: Oh, if it said premiums due within the last 180 days, I could understand it--

Mr. Strain: --And there is a mechanism in the policy to determine the payment of premiums.

Justice Souter: But isn't... doesn't the mechanism take into account the number of employees who are on the rolls at any given time?

Mr. Strain: I believe it does, Your Honor.

Justice Souter: Well, if that's the case, then... then doesn't the premium that you're supposed to pay depend in... in... on the number of employees within the last 180 days, which in turn depends on their working in the last 180 days?

Mr. Strain: It is not understanding... and I may be mistaken because this policy was not placed in the record by Zurich.

It is not my understanding that that is how the policy premium calculations are made, Your Honor.

Now--

Justice Souter: Well, how... maybe you just don't know the answer.

Mr. Strain: --certainly, Justice Souter, you may be right, but we've checked the proof of claim filed by Zurich which started this off, and they did not attach the workers' compensation insurance policy to it.

So it is not in the record, and I simply don't know--

Justice Souter: So that's... that's really not an issue for us.

Mr. Strain: --Well, I... I will not say that it's not an issue, Your Honor.

It is... it is an issue--

Justice Souter: Well, if you want to make it an issue, you'd have to get the... the predicate in the record to do it, and... and we just don't have that.

Mr. Strain: --Well--

Justice Souter: We... we couldn't resolve that.

Justice Scalia: --Or else establish that there's no conceivable way that 180 days makes any sense.

Mr. Strain: --And... and I... I think that, as... as I hope may blend the answers to both questions.

I think that--

Justice Souter: Consider us together, yes.

Justice Scalia: We're together on this.

[Laughter]

Mr. Strain: --I... I think that is... I think that is where we... where we are.

We have a policy that was not placed in the record by the applicant for this priority.

We have our general knowledge of what workers' comp insurance policies are.

We have a statutory requirement which reads, a calculation with 180 days, which I suggest is an anomaly when we compare it to the statutory language.

Justice Kennedy: Is there anything in the statute which says how promptly the premiums have to be paid as it... to... to make it analogous, say, to withholding where you might have to pay every quarter on... by a certain day?

Does... does the statute regulate when and how promptly the premiums must be paid, or is that just all comprehended in the terms of the policy agreement?

Mr. Strain: Well... well, certainly the priority statute does not because the priority statute doesn't--

Justice Kennedy: No. I meant the State workmen's comp law.

Mr. Strain: --The State workers'... workers' comp law.

Your Honor, I... I don't know the answer.

I know that the State laws... I know that the State laws vary, and we have 10 different workers' comp laws that allude to or mention workers' comp insurance policies present just in this case.

So it may be that those statutes might provide some of the basis for an explanation, but I simply don't know the answer to that.

I did want to--

Justice Breyer: If you have an employer who says, I promise to give $200 a month per worker to a fund, which money will go to pay their health costs when they're sick, that's plainly covered.

Mr. Strain: --Yes, it is, Your Honor.

Justice Breyer: And now suppose it's exactly the same, but instead of his paying $200 a month, he pays $200 to an insurance company in return for a promise that they'll pay precisely the same amount to the employee if he gets sick.

In your view, that's not covered.

Mr. Strain: In our view... in our view, Your Honor... I... if... if I may, I think that the hypothetical you pose is not quite our case.

Justice Breyer: Of course.

It's not meant to be.

Mr. Strain: It... it--

Justice Breyer: I want to know how you are going to answer my hypothetical.

[Laughter]

Mr. Strain: --Your Honor, I... I think the... the focus of the answer should be on whether it is an employee benefit or not.

Justice Breyer: I'm not... I'm asking you--

Mr. Strain: Yes.

Justice Breyer: --to answer my hypothetical please.

If in fact... you didn't want me to repeat it?

Mr. Strain: No, no.

No, I--

Justice Breyer: Then what is the answer?

Mr. Strain: --I understand it, Your Honor.

Justice Breyer: In your view, is my hypothetical covered or not?

Mr. Strain: I... I think it is not, Your Honor.

Justice Breyer: It is not.

Mr. Strain: I think--

Justice Breyer: And therefore, if we accept your interpretation, then all those employers who, instead of contributing directly to health funds, instead buy insurance policies to do the same thing, will discover they do not have the advantage of the fifth priority.

Mr. Strain: --All right.

And now I see... now I see, Justice Breyer, I did misunderstand... misunderstand the facts.

Those facts clearly are covered.

They're... they're covered under--

Justice Breyer: Now, if they are covered... if they are covered, as I thought, then what is the difference whether the employer buys a policy whereby the insurance companies pays for their health benefit when they're sick or pays for their accident benefit when they have an accident at work?

Mr. Strain: --Your Honor, I think the difference are... are several.

Number one is what the employer is doing here is insuring itself against a claim that would otherwise be against the insurer.

That was not in your hypothetical, Your Honor.

That makes what we have here a policy for an employer benefit.

It is not an employee benefit.

Now, the... the employer is the insured.

Justice Scalia: The... the correlative hypothetical would be a plan such as Justice Breyer describes in which the employer has contracted to pay his employees $200 a month for when they're sick, and that's a contractual obligation of his, and then he buys insurance to cover that contractual obligation.

Mr. Strain: And--

Justice Scalia: You say that would be this case.

Mr. Strain: --That would be this case, Your Honor.

Justice Scalia: And you say that wouldn't be covered.

Mr. Strain: And that would not be covered, and that would not be covered in great part because it is an employer benefit, employer choice, employer benefit.

And what we have in this case--

Justice Breyer: Well, that's... that's a better way to put it.

If... if that's right, then what you're saying, as I understand it, is in those cases where an employer goes to an insurance company, they give a contractual promise to pay the employee when he gets sick in return for a premium by the employer... and it's a health benefit or a vacation benefit, the most typical thing... you're saying all those... all those... there's no fifth priority.

They don't... can't take advantage of that.

Mr. Strain: --No.

Your Honor, what... what I'm saying is and what we have here, if what you're describing, if I understand it correctly, is a normal fringe benefit.

That is, an employer agrees to take out a... to contribute to a pension fund for the benefit of the employees.

That is clearly covered.

That was the kind of thing dealt with in Embassy Restaurant and the Joint Industries Board that (a)(4) was intended to supplant or overrule.

Justice Ginsburg: And why did--

Chief Justice Roberts: And that's clearly covered.

Justice Ginsburg: --why did you answer Justice Scalia's question as you did?

That is also an employee benefit, that is, vacation, sickness.

Mr. Strain: Your Honor, I answered that because, as Justice Scalia changed the hypothetical, it was not an employee benefit.

It was the employer insuring itself, buying an annuity or, like we have here, insuring itself, so it... so it could make the payments.

What we have here, Your Honor, is a situation where, as is admitted in the record, the employees don't benefit at all.

As Zurich has admitted in this record at page 17, the employees are in the same position whether there is insurance or no insurance.

In fact, the irony here is that if Zurich prevails, not only do the employees not benefit, they are harmed because there are in the (a)(4)... the (a)(4) priority claimants are a total of 1.6 million, including the 400,000 of Zurich.

All the others are health and welfare funds such as Justice Breyer was... was posing.

Zurich is not.

But what happens... and there's not enough money to pay everyone.

What happens is if the Zurich Insurance Company receivable gets an equal priority with the health and welfare funds, then there is a dilution of the money going for the employees' health and welfare and pension, a 25 percent, in this case, dilution of that money because the employer chose to insure itself for its liability, potential liability, to the employees.

The employer benefitted from that insurance.

In some States, it would be required to have the insurance.

In most States, it has the option of having insurance or not.

Justice Alito: Would the same thing happen under multi employer plans?

Would not the employees typically receive the benefits even if their employer did not make the contributions that it was required to make?

Mr. Strain: It would... they would typically... in a multi employer plan, as many of our priority claimants are here, because the money is spread, the employees still get some money.

But if we consider the greater whole, the money, the available res, the available pot, to play those... pay those employees is diminished.

So--

Justice Ginsburg: I thought there's also, isn't there, the Pension Benefit... even if there's no money in the till for the plan, isn't there a Government fund so that the worker would receive the benefit in any event if... I don't see the distinction that you're making based on whether the worker would get a benefit whether or not the employer made the contribution.

Mr. Strain: --Well, Your Honor, there certainly is... there certainly are... in most States at least, there certainly are funds that step in if a workers' comp insurer or an employer does not make... is not available to pay an award to a workers' comp injured... a worker who was injured on the job.

On the other... on the other hand, Your Honor, whether such funds exist to step in and supplant the payments not made to... in the ordinary health and welfare and pension context, I think not, Your Honor.

Justice Kennedy: Well, I recognize there are different schemes.

The only one I'm familiar with is my former State.

But did I understand from your answer that in some or many of these States, the employer is free not to have insurance?

He can be self funded?

Mr. Strain: Yes.

Yes, that's correct, Your Honor, in... in--

Justice Kennedy: And is there any requirement that there be an actual fund in place or is it just a general liability?

Mr. Strain: --Well, there is... there is... it is a... a traditional self insurance with the overlay.

That is, there... there must... there must be a showing of the wherewithal, but with the additional overlay, in all or virtually every State which permits this, of the requirement of a bond.

And that's--

Justice Kennedy: A bond.

Mr. Strain: --which is an interesting point because if Zurich prevails, we have the... the camel's nose is under the tent because in all the self insurance contexts, the bond issuer will have an equivalent claim to Zurich.

Under their broad reasoning or broad interpretation of the statute that should be considered narrowly... under the broad interpretation they want, that camel's nose would be under the tent, and the bond issuer would have an equivalent claim to Zurich on its policy.

To extend that a little further, what Zurich did here... was an insurance company... it required letters of credit of Howard Delivery, the debtor, to issue its policies.

It drew down those letters of credit $1.1 million.

F&M Bank, the letter of credit issuer, of course sought security from the debtor, but not enough.

As is commonly the situation once the liquidation is finished, there wasn't enough security.

So F&M, which had facilitated Zurich's workers' compensation insurance by its letters... letters of credit, would have an equivalent claim to Zurich as well.

So more and more of the camel is going under the tent.

This is a very broad interpretation with major implications that they seek and it is completely inappropriate under the bedrock principles of approaches to priorities under bankruptcy law.

Justice Kennedy: Well, if there were letters of credit, why is Zurich injured?

Because the letters of credit were not large enough to cover the premium liability?

Mr. Strain: They... they were not, Your Honor.

They were not.

Justice Ginsburg: Mr. Strain--

--Mr. Strain, you... you mentioned--

--in... in your brief, you seem to put considerable stress on something that I haven't heard you say one word about so far, and that is that these... workers' compensation is State mandated.

They're not negotiated or even employer determined benefits.

They are whatever the law prescribes.

And you haven't... haven't mentioned that, so I'm wondering where that fits into your picture.

Mr. Strain: It... I haven't mentioned it.

I'll take this opportunity to mention it, Justice Ginsburg, because it is a very important point.

We know that in the statute... (a)(4) we're talking about... section (a)(3)... these are numberings before 2005 amendment to the act.

The language stayed the same.

The numbers were... are different.

But there are two that work together.

The (a)(3) priority for wages for the employees and the--

Justice Scalia: Where does (a)(3) appear?

There... there was that discussion in your brief, and I'm darned if I could find (a)(3).

Mr. Strain: --Section (a)(3), Your Honor.

I'll refer you, if I may, to the brief of amicus at page 11, and that's why I mentioned, Your Honor, that there is a new numbering because the numbering in the amicus brief is using the 2005 numbering in the revised statute.

And what is listed there as (a)(4) is the wages priority, and at the next page, (a)(5) is the priority that we're talking about as... as (a)(4).

Justice Scalia: Well, it would have been nice to have it in your brief--

Mr. Strain: I agree.

Justice Scalia: --and numbered... numbered 3 instead of 4.

That would have helped a lot.

Mr. Strain: I... I certainly recognize that, Your Honor.

The... the provision of (a)(3) and (a)(4)... they work in tandem to protect the workers.

They share a cap.

The more a worker benefits from a wage priority, the less the worker benefits from the... from the employee benefit plan priority.

And so they work together; they work in tandem, which gives meaning to (a)(4) under many of the canons of construction that... that we're familiar with.

It would not work... it's an anomaly that an insurance company receivable would share the cap with the wages priority.

That is simply an anomaly.

And when we look to the legislative history, it is absolutely clear, Your Honor, that the fact of the judicial... the statutory mandate for workers' compensation insurance is very important because what is spoken about, as Judge Niemeyer pointed out in his dissent below... what is spoken about in the legislative history over and over again is a wage substitute or a wage surrogate that employers do not give... will lower the wages but provide fringe benefits.

So the package remains the same.

Now, that's not a workers' compensation insurance policy, but that is the wage surrogates that the Congress was looking at.

Justice Souter: Let... let me, if I may, ask you about other possible wage surrogates because what you're saying now seems to me to mesh with the argument, another legislative history argument, to the effect that the... the current provision was meant to overrule two prior cases of this Court.

And the... the question I have turns on the fact that the... the language is broader than what would merely have been necessary to overrule those cases.

So my question is if the broader language does not cover the premiums that we're concerned with here, what other items dealing with... with wage substitutes would it pick up, would it include?

Mr. Strain: Well, Your Honor, I... I would answer from... in part from the legislative history.

Some of the things discussed were joint apprentices and training programs, by way of example, as new forms of fringe benefits that some of the witnesses wished to see to ensure would be covered.

I think that sort of thing could be covered under... under this language as well.

We know from the legislative history... we know from the legislative history that there was absolutely no intention to incorporate the definition of ERISA, and we know from this Court's teaching in the decision in United States v. C&F Fabrication just 10 years ago that it is absolutely inappropriate to incorporate into the bankruptcy statute an ERISA definition where Congress does not provide.

That's an absolute square holding of this Court that exactly should lead to rejection of the effort by Zurich to incorporate... to ask the Court to engraft onto this statute a... a definition from another statute.

If there are no questions at... additional questions at this time, I would like to reserve my remaining time.

Argument of Donald B. Verrilli, Jr.

Chief Justice Roberts: Thank you, Mr. Strain.

Mr. Verrilli.

Mr. Verrilli Jr.: Thank you, Mr. Chief Justice, and may it please the Court--

I think it's important to focus at the outset on exactly what a workers' compensation plan provides.

A workers' compensation plan provides health insurance that pays for the medical costs of a workplace accident, disability insurance--

Justice Scalia: You're begging the question by calling it a plan.

I mean, that... that's... that's one of the issues here.

Why don't you tell us what workmen's compensation laws require?

Mr. Verrilli Jr.: --Well, I'd be happy to go right to the question of whether it's a plan, Justice Scalia, because I think it's indisputably a plan under this... under the dictionary definition, ordinary meaning of plan, this Court's interpretation of it in Pegram, under ERISA, under the Department of Labor's interpretation of it, and under plain common sense.

A plan is an arrangement or program or scheme, as Pegram said, to... established by an employer or an employee organization to secure the provision of benefits to an employee through insurance or otherwise.

Justice Ginsburg: Mr. Verrilli, there's no employer or employee, for that matter, who's doing the planning.

The planning is all done by the Government--

Mr. Verrilli Jr.: See, I... I--

Justice Ginsburg: --because what's covered is prescribed by law.

Mr. Verrilli Jr.: --I think there is a plan for this reason, Justice Ginsburg.

The... what the law prescribes is that which the employer must provide to the employees.

But it's not a self executing law.

The... the employer has got to make arrangements to ensure that the benefits are provided, and under the laws of the vast majority of the States, the employer has options for doing that.

The employer can contract with an insurance company to do it.

The employer can self insure to do it.

And by the way, Justice Kennedy, there are quite stringent requirements for fiscal solvency and there is a surety bond that needs to be posted in order to... in order to self insure.

Justice Ginsburg: But the it is not negotiable.

We think of a health plan, a retirement plan.

That doesn't have to be any set coverage.

It's negotiated or the employer, if it's not a collective bargaining situation, determines what the benefits will be.

Here, the law determines what the benefits will be.

Mr. Verrilli Jr.: I agree that that aspect of the arrangement is not negotiated, but there is nonetheless an arrangement that secures and guarantees the provisions of the benefits, and that's the plan.

There are steps that the employer has to take to secure the provision of the benefits, here through the purchase of insurance, and that is the plan.

The plan is the arrangement to secure the provision of benefits.

Certainly they are--

Chief Justice Roberts: So that if an employer decides to... because his employees have had a good year, he's going to put in a new parking lot for them... he... his plan is to have a contact with a paving company to pave the parking lot.

Are the payments under that contract contributions to an employee benefit plan?

Mr. Verrilli Jr.: --I don't think the answer to that question is yes, Mr. Chief Justice.

I think the answer is no.

I mean, I suppose you could say that those are... that's a benefit provided to employees, but--

Chief Justice Roberts: It seems like the consequence of your theory though--

Mr. Verrilli Jr.: --I don't think so.

I think there's a limiting principle here and I think the limiting principle is to look to ERISA.

ERISA has a set of... it defines what employee benefits are for ERISA purposes, and it's not... and it's not these benefits and similar things.

It's an exhaustive list of benefits.

The parking lot isn't on the list.

Similarly, a break room wouldn't be on the list.

None of those things are on the list, and therefore, I think by reference to ERISA, one can relatively easily exclude those--

Chief Justice Roberts: --But... but providing for workers' compensation through insurance, rather than through self insurance, is also not on the list.

Mr. Verrilli Jr.: --Well, I think both of them are on the list actually, Mr. Chief Justice, because both of those are programs or arrangements to secure the provision of benefits, and one is through insurance and the other through self... insurance.

So I think they're plans in both instances.

Justice Scalia: What's your answer to the 180 days' question I answered... I asked?

You know, the provision provides contributions.

It doesn't say just contributions to an employee benefit plan.

It says contributions to an employee benefit plan arising from services rendered, and then it goes on to say, but... but the services have to be within the last 180 days.

Mr. Verrilli Jr.: Right.

Justice Scalia: How do you square that with... with the purchase of block insurance like this?

Mr. Verrilli Jr.: Well, because the amounts that Zurich is seeking in premiums are the amounts that were due for providing coverage during the 180 days before Howard ceased operations, and the reason that arises from... it seems to me there are two ways in which that could arise from services rendered.

It can arise from services rendered to the employees in the following sense.

Howard has the obligation to provide those benefits by virtue of the fact that the employees are working for it during that period of time.

That's what Judge King said in his opinion in the Fourth Circuit, and that seems to me exactly right.

Alternatively... alternatively, as other courts have suggested, the... the services rendered--

Justice Scalia: But each of those insurance premiums that's paid by the employer doesn't just cover workers who worked for the last 180 days.

Each premium is divided among all the workers who've been working there for years.

Some of the premiums are going to go to... to allow the insurance company to pay in the future people who have been there for 20 years.

Mr. Verrilli Jr.: --Well--

Justice Scalia: I mean, it just seems to me it's a square peg in a round hole.

I... I don't see how you make sense out of that 180--

Mr. Verrilli Jr.: --I appreciate that, Justice Scalia, but I do think the... the obligation on the part of the employer to keep paying that premiums during that period arises from the fact that the employees are continuing to work during that period.

And what the... and what the insurance company is seeking to recover is merely the cost of providing the insurance during that period of 180 days which arises--

Justice Souter: If... if they don't pay the premium with respect to the 180 days, if there's an accident during the 180 days, the insurance doesn't cover the accident.

Mr. Verrilli Jr.: --That's an important point, Justice Souter, and I would like to focus on that and I... I hope correct something that the petitioners said.

With respect... it all depends on when the insurance policy cancels.

If there's nonpayment of premiums, then the insurance company has the right to cancel the policy, and there has... there's a notice provision, 10 days in some jurisdictions, up to 30 days in others.

But they have a right to cancel the policy.

If an injury occurs before cancellation, that injury is covered and it's covered for all time, even if the policy subsequently cancels.

But the key thing here, I think, the critical point is that without the priority, the... the insurance company is going to look at the situation and say, we have very little prospect of recovering if this company actually goes down the tubes and into bankruptcy as a general unsecured creditor.

Therefore, we need to get out of this situation fast.

And they... at that point, they're going to cancel the policy.

There's going to be much more of a hair trigger sense of the need to cancel policies.

When they cancel policies, the immediate consequence, of course, is that the... that the employees are no longer covered.

And then, the... it seems to me, the secondary consequence, which is also quite important--

Justice Scalia: --You really think that... that they cut it that fine?

They say, oh, yes, this guy is going to go into bankruptcy.

We're pretty sure about that, but don't worry.

We'll have priority.

Mr. Verrilli Jr.: --It's absolutely--

Justice Scalia: I think as soon as they smell bankruptcy, they're going to pull the plug anyway.

Mr. Verrilli Jr.: --That... I... I disagree with that, Justice Scalia.

I think in... in the real common practice here, the amount that they can recover and the amount that they think they have a prospect of recovering is a very important determinant in their decision on whether to hang in and how long to hang in until they get to the Chapter 11 process where the debtor can then husband its assets and can pay the workers' compensation premiums as an administrative claim.

So I think it's a... it's a significant determinant.

Without the priority, there's going to be a hair trigger, which means coverage is terminated sooner, and it's going to mean for many employers that they're going to have to go out of business because you can't operate without--

Justice Breyer: There... there are two parts in my mind to this.

The question is what is the difference between a workmen's... worker compensation and health benefits.

I agree with you, so far tentatively, that that difference can't lie in the nature of the contract providing the benefit.

Now, I know they'll want to argue the contrary, but put that to the side.

If it doesn't depend on that, it depends on the difference between workers' compensation and health benefits.

And you want to say there isn't enough of a difference there, though they argued the mandate makes a difference.

Of course, you could mandate health benefits too, and I don't think that would matter.

But if you're right, what about a... a long term contract for bottled water for the workers?

Mr. Verrilli Jr.: --I think my answer would be the same as to the Chief Justice that in some sense, I suppose you could say it's an employee benefit; in some sense, I suppose you could say that there's a contract to provide it.

But I think you can set the outer bounds here by reference to the employee benefits that ERISA defined as employee benefits.

But in any event--

Justice Breyer: Well, actually... this is... to me anyway, this is an important point because at some point you have to draw the line between the things of a kind that workers might bargain for and things not.

Now, if that's where we're getting there, the history of workers' compensation may cut the other way.

Mr. Verrilli Jr.: --Well, I don't... I don't think so, Justice Breyer--

Justice Breyer: Because?

What's... what's the principle I'm going to use?

Mr. Verrilli Jr.: --Well, first, if I can make a prefatory point, that the bottled water example doesn't distinguish the petitioners' position from our position.

The petitioners' position is that if it's a... if it's a negotiated for, bargained for benefit, it's in.

So I don't think that's a... it provides a limiting principle.

And it seems to me, wherever the line is--

Chief Justice Roberts: Well, sure, if they have a contract, as part of their... part of their contract, they get the bottled water, that's... that's easy to see why that's covered.

But the... the question is when it's not.

It's just something that the employer does in the course of his business that has... that benefits both his business and his workers.

Mr. Verrilli Jr.: --Right, but--

Justice Scalia: It has to be arising from services rendered.

I mean, it... it really has to be part of the contract with the employer--

Mr. Verrilli Jr.: --Well, I... I don't think that's right.

For example, in the... in the case of most voluntarily provided health insurance, the vast majority of employees in this country... it's not bargained for.

It's something an employer provides unilaterally--

Justice Ginsburg: But there's one feature of this that is... does make it different, at least one, and that is this is a benefit to the employer in the way that the others are not.

The employer... there's a tradeoff in workers' compensation.

It's not just I'm going to pay benefits when the person is injured, but I'm going to get off the hook for the tort liability that I might otherwise have.

And in the other cases of the other benefits, there is no... no such tradeoff.

Mr. Verrilli Jr.: --Well, the fact that there may be a benefit to the employer doesn't make it any less of an employee benefit.

The question is whether there is a plan that provides employee benefits, and the insurance coverage provided by workers' compensation are clearly employee benefits.

I also... and... and, of course, the with... with respect to that tradeoff, that's... that tradeoff is an employee benefit too, Justice Ginsburg, because the... the employee has no fault liability, gets paid promptly rather than have to sue and wait years, doesn't lose his or her job as a result of the injury or as a result of bringing the lawsuit.

So I don't think you can make the judgment that it's not an employee benefit plan on the basis of that fact.

And of course, voluntarily provided benefits also benefit the employer by making it a more attractive place to work and... and--

Justice Stevens: May I ask this question, Mr. Verrilli?

Mr. Verrilli Jr.: --better morale.

Justice Stevens: Can I... can I ask you... it goes back to the first point your opponent made.

What is the purpose of granting the priority?

It seems to me the purpose of the priority is to increase the likelihood that the wage claims will be paid.

And if you... if you win, it won't affect it one way or another, as you acknowledge in your brief.

But it seems to me the priority should serve the purpose of increasing the likelihood that the benefits would actually flow to the employee benefit plan.

Mr. Verrilli Jr.: I think there are four things I'd like to say in response to that, Justice Stevens.

First, there isn't a textual hook for... for that being a determinant, and it... and it--

Justice Stevens: Well, it talks about contributions to an employee benefit plan which one would not normally think of as paying insurance premiums.

Mr. Verrilli Jr.: --And the second think... well, I think to the contrary, Justice Stevens.

I think in the overwhelming majority of instances, the contributions employers make to employee benefit plans is the payment of insurance premiums to secure the benefits.

Collectively bargained benefits provided by union trusts are a small minority of the benefits that are provided to workers in this country.

But... but going back to the specific question, of course, as Justice Alito's question earlier suggested, in a multi employer pension plan situation, the plan is obligated by law to provide all vested pension benefits whether or not the employee's employer has defaulted on its payments into the fund.

So it's in exactly the same position as the insurance company is with respect to that set of benefits, and therefore, the argument doesn't draw a distinction between the two.

Justice Scalia: --Mr. Verrilli, what... what is your response to Mr. Strain's assertion that if you get a priority, so should the secondary insurer, that is, the... the bank that gave letters of credit?

They're just insuring... that... that's part of the plan too.

They couldn't have gotten the insurance from you unless they got the letters of... of credit from the bank, which is a kind of secondary insurance.

And also in the case of self insurance, which is something of a plan... I... I guess you'd call it a plan... what about the... the person who puts up the bond?

That person is a kind of insurer, just as you are.

Do all of these people now... now get bumped up to the head of the line?

Mr. Verrilli Jr.: The answer is no.

The statute expressly covers this.

The last provision of section 507 says no subrogation, and those would be subrogation situations.

So the statute just expressly covers it.

They aren't... they don't get bumped in the line, period.

I don't think there's any dispute about that.

If I could, though, return to a... a point that--

Justice Scalia: Where... where does that appear?

Mr. Verrilli Jr.: --I'm sorry.

I can't direct you to where it is--

Justice Scalia: Yes, because it's not in the briefs--

Mr. Verrilli Jr.: --I'm sorry, Justice Scalia.

Justice Scalia: --just... just as the contract isn't before us.

Mr. Verrilli Jr.: It should be in the briefs.

It's not, but that is what the last section of 507 says, that those who are subrogated to the rights of someone with a priority don't get the priority.

So that's just taken care of by the statute.

Justice Stevens: But if the payment of the premiums doesn't increase the likelihood that the employees will get the benefits, why should you get priority?

Mr. Verrilli Jr.: It does increase the likelihood, and it goes back to the example I was... I was discussing with Justice Souter earlier.

And... and what... it will not affect employees who are injured before cancellation, but it will accelerate cancellation.

And as a result of accelerating cancellation, employers who are injured after cancellation will not get the benefits.

And so it will--

Justice Kennedy: What... what about the... the example we discussed, payment of a bond premium if you're self insured?

Mr. Verrilli Jr.: --No.

I think that... I think, again, that last section of 507 takes care of that.

Justice Scalia: How do we know what you've just told us?

Is that in the record?

You're just assuring us what the content of the insurance contract is.

Right?

But we don't have the insurance contract.

Mr. Verrilli Jr.: The insurance contract is not in the record.

That's right, but the--

Justice Scalia: So we... we have your assurance that that's what happens here.

Mr. Verrilli Jr.: --As a systematic matter... it seems to me as a systematic matter, this is what insurance companies will do.

I don't think that's dependent actually, Justice Scalia, on... on the particular terms of this contract.

I'm saying as a systematic matter insurance companies--

Justice Scalia: Well, it has to be that way?

I could write a contract differently.

Mr. Verrilli Jr.: --Well... well, sure, but the contracts comply with State law.

State law sets notice period for cancellation, 10 days minimum, up to 30 days.

We've cited those in our briefs.

And so in most States and in many States here, within as few as 10 days after nonpayment, you can cancel.

Justice Scalia: That's a--

Justice Ginsburg: Mr. Verrilli, before--

Justice Kennedy: But I was... can... can I... I still don't quite understand the answer to the bond premium question.

Mr. Verrilli Jr.: Well, that... there would be no priority there because that would be... that would be a subrogated claim, and the last section of section of... the last provision of section 507 says if you're subrogated to a--

Justice Kennedy: No.

No, it wouldn't be subrogated.

The bond premium... the bonding company says we're entitled to priority.

Mr. Verrilli Jr.: --Well, I don't think--

Justice Kennedy: And it files the claim directly with the bankruptcy.

Mr. Verrilli Jr.: --I don't think that would be a claim for contribution to the plan, Your Honor, in the same sense that we're talking about here.

The... if I... if I could--

Chief Justice Roberts: You couldn't have the plan without the bond, just as here you wouldn't have a plan without the insurance policy.

It's just a different way of paying for the same thing.

Mr. Verrilli Jr.: --Well, I'm... I think there's an order of... there's another order of degree of removal, and it would make it a harder question, I suppose, as to whether there would be a... whether there would be a claim for priority in that context.

But I think, if I could, Mr. Chief Justice, I'd like to return to the question of narrow construction where we started the argument.

Justice Ginsburg: --May I detract you just for a moment?

On... on a question of the statutory history, correct me if I'm wrong, but originally, 1934, the kind of claim that you have would be a seventh priority claim.

And then in '38, Congress said no priority at all covering workers' compensation.

And then when Congress restored a priority, it ratcheted it up to four or five, depending upon which version of the statute we use.

Is there any explanation why, when Congress originally assigned first a very low priority and then no priority, suddenly it gets up to be on a par with the fringe benefits?

Mr. Verrilli Jr.: Yes.

I think there are two significant points there, Justice Ginsburg, in terms of the history.

First, in 1934 what Congress said was that workers' compensation could be a provable claim.

It then said it's... it gets the... the seventh priority, but the seventh priority was not a priority specific to workers' compensation.

It was a priority that's... it was a provision that said you get a priority if State law provides the priority.

In 1938, what Congress did was wipe out that provision for all State law granted priorities, not for workers' comp in specific.

So it doesn't seem to me it was a specific judgment about workers' comp and its place in the priority system.

And, of course, you didn't have the well developed system of employee benefit plans in the 1930's that you have now.

And what Congress did, when it enacted this provision in 1978, following closely after ERISA, was to use language which is identical to ERISA in providing a priority for employee benefit plans which, as ERISA on its face, I think, makes clear, would encompass workers' compensation plans.

Chief Justice Roberts: Mr. Verrilli, your... your friend's argument about the interrelation between (a)(3) and (a)(4) seems like a compelling one.

What is your answer to that?

Mr. Verrilli Jr.: I think the complete explanation for the relationship between (a)(3) and (a)(4) was that Congress was trying to expand the scope of the priority here without doing damage either to the wage priority above it, which... and... and there would have been damage to the wage priority above it if wages were simply redefined to include the broader set of employee benefits... or to the priorities below.

Congress just took the aggregate amount.

It seems to me just an elegant solution that protects the wage priority above, creates a new priority, and doesn't disadvantage any of the... any of the priority holders below.

And I really do think that's the complete explanation for the relationship between the two.

You really can't infer anything more than that.

But if I could just address the so called rule of narrow construction.

Certainly there is a sentence or two in Nathanson and Embassy Restaurant, but those were such clear cases of statutory construction that... that the rule of narrow construction, I submit, played no role there.

In many, many more cases in which this Court has interpreted the priority provisions of the act and the code, the Court has not mentioned this idea that there's a rule of narrow construction or that the principle of equality of distribution to creditors should trump everything else.

We've cited four in our brief, Lewis, Shropshire, Ricketts, and SBA v. McClellan, which by the way, expressly cut back on Nathanson.

But there are many more cases.

There's a whole line of tax priority cases culminating in the Reorganized CF&I Fabricators decision in which the courts adjudicated the question of... of the scope of the tax priority.

Most of the time, they find priority.

Occasionally they find no priority.

But in none of those cases is this so called rule of construction ever mentioned or the supposed primacy of the rule of equality of... of the principle of equality of distribution ever mentioned.

Chief Justice Roberts: Counsel, much of your case hinges on the assumption that Congress incorporated the ERISA definition into the bankruptcy code.

What... what is your strongest evidence for that?

Mr. Verrilli Jr.: Well, I think the fact that the phrase is identical to the phrase that appears in ERISA, employee benefit plan, is significant.

ERISA was one of the most substantial legislative accomplishments of that decade of the 1970's.

And so I think the mere fact that the exact same language appears in both places, importantly, however, with... without the limiting qualification in section 507(a)(4) that exists in ERISA itself with respect to workers' compensation plans.

I also think that if the Court does look at the legislative history, what... what one learns from the legislative history is that when the bill was originally introduced to... to create this priority, it created a priority for... proposed to create a priority for pensions, insurance, and similar employee benefit plans.

The union representatives came in to Congress and said that's too narrow.

We need something significantly broader to ensure that the full range of employee benefits is protected and granted this priority.

What the union representatives all urged Congress to do was to adopt the ERISA definition wholesale.

Now, we don't have anything in the... in the House or Senate report saying that's what we did.

In other words, we intended to adopted ERISA wholesale, but we do know that is what, in fact, they did.

They used exactly the language from ERISA and they moved it into the priority in section 507.

Justice Stevens: To follow up on the earlier question of the Chief Justice, by whom do you understand the services have to be rendered within the meaning of the act?

Mr. Verrilli Jr.: Well, I think that the... I think that the statute could be read--

Justice Stevens: Does it refer to the... the bankrupt's employees or your employees?

Mr. Verrilli Jr.: --It could be the... it could be either, it seems to me, Justice Stevens.

Justice Stevens: You think it could be either.

Mr. Verrilli Jr.: And I... but I don't think it matters in this case because you get to the same answer either way.

If it's the services rendered of the employees, the... the claim is for contributions to... for the cost of providing insurance to those employees during the 180 days.

If it's the services rendered... the provision of services during the 180 days--

Justice Scalia: --But it's not just to those.

It's to a lot of other people.

I mean, that's--

Mr. Verrilli Jr.: --But it... but it arises from.

The... had... I think it arises from in this sense, Justice Scalia.

Had Howard shut down on a certain day and didn't have employees anymore, it wouldn't have any continuing obligation to or need to pay workers' compensation premiums because there would be no workers to cover.

And so it arises from--

Justice Scalia: --Well, except the workers who had already been injured in the past--

Mr. Verrilli Jr.: --Right, but you don't need--

Justice Scalia: --and... and whom you continue to pay.

Right?

Mr. Verrilli Jr.: --But... yes.

But not... but... but we... let's see.

I think that maybe this will clear up the confusion.

We continue to pay for them even after the policy is over--

Justice Scalia: Right.

Mr. Verrilli Jr.: --and... but... and so--

Justice Scalia: And I assume that each of your premiums takes into account the fact that you're not only going to be paying for people, you know, who were injured between the last premium and now, but that you're also going to be paying for people who were injured a long time ago.

Mr. Verrilli Jr.: --Well, depending on the kind of policy, that may be true to some extent.

Sometimes policies are loss sensitive policies in which the amounts owed are calculated very carefully with respect to the amounts actually of loss incurred during the period.

That is, in fact, the case here.

If you have an understanding of insurance, you can infer that from the charts that are included in the joint appendix, although I acknowledge it's very difficult to do so.

So I do think... I do think on any common sense understanding of the... of the phrase, arising from, which is a capacious phrase, it really does arise from.

But in terms of... I think, Justice Stevens, with respect to your question, to get to the same answer, in terms of calculating the amount of the claim, whichever one you pick here, there's actually a division of authority in the lower courts.

There's a Fourth Circuit opinion by Judge Luttig, saying it's services rendered by the insurance company.

Other courts say services rendered the employees.

Since it doesn't make a difference in this case, I would respectfully suggest probably it ought not to be decided in this case because you get to the same place either way.

I do... I do think that it's important also... I'm sorry.

Excuse me.

If I may just go back to the narrow construction rule.

The... the point of this idea of primacy of equality of distribution.

Equality of distribution is an important policy under the bankruptcy code, but it's only one important policy under the bankruptcy code.

Rehabilitation of the debtor is an important policy under the code.

The maximizing the value of the estate is an important policy under the code, and specific code provisions advance other specific policies as well.

So in any given case, as here, all of those copolicies aren't going to align and point in the same direction.

Sometimes they're going to be at cross purposes.

And what... what the Court said in Union Bank, in I think a closely analogous context interpreting the ordinary course exemption from... from the preference rule, was that we don't put a thumb on the scale either way here.

We don't assume that one of these policies is more important than the other.

What we assume is that Congress struck the balance between the potentially competing policies, that the balance is reflected in the text of the statute that Congress enacted, and that we should interpret the text as it's written without... without a presumption in either direction.

I really think Union Bank is highly instructive on that, and it's just... it's just right and plain common sense.

And that's why I think in the vast majority of cases, there is no rule of narrow construction.

Justice Ginsburg: What is... what is unemployment compensation?

Those two I think of as those are law mandated coverage that every employer must have, workers' comp and unemployment.

If there was unemployment, is that a plan too?

Mr. Verrilli Jr.: No, because the employer doesn't have the obligation to provide unemployment compensation.

That's a State run system in which the State has the obligation to provide the benefit, and the State does in fact provide the benefit.

It's usually funded through a tax.

The key difference is this is an employer obligation to provide these benefits, and I think that's why this is an employee benefit plan.

The employer is obligated to provide it to employees by virtue of the fact that the employees are working for the employer.

Not true about unemployment compensation.

In conclusion, if I could just focus on the... the point that it really is the case that enforcing this priority, as it is written, will advance the purposes for which Congress included it in the code.

It will protect the interests of workers, millions of whom have no employee benefit plan other than workers' compensation, because it will increase the prospects that that money is there to pay workers' compensation claims.

It will also advance the code's purpose of better rehabilitation because it will give insurance companies a reason not to pull the hair trigger, to hang in there with these companies, and to allow them to have a chance rehabilitate rather than forcing them into liquidation by canceling coverage which the law allows.

Thank you.

Rebuttal of Paul Farrell Strain

Chief Justice Roberts: Thank you, Mr. Verrilli.

Mr. Strain, you have 4 minutes remaining.

Mr. Strain: Thank you, Mr. Chief Justice.

This Court 10 years ago in United States v. Reorganized CF&I provided that... I suggest, that the engrafting of the ERISA definition into this bankruptcy statute was improper.

Almost word for word what we're asking the Court to find about this engrafting of the ERISA definition into the statute is dealt with in plain language in this Supreme Court decision.

It is simply improper to do that, and yet, that is the answer given by Zurich to the many probing hypotheticals about parking lots and bottled water and the rest.

Justice Breyer: Well, they're doing that to get a standard.

Mr. Strain: I'm sorry, Your Honor?

Justice Breyer: And I'd like to know what your... they're trying to use that as a basis for separating the bottled water from the workmen's comp from the health benefit.

And they're saying here's an example of where Congress put the workers' comp on the same side as the health benefit.

Now, that's their approach.

What's your approach to the standard?

What rule or system would you use from deciding which insured for or paid for benefits count as the plan and which ones don't?

Mr. Strain: What we look to, Justice Breyer, first of all, is whether it is a true wage substitute rather than a policy to take care of a nonnegotiable statutory requirement that's--

Justice Breyer: So if, in fact... if, in fact, the State legislature mandates certain health benefits, then the plan that provides those benefits would no longer qualify.

Mr. Strain: --That would be one significant factor to consider, Your Honor.

There are certainly others, but that would be one significant factor to consider.

That is true.

And I... I suggest to the Court that when we look to the legislative history, as the questions were asked about the legislative history, it is the void of any reference to the commission that recommended the law, the House report or the Senate report, or even one stray Congressperson suggesting that workers' comp insurance policies should get a priority.

Not one.

The industry didn't even put up a representative to make that suggestion at a hearing.

It is devoid of any support for putting this nose under the tent in the way they suggest, and it truly is a broadening.

It is not subrogation.

The bondholder would not have a subrogated claim.

F&M Bank would not have a subrogated claim.

They would have a claim, a direct claim, just as Zurich does here.

And I think that the issue we come back to... and I'm glad my brother ended with that as well because that's where we began.

The issue is what is the Court's proper approach to this attempt to enlarge the priority under subsection (a)(4).

It is not correct that this Court departs from the idea that priorities are a deviation from the bedrock principle of equality of... equality of distribution.

That remains good law, cited by this Court a number of times.

The cases they purportedly cite to the contrary were plain language cases, were Embassy Restaurant and Joint Industries Board.

This Court didn't even feel necessary to cite that principle because of the... because of the plain language.

Where is the plain language establishing clearly, as this Court requires, that this is a plan?

Where is the plain language establishing clearly that this is an employee benefit?

The insurance policy.

That's what we're talking about.

Not the workers' compensation statute.

The insurance policy may benefit the employer.

The statute may benefit the employee.

But we are talking about contributions to an employee benefit plan.

Zurich's insurance policy is neither.

Unless there are further questions, Mr. Chief Justice, that concludes my argument.

Chief Justice Roberts: Thank you, Mr. Strain.

Mr. Strain: Thank you.

Chief Justice Roberts: The case is submitted.

Attribution:

The Oyez Project

Featured:

Rousey v. Jacoway - Oral Argument

Fri, 09 Jan 2009 14:49:01 +0000

Case:

Rousey v. Jacoway

Media File:

03-1407_20041201-argument.mp3

Related Transcript:

transcript.xml

Transcript:

Argument of Pamela S. Karlan

Justice Stevens: We'll hear argument in the case of Rousey against Jacoway.

Ms. Karlan.

Ms Karlan: Thank you, Justice Stevens, and may it please the Court:

Yesterday in Koons Buick against Nigh, this Court emphasized once again that statutory interpretation is a holistic process based on common sense, that the reading of the statute should look at all the words to avoid a passing strange or an anomalous result when the text does not dictate it and the statutory history suggests otherwise.

Justice Scalia: That was a case I dissented in, wasn't it?

Ms Karlan: Yes, but actually, Justice Scalia, I think even you will find our case more appealing.

Justice Kennedy: Yes, but... but it is true you have a strong textual--

Ms Karlan: We have an excellent textual argument.

Justice Kennedy: --I was a little bit surprised at your opening because it seems to me you have a strong textual argument you're now defending.

Ms Karlan: We do.

A holistic reading of the text shows that section 522(d)(10)(E) of the Bankruptcy Code--

Justice Kennedy: What does a holistic reading mean?

Can you stay within the--

Ms Karlan: --Absolutely.

Justice Kennedy: --text and still be holistic?

Ms Karlan: I'm not going to look outside the text at all.

A holistic reading of section 522(d)(10)(E) of the Bankruptcy Code, which is on... in the petitioners' brief at pages 1 through 2--

Justice Stevens: What does the word holistic mean?

[Laughter]

Ms Karlan: --I think it means read all the words in the sense that makes the most sense to you rather than plucking words at random or rather than looking at a word artificially.

For example, when you look at a phrase like on account of in the Bankruptcy Code, as the Court did in North LaSalle, account means a lot of different things, but there it clearly meant because of, as it does in this statute.

Justice Kennedy: So the antonym would be parsimonious or something like that?

Ms Karlan: I think it'd be partial, but I'm not sure.

Justice Kennedy: Well, let... let me ask--

Ms Karlan: Sure.

Justice Kennedy: --ask you this.

The... the statute does say that the right to receive a payment is on account of age, and that seems to me to be an argument somewhat in respondent's favor because the... the payment has to be triggered by the age, if you read it that way, and it seems to me that's a fair way to read it.

Ms Karlan: Yes, and I think payments are triggered by age because section 522(d)(10)(e) is a statute eminently about the protection in bankruptcy of retirement payments.

For individuals--

Justice O'Connor: Well, the problem for the court below was that the person covered can ask for it in a lump sum and pay a penalty.

Justice Kennedy: Right, and that's not--

Justice O'Connor: And... and that isn't then on the basis of age.

Am I right?

Is that... that was the problem the court had below.

Ms Karlan: --Yes, that's the problem the court had below.

I think it's an illusory problem for the following reason.

It's clear that the right to receive full enjoyment of payments under an IRA does not attach until one of the triggering events occurs.

The trigger events are age 59 and a half, disability, illness, or for the estate, death.

And that's the right that we're talking about here, and that's why--

Justice Scalia: Well, when you say full enjoyment, you... you think when... when I'm taxed on something, I... I don't have full enjoyment of it?

The only thing triggered by age, as far as I can tell... the only thing triggered by age... is your obtaining of a tax benefit.

That's all.

Once you reach a certain age, you can withdraw it without... without paying the 10 percent tax.

Ms Karlan: --That's correct, but the 10 percent tax here is designed and does, in fact, operate as a deterrent and a penalty.

Justice Scalia: Well, I'm sure it does, but... but it's... it's hard to accept the notion that simply because after a certain age I get a tax benefit, I'm receiving the money on account of my age.

That doesn't make any sense to me.

Ms Karlan: Well, Justice Scalia, the way that I would view that is prior to 59 and a half, you pay a penalty.

And Congress put that penalty in there because the holistic sense, the full reading of section 522(d)(10)(e) is it is designed to protect retirement savings, replacement income of the elderly, the disabled, or ill people, once they get to the point where those triggering events, which are in 522(d)(10)(e), occur.

Those are the same triggering events--

Justice Ginsburg: Ms. Karlan, the... as long as this money was in the plan, it was shielded from bankruptcy, and there are... there was not unlimited access even with the penalty when it was in the plan.

One thing that I don't know and may be of some significance, did the Rouseys have a chance, even though they lost their employment, to keep their money in the plan where it would be shielded from bankruptcy or did they have to roll it over?

Ms Karlan: --Northrop Grumman's policy is to require individuals who leave the company's employment to roll their pension plans into an IRA.

The Rouseys tried to get work in Arkansas when they moved there.

Had they gotten a job there that they were able to keep, which they were unable to do because of their health, they could have rolled that money back into an undeniably, completely exemptible pension plan.

Justice Ginsburg: Another employer's plan.

Ms Karlan: That's correct.

Justice Ginsburg: But they could not have kept it in this employer's plan?

Ms Karlan: No.

This employer did not permit individuals to keep the money in the plan.

They were told they had to remove the money when they lost their jobs.

Justice Ginsburg: That was a term of the plan that it... you can remain in it only so long as you're employed?

Ms Karlan: Apparently so.

Justice Scalia: Are there any other plans that are... are entities clearly covered by the statute in which the only effect of age is to enable you to avoid a tax?

Ms Karlan: Yes, Your Honor.

Justice Scalia: All right.

Well, then--

Ms Karlan: Let me give you a couple--

Justice Scalia: --then you might persuade me.

Ms Karlan: --Let me give you a couple of examples--

Justice Scalia: Okay.

Ms Karlan: --that I think will be quite familiar.

A 401(k) plan allows you to get access to money before you turn 59 and a half on account of hardship, and you pay a 10 percent tax penalty if you do so.

The Federal Government's thrift savings plan for Federal employees allows you to take a loan out of the plan and to pay the interest back into your own account before you turn 59 and a half, thereby essentially giving you free use of the money.

If you don't pay the loan back, it's then treated as a... as a distribution, and you pay the 10 percent tax penalty on it.

So that if you read this statute to... not to include IRA's, to deny exemption to IRA's, you read this statute to deny exemption to virtually all of the modern forms of defined contribution pension plans or savings plans.

Justice O'Connor: Yes.

That was what I was going... aren't most of the pension profit-sharing, stock bonus plans, and annuities similar to the IRA's in terms of allowing withdrawal on the payment of a penalty?

Ms Karlan: Absolutely, Your Honor.

Justice O'Connor: Yes.

I thought they were all in the same boat.

So what the effect of this rule is... of the Ninth Circuit is that they would all fail to qualify under the bankruptcy--

Ms Karlan: Yes, that's correct.

You would render section 522(d)(10)(e) essentially a nullity.

Justice O'Connor: --Oh, it's the Eighth Circuit.

Excuse me.

Ms Karlan: Yes.

I... I can see why you might have thought it was the Ninth Circuit.

[Laughter]

Justice Scalia: It... it might be wrong anyway.

[Laughter]

Ms Karlan: Yes, yes.

Justice Breyer: What is the percentage amount of the payments that are taken out of all IRA plans before people are 59 and a half?

Ms Karlan: Well, in the Cilek case from the Seventh Circuit, which is cited in our brief, the court there cited statistics that suggested it was between 1.2 and 1.7 percent of funds in IRA's were removed early under the penalty process.

Justice Breyer: And the... the payment here... it says... the statute uses the word payment.

So suppose you simply have an IRA plan but you don't take money out of it.

Then is it exempt from bankruptcy?

Ms Karlan: It would be because it's the right to the future payments and not just the present payments, Justice Breyer.

Justice Breyer: So... so... but I'm trying... what I'm trying to figure out is if a person were to take... just reading it in English, it sounds as if a person were to take the plan out before he's 59 and a half and pay the penalty, that that amount that he took out would not be a... a payment because of age, but one that he took out after he's 59 and a half and didn't pay the penalty would be.

Ms Karlan: That's correct, Justice Breyer.

But in order to protect the ability to take money out after someone turns 59, you have to protect the corpus of the IRA now because otherwise, when he turns 59 and a half, there won't be any money there for him to take out.

And that's why the exemption extends not just to present payments, as the Third Circuit erroneously held, but also to the corpus when it is necessary for the support of the debtor.

And I can't emphasize--

Justice O'Connor: Ms. Karlan, let me ask something about that very point because the statute says that to the extent reasonably necessary for the support of the debtor it's allowable.

Ms Karlan: --Yes, Justice O'Connor.

Justice O'Connor: Are you aware of cases where the bankruptcy court has said, well, you don't need all that money?

That's a big plan.

You don't need all that.

We'll just let you deduct X amount.

Ms Karlan: Absolutely, Justice O'Connor.

We cite a number of them in both the opening brief and in the yellow brief on pages 19 through... to 20, I think is where we... where we talk about--

Justice Ginsburg: Can we take this concrete case?

Hers was something over $12,000; his, something over $42,000.

Ms Karlan: --Yes.

Justice Ginsburg: What was the claim here as to... was part or all of that... it would be some $54,000.

Ms Karlan: The claim was all that all of that was necessary.

If I could give an example that I think Justice O'Connor might find instructive here.

When a debtor, for example, is 40 years old, they generally require turnover of the entire IRA because people have time to earn the money back again.

When the debtor has other retirement savings, for example, in a case from Virginia called Abate, because the person also had a 401(k) plan, they were required to turn over the entire IRA.

When a debtor is able to work, even if the debtor is in his or her 50's, courts will often require exclusion of at... will also require turnover of at least part of the IRA.

In this case--

Justice Kennedy: --What... what do the courts do if they say, well, my client might be ill or something like that?

It seems to me--

Ms Karlan: --Well, if the client is ill now, they get to keep it--

Justice Kennedy: --No, no.

They... they say my client is able-bodied now, but we... we need something because... I don't know... there's a history of family illness or something.

Ms Karlan: --There isn't a reported case that talks about the possibility of future illness as a reason of exempting the money.

Justice Breyer: It's... I'm trying to figure out how... how... what the theory is.

Is... you say I have a right to receive payments because of age.

And you say, well, here I have a body of money and 99 percent comes out of it after you're 60.

1 percent comes out before.

So it's very tempting to say that that corpus there, of course, is a body of money that you're going to have a right to receive because of age because the practical effect of the 10 percent is... is... stops the... the younger person getting the money.

So does the case then turn on that?

I mean, suppose... suppose it were a 3 percent penalty and 40 percent of the people took out the money before they were 60 or a 1 percent penalty and 80 percent did it.

Then should I reach the other result?

I'm just trying to think of how does this analysis work.

What's the right analysis?

Ms Karlan: I would say at the 1 percent and 80 percent of the people are taking the money out, it wouldn't operate really as a retirement plan anymore.

But if I can give another statistic that might be helpful in thinking about this.

18 percent of the participants in large 401(k) plans who are under the age of 50 are taking loans out against those plans today.

Justice Breyer: What percent?

Ms Karlan: 18 percent in one of the surveys.

And yet, those plans are undeniably, absolutely exempt under the bankruptcy--

Justice Scalia: Well, they're taking out loans against it.

They're... they're not withdrawing the money.

Ms Karlan: --Well, but the loans because... for example, in the Federal thrift savings plan, the interest is being paid back into your own account, it's essentially as close to taking out the money as you can get.

Justice Kennedy: I still don't have your answer to the problem that bothered me at the first.

How... how do you reconcile your positions with on account of language?

If the... if your clients can take the money... just take the money out of the IRA at any time, then why is it on account of age?

Ms Karlan: It... it's not the... if you look at the statute... and let me just work my way through it with you.

It's the right to a payment under a stock bonus, profit-sharing, annuity, or similar plan on account of illness.

And the question is what does on account of modify there.

I think the most natural and sensible reading of the statute is a plan that is because of age, a plan that is because of disability, and the like.

Justice Kennedy: So you say that payment doesn't... on account of doesn't modify payment.

Ms Karlan: I don't... I don't think you need to read it that way, and I think the most sensible reading here, especially given that the statute--

Justice Kennedy: Well, I... I think the logical reading is that it... it modifies payment.

Ms Karlan: --Well, I... I'm not sure that it does, but even if it did, Your Honor--

Justice Scalia: It's too holistic for me.

What... what does it... what does it modify?

I mean, if you had to diagram it, on account of goes to what noun?

Ms Karlan: --Well, this is again... I know you dissented yesterday, but this is a less than meticulously crafted statute.

Justice Scalia: No.

I thought I was being holistic yesterday, to tell you the truth.

[Laughter]

Ms Karlan: Okay.

Justice Scalia: But--

Ms Karlan: Well--

Justice Scalia: --but what does on account of modify?

Ms Karlan: --I think what on account of modifies here is the kind of plan out of which the payment is coming.

Justice Scalia: Where... where is that noun?

Ms Karlan: There are a variety of plans, stock bonus, pension--

Justice Scalia: The right to receive a payment under a stock bonus, pension--

Ms Karlan: --Yes.

Justice Scalia: --profit sharing, annuity, or similar plan or... or contract.

It's a plan on account of illness, an annuity?

Ms Karlan: Plans--

Justice Souter: Why... why isn't it a right on account of?

Justice Scalia: It's the right on account of.

Ms Karlan: --Well, I think you can read it either way and you'll get to exactly the same result.

So let me read it the way that you've been reading it, which is if you want to protect the ability of people who have IRA's to withdraw money on account of age, you have to protect the IRA now or there will be no money in it for them to exercise their right to withdraw on account of age.

Justice Kennedy: Yes, but... but there still is a right to take payments at any time.

Ms Karlan: Justice... Justice Kennedy, we don't believe--

Justice Kennedy: So... so then you're... you're--

Ms Karlan: --that that's actually a right.

Justice Kennedy: --Under that, you're giving the... the language that follows it no meaning.

Ms Karlan: No, Justice Kennedy, I don't think that's what I'm doing here, and the reason I don't think that's what I'm doing is because this statute clearly refers to IRA's by name as one of the plans that's entitled to exemption.

Justice Breyer: But as purely English... as purely English, I read it as saying it's a right.

What is that right?

The right is a right to receive a payment on account of age.

That's the... a plan.

That's the right.

Now, your argument, I take it, was... is that yes, it's true you also have a right under certain conditions to take it without respect to age.

So what we have here is a plan that gives you both kind of rights.

Ms Karlan: That's correct.

Justice Breyer: It's a kind that gives you a right to take it with a penalty and a right to take it because of age without a penalty.

And thus, the question is, is that kind of plan which gives you both kind of rights covered?

And the language doesn't answer it.

So--

Justice Kennedy: But under Justice Breyer's hypothetical, that's just like a savings account.

Justice Scalia: Yes.

Ms Karlan: No.

Justice Souter: No, because the savings account doesn't have... I mean, the savings account doesn't have the... the penalty.

Isn't your argument that you've got to read the right as meaning a right without penalty, because if you don't read it that way, then every one of these other retirement instruments is likewise going to fail?

Isn't that your... your strong point?

Justice Scalia: That's your strong point.

Ms Karlan: That's correct.

That's... that's our strong point and we're sticking with it.

[Laughter]

Justice Scalia: Right.

Right... it's not a right if you have to pay a penalty for it.

Ms Karlan: That's correct.

It's not a right, as we say in the reply brief, to park on the sidewalk because if you pay the parking ticket, you can park there.

Justice Scalia: Right.

Ms Karlan: And I think no matter how--

Justice Scalia: That's a good argument.

I like that.

Ms Karlan: --Thank you.

[Laughter]

No matter how you read the statute, it's designed to cover IRA's, and any reading of the statute that ends up not covering IRA's will also not cover many of the other--

Justice Ginsburg: Why didn't Congress just put in IRA's along with the other things?

Ms Karlan: --They did, Justice Ginsburg.

They did in the last line of the statute.

Justice Ginsburg: Yes, but that's sort of an oblique way to get it there.

I mean, why didn't they put it together with the other string of plans?

Ms Karlan: Well, my best guess as to why they didn't do that is they started drafting the exemptions statute in 1973 and they enacted IRA's in 1974, so they stuck it in at the end of the list.

That's my best guess.

Justice Souter: What--

Justice Scalia: What your... what your opponents say is that the... the thing at the end doesn't prove anything because they're willing to acknowledge that some IRA's can be so structured that you cannot withdraw until... until you reach a certain age.

And if they're structured that way, they would be covered.

So you had to mention 408 in the... in the exceptions.

What's wrong with that argument?

Ms Karlan: Well, what's wrong with that, Justice Scalia, is that all IRA's are designed and they're administered on forms that the Internal Revenue Service sets out and you buy the forms to allow for early withdrawal.

So under their theory, there has... there is not now and there has never been a single IRA anywhere in the United States--

Justice Souter: --Well--

Ms Karlan: --that had that inability to take the money out subject to penalty prior to the age 59 and a half.

Justice Souter: --Do... do we know that?

I mean, couldn't someone... I... I don't think this is a very plausible basis for construing the statute, but just as a technical matter, couldn't someone go to the bank or brokerage firm and say I want to set up an IRA, but I want the IRA to be, in... in effect, like an irrevocable trust in which withdrawals can only be made on certain, specific conditions?

And couldn't someone, using both the IRA mechanism and a State irrevocable trust document, create an IRA that would be as restricted as... as the circuit suggested it might be?

Ms Karlan: I don't necessarily think so for the following reason.

IRA's are off-the-rack products.

They're a basic consumer product that 40 million people buy.

People don't usually negotiate the terms.

If you did negotiate the terms, though, here's the second problem.

Anytime you deviate from the form that the Internal Revenue Service gives you, which also gives you these rights to withdraw early subject to penalty, you run the risk that your plan will then be held to be a nonqualifying plan under section 408 of the tax code.

You then lose the ability to deduct the contributions going in.

You then lose the ability to defer the payments on the income as it accrues in the account.

Now, to answer the last part of your question, one of the things that has occurred over the last, say, 5 to 10 years is more and more States are passing laws that essentially protect IRA's in bankruptcy and out, as a matter of State law, from any attachment by creditors.

Why do they do that?

Because they recognize that IRA's are a fundamental piece of the retirement system today.

Justice Ginsburg: And some don't.

The... the State systems vary.

Ms Karlan: That's correct, but only four States offer no protection to IRA's from creditors the other--

Justice Ginsburg: As opposed to how many who do?

Ms Karlan: --46 States offer some kind of protection.

23 States protect them without limit in bankruptcy and out.

6 of them protect them inside of bankruptcy using the State exemptions as long as the amount is reasonable and necessary for the debtor's support.

Justice Ginsburg: Well, that's what... with the purpose that we're talking about now--

Ms Karlan: That's correct.

Justice Ginsburg: --if it's only 6 that, faced with a bankruptcy, would shelter the IRA.

Ms Karlan: No.

No. 23 of them would protect all IRA's.

6 would protect all IRA's if the money in them is necessary to the debtor's support, an additional 6.

6 more would protect all the money in an IRA as long as it was deposited 120 days or a year or 3 years before the debtor filed for bankruptcy.

3 of them will protect all IRA's up to a dollar amount.

In Nevada, the dollar amount is $500,000.

8 States use, as their State exemption law, an IRA that... a statute that has exactly the same language as the Federal statute.

6 of those State statutes have been interpreted by Federal courts to protect IRA's.

Justice Ginsburg: But here there was no choice of picking up on the State?

Ms Karlan: There's a... there's a weird anomaly in Arkansas, Your Honor, which is Arkansas law does, in fact, protect IRA's, but the Federal bankruptcy courts in Arkansas have interpreted that law only to protect the IRA up to $500 because of a provision in the Arkansas constitution, article 9, section 2, that means that you can only save up to $500.

So any bankrupt person in Arkansas who wants to keep any money in his... in his IRA has to elect the Federal exemptions rather than electing the State exemptions.

Justice Ginsburg: And one train that we didn't finish before.

You were explaining that in this case the entire $55,000... that entire sum would be needed... would be necessary for the support of the debtors.

Ms Karlan: That's correct.

The bankruptcy court did not rule on our claim that it was all reasonably necessary because they decided first that IRA's didn't come within the meaning of section 522.

Justice Ginsburg: But you... that was your claim, and I--

Ms Karlan: Yes, Your Honor.

Justice Ginsburg: --How did you come to that conclusion, that the entire amount?

Ms Karlan: Well, if you take, say, $55,000 and you ask what sort of annuity could you purchase when you hit age 59 and a half with that money, it will be an annuity that, I would guess... you know, I... I hate to do math in my head like this.

I'd guess it would throw off a couple of hundred dollars a month in additional income.

And so if you ask will the Rouseys need that money for their support, I think the answer is yes because their only other support--

Justice Ginsburg: Oh, yes.

Ms Karlan: --is Social Security and a $2,000 a month defined benefit plan that will never go up and against which their Social Security will be offset.

So when they start becoming eligible, as Mr. Rousey is about to be, for Social Security, that defined benefit plan reduces their benefits.

So if the Rouseys are to have an old age in which they can afford to live in any kind of reasonable circumstance at all, they need this money.

Justice Souter: May I go back and just nail down one lose end in... in an answer that you... you gave to my question, can you set up a kind of irrevocable?

I assume clearly from what you say is that there is not only no statute, but no IRS reg or ruling to the effect that you can make your IRA terms more restrictive without jeopardizing your qualification.

Ms Karlan: I was unable to find one, Your Honor.

Justice Souter: Okay.

Ms Karlan: I'd like to reserve the remainder of my time.

Justice Scalia: Why didn't the Government come in here, just as a matter of curiosity?

We don't have an amicus brief here from the Government, do we?

Ms Karlan: I... no, we do not have one, and I don't--

Justice Scalia: The Government has no position on the matter.

Ms Karlan: --Well, I... I don't think they've taken a position here.

I will say that in Patterson against Shumate, they referred to IRA's in a footnote in their brief, I believe, as pension plans under section 408.

Justice Scalia: There... they never go bankrupt, so the position they usually take is against any exemption from the--

[Laughter]

Ms Karlan: Well... well, that's correct.

The United States trustee may have wanted them to... I'd like to reserve the remainder of my time.

Justice Stevens: Ms. McKiever.

Argument of Colli C. McKiever

Mr. McKiever: Justice Stevens, may it please the Court:

Pursuant to section 522(d)(10)(e) of the Bankruptcy Code, a debtor's right to receive a payment is not exempt unless two requirements are met.

First, the right to receive the payment must be on account of illness, disability, death, age or length of service, and the right must come from a specified similar plan or contract.

Because neither of those elements is satisfied in this case, the petitioners' IRA's are not exempt.

Justice Scalia: Is it... is it the case that other plans that are clearly covered by the text of this statute also permit early withdrawal for certain reasons?

Mr. McKiever: Yes and no, and let me explain that.

Yes, they do permit withdrawals based upon certain factors.

Those are enumerated based... based upon each individual plan.

However, they do not permit withdrawals for any reason at any time for any purpose.

Justice Scalia: Not a single one of them.

Mr. McKiever: Not a single one of them.

Now, of course, I've not read every plan ever created, but none of the plans that I have ever seen, as the specified plans, the pension plans, the profit-sharing plans, any of those, allow withdrawal for any reason at any time.

Justice Scalia: And you'd say that if one of them did, it would also not be covered.

Mr. McKiever: That's correct.

It... it is thought--

Justice Breyer: What... what--

Justice Souter: I take it... in... in answering Justice Scalia, I take it from what you didn't say that none of the... we'll call them kind of the paradigm example plans are, however, as... as restricted as the language in this... the statute would suggest that it had to be if you read it in a... in a very literal way.

Mr. McKiever: --There are--

Justice Souter: In other words, they're all a little bit sinful, at least, even if they're not as sinful as... as you say the... the 401... the... the IRA is.

Mr. McKiever: --That... that is correct.

The... there probably are plans out there... once again, there are so many plans.

And those are created by financial institutions, by employers, by different entities.

So therefore there are thousands of variations of those.

Justice Breyer: --Now, why?

Okay.

Once you're down that road, you have conceded, as you must, that a plan that says you get the money because of age but you also can get the money without respect to age in certain circumstances can be a plan covered by the act.

Now, that's the kind of a plan that's right in front of you.

So, therefore, literally it falls just as much within the language as the other that you want to say even though that is literally true, this plan is very different from the others in terms of the purposes of the act.

That's what I would like to hear because to me, I'm not so moved by holistic as I am by purposes, which is part of holistic.

So... so the... the point that I would like to know is why, since ordinary people think of IRA's as pensions... I do.

I think of it that way.

I don't know much about it.

It's designed to help in the future, help when you're old and sick.

But there is this extra thing in it which you point to.

So why, in terms of purposes is this different from the others?

Mr. McKiever: This is different because this is the only kind of plan where you can access the funds at any time for any purpose.

It is also--

Justice Breyer: I know that, but... but... and you do it with a penalty.

We agree about the facts.

Mr. McKiever: --That's correct.

Justice Breyer: But I want to know why that difference makes a difference in a world where only 1 or less 2 percent of the people do access it before they're 60, 59 and a half.

Mr. McKiever: Because the right to... to receive the payment, the right to access the money at any time exists no matter if it is exercised or not, and it does not meet the language of the statute.

The statute very specifically--

Justice Breyer: No, no.

I... you've missed my point and I'm sorry.

I put you on the wrong track with my following up.

I shouldn't have.

Mr. McKiever: --I'm sorry.

Yes.

Justice Breyer: My question is we all agree that there can be plans where you can get the money not having to do with age, and they fall within the language of the act, and indeed, you say some are covered.

But this one you say is worse than the others in terms of the purposes of the act, and that's what I want to hear why.

Mr. McKiever: Because there is no causal connection between any of the factors that are enumerated in the statute and the right to receive the money.

And that is--

Justice Scalia: I--

Justice Stevens: May I ask this question?

Supposing instead of a 10 percent penalty, there was an absolute prohibition, would you agree... on getting the money before you're 59 and a half, would then that qualify?

Mr. McKiever: --Absolutely, yes, it would.

Justice Stevens: Now, what if there were a 50 percent penalty?

Mr. McKiever: Clearly, there's a point at which it would qualify as a prohibition more than just--

Justice Stevens: And what is it that makes it a prohibition?

Is it... is it because the purpose is to deter withdrawals, or it is that it becomes economically unacceptable?

What... what is the reason for drawing the line somewhere above 10 percent?

Mr. McKiever: --The reason for drawing the line is because at 10 percent, as the Eighth Circuit has stated in... in the Huebner case, it... it said that it's a minimal penalty.

However, there is still the unfettered access that's available.

Justice Stevens: But what is the purpose of imposing any penalty at all?

Mr. McKiever: I would assume as a disincentive to... to withdraw, but it's clearly not a prohibition, such as the... the parking--

Justice Stevens: But 50 percent would not be a prohibition and neither would 90 percent.

Mr. McKiever: --It would not be a prohibition, but it would operate more as a prohibition than 10 percent.

Justice Stevens: So it's a matter of degree rather than a difference in kind.

Mr. McKiever: Clearly that... it's a very difficult line to draw.

I... I can't make that call at this moment, but--

Justice Stevens: It seems to me the easiest black letter rule is no tax or some tax.

I mean, if it was totally free like an ordinary bank account, then you'd be dead right.

But the fact that for a... an important purpose there is a 10 percent penalty put in seems to me puts it into the category of things that are... you're not supposed to have an absolute right to get.

Mr. McKiever: --But the... the hallmark difference here is that it... it is the only type of account that you can access paying the penalty for any reason--

Justice Scalia: --I assume--

Mr. McKiever: --regardless of the specified reason.

Justice Scalia: --that... that your answer to Justice Breyer as to why that makes a difference with regard to the purpose of the statute is that the purpose of the statute is to make sure that people have money for their retirement, and that if you can withdraw it for any reason whatever, there is no security that that money will be there for their retirement; whereas if you limit the reasons to sickness and... and a certain other number of emergency reasons, the chances the money will be there for the retirement are much higher.

Mr. McKiever: Well, that... that's--

Justice Scalia: Isn't that the answer?

Justice Breyer: But if that's the answer, excellent.

So now we have--

[Laughter]

--let's say--

Mr. McKiever: --Thank you, Justice Scalia.

Justice Breyer: --Let's try... let's try a million percent tax and nobody in history has ever withdrawn the money.

Now, would... that you would say would fall within this.

Mr. McKiever: Yes.

Justice Breyer: Fine, yes.

Mr. McKiever: Yes.

Justice Breyer: Okay.

Now, if that would fall within this, going back to Justice Stevens, because that operates as a bar to prevent the bad world that Justice Scalia mentioned, why doesn't a tax that operates as a bar that's good enough to stop 98.5 percent of the people from withdrawing their money and having nothing left for old age... why isn't that just as good as the million percent tax in a world that is imperfect?

Mr. McKiever: Because clearly the... the access of money and the ability to use it prior to retirement, just as... as Justice Scalia just stated, that allows the... the debtors to... to access freely for any purpose, clearly not showing that... that it would be for retirement purposes.

Justice Souter: But attachment of the--

Justice Scalia: All right, but it's acquired.

Say... say retirement, not old age.

I mean, you know, 60... it's not that bad--

[Laughter]

Justice Breyer: 93.

Justice Souter: --If... if that is going to be your criterion, the... the total freedom for any purpose, then why, if we accept your argument, why... why don't we face sort of a daunting run or the courts face sort of daunting future?

Because the... the question then is going to be, well, what purposes are sufficiently close to old age to... to allow for a continued exemption and how free may the purposes be before a plan falls into the IRA category.

You told us a few moments ago... and I'm sure you... you were right... that the kind of the paradigm example plans vary enormously depending on the terms in which employers set them up.

So if... if we say that the... the dividing line is going to be between plans under which withdrawal can be for any purpose versus plans in which withdrawal is going to be somehow limited, then we're going to have to litigate an awful lot of plans.

Aren't we?

Mr. McKiever: Not necessarily.

The... the line that we're really looking to is that there has to be a direct causation factor between one of the five specified factors such as on... on account of factors, age, disability, death, length of service, and the right to receive the payment.

Justice O'Connor: Well, but typically these plans like 401(k) plans permit hardship withdrawals, and other plans that are mentioned in the act allow withdrawals for medical reasons or to buy housing or something like that.

I mean, you... we would just have endless cases trying to figure out what qualifies and what doesn't.

It seems like such a hard line for you to try to draw here.

Mr. McKiever: Well--

Justice O'Connor: And every plan that I know of allows withdrawal if you terminate employment.

Mr. McKiever: --And that's typically--

Justice O'Connor: In fact, that's what happened to these people.

So I just don't see how your argument is going to work.

Mr. McKiever: --Well, the... the ability to access the funds, oftentimes with termination, has to do with the length of service, the years in service because they accumulate and oftentimes are not payable at the full percentage.

They're not fully vested until that time.

Also, with the... when there are multiple factors existing in the right to receive the payments, each multiple factor can be a cause of the... of the ability to reach the money.

When there are no meaningful factors imposed, though--

Justice O'Connor: Isn't it simpler to just recognize that these plans are covered despite the right to withdraw and then rely on the provision in the statute that only permits the deduction to the extent reasonably necessary for the support?

I mean, that... that seems to me a fall-back position that's provided for in the statute.

Mr. McKiever: --I understand that... that may appear to be correct, but the problem with that is that as... taxpayer status is not the hallmark in this case of if it is or is not exempt.

Therefore, all types of accounts, whether they are truly retirement accounts or... or if they're just savings accounts, could potentially qualify under this statute.

If... if you want to open it up and... and allow all kinds of accounts to be exemptible under 522(d)(10)(e), the problem is that there is no limit on what can be potentially exempt under that statute.

Justice O'Connor: No.

Well, obviously, it's... it's governed by the statutory provision that it has to be a stock bonus, pension, profit-sharing, annuity, or similar plan or contract on account of, and so on.

Mr. McKiever: That's correct.

Justice O'Connor: And it includes IRA's apparently because of the last provision in the statute referring back to individual retirement acts under section 408 of the Internal Revenue Code.

Mr. McKiever: The section 408 reference is... does not in any way expand the exemption.

In fact, it is a further condition to place on the... the exemption.

First of all, section 408 sets out only the minimum requirements for an IRA to qualify as a... as a tax-favored plan.

That--

Justice Scalia: Ms.... Ms. Karlan says she doesn't know of any... of any IRA that did place a... a restriction which would bring it within that exemption even though the ordinary IRA wouldn't be within the exemption.

Do you know of any IRA, a single IRA that... that has a provision in it restricting withdrawal?

Mr. McKiever: --Absolutely.

Those are customizable plans.

Any person can go into--

Justice Scalia: They can, but do... do you know that there's... there's one out there?

I don't know--

Mr. McKiever: --I... I do know of several out there.

Justice Scalia: --You didn't just draw one up for this case, did you?

[Laughter]

Mr. McKiever: I did not create one for this case.

No, I did not.

But they... they definitely exist.

In fact, in the Andersen case out of the Eighth Circuit Bankruptcy Appellate Panel, the debtor had an annuity and prior to the filing of the bankruptcy petition, she elected that she would only receive periodic payments based upon her age, and that was found to be exempt by the Bankruptcy Appellate Panel because that qualified.

The payments were based upon her age, and it was then a similar plan because she could not access the funds at any time but only for the specified reason such as age.

Justice Scalia: Was that... was that an IRA that she had?

It was an IRA?

Mr. McKiever: My understanding is, yes, it was under section 408(b) was... that's my understanding based upon that case.

Justice Souter: Let me... let me ask you.

Maybe this is irrelevant, but were... were these restrictive IRA's that you're aware of set up under those terms in contemplation of bankruptcy?

If the answer is no, why would anyone so restrict his... his IRA?

Mr. McKiever: I... I do not know if that one specifically was, but no.

These have not been set up through--

Justice Souter: But why... why would anyone do that?

They're... they're qualified without these restrictions.

Why would anyone want to cut off his... his rights to... to withdraw?

Mr. McKiever: --Clearly to protect the money potentially for retirement and... and just as--

Justice Souter: In other words, like setting up a personal spendthrift trust?

Mr. McKiever: --That's--

Justice Souter: I... I want to make it tough so that I... I will not be tempted to withdraw.

Is that the motivation?

Mr. McKiever: --Well, that would potentially be a motivation because clearly the money is there readily accessible at any time to... to buy anything that the debtor chooses throughout their life.

So someone who's 30 or 40 years old can liquidate their... their IRA account, whereas with a pension or profit-sharing plan, they don't have that kind of access--

Justice Breyer: Should we put any weight on the title, on the name?

I mean, I... I can't but thinking it's an individual retirement account.

Was Congress trying to fool people?

[Laughter]

Was the Federal Trade Commission?

Should they investigate?

What... I mean, the... the... I think of it as an account that's basically aimed, at least Congress thought it was aimed, at retirement, which has usually to do with age.

Mr. McKiever: --Well, the... the name is clearly not determinative.

Also, Congress in the... in the--

Justice Breyer: I'm reading the statute and if I were voting on it and put in the 408 reference and think of the word individual retirement account, is there any... I would have thought, knowing not that much about it, that of course, they'd be included.

Now, is there any indication, when people passed this, that they didn't think they would be?

Any... any reference in the terrible words, legislative history, that might shed light on it?

Mr. McKiever: --Yes.

First of all, Congress did historically reject, first of all, just tax-favored status overall, such as what an IRA account is.

An IRA account is set up just for tax-favored status.

Congress set forth, instead, the (d)(10)(e)... 522(d)(10)(e) requirements that... that are much more stringent in the requirements of the traditional IRA.

Justice Ginsburg: Well, are they?

Because there was one statement... I think it was in Ms. Karlan's brief... that the Fifth Circuit said profit-sharing plans permit participants to withdraw up to the entire amount on payment of the penalty.

So a profit-sharing plan, which was one of the ones on the list, seems to be substantially identical if you can also take out, whenever you like, as long as you're willing to pay the penalty.

Mr. McKiever: That's a misnomer that that's a... a right to payment.

That is rather the right to borrow as a loan.

And a loan is very different than a right to payment.

They have the right to borrow the funds.

However... for example, in the New York Police Department pension plan, which she referenced in the reply brief, the police officers can borrow up to 90 percent of their pension plan funds.

However, they... as long as they're employed there, they have to continue to repay that.

Justice Souter: What... what if they don't repay it?

What's the sanction?

Mr. McKiever: There is a 10 percent penalty.

However, as the bankruptcy--

Justice Souter: But what... where... where would the... where would the principal repayment come from?

I assume it would come from deducting whatever the balance was from the... the person's account.

Mr. McKiever: --That would be correct.

Justice Souter: I mean, we call it... the... the loan feature then boils down to a... a withdrawal subject to a periodic repayment obligation, but if that obligation is not satisfied, the bottom line will be exactly like a withdrawal because they will simply deduct whatever the balance is from the person's rights under the plan.

Justice Scalia: Plus 10 percent you say.

Mr. McKiever: That's correct.

However--

Justice Scalia: So it's just... just like an IRA.

Mr. McKiever: --But... but this is in the bankruptcy context, which makes it completely different.

The bankruptcy filing of a chapter VII bankruptcy is a picture in time.

At the time that the debtor files the bankruptcy petition, you look to the assets that the debtor has possession of and the interest that the debtor has at that moment.

There's also, for some things, a 1-year look-back period.

But because it's a picture in time, it's what the... the debtor can reach is what the... the bankruptcy trustee looks to, the types of assets that... that the debtor owns.

This is very different than the pension plan which, of course, the debtor could not have... have exhausted to pay the creditors prior to filing the bankruptcy, but any other type of account would be there, would be present at the retirement.

But because they could have liquidated their IRA's to pay off their creditors prior to filing the bankruptcy, the bankruptcy trustee steps into the shoes of that debtor and has the ability to reach the funds that the debtor can potentially reach.

There are other exemptions, of course, set forth in... in section 522(d), you know, for a home or jewelry, but the assets that are not exempt are readily available to repay creditors, for... for the benefit of the creditors.

Therefore, that... that makes it significantly--

Justice Souter: Subject to the 10 percent if the bankruptcy trustee does that?

Mr. McKiever: --That's correct.

That's correct.

Justice Souter: The... the penalty still has to be paid even if it's the trustee who takes money out to pay the creditors, on your view.

Mr. McKiever: That's correct.

Yes, they do.

They do.

Additionally, the petitioners' IRA's are... by allowing unfettered access, are unlike any of the other plans because the petitioners' standard IRA is much more like a savings account.

It's not any form of deferred compensation.

They can't look to that to fill a salary void after they retire because the money may not be there.

Unlike in the pension plans or a profit-sharing plan, they could have liquidated those funds prior to their reaching any age or any illness that... that may befall them.

Justice Ginsburg: But there... there is no penalty attached to withdrawing from a savings account, and there's also no limit on the annual contribution.

Mr. McKiever: That's correct.

That is correct.

But the... the key here--

Justice Scalia: Let me just get... get straight what... what the... what the universe of plans we have in front of us here.

Do you assert that there are no other plans, clearly covered by this statute, that permit withdrawal for any reason but with a penalty?

Mr. McKiever: --That's correct.

None of the specified plans listed, the... the ones enumerated.

Justice Scalia: Would permit withdrawal for any reason whatever provided that a penalty is paid.

Mr. McKiever: That's correct.

Justice Scalia: None of them is like that.

Mr. McKiever: None of them is like that.

They all have specific factors.

There has to be a causal connection between the ability to access the money.

Additionally, it's very important that... that an account or plan that qualifies under the statute... it has to be determined on a case-by-case basis.

And there's no question that there are definitely IRA's that... that could and do qualify for this exemption.

It is, instead, that--

Justice Ginsburg: Do... do you disagree with Ms. Karlan that this is... this is a standardized product so the people, the Rouseys of this world, really couldn't get a tailor-made IRA?

They would have to take the standard product.

Mr. McKiever: --That's not... that's not correct.

There are many customizable products that are... are out there.

In fact, for example, when employers set up different kinds of plans for their employees, they go and they can choose from many different options.

For example, they can choose if they even have a... a loan provision built into a... a 401(k) or a pension plan, just like the IRA.

They... they can be customized because section 408 only sets forth the minimum requirements for it to qualify for tax-favored status.

That... that is an Internal Revenue Code section, and it does not in any way prohibit additional factors being placed into the plan.

Rather, it allows the... the individual or the employer because some... there are two different types of IRA's that can be set up by an employer... to go and customize those so that they could potentially meet the statutory requirements.

Justice Scalia: These... these other plans that allow you to withdraw for certain reasons but not for any reason... what happens if you withdraw for any reason?

Mr. McKiever: That--

Justice Scalia: What is the sanction against... I mean, you just go in.

You withdraw the money for... for a reason that is not allowed by the employer plan.

What... what is the sanction?

Mr. McKiever: --My understanding is that... is that you cannot access the funds for a reason not allowed by those plans, that that is prohibited.

And that... that is similar to Ms. Andersen's IRA in the Bankruptcy Appellate Panel case.

She could no longer reach the funds in the... she could no longer reach the corpus of the account.

The... the lump sum of money was there for her retirement years.

Whereas, in the IRA situation, the money is not protected at any time.

There's no prohibition at all whatsoever on withdrawing the funds from the account other than the payment of the penalty.

But whether an account or plan qualifies under the statute, it... it... you look at the language of the plan on a plan-by-plan basis.

The petitioners' argument renders the terms of the statute superfluous because, first of all, it is dissimilar from the enumerated plans, and secondly, it is not on account of any factors that the money can be reached.

The right to receive the payment is not based upon any factor other than the... the account holder wanting to withdraw the funds.

Justice Stevens: Well, but the right to receive 100 percent is... is dependent on a factor, isn't it?

Mr. McKiever: Yes, it is.

Justice Stevens: Yes.

At least as to the 10 percent that would be penalty, there's no right to get that money unless you have a certain age.

Mr. McKiever: That's correct.

Unless you have... or another factor such as for education or for a home loan, something like that.

There are several different reasons that you can... you can reach the money and not pay a penalty.

However, the penalty is not... is not the deciding factor.

It's their ability to access the funds at any time that... that makes that a right of payment.

It's not a right of payment without a penalty.

It's just that the right to payment exists at all times.

Justice Ginsburg: You don't dispute that... that a very small percentage of people who have IRA's, in fact, exercise the right to withdraw, given the penalty.

Mr. McKiever: That... that... that is... appears to be correct.

I don't have those exact statistics, but yes, that... that appears to be correct, that they have... that they may not exercise that at... in great numbers.

First of all, going back to the causation factor about the... the ability of the debtors to withdraw the funds for any reason or no reason, this Court in the 203 North LaSalle case determined that on account of must mean because of, and that... that is a key point here because if the debtors can reach the funds for any reason, it is not because of any other factor.

And in the LaSalle case, this Court found that that reading, the because of reading, absolutely applies to this section of the... the Bankruptcy Code, that means that the result is that a direct causal connection is required between the right to receive the payment in the on account of requirements.

In... in this case there is no causal connection whatsoever between the right to receive the payments and... and any of the factors enumerated in the statute.

Justice Stevens: Of course, the words, on account of, in this... this statute are sort of unusual, no matter how you construe them, because really the payment is on account of the years of service or it's on account of a lot of things.

You may become eligible at a certain time.

It would be better if it said a payment for which you became eligible for one of these reasons because the payment isn't really on account of all of these things.

You may get the same amount whether you're disabled or not depending on what the terms of the plan are.

Mr. McKiever: That's correct.

There are, of course, always some other factors, such as you have to first deposit the money, you have to become eligible.

But once those barriers are passed, then... then the right to receive the payment has to be at least... one of the causes must be one of these factors.

And it has to be enumerated in the plan.

It cannot be for any reason, but must be an enumerated reason in the plan.

And the... with the penalty, only the avoidance of a penalty is based upon the... the age of the debtor or the... or any of the factors.

It's... section 522(d)(10)(e) is void of any reference to the tax status or to the right to receive the payment without penalty.

It's only the right to receive the payment overall.

Justice Ginsburg: Does your argument draw a ring around IRA's?

It was suggested that if your argument prevails, then these other plans would be affected as well.

Mr. McKiever: Only to the extent that... that they are not payable for any of the reasons enumerated in the statute.

If... if they are available for payment at any time for any reason, then... then they would not qualify.

But the specified accounts, so long as they're payable for... for one of the factors and that there's a direct nexus between the right to receive the payment and... and the factors, then... then they would qualify for the exemption.

It is not, by any stretch, all IRA's.

It is just the types that... currently that the petitioners would have or that people would have that would allow the access at any time for any purpose.

So it's not that the trustee is looking to have IRA's not be eligible for exemption.

It's just the types of accounts from which all the funds can be withdrawn at any time for any purpose.

There are many qualifying IRA's that do exist, that can exist.

It's just that people have set these up from standard plans allowing them access.

Whether they access the funds or not is not the key, but the ability to access the money because it doesn't meet the statutory requirements.

There are several IRA's, though, that can and do meet the statutory requirements.

It's just that the petitioners' don't.

The case law in the Eighth Circuit was well settled, prior to the filing of this bankruptcy, that for approximately 12 years, that the definition of similar plan or contract did not include IRA's such as this, and that the on account of factors had to be satisfied to claim this exemption.

The... the debtors knew or... or potentially should have known that... that their IRA's were likely not exempt out of Eighth Circuit at the time that they filed because of the way that... that these had been construed for a long period of time.

So that they could have set up accounts that did qualify for such exemption, but... but they did not restrict their access in that way.

Thank you.

Justice Stevens: Thank you, Ms. McKiever.

Ms. Karlan, you have about 7 minutes.

You're not required to use it all.

Rebuttal of Pamela S. Karlan

Ms Karlan: I'm going to retire early.

[Laughter]

The... the first point is that there are two rights under IRA's: the right after age 59 and a half or upon death or disability or illness to withdraw the money without any kind of penalty; and there's a second little exercise, an entirely subsidiary right, which is the ability to withdraw money subject to a penalty earlier.

The existence of that second entirely subsidiary, almost never used right... and the statistic on this is in the green brief at page 23... means that the real essence of an IRA is it is a plan on account of age.

The second point.

As this Court said last year--

Justice Scalia: You don't really have a right to receive it on account of age.

You have a right to receive it without a penalty on account of age.

Ms Karlan: --Well, at the age of--

Justice Scalia: It isn't the right to receive the money that depends on your age.

It's the right to receive the money without paying a tax.

Ms Karlan: --Well, that's a right that's very important because let me give you just a mathematical example of the difference.

Justice Scalia: It is a right that's important, but it's not what the statute says.

The statute says--

Ms Karlan: The statute gives that right.

Justice Scalia: --the right to receive a payment on account of, among other things, age.

Ms Karlan: And you do have that right.

You also have another right.

But the existence of that second right doesn't negate the first right.

The statute doesn't here, for example, as section 522 or section 365 of the Bankruptcy Code does, use the word solely to say you... a plan is eligible only if you have solely the right to receive on this--

Justice Scalia: No, but it lists the other reasons: on account of illness, disability, death, age, or length of service.

And... and, you know, when you have a list like that, you would think that the right to receive the money for some other reason doesn't... doesn't qualify.

I mean, I would think that that's--

Ms Karlan: --That might be your first thought, but then--

Justice Scalia: --Or... or at least... at least some other reason that isn't closely related to those.

Ms Karlan: --Oh, but I think even if that were your first thought, you would then get to the implication that many of the Justices have been pressing today, which is the implication of that for all plans is tremendous because all plans give... well, I shouldn't say all plans, but I should say the vast majority of other plans, 401(k) plans, profit-sharing plans, and the like, do give you early access to your money, and that's valuable to you.

That's why in section--

Justice O'Connor: Is it true that none of them give unfettered access?

They're all qualified in some fashion.

Do you agree with that?

Ms Karlan: --Well, the qualification of hardship has been interpreted by many employers to say, you want to buy a house and you can't otherwise?

That's a hardship.

You want to sent your kid to school and you can't otherwise?

That's a hardship.

You have huge, you know, consumer loans and you could consolidate that?

That's a hardship.

So it's not as if IRA's operate differently from everything else in the system.

That's why--

Justice Scalia: Well, yes.

You... you don't have to make up a hardship.

You just say I want the money.

Okay, you want the money?

Here's the money.

Ms Karlan: --I think that's--

Justice Scalia: I don't even have to lie about the hardship.

I mean--

[Laughter]

Ms Karlan: --I need the money.

I don't have the money.

That's a hardship.

If you... if all you have to say is the magic word hardship, I think that's why we would say IRA's are similar plans or contracts because this Court has made it clear similar is not the same thing as identical.

So if similar reasons allow you to withdraw, that's enough.

And that's why in section--

Justice Scalia: In any of these other plans, can you get the money so long as you're willing to pay a penalty?

Ms Karlan: --As I read the New York City--

Justice Scalia: Without any qualification for disability, illness.

No.

I just want the money.

Give me the money and I'll pay you 10 percent.

Is there any plan that works like that?

Ms Karlan: --I don't know, but the New York City Police Department plan appears to work like that.

You can take the money out if you pay the 10 percent penalty.

Justice Stevens: Has any judge ever taken the view that... adopting Justice Scalia's approach, that while you can't put the whole IRA... exempt the whole IRA, but you can exempt 10 percent of it?

Ms Karlan: Not to my knowledge.

Justice Stevens: At least you ought to get that much, it seems to me, under his... his analysis.

Ms Karlan: We'd be happier with 10 percent than nothing, but no judge has ever read the statute that way.

The second point is a point that comes out of this Court's decision last year in the Till case where the Court said, look, you want to pick a manageable line, a line that's straightforward and familiar.

And here's one that I'll give you that comes directly from the text of section 522(d)(10)(e), which is you should hold that section 522(d)(10)(e) permits the exemption of all plans or contracts that qualify under section 401(a), section 403(a), section 403(b), or section 408 of the Internal Revenue Code, which IRA's do.

And this may have led to some of the confusion, I think, between counsel in this case, which is in the Andersen case, although Ms. Andersen was receiving money under section 408, it was not a 408 individual retirement account.

It was, instead, under section 403(b), an individual retirement annuity.

So there are, as far as we know, no individual retirement accounts, the things you put money into while the money accumulates before you're ready to retire and you transfer it into an annuity that are customizable.

And indeed, for the kinds of debtors who need the protections of section 522(d)(10)(e) the most, the unsophisticated people who are putting their money away in an IRA because their pension plan either doesn't exist at all or isn't adequate for their retirement, the idea that they would understand to go in and negotiate at a bank for a customizable IRA strikes me as quite implausible.

That's why we think the most sensible reading of the statute here is to exempt IRA's when the money in them is necessary for the support of the debtor.

Thank you.

Justice Stevens: Thank you.

The case is submitted.

Attribution:

The Oyez Project

Featured:

Till v. SCS Credit Corp. - Oral Argument

Fri, 09 Jan 2009 14:49:09 +0000

Case:

Till v. SCS Credit Corp.

Media File:

02-1016_20031202-argument.mp3

Related Transcript:

transcript.xml

Transcript:

Argument of Rebecca J. Harper

Chief Justice Rehnquist: We'll hear argument next in No. 02-1016, Lee Till v. SCS Credit Corporation.

Spectators are admonished do not talk until you leave the court room.

The court remains in session.

What a contest.

Ms. Harper.

Mr. Harper: Mr. Chief Justice, and may it please the Court:

Deferred payments under section 1325(a)(5)(B)(ii) must equal the present value of the collateral.

Historically present value has been an objective concept equalling the real interest rate and inflation, which is the time value of money.

The Seventh Circuit has redefined this concept in a manner that seriously disrupts two fundamental principles of chapter 13, that being the equal treatment of creditors similarly situated and the debtor's rehabilitation, the debtor's access to chapter 13.

Justice Scalia: When you say traditionally it's been understood to mean real interest rate plus time value of money, it means real interest rate for the particular lender.

Isn't... I mean, the... the interest rate that is given to different lenders is not always the same.

Mr. Harper: Under chapter 13, you're simply trying to value the money.

It's not particular to a specific creditor because you're just trying to equate the amount of money over time to a particular amount of the allowed secured claim.

Justice Scalia: Well, that's right, but the interest rate that I have to pay when I buy a house with a very small down payment is much higher than the interest I have to pay if I make a much larger down payment.

Mr. Harper: That's...

Justice Scalia: And the interest I have to pay, if I make, you know, over $200,000 a year is less than I would get if I have a lower income.

So you can't just speak of a fair interest rate in the abstract as though it's a... it... it's a platonic number floating out there.

It certainly depends upon the solvency and... and the record of payment of the person paying the interest.

Isn't that right?

Justice Ginsburg: I...

Mr. Harper: You're... you're talking about interest in the open market, though, which is not what we're talking about here.

We're... we're talking more about...

Justice Scalia: I'm surprised to hear you saying this because I thought your brief acknowledged that even after you begin with the... with a discount rate, you know, the... the Fed's discount rate... I thought your briefs acknowledged that the bankruptcy court could add to that a... a surcharge depending upon the riskiness of the chapter 13 debtor.

Mr. Harper: That...

Justice Scalia: You didn't acknowledge that?

I thought your brief acknowledged that.

I'm... you... you really want to use the discount rate, period, and nothing... nothing tagged on top of it.

Mr. Harper: I was going to get to that, but in certain circumstances an additional risk factor may be required, but it is our position that there are many other statutory elements under... provisions under chapter 13 that cover the types of risks that would normally be included in a contract, for instance.

Justice Kennedy: Well, I... I think the same thing that's bothering Justice Scalia, or that prompted his question in any event, is... is troubling me.

When I... I read the briefs, I... I thought that the coerced loan approach, which you object to, did have certain deficiencies, because you had to have testimony what the interest rate is, you have to conform it to the particular transaction, it's hard to administer.

I frankly don't see how yours is much different because you add a premium to the prime rate.

What is that premium going to be?

Why shouldn't it depend on the transaction?

Why shouldn't it depend on the risk of default?

Why doesn't your approach have all of the same problems as the coerced loan approach?

Mr. Harper: Because you need to limit the purpose of that premium.

Most risk elements are encompassed within other sections of chapter 13 because your normal risk of deterioration of the collateral, for instance... that's adequate protection.

So you don't have to add on for that.

You don't have... the risk of default is covered by the fact that there is a wage assignment in effect.

I'm saying that in certain instances...

Justice Kennedy: Well, but if that was true, you could bring up the same thing when you're cross-examining the expert on the coerced loan approach and say, well, we don't want 21 percent because there's a wage assignment.

It's the same answer.

Mr. Harper: No.

The 21 percent, such as the 21 percent that was in this record, there was no support for at all.

The creditor did not show any basis for...

Justice Ginsburg: It showed what the creditor had been getting before, and that, I thought, was the argument, that in... out of chapter 17... 13, in chapter 13 our contract rate was 21 percent, and that represents what it would cost this borrower if he were today to take those funds, get the same funds.

It would cost him 21 percent because he's a high-risk borrower.

That's... that's the theory.

But you're saying that that is a wrong theory, as Judge Rovner said in her opinion, but it's... it's not because it's more difficult to apply than some other theory.

Mr. Harper: Well...

Justice Ginsburg: I think you're... you're saying that that's a wrong approach, and maybe you'll say why.

Mr. Harper: Yes.

It's the wrong approach because the only thing that the creditor is entitled to protection for under 1325 is the value of the collateral.

In that 21 percent contract rate, first of all, on the record in this case the expert couldn't even say what it consisted of.

But in your typical contract rate of interest, you're going to have transaction charges.

You're going to have the risk of default, which has already occurred here, the risk of bankruptcy default, for instance.

That risk has already occurred here.

The creditor has already been compensated for that.

Justice Scalia: You think that makes this a better... a better borrower?

It... it makes it a safer loan when you're... when you're... you're owed money by somebody who has already been through bankruptcy once?

You think you're in better shape?

Mr. Harper: In many...

Justice Scalia: Gee, that's... that's a novel approach.

Mr. Harper: In many respects, it is safer because here you're talking about a subprime lender who did enter into a contract where it assumed a great amount of risk, but now the debtor's debt structure, his payment obligations have been modified by the chapter 13.

Justice Kennedy: So you think a lender has two different loan candidates in front of him, one he thinks is going to go through bankruptcy and the other he thinks is not, so he's going to give the loan to the first one?

Mr. Harper: I think that...

Justice Kennedy: That's... that's very difficult for me to assume.

Mr. Harper: a lender may charge additional interest if... under State law if the lender has indication that the debtor may go through bankruptcy, but normally in the subprime market, that's all factored in because most subprime candidates are candidates for possible bankruptcy in the future.

Justice O'Connor: Is it a fact that most chapter 13 bankrupts don't make it to the end of the program?

Mr. Harper: Well...

Justice O'Connor: In fact, the vast majority fail.

Mr. Harper: That's not necessarily true when you talk...

Justice O'Connor: I thought we had statistics on that.

Mr. Harper: The problem is most of the statistics focus on the default rate just from the filing, the number of filings.

They don't focus on the default rate after the chapter 13 has been confirmed because there are many... the case by that point has been reviewed by the court and it's determined to have been feasible.

The debtor by that point has been making payments for a substantial period.

Chief Justice Rehnquist: Are there statistics on that kind of cases that you're describing now?

Mr. Harper: There... I have found limited statistics.

One study that I found said that 63 percent of the chapter 13's completed successfully after they reached the point of confirmation.

So there is suggestion that after the point of confirmation, the success rate gets much higher, which only makes sense because a lot of times...

Justice Scalia: It's still not a very good risk.

I mean, you...

Mr. Harper: Well...

Justice Scalia: you lend money to somebody.

Your chances of getting it back are 2 out of 3?

Mr. Harper: The subprime lender's risk in the open market is not good either.

So...

Justice Scalia: Well, I think it's better than 2 out of 3.

Mr. Harper: It's five times higher than the prime market.

Justice Scalia: Let... let me ask you a... the... the way I see these two approaches.

I'm assuming that... that you're... you're willing to allow over the prime rate some addition which the... the courts that... that follow your... your favored approach do allow for risk factor.

So under your theory, you take the prime rate, and then it is up to the bankruptcy judge to assess what the risk is, something that I think judges are probably not very well qualified to do.

You know when... when you pick the prime rate, that that's not the market rate.

It obviously isn't.

So it's well below the market rate.

I mean, here you had a 21 percent loan and you're going to take what?

Chief Justice Rehnquist: I don't know.

Justice Scalia: A prime rate of 8 percent at most?

You know it's wrong.

And then the bankruptcy judge has to make it right.

Okay?

Under the other approach, you take the market rate, the rate that was actually adopted between these... these two people operating in a free market.

Now, it... it may be... may be high, it may be low.

You don't know for sure that it's either one.

It's... it's... it may be accurate.

It is not surely inaccurate the way picking the prime is.

And then the adjustment to be made by the bankruptcy judge is much less.

If there are some special factors that show a lesser risk now than there was when the loan was originally made, he might take them into account.

Now, as I see it, the less discretion that is left to the bankruptcy judge and the more weight that is given to the... to the real forces of the operating market, the better off we are.

I... I don't think that bankruptcy judges are very good risk calculators.

Mr. Harper: That totally eliminates the fact that a chapter 13 has been filed and that there are certain minimal requirements for chapter 13 confirmation.

A... and the problem is that market rate, the way these courts have defined it... has come to mean anything and everything.

We're talking about two different market rates here.

Justice Scalia: I'm talking about using the rate of the loan that was actually made.

Mr. Harper: But there is nothing in the statute that requires the creditor to be compensated for all of those items that were included in the pre-petition contract.

Justice Scalia: No, but he has to be given the current value of his security and the current value of his security, which is not going to be received 20 years from now or 5 years from now, depends upon how much of a credit risk there is that that money will actually be paid.

Mr. Harper: How could the... how could you possibly contract in advance for the present value of this particular allowed secured claim, $4,000?

That amount wasn't even known when the contract rate was established.

The contract rate was based upon particular characteristics of the creditor and the debtor and many...

Justice Scalia: In... in an open market.

And if the debtor could have gotten... it's a very competitive market, as I understand it.

And if the debtor could have gotten a lower rate elsewhere, he presumably would have.

Mr. Harper: That's...

Justice Scalia: I'm just saying that that's... that that's a reasonable starting point.

Now, if there has to be an adjustment because market rates have gone down since then, that minor adjustment can be made, but that's going to be much less of an adjustment than you're going to have to leave to the bankruptcy judge if you begin with the prime rate which you know is wrong.

You know that nobody would have made this... this car loan at the prime rate.

Mr. Harper: That's not the question.

The question is not what someone would make a new loan for because an allowed secured claim in chapter 13 is a claim.

It's not a loan.

Once the bankruptcy is filed...

Justice Ginsburg: Let me ask you this... this piece of it.

The... Justice Scalia said to give this kind of you-pick-it discretion to the bankruptcy judge is a worrisome thing, but all of the cases that take this approach, the Treasury bill approach or the prime, seem to have a rather narrow range for that risk factor.

They go from 1 percent to 3 percent, and none of them go over 3 percent.

Where did they... where did that range... who invented that range that 3 percent would be the ceiling?

Mr. Harper: That's a good question.

I believe that it just results from the fact that in your typical chapter 13, you don't have a lot of special risk that has to be compensated for because you usually have the fixed asset, there's no hazard... hazardous use, you've got a wage assignment.

You... substantial risk might result, for instance, in a chapter 13 if you had a balloon payment.

Justice Ginsburg: A what payment?

Mr. Harper: A balloon payment instead of periodic weekly payments, which is usually what you have in a chapter 13.

Justice Scalia: As I understand it, your expert in this case, your economist, testified that the prime rate was 8 percent and that in his view a reasonable risk premium would be 1.5.

But he conceded under cross-examination that he was unfamiliar with the relevant rates of default or costs of servicing loans in the subprime market, which...

Mr. Harper: That's...

Justice Scalia: to my mind is conceding that he has no basis for picking 1.5 percent.

Mr. Harper: That 1.5 in that case was actually a local bankruptcy rule.

But that same expert also testified that prime already includes 2 percent which could not be accounted for except for risk and transaction fees.

Justice Scalia: The risk... the risk of a prime borrower, of a fat cat borrower.

Mr. Harper: But, again, we're not talking about borrowing on a new loan in a chapter 13.

The... we're talking about modification to an old loan, an existing loan.

1322(b)(2) allows you to modify that contract.

So we're not looking at what this debtor would have to pay in the open market were it not for the chapter 13.

That's not the proper inquiry.

If there are no further questions, I would reserve the remainder of my time.

Argument of David B. Salmons

Chief Justice Rehnquist: Very well, Ms. Harper.

Mr. Salmons, we'll hear from you.

Mr. Salmons: Thank you, Mr. Chief Justice, and may it please the Court:

The court of appeals here held that the bankruptcy courts are required to presume that the pre-bankruptcy contract rate of interest, which varies from creditor to creditor and could range anywhere from 0 to 40 percent or more in some jurisdictions, is the appropriate discount rate to use in calculating the present value of plan payments under section 1325.

Now, that approach is mistaken, we submit, for three principal reasons.

First, it violates the core bankruptcy principle of equality of distribution for similarly situated creditors.

Under the court of appeals' approach, two creditors could make car loans to the same debtor that resulted in allowed secured claims of equal value, and yet one would receive thousands more in plan payments solely because the other made its car loan at a time when the debtor's financial troubles had not yet become obvious.

Justice Stevens: Is that right?

I just want to be sure I understand the... the point.

I thought if you had that differential before the bankruptcy judge, it's a... the original is a presumptive risk, and the judge could then resolve it by maybe compromising between the two.

Mr. Salmons: Your Honor, this is an important point because I think there is some misconception about what the court of appeals held in this case, and I think that's due in part to the fact that respondents, at least as I read their position, are not really defending the approach taken by the court of appeals.

The court of appeals did not adopt a presumption in favor of the pre-bankruptcy contract rate because it thought that that represented accurately the relevant market, if you will, for the risks of... and benefits and protections that exist under the Bankruptcy Code.

In fact, under the court of appeals' approach, the risk of nonpayment is really irrelevant.

What the court of appeals says is that because the... the creditor is denied use of funds for the period of the payment plan, that it therefore is entitled to whatever rate it would have gone out and funded a new loan at if it had been allowed to foreclose and reinvest the proceeds.

Now...

Justice Scalia: I agree with you, and... and the respondent is not defending that approach, but rather the approach that you use the rate of the... of the original loan as the starting point, and then adjust it as necessary.

Mr. Salmons: That's correct, and I just want to emphasize, though, that... that the adjustment that the court of appeals would make is not one I think that anybody before the Court now would defend because the court of appeals would adjust only if you could prove that the... a particular secured creditor is now making loans at some other rate and there's no reason to think why that has anything to do with what the present value of plan payments would be under 1325.

And... and the problem...

Justice Kennedy: So, but you're saying... but you're saying that under the respondent's view, that... that the creditors would be treated differently?

Mr. Salmons: If respondent's view is that you should have a presumption in favor of the pre-bankruptcy contract rate, then that would be the result.

What's not clear to me is whether it's actually respondent's view that you should have a presumption in favor of the subprime contract rate or the highest contract rate allowed by State law because it's important to remember that pre-bankruptcy contract rates are going to vary.

You could have a 0 percent lender.

You could have a prime lender, and you could have a subprime lender.

And there's no reason to think that any one of those necessarily captures the unique mix of risks and benefits and protections that exist under the Bankruptcy Code.

Justice Scalia: Where do you get the principle that all secured creditors have to be treated equally?

Where does... where does that appear?

Mr. Salmons: Well, Your Honor, on... I would refer you to page 19...

Justice Scalia: I'm sure it's true of all unsecured creditors.

I... I don't know why...

Chief Justice Rehnquist: Page 19 of what?

Mr. Salmons: I'm sorry, Your Honor.

I would refer you to page 19 of the Government's brief where we refer to two cases by this Court, Bigeur v. the IRS and... and Union Bank v. Wolas, that stand for the principle that... that embody the notion that equality of distribution among creditors is a central policy of the Bankruptcy Code.

That's this Court's language.

Chief Justice Rehnquist: Similarly situated creditors.

Mr. Salmons: To be sure, Your Honor.

Chief Justice Rehnquist: Not secured versus unsecured.

Mr. Salmons: That's why I gave the example that I did of two creditors that extend car loans and the only difference between them... they have the exact same allowed value under the code for their claim.

The only difference between them is that one made its loan 2 years prior to bankruptcy when the... when the debtor's credit history was not quite as bad and the other made it 2 weeks before bankruptcy when the only rate the debtor could get is...

Chief Justice Rehnquist: Well, why isn't that a valid distinction?

Mr. Salmons: Because, Your Honor, from the standpoint of section 1325(a)(5), the relevant inquiry is what is the present value of the promised future payments from the debtor.

All creditors are now facing the exact same situation, and I think respondent concedes this.

And those are the risks of inflation, the time value of money, and the risk that particular payments may not be made under a plan.

And there's no reason to think...

Justice Souter: Well, and the risk...

Mr. Salmons: that those are different for creditors...

Chief Justice Rehnquist: The risk of the security will just disappear too, you know, be totally devalued.

Mr. Salmons: Your Honor, I don't think that's embodied in section 1325(a)(5).

If anything, that's captured in the higher replacement value standard for the valuing of the underlying claim that this Court adopted in Rash.

And I would add that... that one reason to think why the discount rate here doesn't need to go too far in taking risks of nonpayment into account is that this Court in Rash adopted the underlying value here, replacement value, that's typically significantly higher than what the...

Justice Breyer: What has that to do with it?

I don't see what that has to do with it at all.

Mr. Salmons: Well, Your Honor, what...

Justice Breyer: I mean, the reason I say that is I thought we were following a statute, and what the statute tells us is that the value of what they receive has to equal $4,000.

They receive a set of promises to pay so much a month and the right to repossess if those promises are not kept.

Now, that's what the statute tells us to do.

So let's do it.

What do we care how they arrived at the $4,000?

Mr. Salmons: Your Honor, my only point is that this Court in Rash noted that the higher replacement...

Justice Breyer: Whatever it said in Rash, reading the statute, unless they actually contradicted that, doesn't the statute say what I just said?

So the problem in the case is how do we value the stream of payments plus the repossession value?

Mr. Salmons: I think...

Justice Breyer: I would have thought that that kind of thing is something bankruptcy judges are paid to make judgments about all the time.

Mr. Salmons: Well, I... I generally with... with Your Honor's statement.

What... what I would add, though, is that the dispute in this case is not... I mean, it's undisputed that inflation and the time value of money have to be taken into account under... under the discount rate.

The only question is whether you have to take into account the risks of nonpayment.

We submit that there...

Chief Justice Rehnquist: Of course, you do.

Justice Breyer: Of course, you do.

There is a risk of nonpayment and anything that didn't take that into account would not be equating the property with the $4,000.

Mr. Salmons: Your Honor, if... if this Court believes that risks of nonpayment need to be taken into account, then we submit that the best way to do that is to start with a market indicator such as the prime rate that captures the time value of money and the risk of inflation and then... then allow... and... and some risk of nonpayment, and then allow the bankruptcy court, which... which, by the way, has just made a determination under 1325(a)(6) about the likelihood that... that the payments will be made.

And it has made...

Justice Scalia: Start with a figure that you know for sure is wrong.

You know for sure that this person who got a 21 percent car loan because he was a bad credit risk was never going to get the prime rate of 8 percent.

Mr. Salmons: Your Honor...

Justice Scalia: Why begin with... with something...

Mr. Salmons: Your Honor, the answer to your question...

Justice Scalia: that you know is going to be abysmally low except for the fact that it will mean less money for the secured creditors and more money for the unsecured creditors, among whom is often numbered the United States?

Mr. Salmons: Your Honor... Your Honor, the answer to your question...

[Laughter]

The answer to your question is because there is no rate you can find that... that precisely reflects the unique mix of risks and benefits and protections that are available under the Bankruptcy Code.

And so by definition, everyone here is talking about a proxy in some form or another.

Now, what the prime rate does do is is it accurately captures the time value of money and inflation.

Now, we submit that the bankruptcy court, which has just examined the plan... it has made a determination.

In fact, it has found that the payments... that the debtor will be able to make the payments under the plan... that bankruptcy court is in the best position to make a determination about plan-specific risks of nonpayment if those risks are going to be included.

And that's a much more efficient system than forcing the bankruptcy court to go out and try and find some... some elusive market that... that would serve as a proxy for that determination.

Justice O'Connor: Well, you could ask them to just look at the contract rate and, if need be, make some adjustment to that because of the fact that they won't have to...

Mr. Salmons: Your Honor...

Justice O'Connor: go through the collection process.

Mr. Salmons: the difficulty with the contract rate approach is that it varies from creditor to creditor, and there really is no reason to think that... that either secured creditors, or unsecured creditors for that matter, for purposes of... of this case, should be treated differently.

They all face the exact same risks of nonpayment, the exact same problems of inflation and time value of money.

They are similarly situated.

Justice Scalia: In this case, as I understand it, this lender always charged 21 percent.

It didn't differ from... from lender... borrower to borrower.

Every one of them was charged 21 percent.

That was the market.

Mr. Salmons: And... and another secured creditor may have made a loan prior to that at a prime rate to the same debtor, and it always charges the prime rate, neither of which is particularly relevant to the question of what's the value of the promised payments under the plan.

Chief Justice Rehnquist: But if the second one was so stupid as to do that, why should he be protected?

Mr. Salmons: Well, Your Honor, it's not a matter of stupidity.

It's a matter of the fact that a debtor's position changes over time and that what may be a good rate 2 years out from bankruptcy and that is still owed would not be the rate you'd give immediately before bankruptcy.

And it may not be the relevant risks of nonpayment that exist under bankruptcy.

The point is that... is that as... as this Court understood in Rash, the... the creditor is entitled to the value of its allowed secured claim, and this Court noted in Rash that already compensates significant risks of nonpayment.

Now, I would add, if I may...

Justice Ginsburg: Because if this had been foreclosure value, then if we were going through this exercise, well, the creditor would... would then sell the asset and... and charge a... a new borrower with the same rate of interest.

But the asset would be worth much less than the price...

Mr. Salmons: That... that's correct, and Your Honor, I would add that in fact we think it's possible to read the statute so there's no risk of nonpayment at all because the statute refers to property to be distributed under the plan, and it requires the bankruptcy court to make a finding that the debtor will be able to make payments.

And there's no guidance whatsoever that would give bankruptcy courts a way to do anything more, and so we think in fact that an appropriate rate could even be the Treasury bill rate which...

Justice Scalia: Thank you, Mr. Salmons.

Mr. Salmons: excludes that.

Thank you.

Argument of G. Eric Brunstad, Jr.

Chief Justice Rehnquist: Mr. Brunstad, we'll hear from you.

Mr. Brunstad: Mr. Chief Justice, and may it please the Court:

The formula approach is surely inaccurate.

It systematically under-values the true risks and costs of a chapter 13 promise of repayment.

We know at best statistically that chapter 13 debtors at best have a 40 percent rate of... of payment on the plans.

Justice Breyer: How... how many default?

Chief Justice Rehnquist: Your... your opponent says that the... that that's... if you're taking after the thing is confirmed, after... that it's a 63 percent.

Mr. Brunstad: Yes, Your Honor.

There... there is one study that suggests that, but I must... I must add that... that there are other studies that say that the successful completion rate is as low as 3 percent in some jurisdictions.

Some 97 percent of chapter 13 fail.

Chief Justice Rehnquist: After confirmation.

Mr. Brunstad: Those are... that's a total number, Your Honor.

Justice Scalia: Okay.

That's the difference between your statistics...

Yes.

and hers.

Chief Justice Rehnquist: Since... and since this is an after-confirmation case, why... why don't we take that percentage?

Mr. Brunstad: Well, Your Honor, giving them the benefit of the doubt, we... the best we can say, based upon what we know, is approximately a 63 percent success rate.

Justice Breyer: After...

Justice Souter: What do you say to Mr. Salmons' argument that in fact the... the plan is not supposed to be confirmed unless the judge makes a... a determination that it can be followed, and it therefore isn't legitimate to take this kind of risk into consideration at all?

Mr. Brunstad: It's what we call the feasibility standard, Your Honor, and it applies in every single one of the reorganization chapters.

The bankruptcy court must merely determine that the bankruptcy judge feels that the debtor will successfully complete the plan.

We know, however, that given the extremely high rate of default in chapter 13, which far exceeds chapter 11, for example, that the feasibility standard doesn't even come close to ensuring...

Justice Breyer: Well, how do we know how... how many... what's the percentage of people in this chapter that default within a year on... on a payment of about $128 a month I guess, that was a small percentage of what they were paying into the court?

What's the figure?

Mr. Brunstad: Well, there are two sources.

The best statistics that I've been able to come up with is that it's about a 60 percent failure rate.

Justice Breyer: 60 percent fail within a year?

You said that 40 percent failed overall.

Mr. Brunstad: 60 percent fail within the 3 to 5-year period.

Justice Kennedy: No.

Justice Breyer: I asked you how many... this is... or let's take it then giving you the benefit of the doubt.

The payment plan was for 17 months.

What is the percentage of people who fail to make a... I guess it was about 10 percent or 20 percent of the amount he was paying into court.

How many fail to make that kind of payment within 17 months?

Mr. Brunstad: The statistics are not disaggregated on that basis, Your Honor.

Justice Breyer: Correct.

That's what I would think.

So what is wrong with us saying just by chance what the statute says?

What the statute says is, bankruptcy judge, here's what you do.

You create a stream of payments such that that stream of payments plus the value of the repossession equals $4,000.

Now, that's your job.

Go do it.

So I would have thought, if I were the bankruptcy judge, the way I'd do it would be by looking to the prime rate and then asking me... asking you or others to tell me how much riskier this is than the prime rate, and I'd choose a number.

And I can't imagine how we're going to come one whit closer than that general instruction, but you'll tell me why it is possible to come closer.

Mr. Brunstad: Your Honor, the contract rate is the best evidence, the single best evidence of the market rate.

Justice Breyer: Contract rate... if there has to be a number that's wrong, it has to be that one.

Mr. Brunstad: But it is less...

Justice Breyer: The contract rate by definition was entered into at some significant period of time prior to the present, and the present, by chance in this instance, is 2 years later, and we know that interest rates fell at least 1 or 2 percent during that time.

Mr. Brunstad: But not for subprime...

Chief Justice Rehnquist: So... what?

Mr. Brunstad: But not for subprime loans.

Justice Breyer: That's impossible.

The prime rate...

Mr. Brunstad: No, Your Honor.

This is why.

Justice Breyer: If that's so, then the risk went up.

Mr. Brunstad: No, that's not correct, Your Honor, and this is why.

Justice Breyer: No.

Justice Scalia: It isn't?

Mr. Brunstad: Because State law caps the maximum rate that can be paid.

Justice Breyer: Oh, okay.

Okay.

Mr. Brunstad: So it increases the pool...

Chief Justice Rehnquist: All right.

Justice Scalia: All right.

Mr. Brunstad: of who can be lent to, but not the rate.

Justice Breyer: All right, because it's a usury problem.

Mr. Brunstad: Correct.

Justice Breyer: So... so you would be free with your experts to come in and say why it happens to be that the bankruptcy judge is wrong to take the prime rate and add a risk factor, but ordinarily a contract entered into in advance would not be good evidence of what the interest rate is today.

Now, where am I wrong in that?

Mr. Brunstad: Because, again, the contract rate is the best evidence of a market rate between this borrower and this lender with this particular...

Justice Breyer: At a prior time.

Mr. Brunstad: At a particular time...

Justice Kennedy: Yes.

Mr. Brunstad: particularly if it's contemporaneous to the filing.

It reflects it and...

Justice Breyer: Oh, yes, of course.

I'm... but I'm... I'm simply saying isn't it true by definition that a contract entered into at an earlier period of time where interest rates fluctuate is not going to be very good interest... evidence of what that interest rate is today.

Mr. Brunstad: Well, Your Honor, the contract rate is not perfect, but it's far superior to the formula approach, and what you see happening... Justice Ginsburg, the Second Circuit in the Valenti case came up with a 3-point factor, just simply canvassing some lower court decisions and decided prime rate plus 1, 2, or 3 points.

It's not based on any evidence.

It's just simply based upon what the court felt was an appropriate range.

Justice Ginsburg: Your...

If you take Mr. Salmons' point that now we're in bankruptcy, it's a different world, and we've got one creditor... let's say $4,000 is the principal for both, but one lent at prime and one lent at subprime.

Once we're in the universe of bankruptcy, why shouldn't those two lenders, both with $4,000 principals, be treated the same?

Mr. Brunstad: If their risks are different, they should be treated differently, Your Honor.

Justice Ginsburg: But once you're in the bankruptcy, the risk of getting back the $4,000 is the same for both creditors, isn't it?

Mr. Brunstad: Not necessarily so, Your Honor.

You can take a situation.

Say you have a hotel, a common asset in bankruptcy.

The hotel may have a senior secured creditor and a junior secured creditor.

The number one secured creditor's risks are materially less than the junior secured creditor's.

They would be separately classified.

Because their risks are different, the interest rates are different.

In this very case at page 12 of the joint appendix, you can see how the debtor broke down its four secured creditors into four separate categories, and they have different rates.

Two secured creditors are offered 9.5 percent and two are offered 0 percent interest for the payments the debtor is going to make.

The concept of equality of distribution is precisely equality of distribution among similarly situated creditors.

Secured creditors are each unique by their own definition of the risks that they take.

They have collateral.

Justice Scalia: And your response to Justice Breyer's question, as I understand it, is that 21 percent may not be precisely what the rate is today for a loan made 3 years ago, but it's going to be a lot closer to it than 8 percent is.

Mr. Brunstad: That, plus the fact that the 21 percent is often going to be actually too low to reflect the actual risk being assumed.

Justice Scalia: Well, that may be.

Justice Breyer: Well, that may be, but what I didn't understand about your answer is when you said that the contract rate must be more accurate than the formula.

Mr. Brunstad: It seems to be.

Justice Breyer: Since the formula by definition is perfect...

Mr. Brunstad: No, Your Honor.

Justice Breyer: Since the formula is an instruction to equate the value of the stream of payments plus repossession with $4,000, the formula by definition is perfect.

Chief Justice Rehnquist: So...

Mr. Brunstad: No, Your Honor.

Justice Breyer: Well, why isn't it?

Mr. Brunstad: The formula rate is essentially standardless, and what we have seen how bankruptcy courts apply the...

Justice Breyer: You're saying I take... you're saying that...

Justice Scalia: But yours is in theory perfect.

Justice Kennedy: Wait.

Justice Scalia: No, no.

Justice O'Connor: Answer...

Mr. Brunstad: Imperfect.

That's correct.

Justice Scalia: No, no.

Yours is in theory perfect just as... as the formula is in theory perfect.

In both of them you... you begin with a starting point, and then you make whatever adjustments the reality of the risk requires.

That brings you theoretically in both cases the perfect answer.

The only question is, as a practical matter, which of the two is likely to come closer to the correct answer, starting with 8 percent that you know is way off the mark and then letting the bankruptcy judge figure out how much you add to that, or starting with 21 percent which, you know, is... is... it could be high, it could be low.

It's much fairer to both parties, but then let the bankruptcy judge adjust that a little bit.

That's the question: what... what the practical consequence is not the... the theoretical

They're both perfect theoretically.

Mr. Brunstad: In theory, Your Honor, yes, but we must be faithful to is the statutory command.

And here what we see happening is what happens in this case.

A bankruptcy judge takes the formula approach, a... basically a low rate, the prime rate, and is supposed to adjust it.

And what do they do?

Well, there's no evidence to support any adjustment in this particular case.

The debtors' expert did not testify that he knew anything about the risks of these particular debtors.

There's no basis for the adjustment.

The bankruptcy court did what bankruptcy courts do in these cases; it simply picked a number.

Chief Justice Rehnquist: Well, couldn't the creditor have brought in an expert?

Mr. Brunstad: The creditor did bring in two witnesses, and the witnesses testified that these particular debtors with their particular credit histories would be charged a 21 percent rate of interest.

Justice Kennedy: Well, can you tell me why is it that the petitioners tell us that their standard is so much easier to administer?

Is it because the courts aren't administering it in the right way?

As I listened to it, it seems to me I have two choices.

I can begin with a low rate and add or I can begin with a high rate and... and subtract.

Why... why is one any more easy to administer than... than the other?

Mr. Brunstad: Because...

Justice Kennedy: In fact, it... it would seem to me... and this I suppose helps you... that if the courts which are using the petitioners' formula are doing it the right way, it might even be harder to administer.

They... they avoid that problem by just accepting some interest factor of 1 to 3 percent out of the blue although I don't know how they do that.

Mr. Brunstad: Well, Justice Kennedy, what we have is we have three circuits which have adopted the formula approach, and so we have the experience of the courts in those circuits, and we have the balance of the circuits, approximately seven, that have taken more of the market rate approach.

And what we see happening is that in those situations where the bankruptcy courts are applying the formula approach, they are systematically giving chapter 13 debtors a rate of interest pretty close to prime.

Now, that can't be correct.

That gives the debtors with the single highest default rate in bankruptcy the lowest rates available in bankruptcy.

Justice Breyer: Would it satisfy you if we said this?

Suppose we said we see what we're after here.

The objective is to equate the stream of payments plus repossession with $4,000.

Now, on the one hand, we know it can't be lower than the prime.

On the other hand, if the creditor wants to come in and give a... present his evidence, the contract, of how risky this person is, then in fact it is evidence absolutely.

And the bankruptcy judge will look at it, and he'll try to figure out the pluses and the minuses, what's happened to the interest rate, whether this particular person is a good or bad risk, and he'll choose a number.

Don't judges do things like that all the time?

Mr. Brunstad: And apparently incorrectly systematically in chapter 13 cases.

Justice Breyer: But no.

But does what I say satisfy you?

Mr. Brunstad: No, Your Honor.

And here's why.

Justice Breyer: If not... because?

Mr. Brunstad: Because the true market rate of interest is almost always going to be at least the contract rate, presumptive contract rate, because the costs in chapter 13 are so much more extraordinarily higher than the costs of collection outside of chapter 13.

The automatic stay stays in place for the duration of the plan.

If you have a default, the secured party has to come back to the bankruptcy court, hire an attorney, pay a $75 filing fee, argue the case.

Bankruptcy judges routinely give the debtor a second chance to cure the default.

They have to come back.

The costs of collection... that's even before you get to foreclose on your collateral.

The costs of...

Justice Ginsburg: But don't you get certain advantages?

I mean, you do have the wage order.

So there's a court supervising that this wage... every month that this person, this borrower, is going to have to pay.

And in the... in... in that setting you also have... going back to Rash, the one thing I don't understand about it because it seems you want to take it the high side both ways.

You've already been given the replacement value rather than the foreclosure value.

Mr. Brunstad: Correct, Your Honor.

Justice Ginsburg: So if we're going to do it your way and say, well, now, suppose the lender foreclosed on the asset, made a new loan at the 21 percent rate... but you would have to use not the replacement value, the higher value.

You could only use what you could get on foreclosure if we follow your theory about we should make it just like you sold the asset, got money, and made a new loan.

But the... but you... but the amount that you got would be much less than the replacement value which is what you're getting inside the bankruptcy.

Mr. Brunstad: Your Honor, the secured creditor in the chapter 13 cramdown context is not trying to make any profit.

It's simply trying to mitigate against the enormous losses that it suffers.

Justice Ginsburg: But isn't that one of the adjustments that would have to be made?

You couldn't say adjust 20 percent against $4,000.

You'd have to say $4,000 minus because your foreclosure price is going to be much lower than the replacement costs that you've got in the bankruptcy.

Mr. Brunstad: But taking the extremely high risks of default and the costs of actually having to foreclose in the chapter 13 context, the relevant market rate for the value of the stream of payments is always going to be at least the... the pre-bankruptcy contract rate.

In fact, it should...

Justice Scalia: Mr. Brunstad...

Mr. Brunstad: Yes.

Justice Scalia: let me suggest a scary thought.

Unidentified Justice: [Laughter]

Justice Scalia: Is it... is it possible that the statute does not provide an answer to this question?

Unidentified Justice: [Laughter]

Justice Scalia: That since both of these schemes, your proposal and the other side's proposal, are theoretically perfect, if they are done correctly, the bankruptcy court is free to use either one so long as he comes up with the right answer.

Mr. Brunstad: No, Your Honor.

Justice Scalia: I mean, the only thing the statute says is what... what Justice Breyer keeps coming back to.

You have to provide him $4,000 in value.

Mr. Brunstad: No, Your Honor.

The... the bankruptcy statutes sometimes are obscure until we see where they come from, which is why we often look at their history.

The master concept of cramdown is indubitable equivalence.

It comes from Judge Hand's opinion in the Murel Holdings case.

And the example in 1325(a)(5)(B) that we're talking about is simply an example of indubitable equivalence.

The secured party must be fully compensated for the risk that it must assume.

The concept of indubitable equivalence must be completely compensatory.

The secured party is not supposed to take uncompensated risk.

Justice Breyer: Nobody is disagreeing with you about that.

That... what we're... I think what we're trying to get to... it's a practical question.

I actually think my approach is more perfect than Justice Scalia's perfect approach.

Unidentified Justice: [Laughter]

Justice Breyer: But the reason is it asks the right question.

Now, what you're telling me is that by asking the right question, the bankruptcy judges systematically have not done it right.

And... and I see your point.

So... so what we're... so we're trying to think of a form of words we could say which would lead... I can't say take the contract rate because I know that must be wrong.

Mr. Brunstad: No, Your Honor.

Justice Breyer: We could say take the contract rate and go down, and then they'll have the same problem.

I... I mean... all right.

But that's what we want them to do, is to honestly equate the value of the payments with the $4,000.

Mr. Brunstad: Yes, Your Honor.

Justice Breyer: I think everybody wants that, and we're searching... at least I am... for a way of how to do that.

You keep telling me you take contract rate.

I hate to tell you I keep thinking no.

Mr. Brunstad: As a presumptive rate, Your Honor.

And it's important to understand just after this Court's decision in Rash set the valuation standard for setting the principal amount, what you see now is that since we got the standard right, in 99 percent of the cases, the parties come to an agreement as to what the value of the collateral is.

Once we get the standard right here, you should expect the same thing.

It won't be litigated over and over again.

The correct standard is I think to recognize, which I think Your Honor does, that this concept of present value is an economic concept, not an equitable one, and that essentially what we're doing is we're saying there is a stream of payments to be made here and we have to figure out what it's worth.

The best test for what it's worth would be what the market says.

Now, the problem is, is that in chapter 11 there is a market.

People do lend to chapter 11 debtors, and the standard is the same in chapter 11 as 13: value as of the effective date of the plan under 1129

So what we... we have to be very careful about is in chapter 11, the markets do value debtors' promises to pay and they lend money and they charge very high interest rates.

Exit lenders or finance lenders charge very high interest rates, 18, 19, 20 percent.

It can't be true that in bankruptcy, in chapter 13, where the riskiest chapter... riskiest debtors with the highest default rate, that we systematically give them a rate which approaches prime.

So I think what you need to do, recognizing it's an economic concept, is say what's the best evidence of a market rate.

Justice Breyer: I understand.

Tell me an... a question I don't know the answer to.

Mr. Brunstad: Yes, Your Honor.

Justice Breyer: When... when... if you repossess... if he defaults again... I mean, the first time he got into bankruptcy.

Now, we've got the plan.

Mr. Brunstad: Yes.

Justice Breyer: And suppose he doesn't make the payments on the truck.

Does it then cost you a lot of money to go back even though you say to the judge, judge, this is the second time?

We'd like our truck now.

It's only worth $2,000 now.

And you still have to pay the $75, get your witnesses and everything the second time?

Mr. Brunstad: What happens the second time, Your Honor, is if the debtor defaults under the plan, the automatic stay is still in effect.

Unlike chapter 11 cases, where the automatic stay terminates when the plan is confirmed or becomes effective, here the automatic stay stays in place until the end of the repayment period.

So if the debtor defaults under the plan, someone has to go back to court and say, I need relief.

I need relief from the automatic stay to exercise my collection rights.

A corporation like SCS can't go back to court pro se.

It needs a lawyer.

You have to hire somebody to go and represent them.

You have to pay a filing fee.

Oftentimes the bankruptcy judge gives the debtor a second chance to cure the default under the plan.

Then the debtor says I'll cure, and then you come back a second time, sometimes a third time, sometimes a fourth time, sometimes a fifth time, incurring costs at each juncture.

On loans that typically range between $5 to $15,000, having to go to court even once...

Justice Breyer: Is that compensated for to some extent...

Mr. Brunstad: No, Your Honor.

Justice Breyer: that factor by the fact they're using Blue Book value to value the car rather than what it'd actually be worth in your hands once you repossess it?

Mr. Brunstad: No, Your Honor.

I think that covers the depreciation problem.

As we have delay and not payment, we have a rapidly depreciating asset, which the debtor is continuing to possess and drive around.

This interest rate compensate for the risk of nonpayment of the promises to pay after confirmation and the costs associated with the debtor's default if the debtor does default under the plan.

Justice Kennedy: I... I don't think it's certainly conclusive of the point, but the initial 21 percent rate, I take it, did take into account the risk of default.

So in a sense, the creditor has received up front some compensation for the risk that in fact has occurred.

Mr. Brunstad: Yes, but at the time the loan is made, Your Honor, we don't know who in the pool of... of debtors is going to default.

Once the default happens...

Justice Kennedy: Well, but... but overall, you account for that.

Mr. Brunstad: Overall the risks are spread, but if you force the secured party to systematically subsidize interest rates to chapter 13 debtors, who have now demonstrated by their filing they are the riskiest of the risky, what you will eventually have happen is a contraction of the ability to lend.

Chief Justice Rehnquist: But... but your original... you charge 21 percent, and a lot of people are going to successfully pay that and that stream there takes into consideration some account for those who don't pay and go into bankruptcy, doesn't it?

Mr. Brunstad: Yes, Your Honor, but we shouldn't reward those who file bankruptcy with a rate that is less, since they are the riskiest of the risky, than we would charge the other members of the pool who avoid bankruptcy.

Justice Breyer: Maybe they're not.

Justice Kennedy: The... the Bankruptcy Code, I take it, has solicitude for debtors.

Isn't that one of its purposes?

Mr. Brunstad: Yes, but...

Justice Kennedy: Or does that just drop out when we come to the cramdown problem?

Mr. Brunstad: As this Court indicated in the Johnson case, section 1325(a)(5)(B) is for the protection of creditors.

It is a limit on the debtor's ability to adjust or restructure the creditor's rights.

It is the creditor's protection.

The debtor has options.

If the debtor wants to surrender the collateral, it may and discharge the debt.

That is the protection for the debtor.

Justice Breyer: But what about then taking this idea?

I'm trying to figure out how... we say, okay, we really mean it.

It has to equate those two things.

Now, that put... and... and then stop and say, you can do it with... I... I think, you know, prime plus or whatever, maybe the other.

But... but then put the burden back on you to produce some real evidence and statistics about what happens to people we don't know about.

Now, who are those people?

We agree they've gone into bankruptcy, so they're risky, but they're also trying to get a second chance, and they also want to keep things like the truck because it will help them in their business.

And the bankruptcy judge has sat there and looked them in the eye.

And you have all those things about it which you don't have about the people you're giving the 21 percent to which is a great mass of undifferentiated people.

So then you have the burden of trying to bear it out with statistics and so forth that these people really are risky.

And the bankruptcy judge can't just sit there and say, oh, I feel sorry for them.

All right?

What about something like that?

Mr. Brunstad: Well, Your Honor, when we get to the chapter 13 confirmation stage, we're in a similar position as when we are at the beginning of making loans to a pool of applicants.

We don't know who's going to default and who doesn't.

We do know that a large percentage will.

We do know that the best evidence of a market rate for these particular class of borrowers is the contract rate.

And the question then becomes, do we want to have a system which requires us in each bankruptcy case then to take evidence complicatedly in 471,000 chapter 13 cases as to, gee, we need statistics and evidence as to this individualized debtor?

Justice Breyer: No, I mean, you wouldn't have to go that far.

Maybe you just have to do it in one or two.

But at least we'd get to the stage of people who have trucks and use them for a year and, you know, at least we'd have somewhat better information than just knowing about the default rate in bankruptcy cases in general.

And we get a little finer than that.

You see, that's what I'm trying to work with.

Justice Kennedy: I don't have an answer.

Mr. Brunstad: I understand.

Chief Justice Rehnquist: I'm asking.

Mr. Brunstad: I understand, Your Honor, and I wish I could give you a precise formula.

The problem is that these things are normally left to the market to do.

Congress has said... Congress has said basically use an economic market concept here in a context in which the default rate is so high that lenders are just not willing to lend to chapter 13 debtors.

Again...

Justice Kennedy: But... but I... I thought difficulty of administration charge was the one that the petitioners were making against you.

How... how do I sort that out?

Mr. Brunstad: And I think... I think it was Your Honor who also mentioned that... that our standard is no less cumbersome than theirs.

We think it is superior because it will yield the correct result more often.

Justice Scalia: No more cumbersome.

Surely, you mean it's no more cumbersome than theirs.

Mr. Brunstad: Yes, Your Honor.

I... I misspoke.

Excuse me.

Justice Ginsburg: Well, Mr.... Mr.... it is to this extent.

Most of these debtors are very small debtors.

You say take the contract rate as the presumptive rate and then we're going to knock down for all these other things.

The high replacement cost that... is one thing.

The interest that they got before bankruptcy is another.

The transaction cost that they're saved, another.

And so let the debtor come in and show that.

But the debtor has no money at all and certainly you don't want the debtor's money eaten up hiring an attorney and further depleting the money that could go to the creditors.

So it seems to me wildly unrealistic to expect that if you say the presumptive price is the contract price, you're going to get a debtor who will be able to... I mean, I was surprised, looking at this record, that this debtor got an expert.

Who... who paid the expert?

Maybe because the union was involved?

Mr. Brunstad: I do not know the answer to that, Your Honor.

Justice Ginsburg: But isn't it typical that these chapter 13 debtors don't have lawyers and don't have experts?

Mr. Brunstad: No.

They often have lawyers, Your Honor.

But let me suggest this.

If the Court were to set the rate at the presumptive... the contract as the presumptive rate, this is what would happen and this is what has happened in circuits where that is so.

The... the contract rate becomes the presumptive rate, and in most cases the debtor will offer that in its plan... in his or her plan as the appropriate rate.

If the debtor doesn't like that, we'll offer less of a rate and then what happens is a negotiation.

And the debtor and the secured party get together and they negotiate based upon the debtor's presentation of this is why I think it should be adjusted off of that because my circumstances have improved or there's a lot of equity in this particular collateral, so your risks are less, so you're more protected.

And those various reasons can then be given, and then the parties can negotiate.

If, however, you set a standard where the bankruptcy court is just simply going to decide based upon the evidence that the parties put in, we're not going to adopt the formula approach, then you'll be back to the problem where we are before, lots of litigation.

Again, because the contract rate is the best evidence of a... of a market rate between these parties, it should be the presumptive rate and we should work from that.

Justice Souter: Is there any...

Justice Stevens: May I ask you a question that's run through my mind listening to this argument?

Going back to the Rash case, was it, that we...

Justice Kennedy: Yes.

Justice Stevens: we did not there... the majority did not there.

I was in dissent in that case.

Mr. Brunstad: Yes, Your Honor.

Justice Stevens: did not take the case to try and replicate what would have happened if there had been no bankruptcy.

They said, we won't... won't treat it as a... now, you're in effect asking we do treat the case as close as possible to what you would have negotiated in a free market.

Mr. Brunstad: Not quite, Your Honor.

I think actually this is the same analysis as in Rash.

What the Court said in Rash that the parties had to do was the debtor had to go out... the debtor already has the truck... had the truck in Rash... is go out and see what it would have cost the debtor to replace that truck.

It didn't actually do it, but simply say what would it have cost.

The same principle applies here.

The debtor should actually go out and see what would someone pay.

How much would someone charge to finance this debtor's loan?

Justice Stevens: Yes, but in doing that, they were saying, we're going to do that instead of trying to predict what would happen to... in the normal course of events between the contracting parties if bankruptcy had not intervened.

Mr. Brunstad: Well, that's true.

In this case, though, that also applies.

What would happen if bankruptcy had not intervened is the secured party would have foreclosed, repossessed the collateral, and avoided all the costs.

Justice Stevens: But not at replacement value.

You would not have gotten replacement value.

Mr. Brunstad: That's true, Your Honor, but the reason why you have replacement value is because the debtor is going to keep the... the collateral and prevents the secured party from exercising its rights and forces the secured party to incur costs that it otherwise would avoid.

Now, the whole purpose of the value requirement and the indubitable equivalent concept and the whole cramdown standard is to make sure the secured party doesn't... isn't shouldered with uncompensated risk.

So the question becomes what's best method of compensating the secured party for its risk.

And the statute, because of what it requires, value as of the effective date of the plan using an economic concept, says we basically have to value the stream of payments.

Nobody really is willing to say I would give this debtor $4,000 or take this debtor's promise of payment of $4,000 at... at a prime rate or anything close to a prime rate.

Again, the contract date is the best evidence of a market valuation that we have.

And so that's what I think we have to work with...

Justice Souter: Is there any...

Mr. Brunstad: to be faithful to the statute.

Justice Souter: Is there any indication that if we take that, that in fact it will increase the likelihood of default under the plan simply because the higher contract rate will tend to put more pressure on the... the debtor than the debtor in fact ultimately can... can satisfy?

Mr. Brunstad: Well, Your Honor, in the circuits where that already is the standard, that the... that the presumptive rate is basically the rate that we use.

Justice Souter: Yes.

What is their experience?

Mr. Brunstad: There... there is no information to say it's higher default rate.

And certainly the fact that most of the circuits have this standard has not stopped chapter 13 from being filed.

They keep... every year the number goes up.

So we're now at about 470,000 chapter 13 cases a year.

Justice Stevens: But it seems pretty obvious if it's a higher rate, there are going to be more defaults.

Mr. Brunstad: Well, not necessarily, Your Honor, for this reason.

Because the debtor makes... the... the debtor does not make payments directly to creditors under the chapter 13 plan.

The debtor makes payments to the chapter 13 trustee as a dispersing agent, and the chapter 13 trustee then distributes the money.

What you're doing here is you're reallocating in this case a few hundred dollars away from unsecured creditors toward the secured creditor because, again, the statute says the secured creditor is not required to take... shoulder uncompensated risk for the benefit of anybody else.

That's...

Justice Breyer: Why not take the credit card rate?

Mr. Brunstad: Sorry, Your Honor?

Justice Breyer: Why not take the credit card rate?

Why not take his mortgage rate?

I mean, you see, those aren't the right rates, are they?

Mr. Brunstad: Here we have a situation in which the correct rate for auto loans is evidenced by... I think best evidenced by the auto loan contract.

It is a loan between this lender and this debtor, decided in the marketplace, with this particular collateral.

It is the best evidence of a market rate that we have.

It's not perfect, Your Honor.

I concede that, but it is the best evidence.

Justice Breyer: It's evidence at a different time before you had all the considerations.

I mean, we're going in circles, and I mean, in some respects it's good, in some respects it's bad.

Rebuttal of Rebecca J. Harper

Chief Justice Rehnquist: Thank you, Mr. Brunstad.

Ms. Harper, you have 2 minutes remaining.

Mr. Harper: Thank you, Mr. Chief Justice.

First of all, we need to get back to the concept of present value.

Present value is the time value of money, which is the real rate of interest plus inflation.

The record in this case shows that the real rate of interest was 2-and-one-half percent, and inflation was 3-and-one-half percent.

Now, in this case, the debtors made all the payments.

They actually paid the contract off early, but we need to start with as pure a base as possible and then if there are special circumstances, sure, the bankruptcy court could have discretion to add on if there is particular jeopardy to the property.

But we're measuring two different things here.

The... the statute doesn't say contract.

The statute doesn't say market rate.

This market rate concept has been misabused.

And it... right now under the bankruptcy court's interpretation anything is okay as long as you put this market rate label on it, and that's not a proper standard for chapter 13 confirmation.

The other problem is with the respondent's approach, the respondent uses words out of the Bankruptcy Act, pre-Bankruptcy Act, that simply were never enacted under chapter 13.

Full compensation, full value of their rights.

That's nowhere in chapter 13.

It's not a part of the chapter 13 requirements.

Indubitable equivalence.

That's not a chapter 13 confirmation concept.

That's a... that's a concept that was brought in to confuse this issue, but it is not chapter 13.

Respondents... their amicus said that under their interpretation of the statute, basically anything goes.

A rate from 100 percent to 300 percent would be just fine with them.

Congress has not chosen to protect subprime creditors.

This goes against...

Chief Justice Rehnquist: Thank you, Ms. Harper.

The case is submitted.

Justice Breyer: The honorable court is now adjourned until 10 o'clock.

Attribution:

The Oyez Project

Featured:

Kontrick v. Ryan - Oral Argument

Fri, 09 Jan 2009 14:49:05 +0000

Case:

Kontrick v. Ryan

Media File:

02-819_20031103-argument.mp3

Related Transcript:

transcript.xml

Transcript:

Argument of E. King Poor

Chief Justice Rehnquist: We'll hear argument now in No. 02-819, Patrick J. Kontrick v. Robert A. Ryan.

Mr. Poor.

Mr. Poor: Mr. Chief Justice, and may it please the Court:

This case presents a single question: Can the deadline for objecting to a bankruptcy discharge be altered by equitable exceptions

To answer that question, we start with the language of the rules.

Bankruptcy Rule 4004 states that an objection to discharge must be filed no later than 60 days after the first date set for the meeting of creditors.

This rule also allows for an extension of the time, but only by motion and only if that motion is filed, quote, before the time expires.

Justice Ginsburg: Mr. Poor, may I suggest that the question you have raised is not the one that I understood this case to involve.

It's not whether the provision allows for equitable exceptions, it's whether you forfeited that claim, the claim that it does not... whether you forfeited it by letting the thing go past your answer.

You didn't raise it in your answer.

You let the case go off on summary judgment on the merits and remained silent until after there was an adverse judgment against you.

So at least in my thinking, the forfeiture question, whether you forfeited, the argument that you would now like us to treat as the question presented, that is the threshold question.

Mr. Poor: And I... and I would agree with Your Honor that the question of waiver, or sometimes referred to as forfeiture, is... is part of... that is the question that's before your Court, whether that... the fact that we had not raised it until some later date is something that can be waived or forfeited.

Justice Breyer: Well, Mr. Poor...

Justice Kennedy: I... I would agree with Justice Ginsburg that that's the way that the question reads on the petition for writ of certiorari.

It's helpful that you did set forth, that the parties did set forth in the joint appendix the chronology here.

I take it that the first time your client raised the late filing issue was June 23, 2000, or am I wrong about that?

Mr. Poor: No, Your Honor.

We raised it in March of 2000 in a motion to reconsider, but we also have maintained...

Justice Kennedy: Oh, that was in the motion to reconsider?

Mr. Poor: Correct, but I would hasten to add that we have steadfastly maintained that we raised it in opposition to the motion for summary judgment in that we specifically said that the family account claim was not in the original complaint, and that to be timely, a claim had to be in that... that original complaint.

Now...

Justice Ginsburg: But in that very pleading you asked the court to strike a number of things in the complaint, and yet you did not ask to strike the family account claim.

Mr. Poor: Well, Your Honor, we have maintained that we did and in the context of this...

Justice Ginsburg: But you didn't... did you expressly say that you wanted those certain allegations struck?

Mr. Poor: Well, we did as best we could at the time because this was part of a...

Justice Ginsburg: Did you... did you say, court, strike these allegations?

Mr. Poor: Yes.

Justice Breyer: Yes, the answer is yes?

Mr. Poor: Yes, we believe we... we did, Your Honor.

Justice Ginsburg: And you did not say, strike with respect to this allegation?

Mr. Poor: Not specifically as to that, and that's... and that's what the... what the bankruptcy court found.

However, at the time this was part of a mass of other allegations, and we felt that we had raised it sufficiently by...

Justice Ginsburg: What was your reason for distinguishing the two, for saying strike others, but as to this one all that you did was mention that it wasn't in the original complaint?

Mr. Poor: Well, we felt that that was... at the... in the opposition we raised the 4004 untimeliness issue.

There were just a number of others that were not even in the... any complaint.

Justice Kennedy: Well, if we're going to get into all of that, then they would say there's a relation back and none of those issues are really before.

We took the issue on the pure question of whether or not, assuming that you were late in objecting that that... that that's a bar.

Mr. Poor: That's correct, Your Honor, and I...

Justice O'Connor: Mr. Poor, there are cases with which I'm sure you're familiar where a statute of limitations has been held to be deemed waived, even though there's nothing in the statute itself talking about waiver.

Mr. Poor: That's correct, Your Honor.

Justice O'Connor: And this is much like that, is it not?

There's a provision in the rules for a deadline for making a claim, but perhaps as in a statute of limitations case, it's not an extension of time to find a waiver.

It's... it's a different concept, and maybe should be viewed much like a waiver of a statute of limitations.

Mr. Poor: Well, in this case, Your Honor, this deadline is very much unlike a classic statute of limitations where you have a, say, a 2-year statute.

This is different because here the language of the 60 days is modified or altered by Bankruptcy Rule 4... 9006(b).

The rulemakers didn't stop with the 60-day deadline.

They stated that this rule will be incorporated into a special subgroup of other rules that may only be extended, quote, to the extent and under the conditions stated.

Justice O'Connor: But what's your answer to the argument that a waiver is not an extension, it's a waiver?

That's a different kettle of fish.

Mr. Poor: Well, it... any... any attempt to excuse a late filing, whether it is waiver, equitable estoppel, and it could be waiver in the sense of it's an implied waiver where a debtor, by inaction, does not raise it, or it could be a situation where there's a stipulation by the debtor to... with the creditor and says, after the deadline the creditor goes to the debtor and says, I want you to stipulate to a late time period.

In the language here, if you take the plain language of 4004 and 9006(b), that plain language simply does not allow for any type of equitable exceptions, whether they're deemed to be waiver or forfeiture or if...

Justice O'Connor: But you could make the same argument for an ordinary statute of limitations that doesn't talk about waiver or equitable alteration.

Mr. Poor: You... and that's correct, Your Honor, for an ordinary statute of limitations.

This one is different for this reason, that the presumption here is that when the drafters adopted 9006, what they did was they patterned it after Federal Rule of Civil Procedure 6(b), almost... almost virtually identically, and the language of 6(b), on which 9006(b) is patterned, has had a long history of being... had an established meaning as setting jurisdictional deadlines and... for its own subgroup of rules, and those rules, as this Court held in the Robinson case, we must presume that rules that are based on that 6(b) rule are presumed to be... to have the same meaning, that is, in the words of the Robinson case, as mandatory and jurisdictional.

Justice O'Connor: Well, do you think that Rule 4004(a) limits the Court's subject matter jurisdiction?

Mr. Poor: Not in the least, Your Honor, and I think that's a very important distinction in this case, because I think that's where the court below got off the trail in focusing on the concept of subject matter jurisdiction.

This case does not deal with subject matter jurisdiction.

That's the idea that... whether the court has the competency.

We're not saying that the, for instance, the Circuit Court of Cook County was the proper court to hear this objection.

In this case we're talking about an entirely different concept, and that is jurisdiction used in the sense that a court may not extend a deadline beyond the plain meaning of the rule with any type of equitable exception, whether it's called...

Justice Ginsburg: Why do you pin the word jurisdiction on it at all when rules, whether bankruptcy rules or creditor rules, cannot alter or affect the Court's jurisdiction?

That's what both rules' enabling acts say, so whatever it is, it... if it is jurisdiction, then it violates... the rule violates the statute.

The rule isn't passed by Congress.

Mr. Poor: I... and I... I, Your Honor, and as I recall in Your Honor's concurrence in the Carlisle case, you pointed out that to use the term subject matter jurisdiction for something like this, for a time prescription, is... is anomalous, where in... in this case if we're not... we're not dealing with subject matter jurisdiction, we're talking about jurisdiction as a shorthand for a time...

Justice Ginsburg: You're talking about a rigid time limit, a time limit that cannot be extended for good cause.

Mr. Poor: Exactly, and I... I know there are a number of courts that decline to even use the term jurisdiction, because they think that that's probably not the best term to use.

It's used by many courts.

Justice Ginsburg: Could you... could you have, according to your analysis of what this animal is, here you made your motion to reconsider after the summary judgment motion was granted, but before judgment was entered...

Mr. Poor: Correct.

Justice Ginsburg: final judgment was entered.

Suppose final judgment had been entered.

Could you then come into the court and say, sorry, court, I forgot to tell you that you couldn't enter any judgment here because an unalterable time bar had passed?

Mr. Poor: I think, so long as it's within the same proceeding, Your Honor, you could, and that's... that was the holding in the Kirsch case, which the Seventh...

Justice Ginsburg: How about initially on appeal?

Suppose you... you suffered the adverse judgment in the bankruptcy court and then you want to raise that, after all, the complaint was untimely, on appeal for the first time?

Mr. Poor: I think that that would probably be a rare instance, but I think that in... if it is jurisdictional or unalterable, then so long as it's within the same proceeding that's just... that is part of what a jurisdictional rule is.

Justice Ginsburg: Do you have any authority with respect to this kind of rule, a rigid time limit, that it's okay to untimely bring that to the court's attention?

I mean, all the precedent that your brief cites are cases where the party who opposes the time extension timely brings up that the complaint was untimely.

Mr. Poor: We have cited a number of those, Your Honor, in our... both our opening brief and our reply brief, and I would invite the Court's attention to...

Justice Ginsburg: Where the defendant was untimely... that...

Mr. Poor: Yes, Your Honor.

Justice Ginsburg: where as here?

Mr. Poor: Yes, and... and even more extreme, a more extreme example, if I would invite the Court's attention to the Dollar case, where after the time limit had passed, the creditor went to the debtor and says... said I want you to extend the time limit, and for whatever reason, the debtor said, okay, I'll agree to that, and then they brought that to the bankruptcy court for approval and the bankruptcy court said, no, this is a jurisdictional time limit, you can't have a side deal with a creditor...

Justice Ginsburg: That was a case where the court made an... an initial ruling without having expended any time in adjudicating the case.

Here, you present the situation where the court grants a motion for summary judgment and then the debtor says, sorry, court, you never should have adjudicated this.

We didn't tell you, but now you have to erase all... everything that you did.

Mr. Poor: Well...

Justice Ginsburg: I did... was not aware of such a case.

Mr. Poor: Well, there... there are a number of them where they're not raised in the... there's a whole spectrum.

They're not raised in the answer...

Justice Ginsburg: Raised after the case is adjudicated on the merits?

Mr. Poor: Yes.

The Kirsch case is one case where it... actually after trial, in Kirsch, the court found that since the rule... and I... it was not alterable under the plain meaning of the twin here, this 4004, 4007, that that could not be altered, even after a trial, and as I recall, the Poskanzer case is yet another one of those where...

Justice Ginsburg: Who made those decision where the...

Mr. Poor: The... the Kirsch case is from the bankruptcy court in the Northern District of Illinois, and... and the Poskanzer case is from New Jersey and we cite a number of them in page 16 and in our footnote on that...

Justice Scalia: The... the law... like... like the time limit here, the law is unalterable, and if you fail to make a legal argument at the trial level, you're not normally permitted to raise that argument on appeal where you haven't raised the objection below.

Mr. Poor: That...

Justice Scalia: The court... the court doesn't say, well, the law is unalterable so you're entitled to... to raise this point at any stage in the proceeding.

That's... that's just not the way we do things, and that's why we do have this terminology jurisdictional.

There is something special about that, but the mere fact that something is unalterable certainly doesn't allow you to raise it whenever you like.

Mr. Poor: Well, Your Honor, the... to go back to the... the concept of... of waiver or... or forfeiture, if the rule is... is truly jurisdictional, using the shorthand that it cannot be altered, then...

Justice Scalia: No, no, no.

That was the point of... of my question.

It is not a synonym for... for the term jurisdictional that it can't be altered.

There are a lot of things that... that can't be altered which you're not allowed to raise late.

Mr. Poor: But if... if the rule itself, for instance, does not allow a... a debtor and a creditor to extend this time line themselves, then it would be, I submit, anomalous to allow the debtor to do, by inaction, what the Court could never do on its own or... or permit a rule that says that...

Justice Scalia: Well, that... that's like saying you cannot let the defendant change the law by merely failing to raise a legal objection that was fully available.

He's not changing the law, he's just forfeited the... that... the benefit of that provision of law.

Mr. Poor: Well, if it can be forfeited, Your Honor, then I would submit that it can also be waived.

It could be... and...

Justice Breyer: What's... what's the citation of that?

I mean, you refer to Rule 6, and Rule 6 governs a whole lot of famous time limits, new trials, 60(b) motions, et cetera.

So, therefore, there must be a lot of cases where the following thing happened: Somebody made a motion under Rule 59, or whatever it is, out of time, all right, a day late

Mr. Poor: A day...

Justice Breyer: A day late.

Mr. Poor: Right.

Justice Breyer: And then nobody said a word about it.

Then one year later, for the first time on appeal, the other side says, oh, I agree we never said a word about this before so we're raising it now for the first time, and the court said, fine, you can raise it for the first time.

Now, what are the cases that hold that?

I mean, I'm not saying there aren't any, I haven't faced this before, but I would have thought it comes up million... you know, quite a lot of times where people forget to... or they don't care or whatever it is, and they raise something very late.

What are those cases?

Mr. Poor: Well, I... I would invite the Court's attention to the cases that we cite on pages 16 and 17, such as the... the Rinde case, debtor failed to plead...

Justice Breyer: No, I'm not talking about bankruptcy.

I'm talking about Rule 6, ordinary civil cases.

Mr. Poor: Well, I can... I can point the Court to a case that is in that 6(b) family, in the Criminal Rule 45(b).

Justice Breyer: I'm talking about civil rules of procedure, ordinary civil cases.

Probably there are, I would guess conservatively 100,000 cases a year that may fall into this category.

In a certain percentage of those, the deadlines will be missed...

Mr. Poor: And...

Justice Breyer: and in a certain percentage of that percentage, the other side will have said nothing...

Mr. Poor: And...

Justice Breyer: waking up on appeal.

Mr. Poor: And in...

Justice Breyer: And then there must be a lot of cases, if you're right, that would say, that's okay.

I'm just repeating myself because I think there are no cases and I think, to me, that shows you're wrong, but now I'm open to hearing that there are a lot or even one.

Mr. Poor: Well, I would... I would invite the Court to the Kirsch case that we cite in our brief.

Justice Breyer: Is Kirsch a bankruptcy case?

I'm not talking about a bankruptcy case.

Justice Kennedy: District court... that's a district court case.

Mr. Poor: In... in Kirsch, the court relied upon that 6(b) analysis in a case called Hulson from the Seventh Circuit, where just such a thing happened where after the... after trial the... the party did not... did not file his Rule 59 motion on time and actually the other side... they stipulated to an untimely rule... they stipulated to it, and then on appeal in that case they... the Seventh Circuit said, we don't care if you stipulated to it, it's untimely and you cannot...

Justice Breyer: All right, so that would definitely support you, and what's the name of that case?

Mr. Poor: That's Hulson, H u l s o n.

Justice Ginsburg: All right.

Mr. Poor: And that's... and that was the basis... that was the basis of this whole analysis in the Kirsch case.

Justice Kennedy: Under your... your view of the law, could the respondent here, the creditor have argued that this amendment relates back to the complaint?

Mr. Poor: Relation back has never been in our...

Justice Kennedy: Could he... could he have made that argument under your view of the law, post-judgment, after you... March 2000, it was decided in 1980... 90... 99, March 2000, you object.

At that point, could the creditor say, oh, well, this relates back, it's okay?

Mr. Poor: He... he could have, Your Honor.

Justice Stevens: All right.

Justice Kennedy: Well, then what you're doing is you're putting this issue potentially in the appellate courts.

We don't do that sort of thing.

It's... it's for the trial judge to say it relates back or not.

Mr. Poor: Well...

Justice Kennedy: And that's... that's... you put all of the parties in a very difficult position by your rule.

Justice Ginsburg: Didn't the court of appeals said... say you didn't suggest that it related back, therefore, they're assuming it didn't?

Mr. Poor: That's correct, that we... we... we've never argued the... there's never... the relation back issue was never before the Seventh Circuit.

Justice Kennedy: I'm not saying it is before, but I'm saying under your view, under your framework, it would be very difficult to handle that at such a late point, and it's a legitimate argument that they could have made.

Mr. Poor: If they... they raised it on appeal, as it might be a... an issue.

I think it's probably more likely in the trial court, but yes, I would agree with Your Honor on that.

Justice Ginsburg: Mr. Poor, I'm still looking for that case that you cited, because at least the two cases that you relied on principally, Taylor and Carlisle, those were both cases where the untimeliness point was timely raised.

Mr. Poor: That is true, Your Honor, both in Taylor and Carlisle it was raised, but I would suggest that in Taylor, if the Court did not allow a late extension based upon a bad faith claim of exemption...

Justice Ginsburg: Well, the rule says good faith isn't an excuse, so...

Mr. Poor: And...

Justice Ginsburg: But... but you are arguing that an untimely raising of the lack of timeliness is okay, and neither Carlisle nor Taylor stand for that proposition.

Mr. Poor: Well, they do in a broader sense, Your Honors, that they do not... I would submit that they do not allow any kind of equitable...

Justice Ginsburg: They were both cases where the objection to the untimeliness was timely made, right?

Mr. Poor: That's correct.

Justice Ginsburg: So then they could not have considered the case such as this one where the objection is untimely made?

Mr. Poor: And that... what that gets... what that gets back to our point in our brief that in the Santos case that the Seventh Circuit relied upon most heavily here, they did what I would call a pick and choose of different type of equitable exceptions.

In...

Justice Ginsburg: I didn't think that forfeiture was an equitable exception.

Mr. Poor: Well, in...

Justice Ginsburg: There is a difference between waiver, which is a conscious act, and forfeiture, which is rule that says, if you don't raise the point, which is the ordinary consequence of not raising a defense, if you don't raise it and the time to amend passes and you have a judgment on the merits, you can't go back to square one and said, oh, sorry, I should have put it in my answer, but...

Mr. Poor: Well, our... our biggest point here, Your Honor, is that either these rules set time limits that cannot be altered by any type of equitable doctrine, be it forfeiture, waiver, or equitable estoppel, I mean, either all of those are in or...

Justice Ginsburg: I didn't think that forfeiture was an equitable doctrine.

Mr. Poor: Well, I... I guess in this case we've always talked about waiver as... as what we're talking about here in terms of... it was an implied waiver in terms of... it was inaction... inaction by the debtor...

Chief Justice Rehnquist: Well, you're... you're talking about the same thing as implied exceptions to the statute of limitations that, you know, the statute may have run but there are certain exceptions where the thing will still be considered.

Mr. Poor: That's... that's correct, Your Honor.

If... a tolling type, and I think that's what we're getting at here is are there tolling-type exceptions to this language and I come back... we come back to the point that if this rule was designed by the rulemakers to track the language of 6(b) and not allow any type of exception, whether it's equitable tolling or... or whatever, then either... either all those exceptions come in or they... or they don't, because...

Justice Scalia: But... but you cite only... in response to Justice Breyer, you cite only one 6(b) case that you're aware of that applied the principle you're arguing for here, namely that a late-raised objection will... will be heard, right?

Justice Breyer: It isn't an exception.

The point is, I think some of us have been pointing out to you, is our belief, which you could try to disabuse us of, that this has nothing to do with exceptions.

We'll assume there are no exceptions no matter what, but there can be a rule of law that you win and there are no exceptions, but still, because you didn't raise the point, you lose it.

That has nothing to do with exceptions.

It has to do with the normal rule, in a court you have to raise a point.

Now that's what I'm interested in.

Mr. Poor: And...

Justice Breyer: And that's what I wonder... I'm asking because Rule 6, I think, would be analogous to that and so if you... there are some cases...

Mr. Poor: And I would... the Hulson case is an excellent example.

Justice Ginsburg: Which case?

Because I'm looking for it in your brief.

Mr. Poor: No, it's in the... the Kirsch... the Kirsch...

Justice Breyer: Cited by another case, right?

Mr. Poor: That's correct.

Justice Scalia: It's cited in Kirsch?

Mr. Poor: Yeah, but... and the... the other point I would make, though, is that the... the overall concept here is this case is really no different than the Carlisle case in that if the claimant Carlisle, one day late, or the... the motion one day late could not be extended because of attorney error...

Justice Ginsburg: But Mr. Poor, it can't be like Carlisle because the Government timely made that objection.

Mr. Poor: But the... the question, Your Honor, is... I would come back to this: Could the Government waive the... the objection deadline in 45(b)

And I think the answer, and I think this is where this all comes together, all of this comes together in this point, is that the Government could not waive that 45(b) deadline, and that 45(b) deadline is the same as 6(b) and it's the...

Justice Ginsburg: So you think that case stands for the proposition that the Government had said nothing and the court had said, I considered this, I grant the motion to acquit, that the Government could then come in and say, oh sorry, we forgot to tell you that this was one day late and so you couldn't consider it.

Mr. Poor: If there are... I would submit, Your Honor, that if these... if these deadlines are such that they may not be...

Justice Ginsburg: But the... the opinion of this Court certainly doesn't give any basis for that... for such a judgment.

Mr. Poor: Well, it dealt with the idea it was their inherent power to do that, but if... if the Court allows a rule that says the Government can waive this or the Government can... if the Government can stipulate to it, which is, in effect, a waiver-type argument, then I think that that pretty much unravels Carlisle.

If the Government is able to stipulate to a late... a late time period by either action or inaction, then I think that unravels Carlisle and all these 6(b) family of cases.

Chief Justice Rehnquist: Do you wish to reserve the balance of your time, Mr. Poor?

Mr. Poor: I do, Mr. Chief Justice.

Argument of James R. Figliulo

Chief Justice Rehnquist: Very well.

Mr. Figliulo we'll hear from.

Mr. Figliulo: Mr. Chief Justice, and may it please the Court:

The best way for me to understand this case is just to walk through the case.

This is a... an adversary proceeding.

Rule 4004 deals with the time for filing a complaint objecting to discharge, and that specifically is provided as an adversary proceeding.

Once we move into the realm or the arena of an adversary proceeding, the rules are pretty clear.

If... if the complaint is late, the plaintiff runs the risk of losing his case if the defense is timely raised, but there's obligations that shift to the defendant once we're in the adversary proceeding.

The defendant has to answer...

Justice Scalia: Mr. Figliulo, do you know of any case in which an objection could be waived and yet prior to the time of waiver, the parties could not, by stipulation, eliminate the objection?

Mr. Figliulo: There's a... a bankruptcy case that holds that, but I don't think... I don't think that's right.

I think the...

Justice Breyer: Well...

Mr. Figliulo: I think you can't agree...

Justice Souter: that... that holds what?

Justice Scalia: You... you think... you think the parties can waive the limitation of... of 4004?

Mr. Figliulo: I believe they can, yes.

Justice Scalia: The parties, if they get together, can waive it?

Mr. Figliulo: Yes, I... I believe they can.

Justice Stevens: All right.

Mr. Figliulo: And I think... I think...

Justice Souter: I have trouble... I have trouble with that.

Mr. Figliulo: Here... here's... here's...

Justice Scalia: I can't imagine that... that you're unable to, by stipulation, agree to eliminate it, but you can... one of the parties can nonetheless waive it.

That... that'd be a very unusual...

Mr. Figliulo: I think the statute of limitations is a personal defense and...

Justice Scalia: It can be waived.

Mr. Figliulo: therefore, it can be waived, and there's tolling agreements that are entered into regularly...

Justice Scalia: Exactly.

Mr. Figliulo: with respect to statute of limitations...

Justice Scalia: Right.

Mr. Figliulo: and I think it could apply to 4004(a) as well.

Justice Scalia: So you think the what's his case is wrong... what was the name of the one that...

Mr. Figliulo: I think it was Barley, In re Barley, Your Honor.

I think that case said that the stipulation was not...

Justice Kennedy: And was that a case in which the... in which the court expressly addressed the issue and say... and said, I'm not going to allow... I'm not going to permit the extension of time?

Mr. Figliulo: I think that was.

Justice Kennedy: That... that's... that's far different than just a waiver.

Mr. Figliulo: I do understand.

Justice Kennedy: There the judges said, you're... we're not going to allow you to delay the processes of this court, and that's quite different than parties simply doing it on their own without the judges' intervention.

Mr. Figliulo: I agree, Your Honor, and the rule, like Rule 6(b) or 9000(6)(b) focuses on motions for extension and enlargement and it is strict and it does provide the guidelines for the court to follow, but I...

Justice Scalia: I... I'm not sure what you're saying now.

Justice Breyer: You...

Mr. Figliulo: Well...

Justice Scalia: you think in Barley, when the parties signed an agreement to extend the time limit, the court should have accepted?

Mr. Figliulo: I believe that, yes.

Justice Kennedy: Okay.

Mr. Figliulo: But I think the court... the reason in the court, as I understood it, was that they could not agree to do that because extensions and enlargement of time is governed by the rule and that it wasn't permitted by the rule.

But in this case I think we have a classic situation where we have a limitations period that's the... it should have been raised in the answer.

It was not raised in the answer.

It wasn't raised until after the court granted summary judgment.

That's a classic case of an implied waiver of a limitations defense and the court recognized that at the bankruptcy level, it's been recognized that way at the district court level, it's been recognized that way by the Seventh Circuit, and it's a, I think, 100 percent right.

It's also directly in accord with the background principles of waiver that apply to any civil-type action.

Justice Ginsburg: Would you agree... do you agree with the Government that if the statute in question, not the bankruptcy rule, but at 157(b)(2)(J), if that required timely objection as some other statutes in the bankruptcy realm do, then you would lose, if the statute rather than the rule required timely objection?

Mr. Figliulo: I think if the statute provided... if Section 157 provided timely, like it does for abstention, I think that would make the rules more of an exercise of the code and perhaps a stronger basis for arguing the mandatory strictness of the rules.

I do not think it would make it jurisdictional.

Chief Justice Rehnquist: Well, many... many statute of limitations are, of course, enacted by the legislature rather than by rule, and nonetheless you have tolling there, do you not?

Mr. Figliulo: Exactly, Your Honor.

In fact, traditionally, and as this Court has recognized from time to time, that statute of limitations, which are phrased in mandatory terms, are silent with respect to whether certain exceptions or defenses traditionally apply, but regularly apply those, and that would apply particularly here where the bankruptcy court is a court of equity, and waiver is one of those principles.

Justice Scalia: In the typical case there's not a whole bunch of people who are hanging on the resolution of this issue.

I mean, what's involved here is, I mean, it... it says no later than 60 days after the first date set for meeting of creditors.

The problem is you have a whole bunch of people who don't know what their rights are going to be until this matter is settled and it... it seems to me that it's... it's quite reasonable to insist upon compliance with that time limit no matter what, because there are other people's interests involved.

Mr. Figliulo: Your Honor, I don't quarrel with the fact that the time limit is important and it serves a valid purpose, but when we look at waiver... and we're not talking about exceptions to extend time here, we're looking at the defendant's objection to... to assert a timely objection to the untimeliness of the complaint.

That promotes banality because that brings the issue to a head and it... it conserves judicial... it does everything waivers should do.

Justice Ginsburg: But are you...

Justice Scalia: Except... except that it does not lead to the conclusion that they should be able voluntarily to agree to extend the time period, which... which is a position you support?

Mr. Figliulo: It's a position I support but it's not critical to the...

Chief Justice Rehnquist: Well...

Mr. Figliulo: position that we advocate, but I do think it's right, because I do think...

Justice Kennedy: Well, would you... would you agree that a district court could override that determination of the parties, say I'm not going to allow the late filing?

Other... the rights of other persons are involved and the district court in the hypothetical case says, I know this is not jurisdictional but it is within my control.

Mr. Figliulo: I think the... the bankruptcy court level, that probably would be within the court's discretion, but I... my view is that it's... it's like a tolling agreement and it should be permitted, because a statute of limitations or a limitations period is a personal defense.

Now, if there's extraordinary circumstances where the court refuses to enforce the agreement, I can't conceive of why that would be permitted.

Justice Souter: Isn't the difference between the statute of limitations and the case we've got here that in the statute of limitations case we make the assumption that the only two interested parties are the plaintiff and the defendant, and if they don't care, why should anybody else?

In this case, however, there are other interested parties and there is a pretty well-articulated governmental interest in wrapping this up quickly.

So it seems to me that in... in the bankruptcy case, the court would have every reason, if it was brought to its attention, e.g., in the form of a stipulation, to say, no, I'm going to keep the ball rolling fast.

Isn't that the distinction?

Mr. Figliulo: Your Honor, I think that's a sound distinction.

I... I happen to believe that dischargeability is a complaint for objecting to dischargeability primarily affects the objecting party and the debtor, and while there may be other rights of people implicated, it's still very personal with respect to the debtor and the creditor who's making the objection to discharge.

And that would also be even more true with respect to dischargeability of particular debts as in 4007.

So I understand the policy consideration, there is a distinction there.

I... I've probably bitten off more than I should have with respect to whether that can be agreed on or not...

Justice Souter: You don't have to maintain that.

Mr. Jones: [Laughter]

Justice Scalia: Why don't you recognize that...

Mr. Figliulo: But I do...

Justice Ginsburg: that this is simply... the question is essentially, where does one draw the line?

And one might say, even if the objection to the timeliness isn't raised in the initial answer, it could be raised in an amendment to the answer.

It could even be raised in opposition to the summary judgment motion.

But there comes a point where it's too late to make that objection, and that's essentially the question for us: Where do you draw the line when it's too late

Now, it could be on appeal, it could be after adjudication on the merits in the trial court.

So on that question of where do we draw the line about raising this objection, what is your position?

Mr. Figliulo: I know that in this case, once... once the court adjudicates the merits, it is waived, it's over, it's too late.

I would...

Justice Ginsburg: And that's all you have to maintain to prevail here?

Mr. Figliulo: I do believe... I do believe that whether there's been an implied waiver or a waiver has some of a fact inquiry that's necessary.

It can be as early as the failure to raise it in the answer, but I do recognize the liberal rules of amendment to answers and that may be permitted it by the court in its discretion, so it's not a bright line before judgment, it's not bright line where you draw the line, in my judgement, but in... and certainly once the court rules, it's too late.

Justice Kennedy: I have one question of bankruptcy practice.

You just... you can tell me how it works.

Is the... is the order for the first meeting of creditors, which is what triggers the... the time limit here, is... does that date often fluctuate the... the order of the first meeting of creditor and then they'll... and then they'll change it?

Mr. Figliulo: No, that... it's pretty set, Your Honor.

That... it can happen, but that's unusual.

The date is... the set... there's notice that goes out and it's a relatively fixed point in time from which these deadlines then are calculated.

Justice Ginsburg: There was a timely complaint filed and it is a little odd that it was never argued that, well, this is really within the... within the frame of the original complaint, so it... it should relate back.

Why didn't you argue that?

Mr. Figliulo: Your Honor, that was argued before the bankruptcy court.

The bankruptcy court did not discuss it at all in its opinion.

It was argued before the district court.

It wasn't discussed by the district court at all.

My client represented himself pro se before the Seventh Circuit.

It was not raised in the briefs on appeal, so with respect to whether that's an alternative grounds for affirmance, that's been waived, somewhat ironically, but I think it has been.

Justice Stevens: If you're through I'd like to ask you an irrelevant question.

I don't want to take your time.

I noticed Judge Schwartz ordered a special hearing on sanctions at the end of the proceeding.

What happened at that hearing?

Mr. Figliulo: Your Honor, I wasn't involved at that time.

My... my understanding is that there was a lot of stuff going back and forth and there was a sanction of attorneys' fees of $1,000 or $1,500 assessed.

That's... that's what my recollection is.

Justice Stevens: I gather it was a pretty acrimonious proceeding in the district court.

Mr. Figliulo: It... it was, Your Honor.

It's former partners and we know that...

Justice Breyer: Is your view on this as a bankruptcy attorney thinking, I mean, I don't see that it affects your client one way or the other, but, I mean, obviously the Solicitor General in this case has suggested an affirmance on the very narrow ground that maybe they're quite right about what the rule should be interpreted, but still they lost the chance to raise the rule because they didn't raise it.

All right, that's a very narrow ground.

On the other hand, the split in the circuits is more on the broader question of how absolute are these rules in... how absolute are the deadlines in this particular rule, and that's a broader question, which is also a possible ground for affirmance, so either way your client would win.

But, as a bankruptcy lawyer, what's your opinion?

Mr. Figliulo: My... and I approach this with little trepidation, but I believe equitable exceptions, the traditional equitable exceptions of tolling and equitable estoppel, continue to apply and should apply to Rule 4004(a) and 4007.

I don't think they've been expressly abrogated.

I think they're such a powerful part...

Justice Breyer: A problem then about the other part that says you can't extend the deadlines in this main part except for the reasons that are there given, which is good cause, et cetera, what do we do about that?

Mr. Figliulo: I... I think the... the... Rule 9006(b) or 6(b), it eliminates excusable neglect as a grounds for extending time for a late-filed motion, but I don't think it eliminates equitable tolling.

I think it's different.

I think tolling and excusable neglect overlap some cases, and to the extent it's excusable neglect, it's not grounds for extension, but a... a true tolling...

Justice Ginsburg: What would be a cause for tolling if excusable neglect is out of it?

It seems to me that this rule is saying there are no exceptions, period, and to say that even if you can show good cause you don't get it extended, but there's some other equitable.

Mr. Figliulo: I... it's a relatively... I think equitable tolling, in the context of this rule, is relatively narrow exception, it's not... it's little broader than the unique circumstances that relate to if a party's misled by a rule of court.

But I do think that it can... there can be circumstances, for example, if a client's lawyer dies right before the deadline is... passes, and there's...

Justice Breyer: Why isn't that excusable neglect?

Mr. Figliulo: I don't think it's neglect.

I... I think there's equitable tolling and... and that... that's why I do think it survives in some way, but I... it's not critical to our position.

Our position is waiver.

I think we're classically correct.

It's approached under the adversary proceeding rules, which engage all the rules of civil procedure, which we all know about, it's a familiar arena, and it should apply as... as it has been applied by the lower courts, and I ask that this Court affirm it.

Thank you very much.

Argument of Kent L. Jones

Chief Justice Rehnquist: Thank you, Mr. Figliulo.

Mr. Jones, we'll hear from you.

Mr. Jones: Mr. Chief Justice, and may it please the Court:

I have very little to add to what's already been said because basically what's been said by respondent is our view as well, which is that this is a question of waiver, not a question of enlargement or extension of the time to file a timely complaint, and the one thing I do want to add, though, is that the court of appeals, it seems to us, correctly pointed out that there is a rules-based answer to the waiver question as well as the general principles that we have articulated.

The rules-based answer is alluded to by respondent, which is the Rule 4004(d) expressly incorporates through Part 7 of the bankruptcy code the pleading requirements of 8(c) of the Federal Rules of Civil Procedure.

Now, that means that the... the debtor has an obligation to plead his affirmative defenses at the answer or they would be treated as waived.

This was an affirmative defense, and so just by applying the rules it was subject to waiver when it was not raised in the answer.

We think the court was right in exercising its discretion to determine that when it's not raised until after the trial, or in this case after summary judgment was entered, it's plainly too late, and it was waived.

Chief Justice Rehnquist: Mr. Jones, when... at what point in that spectrum would it have been tiled permissible to allow it?

Mr. Jones: The broad answer to that question... well, the first answer is, that's not been raised.

They've... they've suggested it can't be waived, not that the court abused its discretion.

The answer to your question, though, is that it's... if it would not be too late to amend the answer, then it's not forfeited or waived.

Chief Justice Rehnquist: Well, when is it too late to amend the answer?

Mr. Jones: That's... there's a... a whole body of precedent about that, and as respondent correctly says, it's clearly too late once the judgment has been determined.

If...

Chief Justice Rehnquist: Now wait, do you mean judgment is... is determined, or judgment is entered?

Mr. Jones: In this case judgment was announced after the trial.

I... let me back up.

I think that it's... the court retains discretion to allow an amendment up to the pre-trial stage.

Up to the pre-trial answer, the court sometimes allows complaints to be amended in its discretion, and...

Chief Justice Rehnquist: Well, quite frequently, does it not, at pre-trial?

Mr. Jones: Not infrequently, but it's also the case that sometimes amendments are denied at that point because of the particularity, facts of the case.

But my point is simply, at this stage of the case it's clearly have been waived and... and...

Chief Justice Rehnquist: Well, now, at this stage of the case, judgment had not yet been entered, but the motion for summary judgment had been granted.

You... are you saying it can never be done at that stage?

Mr. Jones: It would be... I... I think that it... it might be not an abusive discretion... there's a lot of nots there.

A court might be able to exercise discretion if it thought in the circumstances it was appropriate, but it is a matter committed to the discretion of the trial court, and certainly at that stage it was well within its discretion, and again, that issue hasn't been presented or raised.

What was raised is the idea you can't waive it, and the reason that it was raised in that fashion is they said it's jurisdictional.

But it's... but they've conceded, both in their reply brief and in... and in court today, that it doesn't affect the subject matter jurisdiction of the court.

And the cases are clear that...

Justice Scalia: How do you... how do you reconcile your view about the court having such broad discretion with... with the wording of 4004(b), which says that on motion, the court may for cause extend the time, but the motion shall be filed before the time has expired?

And what you're saying is, well, it really doesn't matter, the court has discretion to go ahead even though the motion wasn't filed before the time has expired.

Mr. Jones: I'm sorry, Justice Scalia.

The question that I was answering was whether the court had discretion to accept the late-raised objection to the late complaint.

Justice Souter: I'm sorry.

Mr. Jones: And that's a different... and I do think the court has that discretion.

Whether it had... would have had discretion to allow a late complaint at that... at some later point really isn't before the Court, because they haven't claimed that there is any equitable grounds for enlarging or extending the deadline, so that question isn't presented.

Justice Scalia: I don't... you're distinguishing between granting... I'm sorry... granting...

Mr. Jones: The...

Justice Scalia: granting a late-raised objection and granting a late-filed complaint?

Mr. Jones: Correct.

Chief Justice Rehnquist: Okay.

Mr. Jones: Under ordinary principles of 8(c) and the Rules of Federal Procedure which are applicable here.

My point is that a court could allow the late-raised defense that it... that the complaint was untimely, up to some point it would have discretion to do that, but it exercised its discretion not to allow that late-raised objection, late-raised defense in this case.

Justice Ginsburg: Well, the rule on amendment, which the pleading rules, the Federal rules would apply, says that it should be... if after you miss the time limit in which you are allowed to amend as a matter of right, then you may or may... and with the court's permission, and leave shall be freely given when justice so requires.

Mr. Jones: That's the discretionary standard and I don't... I will be frank, I do not know if there's a case that says that discretion stops at this point.

That's not before the Court.

It would just be odd for the Court to exercise such discretion after it had already determined that the judgment should be awarded to one of the parties.

That's all I was trying to say.

Justice Kennedy: At the outset you said there's a text-based or a rule-based...

Mr. Jones: Rule-based.

Justice Kennedy: And that's 4000(e)?

Mr. Jones: 4004(b).

Justice Kennedy: 4004(e)?

Mr. Jones: B.

Chief Justice Rehnquist: Where is... where is that?

Mr. Jones: It's at...

Justice Kennedy: Was that in... did you make that argument in your brief?

Mr. Jones: We did not make that argument.

The respondent made the argument and the court of appeals made the point.

That provision is quoted in footnote 3 of respondent's brief.

It's a very short provision.

It just says that the... the procedures of Part 7 will have governed, and then Rule 7008 says that incorporates Rule 8(c) of the Federal Rules of Civil Procedure.

Now, we have not addressed the question of whether equitable exceptions would be available under this rule, but we do think that the Court's decision in the Santos case provides a sensible explanation of how to address that question.

In Santos, the Court made the point that the rules appear to say you cannot extend by excusable neglect, but that doesn't preclude equitable estoppel, because estoppel is based on the misconduct of the debtor, excusable neglect is the neglect of the creditor.

So not allowing an extension for neglect doesn't preclude allowing an extension for estoppel.

Justice Breyer: So you think this is a totally different issue and it's a much broader issue and more important...

Mr. Jones: This is a much... this is...

Justice Breyer: And you think, in other words, if they had come in and said, hey, we... I've been taking all the money out of wife's account, putting... put it in... you know, I put it all in her name, ha ha ha, and I had hired people to prevent the creditor from ever finding out, that then the correct defense there would be equitable estoppel, which is an enlargement of the time period?

Mr. Jones: If the... if I understood your hypothetical, if the basis of the estoppel was that...

Justice Breyer: I'm... I'm assuming they acted very inequitably.

Mr. Jones: that we were unable to find... they hid from us what they were doing...

Chief Justice Rehnquist: Yes, yes.

Mr. Jones: yes, I think that would apply.

But I should also point out that in that specific factual scenario, 727(d) of the bankruptcy code would allow the discharge to be reopened in...

Justice Breyer: You see, that... that's the argument the other way.

The argument the other way is you don't really need to import these defenses into the rule itself because there are other ways in the bankruptcy law that an unfair kind of conduct that can be dealt with.

Mr. Jones: If, to the extent that there are other ways to deal with it, then equity doesn't need to step in if there's an adequate legal remedy.

But if... when there's not an adequate answer in the code to this... to whatever facts come up about the estoppel situation, we would think that the rules don't preclude the court...

Justice Ginsburg: Mr. Kent, as I remember the... this case itself, the debtor was never secretive about what he had done.

He told the creditors, he told everybody, yeah, I took my name off the account...

Mr. Jones: Yes.

Justice Ginsburg: but I continued to deposit my salary in it, I continued to pay the family expenses from it.

It wasn't concealed.

Mr. Jones: It's a hypothetical...

Justice Breyer: It's a hypothetical case.

I'm trying to get to the issue the... that's bothering me.

Can you just give me one word about whether my belief about the Rule 6... it refers to a new trial motion in a civil case, motion to amend the opinion, JNOV, all those time limits it says are absolute.

Now, I take it it's never been held or isn't at least normally held that a lawyer can sit there, notice that the time limits weren't complied with, wait to see if he wins, and then if he loses, bring it up for the first time on appeal.

Am I right about that?

Because they're saying, no, I'm not right about it.

Mr. Jones: Well, I... I think you're right about that that you can waive an argument of any... based on those rules in... in the trial court, but let me...

Justice Ginsburg: Is it... do you know of any case, Mr. Kent, because those are all motions that are brought after the trial, after the adjudication, and I'm can't imagine a scenario where a lawyer who won would then... and the other party moves for a new trial... would then say nothing.

Mr. Jones: I'm not familiar with a case of that type, but there... I can imagine that there's a case out there that says something along the following, that this Court's jurisdiction, by statute, is based on the requirement, for example, that there be a notice of appeal filed within 30 days.

Rebuttal of E. King Poor

Chief Justice Rehnquist: Thank you, Mr. Jones.

Mr. Poor, you have 2 minutes remaining.

Mr. Poor: I'd like to return to the... the fundamental point is when these were adopted, 9006(b) was patterned after 6(b), and that identical language, as this Court instructed in the Robinson case, should be read to be mandatory and jurisdictional, that is, not waiveable.

And if we look at a case like Santos, there's nothing in the language that allows Santos to pick and choose between... between saying equitable estoppel would... would not apply but waiver would apply.

The only possible way you can get there in Santos is not through the text, not through the language, which Robinson has told us is mandatory and jurisdictional.

The only way you can get there is through the... a policy argument that says, we think it's a good idea not to have equitable estoppel, but on the other hand, yeah, for policy reasons, we... we should allow waiver to apply.

And if you allow waiver, whether it is waiver in the implied sense of inaction or waiver in the express sense of allowing a stipulation, in that case, you will have really taken what is in the text and these are no longer jurisdictional rules without exception.

Rather, they have become rules that the parties themselves may change, and this deadline has never been like a statute of limitations.

It has always been different.

It allows the parties to, before there's any... before there's any adjudication, any deadline, to take discovery and move the deadline along.

That's not like a typical statute of limitation, and the reason for that is the text.

The text says it may only be extended to the extent and under the conditions stated, the exact language that was at issue in Carlisle and in Robinson, and we would submit that you have to read the same language in the same way, whether it's 9006(b), 6(b), Criminal Rule 45(b), they all are based on the same language.

Chief Justice Rehnquist: Thank you, Mr. Poor.

The case is submitted.

Attribution:

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Archer v. Warner - Oral Argument

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Argument of Craig Goldblatt

Chief Justice Rehnquist: We'll hear argument first this morning in Number 01-1418, A. Elliott Archer versus Arlene L. Warner.

Mr. Goldblatt.

Mr. Goldblatt: Mr. Chief Justice, and may it please the Court:

An individual debtor at the end of a bankruptcy case will typically receive a discharge of that debtor's pre-bankruptcy debts.

That discharge, however, is subject to a number of statutory exceptions, each exception reflecting a congressional judgment that a particular category of debt be paid notwithstanding the prior bankruptcy.

Those exceptions include not only debts for money obtained by fraud, debts for injuries caused by drunk driving, and amounts due for alimony and child support.

With respect to the fraud exception at issue here, under the Bankruptcy Code and this Court's cases, a debt is nondischargeable in bankruptcy if the creditor can establish that the underlying debt arises out of an act of fraud.

The question presented in this case is whether a debt that would otherwise be nondischargeable for that reason becomes dischargeable if the parties enter into a settlement agreement that resolves the amount of the debt.

The court of appeals said that a settlement did have that effect, emphasizing that the effect of a settlement was to trade a fraud claim for a contract action that would be discharged in bankruptcy.

Justice Kennedy: Is it your understanding that if the Fourth Circuit were correct and were to be affirmed in this case, that its rule would be the generally prevailing rule in all of the States, or would certain States differ on whether or not there was, in effect, a novation when there was a settlement agreement?

Would we have to go State-by-State?

Mr. Goldblatt: No, Your Honor.

The question of dischargeability is a question of Federal law.

That is how each of the courts of appeals that have addressed the question has treated it.

Indeed, this Court, in Grogan versus Garner, has emphasized that the construction of section 523(a) of the Bankruptcy Code is a question of Federal law.

Justice Kennedy: Well, my... my question, perhaps, was not as clear as it ought to have been.

The Fourth Circuit placed substantial reliance on the fact that this was a novation under State law, that there was a new debt created superseding the old, et cetera, and my question is whether or not... if we affirm its judgment, that we will find in almost every other State a settlement is also a novation, or will the rule vary from State to State, and if it does vary from State to State, will the Fourth Circuit rule from this particular State be the majority rule or minority?

Mr. Goldblatt: Your Honor, the court of appeals did, indeed, say that the... the settlement effected a novation.

That is a common rule.

I'm unaware of any jurisdiction in which that... that wouldn't be the principle.

The question, nevertheless, before this Court is the effect as a matter of Federal bankruptcy law of that settlement.

Justice Kennedy: I'm... I'm well aware of that, but what I'm just asking is... this case came from South Carolina, was it?

Mr. Goldblatt: From North Carolina, Your Honor.

Justice Kennedy: Oh, from North Carolina.

Mr. Goldblatt: Yes.

Justice Kennedy: Is the North Carolina rule about novations and settlements the majority rule for most of the States?

In most States, would this be called a novation?

Mr. Goldblatt: Yes, Your Honor.

I'm unaware of any jurisdiction in which a settlement doesn't effect novation.

When the parties to a dispute settle that dispute, it is commonly the case that... indeed, in every jurisdiction of which I'm aware, following that settlement, the... the creditor or the plaintiff is unable to bring a new lawsuit for fraud.

Rather, the party is left to enforce the... the settlement.

Justice Ginsburg: Mr. Goldblatt, I take it you're saying, yeah, a novation is fine with you.

No longer do they have the original claim.

They have substituted for it, what the claim is, the amount of the settlement.

The... what was it, immediate payment of X dollars?

Was it 2,000?

Mr. Goldblatt: It was an immediate payment of $200,000 and a promissory note for $100,000.

Justice Ginsburg: And that's... that's what they... they say is the basis of their claim in bankruptcy.

They think... they know they can't go back to the original claim.

To that extent, it's a novation.

That's not disputed.

But there is one element of the background of this case perhaps you can clarify for me.

It's odd that Leonard Warner stipulated that this was a nondischargeable debt, but his wife, who's in the bankruptcy with him, says yes, it is dischargeable.

What is the effect of the stipulation by Leonard Warner that this debt is nondischargeable?

Mr. Goldblatt: Your Honor, Leonard Warner stipulates that the debt is nondischargeable as to him.

With respect to Mrs. Warner, it would remain our burden in bankruptcy to show that... that there is an act of fraud that is properly attributable to her, either because she committed it herself or by some principle of agency that it is nondischargeable because of her, so I... I don't believe that the... the stipulation by its terms is... is dispositive on the question of whether it is nondischargeable as... as to her.

Justice Ginsburg: But does that mean that... let's say the Fourth Circuit is affirmed, that you could still, post-bankruptcy, go after Mr. Warner because he stipulated that the debt as to him was nondischargeable?

Mr. Goldblatt: I... I believe that... that's a final and unappealable order at this point, and yes, that's right, of course.

Petitioners assert that they have the right as a matter of Federal bankruptcy law also to continue to recover on this debt as against Mrs. Warner, who also is an obligor on the promissory note.

On the essential point that, Justice Ginsburg, you were making with respect to the holding below, the description you offered is... is exactly right.

It is true that there is a novation.

It is true that the underlying claim of fraud has been released, but just... that was equally true in this Court's decision in Brown versus Felsen.

In Brown, the parties to a State court litigation resolved that litigation by agreeing to the entry of a consent judgment.

It was as equally true there, as it is here, that the parties who had been... whose litigation had ended in the consent judgment were barred, in that case by the preclusive effect of the consent judgment, here by the binding effect of the settlement, from bringing a new suit claiming fraud.

All they could do was enforce the consent judgment.

Nevertheless, this Court held in a unanimous opinion in Brown versus Felsen that in bankruptcy, the creditor nevertheless had the right to seek to establish that the underlying debt arises out of an act of fraud, and the... the reason this Court--

Justice Stevens: Well, of course, there it wasn't just the underlying debt.

It was trying to find out what the judgment actually decided.

They were... they were able to go beyond the terms of the judgment to determine what the judgment actually resolved.

I'm not quite sure it's exactly parallel--

Mr. Goldblatt: --Well, yes, Justice Stevens, that's right, and here what... what petitioners seek to do is go behind the settlement agreement--

Justice Stevens: --Yes.

Mr. Goldblatt: --and see what the settlement actually resolved.

Justice Stevens: Supposing the settlement... they had gone along with the settlement, and then they came up with a... a third proposal where the debtor said, I'm not sure I'm going to be able to meet my obligations, but I've got another proposal, we'll go in the joint venture to do something else and we'll release the contract claim and substitute a third, could you go... still continue to go behind to find out what the original source of the debt was?

Mr. Goldblatt: Yes.

Yes, Your Honor.

Justice Stevens: So even if, say, they had five or six different transactions, each of which purported to be a complete substitute for the deal they had just been unable to... you can always go... say, Well, the whole thing started because you cheated me out of something?

Mr. Goldblatt: Well... well, for each particular debt that one asserts is nondischargeable, the creditor bears the burden of proving in bankruptcy that that debt arises out of an act of fraud.

Justice Stevens: Directly or indirectly out of.

Mr. Goldblatt: That's right, but nevertheless, under Brown versus Felsen, that is the creditor's--

Justice Scalia: Suppose I have an indebtedness.

I'm running a business and I have one indebtedness, and in order to cover the payments for that indebtedness, I incur a second indebtedness which I otherwise would not have incurred, is that traceable to fraud?

Mr. Goldblatt: --If the original indebtedness arises out of an act of fraud, Justice Scalia, then... then yes, it is all debt--

Justice Scalia: Anything that happens later is... that... that wouldn't have happened but for the original indebtedness is, within the terms of the Bankruptcy Act, traceable to the fraud?

Mr. Goldblatt: --Justice Scalia, we... we certainly acknowledge that there must be some principle of, say, proximate causation.

Justice Scalia: Exactly, and that's all we're talking about here, isn't... isn't it?

How... how... you know, how far down the line do we carry traceable to, and does a novation end the traceability, but you... you have to acknowledge it has to end somewhere.

Mr. Goldblatt: There certainly is a principle of proximate causation.

You... you need to show that there is a direct connection between the act of fraud--

Justice Breyer: Wait, but what about... I mean, this doesn't make too much sense to me.

You say, A owes B $100,000 because of a fraud that A committed against B, so they settle it, and they say, our settlement arrangement is the following.

We enter into a new business called Macy's Department Store, and many years later there's another debt between the partners arising out of buying furniture for Macy's that has nothing to do with fraud, and now you're saying that that debt's going to be never dischargeable because the cause of Macy's was the fraud?

Mr. Goldblatt: --No, Justice Breyer, I'm not suggesting that there is never a point in which the causation becomes too tenuous that you can't prove that the debt that one is contending is--

Justice Breyer: No, I... absolutely.

Macy's would never have been created but for the debt, no doubt about that.

Mr. Goldblatt: --But not... not only is... is the principle of--

Justice Breyer: They never would have had this furniture argument but for the debt.

Chief Justice Rehnquist: Well, you're talking not just about cause, but proximate cause.

Mr. Goldblatt: --Exactly.

It's not just a question of but-for causation, but as in common law, proximate causation.

Justice Breyer: And what does that mean, proximate cause, then?

What's the difference between this case and Macy's?

Mr. Goldblatt: Your Honor, here, all that happened is that the... the form of the debt changed.

The parties entered into a settlement agreement in which they changed the debt from an unliquidated cause of action for fraud into a liquidated promissory note.

Justice Scalia: In... in connection with that, one side said to the other, I don't care whether this has come out of fraud or not.

Regardless of whether it came out of fraud, I'm going to give you this money, and we'll be quits.

Why isn't that enough to terminate the proximity, because the averment of both parties is, never mind fraud, it doesn't have anything to do with fraud, we're going to settle this.

Whether there was fraud or whether there wasn't fraud, you get the money.

Mr. Goldblatt: That... that's right, Your Honor, and all a creditor seeks to do in showing a debt as nondischargeable is seeks to enforce the debtor's promise to pay the amount of money given in that settlement.

Justice Scalia: That's true, but... but here it was... there was no acknowledgement of the fraud.

It was given with the averment that this debt does not hinge upon fraud.

This debt is just to settle this controversy between us whether there was fraud or whether there wasn't fraud.

Mr. Goldblatt: That's--

Justice Scalia: Why isn't that enough to terminate the proximity necessary for... for nondischargeability in bankruptcy?

Mr. Goldblatt: --Just a couple of... of answers.

First, it... it doesn't terminate the proximity any more than the consent judgment in Brown versus Felsen might have terminated the proximity in that case.

It's, of course, true that a... a consent judgment operates as a... extinguishes the prior cause of action and the claims merge into the consent judgment.

Nevertheless, this Court said in Brown versus Felsen that notwithstanding the preclusive effect of that judgment, a creditor has the right in bankruptcy to establish that the debt is traceable to fraud, and what it said is--

Justice Scalia: But doesn't a consent judgment always, at... always hinge upon the existence of a cause of action?

Mr. Goldblatt: --Presumably yes, Your Honor, and--

Justice Scalia: Whereas a settlement doesn't.

Mr. Goldblatt: --That's right, and unless the creditor can prove in bankruptcy that the debt that's now reflected in... in the settlement agreement is traceable to an act of fraud, the creditor will lose the nondischargeability action, and the only question is whether the creditor should have the opportunity to establish in bankruptcy that there is, in fact, an act of fraud that... that is reflected in and resolved by the consent judgment.

The consent judgment says expressly... it doesn't say there's no fraud.

It says that this is a compromise of disputed claims, and in exchange for the release, what the creditor got was a clear carve-out from that release for the right to enforce the $100,000 of debt that's reflected in the promissory note.

Justice Scalia: It doesn't say there's no fraud, but it does say that this indebtedness has nothing to do with whether or not there was fraud.

Whether or not there was fraud--

Mr. Goldblatt: That's right.

The settlement--

Justice Scalia: --this indebtedness exists.

It seems to me it severs the connection between the fraud and the indebtedness.

Mr. Goldblatt: --But it is completely silent on the question of whether fraud had occurred, just as the consent judgment in Brown v. Felsen was completely silent on the question whether that debt arose out of contract or fraud.

In Brown, this Court said that the creditor has the opportunity to look behind the fraud... to look behind the settlement to determine whether or not it was for fraud, and there... there's no difference here.

Your Honor--

Justice Souter: Would there be... would there be a difference if the settlement had expressly said, we stipulate that there was no fraud leading to the creation of the debt of... for which this in effect is a... a novation?

Mr. Goldblatt: --Justice Souter--

Justice Souter: Would that make a difference?

Mr. Goldblatt: --Justice Souter, that would be a much harder case for reasons we set out in... in our briefs.

We contend as a matter of bankruptcy policy there are reasons why such an agreement shouldn't be enforced, but that would certainly be a much more difficult case than this one.

Justice Souter: But your argument here is we don't really have get to bankruptcy policy.

There simply has not been an agreement which eliminates the fraudulent character of the debt.

Is that basically it?

Mr. Goldblatt: That's... that's exactly right, Justice Souter.

The way this works in bankruptcy is that when the creditor files for bankruptcy with this promissory note outstanding for a hundred-and-some-thousand dollars, the creditor comes into bankruptcy and files a proof of claim saying, I have a claim of a hundred-and-somethousand dollars, and I'm entitled to my pro rata distribution on that hundred-and-some-thousand dollars.

The proof of claim is on page 82 of the joint appendix.

No one's contending that the release bars the creditor from seeking recovery on the amount of that debt.

The only question is whether they can receive recovery in the full amount of the debt by showing it's nondischargeable, or whether they're limited to simply the cents on the dollar that the claim will pay in bankruptcy, because the text of the Bankruptcy Code makes clear that the form of the debt doesn't matter, that a debt... that under section 523, a debt can take any number of different... under... I'm sorry.

Under section 523 of the Bankruptcy Code, any debt, the code says, is nondischargeable if it's traceable to an act of fraud, and the code defines debt very broadly to include debts that are liquidated, unliquidated, reduced to judgment, et cetera.

It's quite clear the form of the debt doesn't matter, unless--

Justice Scalia: But the traceability does, and that's what we're talking about here, how traceable is traceable.

Mr. Goldblatt: --That's right, Justice Scalia, and with respect to that question there is... there is no difference between a consent judgment that is a final adjudication of the claims between the parties and a settlement agreement, both of which are equally preclusive, both of which are equally silent on the question of whether fraud occurred.

Unless the Court has further questions, I'll reserve the balance of my time.

Argument of Lisa Schiavo Blatt

Chief Justice Rehnquist: Thank you, Mr. Goldblatt.

Ms. Blatt, we'll hear from you.

Ms Blatt: Thank you, Mr. Chief Justice, and may it please the Court:

When a creditor settles a fraud claim without resolving the disputed issue of fraud, the creditor has the right to enforce the settlement debt for the full amount in bankruptcy by filing a proof of claim and by establishing fraud in response to the defense of dischargeability.

That conclusion is confirmed by Brown, which held that a creditor who settles a fraud claim by consent judgment may establish fraud in response to a bankruptcy--

Justice Stevens: But the real inquiry in Brown, as I read it, is can we go behind a judgment to see what was actually determined by the judgment.

It wasn't any emphasis on the settlement aspect of it, as I read the opinion.

Ms Blatt: --Right.

Justice Stevens: And I guess the holding is, yes, you may go behind a judgment to see what was decided, and that seems to me a little different from going behind a settlement.

Chief Justice Rehnquist: Well, didn't Brown decide two separate issues?

Ms Blatt: The Court in Brown did two things.

The court... the question of fraud was not litigated in Brown because the case was settled, and the Court mentioned in its last footnote that there would be a different situation if the question of fraud was actually litigated.

The question before the bankruptcy court in Brown is whether the money owed under that consent judgment was money obtained by fraud.

So, too, the exact same question is relevant here.

Justice Ginsburg: It didn't look to what the Court had decided, but what the claim was about, but here we have something in addition.

There is a judicial order.

There was a complaint filed, and it was dismissed as part of the settlement.

That complaint in the court action was dismissed with prejudice.

What effect should that have?

Ms Blatt: Not... a dismissal with prejudice following a settlement.

As this Court stated in Lawlor versus National Screen Service, it's cited in the reply brief at page 9, is that it has... does not have preclusive effect on the disputed issue unless the judgment is accompanied by specific findings on the disputed issue, and that's the classic requirement for issue preclusion or collateral estoppel, that the matter be actually litigated.

Justice Scalia: We're not talking issue preclusion, just... just as far as whether it suffices to terminate the traceability.

That... that isn't necessarily coextensive with... with whether there was issue preclusion.

Ms Blatt: No, the... the dismissal with prejudice doesn't impair the creditor's right to walk into court and sue to enforce the settlement debt, including the right to try to get the full amount of the settlement debt in bankruptcy, and on this issue of traceability, it... it is not only identical to Brown, but the code by its express terms disclaims any distinction between a liquidated debt and an unliquidated debt.

The settlement in Brown and the settlement here converts an unliquidated fraud claim into a liquidated claim to collect on the settlement debt.

Justice Stevens: May I... would you just clear up one thing for me?

Say the fraud claim was for $300,000 and the contract was... the novation was $200,000, in the bankruptcy court do you contend they can get the full 300 or just the 200?

Ms Blatt: No.

Under... under... he would be... the... the creditor would be bound by the settlement agreement under principles of State law that the amount of his debt would only be the $200,000.

Justice Scalia: It seems like a strange result, doesn't it?

Justice Stevens: I don't understand that.

Why shouldn't he--

Justice Scalia: --You conduct this big inquiry and find out that the guy's been defrauded of $300, and then that the settlement agreement really covers up a fraud and you say, Well, but you know, a deal's a deal.

Even though you defrauded him of it and the whole thing's traceable to fraud, we're only going to give you $200,000.

That's very strange.

Ms Blatt: I'm sorry, are you talking about the settlement agreement itself was procured by fraud?

Justice Scalia: No, no, no, no.

No, the settlement agreement was just an arm's-length agreement, but if you find that, in fact, the debt underlying that... that agreement was fraudulently obtained, having gone through all the trouble of determining that fact, why don't you make the guy cough up all the money that he got by fraud?

Ms Blatt: The Court... The Court addressed this very issue in Brown.

The creditor there did not get a fraud judgment for exemplary damages and special... special damages under State law.

He was limited to, in bankruptcy, of just seeking this settlement debt, and what the bankruptcy code does is, it gives the creditor a statutory right to render that settlement debt nondischargeable if fraud can be... can be shown.

You don't... and there's another way of looking at it, too.

The Court--

Justice Kennedy: But... but what's the policy reason behind that.

I mean, if... if what we're concerned about is vindicating the Federal policy that the... the Bankruptcy Code protects only honest debtors and not dishonest debtors, why not give them the whole $300,000?

I mean, I... I know Brown didn't do that, but why didn't it do that?

Ms Blatt: --The Court in Grogan... it's because of two issues, Justice Kennedy.

Under State... State law determines the amount of the debt that is owed, and there's just no question, at least I don't think that the creditor could make an argument that he's owed any more than $300,000.

He can't relitigate and try to get up to $600,000.

That's just governed by State law.

Justice Kennedy: Well, the Fourth... the Fourth Circuit says State law says that this is a novation, too, so... and you're... you don't want us to be bound by that interpretation of State law.

Ms Blatt: The... again, this Court in Grogan versus Carter said that State law determines the amount of the debt, and I just don't think the creditor would have a good faith argument that he could go beyond the settlement agreement, but on the question of nondischargeability, what the creditor is trying to do is collect the entire amount of the debt by... by showing fraud, and we think applying Brown--

Justice Souter: What their main argument, I think, on the other side is, you get a debt, that's what it is, a debt for money obtained by fraud, and this is not a debt for money obtained by fraud, this is a debt for money owed under a settlement agreement.

Now, the virtue of that is, it's a bright line, and what we're saying, I think, in the negative... the negative of it is that if you depart from that, well there's no end to it.

You have a settlement agreement, and no matter how long you go into the future, whatever it is, that... whatever it says you're supposed to do in that settlement agreement, it is.

Use the words proximate cause, use whatever they want, but it is a debt.

Where it comes from is the fraud.

That's where the source of the debt is, no matter what it says in that settlement agreement, and there's just no stopping place, no way to look into it, no attenuation forever, et cetera, so that's what I'd like you to here address.

Ms Blatt: --Well, this Court already crossed that bridge in Brown.

Justice Souter: Well, all right, so then maybe Brown was wrong.

Ms Blatt: But the second point is that--

Justice Souter: Maybe it was wrong.

Ms Blatt: --Whatever the limits of the traceability point, which this Court addressed in a separate decision, Cohen versus de la Cruz, which dealt with the traceability aspects--

Justice Breyer: There is no traceability.

There's never a problem.

Underlying this was the fraud.

Whatever it says in that settlement agreement is based on fraud.

Ms Blatt: --The code itself says that any enforceability obligation, whether or not it's liquidated or unliquidated or appears in a judgment, if you can prove that there has been a fraudulent acquisition of money, the resulting debt is nondischargeable, and that is--

Justice O'Connor: Ms. Blatt, what is your... what is the Government's position if the parties had expressly dealt with it in the settlement agreement?

Ms Blatt: --We think the right would be subject to waiver.

We don't think... we don't see anything in the code that would be--

Justice O'Connor: So you don't agree with petitioner's counsel that it's a harder case, but wouldn't give it up?

Ms Blatt: --We think the right can be waived.

What we do think, though--

Justice O'Connor: All right, now, the language in this particular settlement agreement gave up claims arising out of or relating to the matter of the State court litigation.

Was that not a waiver of this claim?

Ms Blatt: --No, it certainly wasn't a waiver of the right to collect on the debt, and in fact there's an express preservation of not only the right to collect all the obligations under the promissory note, but to collect the amounts under the settlement agreement, and we think to apply a contrary rule, the rule that the court below applied, would be unsound for three reasons.

It would force creditors and parties trying to settle a case to start negotiating over bankruptcy contingencies that are purely hypothetical, may never happen, and are entirely extraneous to the settlement.

The rule adopted by Brown also, our second point, is that it reflects the common sense and ordinary understanding that settlements preserve the creditor's right to enforce the settlement agreement and the statutory right to prove fraud to render the debt enforceable, notwithstanding bankruptcy, and that has been the premise of hundreds, if not thousands of settlement agreements entered into by the Government that do not refer to bankruptcy contingencies.

Third, to hold that those settlement agreements waive the creditor's rights in bankruptcy would render debts dischargeable even where the debtor committed fraud, and that result would undermine congressional policy to favor the rights of innocent victims of fraud over the perpetrators of fraud.

Justice Stevens: But you do agree that some fraud claims could be waived as far as the dischargeability, because you wrote the rights settlement agreement.

Ms Blatt: Yes, if there was an affirmative manifestation of an intent.

Justice Stevens: Why isn't that inconsistent with the statutory policy, just as this case would be?

Ms Blatt: Because there is a background presumption, Justice Stevens, that rights are subject to waiver, and so if there's an intentional relinquishment of a Federal statutory right, then a court can give that effect, but not only is there silence on that issue in this case, there is an express reservation of the right to enforce the settlement agreement, and--

Justice Stevens: To enforce the settlement agreement.

Ms Blatt: --Yes, and that includes--

Justice Stevens: But that's not a reservation of the right to sue for fraud.

Ms Blatt: --They're not suing for fraud.

They're suing to collect on the settlement agreement for the full amount in bankruptcy.

By asking the bankruptcy court, not only by filing the proof of claim, but to render the debt survivable and enforceable in bankruptcy.

It's no different than the settlement judgment in... in Brown.

Argument of Donald B. Ayer

Chief Justice Rehnquist: Thank you, Ms. Blatt.

Mr. Ayer, we'll hear from you.

Mr. Ayer: Thank you, Mr. Chief Justice, and may it please the Court:

I would like to make four points this morning.

The first one, to pick up on what Justice O'Connor said, I think there's a fundamental misconception in the question as it's presented and as it was described by Mr. Goldblatt this morning, and this conception is that what we're dealing with here is a categorical rule that says that whenever you have a settlement, because it's a contract, it bars any further pursuit of a nondischarge claim.

That is completely inconsistent with the holdings of the court below, all of which looked specifically at the language of the release and concluded that what had specifically been released was the right to pursue the claim under 523.

Second--

Chief Justice Rehnquist: This would have been a release in State court proceedings?

Mr. Ayer: --Correct, Your Honor, and... and that leads to the second point, which is that what is at issue here really is the interpretation of the language, the specific language--

Justice Ginsburg: There's no language about 523, which you just said--

Mr. Ayer: --That's correct, Your Honor.

Justice Ginsburg: --this is a standard settlement.

It's a compromise.

Neither side is admitting anything.

One side is not admitting fraud, and the other side isn't saying we've proved fraud.

It's just a zero on there.

Mr. Ayer: Well, Your Honor, I think what you said in terms of the language is certainly correct.

I think the important issue is that this is a settlement and, indeed, there is also a... a voluntary dismissal with prejudice in a State court case.

I would submit the proper analysis of that is to interpret the settlement under State law and then ask the question, is there some problem with Federal bankruptcy law that requires you to somehow override what's been agreed to or what's been done in State court.

Justice Souter: But isn't... isn't the problem with approaching it that way... I... at least, I think the problem with approaching it that way is that there is no State law analog to the issue that is being raised here.

In other words, under... under State law, there was a fraud claim, there was a settlement of the fraud claim, but there is no issue under State law about bankruptcy, and that is strictly a... a Federal policy--

Mr. Ayer: Well--

Justice Souter: --and I don't know how we get... we... we look to State law to find out whether there is doubt or not, but I don't know why State law should be a source of an answer to this Federal question, which is peculiarly Federal.

Mr. Ayer: --Well, I... I don't think, Your Honor, that it is the final answer, but it seems to me it's entirely possible for parties in a State court proceeding to enter into a settlement that says, and we hereby specifically release our 523 claim, and had that been--

Justice Souter: They... they might be able to... I mean, I'll assume for the sake of argument that they might be able to do that, but in... in that case, the... the issue here would be resolved, on... on your theory, certainly, by the express agreement with the parties, and they didn't do that, so we've got a case in which they didn't agree on the issue expressly, and I don't see why State law, which doesn't have the issue, is a good place to look for the answer.

Mr. Ayer: --Well, I think... I guess my point, Your Honor, is that the question of whether they expressly agreed to it becomes a question of interpretation, and I would like to get to arguing that they did, in fact, expressly agree to it.

The first--

Chief Justice Rehnquist: Well, didn't Brown versus Felsen suggest some discouragement to the idea of anticipatory litigation in State courts of issues that would arise in bankruptcy court?

Mr. Ayer: --I... I think Brown versus Felsen certainly expressed the view that they didn't want to encourage people to have to affirmatively determine fraud in State court when it had been, in fact, been... been... the issue of nondischargeability had been put into the bankruptcy court, but nothing in Brown versus Felsen in any way qualifies the proposition that parties can, in a State court proceeding, resolve, for example, by trial an issue of fraud that would be preclusive under collateral estoppel.

Chief Justice Rehnquist: You say it doesn't qualify the proposition.

It doesn't address the proposition.

Mr. Ayer: Correct.

Justice Ginsburg: Suppose--

Mr. Ayer: But it does, Your Honor, address it in the sense, and then Grogan confirms that collateral estoppel does apply, so that if you have a State proceeding--

Justice Ginsburg: --There's... there's no collateral estoppel here.

That argument absolutely dumbfounded me, frankly, because for collateral estoppel, issue preclusion, you must have raised, actually litigated, there must be a court determination of the issue, and that determination must be essential to the judgment.

You don't have any actual litigation here, so I don't know how you can--

Mr. Ayer: --Your Honor, under this Court's Matsushita decision, it is perfectly clear that in order to determine whether there's issue preclusion, you have to look at the State law in the State where the judgment is entered, and... and the State law, as we indicate in our brief, in North Carolina is that if you have a voluntary dismissal with prejudice under the Miller Building case, under the Barnes case, that voluntary dismissal with prejudice resolves the issues that were put in issue--

Justice Ginsburg: --The only decision that you cite from the North Carolina supreme court says, we go down the line with what is the standard understanding of issue preclusion, actually litigated, decided, and essential to the judgment.

Mr. Ayer: --Your Honor, I--

Justice Ginsburg: That's what the North Carolina supreme court said.

Mr. Ayer: --I disagree, Your Honor.

The... the Thomas McInnis case that you're referring to is a case where what actually happened with regard to the issue of whether prejudgment interest was available was that a husband, in litigating that issue, in fact, failed to timely raise it, and when he failed to timely raise it, the wife was subsequently collaterally estopped from pursuing it.

There's one sentence in the Thomas McInnis case that says, we apply the usual principles of collateral estoppel.

There are multiple cases, Your Honor, in North Carolina that are entirely clear that the rule is that if you have a voluntary dismissal with prejudice, that voluntary dismissal is determinative as though the matter, and this of... almost a quote, as though--

Justice Ginsburg: Well, that would certainly run entirely against the stream, and it would run against the Restatement of Judgments, which you cite, and that says you must manifest... yes, parties can make a stipulation finding.

They can do it in a consent judgment just as they can in the settlement, but they have to make that manifest.

Mr. Ayer: --Right.

Justice Ginsburg: The court does not infer that an issue that was never litigated was, in fact, decided.

Mr. Ayer: I guess what... what I would like to suggest to... to the Court is that what we do have here is a settlement of a State court litigation followed by a voluntary dismissal with prejudice, that the effect of that, of those acts, including the language, because that's what the courts here... all three of these courts focus specifically on the precise language, and they concluded that that language was a waiver.

I would submit that was--

Justice Souter: Well, if they concluded that it's a waiver of claim, and we don't have any... I presume no one has a problem with that.

The question is whether there is... is a waiver on the disputed fact issue, and... and my... my question to you is, you... you refer to the myriad State law cases that hold in your favor.

Is it clear that those are cases on issue preclusion--

Mr. Ayer: --Yes, Your Honor.

Justice Souter: --as opposed to claim preclusion--

Mr. Ayer: Yes, Your Honor--

Justice Souter: --or res judicata?

Mr. Ayer: --The... the Miller Building case and the Barnes case, both of those cases involved collateral estoppel.

It was invoked by a new party, and it was clearly based upon the fact that the... that the matter had been... in one case, it was a voluntary stipulation with prejudice.

The other was a voluntary--

Justice Souter: Well, was it a stipulation that... that expressly addressed the... the fact issue?

Mr. Ayer: --I don't believe you can tell from the opinion, and that's not, certainly, what they rely on.

The principle that is stated in those cases in a... in a categorical way, and I can... I can read it to the Court, is that... let's see.

Justice Ginsburg: May I read you the language from McInnis, which is the North Carolina supreme court?

It was not just simply a statement that, we recognize issue preclusion in its traditional guise.

It was, issue preclusion does not apply unless, quote, the prior suit resulted in a judgment on the merits, identical issues are involved, the issue was actually litigated, the issue was actually determined.

Unknown Speaker: Now, you're asking us to reject that as the law of the... North--

Justice Ginsburg: Carolina.

Mr. Ayer: Well, I... I think, Your Honor, there are... there are many Federal court cases that recognize that a matter which is not actually litigated in the sense that it went to trial and was determined after a trial or a fact-finding.

If the parties intend for a settlement agreement to be preclusive, and that is incorporated into a judgment, that will have collateral estoppel effect, and that's what happened--

Chief Justice Rehnquist: Well, are you relying on... I thought you were relying on North Carolina law.

Mr. Ayer: --We are.

I'm simply trying to point out that the notion that there is some sweeping, overarching general law that says it always must be actually litigated, that that, in fact, is not correct.

Justice Ginsburg: No, I... no, no, we made it plain, and I don't think there's any question here that the parties can stipulate, and the stipulation will have... will have the same effect as a finding, but, as the Restatement of Judgments points out, that must be made manifest.

You don't imply it from words that don't say, and we stipulate that this claim is going to be dischargeable in bankruptcy.

Mr. Ayer: Well, what... let me suggest to the Court a... a way in which this was clear.

First of all, I... I do really want to emphasize that... that all three of the opinions of the court below, none of them adopt this sort of categorical, it's a contract, therefore the right is waived approach.

That is not the issue in any of these cases.

They all look at the specific language, and they reason to the conclusion.

The... the court of appeals, for example, specifically said that, quote, a--

Unknown Speaker: Where are you quoting from, Mr. Ayer?

Chief Justice Rehnquist: What page?

Mr. Ayer: --Let's see, here.

Page 10a of the... of the appendix.

Chief Justice Rehnquist: Thank you.

Mr. Ayer: The petition appendix.

They said, in invoking the novation concept, it's necessary--

Chief Justice Rehnquist: Whereabouts on the page are you?

Mr. Ayer: --It's actually... I'm sorry, Your Honor, it's... it's 9a.

If you look at the end of the first paragraph, under the novation theory, courts need only address... wait a minute.

I'm sorry, the top of the page on 9a.

When following the novation theory, the terms of the settlement should be examined to determine whether the nondischargeability claims were released.

The rest of that page is an examination of the terms, and if you look over onto the next page, 10a, they quote the West case, which says, a promissory note does not discharge the underlying obligation unless the parties expressly release and substitute the new.

That is what these cases are all about, all three of them, and the question of whether the settlement released the claim is a question, I would submit, in the first instance... not in the last instance, but in the first instance, it's a question of State law, and--

Justice Ginsburg: I think there's no dispute that the settlement released the claim.

There's no dispute that there was a novation here.

There's no dispute that they no longer have the original fraud claim.

They have a claim only on the promissory note that they got as a result of the settlement, so it... they're... they're not claiming, oh, we can go back to the day we filed our fraud complaint.

They're saying, we have a debt here, a promissory note, and that is the sum total of what we can claim.

Mr. Ayer: --Right, but Your Honor, the... the holding of all the courts below went beyond what Your Honor is saying.

Justice Ginsburg: The words that you read--

Mr. Ayer: Well--

Justice Ginsburg: --are simply supportive of that--

Mr. Ayer: --let me... let me--

Justice Ginsburg: --but you can't... you can't get anything more than the amount of the promissory note that results from the settlement.

Mr. Ayer: --Well, let me refer the Court, for example, to 35a of the petition appendix, where it is stated that, quote, by including in the release future claims--

Chief Justice Rehnquist: What... what is this from, this is the opinion of the bankruptcy court?

Mr. Ayer: --This is the opinion of the bankruptcy court.

I'm just trying to... this was the consistent analysis in all of these courts.

By including in the release future claims, the court concludes that the plaintiffs effectively released and extinguished the dischargeability claim which they now seek to assert.

Justice Breyer: Well, that's a new, different issue than we granted, isn't it?

I mean, that's... the question, I take it, is, we're assuming there's a novation, there's a settlement, and fine, and that settlement says, I promise to pay $200,000, so it's a debt.

It's a debt for money, and the question is, is it a debt for money obtained by actual fraud?

Mr. Ayer: Well--

Justice Breyer: If so, how do we characterize that debt?

Mr. Ayer: --I--

Justice Breyer: You're saying it was, but it was released.

I... I don't see that we reach that.

Mr. Ayer: --Well, whether... whether this is a different issue than you granted, I guess... I... I agree that the question as it was presented in the petition--

Justice Breyer: Yes.

Mr. Ayer: --is most easily read as this broad, blanket rule.

That is not--

Justice Breyer: Well, I... I would assume that the text and the wording here that you're relying on, and the rule of the State about a novation and so forth, are... are prevalent, not universal, but are... are the standard form of... of settlement and release in almost every State, and apparently the novation rule is standard as well, so the... the result that you're asking us to reach is that this also forecloses any Federal characterization of this as being a debt incurred by fraud, and... and that's a very sweeping statement, and a very sweeping rule.

Mr. Ayer: --Well, I... I think... I think there is... I think the ultimate question, and the last question and the fourth question I'm hoping to get to, and I will get to now, is the question of, if... if you agree with me for purposes of argument that initially, you look to see what the State settlement does and, indeed, here also what the effect under State law of the voluntary discharge with prejudice is... voluntary dismissal with prejudice is, and... and you see, as these courts below held, that the effect is, in fact, to give up the right, then the question is, is there something about Federal bankruptcy law or policy that prevents parties from voluntarily agreeing to do that?

Justice Ginsburg: May I go back just one step?

Suppose this settlement had been entered as a consent judgment, just as was the case in Brown against Felsen, what then?

Mr. Ayer: I think it would depend, Your Honor, what was in the consent judgment.

Justice Ginsburg: Nothing.

The Court just enters... there's... the parties' settlement is incorporated in the consent judgment.

Mr. Ayer: I... I think it would become a question of whether, under the laws of the place where the consent judgment is entered, the fact that there's a settlement that is somehow appended to that order, if it's appended, whether that becomes limiting or defining of the terms of what's agreed to.

If all you have... I would agree with this.

If all you have--

Justice Ginsburg: Wasn't... in... in Brown against Felsen, there wasn't... the settlement was not on the record?

Mr. Ayer: --There's... there's no discussion, Your Honor.

In fact, what's pretty clear in Brown versus Felsen, and the critical difference between Brown and this case is that there was no... there was no kind of any release of a fraud claim.

You simply had the settlement, and the... the creditor got paid, and... and nobody had yet proven affirmatively that there was fraud.

What this Court said is, on those facts, you get to come in and prove fraud.

Justice Breyer: Okay, so you're... you're then conceding the following, is that right, that if, in fact, I owe you $300,000 because I cheated you by fraud, we then enter into a settlement which might be approved by the court, assume it is, and what that settlement says is, in light of what you claim I did to you, cheat you through fraud, I promise to pay $200,000, and you are conceding that that's all there is to the case, that that is nondischargeable?

Mr. Ayer: I... I am at least conceding that there's no waiver of the right to argue--

Justice Breyer: Well, I want to know on my... the facts I just gave you--

Mr. Ayer: --Well, it... it--

Justice Breyer: --in your opinion--

Mr. Ayer: --Your--

Justice Breyer: --is that 200,000 debt nondischargeable?

Mr. Ayer: --If it amounts to a clear concession that there was fraud, yes.

Justice Breyer: No.

What I'm saying is, you have the facts I gave you.

Mr. Ayer: Okay.

Justice Breyer: Remember what they were.

Mr. Ayer: In consideration of--

Justice Breyer: You said it was $300,000 obtained by fraud.

I said, I will settle that by entering into this piece of paper which says, I promise to pay 200.

Mr. Ayer: --I... I would say--

Justice Breyer: Approved by the court.

Mr. Ayer: --I would... I would say that that is non... that is not nondischargeable without affirmatively proving fraud, although you would--

Justice Breyer: There are... there are too many negatives in your statement.

Mr. Ayer: --Well, you--

Justice Breyer: I'm lost.

Unknown Speaker: [Laughter]

Mr. Ayer: --That leaves--

Justice Breyer: I give... remember my example.

I want to say, in your opinion, is that nondischargeable, yes or no?

Mr. Ayer: --It is not non... it is--

[Laughter]

It is not clear from the hypothetical that it is nondischargeable, but it is certainly not... you have the opportunity to come into bankruptcy court and prove fraud.

Your... your hypothetical does not establish fraud.

Justice Breyer: Oh, okay, but you're saying you have an opportunity--

Mr. Ayer: Yes.

Justice Breyer: --to prove the fraud?

Mr. Ayer: Absolutely.

Justice Breyer: And your case is different from that in... I gave in which respect?

Mr. Ayer: In the respect--

Justice Breyer: In the release?

Mr. Ayer: --In the respect that our case included language which was interpreted by all three of these courts as a release... under State law as a release of the right to go to bankruptcy court and pursue--

Justice Breyer: Fine, and the reason that's in the question presented is?

Chief Justice Rehnquist: Yes, it isn't in the question presented, that's what I thought.

Mr. Ayer: --The reason it's in the question presented is because it's... it is the holding of the case below.

Chief Justice Rehnquist: Well--

Mr. Ayer: The case below doesn't--

Chief Justice Rehnquist: --the... the question presented, Mr. Ayer, is whether a debt that would otherwise be nondischargeable becomes dischargeable if the parties enter a settlement agreement under which the amount of the debt is... it literally doesn't say anything about fraud or collateral estoppel.

Mr. Ayer: --That's correct, Your Honor.

I guess what I would say is that that question is--

Justice Scalia: You're answering the question.

You just want to answer it, maybe, right?

Mr. Ayer: --Well, that's right.

The answer is maybe, and it depends--

Justice Scalia: Sometimes yes, sometimes no.

Mr. Ayer: --and what it depends upon is, has there been a basis on which to conclude that that right has been given up, and the answer is that no such basis arises simply because there's a settlement contract.

We do not claim that, and neither did any of the courts below.

There... there's nobody here in this courtroom or in this case who says, that's the rule of law.

That you can say it's not the rule of law and everybody will agree with you, but that's not the issue in the case.

Justice Souter: Okay, taking your terms, everybody, I guess, agrees that if the settlement agreement said, we agree, the two parties, that there was no fraud involved in the creation of the debt which this agreement settles, that that would, in fact, be preclusive, that they could not, in fact, prove fraud and... and nondischargeability.

Why is the settlement here like the settlement I just described, because that, as I understand it, is your argument.

There's no legal difference between the settlement we've got here, which says nothing about fraud, and the settlement that I described in which fraud is expressly addressed.

Why are the two alike?

Mr. Ayer: Well, one reason why, and this... this gets back to my point that I think you have to take a State court settlement under State law first to understand it, this... this settlement, among the other language of releases which we've talked about, also includes language that commits to filing a voluntary dismissal with prejudice.

Now, as I've indicated, in order--

Justice Souter: Well, isn't... isn't that what any neither party settlement does?

Mr. Ayer: --Well, it may or may not, Your Honor, but in this case in North Carolina, under North Carolina law, under Miller Building and Barnes, when you file a voluntary dismissal with prejudice, it is as though the matter were litigated to a conclusion and the plaintiff lost, and--

Justice Souter: I thought that--

--So far as--

Justice Ginsburg: --I thought that was true, certainly true as far as claim preclusion goes.

Mr. Ayer: --Right.

It's--

Justice Ginsburg: It's claim-precluded, but you constantly mixed up--

Mr. Ayer: --Well--

Justice Ginsburg: --claim preclusion and issue preclusion--

Mr. Ayer: --Well, Your Honor--

Justice Ginsburg: --and yes, a voluntary dismissal with prejudice is preclusive of that claim.

You can never bring that claim again, but it resolves no issues.

Mr. Ayer: --Well, Your... Your Honor, that... that is the law in many places.

That is not the law in North Carolina, and I simply... I know this Court doesn't spend its time deciding State law issues, but--

Justice Ginsburg: I haven't seen a single North Carolina supreme court decision that so holds, that a voluntary... I thought that North Carolina rules, by the way, were based on the Federal rules with respect to the voluntary dismissal rule.

Isn't that so?

Mr. Ayer: --I... I think the rules are somewhat similar.

I've not studied them to know how precisely parallel they are.

Justice Ginsburg: And... and the voluntary dismissal is claim-preclusive but not issue-preclusive?

Mr. Ayer: Well, let me... let me just quote, because I... I've found it... the language in Miller Building and Barnes is that a voluntary dismissal with prejudice, quote, precludes subsequent litigation to the same extent as if the action had been prosecuted to a final adjudication adverse to the plaintiff.

Justice Souter: All right, Mr. Ayer, let's assume that that particular reason isn't necessarily going to persuade all of us here.

Do you have another reason to say that the agreement, the settlement here should be treated in law by this Court under the Bankruptcy Code just like a settlement that expressly says there wasn't any fraud?

Do you have any other reason?

Mr. Ayer: I think the language of the release is quite clear.

The language of the release talks about releasing any and all rights, including future rights.

Unknown Speaker: Well, but it's a question of Federal law as to whether that includes a nondischargeability claim.

I mean, that's what we're here to talk about, and I think that's--

Mr. Ayer: Well, let me--

Justice Kennedy: --that's going to be the same in every State, which is what I've asked.

The very first question we asked, or I asked, was whether or not this was a rule depends on the... the vagaries of the law of North Carolina or not.

Mr. Ayer: --Well... and let me suggest, Your Honor, that... that in order--

Justice Kennedy: And I would... I would have to agree with what Justice... Justice Ginsburg seems to be indicating, that this... that what you're saying is that there's issue preclusion as to an issue that's never been litigated.

Mr. Ayer: --Well, and the parties--

Justice Kennedy: That's astounding.

Mr. Ayer: --But I think we know under Arizona v. California and other decisions that parties can do that if they in... if they indicate an intention to do it, and the question is, have they done that here.

Let me--

Justice Scalia: Can I ask... this... this puzzles me.

Is it, indeed, a question of Federal law whether a contract which... which gives up all future rights in connection with this claim includes... whether... whether the contract includes the right to claim nondischargeability?

Mr. Ayer: --No, Your Honor.

Justice Scalia: Is... is that a Federal question or a State question?

Mr. Ayer: I think... I believe it's not, and I really feel--

Justice Scalia: What do you... you think it's a question of State law?

Mr. Ayer: --I believe it's a question of State law.

Justice Scalia: It's a question of Federal law what the consequence--

Mr. Ayer: Correct.

Justice Scalia: --of that State contract is.

Mr. Ayer: Absolutely.

Justice Scalia: Okay.

Mr. Ayer: And let me address, if I could, what I view as the logical way to think about this.

Once you have a State contract that is given meaning under State law, the question is, is that somehow to be modified or overridden in light of Federal bankruptcy policy, and what we have here, on the other side, I think, are two different views.

We have one view of the petitioners that it can never be done, there's no way, bankruptcy policy won't allow it, and the other view of the Government is that, well, you can do it if it's clear enough, and then you get into nice questions of what, I guess, our Federal common law--

Chief Justice Rehnquist: Your view, Mr. Ayer, would simply encourage anticipatory litigation of issues that might arise in bankruptcy, which I think Brown suggests is not a good idea.

Mr. Ayer: --Your Honor, I think all... all our approach does is allow parties to enter into settlements to be given what effect they have.

Chief Justice Rehnquist: Well, but, I... I think here, too, probably there's general agreement.

If in so many words you say in the State court settlement, I waive my right to claim nondischargeability in bankruptcy, probably everybody would say, or a majority would say yes, but you don't have that here.

Mr. Ayer: Well, what it... I mean, I guess the next question would be, what else might be adequate, and do you really want to develop a... a body of Federal law.

Let me, if I could, just point to the arguments on the other side why this should be treated as essentially a Federal override of State law interpretive principles is based first upon citation of a number of express provisions of the Bankruptcy Code which have nothing to do with the subject and, I think, prove the opposite point.

There's a whole section on debtor reaffirmations which set up detailed procedures that the bankruptcy court enforces to make sure that debtors don't get taken advantage of, and they are specific, and they're clear, and the bankruptcy court follows them.

That's an occasion for the bankruptcy court to get involved.

There's the idea that the automatic stay cannot be voluntarily given up.

Again, that's the product of specific language that creates an automatic stay to protect the debtor and has 18 itemized exceptions, specific language.

There... they invoke the preference provisions which let, of course, the bankruptcy court go back into transactions that occur prior to bankruptcy, and look at them on very specific terms set forth in section 547.

They talk about the fraudulent conveyance section does the same thing in a slightly different way, but there are no such provisions whatsoever with regard to waivers of section 523 claims.

Section 523 claims are something that the creditor loses if he does not affirmatively file within 60 days of the first meeting of creditors.

There are no protections with regard to that in the code, and if... if something isn't filed, they disappear.

Indeed, the whole idea that creditors are... that... that the issues with regard to nondischargeability under (a)(2), (a)(4), (a)(6), and (a)(15), are made a matter of exclusive Federal jurisdiction, the reason for that, and your case and Brown talk specifically about that, is because creditors were abusing the process by pursuing them.

This is not a protection for creditors.

This is a... a way of making sure creditors don't come in after bankruptcy and basically put the screws to... to debtors who have gotten a discharge.

What language there is... and we talk about this in both the briefs, I think specific language runs counter to this.

We talked in the briefs about (a)(11) and (a)(19), which specifically mention settlements, and I would submit the better interpretation of that language is to say, in those instances where the language specifically says that any settlement may give rise to a nondischargeable claim, is to allow the bankruptcy court to go back in and look at those facts even if the right to a nondischarge... right to pursue nondischarge was given away.

I think the bottom line is that the arguments on the other side relate to a series... they don't relate to any language of the code, other than the much overbroad idea that it... that it's any debt, and of course that doesn't mean that a party can't be foreclosed from litigating the 523 claim because he's already lost it in State court, so any doesn't mean absolutely every.

The policies that are invoked are, first, the honest but unfortunate debtor policy, but nobody here, I think, seriously suggests that a party can't give the thing away, give the right away if they want to, and so I think... give the right to pursue the 523 action away by clear enough language.

That seems to be the... the petitioner I think disagrees with me, but other than that, I think the better view is that they can, and I don't think this Court in any of its cases has ever suggested that the honest but unfortunate debtor policy forecloses relying on prior resolutions under State law.

Collateral estoppel certainly applies, and we think settlement language that's clear ought to apply.

They claim that allowing this is some sort of a trap for the unwary.

It would be a trap if the rule were this categorical rule that says, boy, you enter into a settlement contract, you lose your 523 claim.

That's not the issue in the case.

The issue is, does the language here support the... the idea that the... the right to pursue the 523 claim has been given up, and to hold parties to the State law effect of releases that they sign is no trap for the unwary.

That's how we do litigation in this country every day.

Justice Stevens: Mr. Ayer, may I ask you this question: You started out telling us you were going to make four points.

I know what one, two, and four are, but I'm just curious as to what three was.

Mr. Ayer: Three was the State law point.

I... I guess... three was the point that when you look at State law here, the reading of... the fair reading of State law does, indeed, support the State law rulings of all three of the courts below, and point four, of course, is that there's no reason in Federal law to go back and say no, we have to second-guess that.

Justice Kennedy: I... I suppose after this case, no matter which way it goes, you can have an Archer clause in... in the settlement agreement.

I... I've never seen a settlement agreement in which the parties agree that it's going to be nondischargeable.

As a matter of common course, do these clauses appear in contracts, or--

Mr. Ayer: I'm not aware of it, Your Honor.

They certainly can if they want to.

Justice Kennedy: --I know they can.

Chief Justice Rehnquist: Thank you, Mr. Ayer.

Mr. Ayer: Thank you, Your Honor.

Rebuttal of Craig Goldblatt

Chief Justice Rehnquist: Mr. Goldblatt, you have 4 minutes remaining.

Mr. Goldblatt: Okay.

Thank you.

I only have four points.

First, with respect to the State law question of preclusion, we say in our reply brief on pages 7 and 8 that that issue had been waived.

I don't want to belabor that point, but I... I will point out that the brief respondent filed in the court of appeals, which is... which is, of course, in the record here, states State law correctly.

There, on page 29 in the court of appeals respondent said, there is no issue of collateral estoppel in this case because there have never been any evidentiary findings.

We submit that's a correct statement of State law.

None of the North Carolina cases cited by respondent involved a case in which a settlement agreement is given preclusive effect.

Second, with respect to the language of this particular release, it would certainly present a harder case if you had a situation which the release said, we give up all of our rights in bankruptcy, and in the event you file for bankruptcy, we will not make any effort to collect on the debt.

This release is quite far from that, and expressly preserves the right at all points to recover on the amount that was promised in the promissory note, and this Court's opinion in Brown makes clear as a matter of Federal law that what a nondischargeability action is is simply an action to enforce the obligations that were promised as part of the settlement.

Finally, the question of the form of the debt, and whether the form of the debt drove the decision below, there... the Court of appeals certainly does say... and this is in the joint appendix at page 8... I'm sorry, page 9a, footnote 8.

It explains quite clearly that a basis for its decision is the notion that the creditor was substituting the tort claim, the fraud claim for a contract claim and rests its decision on that basis.

The consequence of that decision would be that from the creditor's perspective, if a creditor has an unliquidated claim, and this applies not only to claims for fraud but, say, an injury caused by drunk-driving, any of the categories of nondischargeability, if you have an unliquidated claim and they file for bankruptcy, you can contend its nondischargeable.

If, on the other hand, you've litigated all the way to judgment, under Brown you can say in bankruptcy, even if the judgment doesn't say what it's for, that that's nondischargeable.

It would create an anomalous situation in which the middle category, cases that are resolved in settlement agreements that don't resolve the question of liability, the rights in bankruptcy to show nondischargeability is given up, and because the code makes clear that the form of the debt is irrelevant to persons of dischargeability, and because this Court's decision in Brown versus Felsen is essentially indistinguishable from this case, we submit the decision below should be reversed.

Justice Scalia: It's rather unfortunate, Mr. Goldblatt, that there's nobody in the room to defend the position that I understood was taken by the question presented, namely that a novation... a novation is all you need.

I think that's, at least, an arguable position, but... but nobody... nobody seems to want to--

Mr. Goldblatt: We agree that... that--

Justice Scalia: --discuss the issue on... on which we took the case.

Mr. Goldblatt: --Your Honor, we... we agree, as we say in our reply brief, that the principal basis of the decision below has been abandoned by respondent here, and we believe it's been abandoned because it can't be squared with this Court's decision in Brown versus Felsen, which holds squarely to the contrary.

Chief Justice Rehnquist: Thank--

Justice Ginsburg: --What about the (a)(11) and (a)... the 19, the express provisions for nondischargeability?

Mr. Goldblatt: Your Honor, what Congress was doing in... in sections (a)(11)... I... I see my time has... has run out, but what Congress was doing in (a)(11) and (a)(19) was giving preclusive effect--

Chief Justice Rehnquist: Thank you, Mr. Goldblatt.

The case is submitted.

Attribution:

The Oyez Project

Featured:

FCC v. Nextwave Communications, Inc. - Oral Argument

Fri, 09 Jan 2009 14:50:38 +0000

Case:

FCC v. Nextwave Communications, Inc.

Media File:

01-653_20021008-argument.mp3

Related Transcript:

transcript.xml

Transcript:

Argument of Paul D. Clement

Chief Justice Rehnquist: We'll hear argument now in Number 01-653, Federal Communications Commission v. NextWave Personal Communications and a companion case.

Mr. Clement.

Mr. Clement: Mr. Chief Justice and may it please the Court:

Congress has directed the FCC to use auctions to allocate scarce wireless spectrum in a manner that furthers the public interest.

Those auctions allocate spectrum to the party who will... who values the spectrum most highly and, by assumption, will use it most effectively to serve the public.

In addition, Congress has directed the FCC to consider a number of specific factors in assessing the public interest, including promoting opportunities for small business and ensuring the rapid deployment of wireless services.

Nothing in that public interest regulatory regime runs afoul of section 525 of the Bankruptcy Code.

To be sure, in administering its auctions the FCC does place consequences on the regulatory signals provided by the failure to meet regulatory payment deadlines.

In particular, the FCC views the failure to make a timely regulatory payment as a proxy for a determination that continued possession of the license is not in the public interest.

Justice Kennedy: But your point is, is that the regulatory discretion and authority of the agency has been replaced under the statutory scheme in large part by the dynamics of the free market.

The highest bidder shows us which is the most qualified person.

Mr. Clement: That's right.

It's been replaced in large part but not exclusively, and I think both aspects that are important--

Justice Kennedy: Well, as to the first part, isn't the Bankruptcy Code and the policy of new start and creditors and so forth, isn't that really part of the free market structure?

Mr. Clement: --Well, I think there's a difference, though, when a regulator regulates solely for timely payment for its own sake, and in that case it implicates only the policies that are addressed by the Bankruptcy Code, and I think it's a different situation when the regulator looks at the failure to make timely payment as a proxy for something else.

Chief Justice Rehnquist: Well, but Mr. Clement, in your petition for certiorari, the question presented speaks of an obtained option automatically canceled.

That suggests that it is indeed automatic.

Mr. Clement: Well, it's automatic in the sense--

Chief Justice Rehnquist: I mean, automatic means without any discretion.

Mr. Clement: --With respect, Justice, Chief Justice Rehnquist, when it says automatic, what it means is that it cancels without any, the need for any further action from the commission, but in any given case, the cancellation of a license is a result both of the automatic cancellation rule and the fact that a payment deadline has come forward, and where the commission has discretion is in relaxing the payment deadline, and you can see that in this very case.

NextWave's license is canceled, according to the FCC, because NextWave failed to make the very first installment payment due under those licenses.

Now, according to the licenses in the first instance, that payment was due on April 30, 1997, but the licenses didn't cancel on April 30, 1997 because the commission in its discretion, as part of a multifactor public interest determination, extended the payment deadline a full 18 months.

Justice O'Connor: Well, Mr. Clement, it appears to me that the FCC went along with the bankruptcy filing, filed a claim for the amount that wasn't paid, and apparently went along with the proposals for a while to work this out and then, very shortly before the decision to reauction the things, the FCC decided not to go along with it.

That doesn't sound like some automatic cancellation.

I mean, the FCC appeared to treat it very much like the bankruptcy claim for quite some time, didn't it?

Mr. Clement: Well, to be sure, the FCC participated in the bankruptcy proceedings and protected its interests as a creditor, but at the same time it has independent interests as a regulator, and the FCC, as we point out on page 19 of the reply brief, made clear at various points well before NextWave went into bankruptcy that it did not view bankruptcy as an exception from the regulatory provisions of the Communications Act, and I think if you look at the specific event that NextWave points to as the automatic cancellation, it's the failure to make a payment that was due on October 29, 1998, and it was due on the 29th of October, 1998, rather than April 30, 1997, precisely because of a public interest determination by the commission.

Justice Souter: You say a public interest determination, but the only correlation that seems clear to me is a purely economic correlation.

When the value of the leases dropped, the FCC apparently went into the Bankruptcy Court and said, we want our full $4 billion, and when the value of the leases went up, the FCC took the position, we want to reauction them and get the increase in value.

It seems at each point at which the FCC made a decision, it was making an economic decision, not a regulatory decision.

Mr. Clement: With respect, Justice Souter, I don't think that's correct.

When... I mean, it is true that the FCC tried to go in and protect its interests as a creditor, but at the point that NextWave was trying to keep its regulatory licenses that it promised to pay $4.7 billion for, and trying to keep those licenses for just over a billion, the result of that process would have been that the rest of that amount, the $3 billion plus, would have been an unsecured claim of the FCC, that would have been really worth virtually nothing, so I think the better way to understand this case is that the FCC does have interests as a creditor, and it has tried to protect those interests in the bankruptcy proceedings and has participated in those proceedings, but at the same time, it has interests with the... as a regulator, and in its capacity as a regulator it hasn't acted in a way that would result in a sole-cause cancellation.

Justice Scalia: Mr. Clement, suppose... and I consider this a classic case for what this provision of the Bankruptcy Code was directed to.

Suppose you have a State law that says anyone who is in default of traffic tickets that amount to more than $500 shall have his license revoked, okay, and the person in question goes into bankruptcy, doesn't pay the $500, gets the $500 discharged in bankruptcy, the State you think can revoke his license?

Mr. Clement: No, I don't, but let me give you--

Justice Scalia: Why not?

Isn't there a regulatory purpose there?

Mr. Clement: --No.

The only regulatory purpose there, at least as I understand your hypothetical, is in providing for timely payment, but suppose a State--

Justice Souter: No, the regulatory purpose is having financially responsible drivers so people don't run around the road hurting people and leaving them to bleed on their own account.

Mr. Clement: --Well--

Justice Souter: There's just as much a regulatory purpose in that hypo as there is here.

Justice Scalia: You can always find a regulatory purpose.

I mean, it's the easiest thing in the world to do.

Mr. Clement: --But again, but if a State had a regulatory purpose in ensuring that its drivers were financially responsible, and presumptively said that a license would fail to cancel for the failure to pay $500 in traffic tickets, but provided a mechanism for the driver to go in before the regulatory commission and say, look, I know I haven't paid $500 worth of traffic tickets, but I'm actually financially responsible.

I have a ton of money in the bank, and so you ought to give me a relaxation of the rules or a waiver--

Justice Scalia: There's always such a mechanism whenever you have a debtor and a creditor.

The creditor can always extend the payment.

Mr. Clement: --Right, but--

Justice Scalia: You need some special power from the State to do that?

Mr. Clement: --Well, but again, if you look, and what the regulator is doing is extending the... extending the payment not as a creditor, but as a regulator, I think you're in a very different situation.

Justice Scalia: So you're just making up a regulatory purpose, as a regulator.

I mean, as a regulator, as a creditor you can always say it's being done as a regulator, always.

Mr. Clement: I really don't think that's true, with respect.

I think the kind of waiver proceeding or opportunity to relax the rules would be out of place in a regulatory regime that was only concerned with timely payment.

It's precisely because the FCC uses the timely payment, or the failure to make timely payment, as a proxy for a public interest determination that it has this waiver proceeding, and it gives the regulating entity--

Justice Ginsburg: That's something that I don't fully grasp in your argument.

First you say, this is fully automatic, this cancellation of the license.

You don't pay up, license gone.

But then you say, but we can extend the time if we want to.

We can use our discretion.

Well, the automatic argument seems at war with the discretion argument.

Mr. Clement: --Well, I mean, there is some tension there, and the FCC has been at pains to try to make sure that it doesn't bend over one way too far or the other.

In its restructuring order that I think is critical in this case.

It froze the payments... it suspended the payments ultimately for 18 months, and then it also provided some restructuring options that required further modifications of its rules.

Chief Justice Rehnquist: Well--

Mr. Clement: When it did that--

Chief Justice Rehnquist: --Go ahead.

Mr. Clement: --When it did that, not only did some people complain that they didn't give enough regulatory relief, but other disappointed bidders ran to the D.C. Circuit and said, look, you've acted arbitrarily and capriciously because you haven't stuck with your pre-auction rules.

Chief Justice Rehnquist: But this doesn't sound at all like the question presented, which says at auction, automatically cancel upon the winning bidder's failure to make timely payments to fulfill its winning bid.

It... when you were drafting that question, it sounds like your perception of the thing was quite different than it is now.

Mr. Clement: Well, again I think the key is, the payments do cancel automatically after all the efforts to get the payments extended have failed, and that's just not like a hypothetical consideration in this case, because in this very case--

Justice Stevens: I agree, you've said two different things there.

If it's automatic, it happened without whatever happened next.

But you're saying it automatically canceled after attempts to collect failed.

Mr. Clement: --No, no, not after attempts to--

Justice Stevens: So when was the automatic trigger?

Mr. Clement: --The automatic trigger is when somebody fails to make a payment--

Justice Stevens: All right.

Is that enough?

Mr. Clement: --And... no, it's really not enough, if you look at the broader perspective of the regulation, because there's an alternative way to get out of the automatic cancellation.

It's not... if you're a regulated entity and you don't want your license to cancel, you don't go to the commission and say, don't apply the automatic cancellation.

What you do is, you go to the commission and you say, I've a regulatory payment.

It's going to be due April 30.

I'm not in a good position to make that payment, so what I'd like you to do is relax the payment deadline, and--

Justice Stevens: And you say you have the authority to relax the payment date?

Mr. Clement: --Not only does the commission have the authority to do that--

Justice Stevens: If that's true--

Mr. Clement: --it did it in this very case.

Justice Stevens: --If that's true, why don't you settle the case today?

They say they can pay in full today.

Mr. Clement: Well, the reason we don't settle the case today, although obviously there were efforts to try to settle this, which would require congressional legislation, which we were unable to get in a timely fashion, but the reason that they are not in a position to cure their defaults, if you will, is because our view is that they have... the opportunity to cure has passed.

The licenses have actually already--

Justice Stevens: But is the option to cure... if you wanted to settle, would you be disabled from settling, or could you settle, decide, well, we think it would be wise regulation now to accept the payment?

Mr. Clement: --I think it would be within the agency's discretion to settle the litigation at this point.

Now, of course, if we did that, I'm sure, as in the last time the commission tried to relax its rules, I'm sure we'd draw a D.C. Circuit challenge to that exercise of discretion to relax the rules.

But the very fact that there is that reservoir of discretion to relax the rules demonstrates that the ultimate cancellation is not a sole-cause cancellation.

Justice Scalia: I think... so it is really a legal issue, whether you have that discretion or not?

I mean, there are people who say you don't have that discretion.

Mr. Clement: Absolutely.

Justice Scalia: Well, do we have to decide that in this case?

I didn't realize that was one of the issues presented.

That may be a more important issue than the, you know, few billion dollars involved here.

Mr. Clement: Well--

Justice Scalia: Right?

Unknown Speaker: [Laughter]

Mr. Clement: --But I don't think... whether or not the FCC has the authority to exercise that discretion in a particular case might be an issue, but it's undisputed that they have that right as a general matter and, in fact, NextWave wouldn't be here today if the FCC didn't have the authority to offer discretionary relaxation of its rules.

When NextWave's--

Justice Scalia: Well, you might not be here, but I mean, we're just assuming that it had that.

The case is here.

That is not one of the questions presented.

I frankly don't want to decide that question, because that is not one of the things I've given a lot of attention to.

It sounds to me very, you know, at least quite arguable whether they ought to have that authority.

Mr. Clement: --Well, Justice Scalia, I don't really think it's in dispute, because in this very case the payment deadline--

Justice Scalia: I agree it's not in dispute, which means we don't have to decide it.

It's not presented in the case.

Chief Justice Rehnquist: --the question.

Mr. Clement: --Well, I--

Justice O'Connor: Mr. Clement, the respondent also makes a right-to-cure argument under the bankruptcy law, and you haven't addressed that, I take it, in your briefs, anyway.

Mr. Clement: --No.

We think the right-to-cure argument is best addressed on remand.

I do think there are two reasons why the right to cure is not any longer available to NextWave.

One is that the licenses automatically canceled on their own terms.

The second reason is that the license restriction, the licenses themselves had a restriction on transfer or alienation, and there's law under 11 U.S.C. 365 that deals with executory obligations that says that the debtor in possession cannot take possession of a license, assume the obligations of a license if there are restrictions on its alienation or transfer.

Justice Kennedy: In FCC practice, have you ever revoked a license and then decided that you're going to reissue it to the initial holder?

Mr. Clement: Well, there have been situations like that, not necessarily in the C-Block license situation, but there was a situation with respect to a different program where a license canceled by its own terms by a failure to renew, and the commission renewed that license largely on the basis of the fact that that licensee was already providing service, and so the result of revoking the license would be to deny people service that was currently being provided.

Now, in the reconsideration order that's the subject--

Justice Kennedy: Well, a reconsideration order is different, but a new issuance it seems to me is quite questionable so far as the discretion of the agency, and I think I agree with some of my colleagues, I'm not sure that's before us.

Mr. Clement: --Well, I think that particular instance is particularly relevant, because NextWave relied on that in its reconsideration proceedings before the commission.

And the commission, in rejecting that, I think demonstrated why this isn't a case of sole-cause cancellation.

If you look at the commission's reasoning on page 82a of the petition appendix, the commission says, quote,

"NextWave is providing no service. "

"The spectrum licensed to NextWave has gone unused since early 1997, and represents licenses in 90 markets across the United States. "

Chief Justice Rehnquist: But that same order repeatedly refers to the automatic cancellation rule.

Mr. Clement: Absolutely, it does, and what the commission decided in this order, which is under review in this case, is that it was not going to relax or provide an exception to the automatic cancellation rule, but the reason it decided that is because NextWave wasn't providing service, and that others stood ready to provide service under that spectrum, and what I would respectfully suggest is that under those circumstances the cancellation is not a sole-cause cancellation.

It also reflects the fact that NextWave wasn't providing service, that others stood ready to do it, and that's enough to take it out of 525, which is, after all, a very narrowly written provision.

It only protects against sole cancellation.

It allows the failure to pay a dischargeable debt to be a contributing factor in a regulatory decision, indeed, the primary factor in the regulatory decision, just not the sole cause.

Justice Stevens: May I ask just one question about your interpretation of the automatic cancellation?

Is it the commission's view that they could... there would be a cancellation, they could reauction the licenses, and that the original licensee would still remain liable for the entire debt?

Mr. Clement: I think the position is they might have an opportunity to go after that as an unsecured debt in bankruptcy.

Justice Stevens: Yes, but they would remain liable for the entire debt, in your view?

Mr. Clement: That's true.

I'd like to reserve the remainder of my time for rebuttal.

Justice Souter: Well, may I just follow up on that?

I mean, I assumed that was not an issue here because they had auctioned them off again and they had mitigated their damages.

Is that the way the commission treated it?

Mr. Clement: That's an open question before the commission that they haven't addressed.

Thank you.

Argument of Jonathan S. Franklin

Chief Justice Rehnquist: Very well, Mr. Clement.

Mr. Franklin, we'll hear from you.

Mr. Franklin: Mr. Chief Justice, and may it please the Court:

The question in this case is whether section 525 of the Bankruptcy Code permits a bankrupt company and a bankruptcy judge to override the FCC's regulatory determination of the public interest and thereby allow the company to retain an exclusive entitlement to use the Nation's airwaves that the FCC and Congress have determined is not in the public interest for it to hold.

Chief Justice Rehnquist: You refer to it as a regulatory determination which, of course, assumes the whole point at issue.

Mr. Franklin: Well, I don't think it... I think that that, in fact, is undisputed as this case comes before the Court, that the FCC had valid regulatory reasons for taking the action it did.

Chief Justice Rehnquist: Then why is it phrased in terms of an automatic cancellation rule?

Mr. Franklin: Because the automatic cancellation happened in November of 1998, but one cannot look at that as a mere snapshot.

You have to look at the reasons why the FCC had that rule and the reasons why the FCC had their auction--

Justice Scalia: Why do you have to look at the reasons?

I mean, that's what troubles me.

The language of the statute simply says that a governmental unit may not revoke a charter, franchise, or other similar grant, okay... it goes on, solely because--

Mr. Franklin: --Right.

Justice Scalia: --such person is or has been a debtor, blah, blah, or hasn't made a payment.

Solely because.

Mr. Franklin: Right.

Justice Scalia: Now, let's assume that there is a Federal statute that makes discrimination because of, or failure to hire someone, or let's say, let's say killing someone solely because of his race--

Mr. Franklin: Yes.

Justice Scalia: --a crime, a separate crime.

And someone, let's assume he kills someone who is Jewish, and he said, well, I didn't kill him solely because he was Jewish; I killed him because I disagree with the policies of Israel.

Does that get him out of the statute?

Mr. Franklin: Well, I'm not aware of a statute like that, that says, solely because--

Justice Scalia: Oh, I made it up.

Mr. Franklin: --I know that, but--

[Laughter]

But it's important.

The section 525 is drafted... is an antidiscrimination statute, but it's drafted differently than other... title VII, for example, does not use the word--

Justice Scalia: I'm getting to the question of whether the fact that you have some other motive--

Mr. Franklin: --Yes.

Justice Scalia: --eliminates the sole causality.

The only reason this person was killed was because he was Jewish, and so also here, the only reason this license was terminated is because the person hadn't paid.

Now, there may be some regulatory motive in the background, just as in the hypothetical that I invented there was some international political motive in the background, but that doesn't alter the fact that the person was killed solely because he was Jewish, and it seems to me that the license here was revoked solely because the payment hadn't been made.

Mr. Franklin: With respect, Your Honor, the term because, when it is used in antidiscrimination statutes, and we have cited cases on page 3 of our reply brief, is used to mean motive.

Because means, for the reason that.

That's what the definition of the word, because... when Congress drafted section 525, it drafted the statute narrowly.

It intended to prohibit arbitrary--

Justice Scalia: Then the statute doesn't cover anything, because every regulatory body that cancels a license, whenever there's a license involved, you can say that there is some regulatory motive, as in the hypothetical that I gave to Mr. Clement.

Mr. Franklin: --Well--

Justice Scalia: The motor vehicle cancellation.

Mr. Franklin: --I think that... under section 525, the mere fact that an agency has said it has a regulatory motive is not sufficient.

It has to be a valid one that is not simply an arbitrary attempt to collect a debt, and, Your Honors--

Justice Souter: Okay, can... on that point, do you agree that the statute is a response to... the Perez case, the automobile cancellation?

Mr. Franklin: --Yes.

Justice Souter: There was a regulatory motive there.

The regulatory motive is financially responsible drivers.

The benefits of that are obvious.

Mr. Franklin: Well--

Justice Souter: So if that situation is supposed to be covered by the statute, then by a parity of reasoning, so would this one be.

Mr. Franklin: --But in Perez the Court examined that motive and determined that looking at the statute and looking at the way it operated, in fact, as the Court put it, the sole emphasis of the statute was not the regulatory purpose.

It was... as the Court said, the sole emphasis was the collection of debts.

Justice Souter: Okay, then sole emphasis and sole purpose really boils down not to exclusiveness but a kind of proximate or principal causation theory, and if that's the case, certainly here the FCC treated the debtor relationship as the principal determinant of the various steps that it took.

First, it insisted on its 4 billion, then when the market changed it said, forget it, we want to reauction, and if it's a principal or proximate kind of causation theory, I don't see how you can prevail.

Mr. Franklin: I don't think that section 525 embodies a causation theory in the way that Your Honor is postulating.

I think that section 525 most specifically speaks about which are the valid considerations that an agency can look at, and in this case one needs to look at the auction system that Congress established.

Congress intended to replace the cumbersome comparative hearings and unjust lotteries of the past with a new, more streamlined mechanism under which an entitlement to use our airwaves, everybody's airwaves, is allocated to the person that, or the company that values it the most, and the way we know that is that they must make good on the promises embodied in their auction bid.

Justice Souter: Then why doesn't automatic mean automatic?

Your brother has just explained that automatic means sometimes.

Mr. Franklin: Automatic--

Justice Souter: It means automatic without teeth.

Mr. Franklin: --Automatic means automatic, although there are opportunities, as--

Justice Souter: Automatic except where it isn't.

Mr. Franklin: --Well--

[Laughter]

Our position in this case is that the cancellation was automatic, but that it was supported by valid regulatory concerns, and those concerns... I mean, the auction system mandated by Congress would be completely vitiated if a bidder... and I represent people that, companies that are repeat players in this game.

Bidders cannot come in and obtain an entitlement to use our airwaves by promising that they will make a payment, and that's the reason why they're selected--

Justice Ginsburg: Then Mr. Franklin, why didn't Congress provide an exception, as it did in, for perishable commodities for the Department of Agriculture?

Mr. Franklin: --Well--

Justice Ginsburg: If there is this nonbankruptcy overriding concern, then we have one example where Congress responded to it by saying the bankruptcy provision isn't going to prevail.

Mr. Franklin: --Well, I... no exception was needed here.

The agriculture programs allow the Secretary of Agriculture to do what the FCC may not do here, and that is to cancel a license solely because of a failure, a bankruptcy status.

Now, if you look at the statutes that are cited in our reply brief, the agriculture statutes, they allow the Secretary of Agriculture to terminate an agricultural license where somebody has been discharged from bankruptcy, ever in the past, or even if a partner or a shareholder of a company has been discharged from bankruptcy.

Now, the legislative history of that specific exemption makes clear that Congress... there was a debate in Congress as to whether the solely because language would cover that, whether there was a regulatory purpose or not, and Congress felt like they didn't want to have to deal with that.

In this case, however, it is undisputed there was a valid regulatory purpose, and with respect, Justice Scalia, I do not--

Justice Scalia: Of course, nothing in the Federal Communications Act requires the Federal Communications Commission to stand as the guarantor, you know, to hold the bag for the person that they're giving away this multibillion-dollar license to.

They could require cash on the barrelhead, couldn't they?

And let the person who wants the license get a loan from some bank, let them be stuck holding the bag.

Mr. Franklin: --But even in that--

Justice Scalia: So there's no regulatory necessity for this whole tragedy, is there?

Mr. Franklin: --No, with respect, if one looks at a cash-on-the-barrelhead system, the way the FCC auctions work, and our clients are deeply involved in them, one does not get the license right after becoming the high bidder.

There is a period of time in which the FCC has to look at various factors and people have the right to file petitions to deny.

Under NextWave's interpretation of section 525, which prohibits an agency from denying a license to anyone for failing to pay a dischargeable debt, under their interpretation the FCC would be required to grant a license to somebody who has been declared the high bidder and then declares bankruptcy the next day.

What NextWave is doing here is truly gaming the system.

They are saying, it's a heads I win, tails you lose scenario.

We can go into bankruptcy, we get the license because we promised that we would pay more than anybody else would--

Justice Ginsburg: May I stop you in your hypothetical, because I thought you don't get the license till after you have make the down payment.

Mr. Franklin: --You make a down payment, and NextWave made their down payment.

Justice Ginsburg: Yes, but they didn't have any license until they did that.

Mr. Franklin: But what I'm saying is, even on a cash-on-the-barrelhead system the FCC does not require full payment, it can't require full payment until they actually grant the license, and that is a several-month lag between the time when you're declared the high bidder... in one case, in my client's case it was more than a year after they were declared the high bidder for licenses, and they actually received them, because of proceedings that were filed.

Justice Kennedy: The rationale offered by the commission here was that the policies of the FCC outweigh the policies of the Bankruptcy Act.

Is there authority for us to defer to the commission in making that kind of a determination?

I mean, why don't we defer to the Bankruptcy Court, which says the policies of the Bankruptcy Act are more important than the policies of the--

Mr. Franklin: I don't think that the FCC has deference in interpreting the Bankruptcy Code, but I don't think it's a question of whether one policy outweighs the other.

I think--

Justice Kennedy: --Well, that's the explicit rationale of the commission.

Mr. Franklin: --Well, our rationale--

Justice Kennedy: That's what it said.

Mr. Franklin: --Our rationale is that they can be harmonized, and should be harmonized.

For example, the exception, the regulatory exception to the automatic--

Justice Kennedy: So that you don't defend the rationale offered by the commission?

Mr. Franklin: --I'm not sure that that is the exact rationale, but we think that the policies can be harmonized and should be harmonized.

Argument of Donald B. Verrilli, Jr.

Chief Justice Rehnquist: Thank you, Mr. Franklin.

Mr. Verrilli.

Mr. Verrilli Jr.: Mr. Chief Justice, and may it please the Court:

The record is clear that the FCC revoked NextWave's licenses solely because NextWave deferred a payment to the FCC while reorganizing in bankruptcy.

Two and a half years ago the FCC blocked NextWave's bankruptcy reorganization, and it did so by announcing that NextWave's licenses had automatically canceled because NextWave had deferred a loan payment to the FCC in 1998.

Justice Scalia: What do you mean, had deferred it?

Mr. Verrilli Jr.: Well, because NextWave--

Justice Scalia: You mean, failed to make it?

Mr. Verrilli Jr.: --It did not make it, yes.

It did not make it.

Justice Scalia: Why don't we say that?

Mr. Verrilli Jr.: It did not make it--

[Laughter]

--in 1998.

Justice Scalia: There might have been some legal mumbo-jumbo that had caused the payment not to be due.

Mr. Verrilli Jr.: Well, we were reorganizing in bankruptcy--

Justice Scalia: You didn't pay it.

You didn't pay it.

Mr. Verrilli Jr.: --and we did not pay because we were reorganizing, that's right.

Now, throughout the proceedings in this case the FCC has never identified a ground, other than that single nonpayment, that would support revocation of the licenses, and that's because there isn't one.

What the FCC has done instead, and what it's done here this morning, is to instead suggest that section 525 of the Bankruptcy Code ought not apply because the FCC had a regulatory or public interest purpose for making a nonpayment an automatic sole trigger for revocation of a license, but in passing the Bankruptcy Code, Congress already weighed the public interests, and section 525 of the code is a clear expression of Congress's judgment about where the public interest lies.

Justice Scalia: But they say it's not automatic.

What do you say to that?

Mr. Verrilli Jr.: I think the record utterly and completely refutes that proposition, and it does so in the following ways.

The regulation that they cite, which is 1.2110 of their rules, and it's at page 495 of the appendix to the petition, says that the licenses cancel automatically upon nonpayment.

The face of the license says that the licenses cancel automatically upon nonpayment and for no other reason.

The announcement of the license cancellation in this case in January 2000 said that the licenses canceled automatically for nonpayment and no other reason.

Justice Ginsburg: But we know how the commission has interpreted it.

I mean, they did say, we're going to give you a moratorium.

We're going to give you a chance, and we'll make a deal for you.

You give back some of those licenses, and we'll work out a settlement, and for one year the FCC said, it's okay if you don't pay while we're considering some kind of settlement, so--

Mr. Verrilli Jr.: Yes, Justice Ginsburg, in the restructuring orders they did do that, but that doesn't make the revocation any less automatic.

All it did was move the date back in a legislative, quasi-legislative rulemaking, move the date from when it would initially have occurred to a later time.

When--

Justice Ginsburg: --But if there had been such a settlement, then there could have been some, at least, licenses retained even though there had been the nonpayment, which is supposed to be an automatic trigger.

Mr. Verrilli Jr.: --Well, yes, Justice Ginsburg, but the date was suspended by the FCC well in advance.

The payment date was suspended well in advance of its occurrence, so a payment date never came and went without NextWave or any other licensee failing to make a payment.

All that happened here was that in advance of the payment date, the FCC moved the payment date, but when it did so, it reaffirmed--

Justice Scalia: There had not been a failure to make an earlier payment?

Mr. Verrilli Jr.: --That's exactly right, Justice Scalia.

This was suspended in advance of the due date for the first payment.

Justice Scalia: Okay, so--

Justice O'Connor: --Mr. Verrilli, let me ask you about something else.

The bankruptcy court, as I understand it, ordered a $3.7 billion reduction in the purchase price on constructive broad grounds, is that right?

Mr. Verrilli Jr.: That is right, Justice O'Connor.

Justice O'Connor: And if we were to affirm here, does the FCC have any power to prevent a bankruptcy court from reducing the price in that fashion?

Mr. Verrilli Jr.: Yes.

Justice O'Connor: That's very strange.

Mr. Verrilli Jr.: Yes, it does, and it's already been taken care of, in fact.

The question under the avoidance provisions of the Bankruptcy Code is when the debtor's obligation becomes due, and the issue here was whether the obligation became due on the date of the auction or, instead, later, at the time the licenses were awarded.

Now, that is a matter entirely within the control of the FCC.

All they have to do is make clear in their regulations when the obligation attaches.

The reason that there was a problem here was that the regulations suggested that the obligation attached later and, therefore, if the value of the asset declined from the time of the initial auction to the time of the license award, section 544 would apply.

But the FCC has changed its regulations, and at this point it is unambiguous that the obligation attaches at the time of the auction--

Chief Justice Rehnquist: Well, didn't the--

Mr. Verrilli Jr.: --and therefore 544 can't operate.

Chief Justice Rehnquist: --apply to the bankruptcy order in that case?

Mr. Verrilli Jr.: --and it did.

It's just a nonissue.

It's just... that issue is just a nonissue, and in any event it isn't... the question really here is whether the FCC, when it effectively acts as a lender, is going to be treated any differently than a private company when it acts as a lender.

Justice Breyer: That is the question.

That's my question.

As I read the statute, it seems to me, for at least your argument's sake, it is solely because, and moreover, of course this statute governs the FCC, but in reading the statute, I don't see how this statute was at all intended to govern the instance in which the Government is acting as creditor in respect to receiving payment for a good that it has sold.

Now, I base that on first reading the purposes of this in the history, and reading the whole legislative history, which will not convince some of my colleagues, but nonetheless is a factor in what I think, and I think that this is clearly about a future loan, a future situation in which the future situation, the Government is forbidden to discriminate against a human being because he was once in bankruptcy.

This seems to be to balance, to bring back into balance the Government vis-a-vis the private creditor.

If you're right in your interpretation, and I am wrong, I see no way whatsoever in which the Government would have the right to take a secured interest or in any other way collect a debt which a human being owes it for buying a license.

Now, that's my question.

I want to get your response.

Mr. Verrilli Jr.: My response is the following, Justice Breyer.

First, the text of 525 is unambiguous.

It applies to someone who is or was a debtor, and it applies to debts that are dischargeable, as well as those that have been discharged and, therefore, it is clear on the face of the statute that it applies and protects companies while they are reorganizing and before the debts are discharged, so I think on the face of the statute that's... it's not correct.

It's not the right reading of the statute.

And in terms of what it does in operation, it's this.

Now, if... if this had been a situation where the FCC had demanded cash on the barrelhead up front, and NextWave had gone and bid and gone out and borrowed that money from a bank, and had to pay the bank over time, and then filed for bankruptcy, there would be no question that that, that the debt to the bank could be reorganized and disposed of in the normal manner in bankruptcy.

Justice Scalia: Well, I'm not sure about that.

I think if you accept the FCC's argument here, they would say we have a regulatory purpose, because we want it... we want these licenses to be given to people who have the financial responsibility to operate the radio stations and so forth.

The arguments they made would continue to apply to that situation.

Mr. Verrilli Jr.: Well--

Justice Scalia: So I wouldn't say there's no question.

Mr. Verrilli Jr.: --That's a--

Justice Scalia: I think if we accept their argument here, we would probably have to accept it in the other situation.

Mr. Verrilli Jr.: --Well, I think if we... well, I think that that point is exactly right, Justice Scalia, that the Government's regulatory purpose argument, if accepted, would give them the authority to revoke licenses not only when the payment was not made to the Government, but not made to private parties.

Justice Breyer: So far, I'm trying to get the answer to my question, and so far, in terms of my interpretation, the second point you made is in terms of to the applicability, if my interpretation is right.

I want to know if it's right, and I only come up with one thing that you've said so far, which is text, which is important--

Unknown Speaker: [Laughter]

Justice Breyer: --but I learned the second year of law school, I learned the second year of law school... and obviously many of my colleagues don't agree with me, but I learned the second year of law school that when you have a text which says "all", that there are often implied, not-written exceptions.

All animals in the park.

No animals in the park doesn't necessarily apply to a pet oyster, okay, and so--

Chief Justice Rehnquist: --Well, it's not an animal.

Justice Breyer: Thank you.

An oyster in my course in biology is an animal, all right.

Unknown Speaker: [Laughter]

Justice Breyer: Maybe in yours it was a rock, or a vegetable or a mineral.

But regardless, you see my point, and my question, of course, is that since that's how I read statutes... not everybody... is that I find exceptions implicit in statutes where to fail to read that exception is to destroy the purpose of the statute, and is not backed by anything in respect to what the people who wrote it want.

Mr. Verrilli Jr.: Well--

Justice Breyer: Now, I believe it destroys the purpose of the statute because I see no way in which the Government as creditor could collect the money it's owed through a secured interest in what they've sold, if my interpretation is wrong.

Mr. Verrilli Jr.: --No, it--

Justice Breyer: Now, I'm putting that as strong as I can.

I want to get a complete answer.

Mr. Verrilli Jr.: --Two points.

First, the Government can collect its interest as a secured creditor in exactly the same way a private lender could through the bankruptcy system.

It has enormous protections through the bankruptcy system as a secured creditor.

It gets, it's 100 percent entitled under the Bankruptcy Code to the full value of the licenses, and it has numerous other protections under the code.

It can make an election under--

Justice Breyer: Can I stop you right there?

How does it do that?

Because when it goes to enforce its secured interest, I take it it's revoking the license because of the money that was due it.

And so how do you... when you go in to enforce your secured interest in the bankruptcy court, and the bankruptcy judge on the other side reads 525(c), 525 on your interpretation, how does he do it?

Because it's just like this case.

They're revoking it.

Mr. Verrilli Jr.: --You can't... the FCC, like a private lender, can't foreclose on the lien.

It has to... its debt has to be processed through the bankruptcy system.

Justice Breyer: Of course it should.

That's logical.

My point is, how does the bankruptcy judge at that point get around the language of 525, on your interpretation of it, since on your interpretation of it, you would be taking back the license because of failure to pay a debt.

Mr. Verrilli Jr.: Right.

They can't... under the Bankruptcy Code they can't take back the license.

They can get their secured claim paid to the same extent that a private lender could, but they can't--

Justice Breyer: So they cannot take a secured interest in the license?

Mr. Verrilli Jr.: --Yes, they can, and... but just as--

Justice Scalia: They don't take the license back if they cause the debtor to have to sell the license and to take the money from the sale of the license and give it to the FCC.

Isn't that what's going on?

That's different from a cancellation of the license.

The license subsists, and the debtor can sell it to somebody else, or the bankruptcy court on behalf of the debtor can sell it to somebody else, is that right?

Does that need approval from the FCC?

Mr. Verrilli Jr.: --The transfer would, to somebody else would need approval from the FCC, but the key point here is that section 525--

Justice Scalia: But that's different from a cancellation, isn't it?

Mr. Verrilli Jr.: --Yes, it is different from a cancelation, and the key point here I think, Justice Breyer, in answer to your question ultimately, is that 525 is in the Bankruptcy Code to protect the right to reorganize.

What it says is that those who hold Government licenses cannot be denied the ability to invoke the bankruptcy process and reorganize solely because they do what the Bankruptcy Code allows them to do.

Without this protection, licensing agencies would have the ability to force insolvent debtors to liquidate, because it would have the power to revoke their permission to do business solely because they hadn't paid a debt, or solely because even they were in bankruptcy, and that would--

Chief Justice Rehnquist: Can the FCC... can an FCC licensee encumber the license?

Can it pledge the license to some... to a bank that's giving it a loan?

Mr. Verrilli Jr.: --Yes, it can.

It can give it as a... it can... the answer to that is yes.

There are some restrictions on it, but the answer to that is yes, it can.

If I could, I'd like to get back to the question of whether this was, in fact, an automatic revocation, and the reconsideration order, which is the order under review here, is the order in which the FCC says principally that it departed from the automatic character of the revocation, but that reconsideration order says no fewer than 14 times by my count that the revocation was automatic, and there's one statement in that in particular which I think should put to rest as a factual matter the question of whether this was anything other than an automatic cancelation, and that's at page 74a of the appendix to the petition, and it's right at the bottom of the page, before the footnote.

And the FCC says in the reconsideration order, thus, the only way that NextWave could have avoided the loss of its licenses, even under the rule interpretation it urges, was to have avoided default by making full and timely payment on or before the payment due date.

If the only way that NextWave could have avoided default was by making the payment, then there is nothing else that could have been shown, and nothing else that could have happened in the reconsideration process or any waiver process, that would have provided an additional ground for revocation.

And if I could also point the court to a statement on the prior page, page 73a: For all these reasons we reject NextWave's interpretation of our default and cancellation rules and reaffirm that the failure to make full payment in a timely manner, following exhaustion of all applicable grace periods, constitutes a default and results in the automatic cancellation of the license without further commission action.

Their theory is that this happens by operation of law on the day after nonpayment.

It is as automatic as anything can be, and nothing about the reconsideration process, and nothing about their waiver authority changes that one iota.

Justice Ginsburg: Well, at least according to this presentation the FCC said that it does have discretion to grant relief from the automatic cancellation.

Mr. Verrilli Jr.: Well, but they said in the reconsideration order that they were not going to do that, ever, because it was an automatic cancellation.

They also said in the restructuring orders, Justice Ginsburg, that you referred to earlier, in each of the restructuring orders they said they would not grant a waiver of the payment deadline under any circumstances, and then when individual licensees sought waivers, the FCC rejected the waiver requests, and it cited back to those provisions in the restructuring order saying, we told you this was an automatic rule, and we reject your request, and it did so even in instances, in two cases where the licensees were providing service.

And so there's just no question that this was an automatic cancelation rule and therefore precisely at the core of what section 525 forbids the FCC or any other licensing agencies from doing.

If I may, I want to turn to the question of whether there is any conflict between the FCC's exercise of its authority under section 309(j) and the Bankruptcy Code.

The answer is, as a statutory matter there is no conflict, because the FCC was not required to have an installment payment plan, and even if it were required to have one there wouldn't be a conflict because Congress didn't say that the FCC had to make license revocation automatic upon nonpayment.

So the FCC's argument really is an implied repeal argument here, that 309(j) implicitly repeals 525 in some applications, but--

Justice Kennedy: Assuming we think there's a conflict, is there any authority for the agency's assertion that it has the authority to determine which statute outweighs the other?

Mr. Verrilli Jr.: --Yes, and the authority is exactly contrary to the position that the FCC deserves deference.

The FCC deserves deference only with respect to interpretation of its own statute, not with respect to the Bankruptcy Code.

So the answer is clearly that they don't get any deference, and... but there isn't any conflict.

All there is is the FCC... there isn't any statutory conflict.

All there is, the only conflict arises from the FCC's desire to make this an automatic cancelation rule, and the conflict is between an FCC policy choice and a directive from Congress.

When the conflict is at that level, there's no doubt about what the answer is, which is that the directive from Congress prevails.

Justice Scalia: If they just simply changed their rules to say the FCC "may" cancel the license in the event of the nonpayment of any installment, that would be enough?

Mr. Verrilli Jr.: No.

Justice Scalia: No?

Mr. Verrilli Jr.: No, because what 525 forbids are the grounds on which the license is revoked, so if the license is revoked solely because of nonpayment of dischargeable debt, then whether there's a rule or not--

Justice Scalia: Oh, it isn't solely because of that.

That is a necessary but not a sufficient condition.

the FCC would be saying, we will consider the regulatory situation.

If you fail to make a payment, you are revocable, but we won't revoke necessarily.

It depends upon the regulatory situation.

Mr. Verrilli Jr.: --I think that would violate 525, but for a different reason.

Justice Scalia: Ah, okay.

Mr. Verrilli Jr.: And it's this.

525 doesn't merely forbid revocation for nonpayment.

It forbids discrimination, and it forbids imposing conditions solely because of nonpayment, solely because of being in bankruptcy, so--

Justice Ginsburg: What does the word "solely" do?

I can follow what you just said if it simply said because of, but Congress wrote solely, and that has to have some function.

Mr. Verrilli Jr.: --I think it does have several functions.

For example, Your Honor, the FCC has a build-out rule for these licenses, says you have to build them out within 5 years, and to serve, a requirement that we were in compliance with, by the way.

But if we hadn't been in compliance with them and the FCC had moved to revoke the licenses because we weren't in compliance with the build-out rule, and we had said, well, the reason we are not in compliance with the build-out rule is that we're in bankruptcy and we can't pay the vendors to build it out, that would be a situation in which the FCC could enforce its rule, even though at some level it is because we were in bankruptcy.

It's just not "solely" because.

It's because we violated a neutral rule that was not focused solely on nonpayment.

And I think there would be other circumstances in which the fact of nonpayment could be a consideration in a broader or a different... in a broader or different set of circumstances.

But when you have what you have here, is where it is the only consideration, the only factor, the determinative consideration, that is the paradigm case of violation of 525.

What the FCC has done, it's--

Argument of Laurence H. Tribe

Chief Justice Rehnquist: Thank you, Mr. Verrilli.

Mr. Tribe, we'll hear from you.

Mr. Tribe: Mr. Chief Justice, and may it please the Court:

Clearly, we're dealing in 525 with something that is an exercise of regulatory power, and as several members of the Court have noted, it's always possible to say, even though we are revoking or canceling this license automatically because you didn't make the payment, we have other motives in mind, responsible, financially responsible drivers on the road.

We are not simply out to get you because of the dollars.

That's, of course, not what this statute is about.

The whole point of the Perez decision was to get rid of Kesler and Reitz, which required peering into the mind of the bureaucrats, not always a wonderful vision to behold, and not clear.

This is a causation provision, and let me turn to Justice Ginsburg's question from the perspective of creditors who need to be able to rely on a bright line test of whether something was done solely because of nonpayment of a dischargeable debt, or solely because of insolvency, or solely because of an invocation of Chapter 11.

The word solely, I think, does serve a function there, and that is, in its absence I suppose it would be possible for a licensee in regulatory default, a licensee who hadn't built out, to hide behind the existence of a fiscal default and say, you see, it's because of the fact that I didn't make a payment, not because I didn't build out.

Then one has a complicated mess, and from the point of view of creditors who need to know whether an agency is going to pull out the lifeline without which this entire edifice collapses and is just a bunch of hardware, not worth anything more than the separate parts, from the point of view of creditors who need to know, it seems to me a very clear test is needed, and that is, was this the sole trigger?

Have they come up with some other substantive, independent basis which either was the necessary cause or a sufficient cause?

That's what the D.C. Circuit said, and it makes sense.

Justice Stevens: Mr. Tribe, what do you say in response to Justice Breyer's point that the statute really deals with a situation in which the Government agency is not the creditor?

That's what it basically was--

Mr. Tribe: Well, I... in a way, I think that that makes our point all the stronger, that is, even when the agency has no conflict of interest, it might not be in it for the money, and one wonders here why, for example, why they don't yank the license when the debt is owed to private creditors?

Doesn't that show in just the same way that they're not reliable?

That is, in this very case--

Justice Breyer: --No, no... well, they want their money is all.

Mr. Tribe: --Well, money--

Justice Breyer: They want their money, but there are taxicab licenses, there are nuclear power licenses... licensing is the most common thing in the world.

You often pay for it, and what I really am worried about is, imagine they took a secured interest in the license, and on your interpretation, how do they get the taxicab license back--

Mr. Tribe: --Well--

Justice Breyer: --which the guy never paid the $100,000 for?

Mr. Tribe: --the license on my interpretation--

Justice Breyer: Yes.

Yes.

Mr. Tribe: --does not cancel and at confirmation the license is one of the assets of the estate, and at that point--

Justice Breyer: Well, they could get it back... in other words, they could take it back because they didn't revoke it.

Mr. Tribe: --No, they don't take it back.

That is, when... there are a number of things in the estate at confirmation.

Justice Breyer: I'm a creditor, I'm a private creditor, I say I have a secured interest in this, it's mine, okay.

I sell it at auction.

Now, the FCC--

Mr. Tribe: I'm sorry, Justice Breyer.

The bankruptcy court is filled with elaborate rules about when you can and cannot foreclose.

That is, an asset is part of the estate at confirmation, and whether you're going to be able to get your money back is a function of whether you are under or oversecured.

There are provisions in 1111(b) for dealing with both situations.

Your situation is no worse when you are a regulator than the Bank of America, or one of the clients in our case, Citicorp, and no better.

Justice Breyer: --That's the part that's precisely bothering me, my situation is no worse.

When I read the statute, it seems to me my situation is worse, because if the statute applies here, it applies there, and you and your colleague both tell me no, that isn't so, and if you can show me it isn't so, my problem disappears.

Mr. Tribe: What I'm saying, Justice Breyer, is that after bankruptcy, if NextWave, for example, were to emerge from bankruptcy they would still have the license, but only on conditions in which you as the FCC, like other creditors, in light of your secured interest, had taken an appropriate piece of the pie.

You don't get it all, that's the point.

Nor does a private creditor get to grab the license and all the value from all the other creditors and, in fact, when you are an agency that is wearing really two sets of shoes, the ordinary regulator's running shoes but also the wing tips of the creditor agency, it makes the situation worse, not better.

That is, this law is designed to assure that even the agency, which does not have a monetary interest, can't simply yank all the value for itself because it has the power over this license.

If the agency, on top of all that, is a creditor and has that additional set of incentives, then it's all the worse.

You wonder, for example, why it is that in the MMDS licenses, in which there are licenses that are held by a number of bankrupt licensees who did not make the payments they promised to make, why it is that the FCC does not regard them as not having been what they looked like at the time of the bid.

The reason is that it's been paid in full.

So it really is a situation in which the FCC's position as a creditor should not redound to its credit.

If anything, that makes this statute all the more vital.

The capital formation that is necessary to make 309(j) work, to make it possible, Justice Scalia, sometimes not to demand all the money up front, but to have something more creative, maybe demand letters of credit, guarantees, none of that can work if creditors who put in over half a billion dollars, not in a gamble but on a very careful business plan that was completely carried out, they're not providing service, but Catch-22, it's because their attempt to emerge and fully cure any default was frustrated by the agency that saw pie in the sky, large numbers.

In that situation, for the agency to be able to collapse the capital formation here tells us something rather unpleasant about the future.

How likely is it that Citicorp and the California and Kansas pension funds and all of the other organizations that have put money in on reliance on the way section 525 works will do this again next time around?

The formation of capital, the market on which the FCC chose to rely, choosing to rely in the capacity of a first lender, with no more or less secured protection than others, that whole system depends on, in the most literal sense, the rule of law.

It does not depend on the question whether we can attribute to the regulator some motive that does not relate solely to the money.

So if the system is to work the way the FCC claims, 525 is a dead letter.

Now, if you were right, Justice Breyer, if there really was a problem that couldn't be solved in the way the confirmation rules work, in the way the pie is divided up, then maybe, as with perishable commodities, there would be a problem for Congress to solve.

Congress has in section 523 enumerated 18 categories of debts that are not dischargeable in bankruptcy, and sometimes it does it in another statute, not always in the Bankruptcy Code.

These are policy judgments about whether something is unique about the situation that requires treating the Government in some different way, the way the Department of Agriculture is treated.

Chief Justice Rehnquist: Thank you, Mr. Tribe.

Mr. Tribe: Thank you.

Rebuttal of Paul D. Clement

Chief Justice Rehnquist: Mr. Clement, you have 3 minutes remaining.

Mr. Clement: Thank you, Mr. Chief Justice.

Let me first address Justice O'Connor's very proper concern that licensees are going to be able to enjoy their licenses for much less than they agreed to pay the commission.

That is not a dead letter and, in fact, one of the cases that is being held for this case involves Kansas PCS, where the bankruptcy court approved the plan that gave the FCC 5 cents on the dollar for the value of its licenses.

Now, it's true that one mechanism to get the licenses for less than they paid for, the fraudulent conveyance theory, is something that the FCC can address.

That was the GWI bankruptcy, where the FCC only got 16 cents on the dollar.

But there's a second way to do it, which is to only give the FCC the value for its security interest, the value of the licenses at that point, and the bankruptcy court did that in Kansas PCS, and only gave the commission 5 cents on the dollar.

Second, let me address Justice Kennedy's concern with, where's the authority for the FCC to take into account bankruptcy policy concerns?

The authority comes from a D.C. Circuit decision called LaRose, which is cited on page 79a of the decision, the reconsideration decision that's under review.

The LaRose decision is a D.C. Circuit decision that tells the FCC that it must take bankruptcy policy considerations into account.

Now--

Justice Scalia: It's not binding on us, certainly?

Mr. Clement: --Well, it is binding on the FCC, though, and the FCC tried to do its best to take bankruptcy considerations into account.

Now, if it failed to do it properly--

Justice Kennedy: But this, they're saying that they're not going to take bankruptcy considerations into account.

Mr. Clement: --No, they did.

They did, and again I think they... one of the reasons they took bankruptcy considerations into account is by extending payments for all the C-Block licensees for 18 months.

But if you think the problem here is that the FCC didn't do the right balancing of bankruptcy policy and telecommunications policy, then the D.C. Circuit or this case could reverse for an arbitrary capriciousness, but that's not the role of 525.

525 is an exceedingly narrow provision that simply prevents a regulator under any circumstances from canceling a license solely because, and here it's just not true that the failure to make a payment was the sole trigger, because you have to look at it in context, and what triggered default is the failure to make a payment of a payment that was due for a particular reason.

Now, anybody in... any FCC licensee could have gone to the commission and tried to get a further extension of that payment deadline.

They'd already gotten extended 18 months.

They could have gotten extended even further, and it's hard for me to understand how there's a sole trigger when the very payment deadline that is supposed to be... trigger the automatic cancelation is itself the reflection of a multifactor public interest determination by the commission.

They extended it 18 months but no further, based on a consideration of the public interest.

Now, on Justice Breyer's concern about what's going on here, I think your concern is exactly right, and what sense does it make from a bankruptcy policy to disable the Government to make installment payments?

Justice Breyer: Exactly right.

Why didn't you argue it?

Mr. Clement: Well, I think... no, I think... I think--

[Laughter]

I think... there's two reasons we didn't argue it.

One, we did... there is that flavor in the brief, but the other reason is, you at one point said, doesn't the commission just want the money?

That's actually not true.

What we want is, we want the licenses back--

Justice Breyer: I know, but if they did, it's such an obvious argument that I feel there's something wrong with it if you didn't argue it.

Mr. Clement: --Don't worry... thank you, Your Honor.

Chief Justice Rehnquist: Thank you, Mr. Clement.

The case is submitted.

Attribution:

The Oyez Project

Featured:

Young v. United States - Oral Argument

Fri, 09 Jan 2009 14:50:23 +0000

Case:

Young v. United States

Media File:

00-1567_20020109-argument.mp3

Related Transcript:

transcript.xml

Transcript:

Argument of Grenville Clark, III

Chief Justice Rehnquist: We'll hear argument now in No. 00-1567, Cornelius P. Young v. the United States.

Mr. Clark.

Mr. Clark: Mr. Chief Justice, and may it please the Court: This is a case about discharging taxes in a bankruptcy proceeding.

The Bankruptcy Code provides that income taxes that are more than 3 years old are discharged in a bankruptcy proceeding.

In the petitioner's case, the Youngs filed a Chapter 7 bankruptcy proceeding in March of 1997, some 3 years, 5 months after they had filed their 1992 income tax return in October of 1993.

The Bankruptcy Code provides, on this simple set of facts, that the Youngs' 1992 income tax obligation is discharged.

The operative code sections are 727, 523, and 507, which I set out at pages 10 and 11 of my brief.

Chief Justice Rehnquist: Well, they also filed an earlier bankruptcy petition, didn't they?

Mr. Clark: They did indeed, Your Honor.

That was filed in May of 1996.

It was a Chapter 13 proceeding.

It lasted just short of 6 months, and the... the argument that the IRS has tendered in this case and below is that you subtract out the 6 months they are in the prior proceeding from the calculation of the 3 years, 5 months, and when you do that, you come out with the Youngs ending up with being only 2 years 11 months away from the 3-year mark--

Chief Justice Rehnquist: Well, why was the first Chapter 13 petition dismissed?

Mr. Clark: --It was dismissed at the behest of the Youngs for a variety of reasons that did not appear in the record.

During the Chapter 13 proceeding, they had succeeded in selling their house and paying off mortgages on the house that had... they had placed on there.

Later on in the proceeding, they had gone through the trouble of engaging special counsel, an attorney Noreen Farr, to do something which does not appear in the record.

But they finally decided that they would dismiss the case rather than go forward with it.

The reasons that they did not... do not appear in the record.

They dismissed the case about 3 weeks before they would have gotten to confirmation of their plan, which they had submitted earlier in the case.

Justice Ginsburg: But there was also the fact that they... in addition to dismissing the Chapter 13, the day before that order was entered granting the dismissal at their request, they started a new bankruptcy proceeding.

They started a Chapter 7 proceeding, and that way they were able to stretch out the stay of any effort the Government might have made to collect the tax.

Mr. Clark: The... the bankruptcy... the Chapter 13 bankruptcy proceeding was dismissed.

The final closing order in the case was entered in March of 1997.

The motion that... or the request, I think, that the Youngs had filed was in October of 1996, October 23, 1996.

It is our position that the automatic stay expired as soon as the case was dismissed and not later when the case was closed a number of months later.

And I think that is significant because in our view the IRS was entitled to restart their enforced collection efforts against the Youngs--

Justice Ginsburg: Do you have authority for that, for saying that... that it's not the date that the bankruptcy was closed, but some... the earlier date when they... when they made that motion?

Mr. Clark: --Yes.

It's in the Bankruptcy Code itself, section 320... yes... I'll have to get the--

Justice Kennedy: Is the filing of the notice of dismissal, which was October 23?

Mr. Clark: --Yes.

It's the filing of the notice of dismissal, and that we contend is the dismissal.

What happened subsequent to the... the filing of that notice is the Chapter 13 trustee held some funds that had been paid in.

He sought to apply for an administrative expense, and that was put on for a hearing and eventually it was granted.

And then thereafter the clerk's office closed the case in March of 1997.

Justice Kennedy: Did anyone object to the notice of dismissal?

Mr. Clark: Not in a... not in a Chapter 13 where the debtor seeks dismissal.

The debtor has the absolute right to seek dismissal of his Chapter 13 case because it's a voluntary proceeding.

Chief Justice Rehnquist: You used the term seek dismissal, move to dismiss in October, and then the proceeding was actually dismissed in March.

Are you saying that your simple motion to dismiss is the same thing as having it dismissed?

Mr. Clark: Yes, I am in this situation, Mr. Chief Justice, because of... the bankruptcy rules are a little... were a little vague at that point in time.

Whether you seek a dismissal by simply filing a, quote, request or moving for a dismissal, the rule says that upon a request for dismissal, the judge shall dismiss it.

In this particular case, the judge did not actually enter an order of dismissal.

It simply accepted the dismissal as entered or requested in October of 1996.

Chief Justice Rehnquist: Well, this whole sequence of events seems a bit gimmicky.

Mr. Clark: Well, if... if there are gimmicks, if somebody is trying to manipulate the system, to game the system, certainly the Government... any party in interest who was affected by the gaming, the manipulation... can object, can take... can move to dismiss... to convert the case, for example, which--

Justice Kennedy: I thought there was a finding of good faith here, wasn't there?

Mr. Clark: --Yes, there was, Your Honor.

Justice Souter: Was it a finding of good faith or... or a finding that he was making no finding of bad faith?

Mr. Clark: No.

The... the judge below, Judge Vaughn in the Bankruptcy Court, found in favor of the Government, suggesting that there was a potential, in similar cases such as this, for abuse or manipulation by debtors in general.

But in this case, Judge Vaughn had found that he attributes no bad faith to the Youngs in this particular situation, and I think that's an important fact.

The Government, when it objected to--

Justice Kennedy: Is it bad faith to look for a tax loophole?

I think thought that's what all the tax attorneys always did.

Mr. Clark: --It's certainly not in our view bad faith to look for a tax... for a way to get a grant of a discharge of an obligation that you formerly owed.

Justice Scalia: Do you think that that's what the judge meant... meant by not attributing bad faith?

He didn't even think that your client was legitimately trying to take advantage of a tax loophole?

That... that's what I took it to mean.

Mr. Clark: The case... Justice Scalia, the case came before the court, before the Bankruptcy Court, on a motion for summary judgment by the motion... by the Government.

The... there was no findings of fact as such other than those that were on summary judgment.

The... what the... I see Judge Vaughn has... as finding is that he sees no evidence before the court from which he would infer any manipulative or abusive scheme.

Justice Kennedy: Well, would it be manipulative or abusive just to take advantage of the provision of the statute?

Mr. Clark: No, Your Honor, it would not be.

Justice Kennedy: So, the finding doesn't make any difference one way or the other, does it?

Mr. Clark: When bankruptcy... bankruptcy debtors take advantage--

Justice Kennedy: You're just saying you have a statutory right to do what you did.

Mr. Clark: --That's exactly right, Justice--

Justice Breyer: Why should we read the statute regardless, when it's good faith or bad faith, as allowing the following?

We look back 3 years to see how much money a bankrupt filer owes the Government.

He's going to have to pay it.

Let's say it's $100,000.

He dismisses that after a number of years, the first bankruptcy, then brings the second bankruptcy proceeding and says, well, if we look back 3 years from the second one, this $100,000 I owned... I owed falls outside that period.

It's simply a windfall to him because he brought two bankruptcy proceedings rather than one, and it's a loss to the Government for no reason other than his having brought two bankruptcy proceedings rather than one.

It serves no purpose whatsoever that I can fathom in the bankruptcy statute, and what purpose is there in reading the statute to permit such a result?

Mr. Clark: --Justice Breyer, you would have to look at what happened in the prior bankruptcy I think to see why the debtor was able to stay in bankruptcy for the length of time that the debtor did and thereby supposedly prevent the Government from collecting taxes from the debtor.

A chapter... usually the prior bankruptcy is a reorganization bankruptcy, a Chapter 13, possibly a Chapter 11.

During the Chapter 13 proceeding, that had... had a long life, the debtor had to propose a plan that had to pay the taxes that the debtor owed in full over the life of a plan, whether that be 3 years, 4 years, 5 years, whatever it was.

The plan has to go to confirmation.

If the plan is confirmed, all the plan payments that have accumulated to that point are now paid out to the Government and to other creditors in accordance with the plan.

Plan payments that follow on still go to the Government and to other creditors as designated in the plan.

The Government is getting money here during the... during the prior bankruptcy proceeding.

Yes, a person can file for bankruptcy, submit a plan.

It might be a 5-year plan.

They get the plan confirmed.

They make payments for 3 years and then they elect to dismiss.

That is their right to... to dismiss.

Justice Ginsburg: Do they get the payments back if they--

Mr. Clark: No.

No, Your Honor, they do not.

The... the plan payments have been paid to the Government all throughout the 3-year period.

They have a confirmed plan.

Once you have confirmation, the confirmation order releases the money to the... the payees, the creditors, including the Government.

Justice Ginsburg: --How much of the... how much of the tax liability did the Government receive during the course of the first bankruptcy?

Mr. Clark: In the Youngs' case, the Government did not receive any payments whatsoever.

The Youngs' Chapter 13 lasted about... just short of 6 months.

They had not filed that tax case, that Chapter 13 until 2 and a half years after they had filed their tax return.

They... but they did not receive any payment because we did not get to confirmation in the Youngs' case.

Justice Ginsburg: Did you... did you seek confirmation?

Mr. Clark: The confirmation hearing had been set by the court at the outset of the case, and it was scheduled for November 15 of--

Justice Ginsburg: But it was... it was the debtors' voluntary action that stopped the Government from getting any payments under that plan.

Mr. Clark: --It was... in this particular case, yes, Your Honor--

Justice Ginsburg: Could the judge--

Mr. Clark: --for the... because they had not gotten to confirmation.

Justice Ginsburg: --When the debtor asked to have the Chapter 13 dismissed, could the judge have said, I will enter the dismissal order, the closure order, but only on condition that you do not attempt to assert a time bar, should you... as everybody knew was... that was going to happen, go into a successive bankruptcy proceeding?

Did... would the judge have any authority to do that?

Mr. Clark: Yes, Justice Ginsburg.

Under, I think it's section 349 of the Bankruptcy Code which governs dismissals, the judge certainly has the authority to put conditions upon the issuance of the dismissal.

Justice Breyer: Well, then why is the dismissal automatic, which is what we talked about at the very first?

Mr. Clark: Well, because the debtor... I think the procedural problem here is because the request... the rules, at least at the point of this request for dismissal was... was made, were a little vague as to how you request or move for a dismissal.

Justice Breyer: All right.

Mr. Clark: But the debtor has the absolute right to request the dismissal.

The effect of the dismissal the judge can impose a condition on to say, well, yes, we're going to dismiss the case, but we're going to enter an order that says you cannot count the 6 months that the Youngs were in bankruptcy.

Justice Scalia: Well, the debtor... the debtor has a right to reject that condition and say, if that's the condition, I don't want to dismiss, I assume.

And if that's so, then the dismissal is not automatic.

I mean, you can't have it both ways.

Mr. Clark: I don't... I think the--

Justice Scalia: If he has a right to reject that condition, then once you say the judge may impose a condition, you have to say that... that dismissal does not occur automatically once you request it.

Mr. Clark: --I think in that--

Justice Scalia: You can't have it both ways.

Mr. Clark: --I... I'm not saying it's... I think what I'm saying is that the court has the ability to put a condition on it.

If the judge... if the debtor doesn't wish to accept it, it's going to have to withdraw the motion to dismiss.

Justice Scalia: Right, and we don't know, until the judge enters an order of dismissal, whether he's going to put a condition on it.

So, how can you say the dismissal is automatic as soon as you request it?

Mr. Clark: I'm saying it's... Justice Scalia, I'm saying it's automatic in the sense that the... the debtor has an absolute right, quote/unquote... and that's not an absolutely absolute, but the debtor has a right under Chapter 13 to have his case dismissed.

Justice Scalia: No, but... no, but you say he doesn't because the judge can say, I'll let you dismiss it if.

Whereupon, the debtor can say no... no deal.

So, it's not an absolute right.

Mr. Clark: Well, it's... I think it is an absolute right or nearly so.

I don't think that putting a condition on it makes it less of... of an absolute right to dismiss.

Justice Ginsburg: But it doesn't mean that you can't equate the date that you file the motion to dismiss with the termination of the Chapter 13.

It can't be.

If the judge could put a condition on it, then the... the 13 proceeding doesn't terminate until the closure order is entered.

Mr. Clark: I think the... well, I don't know that the judge could withhold or... or delay the entry of a dismissal order.

It could put a condition on it that the time in Chapter 13 won't count against the--

Justice Scalia: Let's say we disagree with you and we find--

Justice Stevens: --Have you cited any cases in which this kind of condition was imposed?

Mr. Clark: --I do not know of any cases where, in a Chapter 13, a condition has been imposed.

Justice Kennedy: So, this is totally speculative, really, I think.

I would assume if the... if this problem has occurred as many times as the Government says it has, and if the solution that you suggest is available, I would have thought some judge would have thought of it.

Mr. Clark: Well, I think no... no judge is going to impose the condition I think under section 349 unless the IRS comes in and makes a motion or brings it to the attention of the court that--

Justice Kennedy: But then the lawyers have never had enough sense to do this, as I understand it.

Unknown Speaker: [Laughter]

Mr. Clark: --Well, they've gone a... the Government I think has gone on a different track on... on this issue.

Justice Kennedy: The answer is no.

Mr. Clark: The answer is no, Your Honor.

Justice Kennedy: In... in all events, let's assume that we think that the dismissal occurs in... it would be March 13.

Does the difference between October and March make a difference in this case?

Mr. Clark: No, it does not, Your Honor.

Justice Kennedy: All right.

So, it doesn't make any difference.

Mr. Clark: This... we got into this in the court of appeals a little bit, but it really makes no difference whatsoever in the computation.

Justice Scalia: Mr. Clark, can I get your understanding of what you think would be manipulation?

Because it may have something to do with my view of... of this case.

You don't assert that... that somebody can go into a Chapter 13 proceeding with the... with the avowed intent of not carrying it through to completion and of dismissing it in order to get the benefit of... of the... the shorter lookback.

Suppose... suppose I open a 13 proceeding and I have no intention... I propose a plan.

I have no intention of completing that plan.

I ask the court to approve it.

From the beginning, I have no intention of... of going through to the end of it.

Isn't that a fraud on the court?

Mr. Clark: I would... I would never... I would... I agree with you, Judge Scalia.

It would be a... an abuse of the bankruptcy process.

Justice Scalia: And if that were shown, I suppose there's no doubt that the... that the Bankruptcy Court in the later proceeding could disallow the... the shortening of the lookback period because of that fraud.

Mr. Clark: Yes, Your Honor.

Justice Scalia: Okay.

So, we're talking here only about cases in which someone in good faith, at least as far as the IRS can approve, commences a 13 proceeding, and then for... for some... some plausible, good reason, before it is concluded, dismisses.

Is that how you--

Mr. Clark: Yes.

Justice Scalia: --understand the situation?

Mr. Clark: Yes, it is.

Justice Kennedy: Whose burden is it to show that there was some reason other than just getting advantage of the automatic stay?

Do you have to put in any evidence to show that?

I mean, you're suggesting... I guess Justice Scalia's question... that there should be a fact question in every case as just what was the motivation of the petitioner who file the Chapter 13 proceeding.

Mr. Clark: I think there has to be... if... if somebody is charging that there is an abuse, there has to be some factual determination that there's an abuse.

The... under section 105, even the bankruptcy judge himself, sua sponte, can look at this and enter orders if he detects abuse.

And bankruptcy judges happen to be rather good at this.

They... they see cases that emit an odor, if you will, and they are not reluctant to get involved in that.

Justice Kennedy: So, suppose the bankruptcy proceeding is commenced with the intent ultimately of getting the discharge, but there's also the intent to do it in two steps.

You say, I'm going to... I want... I want to get Chapter 13 or Chapter 13... 11, but I'm just going to do it in two steps.

Is... is that... that abuse of process?

Mr. Clark: No, I don't believe so, Justice Kennedy.

Here's what happened--

Justice Scalia: I don't understand the question.

Justice Kennedy: The hypothetical is I... the bankrupt intends to get a bankruptcy discharge, but he also intends to do it in two steps.

He intends to have a Chapter 13, wait for 3 years, and then after a very short interval, refile under 7.

And then hypo two is under 13.

I take it you can do it under 13?

Couldn't you have two successive 13?

Mr. Clark: --You could have... you could have--

Justice Kennedy: And your argument would be the same.

Mr. Clark: --Yes, Your Honor, it would--

Justice Kennedy: In either of those cases, would that... would that be abuse of process in your view?

Mr. Clark: --Not in my view, Justice Kennedy, and here... here is why.

If you're going to go... if you're going to go into Chapter 13 and stay there for 3 years, you're going to get a plan confirmed during the course of those 3 years.

You better, sure as heck, get a plan confirmed during those 3 years.

And you will be... once the plan is confirmed, payments are going to be made to the IRS for those 3 years.

It may or may not pay off the debt to the IRS in full during the 3 years, but it is the debtor's best effort, according to the Chapter 13, to be paying those dollars.

So, it's not as though the IRS is getting nothing in this... in that hypothetical situation.

Justice O'Connor: But if... if taxes had been paid during the Chapter 13 proceeding, wouldn't they have to have been returned on the dismissal of that proceeding?

Mr. Clark: If there... Justice O'Connor, if there were no confirmation order entered prior to the dismissal--

Justice O'Connor: Right, as was the case here.

Mr. Clark: --which was the Youngs' case.

Yes.

Justice O'Connor: As was the case here.

So, presumably even if something had been paid in for the taxes, they would have been given back on the dismissal.

Mr. Clark: Yes.

The magic moment in Chapter 13 is the entry of the confirmation order, and once the confirmation order is entered, whatever plan payments the trustee has already accumulated, because the--

Justice O'Connor: Well, why... why do you think it's improper to equitably toll that lookback period for this situation?

Mr. Clark: --I... I do not think it is proper at all to... I... there are several reasons why I think it's improper.

First of all, the language of the statute itself is very plain and straightforward and has no provision for equitable tolling or any tolling.

Chief Justice Rehnquist: We have held that equitable tolling applies in similar statutes which have no provision for equitable tolling.

Mr. Clark: Yes, I'm... I... I know that the... I know that you have, Mr. Chief Justice.

Justice Kennedy: Well, I... I thought your point is... one of your points was that statutes of limitations are different from this, that this is not a statute of limitations.

Mr. Clark: It's... my point is that it is... this is a part of the definition of which taxes can be discharged in bankruptcy.

There are several time elements to defining which taxes can be discharged in bankruptcy.

There is this 3-year lookback period.

There is a 2-year period where a taxpayer has filed a return late and then we go to a 2-year lookback.

And then there's a third 240-day period that the taxpayer/debtor must satisfy and that is 240 days from the date of assessment.

Now, the debtor must meet all three of these to be able to discharge the taxes.

In the Youngs' case, the taxes were assessed promptly, about 2 and a half months after they filed their tax return.

They clearly met that one.

The... they did not file a late return because they got extensions to file their return in October of 1993.

So, they... that one doesn't apply.

And the only one in question in this particular case then is the 3-year, and how do you measure 3 years and do you toll the 3 years for the period of the prior Chapter 13.

Justice Souter: Mr. Clark, is the Government correct in... in pointing out that the debtor here could, instead of seeking dismissal of the 13 and starting a 7, simply have moved to convert the 13 into a 7?

Is that correct?

Mr. Clark: That is correct, Your Honor.

Justice Souter: If... if the debtor had done that, the 3-year period would continue to have been calculated as it originally was under the Chapter 13 proceeding.

Mr. Clark: Yes, Justice Souter, that is correct.

Justice Souter: Would... would it have been error if... if the judge or any judge in a case like this, when... when confronted with a motion or a request to dismiss, simply questioned the debtor whether it was the debtor's intent to start a Chapter 7 proceeding, and if the answer was yes, for the judge simply to say, well, I will treat your motion as a motion for a conversion and we'll grant that?

Would that have been error on the judge's part?

Mr. Clark: I think it would be error for a judge to take a motion to dismiss a Chapter 13 and make it a chapter... and say, we are going to make it instead a Chapter 7 case.

Justice Souter: Even when the debtor says, yes, my plan, my intent is to... is to initiate Chapter 7 proceedings.

Mr. Clark: Yes.

Justice Souter--

Justice Souter: The... I take it the only harm to the debtor in that case would simply be the... the argument about the 3-year lookback because the debtor would be getting exactly otherwise exactly what the debtor wanted, i.e., a Chapter 7 filing.

Mr. Clark: --Yes, Justice Souter.

But keep in mind in the... in the case of either dismissal or conversion, in the example in the Government's brief, the... it does not do any good to seek conversion... I'm sorry... to dismiss and then refile unless you're toward the end of the 3-year period in any event.

So that when the case is dismissed, now the 3-year period has expired, and now you go the next day and you file your Chapter 7, saying, well, I've been... it's been now more than 3 years since the filing of the return.

Justice Souter: Yes.

Mr. Clark: But in the meantime, of course, the plan payments are being made, hopefully, to the Government and to other creditors for the 2 years and however many months.

Justice Souter: Well, that... that's so.

But, I mean, even in the case in which there has been a confirmation under... under the Chapter 13 and plan payments have been made, it may very well be that the amount of tax liability that has actually been paid could be minuscule, so that it would be very much in the debtor's interest to... to start a new Chapter 7 and save whatever the balance due is on the taxes.

Mr. Clark: Well, except that, Justice Souter, the problem is that the tax payments are not going to be minuscule during the Chapter 13.

Justice Souter: Well, whether they're minuscule or not, if they're not 100 percent, the debtor still gains something by going... so far as the Federal taxes are concerned, by dismissing and starting a Chapter 7 because whatever the balance due is, in... on the facts of a case like this, the... the debtor is going to... going to obtain.

Mr. Clark: That is correct, Justice Souter.

But again, I would point to the fact that the Government is getting something.

It may not get the whole amount.

And in tax collection in general, apart from bankruptcy, even when bankruptcy is not in the picture at all, the way the Government is trying to collect taxes is through installment payments as the Youngs--

Justice Souter: Well, that's right.

But I think the Government's answer to that is unless we, in fact, make a compromise agreement, we're entitled to 100 cents on the dollar.

And the... the fact that... that the Government may get 50 cents on the dollar before you go from 13 to 7 I... I don't think really disparages the Government's argument any.

Justice Ginsburg: Or it can be, as it was here, the Government got nothing.

Chief Justice Rehnquist: The Government got nothing.

Mr. Clark: --The Government did get nothing in this situation, Justice Ginsburg, for the 6 months.

Justice Ginsburg: And would there... in... in this very case where the Chapter 7 was started the day before the Chapter 13 was closed, was there any advantage, other than wiping out the lookback period, to instituting two proceedings rather than having the 13 converted to a 7?

Mr. Clark: Well, the reason the Chapter 7 was filed was because I think other creditors were descending upon the Youngs.

They had dismissed their Chapter 13 back in October, and that, of course, put everybody back into the status quo ante, except with respect to the sale of their house, of course.

But the creditors now were free, once the case has been dismissed, to come forward again.

Justice Ginsburg: Well, we're getting into filing versus dismissal.

Mr. Clark: Yes.

Justice Ginsburg: But if... if we take the order of the court as what counts, there wouldn't have been any period in which other creditors could have jumped in because the Chapter 13 hadn't yet been closed.

So, from the point of view of the debtors here, was there any advantage that they gained other than wiping out the lookback period?

Mr. Clark: With... with the filing of the Chapter 13, they obviously gained the advantage also of eliminating their other debts.

Justice Ginsburg: I mean, when they got to the point of saying we're not going to make it under this plan, so we're going to have to quit the 13, at that point they could have done... either asked for conversion to 7 or started a new proceeding.

Is there any difference from their viewpoint other than they'd get the benefit under a reading of the statute of putting the Government out of the picture because the 3-year lookback has run?

Mr. Clark: I'm not quite sure I understand the question, that they... Justice Ginsburg.

I think they... they get the... when they... when they dismiss and then refile, they obviously get the benefit of discharging their other taxes in... their other debts, non-tax debts.

Argument of Patricia A. Millett

Chief Justice Rehnquist: Thank you, Mr. Clark.

Ms. Millett, we'll hear from you.

Ms Millett: Mr. Chief Justice, and may it please the Court: I would like to address first the... there's been some discussion about protections that maybe or maybe could not occur in a Chapter 13 proceeding to prevent the... the Government from losing its claim.

And in fact, that rarely, if ever, is capable of happening because we don't know... debtors don't telegraph to us at the time they're in Chapter 13 or dismissing their Chapter 13... that they plan to file a second bankruptcy.

And if you don't know that's going to happen, you can't prove bad faith.

You can't ask for conditions, or it would be virtually impossible to do that.

Justice Scalia: Well, sure you can.

You can ask the bankruptcy judge to inquire and... and say if... if that is the plan, Your Honor, we... we request that it not be dismissed but rather converted.

Ms Millett: I think--

Justice Scalia: Or that that be a condition of... of the dismissal that you not... that you not refile.

Ms Millett: --I think there's two difficulties with that approach, and the first that it would be an enormous burden in every Chapter 13 case that is filed and then sought to be dismissed... and an awful lot... the vast majority are... to have that inquiry undertaken.

And secondly, there is... there is no authority under the code that we're aware of that allows a court to condition... a voluntary dismissal, which they have as of right, on willingness to forego a discharge in a future bankruptcy proceeding.

Justice Scalia: But, I mean, let's assume someone has in all good faith commenced a Chapter 13 and has in all good faith dismissed it because, part the way through it, said, you know, I think I can make it on my own now, and... and then, you know, sometime after that, decides, no, I can't make it and... and files another bankruptcy proceeding under 7.

No bad faith.

You would still want to alter the 3-year lookback in the statute to make it... to make it what?

5 years or whatever.

Ms Millett: We would... we would want the 3-year lookback period to tolled during the time the automatic stay prevented us--

Justice Scalia: That's not what the statute says.

There's no fraud here.

There's... there's nothing going on.

You're just saying here's a loophole in the tax law or the bankruptcy law, that aspect of the bankruptcy law dealing with taxes.

I'll call it a tax loophole.

And you're saying, you know, courts, repair this loophole.

That's not what courts normally do.

Ms Millett: --Well, as the Chief--

Justice Scalia: I mean, that's the fun of practicing tax law.

Unknown Speaker: [Laughter]

Justice Ginsburg: Bankruptcy law.

Justice Scalia: You take all the joy out of it.

Unknown Speaker: [Laughter]

Ms Millett: --That's what we do.

As the Chief... as the Chief Justice pointed out, in fact, equitable tolling... in virtually every case that I'm aware of, equitable tolling is applied when the statute is silent, and in fact when it may provide specifically for tolling in other circumstances, as occurred in Bowen v. City of New York and American Pipefitters v. Utah.

And equitable tolling has not... never been held to turn upon the existence of bad faith.

Justice Scalia: This is not equitable tolling in... in the statute of limitations sense.

What is involved here is not the termination period for bringing a cause of action, but rather the quite different question of when taxes will be discharged and when they don't.

Congress provided for, you know, a 3-year lookback.

In some circumstances, they get the benefit of... of less than that if... if they brought the two... but at least, where there's been no fraud, at least where you haven't been able to show that... that they were gaming the system intentionally, I don't see why equity should... should come... there is legislation pending to close this gap, isn't there?

Ms Millett: There is and there has been for a number of--

Justice Scalia: Well, I don't know why we don't leave it to Congress.

Ms Millett: --Well, Your Honor, there's... there's a number of responses to that.

And the first is we would respectfully disagree that this is not sufficiently analogous or akin to a statute of limitations that the First Circuit described in this case to merit equitable tolling.

A time period does not have to be a statute of limitations to be tolled.

In Zipes v. TWA, in Honda v. Clark, this Court has applied equitable tolling to other types of time limitations, and within the bankruptcy context, which is a specialized context, this lookback period has the same operation and effect as a traditional statute of limitations.

It prevents the assertion of stale claims, stale claims defined as ones that the Government has allowed to linger.

It... it extinguishes a claim if the period does lapse as effectively as a bar on the time limitations.

Justice Scalia: It doesn't extinguish it.

The... the Government is just thrown in with the other... with the other creditors, isn't it?

I mean--

Ms Millett: Well, this--

Justice Scalia: --they may come out without any money, but it's just... the... the question is whether the Government is going to have the preferred position of not having its debt discharged.

It will be thrown in with the other general creditors.

Ms Millett: --That's not entirely correct, Justice Scalia, for... for... in two ways.

First of all, there are two... there are two aspects to the priority.

There's a priority as against other creditors, but what is at issue here, and again what is at issue in virtually all of these Chapter 7 cases, or these no... no-asset Chapter 7 cases, is the discharge.

That's what's at issue here, and the discharge is... does extinguish a claim as much as a bar on... on filing.

Justice Scalia: Well, I know, but it... but it discharges the Government's claim just the way it discharges the general creditors' claims.

The Government is thrown into that pot instead of having the preferred position that you can pay off everybody else 3 cents on the dollar, but not the Government.

All that happens is the Government goes in with the other creditors.

Isn't that--

Ms Millett: Taxes have always been different.

And the... the treatment of this is simply a 3-year... 3-year period that... that the debtor has to run out, and it doesn't afford the Government any capacity to enforce the claim would be, I think, an extraordinary assumption on the part of Congress.

Justice O'Connor: --Well, what is your... what is your main argument?

Is it to ask us to apply the principle of equitable tolling to this section 105 lookback provision?

Ms Millett: Section 507.

Justice O'Connor: Yes.

Ms Millett: Yes, that is... that is our... that is our submission.

The Congress--

Justice Scalia: And what's your best case for that?

Ms Millett: --The body of equitable tolling cases, but the most analogous one I think is Honda v. Clark... Clark and Burnett v. New York Central Railroad, both of which are cited in our brief.

Honda v. Clark involved not a traditional statute of limitations, but the time for filing proofs of claim under the Trading with the Enemy Act, which was specifically modeled on the Bankruptcy Act.

And there... there the Court held that it would be equitably... equitably... the time period would be equitably tolled--

Justice Scalia: Why isn't that a traditional statute of limitations?

Ms Millett: --I'm sorry?

Justice Scalia: Why isn't that a traditional statute of limitations?

Your claim is invalid unless you file it within a certain period.

Ms Millett: Well, within the bankruptcy context, in fact a claim can still be paid as long as it's on the schedules.

The filing of a proof of claim does not--

Justice Scalia: No, I'm not talking about this case.

I'm talking about the case you're citing us as... as being analogous to this one.

You said it didn't involve a traditional statute of limitations.

Why did that not involve a traditional--

Ms Millett: --The... the reasoning of the Court in Honda v. Clark was... was that Congress modeled... the proof of claim there may have been closer to an actual statute of limitations, but the rationale the Court applied was looking to the treatment of proofs of claim in the Bankruptcy Code, and that was the analogy that Congress was drawing at the time it enacted the Trading with the Enemy statute, and that those proofs of claim... it was in the bankruptcy context--

Justice Scalia: --Maybe, but Trading with the Enemy statute itself contained what was a statute of limitations, and in the case at hand, we were equitably tolling what was effectively a statute of limitations.

What's your other best case?

Ms Millett: --And Nassau Smelting v. Refining Works, which is discussed in Honda v. Clark, was a bankruptcy case where the proof of claim was not filed until a year after the deadline and the Court allowed participation nonetheless.

And again, it's the nature of the proof of claim that's--

Justice Breyer: Those are also... the difficult issue I think in this case is exactly what Justice Scalia has been saying, that this isn't a traditional statute of limitations.

You have to do one of two things.

You either have to say the word 3 years shall be read 3 years plus days tolled.

That's one thing you could do.

Or the second thing you could do is you could look to 105(a) and you could say that the order that can be issued is an order pay money... this is in the section 7... pay money as if this were the section 13 that hadn't been dismissed.

Now, both of those, the question would be, does... does the judge have the authority to do that?

And looking simply to statute of limitations provisions doesn't answer that question.

It... it provokes the question.

It proves you might be right, but... but the worrying thing is whether you can just stick those words in, either plus days tolled, or read 105(a) in so broad a manner.

So, those are the... I'd like to know what should we do and what's the authority for that.

Ms Millett: --To take the first... the first... first scenario first, the proposition for reading the 3-year lookback period as 3 years plus--

Justice Breyer: Plus days tolled.

Ms Millett: --3 years plus.

In deciding what the character of the lookback period is, whether it's akin to the statute of--

Chief Justice Rehnquist: Could you speak up a little bit, Ms. Millett?

Ms Millett: --In deciding what the... the character of the lookback period is, equitable tolling does apply in Zipes in filing a proof of... filing of a claim with the Equal Employment Opportunity Commission.

There the Court described it as similar to a statute of limitations, but it was not a statute of limitations.

So, equitable tolling does not require--

Justice Scalia: Which case was that?

Ms Millett: --Zipes v. TW... Trans World Airlines.

That does not require the presence in the actual statute of limitations.

It has to be a time limit.

If the question is whether Congress would have intended that type of time limit to be subject to tolling principles.

And the... we can either assume the lookback period would have for many of the policy reasons that have been discussed... the... the conclusion that results if we decide that it is not something that Congress would have intended to be subject to equitable tolling is that the 3-year lookback period is an empty gesture as far as protecting the Government.

The Congress--

Justice Breyer: You have no problem convincing me about what I'd call the equitable merits of your side.

The problem you have, as far as I'm concerned, is how to work, which route do we take and what's the authority for doing it, just what I asked in the first place.

Ms Millett: --And that is I think... and it's both prongs of your... of your question.

It is... we think that the nature of the time limitation is sufficiently similar within the bankruptcy context.

This is how you enforce claims within the bankruptcy context.

Justice Scalia: Well, I don't think it is similar.

I... I... I mean, the only thing... the only respect in which it's similar is that it involves time, but all of the other cases that... that you refer us to, the statute of limitations proper, Zipes, they're all cases in which action by the party seeking to enforce something is limited by a period of time.

He has to do it within a certain time or else it's no good.

Now, whether you call it proof of claim or anything else, that's... that's the scenario.

In this case, it's... it's not a matter of whether the Government has filed in time at all.

This lookback is quite a... quite a different animal.

It's how far back you... you can go in... in deciding which claims cannot be discharged in bankruptcy.

Now, it involves time.

I guess, if you think that's enough of a commonality, then... then I'd agree, but gee, I... I don't think that's enough to... to make me think that we have the... the authority by long tradition to rewrite a statute so that where it says 3 months, it's going to be 3 months... 3 years, it's going to be on our authority 3 years plus some other period of time.

Ms Millett: I think this is exactly the situation that you described.

It's like a typical statute of limitations, and that is unless the Government takes action within 3 years to enforce its claim, unless it acts within those 3 years, it will, for all intents and purposes and all practical purposes, within the unique context of bankruptcy proceedings, have no claim left.

It will be discharged.

There's nothing--

Justice Scalia: But it's not a limitation on the Government's action within 3... it doesn't say the Government has to act within 3 years.

It says when you have a bankruptcy proceeding, you look back only 3 years.

It has nothing to do with how soon the Government has to come forward.

The Government has absolutely no control over that lookback.

Chief Justice Rehnquist: If the Government comes forward after 3 years, it loses.

Ms Millett: --That's right.

It eliminates... and the legislative history describes this quite... from Congress' vantage point that this was an enforcement period, a collection time, and that... that if the... it would eliminate stale claims, which this Court said in Zipes is one of the purposes of a statute of limitations.

It would... it would extinguish liability if the Government doesn't act within the particular period of time, which again is akin to a traditional statute of limitations.

The--

Justice Kennedy: I have one... one technical question.

I should know the answer.

Suppose before the Chapter 13 proceeding is commenced, the Government says, oh, we've got a lot of taxes here and this debtor may file Chapter 13.

Can you file a lien against his property which somehow protects you?

Ms Millett: --If we... if we have assessed the taxes, which in itself requires a 90-day period as a matter of law, but if we have assessed the taxes, which we had here, we can go file a notice of federal tax lien which would protect us.

What happened in this case--

Justice Kennedy: And that would protect you.

Ms Millett: --That would protect us, but it's important to keep in mind how tax collection works.

The IRS, as a matter of policy and as a matter of some statutory provisions, tends not to descend immediately upon taxpayers the second there's a liability.

In this case, we had been working with the Youngs, and they had been making some payments.

And it's routine for us to try voluntary compliance.

It's good policy and that's what we do, and it wasn't... we tried to--

Justice Kennedy: If you... if you imposed a lien, could you still work with the taxpayer?

The lien doesn't prohibit you from trying to work it out, does it?

Ms Millett: --We... we could have, but it certainly has some consequences for... for the taxpayer.

And... and again we... we try... we try to work these things out without going to that sort of adversarial level of proceedings.

And there had been payments being made here.

But if I could get back to Justice Breyer's--

Justice Kennedy: And just... just so I get the technical--

Ms Millett: --Sure.

Justice Kennedy: --But once the Chapter 13 proceeding commences, you--

Ms Millett: We cannot impose--

Justice Kennedy: --cannot impose a lien.

Ms Millett: --Absolutely not.

That's part of the automatic stay.

If I could get back to Justice Breyer's question.

What we think is important here is... is the... the combination of the two factors that you discussed is that this is sufficiently like a statute of limitations, and Congress intended it to operate like a statute of limitations, and it does operate like a statute of limitations within the bankruptcy context.

And we've combined that with the unique equitable powers the bankruptcy courts have and the unique operation of equitable principles within the bankruptcy context.

So, it's not an either/or.

I think the combination of those is a sufficient reason as to why tolling of this lookback period would be appropriate.

Justice Ginsburg: Ms. Millett, Mr. Clark said in his brief that, well, if you're going to do this for taxes, the same logic would apply to wage claims that have a priority.

What else did he say?

Employee benefit claims.

Is that... is that so?

Ms Millett: Those are the only two nontax provisions that have these type of--

Justice Ginsburg: So, could you--

Ms Millett: --lookback periods.

And I... I'm assuming that it would, in fact, apply.

I... I haven't analyzed... the same analysis would apply and assuming that the same congressional purpose would be shown and the consistency of congressional purpose to apply equitable tolling... it would apply there.

It doesn't actually happen to be a problem in that area because those... for two reasons.

Those types of... those two claims involve very, very short time limits, 90 and 180 days, not 3 years.

And so, in order to avail themselves of this procedural roundabout, they would have to file two bankruptcy proceedings very closely on top of each other, and that just doesn't happen.

Justice Ginsburg: --Well, as they did here.

Ms Millett: No.

I mean, they would have to file their first one, and then within 3 months to get out of the 90 days, you'd have to file another one.

This... the first one lasted I guess approximately 6 months.

Justice O'Connor: Ms. Millett, there is legislation pending to do what?

How is it drafted?

Ms Millett: It... it is drafted to provide for tolling of the lookback period during the pendency of... during the time an automatic stay in a prior bankruptcy case.

Justice O'Connor: As an amendment to section 105 or what?

Ms Millett: I think it's to section 507, which is... 507(a)(8), which is what provides the lookback period itself.

But that legislation--

Justice O'Connor: Is it part of the overall Bankruptcy Code revision?

Ms Millett: --It is.

It has not been--

Justice O'Connor: You know, the big bill.

Ms Millett: --The big bill.

Justice O'Connor: Which may or may not go anywhere.

Ms Millett: Which may or may not go.

There are... there is... there are, you know, different bills before Congress.

They've both been passed.

Conferees have been appointed.

They aren't fighting over this provision, but there are lots of other provisions that they are in disagreement over.

I also think it's important to keep in mind what... what we would have to assume Congress intended were we to read the lookback period as something not subject to tolling.

Now, there have been some suggestions that people like to avail themselves of tax loopholes.

That's usually done to decide how much taxes you owe.

What we're talking about here is an admitted acknowledged tax liability that they want to get out of paying and that... that we want to hold that... that debtor--

Justice O'Connor: Well, if you were the lawyer for the Government faced with a taxpayer that had a big tax liability and it looked like bankruptcy might be looming, what would you advise the Government to do?

Ms Millett: --Depending on this Court's holding, there... I have to say in all candor the volume... the sheer volume of cases that the IRS handles in bankruptcy makes much... and it's handled often at the initial stages, as it was here, not by lawyers, but by special agents in the bankruptcy proceeding.

I think we would have to go to a system where we would go to the tax liens immediately, but that's not what--

Justice O'Connor: No doubt, but absence that, what is the best way for the Government to protect itself, do you think?

Ms Millett: --To immediately as soon... as soon as they assess, immediately file a tax lien.

And... and that's... normally we go... there are administrative... other administrative means of collection.

We try to work things out.

We have offers in compromise, and there's no reason that Congress would have intended our tax system to go that way and to be driven by these bankruptcy procedures.

Again, to get back, we're talking about whether the lookback period--

Justice Scalia: Well, that's how they wrote it.

I... I mean, you say... Congress often does not enact perfect statutes.

It... it leaves some holes that it should have thought about and... and we don't normally think it's our job to patch it up.

I... I agree with you.

I... I find it unlikely that Congress intended this to work this way, but it is just one of the eventualities that they didn't have in mind, and that's why we have things called statutory amendments.

We... we don't run to the courts and ask the courts to fix them.

And... and I'm just very leery of extending our... our powers, the equitable powers that we've used in the past, for extending statute of limitations, tolling statute of limitations to this quite different situation of a lookback.

I... and there are other lookbacks in the Internal Revenue Code and there are other time provisions, and I... I'm not willing to say whenever there's a time provision, it's an invitation to us, if... if Congress hasn't foreseen every problem, to adjust it.

Ms Millett: --I think... I think that given the equitable powers of bankruptcy courts, most of those... many of those time limits are in fact considered to be subject to equitable tolling that are in the Bankruptcy Code, although I don't know that this Court, other than the proof of claim context, has ruled on the question.

But in deciding... Congress legislated against backdrop principles of equitable tolling.

In deciding whether this is the type of thing that should be subjected to equitable tolling, this Court made clear in American Pipe & Construction v. Utah that it's a question of... of congressional intent, not whether you think the provision is substantive or procedural.

And we think congressional intent drawn from the structure of the statute, the network of tolling provisions, limitations on filings, conversion rules, to think that all of those were put in by Congress not to protect the Government's enforcement period but simply to channel debtors into one particular procedural route for not paying taxes is a highly unlikely assumption.

And to think that Congress would... to read the lookback period as intentionally empowering debtors not to fight about how much taxes they owe, but to take an admitted tax liability and say that because of what we do in bankruptcy, not because of anything the Government did in becoming a creditor or in enforcing its claim, we get to decide that you will not have prioritized status.

You will have, in some cases, not a minute of enforcement activity, and we don't have to pay our taxes.

That makes the Government not like other creditors at all, not at the same level, but in the... the States and Federal Governments will be in the worst position of anyone in bankruptcy.

We don't get to choose our debtors.

We don't get to seek the security in advance, and we will have no capacity to enforce, other than at the mercy of the debtor who initiates these proceedings.

And I think... I understand this isn't a perfect fit with the statute of limitations, but I think taking those considerations and the... the consequences of accepting the alternative view of the lookback period, the implausible assumptions that would assume Congress made and the implausibility of this operation of the statute as a whole combined with the traditional equitable powers of Bankruptcy Court and the role of equity in these proceedings, all of that packaged together is sufficient to allow this Court to toll a lookback period and effectuate Congress' intent, which... which is--

Justice Kennedy: May I ask you a question about your view of the automatic tolling statute?

As I understand this case, the notice of dismissal of the Chapter 13 proceeding was filed in October, and the actual dismissal was not until March 13 of the following year.

And it was the day before that that they filed the Chapter 7 so there--

Ms Millett: --That's right.

Justice Kennedy: --was the base of their changing their mind or something like that.

Is it your view that the automatic stay was in effect between October and March?

Ms Millett: Absolutely, and--

Justice Kennedy: Because I think your opponent seemed to suggest maybe that wasn't so.

Ms Millett: --Right.

In 1307(b), which is the provision that allows automatic... it's 11 U.S.C.... that allows voluntary dismissal by the debtor, provides that the... that the debtor may... may ask the court, but that the court shall dismiss the case.

And so, until a case has been dismissed or closed, neither of which would have happened under this provision until March, or a discharge has been granted, which obviously did not happen in this case, the automatic stay remains in effect.

And we were unable to do any... take any steps to enforce our claim.

Justice Kennedy: And is it true that in this case there was some kind of report filed on February 2?

So, there was activity in the case.

Ms Millett: There was.

A trustee had filed a report, and there had been... the court set time when it got the... the notice, it set the time for the hearing on this or time for action on this.

So, it was in fact... and again, if... if we're going to suppose that courts can impose conditions on these dismissals, that would again require... assume that the case is alive and is still before the court.

But I think the statute is quite clear that it... that the debtor doese not dismiss the case; the court does.

And that didn't happen until March.

And again--

Justice Kennedy: Are you aware of any cases of this kind in which the court has imposed a condition relating to this problem?

Ms Millett: --No, and again because I think the statute doesn't--

Justice Kennedy: Doesn't authorize.

Ms Millett: --I don't want to say it doesn't in case we get to some situation where we might want to try, but it doesn't seem to... clearly to allow that and I think it would be extraordinary reading of the Bankruptcy Code to think that a court can impose, as a condition on a voluntary dismissal that's entirely within the discretion of the debtor to seek.

Justice Kennedy: Well, that--

Ms Millett: We do not accept--

Justice Kennedy: --That... that brings me to this question.

Suppose I thought that section 105(a) was the best basis for an authority for a tolling rule under the abuse of process.

Would it follow that the tolling rule has to be on a case-by-case basis to determine if they're good faith, or can I say because of abuse of process, we're going to have a general tolling rule?

Ms Millett: --The Court has the authority to impose uniform rules of equitable tolling.

It did that in the Burnett v. New York transportation case.

That was a Federal employer liability action--

Justice Kennedy: But is that consistent with my assumed approach of just hinging the rule on the abuse of process?

Ms Millett: --I think what it would be consistent... equitable tolling as... equitable estoppel tends on the behavior of bad faith of the person who's--

Justice Kennedy: Yes.

Ms Millett: --here the... the debtor.

Equitable tolling turns upon the legal disabilities imposed on the person who wants to enforce their claim.

And that isn't going to change from case to case, as in Bowen v. City of New York where this Court again applied a class-wide rule of tolling because the Government's actions with the Social Security plaintiffs in that case had been the same.

Justice Breyer: Your argument doesn't hinge on bad faith, anyway, as I understand it.

Ms Millett: No.

No, it doesn't.

Justice Breyer: You... you assert that... that without the tolling, we would frustrate Congress' intent even where there has been no bad faith, that Congress would not have intended where there's good faith to give the person an added... an added couple of years of... of no taxes.

Ms Millett: Of no taxes or to get out of paying their taxes or to relegate the Government to this lowest subsidiary position within the bankruptcy process.

But uniform rules have been applied by this Court when that circumstance doesn't change, and in this case for purposes of equitable tolling, what's not going to change is that the Government hasn't had the time Congress gave it in the statute.

That's going to be the same.

Beyond that, amount of tax liability shouldn't matter.

That's a judgment for... for Congress and the Government to take.

It's not... it shouldn't... equitable tolling shouldn't turn upon that, and the bad faith or good faith of the taxpayer wouldn't be determinative.

And in that regard, I think it's important to keep in mind that if we had a test where we had to show bad faith in every one of these cases, again we're talking about an enormous volume of bankruptcy cases.

And... and showing... in those... in those circuits where they have applied this sort of case-by-case equitable tolling, the Government has had to be very selective in which cases it decides to make that showing, giving a lot of people a pass on taxes.

And those proceedings can take 9 to 12 months.

You have to have discovery and full-blown hearings on people's faith and intentions and that really is not what the purpose of the Bankruptcy Code is for.

Justice Ginsburg: Ms. Millett, would you remind me?

I think that Congress wanted the Government to have 3 years, and that was a cutting back on what the Government had before.

Right?

Ms Millett: Absolutely.

Justice Ginsburg: They said, we gave you too much.

We're now giving you 3 years.

Ms Millett: Absolutely, and that's why I think it... it's extraordinary to think that Congress... Congress went to the steps that you would have to decide, if you decide this is not a collection period and akin to a statute of limitations, because prior to 1966, these tax claims, regardless of age, were all entitled to priority and were all nondischargeable.

And what Congress did in 1966 was decide it was going to balance competing interests within the bankruptcy process and condition the Government's entitlement to that special status on its diligent enforcement of those tax claims.

And that is why it's like a statute of limitations.

But to hold otherwise is to say that what Congress went to in 1966 was a situation where everything was protected to where nothing is protected except at the sole discretion and choice of the debtor proceeding in bankruptcy.

The Government will be left with no capacity.

We can't choose our... we can't choose our debtors, and we will... and they have the entire authority to prevent any enforcement.

And we're not just talking about enforcement of claims that arose before they filed bankruptcy.

If you have bankruptcy proceedings that go on for more than 3 years, as many do, this... this rule would apply to tax claims that arose while the case was in bankruptcy and the 3 years ran.

And that in fact is what has happened in a case we have pending in the Fifth Circuit.

If they can discharge not just the things that you may have had a few months before... or a year before the bankruptcy was filed, tax claims that we have never had a millisecond outside the freedom of the automatic stay to enforce will be extinguished, not because of anything the Government did or did not do, but solely because of the procedural steps taken by the debtor in Bankruptcy Court.

And we think it's extraordinary to think that that's what Congress did and intended to do in 1966.

The... it went for that transformation.

And statutes aren't to be construed to assume that Congress would imperil State or Federal revenues.

Justice Scalia: Of course, I don't think anybody suggests that Congress intended the result.

The question really is whether... assume we know exactly what Congress intended.

Do we have the authority to fill a gap in the statute anyway without, you know, the express text?

Ms Millett: And I think equitable tolling, particularly in the context of traditional equity courts like bankruptcy and traditional equity proceedings, is appropriate.

Again, in American Pipe, this... thank you.

Chief Justice Rehnquist: Thank you, Ms. Millett.

The case is submitted.

Attribution:

The OYEZ Project

Featured:

Raleigh v. Illinois Dept. of Revenue - Oral Argument

Fri, 09 Jan 2009 14:50:19 +0000

Case:

Raleigh v. Illinois Dept. of Revenue

Media File:

99-387_20000417-argument.mp3

Related Transcript:

1999_99_387_argument.xml

Transcript:

Argument of Robert Radasevich

Chief Justice Rehnquist: We'll hear argument now in Number 99-387, Thomas Raleigh v. the Illinois Department of Revenue.

Mr. Radasevich.

Mr. Radasevich: Mr. Chief Justice, and may it please the Court:

The issue in the case before the Court this morning is whether taxing authorities should be subjected to shoulder the same burden of persuasion as other creditors in bankruptcy to prove the allowance of their claims.

We think it's essential, in resolving that question, to note that the validity of claim under State law is not the same as the allowance of a claim under the Bankruptcy Code and under the Bankruptcy Act which preceded the code.

This Court's prior decision in Vanston is illustrative of that dichotomy.

Bankruptcy is fundamentally a process which realters and restructures debtor-creditor relationships.

When matters of State law giving rise to rights between parties are at odds or are inconsistent with policies or procedures underlying the Bankruptcy Code, those aspects of State law give way.

We argued in our brief that the general practice under the Bankruptcy Act was to require taxing authorities, like all other creditors, to shoulder the burden of persuasion to establish the allowance of their claims.

Chief Justice Rehnquist: Now, the respondent disputes that, Mr. Radasevich.

He says there really wasn't... there was authority on both sides and it simply wasn't well-established.

Mr. Radasevich: We recognize in our moving papers, Your Honor, that there was aberrant authority that took the position that taxing authorities did not bear the burden of persuasion on their claims.

Justice Ginsburg: There was no decision from this Court.

Mr. Radasevich: Correct, Your Honor.

Justice Ginsburg: So that you characterize as aberrant one side rather than the other.

What is your basis for that?

Mr. Radasevich: The basis, Your Honor, is the decisions that come down and the volume of the decisions that came down on the side of the equation that taxing authorities bear the same burden.

The statements in Collier's which this Court recognized in Kelly as an authoritative treatise as to what the standard of pre-code practice was, with no indication of any alternative viewpoint, took the position that the burden... that taxing authorities bore the burden of persuasion on tax claims.

When Congress enacted the Bankruptcy Code of 1978, the legislative history indicates that it gave careful consideration to the treatment of tax claims in bankruptcy estates.

The legislative history that we cite in our brief, I believe on page 16, indicates that Congress was concerned about the interplay between creditor rights of ordinary trade creditor variety, consensual trade creditors, the interests of the debtor, and the interests of taxing authorities...

Justice Scalia: Mr. Radasevich, what was the head count of cases on your side versus those on the other side under the previous legislation?

Mr. Radasevich: Many of the cases that were cited in the appellant's brief we don't believe stood for the proposition that the taxing authorities bore the burden of persuasion.

Justice Kennedy: How about Judge Posner's opinion on B-8 of the appendix?

He sets forth the cases that are in your favor, but... which he acknowledges are a majority, and he says the Third and Fourth Circuits have reached an opposite conclusion.

He cites Landmark.

Mr. Radasevich: That is correct, Your Honor.

There were decisions on both sides of the equation.

We do not take the position that there weren't decisions on both sides of the equation.

What we argued in our briefs was that what appeared to be the majority view under the Act, and which Collier's thought was a majority view under the Act, was that taxing authorities bore the same burden of persuasion as other creditors.

Whether...

Justice Ginsburg: But then we...

Mr. Radasevich: Excuse me.

Justice Ginsburg: in that mixed picture I think would have the obligation to decide which is the better view, since we're not bound by one side or the other of that pre-code split.

There is nothing definitive earlier, so shouldn't the proper role for this Court be to decide what is the better position?

There is... the code itself is totally silent on this issue, is it not?

Mr. Radasevich: Yes.

The code and the act before it were silent, Your Honor, and we do agree that because there was no decision from this Court under the Act it's proper for this Court to look at the rationale of placing the burden either on taxing authorities or on the objecting party under the Bankruptcy Code.

And if the Court determines that there wasn't a predominant practice under the Act, so that it was... Congress was deemed to have accepted that practice under the code, certainly practice under the Act and the legislative history under the code is illustrative of the concerns that Congress had, and I think it's helpful to this Court in reaching its decision as to where the burden of proof should lie.

Justice O'Connor: Well, wouldn't we normally look to State law for the substantive law giving rise to any claim?

I mean, is that what we normally do?

Mr. Radasevich: Yes, Your Honor.

Justice O'Connor: And if the State law provides that the burden of proof is on the taxpayer, why wouldn't we follow that, or vice versa?

Mr. Radasevich: The validity of claims under nonbankruptcy law is not the same as the allowance of those claims in the bankruptcy estate.

If the Court hearkens back to its Vanston decision, in Vanston what the issue was was whether interest on interest was due in an indentured bond situation.

What the Court found was that because the Bankruptcy Code...

Chief Justice Rehnquist: Bankruptcy Act.

Mr. Radasevich: Bankruptcy Act.

Excuse me, Your Honor.

Since the Bankruptcy Act changed the relationship of the parties with respect to the debtor's ability to make payments, that allowing the creditor to obtain interest on interest, which was... the Court assumed was valid under the prevailing State's law, it's inequitable to other creditors of the estate.

So the Court didn't focus on whether the entire claim of the creditor was invalid.

It focused on a small aspect of the claim.

Justice O'Connor: Well, but the code... the Act gives tax claims priority, which indicates a certain preference, in a sense, for paying the taxes.

Mr. Radasevich: Absolutely it does, Your Honor.

The Bankruptcy Code gives taxing authorities benefits in several different areas, and the legislative history that we cited indicates the best result of Congress' concern about the interplay of taxes and creditor rights and rights of bankrupt debtors.

But this Court also recognized in Whiting Pools and in Energy Resources that just because taxing authorities or other creditors are given priorities, are favored in one portion of the Act, does not necessarily mean they're favored in others, and when Congress attempted to balance the interests of taxing authorities, other creditors, and the debtor, it did so by giving taxing authorities and banks tier priority.

Chief Justice Rehnquist: Well, one might argue that the view of the Seventh Circuit here does not really favor taxing authorities in that sense.

It simply says, we're taking the substantive law from State law in each case and that the burden of proof in this case is a matter of substantive law.

That's what the case is really all about, isn't it?

Mr. Radasevich: Yes, Your Honor.

That is what Judge Posner held in his decision.

We respectfully disagree that in filling a gap, essentially, in the text of the Bankruptcy Code, that this Court is required to adopt State law.

Chief Justice Rehnquist: You don't deny, I take it, that that is a part of the State law of Illinois, the burden of proof.

Mr. Radasevich: Burden of proof were matters of substantive law under Erie, yes, Your Honor.

Justice Souter: I guess the question is, is whether we in effect would be chipping away at the concept of the validity of the claim if we did not recognize the burden-of-persuasion rule, and the argument, I suppose, that we would be chipping away at it, that we really would not be recognizing validity 100 percent, is the argument that the burden of persuasion is so important to the Government's claim that you really cannot conceive of the claim in traditional terms without conceiving of it as one upon which the taxpayer has the burden.

And the argument for that, as I understand it, is, the taxpayer is usually the one who has the most easy access to the facts, and the easiest access to the evidence upon which ultimately the tax liability is going to depend, so if you take that argument, that by removing the burden of persuasion you really are taking away an element that goes very importantly to the validity, what is your response to that?

Mr. Radasevich: I think that is precisely the argument of the Government, Your Honor, and our response is that bankruptcy historically alters debtor-creditor relationships as a matter of fact in every single case, and burdens of persuasion which exist outside of a bankruptcy context and are meant to allocate risk, are designed to allocate risk between litigants, we don't think apply in a bankruptcy context when parties in interest are different.

In a bankruptcy context this Court has found repeatedly it transfers claims against the debtor, legal claims against that debtor, to equitable claims against assets which comprise a bankruptcy estate.

It's no longer the Illinois Department of Revenue litigating with Mr. Stoecker.

They have the ability to continue to do that outside of bankruptcy, like most taxing authorities, because tax claims by and large, unless they're extremely stale, are nondischargeable under section 520(p) irrespective of whether a proof of claim is ever filed or allowed.

Justice Souter: True, but I mean, I'm not sure that that gets to the, really to the heart of the point, that by adjusting, we'll say, the relations of fairness as between the original parties, the original taxpayer and the Government, you are in fact, or you would in fact, under the Bankruptcy Code, be changing the nature of the claim because you simply cannot understand the claim except in terms of who has the burden.

If the Government has the burden, it doesn't have that much of a claim because it simply doesn't have access to the means of showing it, and so it seems to me that the meat of their argument really is not affected by the fact that we have a slight shift in the actual parties to the relationship here.

The meat of their argument is, the claim itself would be changed if you changed the burden, regardless of who happens to be fighting about it at a given time, and I'm not sure that you really responded to that.

Mr. Radasevich: Your Honor, if you start with the presumption that the Government's claim is based... their tax claim is based upon something, often their internal audits and internal assessments, if we look at what happens when they file a claim under section... under the Bankruptcy Code, and the prima facie validity of that claim that ascribes under section 3... under Bankruptcy Rule 3001(f), it's not the Government's initial burden at that point to do anything.

The burden's on whoever the objecting party is, be it the taxpayer, a creditor, a Chapter 7 bankruptcy trustee, or a creditor's committee, to introduce an argument, evidence of an argument of equal probative value, which is the standard that a lot of courts talk about when they talk about displacing the prima facie validity of the claim in order to shift the... to make the creditor, the taxing authority come up with additional evidence to prove its claim, so it...

Justice Ginsburg: Mr. Radasevich, I think you're now talking about the distinction between the burden of coming forward, which you concede that the taxpayer would have, and the ultimate burden of persuasion, but it is the ultimate burden of persuasion that's critical here, and why isn't it part and parcel of the substantive right?

That is, this is not just any general rule about burden of persuasion.

This is a rule that is stuck together with a certain kind of claim.

This is a rule not for claims generally, but for tax cases, so we tend to think of built-in statutes of limitations, rules about processing, if you will, but that go together, that we have in other contexts called part and parcel of the substantive right, and so it doesn't answer that question to say, well, the taxpayer would have a burden of coming forward.

Mr. Radasevich: Justice Ginsburg, I think that the burden of proof attendant to tax claims is as much substantive of those claims as the burden of proof on any other claim.

Congress and State governments, State legislatures have decided that because of certain policy reasons the burden of persuasion on an assortment of different tax claims should be borne on the taxpayer rather than the taxing authority.

Those policy reasons are generally recordkeeping requirements, access to documentation, and knowledge about the underlying tax claim.

Those interests are not disserved by placing the burden of persuasion on a taxing authority in a bankruptcy estate because of the way claims are adjudicated in bankruptcy.

Because the taxpayer has to come forth with credible evidence, hopefully supported by records, in order to counter the prima facie validity of the claim, we think those same purposes are served.

For example, in Landbank, the decision that holds that the burden of persuasion is on the taxpayer, on the objecting party in bankruptcy, in that case the taxing authority filed a proof of claim and based upon an estimated valuation of bad loss, bad debt losses, the objecting trustee said no, you should figure... you should determine bad debt losses based upon the actual accounting method, but the Court's opinion indicates that nobody had any records of what the bad debt losses under the actual accounting method was.

In that instance, the objecting creditor failed to rebut the presumption of the taxing authority's case.

The taxing authority's case in Landbank, the taxing authority would have won even if the burden of persuasion would have been on the taxing authority, because the debtor, without adequate records, without justifiable evidence to rebut the presumption, can't overcome the validity of the tax claim.

Chief Justice Rehnquist: Well, did the objector here introduce some sort of evidence of the kind you're talking about?

Somewhere in these opinions one of the courts says there's virtually no evidence on the subject either way.

Mr. Radasevich: The Illinois Department of Revenue's evidence consisted of the notice of penalty or liability that was issued by the...

Chief Justice Rehnquist: I mean, what about the objector?

You say that person at least has to come in with a plausible argument.

Mr. Radasevich: Yes, Your Honor.

Chief Justice Rehnquist: Was that done here?

Mr. Radasevich: Yes, Your Honor.

The evidence that was submitted by... on behalf of the trustee was an opinion of counsel of the target company, Chandler Enterprises, that the subject transaction was exempt from taxes as an occasional sale.

They also have the certificate of exemption from the seller indicating that it had only sold one airplane, ever, and it was an... this was an exempt sale.

It also had the testimony of the lawyer supporting those arguments, and the testimony of Mr. Prewitt from the leasing company supporting those arguments.

What the Illinois Department of Revenue had, as indicated by Brenda Thompson, her testimony, was, when Chandler never responded to the notice of tax liability against it because it was only a shell and its principal was in bankruptcy, it checked with the Illinois Secretary of State and found out that Mr. Stoecker was an officer and director, as was an individual named Larry Pluhar.

Based upon that evidence and that evidence alone, when they didn't respond to letters they issued notice of penalty and liabilities against Mr. Stoecker and Mr. Pluhar with zero evidence that they were, in fact, responsible or, in fact, willful, so we believe that the evidence that we offered, which was the opinion letters and the certificates and the testimony, was sufficient to rebut the presumption of the validity... was at least equal to the probative value of the...

Justice Breyer: Why didn't you just call him to the stand, Stoecker, and say, look, did you get the letters to the lawyer?

Yes.

Did you think you were liable for tax in Illinois?

No.

Okay, thank you very much, and then you would have won.

So why... I mean, it... what Justice Souter said, I don't see that it makes much difference where the burden of proof is, frankly, and this seems like a case that illustrates that, and on the state of mind, where it's willful, I mean, you'd think that Mr. Stoecker was the best... is the best witness in respect to that, and if he doesn't show up, you begin to get suspicious.

Mr. Radasevich: Your Honor, Mr. Stoecker is currently a guest of the Federal Government, residing at a facility in Wisconsin, and...

[Laughter]

Justice Breyer: I didn't know that.

Mr. Radasevich: During the trial...

[Laughter]

Justice Breyer: But it might be easier to locate him.

Unidentified Justice: [Laughter]

Mr. Radasevich: During the trial, Your Honor, his deposition was taken and he asserted his Fifth Amendment rights.

In fact, the Illinois Department of Revenue attempted to assert the inferences arising from the assertion of a Fifth Amendment right against the trustee.

That did not fly, because the trustee is not the debtor.

We are fundamentally not the taxpayer.

We are a Chapter 7 trustee operating for the benefit of our creditors.

Justice Ginsburg: Isn't it the case that at least the trial court here said, yeah, this is one of those cases where the burden of proof does matter.

I'm in equipoise.

They have what... a good case, the other side has a good case.

There were gaps.

Given that situation, I am deciding this case on the basis of the burden of persuasion.

Isn't that so?

Mr. Radasevich: Actually, Your Honor, the trial court Judge Squires found that under State law the burden of persuasion was on the taxing authority, and the Illinois supreme court came down with a decision during the middle of our case which clarified that point, and found that the burden of persuasion was on the taxpayer.

Judge Squires, then affirmed by Judge Anderson, found that the burden of persuasion on a claim objection, on the allowance of a claim in bankruptcy fell with the trustee.

The court found that we rebutted the presumption.

The court did not make the alternative finding that if the burden was on the taxpayer...

Justice Ginsburg: There was some judge in this case who said, this is a case where there are gaps in the evidence, and it's one of those cases where the burden of persuasion is determinative.

Now, which judge said that?

Mr. Radasevich: Judge Anderson, Your Honor.

Judge... I'm... excuse me.

Judge Squires, Your Honor.

Justice Ginsburg: And he was what?

Mr. Radasevich: He was the bankruptcy judge, and he found that the evidence that we submitted was sufficient to rebut the presumption.

In...

Justice Stevens: Perhaps this is an unfair question, but was it only after the Illinois supreme court decided that issue that you decided this was a matter of Federal law?

Mr. Radasevich: No, judge... Your Honor.

Excuse me.

No, Justice Stevens.

[Laughter]

We have... these issues have been hanging around in this case since we started litigating in 1992.

Justice Stevens: So you had two arguments before, and now you have only one?

Mr. Radasevich: Your Honor, in the beginning we had a host of different arguments.

[Laughter]

We're down to one.

Justice Kennedy: I noticed you cited in your brief the Vanston case in 1940, 1946, something like that, and you don't cite the Butner case which the... or you didn't talk about it in your oral argument, which the respondent relies on.

Can you tell me, why didn't the Court... this Court in Butner cite Vanston?

You should ask me, not him.

Mr. Radasevich: Yes, I'm trying to...

[Laughter]

Justice Kennedy: Well, isn't the answer that it was that Vanston was pre-amendment of the Bankruptcy Code?

Mr. Radasevich: I don't think so, Justice Kennedy.

What was going on in Butner was whether there was a Federal interest underlying the need to have a uniform rule around the country about what a secured lender has to do once bankruptcy is filed to perfect a security interest in rents.

The Court found that that, much like whether a... how you establish a contract claim in Connecticut, or how you do a tort claim in Arizona, is the constituent elements of the rights of parties are determined under State law.

The Court found that the rights of a secured lender under State law to obtain rents on property should be left to State law.

There's no overriding Federal interest to make it otherwise.

You compare that case with the Court's decision in... so it didn't need to discuss Vanston because there wasn't an impact on creditors.

You converge that case with a case like Rash, where the Court determined that in order to determine the... what constituted value of collateral under section 506 and a cram-down under section 1335.

You don't look at what the secured creditor would get under State law, which is the foreclosed value of the collateral.

You look at it from the debtor's perspective in bankruptcy court and you determine that it's important for uniformity and predictability cases that we have a uniform rule that should be the fair market value of the collateral and not... without reference to State law.

Justice Breyer: Is... I notice that the Government on page 15 of their brief cites a large number of cases that really come out of the amici briefs of the States.

They have four where they say burden of proof is shifted.

It isn't always the creditor, and they say there are Tyler cases, there are laches cases, there are accord and satisfaction and usurious debt cases, so there are a bunch of them where really the burden is not on the creditor, and this is just one more of those.

Now, what's your response to that?

Are those accurate, and if they are accurate in your opinion, why isn't this just one more of those?

Mr. Radasevich: Your Honor, I think the cases cited... excuse me.

I think the cases cited by the Department and the amici in those... in that regard are affirmative defense cases.

You assume that the claim is valid.

You introduce an affirmative defense of statute of limitations.

You assume the debt is... that the instrument says that interest was supposed to be at this rate.

You bring in the affirmative defense that that rate is usurious under Illinois law.

Justice Breyer: Is the Truth in Lending Act an affirmative defense case, too?

I can see the others.

You'd argue for the simple rule, you'd say, all right, if it's an affirmative defense, the burden shifts, otherwise not, and they're arguing for the simple rule, let's look to see what it is under State law and treat it the same.

Mr. Radasevich: I'm not looking to... strike that.

The trustee is not looking to establish a rule going to who should have the burden on various different types of affirmative defenses without looking at what the underlying case is.

What we are looking for is a rule that says, creditors, when it comes to proving the prima facie evidence, the prima facie validity of their claim, can rely on their proof of claim.

When it comes to a situation where that claim is rebutted, taxing authorities in bankruptcy should be treated no differently than any other creditor when it comes to the allowance of their claim, because Congress... there's no indication that Congress thinks that it should.

When Congress thinks that they need an extra time period to file burdens of proof, or file proofs of claim, because they have an awfully hard time getting their records together and because they tend to be bureaucratic beasts, they give them additional time periods to file proofs of claim.

They give them dischargeability notices.

They give them priorities of claim.

But the eight groups of creditors that have... or the seven groups of creditors that have priorities above taxing authorities all have to prove their claims.

When this Court in...

Justice Breyer: Of course, the Congress didn't say anything about affirmative defenses, either.

Mr. Radasevich: It did in section 547, Your Honor, which deals with preferences, and there's a burden of proof allocation in section 547 of the Bankruptcy Code where Congress says that basically the trustee or the plaintiff has the burden of persuasion on the prima facie elements of a preference claim, and it's up to the defendant to have the burden of proof... they never say persuasion... burden of proof on the subsection (c) matters which are in the nature of affirmative defenses, that it was in the ordinary course of business, et cetera.

Justice Scalia: You say that the other creditors have to prove their claims.

That's purely accidental.

I suppose you could have another State law that gave some creditors other than the taxing authority the same kind of benefit that you're fighting here.

In other words, suppose there is a State law that does not require another creditor to bear the burden of proof.

You would likewise disallow that one.

Mr. Radasevich: We would likewise place the burden of persuasion on that creditor in bankruptcy to establish its claim, yes, Your Honor.

As it comes to pass, our research didn't indicate many other situations where creditors have burdens of proof.

Justice Scalia: Are there any other?

I was trying to think of one to give you a hypothetical, but I...

Mr. Radasevich: There was a case...

Justice Scalia: There is a Due Process Clause that seems to stand in the way of that, except for taxing authorities, for some reason.

Mr. Radasevich: There are presumptions that arise in certain Federal taxing concepts.

There's one under the Black Lung Act, something called the true doubt rule, that if somebody works in the mine for 40 years and gets lung disease, pretty good bet it's a result of him working in the mine.

The Court, though, in a decision the name of which escapes me found that that true doubt presumption doesn't hold in cases under the Administrative Procedures Act, because the Administrative Procedures Act says that the burden of persuasion should be on the claimant.

Burden of procedures, or the Administrative Procedures Act, Administrative Review Act is different than bankruptcy.

Bankruptcy is not a venue.

Bankruptcy's a process, and that process requires that all creditors, taxing authorities and otherwise, bear... shoulder the same burden of persuasion to establish their claims.

I would like to reserve the balance of my time, please.

Chief Justice Rehnquist: Very well, Mr. Radasevich.

Mr. Radasevich: Thank you.

Argument of A. Benjamin Goldgar

Chief Justice Rehnquist: Mr. Goldgar.

Mr. Goldgar: Mr. Chief Justice, and may it please the Court:

I'd like to begin by clearing up one area of potential confusion, and that has to do with the difference between, if there is a difference between the validity of a claim and the allowance of a claim.

Mr. Radasevich said that validity is not the same as allowance.

That is both true and untrue.

Allowance can mean more than validity, certainly.

There are reasons under section 502 of the code for disallowing a claim that have nothing to do with its validity, but validity is itself a reason for disallowing a claim.

It was, in fact, the reason why the trustee in this case challenged the claim.

It was the trustee's assertion that the Department of Revenue's claim was not valid under State law.

Under Illinois tax law, he contended, we did not have a claim.

In that instance, validity is indeed the same as allowance.

Now, to make matters more complicated and talk about how allowance is used in the Vanston case, under the Act, as opposed to under the Code, allowance meant something else again.

It not only meant allowance in the sense that it's used in section 502, but it also incorporated notions of equitable subordination, so that the Vanston case... and I can't speak to why it wasn't cited in the Butner decision, but it was cited in the opinion that Justice Stevens wrote in Grogan v. Garner.

In Vanston, the Court first observed that the validity of a claim... I believe they termed it existence, but that's really the same thing.

The existence of a claim is a matter of State law except where there is overruling Federal law, but the Court went on to say that essentially the equivalent of equitable subordination applied, and that is that it was unfair to allow these particular creditors interest on interest at the expense of other creditors, so in this case we are talking about allowance.

We are also talking about validity.

The trustee in this case is asking the Court to do something that we contend is pretty radical and that is, in the face of congressional silence and ignoring the vital interest that States have in the integrity of their tax schemes, he's asking the Court essentially to fashion a Federal common law burden of proof only, apparently, for tax claims and only in bankruptcy.

Under his rule, tax claims would be decided differently in bankruptcy court than in State court.

Justice Ginsburg: I thought, Mr. Goldgar, that Mr. Radasevich had said if there were other claims that were like the tax claims, his rule would be the same, but he said on inspection there weren't many, that most of the others were affirmative defense cases.

Mr. Goldgar: Yes, he did say that, as a matter of fact.

I stand corrected.

Although if there are no other burdens of proof that are similar, we believe the rule he is asking for would only have an impact on tax creditors.

Justice Ginsburg: Are there?

He didn't fully answer that.

He said there weren't many, but he... and he gave the black lung benefits.

Mr. Goldgar: I don't know of any myself.

Justice Ginsburg: You don't know of any.

Mr. Goldgar: That doesn't mean there aren't any, but I couldn't name any for you now.

Under his rule, essentially what happens is that State tax law is changed, altering the rights of really a single creditor, a single class of creditors to the benefit of all other creditors in bankruptcy, and that class of creditors that is disadvantaged is, in fact, a class of creditors that is ordinarily favored in bankruptcy.

Chief Justice Rehnquist: But of course your argument assumes that the burden of proof, or the burden of persuasion is part of the substantive law that governs the claim.

Mr. Goldgar: Yes, that... we do assume that.

We think that's an accurate statement of the law.

Justice Scalia: But you're... I mean, I don't think it's fair to say that the trustee here is asking to single out for some discriminatory treatment one particular class of creditors.

The fact is, this is the only class of creditors I know of that doesn't have to prove its claim.

Mr. Goldgar: Well, I don't...

Justice Scalia: The black lung cases, maybe that's another, but...

Mr. Goldgar: Well, let me...

Justice Scalia: The argument being made is, this is a very strange provision that does not exist in the common law normally and the purpose of it is to enable the Government, which normally does not have in its control the documents necessary to prove its case, to collect taxes that are due, and that when you shift over into a bankruptcy context the situation changes.

It's not the Government... the other creditors are no more in control of the necessary documents than the Government is.

Mr. Goldgar: Let me answer that a couple of ways.

The first is, tax creditors do have to prove their claims.

We had to prove our claim here.

We proved it the way State law required that we prove it.

We proved it with the certified record of our proceedings, which in this instance, with an unavailable taxpayer, essentially...

Justice Scalia: That's playing word games.

Mr. Goldgar: Well...

Justice Scalia: I mean, you had to prove it the way the State law said you had to prove it, which is not the way everybody else has to prove it, that is, by a preponderance of the evidence, right?

Mr. Goldgar: That's the burden of proof, though, that attaches to their claim, whatever it may be.

This is the burden... and therefore that's...

Justice Scalia: But this is a distinctive burden of proof that has been singled out for tax claims, and the argument being made is, there are good reasons for that, but those reasons don't apply in bankruptcy, and therefore this particular very weird element of, you don't have to bear the burden of proving your claim, should not be carried over into bankruptcy law, and there were many courts that came out that way under the old Bankruptcy Act, and Collier on Bankruptcy, the only bankruptcy authority I ever used, agreed with that.

Mr. Goldgar: Well, some courts came out that way and many courts did not.

I think what the trustee is really suggesting here is that in bankruptcy we can end up doing a kind of ad hoc balancing and determine whether we like or dislike the substantive law attendant to a particular creditor's claim when we're deciding the validity of that claim.

In this instance it apparently, according to the district court, was simply deemed to be unfair to the other creditors to allow tax creditors to have the benefit of their burden of proof.

Justice Breyer: Yes, but that's... look, he had very good answers to my questions.

I was trying to think, just following up on what Justice Scalia says, it seemed to me fairly easy, this case, because it seemed like there are a lot of instances in which you go into bankruptcy and really it's not the creditor that has to prove the claim, it's somebody else, all right, just like this, and then every one of those he says, with a very few exceptions, maybe Tyler, is really not so.

It's an affirmative defense.

So I wonder if you can be borne out historically.

And then he had... his second answer was, look, when you shift the burden of proof in an ordinary nonbankruptcy context, obviously the taxpayer can go in and declare his state of mind, for example, or the records, but here it's not the taxpayer who's at issue.

It's, let's say the widows and orphans who are the other creditors, and they have no easier access to that taxpayer than you do.

You all start out with the same nonaccess or access, so why shouldn't you have to call Mr. Stoecker in just as you're saying they should have to call Mr. Stoecker in.

So if there's no tradition, and if the reason disappears, why should you win?

Mr. Goldgar: We should win because... well, for a couple of reasons.

Because it is part of our claim.

It is part of the substance of our claim.

Justice Breyer: Oh, no, I understand that's the conclusion, but the... to get to that conclusion you're going to have to show some kind of history, tradition, or reason, and those were the parts that I wanted to hear your answer to.

Mr. Goldgar: History or tradition or reason of the burden of...

Justice Breyer: The reason why, for example, although you have a good reason for saying the taxpayer should pay the burden where it's State v. Taxpayer, namely Taxpayer has the ability to keep the records, et cetera, you do not have that good reason where it's State v. Widows and Orphans, and the taxpayer is equally inaccessible to all of you.

Mr. Goldgar: Well...

Justice Breyer: I'm not... I just want to know what your response is to what I take to be his responses to what I asked.

Mr. Goldgar: First of all, even if... I don't agree that that is the particular playing field we should be on.

I mean...

Justice Breyer: But still, I'm just curious what the answers are.

Mr. Goldgar: But I take... you know, for the sake of argument, even if the set of facts that Mr. Radasevich posits is true here, or even occasionally true, it's certainly not always going to be true.

In many instances, if not most instances, the debtor-taxpayer is the objecting party in bankruptcy.

In many instances when the trustee is the objecting party the trustee has the information.

This is the most sympathetic case for a trustee.

We've got a Chapter 7 bankruptcy with insufficient assets.

We have a trustee who's the bankrupt... who is the objecting party, and a trustee who happens to have no records, despite efforts on both sides to get them, because we had a taxpayer who was under indictment and eventually convicted of a crime.

But that isn't always going to be the case.

In most instances it won't be, and if the burden of proof is a legal rule, do we want bankruptcy courts making what are essentially ad hoc balancing determinations before we ever even get into the litigation of the claim.

Justice O'Connor: I don't understand why you claim it's an ad hoc balancing.

It's who has the burden of proof.

I don't see that that's ad hoc balancing.

Let me ask you something else.

The taxes that the State wants presumably are exempt from any debtor's discharge in bankruptcy, is that true?

Mr. Goldgar: These would be nondischargeable, yes.

Justice O'Connor: Right, so you could go after the taxpayer without ever making a claim in bankruptcy.

Mr. Goldgar: Well, in this instance the taxpayer who, as Mr. Radasevich pointed out, is a guest of the Federal Government, and...

Justice O'Connor: Presumably won't always be, and the State can go after him in the future.

Mr. Goldgar: Well...

Justice O'Connor: This is a nondischargeable debt.

Mr. Goldgar: Two points about that.

First, though nondischargeable, if it's disallowed in the bankruptcy, presumably that would mean that we have no claim.

I don't imagine that we would...

Justice O'Connor: But if you never made a claim through the bankruptcy proceeding, presumably the State can always go after the taxpayer.

Mr. Goldgar: Well, in that event, Justice O'Connor, the Government is put to an impossible choice, because in that instance we either have to choose, apparently, between making our claim in the bankruptcy and suffering a different burden of proof than we would have if we made the claim in the State court, or waiting until the bankruptcy is concluded, in which case the assets have been distributed hither and yon, and...

Justice Scalia: Why can't you do both?

I mean, if there is a different burden of proof, I mean, res judicata in a civil case doesn't cover in a criminal case because they're different burdens.

I'm not sure you couldn't bring the second action even...

Mr. Goldgar: Well...

Justice Scalia: if you lost the bankruptcy action at all.

Mr. Goldgar: I'm not sure if we could or we couldn't.

I think that raises difficult problems, but let's assume that we could.

Justice Scalia: Right.

Don't hypothesize the worst.

Be optimistic.

Unidentified Justice: [Laughter]

Mr. Goldgar: Well...

Justice Ginsburg: Well, but a bankruptcy is not a criminal proceeding, so it's not a beyond the reasonable doubt.

Mr. Goldgar: No, that's true, but still what happens is, and I don't think this can really be denied, the assets get distributed.

The money is going to be distributed.

Justice Ginsburg: How much were we talking about?

What was the...

Mr. Goldgar: In this case, $ 911,000, almost $ 912,000.

Mr. Stoecker I don't believe is going to have $ 912,000 any time soon.

Justice Ginsburg: So your point is, waiting till after could be more theoretical than real, because the chances that he would amass $ 900,000...

Mr. Goldgar: It could be a very long wait, and that at the same time that Congress has said that we should be a priority creditor and instead, if we have to wait, then we actually come after all the general unsecured creditors instead of before them.

That's not a dilemma, that's not a choice that Congress has indicated we should be put to, not in a case like this.

Justice Breyer: What are your best historical or traditional examples, an example of an instance that isn't an affirmative defense, where Congress is silent, and where State law or some other law puts the burden not on the plaintiff or the creditor but somebody else, and that's followed into bankruptcy?

Mr. Goldgar: I...

Justice Breyer: What are your... yes.

Mr. Goldgar: I don't know of anything that I could cite to you, Your Honor.

Justice Breyer: So this would be the only one.

Mr. Goldgar: As far as I know.

Justice Breyer: In other words, for you to win, then, we're saying tax cases are special.

Mr. Goldgar: No.

Justice Breyer: State tort tax cases are special, or we're...

Mr. Goldgar: sorry.

Justice Breyer: Or we're saying if the State passes these burden of proof things in other areas they get followed into bankruptcy, too.

Mr. Goldgar: Oh, yes, I would certainly say that.

I mean...

Justice Breyer: Well, if that's so, why doesn't the State just have a law, say we always win, or, you know, a State...

Unidentified Justice: [Laughter]

Justice Breyer: would say, if it's in bankruptcy the burden shifts to the other side?

Mr. Goldgar: Well, I certainly can't speak to that, but you know, perhaps that will happen one day, although it seems unlikely, but we're not asking for anything special.

That's our point.

We're... we want what everybody else gets in bankruptcy.

Everybody else gets their substantive rights under State law in deciding whether their claim is a valid claim under State law.

That's what we want.

If...

Justice Scalia: But you have a special preference outside of bankruptcy.

I mean, it is weird.

I don't know that the States could do what Justice Breyer suggested and simply in other fields, other than taxation, where we've allowed this.

It is due process in taxation to put the burden on the taxpayer to show that he doesn't owe the tax.

I seriously doubt whether it would be due process in other instances to say that this plaintiff wins unless the defendant can prove that the plaintiff doesn't have a cause of action.

I think that's very problematic.

Mr. Goldgar: Well...

Justice Scalia: And the reason you have this special preference has nothing to do with what's up in the bankruptcy case, and the equities are so much different.

You're not going after the taxpayer.

You're going after his money.

You're going after the widows and orphans, to put it tendentiously.

Mr. Goldgar: Well, here the widows and orphans are banks, just to make that...

[Laughter]

So you know... but again, what Your Honor is assuming is what the trustee is assuming, and that is, in bankruptcy suddenly everything changes and the trustee doesn't have the information.

Chief Justice Rehnquist: Isn't some of the reason for the benefit given by State law to the taxing authority illustrated here, where apparently it took the State a number of years to learn that this $ 12 million airplane had even been sold?

Mr. Goldgar: That's right.

We didn't know about this taxpayer, and by taxpayer I mean Chandler, the corporation.

We... he had... this corporation was, according to the indictment, a shell with no real business operations at all that was apparently used for the purchase of this plane and for nothing else, and there was no information available to us.

You know, what Mr. Stoecker would have said I don't know.

This was a corporation that never paid any taxes, it was never registered with the State, so there was nothing we could do, so in many respects this is the most sympathetic case for the Government.

There was no evidence available here, and yet there was a sale or purchase, both, of a $ 12.5 million airplane which was subject to Illinois use tax to the tune of a million dollars.

Now, if the burden of proof is on us to prove the elements of responsible officer reliability here, these people succeeded in what they were trying to do.

They get off scott-free, no tax.

The banks, not the widows and orphans, collect their money.

It's important to remember that we're still litigating the debtor's liability, and it's still the Government on the other side, and the Government still doesn't have the information, even though the situation is in bankruptcy.

Ordinarily, lack of evidence is called a failure of proof.

It's not a reason for shifting the burden of proof.

In many respects the trustee and any other creditors are better off in the bankruptcy court.

If we were litigating this outside of bankruptcy, well, there wouldn't be a trustee, of course, but the other creditors would not get notice of this claim.

We could go and sue for these taxes and not tell anybody but the taxpayer.

Here, they get notice.

Here, they have standing to come in and complain about it.

They get to reopen an assessment that was defaulted under State law and was final against this taxpayer, so they have many rights.

They have many rights.

At bottom, this is an argument, we suggest, for amending the code.

It's not an argument for imposing a common law burden of proof in the face of total congressional silence on this issue.

Unless there are further questions, thank you very much.

Argument of Lawrence G. Wallace

Chief Justice Rehnquist: Thank you, Mr. Goldgar.

Mr. Wallace, we'll hear from you.

Mr. Wallace: Thank you, Mr. Chief Justice, and may it please the Court:

Under our self-assessment and self-reporting systems of State and Federal taxation the traditional burden of proof on the taxpayer is not a peripheral matter.

It's essential to the successful functioning of tax authorities and to providing an incentive for the maintenance of adequate records to enable fair determinations of tax liabilities to be made.

Now, the court of appeals was quite correct in pointing out that the code addresses burden of persuasion in a number of contexts but not with respect to burden of persuasion on tax claims, and referred to its silence as eloquent.

Actually, there is perhaps something more than silence that implies an answer to this.

Tax claims arise in bankruptcy proceedings sometimes in the form of judgments that have been adjudicated by tax tribunals, whether State or Federal, but have not yet been paid, and sometimes as claims that have not been reduced to judgment, and in the section of the code, section 505 of title XI, entitled Determination of Tax Liability, Congress explicitly addresses the situation when a tax claim is reflected in a judgment.

As the court of appeals pointed out, section (a)(1), subsection (a)(1) of section 505, a provision which is cited in the briefs but not set forth in the briefs, does give the... a bankruptcy court authority to determine the amount or legality of any tax except as provided in paragraph 2, and paragraph 2 of section 505(a) says that the bankruptcy court may not make that determination if the amount or legality has been contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.

Then that judgment is binding in the bankruptcy proceedings.

Now, two observations might be made about this in a search for congruity in administration of the bankruptcy proceedings themselves with respect to tax claims, first that by 1978, when these provisions were enacted in the code, it was very familiar where the burden of proof lies in these tax adjudications and Congress was comfortable in giving conclusive effect to those that have been adjudicated in a tribunal.

But the other, rather strong implication is that the bankruptcy court is being told it's bound by those determinations, but when those determinations have not been made by a tax tribunal, then the implication, it seems to us, is that the bankruptcy court should be acting as the surrogate for the tribunal that ordinarily makes these tax determinations and should try to reach the result that would otherwise be binding in the bankruptcy proceedings in the spirit of Erie Railroad v. Tompkins.

This is a question governed by tax law, whether State or Federal, in this case State tax law, and you try to reach the result that the tribunal that can speak authoritatively for the State government in this case which creates the tax claim would have reached.

What petitioner is arguing for is a rule that would encourage the reaching of disparate results, depending on which tribunal is making the determination, a return to a pre-Erie kind of administration of the law, which would destroy congruity in the achievement of results here.

Justice Ginsburg: Mr. Wallace, it's not just Erie, is it?

As I understand it, in choice of law generally the burden of persuasion would go with the substantive right, so if we were making a State-State judgment, and Illinois is applying the law of Indiana to a particular claim, with that law would go Indiana's burden of proof and not Illinois, so it's not just a vertical Erie, but a horizontal...

Mr. Wallace: Well, I'm just... I'm talking about the spirit of Erie.

Erie revolutionized our thinking about how tribunals should go about making determinations when they're really determining something that is law emanating from another jurisdiction.

They should try to achieve the determination that that jurisdiction would have achieved through its normal processes.

It's just an analogy that I'm drawing.

I'm not saying that Erie controls this case.

What I am saying is that the petitioner is asking this Court to construe the Bankruptcy Code to encourage disparate results, depending on which tribunal has made the determination, when Congress quite explicitly said that if it has gone to determination before the normal tax tribunals which apply the normal burden of persuasion in tax cases, that will be binding in the bankruptcy proceeding.

There should be some reason before we should read the companion provision, which says nothing about burden of persuasion, to encourage the bankruptcy court, when it has to step in as the surrogate for the normal tax tribunals, to reach different results by applying different ways of determining the tax liability.

In fact, occasionally bankruptcy courts, when there's a particularly complicated tax question, will lift the automatic stay, as they're authorized to do to enable a tax court proceeding to go ahead to a conclusion because they feel that the tax court can make a more accurate determination on a complex tax issue, and then under this provision that will be the binding determination for the bankruptcy proceeding.

So what's really being advocated here is an incongruity in reaching results with respect to tax claims, because they often come before the court with a preexisting, embodied preexisting judgment which Congress has taken no chances on here, but has said will be binding, and it's barred the bankruptcy court from making any other determination with respect to the tax liability.

Justice Scalia: I'm not sure that's an incongruity.

It seems to me quite Congress to say judgments are judgments.

Are not other judgments accepted by the bankruptcy court, too?

Mr. Wallace: They are as very strong evidence of the claim and it's often argued that they're res judicata, but there's nothing in the code about other kinds of judgments.

The code... I mean, the fact that Congress explicitly said that the bankruptcy court is bound by tax judgments and is not to redetermine those does seem to, it seems to me indicate both a comfort with having tax claims decided under the ordinary burden of persuasion for their decision and...

Justice Scalia: But they'd be bound by other sorts of judgments on some issues which, if the... if there had not been a judgment, and the issue were presented to the bankruptcy court, the bankruptcy court might well determine that issue differently from the way the State court... I mean, let's assume it wasn't an issue of burden of persuasion, but an issue of, I don't know, something that the forum decides.

Mr. Wallace: I don't mean to suggest that they should not be bound by other kinds of judgments.

We're looking for what Congress might have intended here, and the fact that there was this explicit provision is of some importance, and there would be some question whether, if there were actually a different burden of persuasion, ordinary principles of res judicata would carry over, and yet explicitly the bankruptcy court is not to redetermine a question of tax liability that's embodied in a judgment, so there's corroboration on the face.

Rebuttal of Robert Radasevich

Chief Justice Rehnquist: Thank you, Mr. Wallace.

We'll hear now... you have 4 minutes remaining, Mr. Radasevich.

Mr. Radasevich: Thank you, Your Honor.

I'd like to address one point during my rebuttal, and that's the other five code sections which... in which Congress did, in fact, determine an allocation of the burden of persuasion.

The first three are instances where Congress allocated the burden to two separate parties in litigation on different things that were involved in the matter.

Under section 547, as I discussed with Justice Ginsburg, the prima facie proof is on the plaintiff, the affirmative defenses are on the defendant.

Under section 362, dealing with modification of the automatic stay, the movant has certain burdens, the debtor has other burdens.

Under section 363, dealing with the use, sale, and lease of property, the debtor has certain burdens where the trustee, the party asserting an interest in the property has other burdens.

So Congress split the burdens because there were a bunch of things going on.

That's not what we have in claim objections.

Chief Justice Rehnquist: Was there a defaulted administrative proceeding in the Illinois Tax Commission, or whatever body it is in Illinois that decides those sort of things?

Was this just a claim that had never been even administratively adjudicated?

Mr. Radasevich: It was a claim that had not been administratively adjudicated except for the issuance of the NPL, which is the assessment.

After that, the Illinois Department of Revenue found out about the bankruptcy.

They didn't... this certain Department, though they had filed other claims, didn't know about the bankruptcy.

They issued the NPL, filed proof of claim, Judge Posner in his decision recognized that that proof of claim was subject to challenge in the Circuit Court of Cook County administratively, so they recognized there was a procedure there that was not completed because of the filing of the bankruptcy.

Chief Justice Rehnquist: Which would have been a circuit court challenge to the administrative adjudication?

Mr. Radasevich: Correct, Your Honor, and...

Justice Scalia: And the bankruptcy court, Judge Posner... or the bankruptcy court could have lifted the stay and allowed that circuit court proceeding to go forward?

Mr. Radasevich: Sure.

Justice Scalia: In which case the burden would have been the burden that you don't like?

Mr. Radasevich: Absolutely.

Justice Scalia: So it's going to be up to the bankruptcy judge whether you're going to have the burden or not?

Mr. Radasevich: Absolutely.

Justice Scalia: Why...

Justice Breyer: So is there any other instance you could think of where bankruptcy courts follow a different burden where Congress has been silent?

Mr. Radasevich: Justice Breyer, I've read title VII cases which has a burden, but that's really a burden of shifting the production.

The burden of persuasion ultimately remains with the claimant.

I'm not aware of any.

And the other two code sections where Congress did specifically set forth the burden of persuasion, 1129 deals with the right unique to taxing authorities to trump plans if the plans are meant to defeat taxes.

Rather than have the debtor prove the negative that a plan is not designed to defeat taxes, the taxing authority has to argue and prove it.

Under 364, dealing with obtaining credit, the usual rules, you can obtain unsecured credit.

If you can't, subsection (b) says give them an administrative claim.

If that doesn't work, give them a superadministrative claim and a junior lien on assets.

If that doesn't work, give them a super-duper administrative claim and a charging lien on all assets, but if you're going to do that, trustee, then you better have... you're going to sustain... substantiate the burden of persuasion to show that those creditors whose rights you're priming in assets have been received adequate protection.

That's the exception to the rule, and Congress allocated a burden of persuasion dealing with that exception.

The usual rule in bankruptcy allocates the burden of persuasion to all parties.

Had Congress wanted to claim... to establish an exception for taxing authorities, they could have.

They didn't.

We don't think this Court should either.

Thank you very much.

Chief Justice Rehnquist: Thank you, Mr. Radasevich.

The case is submitted.

Attribution:

The Oyez Project

Featured:

Hartford Underwriters v. Union Planters Bank NA - Oral Argument

Fri, 09 Jan 2009 14:50:19 +0000

Case:

Hartford Underwriters v. Union Planters Bank NA

Media File:

99-409_20000320-argument.mp3

Related Transcript:

1999_99_409_argument.xml

Transcript:

Argument of G. Eric Brunstad, Jr.

Chief Justice Rehnquist: We'll hear argument next in Number 99-409, the Hartford Underwriters Insurance Company v. the Union Planters Bank.

Mr. Brunstad.

Mr. Brunstad: Mr. Chief Justice, and may it please the Court:

In the century preceding the enactment of the Bankruptcy Code in 196... 1978, this Court and other Federal courts recognized and enforced the rule that an unpaid administrative claimant in a bankruptcy case can come to court and have his or her claim paid if the expense benefited the secured party.

The Federal courts also recognized the rule that a trustee who pays a claim may come and seek to charge the secured party's collateral if there was a benefit to the secured party.

In enacting section 506(c) of the Bankruptcy Code, Congress recognized the right of the trustee, and the issue before the Court today is whether Congress' recognition of the right of the trustee was therefore intended to abrogate the other pre-code practice, which is that the administrative claimant could come to court and have the claim paid.

Chief Justice Rehnquist: So you're simply arguing that if the code says nothing, the pre-code practice applies, notwithstanding something like 506(c)?

Mr. Brunstad: Yes, Your Honor.

As the Court stated 2 years ago in the Cohen case, cited in our brief, at 523 U.S. at 221, we will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.

Justice O'Connor: Well, here, Congress said the trustee...

Mr. Brunstad: That's correct, Your Honor.

Justice O'Connor: can bring it, and it doesn't talk about the creditor, so maybe that's a change.

I mean, it's pretty clear language.

Mr. Brunstad: Yes, it is, Your Honor, but I think that the part that Congress recognized was the tip of the iceberg.

As this Court made clear in the Wilson case, which we cite in our brief, the rule which this Court recognized was that the unpaid administrative claimant could come forward and have the claim paid.

Now, we know under the Bankruptcy Code that Congress will codify some of the equitable doctrines that preceded its enactment, and yet this Court has recognized other equitable...

Justice O'Connor: Well, I mean, this just looks like pretty clear language.

Did your client ask the trustee to take action?

Mr. Brunstad: Actually, Your Honor, yes, my client did.

Justice O'Connor: Yes.

Mr. Brunstad: And the trustee's position was that the trustee had no interest in this case and would not pursue it.

Justice Kennedy: Could you have asked the judge to instruct the trustee to exercise his discretion to collect the... to impose the surcharge?

Mr. Brunstad: Yes, we could have asked the Bankruptcy Court to do that, but we think that the... it would have been futile, because the trustee had no funds whatsoever to engage in litigation with the secured party.

Justice Kennedy: So that it would have been abuse, an abuse of discretion for the trustee to go ahead and seek the surcharge?

Mr. Brunstad: It would have been, Your Honor, completely futile, plus I think Your Honor would have to recognize in this case that the trustee having no interest in recovery because the trustee had not paid the claim in the first place, one could argue that the trustee having no interest and no incentive and no ability, it simply could not have happened.

Justice Kennedy: Did the trustee in your view in this case have the discretion either to seek the surcharge or not to seek the surcharge?

Mr. Brunstad: Well, if the trustee had wanted to do so for free, certainly the trustee could have pursued the claim.

Justice Kennedy: Do you think, if you were the counsel for the trustee, you would have told the trustee that he has discretion not to pursue the surcharge?

Mr. Brunstad: Yes, Your Honor, I would, because the State of...

Justice Kennedy: So now we're in the position where the code says, with its... within the trustee's discretion not to pursue the surcharge, and yet the creditor can force it.

That seems a little odd to me.

Mr. Brunstad: Well, Your Honor, our position is not that the creditor can force the trustee to do it.

Our position is that the creditor can pursue the claim directly.

Justice Kennedy: It still seems odd to me.

If the trustee has the discretion not to do so, for the creditor to force it, it seems to me to be in effect controlling the discretion of the trustee.

Mr. Brunstad: I think perhaps, Your Honor, the question here is not whether the trustee has discretion.

It would be whether the trustee has the ability.

In this case, the trustee having no funds to litigate with the secured party simply could not pursue the claim.

Chief Justice Rehnquist: If you had had a prior arrangement with the trustee... I don't know whether you did or not... could an action be brought in State court on the basis of representations?

Mr. Brunstad: We think, Your Honor, that the remedy here is a remedy under the bankruptcy laws.

Chief Justice Rehnquist: Yes, I didn't... that's not the question I asked you.

Mr. Brunstad: Okay.

Chief Justice Rehnquist: I thought maybe the Eighth Circuit had reserved the question of whether there was some right you had to go into Federal court on diversity or State law.

Mr. Brunstad: I think, Your Honor, that the Eighth Circuit, the en banc decision was merely saying that the only question here is whether there is a question under Federal law.

Chief Justice Rehnquist: What did the panel opinion say?

Mr. Brunstad: The panel opinion, Your Honor, said that we had the right under section 506(c).

There was no mention of any alternative right.

Chief Justice Rehnquist: Had you brought any claims in the district court, or any other court?

Mr. Brunstad: No, Your Honor, we had not.

This is the exclusive means of recovery which we are...

Justice O'Connor: I'm curious about a prior question about what 506(c) covers.

Mr. Brunstad: Yes, Your Honor.

Justice O'Connor: The text of 506(c) says the trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving or disposing of such property, and I think we're dealing here with Workman's Comp...

Mr. Brunstad: Yes, Your Honor.

Justice O'Connor: premiums that were incurred after the original Chapter 11 proceeding was begun...

Mr. Brunstad: Correct.

Justice O'Connor: in an attempt to keep the business going.

It didn't have anything to do with a cost and expense of preserving the real property, did it?

Mr. Brunstad: It did, Your Honor.

In this case the assets in question were operating businesses... gas stations, restaurants... and in order to operate those businesses the debtor had to have Worker's Comp insurance or it could not operate at all, so but for the provision of the insurance there would have been no operation.

Justice Scalia: Mr....

Justice Kennedy: Yes, but if they operate at a loss, that's not much of a benefit to the secured creditor.

That's the whole problem, is these people have been operating.

Mr. Brunstad: Well, Your Honor, I think that the difference is that between liquidation value and going concern value of the gas station.

Justice O'Connor: Well, put it this way.

I'm not sure... I mean, if your client had been hired to go paint the building, or to repair the plumbing, I can understand how it would fit under 506(c), but to incur an expense for paying these premiums for Workman's Comp to run the business, as opposed to actually enhancing the real property or the building, I'm not sure I see how it fits under 506 at all...

Mr. Brunstad: Well, Your...

Justice O'Connor: instead of 503(a).

Mr. Brunstad: Well, Your Honor, you never get to 506 unless you go through 503.

503 allows the administrative expense and creates a class of administrative expense claimants.

Justice O'Connor: Presumably your client is within that general category.

Mr. Brunstad: There is no dispute, Your Honor, that our claim was allowed as a proper administrative expense.

Justice O'Connor: But you just want to go now against the real property because that's the only thing there is, I guess.

Mr. Brunstad: Correct.

506(c) articulates...

Justice O'Connor: Yes.

Mr. Brunstad: a priority for certain claims.

Justice O'Connor: Okay, but why doesn't it... isn't it limited to something that actually enhances the property as opposed to the broader 503 claim?

Mr. Brunstad: Your Honor, in this case it's undisputed that our claim provided a benefit to the secured party, and the reason that it did was because the value which the bank realized from the sale of these businesses as a going concern was actually much greater than the value that they would have received if the gas station had shut down.

Picture the storage tanks under a gas station which is not operating or generating revenue.

Typically, those operations sell for very little money.

If, however, you have an operating store, and some of these stores are, in fact, still operating, but with different owners, the value is much more, so the bank got the benefit of the difference in value because the debtor was able to operate in a going concern value and those values were preserved.

That is, of course, one of the purposes of Chapter 11.

Justice Scalia: Mr. Brunstad, I have...

Chief Justice Rehnquist: Who can speak to engage a client such as yours to continue?

Is it the trustee?

Do you have to have an arrangement with the trustee?

Mr. Brunstad: Well, I think Your Honor should understand that the trustee and creditors are adversaries, and that it would not be... it would be unseemly in the least for a creditor, who is adversary to a trustee, to have to hire the adversary to pursue the creditor's claims.

Chief Justice Rehnquist: Yes, but in the first place, after bankruptcy, who authorizes your client to continue paying for Workman's Compensation?

Mr. Brunstad: Oh, I see.

Well, in this case, Your Honor, our client did not even know of the bankruptcy.

The debtor concealed that fact from us, so we've continued to provide the services without knowledge of the bankruptcy.

Chief Justice Rehnquist: Without any authorization from the trustee?

Mr. Brunstad: Well, it was authorized, Your Honor, but in the Chapter 11 context it doesn't quite work that way.

What happens is that when the debtor, who is in possession of all of the estate, the case is filed, the debtor continues to operate as it had.

Section 1108 of the Bankruptcy Code provides for the continued operation of the businesses, and the ordinary expenses which the debtor would incur in operating the businesses continued to be paid.

Chief Justice Rehnquist: Now, but is the debtor authorized to incur expenses which will be ultimately classified as administrative expenses?

Mr. Brunstad: Yes, Your Honor, and that... expenses that are incurred in the ordinary course, the debtor is authorized by statute to continue to incur those expenses, and in this case what we have, Your Honor, is an involuntary creditor.

We have the insurance company who provided insurance because the debtor could not get it in the market, and it was an assignment through the assigned risk pool, so as an involuntary creditor Hartford had to continue to provide the insurance.

Justice Kennedy: Even when the premiums were not paid?

Without...

Mr. Brunstad: Once the premiums were not paid, the Hartford then went and issued a default notice to the debtor...

Justice Kennedy: No, my question is this.

Mr. Brunstad: Yes, Your Honor.

Justice Kennedy: Let's assume the current premium has not been paid.

Mr. Brunstad: Yes, Your Honor.

Justice Kennedy: Does Hartford, under Missouri law, have the requirement to continue to provide the coverage?

Mr. Brunstad: For a period of time, yes, because...

Justice Kennedy: How long?

Mr. Brunstad: contractually there is a 30-day notice period before the policy can be cancelled.

Justice Kennedy: For just 30 days?

Mr. Brunstad: That's what the contract provides.

Justice Kennedy: But you seek for some 6 or 7 months, am I right?

Mr. Brunstad: Yes, Your Honor, but what happened during that period of time was that initially a part of the premium was paid when the application for the insurance was submitted, so that was covered for a period of time.

The way these policies work...

Justice Kennedy: up front.

Mr. Brunstad: I believe it was over $25,000.

Justice O'Connor: Could not the insurer have said in a situation like this, the debtor is in Chapter 11, I'm not going to be at risk, put up the whole thing in front?

Mr. Brunstad: If we had known about the Chapter 11, perhaps we could have done that, but we did not know, Your Honor.

Justice O'Connor: As soon as you found out about it, couldn't you say, at this point we stop until you pay the premium in advance?

Mr. Brunstad: We did not find out until after the policy was terminated, Your Honor.

Justice Souter: How does that relate to your argument that you were required to provide insurance anyway because this individual, or the company would have been within the assigned risk pool?

Mr. Brunstad: Your Honor, what happened was that they tendered their application with part of the premium, and then the... a period of time went by.

Premiums are calculated on an audit basis, meaning the debtor has to submit their payroll reports to the insurer.

Then the insurer calculates the premiums based upon the number of persons who are employed times a certain rate.

The debtor in this case neglected to send those monthly reports, so Hartford sent an auditor in.

The auditor conducted the audit, went back to Hartford, Hartford calculated the premium and then sent a demand to the debtor.

The debtor paid part of the premium.

Now, all of this took a lot of time to happen.

After the debtor paid a part of the premium, the second installment, in addition to the one that was with the initial application, it was not enough to carry through the term, but by the time the Hartford went and said, you haven't paid the full amount, we were 30 days away from the termination of the policy, so it was too late to cancel.

Justice Souter: So all you're saying is, we had to start insuring.

When we could stop insuring was in fact a complex function of the audit.

Mr. Brunstad: Correct, Your Honor.

Justice Souter: Okay.

Justice Scalia: Could I ask you about section 506, which is on page 2 of your brief?

Mr. Brunstad: Yes, Your Honor.

Justice Scalia: It says the trustee may recover necessary costs and expenses of preserving or disposing.

Now, I assume that he can't recover them until they've been expended.

Mr. Brunstad: That's correct, Your Honor.

Justice Scalia: Well...

Mr. Brunstad: When the trustee... the trustee...

Justice Scalia: That's a reasonable reading of it.

Mr. Brunstad: Correct, Your Honor.

Justice Scalia: Isn't it also a reasonable reading of it that he can't recover them unless he has expended them?

I mean, I'm...

Chief Justice Rehnquist: Correct, Your Honor.

Justice Scalia: When the trustee...

Well, but that's not the position you're taking.

In response to other questions here, you have assumed that the trustee could sue to recover money that he didn't expend but that you expended.

Mr. Brunstad: I think that the best reading of the statute, Your Honor, on its plain meaning, is that the trustee, when the trustee expends, then the trustee recovers.

Justice Scalia: Right.

Mr. Brunstad: But under prior practice, that was not necessarily the rule.

Under prior practice, trustees could recover whether they expended or not, and individual claimants could recover whether they expended or not, and the problem that the court faces...

Justice Scalia: So long as somebody else had expended.

I mean, somebody has to have expended.

You acknowledge...

Mr. Brunstad: Somebody has to be out some dollars before they can recover, and it has to be an administrative, allowable administrative expense before you get to 506(c).

Justice Scalia: You agree that the most straightforward reading of the statute is that the trustee can recover any money that he's expended...

Mr. Brunstad: Correct.

Justice Scalia: in securing the...

Mr. Brunstad: That's correct, Your Honor, but that doesn't, of course, tell us what to do when the trustee has not expended and the individual claimant is out...

Justice Ginsburg: You would agree, Mr. Brownlee, that the standard situation in which 506 applies is where the trustee has paid out cash, and...

Mr. Brunstad: Where the trustee has paid out cash...

Justice Ginsburg: and then he gets back that cash from the security, from the sale of the secured property.

Mr. Brunstad: Correct, Your Honor, and that has always been the uniform rule in the Federal courts including as articulated by this Court.

Justice Ginsburg: So how often has 506 applied to credit transactions?

Mr. Brunstad: It applies in almost every single case, Your Honor, in one way or another, where there is a secured party.

The problem that we face, Your Honor, is that in some cases...

Justice Ginsburg: No, I mean practically.

You've just said the standard instance in which 506 is used is, the trustee pays out dollars, and then the property is sold, and he gets those dollars back from the top of the price.

Mr. Brunstad: Correct, but that presupposes, Your Honor, that the trustee paid the expense first, and that presupposes the trustee had funds, unencumbered funds to pay these...

Justice Ginsburg: All I'm suggesting is that that is the core situation to which 506 applies.

Mr. Brunstad: It is the...

Justice Ginsburg: I thought you agreed with me.

Mr. Brunstad: It is the logical situation, the paradigm which Congress seemed to have had in mind, and now what we must do is fill in the gap for the part that Congress didn't seem to have in mind, and so the question becomes, do we follow the pre-code practice to fill the gap?

Justice Ginsburg: Well, that's... you know, you keep talking about pre-code practice, and I looked at your cases, and there isn't all that pre-code practice.

I mean, there's the one decision that you're relying on from this Court before there was any bankruptcy legislation, and then another one that's an admiralty case.

Mr. Brunstad: The Poznan case was an admiralty case, that's correct, Your Honor.

Justice Ginsburg: That doesn't show a very solid pre-code practice.

Mr. Brunstad: Well, Your Honor, the case which we rely on from this Court, the Wilson case, I think quite clearly addressed the specific problem and provided the specific solution that we're seeking.

In the lower court decisions, as the bankruptcy laws evolved up to the point of the Bankruptcy Code, those courts relied on Wilson for the proposition that the administrative claimant has the right to come to the court and have its claim paid when it has not been paid, and one of the cases that we cite in our brief is a case involving... bear with me for one minute, Your Honor.

It is the Louisville case, Louisville Storage Company case, 21 F. Supp. at 897, where the Court, citing Wilson, said, quote, it has always been the rule, inherent in general principles of equity, that the lienholder must bear the expense of bankruptcy administration, which is solely for his benefit, or to which he consents, or to which he causes, and there, and in those other cases relying on Wilson, the courts would allow on occasion the unpaid administrative claimant to come forward and have their claim paid.

So Wilson is the lodestar, in a sense, and the lower Federal courts followed it.

Justice Ginsburg: Yes, but you're relying on one rather old Supreme Court decision and some lower court decisions following it up.

I'm just suggesting that that is not a very strong peg for claiming this understood pre-code practice.

Mr. Brunstad: Well, Your Honor, it was uniform.

There were no opinions to the contrary, and the... this practice, I would submit, Your Honor, is more established than the pre-code practice which this Court was willing to accept in Midlantic for the proposition that a trustee's power to abandon carries with it the corollary that the trustee cannot abandon in violation of certain health and safety requirements under applicable State law.

Chief Justice Rehnquist: Well, isn't it possible Congress might have wanted to change this, figuring that what you describe as pre-code practice would attract a certain amount of leeches who wanted to get at the secured property?

Mr. Brunstad: Well, Your Honor, the rule, I think, is one which initially five courts of appeals, and the Eighth Circuit changed its mind, had adopted and the courts had no ability administering.

I don't think there's any evidence, Your Honor, that Congress intended to change the practice.

In fact, the only evidence in the legislative history is that Congress intended to maintain the status quo, so there's no... there being no evidence of an intent to change, the presumption, I think, is that, and properly so, given the nature of what we're talking about, the bankruptcy laws, that the pre-code practice endures.

Justice Kennedy: If the trustee chose to seek these funds to surcharge the property and, either by an accounting entry or by the actual receipt of cash, received $25,000, would that be paid 100 percent to you, or could the trustee say, well now, I have my own administrative expenses, too, and other, and there are other administrative... how does that work?

Mr. Brunstad: If the trustee has paid the claim from unencumbered funds of the estate, and the trustee then seeks to recover it from the secured party's collateral, and the trustee is basically replenishing the estate and then the funds would be distributed, but in that situation, of course, the administrative claimant is paid in full...

Justice Kennedy: No, but in my hypothetical he's not quite sure, and so he goes to court seeking authority to pay.

He gets it.

Does that go just to you, or does it go to other administrative claimants as well?

Mr. Brunstad: It would go to us if we were the only section 506...

Justice Kennedy: No, there are other ones.

Mr. Brunstad: Well, those claimants' claims are not entitled to the priority that section 506(c) provides.

If those claims did not provide a benefit to the secured party...

Justice Kennedy: They say they did.

Mr. Brunstad: Oh, if they did, and they were properly also 506(c) claimants...

Justice Kennedy: They claim that, but he just seeks authority to recover the money for you, and then it's there in the pot.

Doesn't everybody get to share it?

Mr. Brunstad: If those other claimants' claims were determined ultimately by the court to be entitled to 506(c), we would share with other 506(c) claimants.

Justice Kennedy: Do you have to do that under your theory of the case, where you yourself can sue?

Mr. Brunstad: Yes.

Justice Kennedy: So once you get a surcharge you have to share it with everybody else?

Mr. Brunstad: I think it's important to understand, Your Honor, that in the bankruptcy case the timing of when claims are presented is not what's important.

At the end of the case, after all claims have been cut off by a bar date and then determined, those... that is when the distributions can be made.

Justice Kennedy: I know.

Well, you help me with my question.

What happens if you prevail and you succeed in a surcharge?

Do you have to share with other administrative claimants who have made a claim?

Mr. Brunstad: If they have 506(c) rights, yes.

Justice Souter: Now, are there priorities within the 506(c) administrative claimants?

Mr. Brunstad: No.

All 506(c) claimants are equal.

Justice Souter: Including those pre-conversion and post conversion?

Mr. Brunstad: No. 506(c) only applies, Your Honor, to post petition.

Justice Souter: Ah.

Okay.

Justice Breyer: What happens pre-petition if a debtor has a huge claim against, say, General Motors that requires a lawsuit, let's say, millions of dollars, and the trustee, thinking it isn't that great a claim, won't bring the lawsuit...

Mr. Brunstad: Yes.

Justice Breyer: but the creditor, who's a big creditor...

Mr. Brunstad: Yes.

Justice Breyer: thinks I'd certainly like this money in the estate...

Mr. Brunstad: Yes.

Justice Breyer: I want him to bring the lawsuit.

What happens?

Can the creditor sue General Motors directly?

Mr. Brunstad: Your Honor, we believe that the Court answered that question in Meyer v. Flemming...

Justice Breyer: Yes, and what's the answer?

Mr. Brunstad: which is cited in our brief, and the answer is that of course the lawsuit should not be allowed to lapse.

The creditor can come and bring the cause of action.

Justice Breyer: So the creditor can bring his own lawsuit in that case for the benefit of the estate because the trustee wouldn't.

Mr. Brunstad: Correct, Your Honor.

Justice Breyer: And you say that's really the same principle here.

Mr. Brunstad: Correct, Your Honor, and I think...

Justice O'Connor: What could Hartford have done here to protect itself?

I mean, what's conceivably...

Mr. Brunstad: Conceivably...

Justice O'Connor: out there to protect Hartford?

Mr. Brunstad: Well...

Justice O'Connor: Is no notice required to be given to people post petition in a Chapter 11?

Mr. Brunstad: Notice is required, Your Honor.

It should have been done.

It was not done in this case to the Hartford, so the Hartford was without notice.

But let's... assuming that Hartford had notice, what could Hartford have done?

Well, being an involuntary creditor, and having to provide insurance as long as the premium was paid, very little, and Hartford's relief is section 506(c).

Just like when the United States comes in and cleans up an environmental site post petition, and the cleanup of the site benefits the secured party by increasing the value of the collateral, the United States in that situation, courts have recognized, can then come to court and say, the trustee has not paid our administrative expense for cleanup because the trustee has no unencumbered funds to do so and the courts have said, well, you may surcharge the collateral to the extent that it benefited the secured party.

Now, if that were not the rule, and the trustee had no funds to pay the United States' cleanup cost, then essentially the United States would be subsidizing the recovery of the secured party, who would walk away with the full value of the collateral, having the benefit of the cleanup cost, but not have to pay that cost from the collateral, and this Court's principle, which is... it's articulated in Burnham v. Bowen, in Wilson, a whole line of cases, is that that is not the bankruptcy rule.

Justice O'Connor: Was this property... was the business ultimately sold as a going concern here?

Mr. Brunstad: Yes, Your Honor.

During the case... the stores were sold during the course of the Chapter 11 case.

In fact, that was planned from the beginning.

In our appendix there is, at one of the pull-outs that we have, which shows the budget and what the parties were to expend, listed at the top... and this is page 175a... you will see at the top, stores to close, and this was the exhibit that was attached to the order on the first day of the bankruptcy, and it shows that there were... identifies a number of stores to be closed, and in fact a number of the stores were closed and sold as going concerns, and the bank realized the proceeds from those sales, so the bank got the benefit of the going concern, and our simple point is that...

Justice Ginsburg: But a number of them weren't.

I mean, the thing eventually ended up in Chapter 7, and it was liquidated.

Mr. Brunstad: After the stores were sold...

Justice Ginsburg: All of them?

Mr. Brunstad: I believe all of them.

There may have been one or so, but...

Chief Justice Rehnquist: Mr. Brunstad...

Mr. Brunstad: No, all of them were, Your Honor.

Yes, all of them were.

Chief Justice Rehnquist: Mr. Brunstad, in Midlantic, which you say is the case that stands for the proposition of bringing forward pre-code practice if Congress doesn't... we said in codifying the judicially developed rule of abandonment, Congress also presumably included the established corollary, et cetera.

Mr. Brunstad: Yes, Your Honor.

Chief Justice Rehnquist: Now, what rule are you saying that 506(c) codified that should bring with it your position?

Mr. Brunstad: 506(c) codified the tip of the iceberg of the...

Chief Justice Rehnquist: Well, the tip of the iceberg really isn't a very... I mean...

Mr. Brunstad: Certainly, Your Honor.

Chief Justice Rehnquist: It's certainly... Midlantic is much narrower than saying the statutory... is just the tip of the iceberg, that we bring all sorts of other things with it.

Mr. Brunstad: Well, I think, Your Honor, in this case, what should come with 506(c) is the undisputed established pre-code practice.

There is no contrary precedent, contrary to Wilson.

Chief Justice Rehnquist: Yes, but it's... Midlantic is talking about, they're codifying something and you can tell from the language of the section that they're codifying it.

You can't tell from 506(c) that they're codifying anything as broad as you say, it seems to me.

Mr. Brunstad: Well, Your Honor, the bankruptcy codifies in section 553 rights of set-off.

That says nothing about rights of recoupment, yet in bankruptcy that was an established right and this Court in Ritter v. Cooper said it's well-settled that recoupment applies in bankruptcy, so this Court in construing the bankruptcy laws has not been shy about incorporating and recognizing its...

Chief Justice Rehnquist: Yes, but set-off and recoupment seem much closer to one another than 506(c) and what you're talking about.

Mr. Brunstad: Well, I think, Your Honor, that actually the opposite is true, and what we're talking about here is a rule that the administrative claimant can come, which is inextricably intertwined with the right of the trustee.

The general principle is the same.

I think it's important to emphasize that bankruptcy proceedings are in rem, and that the bankruptcy court, as this Court made clear in the Adair case, that it is the responsibility of the court, the bankruptcy court to see to it that the in rem assets, which are in custodia legis, are, in fact, distributed properly.

Chief Justice Rehnquist: Yes, but that's a general statement that really I don't see... how does that aid you in this particular case, when you're talking about 506(c)?

Mr. Brunstad: Because Adair is the case, Your Honor, which articulated the rule which we're relying on here, the general rule that the administrative expenses must be paid out of the secured party's collateral to the extent of the benefit and the court... it would I think be... lead to an absurd result to say that if the trustee doesn't come to court, that the bankruptcy court has no authority to allocate the charges properly, and if the bankruptcy court has authority to do so, any party in interest in the case should be able to come to court to say to the court, this is how it must be done.

Justice Scalia: Well, that would be all the more so if you interpreted 506(c) as allowing the trustee to recover only those expenses that he has paid.

Mr. Brunstad: Correct, Your Honor.

Justice Scalia: I think your case gets harder if you read 506(c) to say that the trustee may also recover on your behalf expenses that you've paid.

I don't read it that way, but you apparently do.

Mr. Brunstad: Well, Your Honor, I think Your Honor's reading is the correct reading.

In response to Your Honor's prior question I think it was... my response was that pre-code practice allowed either way.

I think Your Honor's reading is the best reading, and that the administrative claimant, following pre-code practice, can come to court when the trustee has not paid the claim.

Chief Justice Rehnquist: Under what section?

Mr. Brunstad: Under what section, Your Honor?

Justice Scalia: Yes.

Mr. Brunstad: Well, the bank... under pre-code practice, the lower courts often would invoke this rule as a gloss on the court's power to allow administrative claims in addition.

Chief Justice Rehnquist: But to me that is the difficulty with your position, and the cases where we've said pre-code practice, you can point to a section and say, yes, this brings... this says (a), but it also means the corollary to (a) under prior practice, but you don't have an alternative section to point to.

506(c) doesn't help you.

Mr. Brunstad: Well, neither does the doctrine of recoupment, Your Honor, or the doctrine of ear-marking or substantive consolidation, and those are all equitable doctrines which endure under the...

Justice Ginsburg: Mr. Brownlee, I'm not... you made a major shift from your brief in response to Justice Scalia's question, and so I'd really like to know what your position is.

That is, you made a big thing about 50(c)... it wasn't the trustee only.

It was the trustee and Carrot Mark... your client, but now you say Justice Scalia has the better reading and 506 has nothing to do with this case, so which one is it?

Mr. Brunstad: It does, Your Honor, because 506(c) clearly recognizes that expenses of the kind which we are talking about are chargeable against the secured party's collateral, and the question in an in rem bankruptcy proceeding where we're simply talking about dividing up assets, who's going to get what, the question is, can a party in interest come to court and say, this expense should be put in this bucket, or moved here, because the trustee has no incentive or ability to come to court to say it should be so.

And where the... because the bankruptcy court has the power under 105, under its general equitable powers, which this Court recognized recently in the energy resources cases to be quite broad, to allocate...

Justice Ginsburg: Are you dropping your reliance on 506?

Mr. Brunstad: No, Your Honor.

506(c) recognizes that the expense of the kind which we are talking about here is chargeable.

All we are saying is simply, the Court should adopt the gloss which the courts adopted pre-enactment of the bankruptcy code, that individual claimants, parties at interest, unpaid administrative claimants can come to court and say, the trustee won't act, we get to have this particular expense...

Chief Justice Rehnquist: Come to court under 506(c)?

Because that's the question presented in your petition for certiorari.

Mr. Brunstad: The Court, under 506(c), following pre-code practice, could rule, and... I think it doesn't make any difference, Your Honor, whether you rely on 506(c) directly or on pre-code practice, but I think that you can rely on section 506(c).

Chief Justice Rehnquist: Well, if you can't, you lose on the question presented.

Mr. Brunstad: Well, our position, Your Honor, is that you can.

Chief Justice Rehnquist: Your time has expired.

Mr. Brunstad: Yes, Your Honor.

Thank you.

Argument of Robert H. Brownlee

Chief Justice Rehnquist: We'll hear now from you, Mr. Brownlee.

Mr. Brownlee: Good morning, Mr. Chief Justice, may it please the Court:

I don't know if it would make any difference in the Justices' rulings, but I'd like to... my friend and colleague Mr. Brunstad misspoke on a couple of questions, one I believe by Justice Kennedy.

I may be wrong about that, because I think it was the first question in the argument, where Hartford indicated it had asked the trustee to proceed and the trustee had refused.

In the blue brief at page 5, note 4, it is stated, Hartford did not request the trustee to pursue its claim under section 506(c) because the law in the Eighth Circuit as it existed at that time permitted administrative claimants to pursue such claims on their own behalf, citing the Boatmen's case, which was overruled by the Eighth Circuit.

In fact, not even that is really so.

When the Boatmen's case was decided, the one that was overruled in this case, the issue was at contest in the Hartford v. Magna case, Magna being the predecessor of my client, so I believe Mr. Brunstad misspoke in response to the answer to that question.

Justice O'Connor: Well, how could Hartford have avoided losing its claim here, do you think, if there was something that was obtained when the business was sold as an ongoing business, and assuming that the Workman's Comp insurance somehow benefited the property?

Mr. Brownlee: Justice O'Connor, Hartford's policies were such in this case... you can look at the record below... that it did not know that it was insuring a debtor for a period of some 15 months or so.

The one thing Hartford could have done, I believe, although I don't intend to tell them how to run their business in any... and I don't mean this in any way derogatorily or in a pejorative manner... would have been to have some procedures in place so that they would have known, even though the debtor... I have no evidence that the debtor did notify them.

Bankruptcy is and always has been somewhat creditor emptor, and it is true in this case that there's no evidence that Hartford was actually notified.

There is evidence in this case on the record below that Hartford knew that it had a series of quarterly bills that were going unpaid, and so it couldn't have found out.

Had Hartford known earlier, before the case was converted to a 7, and before the case was in a total liquidation mode, Hartford could have come to court, Hartford could have asked to terminate the policy based on nonpayment, at least cut its losses, and also Hartford could have tried to take steps to persuade the bankruptcy court perhaps while there were still funds in the estate to allow it within an administrative claim and force the payment of that claim.

Bankruptcy has a lot to do with timing, especially in a reorganization case that's going downhill.

Hartford in fact is correct that it did not know until substantially later.

If the Justice's question is, how could Hartford have protected itself after the fact, once we got to March of 1993, or whatever the record will show the date was that it learned, Hartford cannot protect itself under 506(c), I submit.

506(c) says the trustee may recover.

Justice Breyer: Well, what happens in... I don't know that that Meyer case really answers the question, but what happens in the case of a pre-petition, a pre-petition debtor, the pre-petition debtor has a giant claim against General Motors, a lawsuit...

Mr. Brownlee: Okay.

Justice Breyer: and the trustee doesn't bring the claim, and one of the creditors says, I'd like to bring it.

Now, Meyer dealt with the case of the debtor having filed the suit, not a creditor.

It could be taken as authority for the creditor.

So what happens?

Is it the case that creditors in such circumstances simply go and bring their own lawsuits in the name of the estate instead of the trustee doing it?

Mr. Brownlee: Well, Justice Breyer, if I could just observe first of all in the Meyer case, it's my reading of the Meyer case that while the Court allowed the principle of the second debtor to proceed with the prefiled proof of claim in the first bankruptcy, it was clear that any recovery would be on behalf of the estate, which is not something that Hartford seeks here.

Hartford seeks a nonshare.

Justice Breyer: I know, but what I'm trying to do for my own purposes is to find an analogy, and I know it's a rough analogy, but I would like to know just for my own purposes what happens, and it must happen often, of when a trustee doesn't bring a lawsuit to get some money for the estate, that a big creditor thinks he ought to bring.

Does bankruptcy normally work... this can't be unusual.

Mr. Brownlee: It's not unusual.

Justice Breyer: And in such circumstances there are two possibilities.

One is that you bring a suit to sue the trustee and make him do it.

Another possibility is, you bring your own lawsuit but it... somehow you're standing in the shoes of the trustee.

Mr. Brownlee: Both exist.

Justice Breyer: Both exist.

All right.

If the...

Mr. Brownlee: You can file a motion...

Justice Breyer: Fine.

Mr. Brownlee: in the bankruptcy court to compel the trustee to act...

Justice Breyer: Okay.

Justice O'Connor: or you can seek what is known in many of the cases as derivative standing.

Justice Breyer: Fine.

Now, if that's so in that circumstance, why shouldn't that be so in this circumstance?

Mr. Brownlee: Because in this circumstance Hartford didn't follow that procedure.

Hartford didn't ask the trustee to act.

Hartford didn't ask the bankruptcy court to force the trustee to act, and Hartford didn't go to the bankruptcy court having made a record on that subject and said, you know, somebody needs to sue Union Planters because we think there's a pretty good 506(c) claim...

Justice Breyer: And now, in your view as a bankruptcy lawyer, if they had, I mean, is that a good way to resolve the problem?

You say, look, you're a creditor.

You're a post petition creditor.

You have a right to get your money, but you'll have to go first to the trustee, because otherwise there are going to be those leeches, you know, or there are going to be all these people running around.

Is that a good resolution?

Mr. Brownlee: Well, Justice, it's not the leeches issue, it's the quality-of-distribution-among-creditors-of-equal-rank issue.

If the trustee, who is clothed under 506(c) with the responsibility to pursue this right, this action to obtain funds that were otherwise the property of the secured creditor, either doesn't proceed in her own behalf, or there isn't a court order that allows whatever surrogate, Hartford or whomever, to proceed in the name of the estate and on behalf of the estate, then you're going to have a circumstance where that recovery is going to be, as Hartford seeks here, kept to itself and not shared with other creditors of equal rank.

Justice Kennedy: Where does...

Justice Souter: Well, can't...

Justice Kennedy: the court have the authority to allow Hartford to proceed, under what section of the code?

Mr. Brownlee: There is none.

Justice Souter: Hartford...

Mr. Brownlee: I'm not aware of a statutory basis, Justice, for derivative standing.

Justice Kennedy: All right, but...

I thought that in response to Justice Breyer you said, now, you go to the trustee and the court, and if the trustee doesn't want to do it, then you ask the court for authority to do it on your own, but now you're saying that a court doesn't have... can't allow you to do it.

Mr. Brownlee: The bankruptcy courts have developed a body of law wherein they will... some will grant what is called derivative standing, and the cases are cited in the briefs.

As a matter of fact, the best example of them is in the amici for the petitioner, when the AIA and the National Union suggests that even under the preference section and the fraudulent conveyance sections, which also start with the words, the trustee may recover, that there are cases which have allowed third parties...

Justice Kennedy: Are those proper cases, and proper holdings in your view?

Mr. Brownlee: Justice, I don't think... I know that this Court doesn't need to decide whether derivative standing is appropriate on a Nation-wide basis for us to win this case, because I don't think this Court should hold, and I hope it doesn't hold the 506(c), the word trustee means anything other than trustee.

I don't think you should hold that it means... because I don't think there is any established pre-code practice and, if there were, the statute is sufficiently clear.

It shouldn't...

Justice Kennedy: Well, then I'm not sure why your answer to Justice Breyer isn't that the Hartford goes to the Court, it asks to order the trustee, if the court and the trustee give no relief, there's nothing Hartford can do.

Mr. Brownlee: Well, Justice Breyer...

Justice Kennedy: I don't know why you didn't say it that way.

Mr. Brownlee: I understood asked me a factual question, Justice Kennedy.

I don't mean to argue with you.

In practice, and I'm in the trenches a heck of a lot more than I'm in the appellate courts, in practice bankruptcy courts will occasionally, if a trustee refuses to act, call a creditor or another party with the right to act in the estate's name on behalf of the estate to pursue the claim if the court feels that it should...

Chief Justice Rehnquist: Is that pursuit in the bankruptcy court...

Mr. Brownlee: In the bankruptcy...

Chief Justice Rehnquist: or in the plenary action?

Mr. Brownlee: In the bankruptcy court.

Chief Justice Rehnquist: In the bankruptcy...

Mr. Brownlee: Now, there is another...

Justice Souter: If we assume that is correct, then, if we assume that is a proper practice, then if Hartford had done two things differently, Hartford would be entitled to recover, I take it, on the assumption that there may be a derivative action, and the two different things are, number 1, Hartford would have to have gone to the trustee, and the trustee would have had to indicate refusal.

Mr. Brownlee: Right.

Justice Souter: And number 2, Hartford, in bringing its suit, would have to have captioned it, Hartford ex rel, or Trustee ex rel Hartford, rather than Hartford, and if those two facts had been different, assuming derivative actions are appropriate, Hartford could recover here.

Am I right, or am I missing something?

Mr. Brownlee: I don't precisely disagree with the way it's phrased, Justice Souter.

You're basically right.

Hartford would have had to get a court order that said, that established the trustee was not proceeding...

Justice Souter: Okay.

Now, why does it have to get the court order if there's no statutory section on it?

Mr. Brownlee: I'm not here to argue whether derivative standing is the right approach.

Every bankruptcy court...

Justice Souter: Right, but if we assume derivative standing is... I'm making that assumption... what difference does it make whether Hartford gets the court order or doesn't get the court order?

Mr. Brownlee: Because...

Justice Souter: Is it merely orderly procedure?

Mr. Brownlee: No, because if Hartford recovers it has to share with all other creditors of equal rank.

Justice Souter: Well, Hartford has indicated that that's exactly what it will do, although that's I guess an easy concession, because it says there aren't any.

Mr. Brownlee: If you could hear me for a minute on that.

Justice Souter: Yes.

Mr. Brownlee: I believe your question earlier to Mr. Brunstad was pre-conversion or post conversion, and his answer was pre-petition or post petition.

Those are big differences.

There aren't any administrative creditors pre-petition.

Pre-conversion and post conversion...

Justice Souter: Ah.

Ah, okay.

You're right.

Mr. Brownlee: in an 11 that goes to a 7, there can be a bundle of administrative creditors on both sides.

In fact, under 726(b) of the Bankruptcy Code, the post conversion administrative creditors in fact do have a priority, so...

Justice Souter: Well...

Mr. Brownlee: while he says there wouldn't be any others, that's not so...

Justice Souter: Okay.

Let's assume for the sake of argument, then, that I misspoke or he misspoke on that.

Mr. Brownlee: He did misspeak.

Justice Souter: He's... I will make the further assumption that any recovery would be subject to the claims of all others in the same class that Hartford is in.

Mr. Brownlee: Correct.

Justice Souter: Now, if that would be the legal effect of Hartford's recovery here, is the only thing, then, that prevents Hartford from doing that the failure of Hartford to have gone to the trustee in the first place and said, let me bring a derivative action?

Mr. Brownlee: If you are in a district where a judge will allow derivative standing in the name of the trustee, that's correct, because 506(c) talks about an action to recover by the trustee.

The bankruptcy court in a number of districts will allow that.

In a number of districts, some bankruptcy courts are critical of that.

But in any event, Hartford came here, and there has been I think a shift in the briefs, quite frankly, as I understand the argument, or maybe I just misperceived it.

Hartford came here on the merits briefs to ask the court assembled to rule that under 506(c)'s meaning, 506(c) could deemed to say, the trustee may recover, da-da, da-da, comma, and any unpaid administrative creditor may also recover under this section, and if that unpaid administrative creditor does recover under this section, it will have a super priority claim over all other administrative creditors as described in section 507(a).

Now, that's a big mouthful, but from a little section that says the trustee may recover, for Hartford to win on the merits briefs, all those things I just said, I respectfully submit, have to be engrafted onto a simple statute that gives the trustee in bankruptcy under limited circumstances as defined under the merits the right to...

Justice Stevens: Mr....

Does the record tell us whether there are other administrative creditors now competing for this money?

Mr. Brownlee: It does not, Justice Stevens, and I did not have the case below...

Justice Stevens: I had understood the record to indicate that this was the only administrative creditor, and that in no event would there be money available for any other, either general creditors or post petition creditors.

Mr. Brownlee: I can tell you this, Justice Stevens... I did not have the case below, so I'm not going to tell you something I don't know, obviously.

We called up from the archives the final report.

The final report doesn't say, so I can't tell you that.

I can tell you that Union Planners' predecessor had a $4 million loan, we lost a million and a half in principal, all of our interest, and all of our attorney's fees and costs.

If there was any other administrative creditor in the case, they didn't get paid.

Now, whether, as a matter of fact, there was another group there is unknown.

Intuitively, I would suggest to the court that Hartford went to a lot of trouble to make this end run if it was the only unpaid administrative creditor, because it could have made a simple demand on the trustee and taken its shot for derivative standing, and I would also like to suggest something else...

Justice Stevens: Well, but let me just...

Mr. Brownlee: Go ahead, Justice Stevens.

I'm sorry.

Justice Stevens: One other question.

Am I correct in assuming that they did satisfy the requirements of 503(a) and (b)?

Mr. Brownlee: They satisfied the requirements of 503(a) in that they... I'm trying to think which is which.

They made... in the same motion that they sued under 506(c), they made a request for payment of their administrative claim, and I believe they made a...

Justice Stevens: The bankruptcy judge allowed it.

Mr. Brownlee: Yes, and I made... I believe they made a request for allowance and payment.

Justice Stevens: Yes.

Mr. Brownlee: So I... it's my belief that they did follow 503 at least.

Justice Stevens: You see, the thing that troubles me about your position... it's a very difficult case, but the thing that troubles me about your position is, it seems to me it makes 503(a) and (b) meaningless.

Mr. Brownlee: Well, let me try to respond to that.

503(a) says you can file a request for an administrative claim or you can file a request for a payment of it, and that's fine.

I mean, any creditor ought to be able to file a proof of claim.

Unsecured creditors can.

Secured creditors can.

I certainly couldn't imagine why administrative creditors shouldn't be allowed to.

Anybody can ask for payment from the estate, but 503 talks about a direction to the estate to seek payment.

Creditors can't typically sue secured creditors as if they could sue outside under State law, to go back to a question you previously asked, Justice.

Within the bankruptcy, the Bankruptcy Code's... I believe the Court's language in some cases in looking at plain meaning has been a consistent and coherent scheme, has been that creditors deal with the estate, and the estate deals with creditors.

Hartford wants to deal with us.

They want to call us outside, and they don't have any way to do that except to make the argument that's made on the merits briefs and partially made today, although there may have been a shift in argument, that they can do it under 506(c).

Now, I would suggest to the Court that the Congress was not totally unmindful when it adopted the code of the possibility that inter... that there might be intercreditor fights under some circumstances, under some hypotheticals.

In fact, Congress enacted section 510, and in 510(c), which is the equitable subordination section, the Congress said that on application to a court, after noticing a hearing, the court can subordinate all or part of one creditor's claim to all or part of another creditor's claim, or give the lien to the estate if it wanted, under general principles of equitable subordination.

Now, the rule isn't the same as the substantive rule the trustee must meet to recover ordinary and necessary expenses of preserving the estate and benefit of the creditor under 506(c), but 510(c) does provide a remedy, but Hartford wasn't willing to share.

Justice O'Connor: Is it ever used in these administrative expense areas, that section, 510?

Mr. Brownlee: It's used a lot in winner liability type claims, or any kind of claim where you've got some sort of equitable misconduct, Justice O'Connor.

I have not personally, and I... that doesn't mean it's not used, and I have not researched the issue.

Justice O'Connor: What about the...

Mr. Brownlee: I do not know how often it is used.

Yes, Justice Ginsburg.

Justice O'Connor: Mr. Brownlee, what about the suggestions that petitioner made of the clean-up costs, or even the Government.

It's an ongoing operation, and there are tax liabilities.

She said that your position means that a Good Samaritan, or a Government agency who comes in and cleans up the toxic junk gets nothing...

Mr. Brownlee: Well...

Justice O'Connor: and the Government would get no tax.

How do you deal with those cases?

Mr. Brownlee: Well, in the first place, in terms of... and I gather your question is, a volunteer comes along post petition and cleans up the property, which directly benefits the property, or the secured creditor.

Justice O'Connor: Well, he... I'm addressing... I don't remember precisely how he put it in his brief.

I'm sure you focused on it, so you remember better than I do.

He talked about...

Mr. Brownlee: I'm not sure about that.

Justice O'Connor: the clean-up costs that could be incurred by a private contractor or by a Government agency to decontaminate the property.

Mr. Brownlee: Well, if the case is in a Chapter 7, the case is...

Justice O'Connor: This... it has to be...

Mr. Brownlee: Okay.

Justice Ginsburg: when it was in 11, because that's what made it possible for the thing to go on.

Mr. Brownlee: If the case is in Chapter 11, and the debtor hires a private contractor to come in and clean up dirty property, and that contractor does it, and the court finds that the reasonable and necessary, all of that is met, which it obviously sounds like on those facts, most bankruptcy courts would find that, and the estate becomes insolvent, and the contractor has not protected itself and gotten paid, then the contractor is his administrative claimant in the bankruptcy and is treated of equal rank with all others, and if that's unfortunate, and that means the statute's broke, then the Congress ought to fix the statute.

Justice Ginsburg: So you would... that's a very candid answer.

It wouldn't make any difference whether a Government agency came in to do the clean-up, having been authorized by the debtor?

Mr. Brownlee: I'm not aware, Justice Ginsburg, of any super priority for administrative creditors inter se under the 507 priorities of the Bankruptcy Code, except for the one that Hartford asks you today to judicially engraft onto a statute which only provides for the trustee to recover.

I'm not aware of...

Justice Breyer: Is it the case that if the trustee... the trustee himself goes and brings this lawsuit against Justice... she can do it.

I mean, the trustee can do this under 506(c).

Mr. Brownlee: Absolutely.

Justice Breyer: And, say, collects $10 million, which happened to be the cost of the contracted-for clean-up.

Mr. Brownlee: Okay.

Justice Breyer: All right.

So now there's $10 million in the trustee's hand.

Now, there are another $20 million of administrative expenses that were not related to preserving the property.

Now, does that $10 million... does the trustee give that $10 million to the toxic waste contractor that helped to preserve the property, or does that toxic waste contractor get only one-third and two-thirds has to go to these other administrative claimants who had nothing to do with preserving the property?

Mr. Brownlee: It's even worse, Justice Breyer.

First, the trustee takes the trustee's fees and expenses and expenses of counsel off the top...

Justice Breyer: Well, that's all right.

I don't object to find...

Mr. Brownlee: And then it goes two-thirds, one-third.

Justice Breyer: It does.

Mr. Brownlee: I am not aware of...

Justice Breyer: But then there's... that...

Mr. Brownlee: Unless there...

Justice Breyer: Yes.

Mr. Brownlee: Make sure I don't misspeak as an officer of the court.

Justice Breyer: Yes, mm-hmm.

Mr. Brownlee: Unless there is some Federal statute that grants a priority outside of bankruptcy to clean up contractors because of the importance of the environmental laws, where you'd have a clash between Federal statutes.

Justice Breyer: So then this is a bigger...

Mr. Brownlee: I'm not aware of a bankruptcy priority.

Justice Breyer: All right, so the... (c) has as its purpose simply getting money from the secured creditor into the estate.

It doesn't have as its purpose giving that money to the people who incurred the expense.

Mr. Brownlee: Oh, no, Your Honor.

Distribution...

Justice Breyer: Is different.

Mr. Brownlee: is governed by 726...

Justice Breyer: Wow.

Mr. Brownlee: in a liquidation.

Justice Breyer: And what was the prior practice?

Was the prior practice that when the... our secured toxic waste person... nonsecured, sorry.

The toxic waste person sues against the collateral, and apparently can get the money.

Did that toxic waste person get to keep the whole thing, or did the toxic waste person have to put it in the estate and share it with the other nonrelated administrative claimants?

Mr. Brownlee: I am not sure that I'm aware of a toxic waste case pre...

Justice Breyer: No, no, it wouldn't have been toxic waste.

What I mean is, a person...

Mr. Brownlee: Certainly not in the 1800's.

Justice Breyer: A 506(c)... a 506(c) creditor, and then there are non-506(c)'s, but 503(a) creditors, and when the 506(c) creditor brought the suit... I know there wasn't a 506(c) at that time...

Mr. Brownlee: I didn't mean to be cute.

Justice Breyer: but I mean, that kind of a person brings the suit, collects the $10 million, did he get to keep the whole $10 million, or did he have to throw it in the pool and he only got one-third and the non-506(c) administrative creditors got two-thirds?

What happened?

Mr. Brownlee: My best answer, and I don't want you to think this is a dodge, because I don't mean it to be, is it's my understanding of the pre-code practice was that it was all over the lot in terms of the equitable rule...

Justice Breyer: So this is quite...

Mr. Brownlee: what the judges decided to do.

We cited at page 44 of the red brief an article by Toth which recounts some of the history to the... the article itself is in the West New England Law Review.

It recounts a lot of the history to the predecessor to 506(c), and in that article it concludes that, as Collier's did in 1978, which we also cite on that page, that there was no firmly established rule as...

Justice Breyer: Why would you want to allow such a person, i.e., a 506(c) person, to get from the secured creditor money that he isn't going to keep and he in fact is going to give to two other people...

Mr. Brownlee: Because...

Justice Breyer: who, vis-a-vis the secured creditor, shouldn't get it?

Mr. Brownlee: Because, Justice... because of the equality of distribution rules of the Bankruptcy Code.

There are administrative claim creditors, and there is not a super priority that says you're a 506(c) creditor, because creditors don't have the right to pursue the action under 506(c).

Congress never intended 506(c)...

Justice O'Connor: My question is...

Mr. Brownlee: to be... allow you to bring that case.

It was for the trustee only, so a fortiori it was to be distributed to all the creditors of equal rank, and that's what Congress decided in 1978.

Justice O'Connor: Mr. Brownlee...

Mr. Brownlee: Yes, Justice O'Connor.

Justice O'Connor: my question is related, and it seemed to me in reading the text of 506(c) and 503 that not every administrative expense under 503(a) would fit under 506.

Mr. Brownlee: I agree with that.

Justice O'Connor: 506 is limited to the reasonable, necessary costs and expenses of preserving or disposing of the secured property.

Mr. Brownlee: I agree with Your Honor.

Justice O'Connor: And presumably some wages and salaries don't fit under that.

Maybe some insurance premiums don't fit under that.

It would depend on what it was.

Am I right?

Mr. Brownlee: Yes, you're absolutely right.

Justice Kennedy: Mr. Brownlee, going...

Justice O'Connor: I mean, I could see that 506(c) would be related to things like painting the building, or paying the real estate commission to sell it.

Is that right?

Mr. Brownlee: Your Honor, I know you're way past this, but I wished at one point you'd been a bankruptcy judge in our district.

I couldn't agree with you more.

Justice Stevens: Well, let me...

Mr. Brownlee: But some courts will find an implied benefit, or find some reason...

Justice Stevens: But wait a minute...

Mr. Brownlee: to try to toss these things into 506(c) on the merits.

That's not the case here we're talking about.

Justice Stevens: But let's clarify one thing here.

Mr. Brownlee: Yes, Justice Stevens.

Justice Stevens: I thought you had agreed that if this action had been brought by the trustee, because the trustee had expended this very money, 506(c) would apply.

Mr. Brownlee: If this action had been brought by the trustee...

Justice Stevens: So the fact that it's insurance premiums doesn't distinguish it from paint on the buildings.

Mr. Brownlee: We fought it below.

Justice Stevens: And you lost on it.

Mr. Brownlee: And we lost.

Justice Stevens: Yes.

Mr. Brownlee: I don't think we'd lose in every court.

Justice Stevens: No, but for the purposes of our decision...

Mr. Brownlee: For the purpose of this case...

Justice Stevens: we assume that this is just like paint on the buildings or something like that.

Justice Souter: Mr. Brownlee...

Mr. Brownlee: You're absolutely right.

Yes, Justice.

Justice Souter: do you have this answer to Justice Breyer's one-third, two-third hypothetical?

I mean, it's a problem for your case, and I thought the answer might be this, but tell me if I'm wrong.

Assuming derivative standing... the premise of my other question.

Assume it again.

If the one administrative creditor has administrative standing, what he will do, I presume, is to bring an action on behalf of all administrative creditors, so he will not nearly collect his insurance premium.

He will collect the charges of all other administrative creditors, and therefore he will get in a... theoretically 100 percent of what is owed, and so he will get his one-third, and they will get their two-thirds, and everybody will be whole.

Is that the answer to the problem?

Mr. Brownlee: Well, if every administrative creditor qualified to be a surcharging creditor under the standards of 506(c)...

Justice Souter: Right.

Right, yes.

Mr. Brownlee: But you're assuming every administrative creditor in the estate does so qualify, and I suggest to you that that hypothetically is an interesting question...

Justice Souter: Okay, dumb assumption.

Mr. Brownlee: but it doesn't happen in practice.

Justice Souter: But to the extent that that assumption would be true, is that the way we avoid the one-third, two-third problem?

Mr. Brownlee: To the extent that that assumption is true, if every administrative claim in a case qualifies for a surcharge... let me make sure I understand your hypothetical.

Justice Souter: Yes.

Yes.

Mr. Brownlee: And the trustee refuses to act, which is... I won't go into the inconceivability of that, because it would be such a large claim that very few trustees would not be highly incentivized, but if...

Justice Souter: We'll assume the trustee is broke and so on, but assume it anyway.

Mr. Brownlee: If it was a large case the trustee would be fixing to get unbroke very quickly when she won, but I don't mean to argue.

Justice Souter: No.

Mr. Brownlee: Under that assumption, the trustee refuses to act, the bankruptcy court refuses to direct the trustee to act, the bankruptcy court refuses to appoint a new trustee who will act, and the bankruptcy decides, in the exercise of its discretion, without any direct statutory authority, to grant derivative standing, and the Hartford brings the claim in the name of the estate on behalf of all the administrative claims in the estate, and wins on the merits of the individual little lawsuits it will have to prove reasonable, necessary, direct benefit, secured creditor, if that's the hypothetical, then yes, they'll recover and you'll avoid the one-third, two-third problem.

Justice Kennedy: Okay.

Suppose a pipe in the building is leaking.

They need a plumbing contractor immediately, or the building's going to be wrecked.

You represent the plumbing contractor, and he comes to you and says, I want to be sure I get paid.

How... what are the different ways he can do it?

Mr. Brownlee: In practice?

Justice Kennedy: Yes.

Mr. Brownlee: I'd call the bank.

I'd bypass the bankruptcy court entirely.

I'd call the bank and say...

Justice Kennedy: And anything else...

Mr. Brownlee: I'd call the bank and say, you're building's...

Justice Kennedy: you're at risk of...

Mr. Brownlee: going to fall in and it's your collateral.

You want to give me the money, I'll fix it, and if you don't, I'll stand by and take a picture of it while it falls in.

Justice Kennedy: And anything else you're...

Unidentified Justice: [Laughter]

Justice Kennedy: Anything else you're at risk of having to share with the other administrative creditors?

Mr. Brownlee: Absolutely, Justice.

Justice Scalia: Do you... on what basis does the trustee have the right to sue for money that the trustee hasn't expended?

Mr. Brownlee: There is a line of authority, Justice Scalia, and it may be the better one.

It can be traced to the statement in, I believe, the floor reports in the legislative history that's in the briefs, where there's a reference to the moneys that the trustee has expended, or some phrase to that effect.

It escapes me, the precise phrasing.

It's that really 506(c) isn't intended to collect unpaid administrative claims.

It's intended only for the trustee to bring an action to recover those administrative claims that the trustee has paid out that justify to tag the bank to bring it back in and...

Justice Scalia: Right.

Mr. Brownlee: split up the deficiency.

That opinion was adopted in the plurality opinion in K & L Lakeland in the Fourth Circuit, but as I read that opinion there wasn't enough votes in the Fourth, even though the Fourth is a JKJ circuit, which was the other circuit on our side, other than this case, which I hope is affirmed at the end of this argument, to make that part of circuit law.

This Court doesn't have to decide that today, but I would agree with the Justice that that is a strong read of the real congressional meaning of the words, but the plain meaning of these words fit if you want to include an attack on unpaid administrative claims.

It just makes it real complicated, and it makes for the kinds of questions that we've discussed today.

If there are no further questions, Mr. Chief Justice...

Chief Justice Rehnquist: Thank you, Mr. Brownlee.

The case is submitted.

Attribution:

The OYEZ Project

Featured:

Bank of America v. 203 North LaSalle Partnership - Oral Argument

Fri, 09 Jan 2009 14:50:12 +0000

Case:

Bank of America v. 203 North LaSalle Partnership

Media File:

97-1418_19981102-argument.mp3

Related Transcript:

1998_97_1418_argument.xml

Transcript:

Argument of Roy T. Englert Jr.

Chief Justice Rehnquist: We'll hear argument next in Number 97-1418, Bank of America National Trust and Savings v. 203 North LaSalle Street.

Mr. Englert.

Mr. Englert: Mr. Chief Justice, and may it please the Court:

Bank of America lent 203 North LaSalle Street Partnership $ 92 million.

The loan was secured by 15 floors of an office building in the Loop, in Chicago.

Outside of bankruptcy, the bank would have been entitled to be repaid $ 93 million in January of 1995, or to foreclose on the real estate.

In the bankruptcy proceeding that the Court is reviewing today, the bank was denied the right to foreclose.

Its right to receive a $ 93 million repayment in January 1995 was converted into a right to receive $ 60 million worth, present value, of payments over a period extending to the year 2005.

Ownership of the real estate was left in the hands of 203 North LaSalle Street Partnership, despite its default on the loan, in exchange for a promise to contribute $ 4.1 million net present value of new value into the estate over 5 years.

Justice Stevens: May I ask just a... I'm a little fuzzy on the facts.

It retained the same part... it was the same owners as before?

Mr. Englert: It's the same partnership.

It's been reconstituted with the percentage ownerships changing.

Justice Stevens: It's reconstituted with the... some partners contributed and some did not; is that right?

Mr. Englert: That's correct, Your Honor.

Some partners exercised their option; some did not.

Justice Stevens: So that it's actually a different group of individuals than it was before?

Mr. Englert: It is a...

Justice Stevens: If it's a different partnership, in effect, do they have different partners?

Mr. Englert: It is the reorganized debtor.

It was not reconstituted as a separate partnership, but as a reorganized debtor.

Chief Justice Rehnquist: Are there any individuals in the new partnership that were not in the former one?

Mr. Englert: I don't know the answer to that question, Your Honor.

Justice Ginsburg: Well, the new partnership still preserved the tax shelter, right?

I mean the... the whole problem here was that if there is a default which constitutes a sale, there's... there's this enormous tax bill to be paid.

Mr. Englert: That's correct, Your Honor.

Certainly the owners of the equity are mostly old equity owners.

They may be all old equity owners.

I'm just not sure whether anybody new came in.

But the main purpose of this plan was to save the individual partners from suffering tax losses on transfer of ownership.

Justice O'Connor: What if the plan here had let any creditor participate if it wanted to...

Mr. Englert: That would be a very different case, Your Honor.

Chief Justice Rehnquist: in the reorganization?

Mr. Englert: That would be a very different case.

Justice O'Connor: Would that have satisfied the claim here and overcome the so-called absolute priority rule?

Mr. Englert: It might well have.

The key statutory phrase, Your Honor, is that the... is that the junior interest holders may not receive or retain under the plan, on account of such junior claim or interest, any property.

Chief Justice Rehnquist: And what section is that, Mr. Englert?

Mr. Englert: It's section 1129(b)(2)(B)(ii) of the Bankruptcy Code.

It's on page 2(a) of the appendix to our brief.

Justice Breyer: Could I ask you a quick preliminary question just to test my knowledge.

Why, in this case, since your clients are owed I guess tens of millions of dollars, isn't it...

Mr. Englert: The claim of our client... of my client?

Chief Justice Rehnquist: Yeah.

Justice Breyer: The... the... the creditor is owed tens of millions of dollars, the main creditor.

Mr. Englert: The creditor is owed $ 93 million.

Justice O'Connor: Right.

Justice Breyer: And... and the... the... the only other class are a group of people who are owed like $ 50,000.

Mr. Englert: The trade creditors had claims of $ 90,000.

Justice Breyer: All right, 90,000.

So why wouldn't the major creditor just have paid them their $ 90,000?

Am I right, that if... if your client had just said, I'll write a check for $ 90,000, you get the money, at that point you would have been the only one left.

Mr. Englert: Correct.

Justice Breyer: And then there would have been no doubt they couldn't do this.

Mr. Englert: Well, I agree with you, Your Honor.

But the Seventh Circuit certainly thought otherwise.

Justice Breyer: No, no, no.

Suppose you... they would have thought... if you were the only creditor left, if there was only one class of creditor, because you had paid off the other ones, then is there any doubt that you could have objected to a cram down plan or not?

Mr. Englert: Well, Your Honor, if I...

Justice Breyer: Can they cram down a plan if there is one... the only creditor is the one who is being sort of crammed down, so to speak?

Mr. Englert: We... we can object.

We did object.

The... the provision that makes the unsecured creditors important is Section 1190... 1129(a)(10), which requires the assent to the plan of at least one impaired class.

And keeping the trade creditors in the plan not to be paid in full in... in the case... not paid in full... was important to the debtor.

We can't take them out of the bankruptcy case just...

Justice Breyer: Why can't you just pay them?

If you write a check, don't they disappear?

Mr. Englert: We can... we can purchase their claims.

Chief Justice Rehnquist: Yeah.

Justice Breyer: Well, is this a test case, in other words?

Is this some kind of test case?

Or is there some good economic reason why you couldn't have written a check for 90,000, gotten rid of them, and then won?

Mr. Englert: We... the debtor got to them first.

The debtor paid them in full.

Justice O'Connor, in response to your question, the key phrase here is... is.

nd if they had not been granted property on account of their pre-petition equity interest, this would be a vastly different case.

They were granted two forms of property on account of their pre-petition equity interest.

One was the exclusive option to buy equity in the reorganized debtor.

An option is itself a property right.

Options in publicly traded stocks are bought and sold every day.

Judge Reinhardts opinions in the Ninth Circuit in Bonner Mall, conceded that the...

Justice Scalia: But that was not under the plan.

Mr. Englert: Your Honor, every...

Justice Scalia: The plan didn't give them the right to buy that option.

Mr. Englert: It did, Your Honor.

Justice Scalia: It did?

Mr. Englert: It did.

The plan doesn't give anybody anything until a bankruptcy judge confirms it.

So, under the plan, has to mean what happens when this plan is confirmed.

And it was the plan that excluded anyone other than the pre-petition equity holders from having the option to buy equity in the reorganized debtor.

It's also the plan that gives the pre-petition equity holders the equity interest in the reorganized debtor on account of being pre-petition equity holders.

In other words, on account of their prior claim or interest.

Justice Kennedy: Are you saying that if an equity owner is ever to be allowed to contribute new value, that that must be made available on the same terms and conditions to all... to the... to all persons?

Mr. Englert: Not quite, Your Honor.

If they're ever to be allowed to contribute new value over the objections of a class of impaired creditors, then yes, we... our position is that the... the opportunity to buy the equity for new value must be distributed equally.

But the real-world way that new value plans get confirmed all the time is through creditor consent.

And that's what Congress intended.

It didn't intend judges to cram down new value plans.

It intended negotiation among the parties to allocate any going concern surplus.

The legislative history says that explicitly... page 224 of the House report.

This Court...

Justice Scalia: Yes.

Justice Stevens: But if you always had creditor consent, would you ever have a cram-down?

Mr. Englert: There are many cram-downs, Your Honor, in many kinds of cases.

We're dealing here with a single asset real estate case, where there are, as Justice Breyer's question points out, essentially two real parties in interest.

The typical bankruptcy case is not a single asset real estate case.

It has multifaceted parties...

Justice Stevens: Right.

Mr. Englert: with multifaceted interests, and cram-down is often necessary.

Justice Stevens: But isn't it... is it not a given in every cram-down that some senior creditor objected?

Mr. Englert: You don't reach 1129(b) unless there is an objection by a class of creditors...

Justice Stevens: But is it not also true that whenever a cram-down is approved, some objector has been not paid in full?

Mr. Englert: That's also correct, Your Honor, yes.

Justice Kennedy: Okay.

Mr. Englert: But the absolute priority rule says that you go in absolute priority, that you see if the people who are not being paid in full are more senior than junior people who are receiving or retaining property.

And if they are, the plan violates the absolute priority rule.

Justice Kennedy: So there could never be a cram-down unless equity owners and non-equity owners are treated on an equal basis so far as new value participation?

Mr. Englert: Yes, Your Honor.

Because, otherwise, the equity owners are receiving something on account of their junior claim or interest.

Which is exactly what 1129(b)(2)(B)(ii) prohibits.

Now, it's our position that the statutory language is dispositive here.

But the legislative history is also legislative history is also extremely helpful to the bank.

Justice Stevens: Before you get to the legislative history, would you just answer... make sure you've answered one question.

Would your position... is your reading of the statute the same as if the wordswere deleted from the statute?

Mr. Englert: Absolutely not, Your Honor.

Justice Stevens: And tell me what the difference is.

Mr. Englert: In a typical bankruptcy case, especially involving a small business, the debtors' pre-petition equity holders will often have lent money to the business in the form of debt and not equity.

If we excise the phrasefrom the statute, those people could not receive or retain anything on account of their debt, as well as being unable to receive anything on account of their... on account of their equity interest.

That would be a radically different world than the world we have under Section 1129(b)(2)(B)(ii).

In addition, as Justice O'Connor...

Justice Stevens: But if you... if you deal only with the cases where everybody is only a member of one class, you say there are some people who are members both debtors and equity holders.

Mr. Englert: Yes.

Justice Stevens: But if everybody just was... only fit in one class and you don't have membership in more than one class, then would the statute mean exactly the same thing whether the wordswere included or deleted?

Mr. Englert: No, it would not, Your Honor.

That raises the... the questions of bidding for the equity.

If the wordswere deleted, the debtor could not bid against the bank for the equity.

Because the wordsare in there, if someone wanted to hold an open auction for the equity in which the... the debtor bid, or the debtor's pre-petition equity holders bid, and the bank bid as well, then whoever won that auction would be receiving the equity on account of having the highest bid and not on account of the pre-petition equity interest.

That's why the wordshave a role to play in addition to their role of allowing people to be paid on their debt claim.

Justice Stevens: So you're concerned only with cases in which the equity position is not the highest bidder?

Mr. Englert: Well, here there was a one-horse bid, a one-horse... a one...

Justice Kennedy: No.

Justice Stevens: But presumably, if somebody had come in with more money and told... and somebody advised the bankruptcy judge... that you can get more money by somebody else is going to put into the operation, presumably the judge wouldn't have approved the plan.

Mr. Englert: Oh, no, he would have approved the plan.

Because we were prepared to say we'll put in more money, and he approved the plan anyway.

He said, I'm not terminating exclusivity.

You can't do that.

I'm going with the debtor's plan.

Justice Ginsburg: Can you elaborate a bit on this open auction, which we don't even know whether this is already the order, but you did answer the one-horse race, to say no, of course there would be a two-horse race, and the bank would always have the stronger horse, because it could pay... it could... I forgot what footnote it was in which you explained that, but...

Mr. Englert: The bank wouldn't always have the stronger horse, but the bank would always be in the race.

Because there is a point at which they could outbid us, on the facts of this case.

There comes a point at which they could outbid us for the equity in this property.

It's in our best interest to maximize the value of the estate.

And if their bid for the new equity is so high that we think we're really going to get more money out of their plan than out of foreclosure, then they can win the auction with our blessing.

But we think this property is worth a lot more than what we're going to get under this confirmed plan.

And up to the point where they have satisfied us that they're going to make us better off, we will continue to outbid them, bidding our deficiency claim... or bidding cash, because we get it back on a deficiency claim... so that... so that we can win the auction.

And... and in many cases, if banks... if senior unsecured creditors, or senior secured creditors with unsecured deficiency claims, are allowed to bid, that's how the auction will work.

Now... now, let me add, to the best of my knowledge, no debtor and no creditor has ever proposed an auction as the way to get around Section 1129(b)(2)(B)(ii).

Only bankruptcy judges have ever proposed that as a creative solution.

Debtors don't like it because they want exclusivity.

Exclusivity matters a very great deal to them, to be able to keep the property.

And creditors don't like it because they don't want to go through the nonsense of an auction.

They just want to have the absolute priority rule applied as it's written.

Justice Kennedy: Suppose the court had said that the bank could contribute dollar for dollar with the equity holders and receive a proportionate share of the equity.

Mr. Englert: That...

Justice Kennedy: Not, not quite exclusivity.

We'll say we'll... we'll allow the bank to participate on the same terms as the...

Mr. Englert: That would clearly violate the statute.

No question it would violate the statute.

Justice Kennedy: Because?

Mr. Englert: Because they are receiving something... the right to the 50 percent equity interest... on account of their junior claims of interest.

Justice Kennedy: Well, but you're getting the same... the same deal, and you're not receiving it on account of your prior equity interest.

Mr. Englert: No, but...

Justice Stevens: So how can that be?

Mr. Englert: The statute doesn't ask whether we get anything on account of our junior claim or interest because we're the objecting impaired class.

Justice Kennedy: Well, but I... I... I'm not so sure.

If... if they have the right and you have the right, then it's not just because of their... of their position.

Mr. Englert: It's... it's not just because of their position.

But it's because of their position.

It's on account of their position.

And that's the question the statute asks.

Justice Scalia: Well, that would be the case if you had an auction in which only the... only the debtors and creditors were allowed to participate in.

Mr. Englert: I agree, Justice Scalia.

Justice Scalia: You... you have to let John Doe walk in off the street and participate in that.

Mr. Englert: I agree.

And that would delight the bank, because that's the way we're going to maximize the value of the estate, which is what we want.

Justice Breyer: Is it... suppose that... not this case... but imagine a case in which a large, under-secured creditor has, let's say, $ 50 million of unsecured debt.

And it's a company that has a lot of employees.

And the bankruptcy judge thinks, I wish this company could survive, because it would be good for the community, the employees.

But if this unsecured creditor gets it, he's going to sell it for scrap, basically.

So I think I see new capital coming in here.

And I would like, even though that unsecured creditor objects, to make this go forward.

Under your view of the case, would that be possible?

Is it ever possible on their view of the case?

Is it... what's the status of that?

Mr. Englert: Under our view of the case, it is never possible for him to say for that reason, I'm going to choose to allow the equity holders to retain the equity without some sort of competitive bidding.

Justice Breyer: Well, he could have a competitive bid but exclude the big creditor from that.

I mean that's logically possible.

He could say, we're going to have a competitive bid but a competitive bid among people who want to keep the company in business.

Mr. Englert: Sure.

Sure.

Justice Breyer: Is that possible legally?

Mr. Englert: That's a clear violation of the statutory language.

Because, at that point, there's absolutely no secret what's going on.

He is trying to favor the prior equity holders as such.

He is trying to...

Justice Breyer: No.

Justice Scalia: No.

Justice Breyer: My... my theory... my hypothetical is that there are 500,000 people in the world who will put in $ 6 million of new capital.

And he's indifferent, among all those 500,000, but one.

The one he doesn't want is your equivalent.

Now, can he do that?

Mr. Englert: No.

Justice Breyer: Because?

Mr. Englert: He cannot do that because he is still giving equity a preferred position.

He is not excluding equity from the auction, whereas he is excluding the debtor... the creditor, excuse me... from the auction.

And he is still giving the junior interest holders something on account of their claim.

But let me add, Justice Breyer, in response to your... to your question, that's a very unworldly scenario for this reason.

A bank that thinks there is more money to be gained for its claim by letting someone else come in and bid on the equity, but nevertheless can insist on its pound of flesh and says, we're going to sell this for scrap, is acting irrational.

Justice Ginsburg: Mr. Englert, you said that... that your client, the bank, put in a competing plan, but that that was rejected.

Mr. Englert: We asked for permission to put in a completing... a competing plan.

Justice Ginsburg: Oh.

But you actually didn't file anything?

Mr. Englert: We did tender a competing plan, but it was not... we were not allowed to file it because of the statutory exclusivity of 1121(c).

Justice Ginsburg: How did it compare, the plan that you tendered, with the one that the mortgagee tendered in the Coltex case?

Justice Stevens: Was it similar or you don't know?

Mr. Englert: I have forgotten the facts of the alternate plan in the Coltex case.

But our plan in this case was a plan of liquidation.

Because that is how we believe that the estate... the value of this estate will be maximized.

I'd like to reserve the balance of my time for rebuttal.

Argument of Patricia A. Millett

Chief Justice Rehnquist: Very well, Mr. Englert.

Justice Kennedy: Ms. Millett.

Ms Millett: Mr. Chief Justice, and may it please the Court:

Because Respondents concede that they received property under this reorganization plan, the only question presented under the governing text of the absolute priority rule is whether they received that property, quote, on account of their prior equity interest.

We believe they did for two reasons.

First, the ordinary meaning of the phraserequires an inquiry into causation.

The absolute priority rule, thus, asks whether there is a causal nexus between the prior junior equity interest and the retentions of property.

That causal nexus is clearly present in this case.

Under the reorganization plan, the junior partner... the junior interests, the partners, and only those partners, were allowed to receive interest in the reorganized debtor.

Now, Justice Scalia, you asked about whether that was in fact an option under the plan.

And under... under section 5.2 of the plan, which is at the Joint Appendix, pages 38 through 39, section 4.5(d), which is also at Joint Appendix, page 38, it says clearly that the decision whether or not to make a payment to purchase this new equity interest will be made 2 business days after confirmation of the plan.

And then, the default provision of the plan, section 6.1, which is Joint Appendix, page 46, says what will happen if the contributions aren't made.

This previous position... previous provisions that I cited also address what happens to people who do not exercise the options.

So we think that's clearly under the plan.

And, in addition, it's important to understand what the concept of the under plan means.

It's... it's much like under... under law, the authority... there was no authority to have this option or to acquire interest without a plan.

So we believe it was clearly under the plan.

Under the plan, no one... no one else could acquire these ownership interests.

Thus, there was a 100 percent certain... certainty, excuse me... that partners, because they were partners, because they had junior interests...

Justice Stevens: But... but let me just interrupt there.

Some partners did acquire an interest.

Some did not.

Those that acquired it put in some cash.

And on account of the fact they put in the cash, they got an interest.

Those that did not put in cash did not get an interest.

Now, why... I don't see that it's because they were partners that they got the interest.

It's, rather, because they put in the cash.

Ms Millett: Well, this Court has recognized that you can have more than one cause for an event.

We don't dispute that money was an additional requirement.

But money alone was not enough.

The bank would have liked to put in money and was ready to put in money, but that was not enough.

The status as a junior equity holder, as a partner, was a necessary and indispensable cause to acquiring this interest.

And...

Justice Stevens: And does the record show the bank was prepared to put in new money that would not have been just used to retire their own debt in a larger amount than... than these people were?

Ms Millett: I believe... I believe so.

I'm not... we have not seen the copy of the bank's plan...

Justice Stevens: I'm just asking whether the record shows whether they would or not.

You don't know?

Justice O'Connor: If you don't...

Ms Millett: I'm sorry, I don't know that.

Justice Scalia: The bank's plan was a liquidation plan, I thought.

Ms Millett: A liquidation plan, that's correct.

Justice Kennedy: Yeah.

Chief Justice Rehnquist: Right.

Well, at any rate, under this plan, nobody else had the opportunity to put up any money than the people who finally put it up; isn't that correct?

Ms Millett: That's absolutely right.

And so there was a 100 percent certainty that partners and only partners, because they were partners, would end up in possession of this property.

We think that falls within the plain language of...

Justice Stevens: Well, but... but let me just... maybe it's just that I don't have enough familiarity with reorganization positions... but what if a stranger came in, not seeking liquidation, as I gather the... the... you suggest the bank's plan was, but offering more new money into the plan, and that was known to the bankruptcy judge, and more money available from others.

Is there anything to indicate the judge would have thought this plan fair and equitable?

Ms Millett: Well, first of all, it's not totally clear...

Justice Stevens: See, I... the way I understood the case... maybe I'm wrong... I understood the fact that these people have a huge tax loss that makes them willing to put in more new money than anybody else around.

And therefore they are, almost by definition, the highest bidder available for this property that would put in new money.

Now, is that an incorrect understanding of the facts?

Ms Millett: I think we don't know yet, because there was no competition.

We don't know.

Justice Stevens: But if there were... I mean was there anything to prevent a stranger from coming in with more money and letting the... you know, making an offer to the creditors and so forth, and that would be known by the judge, and the judge then would say, well, I'm not going to approve this plan because there's more money available from outsiders?

Ms Millett: Well, a couple... a couple of things.

First of all, there was an exclusive... we're... we're... this all occurred within the period of... of exclusivity.

Which means...

Justice Stevens: Well, I understand.

But in that period...

Ms Millett: no one else could submit a plan.

Justice Stevens: somebody finds out about this and wants to buy the business and comes in with some money.

Ms Millett: Well, under... under reorganization, you can't just come in off the street and produce a plan.

You have to...

Justice Stevens: No, you have to get a creditor to... to make your position known to the judge.

Ms Millett: You have to have a plan submitted.

And then... and then, as... as the bank discovered, you have to not only have someone submit a plan, but get the court to agree to lift the period of exclusivity so that that plan can be considered.

But had... I mean the important thing is that... we have to keep two things in mind on the amount here... it's conceded that the tax li... liability that they were trying avoid was up to $ 20 million... and then why a... a present value of $ 20 million... and yet they only had to kick in present value $ 4 million to preserve that.

Now, I think it's certainly fair to assume that had there been some competition that they would have been willing to go up to 19 or close to $ 20 million.

You have...

Justice Souter: But what you're saying is the only thing they would have had to have done to save this would simply have been to open the class beyond the exclusive... beyond the exclusive condition of prior equity ownership, and then we would have found out whether anybody else would step up to the plate?

That's the nub of your argument?

Justice O'Connor: That would have given us some... some information.

But I want to make clear one thing, that even when a number of plans are submitted, the absolute priority rule and the requirements in 1129(b) must be satisfied as to the actual plan that is confirmed.

So had 50 different plans been submitted here and the court had still chosen this one, we would still say there was a violation of the absolute priority because this plan is...

Justice Souter: Because this one would have had the... the exclusive condition of prior equity ownership?

Ms Millett: Right.

Right.

Justice Souter: And... and so that's why I said, your... your position, I take it, is that remove that exclusive condition and there's no further problem so far as... as this provision is concerned?

Ms Millett: The exclusive condition on bidding and purchasing?

Justice O'Connor: Yeah.

Yeah.

Ms Millett: I believe... I believe... yes... in large part, yes.

There may be some other circumstances we would need to consider in a particular case, but that is an enormous factor in deciding that this was on account of.

Now, why is this so important, this exclusivity?

It's important to understand that...

Justice Scalia: But before you get on to that, I'm troubled by the fact that this puts this the debtor in... in a worse position than anybody else.

Anybody else could come in and offer, you know, 15 million of new value and be able to proceed with a plan.

They could come in and offer 19 million of new value and not be able to proceed with a plan.

Ms Millett: Well...

Justice Scalia: Why does that make sense?

Ms Millett: It makes sense, first of all, because the statutory text puts a special restricted status on the holders of junior interest.

That's the first answer.

And... and there's a good reason for Congress to do that.

And it's important to understand that the absolute priority rule is not just about money.

It reflects a historic concern with insider self-dealing at the expense of creditors.

And in... the insiders, the partners here, will have... will have the, because of the benefits of being debtor in possession and of their position, information that won't be available to others that will allow them to know about the value of the company and take advantage of that.

But in addition, another thing the absolute priority rule does... remember, we're in a reorganization, where this entity is going to continue, many times in cooperation with its creditors, and the creditors have a right to limit the ability of the equity holders to stay in control of that reorganized debtor.

And then to... especially in a manner that's going to benefit themselves, to set their own price for new equity interests to exclusively and completely take control of the enterprise while forcing a bank, Housing and Urban... the... the Department of Housing and Urban Development, or another senior creditor into long-term, unwanted financial relationships solely to benefit the junior interests.

So it's not just a matter of money; it's also... if... if... essentially the absolute priority rule says if you want to stay in control, having presided over the bankruptcy of this entity, you have to either not impair us, pay us in full or make us happy to continue working with you.

And that's our view of why they would be uniquely impaired.

Justice Kennedy: Did the government appear in this... in this proceeding below?

Ms Millett: No, we were... we have not been involved.

This is our first appearance...

Justice Kennedy: Could you have... could the argument have been made that this was for the avoidance of taxes?

Ms Millett: There is... I think you're talking about 1129(c).

Chief Justice Rehnquist: Yes.

Ms Millett: The argument... the argument can be made... it's... it's admitted that it was to avoid a capital gains tax.

The Internal Revenue Service's application of 1129(c) has actually been very, very narrow.

And where someone is just avoiding, in a legal and proper manner, a taxable event, then we have not invoked it although the statutory tax arguably might allow that should we change our position.

But also it does require that we would have been a party in interest, and we are not a party in interest in this case.

Justice O'Connor: How does your position differ from the Petitioner's, if it does?

Ms Millett: I don't believe in this case that it does... that... that it does.

I think we are in agreement.

Whether in hypotheticals in future cases we would consider something to still be on account of and they wouldn't, I don't really... it hasn't really been tested by this case.

And that's because whatever your definition of causation and whatever your definition of on account of, a 100 percent certainty that junior equities obtains property because they're junior equity will satisfy that.

Argument of Richard M. Bendix, Jr.

Chief Justice Rehnquist: Thank you, Ms. Millett.

Mr. Bendix, we'll hear from you.

Mr. Bendix: Mr. Chief Justice, and may it please the Court:

I want to start by answering a question that... one or two questions that had been asked earlier in the argument.

The bank did propose a plan of reorganization here, or asked to propose a plan of reorganization, which was a plan of liquidation.

It's really not correct for the bank to stand up here and say they were proposing to put in money, when their plan was a plan of liquidation that did not propose to put in $ 6 million or any lesser sum.

It was a proposed plan of liquidation that was defective on its face because it didn't satisfy the best interest of creditors test.

And that's why the court properly denied the bank's motion.

The bank could have appealed.

It chose not to.

And this whole auction argument I think is simply an attempt to...

Justice Breyer: Whose interest didn't it satisfy, if the only other creditors were the trade... trade creditors?

They got paid in full.

The only creditor is the bank, and it gets... it wants that.

So that's one thing that puzzled me.

Whose interest could that not have satisfied?

Mr. Bendix: Well, Justice Breyer, if I understand your question, the unsecured class was impaired in this case.

Which meant that they were not paid everything that they were entitled to.

Justice Breyer: Well, who is that?

Mr. Bendix: That was the class of trade creditors.

Justice Breyer: All right.

How much money did they get?

Mr. Bendix: They got the principal amount of their claim.

They did not get interest.

The correct amount is...

Justice Breyer: So we're talking about like $ 3,000 or $ 4,000, is that what that was?

Mr. Bendix: That's correct.

Justice Breyer: So this is some kind of a test case; is that what... I take it?

Mr. Bendix: I believe it's a test case, Your Honor.

Justice Scalia: All right.

Mr. Bendix: And it's important to point out that the amount of claims in a particular class is not relevant to the fair and equitable...

Justice Breyer: Yes, yes.

Justice Kennedy: Your quite right.

Justice Breyer: I just... then, if we're talking about really not this case but this is a test for many, many other cases...

Mr. Bendix: And I think...

Justice Breyer: what... what is it wrong with... with what has been suggested, that the rule simply should be the debtor in possession, when he proposes during that exclusive period his plan, in your kind of a situation, what he should say is we, the past equity holders, will receive equity in return for new value of, let's say, $ 10 million, provided that anyone but for the principal secured creditor who wants to liquidate... let's say anyone who doesn't want to liquidate... puts in more.

If anyone who doesn't want to liquidate will put in more, then of course we concede; they get the equity, not us.

Now under, what would be... I'm sure there are things wrong with that, but I... I ask it because it seems to me that would be consistent with the statute.

Whoever ended up with it, including the old holders, wouldn't be getting it because of their prior equity holding.

It would keep what you want not to happen not to happen... liquidation.

Mr. Bendix: The difficulty with that example, Justice Breyer, is that any dilution... because of the tax laws in this case... any dilution of the ownership would have basically destroyed the ability to defer the taxation.

And it was that ability to defer the taxes, not to avoid taxes, but to defer the capital gain, that ability to defer was the economic incentive for the investors to put money in.

If that incentive disappeared, then they would have had no reason or economic motivation to put the money in.

Justice Breyer: Then you would have lost absolutely nothing by having that condition in, because there would have been no such person to put in more equity.

Mr. Bendix: I don't... I don't know whether there would be or there would not have been, Your Honor.

But it's... it's important to point out and to understand what the confirmation process is.

Section 1121 of the Bankruptcy Code gives the debtor the exclusive right to file a plan for the first 120 days of a case.

That is clearly a valuable right.

It's a right to set the agenda, to set the option.

It's like... somewhat like writing the first draft of an opinion.

Congress recognized that's a valuable right.

And in fact, the bank, in its amici, recognized it was a valuable right.

Because in 1978, when this particular section was being debated, the creditor... the secured creditor lobby, which is here today, lobbied to do away with debtor exclusivity altogether.

Congress decided not to do that and instead to have a compromise, where the debtor got an exclusive right, for the first 120 days, which could be shortened for cause shown... if somebody came in and said, I... here are the following circumstances, and I believe that they... they demonstrate cause for terminating the exclusive period, the bankruptcy court has discretion.

Once a plan is filed, Section 1123(a)(5) says that the plan must specify the means of implementation.

That means a plan has got to say where the money is coming from to make the payments required under the plan.

The Code, in various subparagraphs, lists examples of means of implementation.

And one of them, in subparagraph (J), is the sale of the securities of the debtor for cash or in exchange for claims or other interests.

If Congress had meant to limit the debtor's discretion in what kind of package it was going to put together in an offer to the creditors for a restructuring, it easily could have said so.

It could have said you've got to specify means of implementation.

You can sell the securities, but if it's the debtor proposing a plan, you must do it by way of auction or you must cut other people in.

It simply didn't say that.

What Congress decided was that if creditors or other parties and interests didn't like the plan and, instead of simply objecting to it, wanted to propose a different plan, they had an obligation, under Section 1121(d), I believe, to come in and ask the court to terminate exclusivity.

And if the court terminated exclusivity, both plans, if there was a proper disclosure statement, would go out to the creditors.

The creditors would vote.

And if both plans were accepted and if both plans met all of the requirements of 1129, then the bankruptcy judge, in 1129(c), is required to decide between those plans, and choose one based on the preferences...

Chief Justice Rehnquist: But what, Mr. Bendix, then what is your interpretation of thelanguage?

Mr. Bendix: My interpretation, Your Honor, is that it means an exchange for or synonyms for that, such as in satisfaction of or in consideration of.

And the reason we take this position is that the phrase must be interpreted in the context in which it appears.

We're talking here about corporate reorganizations, companies whose... unable to meet their obligations and to pay their interest because they don't have enough income, and they make a proposal to creditors to restructure the capital structure.

And there are an infinite number of ways that a troubled company can restructure its finances.

You can extend debt.

You can turn debt into equity.

You can pay a percentage on the dollar.

And that's why, because there are so many different ways... well, let me go back to... to the.

hat happens in a...

Justice O'Connor: On account of.

Mr. Bendix: On account of.

What happens in a reorganization is that new obligations or property are exchanged.

They're given to creditors in satisfaction of their old obligations or in exchange for existing securities.

For example, a class of unsecured creditors might get under the plan 50 cents on the dollar.

They receive that not because they are creditors but in satisfaction of their pre-petition claims.

Similarly, a class of equity holders or preferred...

Chief Justice Rehnquist: Well, but that really is parsing words rather finely, to say they don't receive it because they're creditors but because of their pre-petition claim.

It's their pre-petition claims that makes them creditors.

Mr. Bendix: That's correct, Your Honor.

But you also have to consider, first, that we're talking about a... an economic situation that involves exchange.

Second, I think we submit that you have to consider the meaning ofin relationship to what the absolute priority rule is designed to accomplish.

Everybody... one of the few things that everybody agrees on in this case is that Section 1129(b)(2)(B)(ii) is the so-called absolute priority rule.

This Court has held for more than 100 years that the purpose of that rule is to prevent transfers for less than a fair equivalent value, a transfer, if you will, a fraudulent transfer.

What that means in the context of a reorganization is that a senior class of creditors that has not been paid in full gets first claim on all of the reorganization value of the company.

That's all they get.

That does not mean that somebody can't come in and... well, let me go back.

If some of that reorganization value is diverted to a junior class of stockholders, for instance, then the senior class of creditors which hasn't been paid in full, hasn't gotten everything that it's entitled to.

Chief Justice Rehnquist: I don't... it seems to me you're going around Robin Hood's barn here.

you've heard what the... what the Petitioners argue, that it means... it means... it has a causal connection.

And do you have a brief response to that?

Mr. Bendix: Yes.

Cause has nothing to do with the purpose of the absolute priority rule.

Chief Justice Rehnquist: Well, it may not have anything to do with the purpose, but lots of times Congress may have a purpose in mind, but it adopts language that may carry out that purpose, may be broader than the purpose, may be narrower than the purpose.

So what do you saymeans?

Mr. Bendix: We say, Your Honor, that it means in exchange for or in satisfaction of.

And as a fall-back, as we've said in our briefs, even if you were to take the position that it meant cause... which I think is irrelevant to the idea of whether you have a fair exchange, which is the purpose of the absolute priority rule... even if you said it meant cause, as this Court said 2 years ago in the O'Gilvie case, cause means direct cause.

And it's interesting to note that in the O'Gilvie case, the Solicitor General filed a brief with this Court saying that,as it appeared in the Internal Revenue Code, did not mean but for a cause, where any sort of remote fact could influence the decision, but meant direct cause.

They haven't mentioned that here today.

If you take a causal analysis, then it must mean direct cause.

And direct cause is a question of fact, which...

Justice Ginsburg: Mr. Bendix, may... may I ask you a question about the... the absolute priority rule... which sounds like, you know, what it says, that the senior creditor has to be paid in full before the next... and then the case in which... the case... case in which Douglas presented this corollary or new value exception.

He was talking about necessity to keep a going concern going.

When you think of going concern, a business with goodwill, with employees.

Here we have nothing at stake for anybody other than to preserve this leaky tax shelter.

So I... I really don't comprehend how you would even satisfy the necessity standard of the new value, if I comprehend Douglas right, that what he had in mind was keeping a going concern going, where there are employees and suppliers and all that.

Mr. Bendix: Chapter 11 encompasses far more than operating businesses.

As this Court has held, it encompasses individuals that don't have businesses.

It certainly encompasses real estate partnerships.

Old Chapter 12, which is real estate partnerships, was intentionally included in Chapter 11.

So the fact that there are no... there aren't a large number of employees here really is not a reason that you shouldn't apply Chapter 11, and the absolute priority rule in particular.

Justice Ginsburg: Yes, but I'm asking, what is that absolute priority rule?

And if I think Douglas used the word, in describing it,,necessity for keeping something going, these are going to be the same tenants, nobody is going to... I think one of the briefs put it, the only change would be who the managing agent pays the rent to.

Mr. Bendix: The reason why reorganization is good in this case... if I'm... if I'm answering your question properly... is that it allowed creditors to realize on the tax problem that these investors had.

The creditors got a windfall, got more money, 6 and a half... or 6 and a quarter million dollars, plus the... the insiders had $ 8 million worth of claims, which they waived, and thereby gave up $ 3 million in cash.

Justice Scalia: Well, that... that all depends on how much the property would have sold for.

I mean, the reason the bank didn't like it was that they... they disagreed with that.

They thought the property would have sold for a lot more than the 6 million.

Mr. Bendix: They did, Justice Scalia, but they never appealed the bankruptcy court's factual finding that the value of the property was $ 55.8 million.

And it's important to remember in this case that the bankruptcy judge's factual decision was 2.8 percent... factual valuation... was 2.8 percent less than the value which the bank's own appraiser gave.

So it really I don't think is proper for the bank to come in here, having not appealed that factual determination, and suggest that the bankruptcy judge made a mistake or to say that because bankruptcy judges may make mistakes that banks should have the right to decide and overrule the vote of other creditors.

Justice Stevens: In answer to Justice Ginsburg's question, I suppose the going concern value here is postponing the capital gain, really?

Mr. Bendix: In a real sense, yes, Justice...

Justice Stevens: Indicated in the economic motivation to keep the business going?

Mr. Bendix: It allowed the creditors to get the benefit of something that the debtor didn't own and didn't have a right to sell.

The tax problem was something unique to this group of individuals.

It wasn't anything that appeared on the balance sheet of the... of the company.

And... and because of that, you're correct, that they... they were able to realize on this thing that the debtor didn't own and couldn't sell.

Justice Breyer: What would your view be on a case that's similar to this one but with the following difference: You have a plan

You put it forward just like the one you have.

What was it, 9 million... 6... I forget... 6 million you put in?

Mr. Bendix: Six $ 6.125 million.

Justice Breyer: 6.125.

And suppose a creditor says, you know, I... I have a plausible person over here who will put in 8 million.

And he'll put in 8 million if he gets the shares.

And the bankruptcy judge says, no, I'm not going to consider that; I'm going to adopt your plan.

Suppose those were the facts.

Would there be any way to avoid saying, in that case, that the old owners got the equity on account of their prior ownership?

Just like this case, but we have really someone who comes in and wants the... wants this...

Mr. Bendix: In that case, the... the short answer to your question is that the owners are still getting something... they're getting their interest only on account of the money they put in.

The bankruptcy judge... you're suggesting by your question that perhaps the bankruptcy judge makes a mistake or abuses his discretion in not...

Justice Breyer: I don't know all those things.

I mean there could be complicated cases.

But...

Mr. Bendix: But in...

Justice Breyer: But I'm thinking it's just like this case, but we have a real bidder out there for 8 or 10 million, and he... and the only reason really the bankruptcy judge is doing it is... is it then not on account of?

And you say no, because...

Mr. Bendix: Well, Justice Breyer, in that case, frankly, if I was a bankruptcy judge, I would terminate the exclusive period and let both plans go out to creditors.

The interesting thing about the bank's position is that they say, even if there is competing plans, and even if the debtor's plan, the debtor's new value plan, puts in more money, that somehow the... the owners have still gotten something on account of their prior ownership interest and the debtor's plan couldn't be confirmed without...

Justice Breyer: But then it seems we're not arguing about very much.

Because then all you'd have to do... even on their theory... is... is put a provision in... maybe not on their theory, but put a provision in and say, we aren't the exclusive ones; we'll let anyone else who wants to keep it going as a going business do it.

And... and it's just a question of that boiler plate.

Because if in fact there is such a person, you agree, he should get it?

Justice Scalia: That would work in all cases except yours, because of the tax problem that... that you had.

You couldn't let other people in.

But... but in the ordinary case, why wouldn't that happen?

Mr. Bendix: I don't know.

But the point is that nowhere in the Bankruptcy Code does the wordappear.

And it certainly doesn't appear in any of the provisions dealing with what a plan must contain.

Justice Kennedy: No, no.

Justice Breyer: But the virtue of the auction of course is that it gets around this.

aturally it doesn't appear.

Mr. Bendix: Well...

Justice Breyer: But where it's an auction, you can't possibly say it's on account of.

Mr. Bendix: It doesn't appear.

And... and we are trying to interpret the plain language of the statute.

It seems anomalous to me to say that, if you're the bank, we're relying on the plain language of 1129(b)(2)(B)(ii), and it clearly says that the only time a plan like this can be confirmed is if you have an auction.

And in fact, in footnote 6, at page 11 of the bank's brief, they concede... indirectly, but I take it as a concession nevertheless... that there really isn't a section... there... there is nothing in the Bankruptcy Code that permits it.

It says it raises many questions about whether you could do it.

The fact is there is nothing in the Bankruptcy Code that requires it or...

Justice Ginsburg: But, Mr. Bendix, it is... it is essential, for the preservation of the... the tax benefit, that you have the... this exclusivity, that you be the only ones that... that end up as equity holders.

Mr. Bendix: That is...

Justice Ginsburg: You cannot have anybody bidding against you; that would defeat the whole thing?

Mr. Bendix: That is correct.

And if you think about it, who else besides somebody facing a tax liability, would pay 6 million-plus dollars for this interest, which the court has found is worthless because it's completely subordinate to the bank's deficiency claim?

Chief Justice Rehnquist: Well, but it might be possible, if there were other people who felt that the property had been undervalued, to bid up... requiring your clients to bid up, so they end up paying, but they end up paying not 6 million, but 10 million, maybe?

Mr. Bendix: Well, that's possible.

The interesting fact here is that... it's important to remember that the bank is here, arguing as an unsecured creditor.

1129(b)(2)(B)(ii) and the absolute priority rule only applies to a dissenting class of unsecured claims.

Under this plan, the deficiency claim got all of the future appreciation in the building until its claim was paid in full.

Therefore, what difference does it make to an unsecured creditor who gets that whether the building, for purposes of the bank's separate secured claim... which they're not here contesting today... was worth a million dollars more or less?

They get everything that's there before the investors got a penny.

And that's why it just seems obvious, and it seemed clear to the judge, that this was a... a fair price to pay for the... for the equity interest, because the owners get nothing back except this tax deferral until the bank has been paid...

Justice Ginsburg: The question is, why should the judge be the judge of that rather than what is the only substantial creditor in the picture?

Mr. Bendix: Because that's what Congress has said.

What the bank is really doing here is making a policy argument that they don't like bankruptcy judges second-guessing their decisions.

That's... that's a plausible policy statement to make.

But Congress said judges decide value and judges decide whether plans are fair.

If they don't like that, they are perfectly free to walk across the street and argue to Congress that the... the statute should be changed.

But...

Justice Ginsburg: Mr. Bendix, what about the argument that when this new value corollary came in, in the Case case, that the Bankruptcy Act was structured differently, so that you could have one recalcitrant creditor holding up the whole works and everybody else is willing to go through, now the Bankruptcy Act has taken... the Bankruptcy Code has taken care of that by having classes of creditors and you can't have just one creditor holding out, so that the problem that that was addressing is now handled in a different way?

Mr. Bendix: Well, the earlier cases really didn't address that problem.

The earlier cases addressed the problem of whether the unsecured creditors are getting all of the reorganization value of the company or whether something is being diverted to a junior class.

The change in the Bankruptcy Code doesn't affect that.

What... what we have now is, instead of under... as under old Chapter 10, the right of an individual creditor to object, now it has to be by classes.

But as somebody pointed out earlier, the absolute priority rule only comes into effect if you have one class that agrees and one class that disagrees.

So the analysis that you go through with respect to the disagreeing party... whether that party is an individual creditor or class... is exactly the same under the Code as it was under Chapter 10 and, indeed, under the Federal equity receivership proceedings that existed even before Chapter 10.

The change, quite simply, has no effect on the content of the absolute priority rule.

I want to address for a moment the idea that there was an exclusive option here.

Justice Scalia, I think, pointed out correctly there's nothing in the plan in this case that creates an option.

An option existed in the case that we cited in our brief, Consolidated Rock.

There, the plan said the old owners are getting an option, and they're not paying anything for it.

An option itself is not a bad thing.

It's simply a question of whether you pay for it.

The language of the plan in this case is absolutely clear that the owners had an obligation to put the money in, and the debtor had an obligation to sell the equity to the investors.

Chief Justice Rehnquist: Well, even if... if it wasn't properly described as an option, it included an option, did it not?

Mr. Bendix: No, it didn't, Mr. Chief Justice.

Before the plan was confirmed, the debtor had this exclusive right to file a plan.

And it had to designate somebody who was going to put the money in.

Before a plan is confirmed, it is nothing more than an offer.

It's not a contract.

It creates no legal rights or obligations unless and until it's been confirmed by the bankruptcy court.

So, yes, of course, there was some... in some colloquial sense, an opportunity that these people had before confirmation, but they had no legal rights.

They couldn't exercise an option and say, now... now give me my stock.

Chief Justice Rehnquist: Well, but the bank... it was the bankruptcy plan that gave them the legal rights, I take it?

Mr. Bendix: Yes.

But once the plan is confirmed, you have a consummated sale.

The... the record shows in this case that the money for the... the new capital was... the cash... was put into escrow before confirmation, so that the judge would be satisfied that the plan would be feasible.

As soon as the plan was confirmed, simultaneously, the money went out and the... and the new stock came back.

There was never a moment in time here where there was any discretion in the sense that it exists under an option where...

Chief Justice Rehnquist: But are you saying, then, they didn't receive any property within the meaning of (b)(2)(B)(ii)?

Mr. Bendix: No, not at all, Your Honor.

They... they received a very obvious form of property; namely, 100 percent of the equity in the reorganized company.

Chief Justice Rehnquist: How does that differ... how does that make your case any better for purposes of (b)(2)(B)(ii) and thelanguage?

Mr. Bendix: Well, the bank is not here arguing that our purchase, the investors' purchase of the equity, violated the statute.

They say disregard that.

We admit that that's not a problem.

What they're saying is that in addition to the actual equity interest that was purchased, there was this so-called option.

That's what they hinge their case on, in addition to whether...

Chief Justice Rehnquist: ell, because of their prior status, they and they alone were entitled to make this purchase.

Mr. Bendix: That's true before the plan was confirmed, and even afterwards.

Any time you have a contract... if I sell you my car, nobody else but you can buy that car.

That doesn't mean that you have gotten some option in addition to the car that you've purchased.

That's inherent in... in the nature of a completed contract for the sale of property.

What they're trying to do is create a separate option here, separate and apart from the obvious form of property that was purchased.

And that simply doesn't exist.

Justice Stevens: Well, but there was an option, because all the partners didn't have to participate.

I mean each individual partner had an option, did he not?

Mr. Bendix: Not in... perhaps in a... a colloquial sense, but not in the sense of my giving you an option to buy 100 shares of my stock at a fixed price for the next 6 months.

There was... there was a general obligation on the part of the partners to put in $ 6 million... a little bit more.

Those who didn't put the money in lost their interest.

In a true option, if you don't exercise your option, you don't suffer the kinds of legal consequences that the non-contributing partners suffered in this case.

Justice Stevens: Did that mean that when some people didn't participate, the shares of the others had to be that much larger?

Mr. Bendix: Effectively, yes.

Justice Scalia: Okay.

Mr. Bendix: Sixty percent of the ownership interest changed hands under this plan.

People received interest in the reorganized firm in direct proportion to the amount of money that they put in.

And the amount of money that they put in was not necessarily related in any way to their pre-bankruptcy percentage ownership interest.

Chief Justice Rehnquist: Were... were there any new members of the reorganized firm that hadn't been members of the old one?

Mr. Bendix: No, Mr. Chief Justice.

And, again, it's important to remember that if that had happened, that would have basically destroyed the... the tax benefits that these people were buying.

Chief Justice Rehnquist: So it was a very limited universe that you're talking about?

Mr. Bendix: That's correct.

Justice Breyer: Why are people arguing about option?

I didn't understand that part of it.

I mean they got... they got the building.

They got the building.

And they put up the 6 million.

And I thought the issue in the case... they got the building under the plan.

It provided that they get the building for the 6 million.

And I thought we were arguing about whether they got the building for the 6 million and also because of their prior ownership.

I mean I don't understand why it matters whether we're talking about an op... why are we looking for an option?

They... we must be.

Because I agree with you, they want to.

But can you explain it to me?

Mr. Bendix: The bank is trying to say that we got some form of property in addition to the equity that we purchased, that we...

Justice Breyer: Why... why isn't enough for the case that you got the equity?

You got the equity, you got the building.

You got the equity.

You put up 6 million.

You say, we got it just because of the 6 million.

You... they... as far as the statute is concerned, they say you got it because of the 6 million and also on account of other prior ownership.

So how does it change the case?

Mr. Bendix: Well, they make that argument with respect to the so-called option, Justice Breyer.

They don't make the argument with respect to the actual equity interest that was...

Justice Breyer: If I drop the option out in my mind, is it going to make a difference to the decision?

Mr. Bendix: If you accept our interpretation ofas meaning in exchange for or in satisfaction of, then of course our position is that we received this equity interest in exchange for the new money.

And, again, it's important to remember that the interests of non-contributing partners were wiped out.

So they received absolutely nothing under the claim.

They lost their interests.

There's a number...

Justice Souter: In substance, this so-called option is nothing more or less... as I take it... than the limited eligibility to put up the 6 million.

That's all it means, isn't it?

Mr. Bendix: I think that's what they've tried to characterize it as.

And... and it's... it's important to remember, as I think Justice Scalia mentioned in the earlier colloquy, that the property... in order to run afoul of the statute, you have to receive property, you have to receive it on account...

Justice Souter: Well, isn't that a valuable right?

Mr. Bendix: The... the exclusive right to file a plan and to be designated as a potential funder of the plan is certainly valuable.

It's not something that was... it was not property that was distributed under the plan as confirmed.

There is this...

Justice Souter: Well, but where does the provision say it has to be property as distributed under the plan?

Mr. Bendix: It's... it's right in Section 1129(b)(2)(B)(ii).

Justice Souter: Yes, but what's... what's the exact language that you rely on?

Mr. Bendix: Bear with me one second.

Justice Souter: The reason I ask the question is that Subsection (2)... (2)(B)(ii) refers to any property.

Mr. Bendix: But the earlier...

Justice Souter: And that... which sounds pretty broad.

Mr. Bendix: Let me just read... let me read the language.

It says: For purposes of this subsection, the condition that a plan be fair and equitable with res

Chief Justice Rehnquist: Where are you reading from?

Mr. Bendix: I'm reading from...

Justice Breyer: I guess if we take the bank's brief...

Justice Scalia: (b)(2)(B)(ii) or...

Mr. Bendix: (b)(2)(B)(ii).

It says: The holder of any claim or interest that is junior to the claims of such class will not receive or retain under... under the plan, on account of such junior claim or interest, any property

We read that to mean... that phrase,... to mean under the plan as confirmed.

Chief Justice Rehnquist: So are you saying you didn't receive any property under the plan?

Mr. Bendix: No, Your Honor.

We're saying that we received an equity interest under the plan and not any option to purchase equity.

Justice Souter: No, but you also received another ben... or would have received another benefit under the plan.

And that was the exclusive opportunity to acquire or retain that equity interest.

Mr. Bendix: But that's really not what... that's not an opportunity.

That is... once the plan is confirmed, that's what you bought.

I guess you could say that...

Justice Souter: Well, in the sense that you undertake, by presenting the plan, to exercise that opportunity.

So that I suppose, you know, there is a legal instant in time in which all of this occurs.

But it's still the case that at the moment the plan becomes operative, you have an opportunity, and nobody else can have one.

Mr. Bendix: Actually, not, Your Honor.

Under the plan, there is an obligation... there's a binding obligation to put the money in.

It's not an opportunity.

Thank you very much.

Rebuttal of Roy T. Englert Jr.

Chief Justice Rehnquist: Thank you, Mr. Bendix.

Mr. Englert, you have 3 minutes remaining.

Mr. Englert: Thank you, Mr. Chief Justice.

There are two forms of property that were received or retained under the plan on account of the junior interest, in violation of the statute.

One is the option.

The second is the equity.

Mr. Bendix says we do not contend that the equity was received on account of the prior junior interest.

That's flatly wrong.

We do contend that both forms of property were so received.

This is the second time the Court has construed 1129(b)(2)(B)(ii).

The first time, the debtor's counsel stood at the lectern in this Court and said the creditors are getting a windfall because we're putting in new value.

This Court's response, in a unanimous opinion, was: The Court of Appeals may well have believed that Petitioners or other unsecured creditors would be better off if Respondent's reorganization plan was confirmed

But that determination is for the creditors to make in the manner specified by the Code.

Chief Justice Rehnquist: What case is that?

Mr. Englert: Norwest Bank Worthington v. Ahlers, 485 U.S., at 207.

Justice Stevens: Of course, if we meant that literally, we shouldn't have left the question open.

Unidentified Justice: [Laughter]

Mr. Englert: Your Honor, I do suggest that the Court meant that literally.

And I do suggest that that's what the legislative history and text of the Code both say.

In... in reference to the legislative history, let me say, Mr. Bendix relies heavily on pre-Code practice.

The legislative history, at page 414 of the House report, says: The elements of the test are new, departing from both the absolute priority rule and the best interest of creditors test found under the Bankruptcy Act

Justice Stevens: Wasn't that with regard to the bill they didn't enact?

Mr. Englert: No, absolutely not, Your Honor.

H.R. 8200 was passed by the House.

Its language was taken into the Code that was enacted, in preference to the Senate report.

And the debtor says, look at what the conferees said.

Let me tell you what the conferees said.

I'm quoting: Except to the extent of the treatment of secured claims under subparagraph (a) of this statement, the House report remains an accurate description of confirmation of Section 1129

That's from 124 Congressional Record, 32,408, and 34,007.

It's quoted in footnote 23 of the Solicitor General's brief.

Justice Breyer: That may be wrong.

Mr. Englert: Justice Scalia, legislative history always could be wrong.

[Laughter]

But the legislative history is very one-sided in this case.

annot possibly be the meaning of.

ection 1123(a)(5)(J) of the Bankruptcy Code usesand not.

nd you cannot receive or retain property in exchange for something.

The fact thatis used repeatedly in connection with the phraseshows that it must have a broader meaning than.

nd, indeed, if... if Mr. Bendix's argument aboutwere correct, ours was wrongly decided.

It's holding and not just every literal word of it, Justice Stevens.

Justice Stevens: No, there is no new cash in that deal.

Mr. Englert: There was no cash.

That was a...

Justice Scalia: In the farmer deal?

Mr. Englert: I'm sorry, there was... there was an exchange.

There was sweat equity.

Justice Scalia: Yeah.

Mr. Englert: That's correct.

But the... the sweat equity was treated as having economic value.

The... Justice Scalia, there is...

Justice Stevens: That was precisely the kind of economic value that Justice Douglas said should not count.

Mr. Englert: Correct.

Justice Stevens: Yeah.

But... and he said the other with respect to cash.

Mr. Englert: He said the other with respect to cash under the 1898 Bankruptcy Act, yes.

Thank you.

Chief Justice Rehnquist: Thank you, Mr. Englert.

The case is submitted.

Attribution:

The Oyez Project

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