Cases by Issue - Priority of Federal Fiscal Claims

United States v. Romani - Oral Argument

Fri, 09 Jan 2009 14:50:02 +0000

Case:

United States v. Romani

Media File:

96-1613_19980112-argument.mp3

Related Transcript:

1997_96_1613_argument.xml

Transcript:

Argument of Kent L. Jones

Chief Justice Rehnquist: We'll hear argument next in Number 96-1613, United States v. The Estate of Francis Romani.

Mr. Jones, you may proceed whenever you're ready.

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

On the date of his death Francis Romani owned real property worth about 50,000 dollars.

That property was subject to a private judgment lien and to a laterfiled Federal tax lien.

Both of the liens were for amounts that exceeded the value of the estate, and the estate therefore brought this case to determine whether the claim of the United States or the claim of the private judgment creditor should be paid first.

The answer to that question appears in the direct text of what is known as the absolute priority statute.

Since 1797, that statute has provided a simple rule for the narrow category of cases in which the United States seeks to recover a claim against an insolvent estate.

Unknown Speaker: Well, the statute is different in this respect.

Until the revision of the statute in question, which I think was 1982, it talked in terms of debt.

3713(a) at page 2 of your brief talks about claim, and it seems to me that a... that the word claim may be quite different than debt.

Claim sounds to me as... has the connotation of something that's not... that's ambulatory, or that hasn't been executed yet, whereas debt sounds as if it's something that's fixed.

Mr. Jones: When Congress enacted that provision in 1982 they said it was a formal change of language that was not intended to change the scope of the statute.

Unknown Speaker: But the language still is different.

Mr. Jones: The language is--

Unknown Speaker: One is claim, and the other is debt.

Mr. Jones: --The language is different, but Congress didn't intend it to have a different meaning, but moreover--

Unknown Speaker: How do you know that?

Mr. Jones: --That's... the legislative history--

Unknown Speaker: Well, but, you know we don't always pay a lot of attention to legislative history.

Mr. Jones: --It's... you may not always pay a lot of attention to it, but in the context where a change has been made to words, and the question is whether that changed the meaning of the statute, it's appropriate to look to the legislative history, especially when Congress says in that history, we're not changing the meaning.

That should be authoritative.

But--

Unknown Speaker: A committee says in that regard.

Mr. Jones: --That's correct.

There is an answer, I think, in any event to your question apart from that, and that is... I may be... I may have the wrong case, but I think it's United States v. Moore where the Court said that whether the claim is unliquidated or not, it's still covered by the absolute priority statute.

But the importance of the absolute priority statute is that it provides the simple rule that the United States shall be paid first.

Unknown Speaker: Well then, what's the point of 6321 and 6323(a), which deal specifically with tax liens?

Mr. Jones: Yes, that's indeed the ultimate question in the case.

Unknown Speaker: Yes.

Mr. Jones: Does that statute change the application of the absolute priority statute for tax claims?

The Pennsylvania supreme court said that it did, and we say it doesn't.

The rationale of the Pennsylvania supreme court was that this tax lien statute provides a limitation on the effectiveness of the Federal tax lien, and that by limiting the validity of the lien, you limit the priority of the United States, but in United States v. Key and United States v. Emory the Court said that only the plainest inconsistency between two statutory schemes would justify disregarding this ancient and clear command that the United States be paid first.

There is no claim inconsistency between these statutory schemes.

The absolute priority statute is a priority statute.

It does not require any lien of the United States.

In United States v. City of New Britain, and United States v. Vermont, this Court held exactly that, that the right of the United States under the absolute priority statute exists wholly without regard to the existence of any lien.

Unknown Speaker: But in the New Britain case they discussed at great length the tax lien statutes, too, did they not?

Mr. Jones: Yes, because that--

Unknown Speaker: Well, why would that have been necessary if the only holding of the case was that it's governed by the absolute priority statute?

Mr. Jones: --Because in the New Britain case the debtor was solvent.

The absolute priority statute did not, by its terms, apply, and the very important part of that opinion for this purpose is what the Court went on to say about how the Tax Lien Act applies in that situation.

What the Court said was, the Tax Lien Act only determines the validity of the Federal lien.

It does not, by its terms, contain any priority provisions.

It does not set a priorities, it is a lien statute, and the Court said that to determine priorities we look to the background common law rule of first in time is first in right, unless that has been modified by statute, and the Court pointed out that in the insolvency situations to which the absolute priority statute applies, it has been modified by statute.

Congress provided specifically since 1797 that in the narrow category of cases involving insolvent estates the United States is to be paid first.

Unknown Speaker: But if... the whole thing is so strange.

What if the insolvent debtor, instead of dying, became bankrupt?

Then the Government isn't necessarily going to come out the same way.

Mr. Jones: Congress specifically has provided that bankruptcy cases are to be determined not under the absolute priority statute but under the priority provisions of the Bankruptcy Code.

It's not illogical for Congress to determine that one set of priority rules apply in one context and a different apply in different contexts.

Unknown Speaker: But if the debtor is insolvent and dies, then you say this 3713 has to apply, even if it's a tax that we're talking about.

Mr. Jones: Absolutely.

Congress said that, but more important... well, equally importantly, this Court has said that no less than seven times in the last 180 years.

Unknown Speaker: Well, what if under 3713 instead of a judgment lien there had been a prior recorded mortgage?

Mr. Jones: Well, that takes us to the heart of an ancient dispute that this Court has, by its express statements, never resolved.

The--

Unknown Speaker: Well, what's your position?

Suppose there was a prior recorded mortgage here--

Mr. Jones: --The--

Unknown Speaker: --and we were talking about that in the case of an insolvent who dies--

Mr. Jones: --The Court--

Unknown Speaker: --versus the Government's claim.

Mr. Jones: --In New York v. Maclay, for example, the Court said a mortgage is more than a lien, that it is closer to a title and possession of the property, and--

Unknown Speaker: Well, do you concede that in the mortgage situation the mortgage holder would come out ahead of the Government here--

Mr. Jones: --I would--

Unknown Speaker: --if it were a recorded mortgage?

Mr. Jones: --I would concede it to this extent.

The Court so stated that in Thelusson.

Unknown Speaker: Yes.

Mr. Jones: The Court confirmed that in the Maclay case, but I believe it was in either Mass... United States v. Massachusetts or United States v. Texas, in one of those two opinions when they were reciting the wellestablished rule about we prevail against judgment liens but we may not prevail against mortgages, the Court said something to the effect that if the mortgage cases are still valid.

Now... and so I suppose that what the Court was saying then was, they weren't revisiting to decide whether the mortgage case--

Unknown Speaker: Well, what are you saying?

Mr. Jones: --Well, I'm... I'm just--

Unknown Speaker: I think we'll try to figure out--

Mr. Jones: --Okay.

That issue--

Unknown Speaker: --what we were saying.

I want to know what you're saying about this.

Mr. Jones: --What I'm saying is that the Court has always held that we prevail against the general lien of the judgment.

The question of whether we prevail against a mortgage isn't presented in this case.

The question in particular--

Unknown Speaker: Well, I know that.

I'm asking what your position is if it were.

Mr. Jones: --Well, I'm... my position is that the Court has twice held that we lose to a mortgage, and has once said that it's not certain that that's good law.

I really don't--

Unknown Speaker: What about all the repair... the repairmen?

You know, people come in and they fix the house, and normally you fix the house or you fix the plumbing and throughout the law there are all kinds of ways of making certain those people get paid.

They're usually called mechanic's liens, and here Congress has a specific statute that says, you know, if Smith dies and he... or if Smith owes money on taxes, we get it first.

We use this magic word lien, but all that means is, we get it first.

But by the way, we don't get it first in respect to the mechanic.

Mr. Jones: --No, Con--

Unknown Speaker: He gets his money first, right?

Mr. Jones: --Congress--

Unknown Speaker: You're saying that the mechanic lien... the mechanics get their money first, before the tax money, I take it.

That's not right?

Mr. Jones: --First of all--

Unknown Speaker: I was reading 632... yes.

Mr. Jones: --the absolute priority statute doesn't create a lien.

Unknown Speaker: I mean, I'm taking... a lien is just a magic way of saying the Government gets paid first, I think.

Mr. Jones: It's not a... it's not that kind of a magic word, and this Court has made the very distinction on this subject, and so it's important for me to emphasize it.

The right of the United States under the absolute priority statute does not depend upon the existence of any lien, valid or not.

It defeats any... what the Court has described in I think seven cases that we've cited.

It defeats anything that is a quote, general lien, which is a lien that does not... as the Court said in Thelusson all the way to Gilbert Associates, a general lien does not divest title or possession from the United States.

The property remains in the debtor's estate and therefore the United States is to be paid first.

And so, is the... so the question that I believe was implicit in your remark was, is a mechanic's lien a general lien covered... you know, which the United States prevails, or is it a specific lien that might come in ahead of the United States under the absolute priority statute.

Unknown Speaker: Yes.

Mr. Jones: My perception of that is that if the Court had to reach it, under its precedent it would hold that it was a general lien, although it could hold it was a specific--

Unknown Speaker: And not like a mortgage.

Mr. Jones: --It's certainly not exactly like a mortgage.

Unknown Speaker: So then my question actually is... thank you, that is much clearer, and my question really is what any Congressman or Senator would have had in mind in saying that my goodness, we want to be certain those mechanics who come in and fix the roof are paid before the IRS, and that's what they seem to say in 1623 and, in fact, if we're reading of the statute is correct, every time a person dies insolvent the IRS gets paid before the mechanics.

Now, that to me just doesn't make any sense.

Mr. Jones: Well, I'm not... I'm not saying what our position is on mechanic's liens, because I can hear an argument to be made for saying, oh, that's a specific lien within the context of how the Court uses that term.

But let's take the judgment lien, which is also referred to in 6323, and which the Court's opinions say clearly we prevail against under the absolute priority statute.

Did Congress intend, in adopting 6323, to repeal the application of the absolute priority statute to judgment liens?

The answer to that is no.

Why?

Because at the same... in terms of intent, at the same time that the repealing legislation was presented for... I mean, that the Federal tax lien legislation was presented to Congress in 1966, Congress was also presented with three bills designed expressly to repeal the application of this statute to tax claims.

Congress conducted hearings on those legislation, informed itself of the objections, and declined to enact it.

4 years later, the same repealing legis--

Unknown Speaker: Or a committee did, anyway.

Mr. Jones: --Yes.

Unknown Speaker: I'm normally with you on legislative history, but I'm getting off the train in this instance for the reason that I'd ask before these particular bills, of what sense it would make?

What sense would it make--

Mr. Jones: It--

Unknown Speaker: --for... to have a law which says, like 6323, we normally put all these things ahead of the secret IRS lien, because it isn't necessary... but we don't--

Mr. Jones: --The sense that it--

Unknown Speaker: --we don't put it ahead when the person dies.

I'm looking for some sense in that.

Mr. Jones: --The sense that it makes is, when the tax lien provisions are applicable, they're applicable within a priority context determined by some other statute or legislation.

In the situation you've described, if he goes into bankruptcy, then it's the Bankruptcy Code that prevails, the Bankruptcy Code that is operative.

All that the tax lien provisions say is whether we have a valid lien, and then you should ask, so what if we don't have a valid lien, and the answer under the absolute priority statute is--

Unknown Speaker: Mr. Jones--

Mr. Jones: --it doesn't matter.

Unknown Speaker: --You are presenting the position as though it's clear and certain this is the Government's position, the only question mark is what this Court may have done in some mortgage cases, and yet the red brief cites an Attorney General's opinion from 1857.

But you don't... as far as I remember don't address that at all in--

Mr. Jones: Well, one of the reasons we don't address that opinion of the Attorney General is because all of that portion of their argument relates to an issue that wasn't raised below, which is whether this is--

Unknown Speaker: --No, but they can defend the judgment on the ground that it wasn't thought of below.

That's wellsettled.

Mr. Jones: --They can defend it on a ground that wasn't even raised below.

Unknown Speaker: Sure.

Mr. Jones: Or addressed below.

They--

Unknown Speaker: If their reading of the statute is correct, namely that the... what you call an absolute priority statute merely applies to unsecured claims, then we don't have to get into all this, and we would have to affirm--

Mr. Jones: --If the--

Unknown Speaker: --if that's a correct reading of the statute.

Mr. Jones: --If the Court were going to revisit the question of whether the judgment lien was subject to the absolute priority statute I would think it would want to do that in a context where it was raised below, because the Court has already decided that issue seven times.

Unknown Speaker: Well, it's been fully briefed in this, by both sides in this case.

You filed a reply brief.

Mr. Jones: And stare decisis would also suggest--

Unknown Speaker: Well--

Mr. Jones: --that what the Court would do would be to apply Thelusson, Gilbert Associates, United States v. Texas, United States v. Massachusetts, City of New Britain and Vermont, and say--

Unknown Speaker: --United States v. Massachusetts was a 5 to 4 decision, so it has less claim to stare decisis than--

Mr. Jones: --Well, it was just one of a long string of decisions, and my point is simply that this is wellsettled since 1817.

If the Court wants to revisit the issue, I would think it would do it in a case where we had an opportunity to brief it in the courts below and fully here, instead of just in a reply brief.

Unknown Speaker: --Mr. Jones--

--But you still haven't commented--

Mr. Jones: Yes--

Unknown Speaker: --on the merits of the Attorney General's brief.

Mr. Jones: --Right.

Unknown Speaker: You said we didn't discuss it because it wasn't raised below, and that's your only answer to that opinion?

Mr. Jones: No, I... that's not my only answer.

That opinion was in 1850-something.

It was... what it really was, and what the opinion reflects, is that it was an issue about whether a mortgage takes priority under the absolute priority statute, and the Court cited Conard, and maybe Thelusson, but certainly Conard for that proposition, which... we don't intend to dispute Conard.

We don't intend to dispute that a mortgage... this Court has held that a mortgage takes priority, and--

Unknown Speaker: Why not?

It doesn't make any sense.

Mr. Jones: --Well, when Justice O'Connor asked me that, it's sort of like... well, I... I'm not trying to reformulate the Court's cases.

I'm trying to describe them, and the Court's cases have contained that last caveat about, well, whether that is still good law.

We don't place that at issue in this case.

But getting back to Justice Breyer's question about why does this make sense, this makes sense because Congress has provided priorities for cases involving bankrupts in the Bankruptcy Code.

Congress has provided by indirection cases for insolvents, which is that they haven't changed the common law rule of first in time, and that's what the Court held in City of New Britain.

Unknown Speaker: Well, the priority under this would be first in time, first in right.

I mean, it's not a mystery what the priority would be if--

Mr. Jones: No, the priority here is we're paid first.

Unknown Speaker: --6323(a) governs.

Mr. Jones: No, the priority in an insolvent estate is the absolute priority statute, and that's we're paid first.

These are different rules.

Congress--

Unknown Speaker: That's the issue.

If we were to say 6323(a) was the more specific and it applies, then it would be first in time, first in right, wouldn't it?

Mr. Jones: --That is... well, I wouldn't think you'd say that for a variety of reasons.

One is, the Court doesn't apply that method of analysis to the absolute priority statute, but even if it did, which of these provisions is more specific, which is a point I've been trying to get up to.

The absolute priority statute is a very narrow statute.

It has an extremely narrow scope of operation.

It only applies in these narrow categories of cases involving insolvent estates and a few other narrow insolvency situations.

The dominant majority of cases are governed by other priority provisions.

Bankruptcy cases, solvency--

Unknown Speaker: But are you saying that priorities, lien, or debt priority statutes come into play in a majority of cases where there is no insolvency?

That seems odd to me.

I would think the time that it would be most useful and probably most applicable is when there is some sort of insolvency.

Mr. Jones: --And in the vast majority of those cases they're in the Bankruptcy Code, covered by the Bankruptcy Code.

I mean, we know Congress intended to have two different priority schemes, because the absolute priority statute specifically excepts bankruptcy cases from its application.

Unknown Speaker: But Mr. Jones, the Government is owed all kinds of money by all kinds of people, and that's... the absolute priority statute could cover those debts, but here we have something that deals with tax liens, so that's the specific subject matter, as--

Mr. Jones: Well, that deals with tax liens, and that's the point, because Congress certainly knew full well that this Court had held in Thelusson in 1817 and in the several cases in the fifties, like City of New Britain, knew full well that this Court had held that you don't need a tax lien.

It doesn't matter if you don't have a valid tax lien under the... in the narrow situations that the absolute priority statute applies, and so you have to understand that these statutes really operate in different... on different issues.

Every Federal court that has considered this has recognized that the priority statute establishes priorities, the lien statute deals with liens.

These are different subjects.

There's no inconsistency between these two provisions because they both have full application in the separate contexts that they apply.

Unknown Speaker: --What is the... so I'm still back to the... I'm looking at it... to be honest with you, I'm seeing your statute as a very old one, and once you take that statute the courts have to get into a real nightmare of an issue of deciding when title is passed, or when it isn't passed.

It isn't true that any physical property in the possession of the deceased is going to go to the Government.

You have to draw odd lines.

Time passes.

Congress begins to pass specific statutes dealing with specific situations that set up priorities, and unless there is some reason for not applying these later, specific statutes, I don't know why we wouldn't--

Mr. Jones: Well--

Unknown Speaker: --because they're a more thoughtout, careful method of distinguishing between different kinds of--

Mr. Jones: --You can't come to that conclusion--

Unknown Speaker: --Yes.

Mr. Jones: --after reading the City of New Britain opinion, because the City of New Britain opinion says that in the insolvency situation Congress has provided specific priorities, and we win without regard to the existence of any lien.

Unknown Speaker: What's the... what is special about dying insolvent as opposed to just living and not paying your taxes?

What... what's the difference.

Mr. Jones: It's not so much that there's something special about it.

It's that the statutes have different words, they have different histories, they have different purposes, they do not conflict if you take them each at their fair reading.

The... okay, let's say the fair reading is, this is a judgment lien, our lien would not be valid against it.

The next question is--

Unknown Speaker: If you go into history, your opponent argues you go back to the prerogative of the Crown and apply to everything, just general claims and not secured claims.

Mr. Jones: --I think that that's a--

Unknown Speaker: You ignore that history?

Mr. Jones: --vast overstatement again.

I mean, they cite a case called Marshall v. New York, where the Court says that the common law rule was that specific liens, only specific liens prevail--

Unknown Speaker: Do you think they correctly or incorrectly describe the law in England before we got started?

Mr. Jones: --I... they didn't correctly describe the law in England as this Court described it in Marshall.

Unknown Speaker: Well--

Mr. Jones: As far as what the law in England was before, this Court has said it doesn't matter, because in United States v. Moore, and all the way back in 1824, I think, in the Bank of North Carolina case, the Court said that whatever the common law rule is, this priority of the United States arises solely by statute, and it is interpreting that statute that the Court has said, seven times since 1817, that a general lien such as a judgment lien, or a State and municipal tax lien, or a landlord's lien does not prevail against the absolute priority of the United States.

And in City of New Britain they said we don't need a lien in these cases.

A lien... and or repeated that same conclusion in United States v. Vermont.

The lien... the existence of a lien is a security device.

It's not a right to payment.

We don't have a lien, so when there's property... in the absolute priority situation, when there's property possessed by the insolvent estate, if it's transferred out of the estate we don't have a lien that follows it, and the absence of such a lien doesn't affect our right to be paid out of the property of the estate.

Unknown Speaker: --You do concede that certain secured creditors can get priority in an insolvent estate situation, and you would--

Mr. Jones: Yes.

Unknown Speaker: --say, well the mortgage... is there anything... well, as to the mortgage, do you make a distinction between--

Mr. Jones: I think a purchase money mortgage--

Unknown Speaker: --title States and lien States?

Mr. Jones: --I think a purchase money mortgage would plainly be the sort of thing this Court would hold as a practical matter would hold it's a specific lien that prevails against the absolute priority of the United States.

I think that much is clear, to answer your question.

Unknown Speaker: Any other--

Mr. Jones: The Court has never decided that question, and has specifically avoided it, so I can't tell you how you'd decide it.

Unknown Speaker: --I just wondered what worked in with your theory.

Mr. Jones: The theory that the Court has is that to be specific for purposes of the absolute priority statute you have to divest title or possession of the good from the debtor's estate before the claim of the United States arises.

Unknown Speaker: So then in mortgage lien States, as distinguished from title States, then in the lien States the creditor would lose.

Mr. Jones: Justice Cardozo who addressed that very point in New York v. Maclay, and he said, well, I don't have... I can't decide now whether a lien State the mortgage would win, but, he says, this... a mortgage is more than a... more than merely a lien, he said.

It's more akin to title.

It's more akin to possession.

Now, there's a reason why the Court hasn't had to address that question.

The reason is that it has never had a case before that presented anything other than a general lien that did not divest title and possession, and so that boundary is still out there.

It... but it's never been defined by the Court other than in Thelusson, and it... they said, well, it's title or possession--

Unknown Speaker: We--

Mr. Jones: --and the Court has followed that for 180 years.

Unknown Speaker: --This is a slightly picky point.

I'm reminded of my tax professor, Ernie Brown, and I'm looking at the lien statute, and you're saying, well, that's just a lien statute.

We win anyway.

But it doesn't say the United States shall have a lien.

It says the amount owed shall be a lien, right?

Mr. Jones: That's 6321.

Unknown Speaker: Yes, 6321.

Mr. Jones: 6323--

Unknown Speaker: So it says, if I die insol... I know, 6323 refers to the lien in 6321.

Mr. Jones: --And says it won't be valid--

Unknown Speaker: Yes, the lien won't be valid.

Mr. Jones: --Right.

Unknown Speaker: But what 6321 says is, the amount when I die insolvent and owe it to the IRS, it says that amount shall be a lien, so the amount that I owe you is a lien.

It's not that you have a lien.

Mr. Jones: But we don't--

Unknown Speaker: And therefore the language of the statute is consistent with it replacing the statute that you're talking about.

Mr. Jones: --Well, that... I'm sorry, I--

Unknown Speaker: I put that--

Mr. Jones: --I'm just surprised at that suggestion.

The Court... I can't remember the case, but I'm quite confident that the Court has said that the tax lien provisions supplement the right of the United States to recover a tax.

Unknown Speaker: --We have to say it's a supplement?

Mr. Jones: Well, I think it obviously is.

Every lien is a supplement to the underlying claim.

I mean, it doesn't substi... it doesn't replace the claim.

It's a security device.

The question is, do we need it?

No, we don't.

The Court has so held.

We don't need that lien.

Unknown Speaker: Why did Congress give it to you if you didn't need it?

Mr. Jones: Well, we don't need it in the absolute priority, in the narrow categories of the absolute priority statute, because there we have a right to be paid first.

When those priorities aren't applicable, yes, we benefit from the lien in other priority contexts.

Congress intended these priority rules to apply here, intended other priority rules to apply elsewhere.

I've got just a few minutes left.

I only want to make one other point at this time, and that is that respondent claims that this ancient statute should be modernized to avoid an inconvenience to creditors.

The simple answer to that is what the Court said in Emory.

Whatever the merits of that objection should be made to Congress, not the Court.

And that brings me to the point that these objections were raised with Congress twice.

In '66 and '70, Congress conducted hearings on them and declined to make the changes that respondent now asks this Court to make.

Going all the way back to 1805, in the first case that this Court decided under the absolute priority statute, Chief Justice Marshall said for this Court that the inconvenience of the statute did not justify its judicial nullification, and for that reason the Pennsylvania supreme court's decision should be reversed.

I'd like to reserve time for rebuttal.

Unknown Speaker: Very well, Mr. Jones.

Mr. McCartan, we'll hear from you.

Argument of Patrick F. McCartan

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

If I may, I would like to start with the question posed by Justice Stevens, which is whether antecedent security interests, traditional security interests survive assertion of the priority of the United States Government under the priority statute.

We did not handle this case below, and cannot tell the Court, therefore, why it was not discussed below, but I can and do say that it is clearly embraced within the question presented by the Government in its petition.

That is why they argued this issue at pages 9 and 10 of the petition, and why they reargued it at pages 14 and 16 of their opening brief on the merits here.

The statute under which the Government claims priority had its origins in the prerogative of the Crown for the payment of debts due to the sovereign.

When it was enacted, there was more than a century of English precedent to the effect that antecedent security interests would survive assertion of a priority under the prerogative of the Crown.

I would urge this Court to revisit your early decisions and those of some of the lower Federal courts at the time.

It is old learning, but it demonstrates quite clearly that there is not an unbroken line of authority from Thelusson v. Smith to modern times, as contended by the Government.

Thelusson was decided in 1817.

11 years later, this Court decided Conard v. Atlantic Insurance Company, stating, and it was essentially the same Court, that Conard should be limited... or, excuse me, that Thelusson should be limited to the circumstances of that case, and stating unequivocally that Thelusson did not stand for the proposition that a perfected lien could be displaced by, and I quote, the mere priority of the Government under Revised Code section 3466.

Subsequently, this Court, in United States v. Hack and Brent v. Bank of Washington, upheld traditional security interests against assertion of priority under the priority statute.

For a period of 75 years thereafter, it was the understanding of the lower Federal courts that traditional security interests would survive assertion of priority by the Government under this statute.

The Attorney General of the United States in 1857 issued an opinion to the effect that Thelusson was overruled by Conard, and that was the understanding, that was the assumption, that was the premise on which the lower Federal courts acted from that point on.

Cottrell v. Pierson, which appears on pages 11 and 12 on our brief, I think is illustrative of the understanding of the lower Federal courts.

Now, it wasn't until 1933 in New York v. Maclay that the language of Thelusson referring to the need of a lienor to perfect the lien by acquiring title or possession was revived.

Maclay, though, was a case which involved personal property and an unliquidated amount in terms of the lien.

The New York State statute with respect to franchise taxes is very, very unusual.

Franchise taxes under the New York law are a lien in advance of the years in which they are due, so in Maclay you didn't even have the amount of the lien determined because it wasn't yet due and, secondly, any property to which it may have attached may not even have been in existence.

The lien is obviously--

Unknown Speaker: Counsel, what's your best case for support of your position that the judgment lien comes before the Government's right under 3713?

What's your best case?

Mr. McCartan: --You mean ahead, Your Honor, in terms of whether the lien survives?

I would say it would be Cottrell v. Pierson, United States v. Hack, and Brent v. Bank of Washington.

Those three cases all established the traditional security interests would survive assertion of priority by the Government under the statute.

Unknown Speaker: Well, is the judgment lien situation different somehow from a mortgage or other type of secured interest where possession changes, or title, or--

Mr. McCartan: I think not, Your Honor, and this Court itself in Rankin & Schatzell v. Scott said that a judgment lien has the same power as the mortgage to hold the land, and if we look at these early cases--

Unknown Speaker: --We... the court below didn't really get into the question of the nature of the judgment lien here, did it?

Mr. McCartan: --No, it did not, Your Honor.

Unknown Speaker: So we don't actually know the nature of it here.

Mr. McCartan: Well, we know that it was a judgment lien that was definite with respect to the identity of the judgment creditor, the amount of the judgment, and that it was immediately enforceable.

It was properly perfected--

Unknown Speaker: Did it apply to all property in the State of Pennsylvania?

Mr. McCartan: --I'm sorry, Your Honor.

Unknown Speaker: Did it apply to all property in the State of Pennsylvania--

Mr. McCartan: No, Your Honor.

It applied only--

Unknown Speaker: --or just a particular county--

Mr. McCartan: --only to property located within Cambria County, which is the county where the judgment was entered, indexed, and was immediately enforceable, and there was only one parcel of property in Cambria County which was owned by the debtor.

Unknown Speaker: --But there was nothing to make it more specific than that.

Then why isn't--

Mr. McCartan: There was nothing that need make it more specific than that, Your Honor.

In order to protect the interests that are involved here, which would be subsequent purchasers, or anyone else with an interest in the affairs of the debtor, a simple title search would reveal this.

It's not just a matter of journalizing the judgment in the court of record.

It is taking that judgment to the county recorder and then entering it there and indexing it so that it will appear in the land--

Unknown Speaker: --Well, except the suggestion is that a mortgage is specific as to property, and that judgment liens are not, and whether or not this Court can get into State lien law as to what's specific and what's general is certainly problematic, but that's the suggestion.

Mr. McCartan: --Well, Your Honor, when they say that the mortgage is more specific, are we looking at the nature of the mortgage, or are we talking just about parcels?

In this case, there was only one piece of real property located within Cambria County to which this judgment lien could attach.

The judgment lien was definite with respect to the identity of the judgment creditor--

Unknown Speaker: Well, but--

Mr. McCartan: --the amount of the lien, and the property.

Unknown Speaker: --It seems to me unlikely we're going to base our holding on that.

We have to assume that there were five other pieces of property in other counties, if your reading of the statute is correct.

Mr. McCartan: No, Your Honor, it would not apply to any property located in other counties unless that judgment were taken to those counties and indexed.

Unknown Speaker: But under your submission if you file it in every county, then your lien is good in every county.

Mr. McCartan: In every county... if you take that judgment and enter it according to State law, it is good in any county in which real property is located, and that lien has sufficient capacity to bind the land.

If you look at the early cases, Justice O'Connor, with respect to mortgages, we have to be careful, I think, in looking at these cases that we don't become hidebound by the common law's emphasis on the form of the transaction.

At common law, a mortgage took the form of a straight conveyance of title, but it was always subject to defeasance.

The mortgagor had an equity of redemption.

The mortgagee was never entitled to realize any more from the property than the amount of the secured interest.

The mortgagor's spouse even retained dollar.

The mortgagee's spouse did not.

With respect to real property... and none of the cases relied upon by the Government here involve real property.

They all involve personal property.

In cases of real property, a lien can be perfected if it is filed after entry of judgment and indexed in accordance with State law.

That was done here, and that lien was, therefore, perfected with respect to real property within the county where it was recorded.

Now, if the Government's theory is correct, it should apply to mortgage liens as well, and mortgages are liens in 30 State jurisdictions.

There's no reason to distinguish between a mortgage lien and a judgment creditor's lien, which has a history at least at long and as enforceable as a mortgage lien.

Unknown Speaker: Mr. McCartan, if I understand your position correctly you're not asserting that just the entry of the judgment would have been sufficient to overcome the Government's claim here.

That it is the entry of the judgment plus the perfection of the lien--

Mr. McCartan: That is correct.

Unknown Speaker: --by recording it in... as against particular property?

Mr. McCartan: That is correct, Your Honor.

Unknown Speaker: In Arizona, where I practiced, if you got a judgment you would have to take a... get a certified copy of the judgment from the clerk of the court and take it to the county recorder, and the county recorder would record it the same way it would record a mortgage.

Is that the way Pennsylvania procedure works, too?

Mr. McCartan: That's the way Pennsylvania works, Your Honor, and at that point, that lien is immediately enforceable without any further judicial proceedings of any kind, as was the case in United States/Texas, a case on which the Government relies here.

The mortgage, or the certified copy of the judgment is taken to the county recorder, it is indexed, and it is placed on the land records.

It is therefore specific with respect to any land that is located within that county, and it binds that property.

There is no way in which a mortgagee or a judgment lien creditor can protect themselves against the kind of theory that's asserted by the Government here.

Do you realize that 400,000 dollars of this 490,000 dollar tax lien, or tax claim, as the Government would prefer to say, was for tax years that were after the time when this judgment was entered, indexed, and perfected as a lien under Pennsylvania law?

The commercial mortgage market would be in total chaos if that theory were to be accepted.

Let me address next the question of the interaction of these two statutes.

The Government would make it appear that the only issue here is whether there is an implied exception to the priority statute, when in fact the issue is really whether there is an implied exception to one statute or an implied limitation on another, as I think Justice Breyer suggested.

There are really two separate and distinct questions presented by this phase of the case.

First, whether the competing statutes are inconsistent within some range of overlapping application.

Unknown Speaker: Well, we've applied, I think, a higher standard in justifying any displacement of section 3713.

We really have at least articulated a higher standard than just finding a more specific statute.

Mr. McCartan: Well, when you say a higher standard, Your Honor, I assume that you are referring to the test in United States v. Key, where the Court set forth a threepart test--

First, is there a facial inconsistency, or a logical inconsistency between the two statutes, secondly, would application of the priority statute make the subsequently enacted and more specific statute redundant, or does the legislative history in any way suggest a congressional intention to carve out an exception to the priority statute?

I submit that while it is doubtful in my mind that in a case that didn't even involve an inconsistency the Court was setting forth an overarching test to resolve all of these cases, I submit the situation here does satisfy the test that was set forth in United States v. Key.

To begin with, the competing statutes are inconsistent, and they are inconsistent in the very area presented by this case.

The relative priority of the Government depends upon which statute applies.

And, Justice Breyer, it doesn't make sense for the Government to argue that, well, we are here as a tax claimant as well as a lienholder, and we would prefer to proceed as the holder of a tax claim rather than as a lienholder.

If you think about that, it's another way of saying that the Government should stand in a better position as an unsecured creditor than as a secured creditor, something that Professor Kennedy, the leading commentator in this area, said was quite paradoxical, that the Government should be better off--

Unknown Speaker: I think it--

Mr. McCartan: --as an unsecured than as a secured creditor.

Unknown Speaker: --Where... suppose they're right on the lien statute, and he's clarified the argument quite well.

Suppose they're right, then where... suppose they're right, in other words, that the priority statute applies.

It would apply to people who die insolvent.

If that were true, where would the tax lien statute apply?

It couldn't apply to dead people, because the other one does for dead people.

It would apply to live people.

It couldn't apply to live bankrupt people, because the bankruptcy statute would apply to those people, so it would apply to insolvent live people who aren't... no, sorry, it would apply to people who... perhaps solvent live people.

Now, what is that universe like, the universe of solvent, live people for whom one needs a tax lien statute for the Government to collect its money?

What is that universe?

Mr. McCartan: That universe is one where the tax lien would have no... tax lien statute would have no significance whatsoever, as the Chief Justice pointed out earlier.

If the debtor is solvent, there is no need for these carefully crafted priorities in section 6326(a).

If the debtor is solvent, everyone is going to paid.

Unknown Speaker: There would at least be people who disappear, but even--

Mr. McCartan: Pardon, Your Honor?

Unknown Speaker: --There might be somebody who disappeared, leaving a house behind, and you'd have a tax lien against the property you could find.

Mr. McCartan: And that very limited area of cases is hardly what Congress had in mind--

Unknown Speaker: Is there any other area?

Mr. McCartan: --in crafting this.

There isn't.

The Government says, in an effort really to prove that the priority statute is really the more limited and specific statute, that the Tax Lien Act would have application to cases involving solvent debtors, where, of course, it wouldn't be necessary, and secondly in bankruptcy cases.

Contrary to what the Government suggests, priorities in bankruptcy are determined by sections 724 and 726 of the Bankruptcy Code, not the Tax Lien Act, and the Government's reliance on Terwilliger here is misplaced.

There is no reference to the Tax Lien Act in the Bankruptcy Code, nor does the Tax Lien Act apply with full force when a trustee in bankruptcy, acting under section 544 of the Bankruptcy Code, which gives the trustee status of a hypothetical judgment lien creditor at the outset of a bankruptcy proceeding, to determine what liens would survive the bankruptcy, which secured liens might exist.

The trustee would refer to the Tax Lien Act to determine if a Federal tax lien were involved, it had been perfected, but then the priorities of the bankruptcy statute would kick in to determine how these payment would be made and to whom and in what order, and in that situation, Your Honor, the Government would apply in the third category and in the sixth category, not in accordance with the provisions of the Tax Lien Act.

This is the basic structural flaw in the Government's case.

If you accept this theory, the Tax Lien Act has application only to cases where its carefully crafted protections of other creditors would have no significance, and it would also be inconsistent with what this Court itself said in the Kimbell Foods case, and that is that this statute represents congressional disapproval of the unrestricted Federal priority in tax matters.

Now, I don't think that Congress took the time to craft this very detailed statute in order to have it apply only to situations where it would have no significance, and where its priorities would be rendered totally ineffective, but that is what the Government's position is.

Going back, Justice O'Connor, to the key test, I think I've already demonstrated there is an inconsistency between the statutes, because the priority depends upon which statute is applied.

Secondly, as I've just discussed, the Tax Lien Act would be totally redundant, as would, I might add, other Federal lien statutes if the Government's theory is to be accepted.

If you have a solvent debtor, it doesn't matter if you have a lien or not, you're going to be paid.

Now, with respect to the legislative history, the Government points to two proposals that were advanced by the ABA in 1959 and again in 1970 by way of amendment to the Federal tax lien... or, excuse me, to the priority statute.

Those amendments went far beyond any issue that is involved in this case.

This Court has always been reluctant to draw any inference from congressional inaction, and I submit in this case it would be totally inappropriate to do so because of the breadth of the amendments--

Unknown Speaker: But do they go beyond what your reading of the statute was in the first part of your brief?

Mr. McCartan: --No, Your Honor.

In fact, in the final report of the ABA, which is referred to in the legislative history, I think it is clear that the ABA at that point thought that one of the proposals that was being advanced was really to clarify that traditional security interests have always survived assertion of priority by the Government under the statute.

In other words, with respect to that specific proposal, which was part of a much larger package, the ABA was of the view that they were really conforming law to what traditionally it had understood to be, contrary to the suggestion in some cases.

If you look at the legislative history of this statute in terms of how the structure of the statute has evolved over time, I think it is also clear that we meet the test set forth in The United States v. Key.

This is a statute that started out as a means of facilitating tax collection on the part of the Government.

Over the years, there has been a steady expansion of the protection afforded to competing creditors, and if you look at the committee report of the 1913 statute, Congress was of the view at that time that they were putting these other creditors on an equal footing with the Government in tax matters.

In 1966, the 1966 amendments, which gave even unsecured creditors, Justice Breyer, priority over a properly filed and perfected Federal tax lien, Congress said that these amendments were designed to bring the Federal Tax Lien Act in conformity with the provisions of the Uniform Commercial Code, and under Article 9 of the Uniform Commercial Code, secured claims are always given preference over unsecured claims.

So I think that in terms of whether we have satisfied the standards set forth in the United States v. Key, it is clear that we have.

With respect to the cases relied upon by the Government, I want to emphasize that in the case of New York v. Maclay you had a situation of a State lien, State franchise tax lien that was designed to cover all property of the debtor that were accrued in advance of the years in which the amount of taxes were due, so you had an amount that was undetermined, you had property that was undetermined.

Unknown Speaker: It wouldn't have been a perfected lien under the Uniform Commercial Code.

Mr. McCartan: It would not have been a perfected lien under the Uniform Commercial Code or under any other standard, Justice Scalia, that I can consider.

The same was true of United States v. Texas, another case on which the Government relies very heavily.

In that case, the amount of the lien was undetermined.

It required judicial proceedings to determine the amount.

The property there was not only all property used in the business, but all property that might thereafter be acquired, far different from the property in this case located within the county in which this judgment was entered, indexed, and perfected as a lien.

Every other case that is relied upon by the Government involved... and which turned on possession of the property involved, was a case involving personal property.

Liens on personal property at common law required the creditor to take possession of the collateral.

If the creditor did not have possession of the collateral, there was no lien at common law.

Unknown Speaker: Are these all very old cases, Mr. McCartan, because that's certainly not the rule now--

Mr. McCartan: No, that--

Unknown Speaker: --under the UCC.

Mr. McCartan: --Now you can make the filing with the UCC, but at common law, absent possession of the collateral, the creditor was not deemed to have a lien.

In fact, any lien on personal property absent possession was deemed to be fraudulent.

So all of these cases on which the Government relies, the socalled modern cases, are really just reaffirming, in the case of personal property, traditional common law principles.

The case is different, the considerations are different with respect to real property.

Unknown Speaker: But you want us to bring the lien statute up to date with the UCC, which is what you say the legislative history expresses as the purpose--

Mr. McCartan: Well, the--

Unknown Speaker: --and you're not going to do that if we continue to make this absolute requirement that in the case of personal property you have to be in possession.

Mr. McCartan: --Well, in terms of... no, today in terms of personal property with a UCC filing you can obtain a lien on personal property.

Unknown Speaker: Right.

Mr. McCartan: What I'm talking about are the cases involving State tax liens, where personal property was involved and this Court said, absent divestiture of title or possession of the property you don't have a perfected lien on personal property.

Unknown Speaker: Isn't what we're talking about here real property?

Mr. McCartan: That's right, Your Honor, and all of the cases that the Government relies on have turned on the requirement of possession for the property, as enunciated in Thelusson v. Smith, have involved personal property.

Unknown Speaker: So you're just saying that that feature makes it impossible for the Government to claim authority from those cases, rather than those features should be regarded by us as a basis for present law.

Mr. McCartan: That's correct, Justice Souter, and I think that, too, is really why stare decisis is not implicated here, in addition to several other reasons, but these cases on which they rely do involve personal property and not real property, and if we're talking about stare decisis we have to go back to Conard v. Atlantic Insurance Company, and there the Court was of the view that Thelusson should be limited to its facts, and that the requirement that the judgment creditor obtain title or possession of the property was limited to the facts in that case.

Unknown Speaker: Was Thelusson personal property?

Mr. McCartan: No.

Thelusson was real property, Your Honor, but in Thelusson the judgment creditor was attempting to reach the proceeds of the sale of the property and, as the Court pointed out in Conard, what the judgment creditor should have done was to proceed against the land rather than the proceeds from the sale of the land, and that is why Thelusson was being limited to what the Court said were its circumstances.

The Court was very emphatic that Thelusson did not stand for the proposition that a perfected lien could be displaced by the mere priority of the Government under revised statute section 3466.

Unknown Speaker: And that's the position you say the Attorney General in that 1857 opinion--

Mr. McCartan: That's correct, Justice Ginsburg.

In 1857 the Attorney General's opinion was to the effect that Thelusson had been overruled, not just limited to the circumstances of the case, and that the priority statute would not reach back over liens general or specific that were antecedent to the accrual of the Government's claim.

Unknown Speaker: --And yet he--

--Your position would require us to overrule Thelusson, I think.

Mr. McCartan: My position, I think, would require you to at least distinguish it, Your Honor.

Conard, if you accept what the Court said in Conard, that Thelusson did not stand for the proposition that a perfected lien could be overcome by the priority statute, then consistent with Conard you don't have to overrule it.

Unknown Speaker: But normally a lien attaches to the proceeds, or I mean... well, anyway, go ahead.

Mr. McCartan: You see what I mean, though, that the distinction made in Conard would permit the Court to proceed on the basis of Conard without addressing specifically the issue of whether Thelusson should be overruled.

As this Court said in Rankin, the judgment lien does follow the property and can be foreclosed, even in the case where a junior lienholder or unsecured creditor has moved against the property in the first instance.

I submit that the Government's position in this case, and we are talking about real property, confuses what is necessary to perfect a lien with respect to that property with satisfaction of the underlying judgment.

Requiring a creditor to take possession of the property or to foreclose on the lien is a means of satisfying the underlying obligation.

It is not required to perfect the lien under modern recording statutes, and the only cases that would indicate to the contrary are cases that have involved unspecified personal property or real property that could not be identified.

In this case, the property is clearly identified, the identity of the lienor is clear, the amount of the lien has been established, and the property is located within the county in which the lien was perfected.

We satisfy the test in United States/Key, in United States v. Campbell, and I submit that the judgment of the Pennsylvania supreme court should be affirmed.

Thank you.

Unknown Speaker: Thank you, Mr. McCartan.

Mr. Jones, you have 4 minutes remaining.

Rebuttal of Kent L. Jones

Mr. Jones: Thank you.

There are basically two propositions respondent makes.

One is that the Court should disclaim reliance on a distinction that's recognized for 180 years, from Thelusson through Gilbert Associates, between a general lien that does not defeat the absolute priority of the United States and a more specific lien that may.

The Court has held... I'm repeating myself, probably, but I think seven times that a judgment lien is such a general lien and that the priority of the United States prevails against it.

It's said it not only with respect to personal property, it's said it at least twice with respect to real property.

In United States v. Texas in 1941 the Court said, and I'm quoting from page 7 of our brief, but I'm quoting the Court's opinion, a general judgment lien upon the land of an insolvent debtor does not take precedence over claims of the United States unless execution of the judgment has proceeded far enough to take the land out of the possession of the debtor.

Unknown Speaker: Mr. McCartan's point, as I recall, was that the lien in that case was not perfected.

The amount was not even established.

Mr. Jones: He's confusing something that this Court has made clear shouldn't be confused, and that is the standards for specificity under the Federal Tax Lien Act, as contrasted with the standards for specificity under the absolute priority statute.

The Court in Vermont and in New Britain made clear that those are really two entirely different questions.

The question under the Federal Tax Lien Act is, is there a State lien, and the answer is yes if it's become definite in terms of the name of the lienor, the amount of the lien, and the property to which it applies.

But as the Court explained in Vermont, the question of whether you have a specific lien for purposes of the absolute priority statute is a different one, and turns on whether, as the Court said in that case, the debtor has been divested of title or possession--

Unknown Speaker: Well, why should they be different?

Mr. Jones: --They are different because the statutes have different scopes and application, which this Court has clearly held in at least two cases this century.

Unknown Speaker: Is it... was the distinction, or they're saying they're different based on the difference in language in the statutes?

Mr. Jones: And the statute's objectives, yes.

I mean, it goes back to the language.

The absolute priority statute simply says we get paid first, and the question is, well, is there something that prevents that from happening, and the Court's answer has been, well, if the property has been taken away from the debtor, then you don't get paid first.

If it's been taken away from the debtor by something so specific, like a mortgage, then you don't get paid first, but if it's just a general claim against that property, you still get paid first, because it's still in the possession of the debtor, and the statute says, and the Court says we obey the plain language of the statute that the United States gets paid first.

To reach a different conclusion the Court would have to overrule no less than seven opinions over the last 180 years.

The cases that he says are his best cases for this proposition were all in the early part of the 19th Century.

They don't... as our brief describes, they don't stand for the proposition that he contends.

This Court has expressly limited the application of those cases to the mortgage situation in the Maclay, New York v. Maclay, that's what Justice Cardozo carefully explained.

The second argument that they make is that this statute, this application of the absolute priority statute somehow makes the Federal tax lien provisions meaningless, which if you think about it is a preposterous contention that has absolutely no support for it.

The Federal tax lien provisions of course apply in the ordinary situations that the absolute priority statute doesn't apply.

In bankruptcy court, for example, they will determine whose lien comes first, where it matters whether your lien came first or not.

In the... I'm sorry.

My time has expired.

Chief Justice Rehnquist: Thank you, Mr. Jones.

The case is submitted.

Attribution:

The OYEZ Project

Featured:

United States v. Reorganized CF& I Fab. of UT - Oral Argument

Fri, 09 Jan 2009 14:49:46 +0000

Case:

United States v. Reorganized CF& I Fab. of UT

Media File:

95-325_19960325-argument.mp3

Related Transcript:

1995_95_325_argument.xml

Transcript:

Argument of Kent L. Jones

Chief Justice Rehnquist: We'll hear argument next in Number 95-325, United States v. Reorganized CF&I Fabricators of Utah.

Mr. Jones, you're a bear for punishment.

You're up again.

Mr. Jones: And I'm getting it, too, Your Honor.

[Laughter]

Unknown Speaker: Either you or we.

[Laughter]

Mr. Jones: Well, I take comfort in the thought that we're all suffering together here.

This case presents two questions.

The first question is whether the tax imposed by section 4971 of the Internal Revenue Code is within the priority that Congress has established for excise taxes in section 507(a)(7)(E) of the Bankruptcy Code.

The second question is whether, if this tax is not entitled to that statutory priority, it may then be subordinated to the claims of general unsecured creditors under the principles of equitable subordination that we've been discussing.

I would like to briefly discuss the second question first.

The case that was just argued could be said to stand, or present the question of whether the principles of equitable subordination on grounds of fairness alone, would permit a court to deviate from what is known as the absolute priority rule.

That rule, as discussed by this Court in the Norwest Bank case, is that all claims of a higher priority have to be paid before any claim of a lower priority is paid.

In the case that was just argued, the higher priority was the first priority for postpetition tax penalty claims.

This case, the second question in this case, if it is reached, could be said to present the question of whether the principles of equitable subordination permit a court, again on grounds of fairness alone, to deviate from what is called the equality of distribution rule.

That rule, as discussed by this Court in the Begier case, is that all claims of the same rank must be paid pro rata, without discrimination among them.

Now, because, in our view, the principles of equitable subordination are the same in both contexts, and in the absence of creditor misconduct don't permit subordination either of claims of the same or of a different rank, the court of appeals erred in this case in subordinating the innocent claim of the United States.

Thus, if the court was right that the claim of the United States didn't have a statutory priority, it was wrong in then saying that the innocent claim of the United States could be subordinated to other general, unsecured claims.

That violates the principle of equality of distribution and it also--

Unknown Speaker: So you're saying, in effect, even if you lose on the first question, you're entitled to some sort of relief on the second question?

Mr. Jones: --Yes.

The relief that we would be entitled to would be to be treated pro rata with other general unsecured claims, if we're not a priority claim.

Now, the first question in this case is whether we are a priority claim.

Section 4971 of the Internal Revenue Code was enacted in 1974 as part of ERISA.

It imposes a tax of 10 percent on underfunded pension plans.

Congress expressly designated and described this tax as an excise tax, and it--

Unknown Speaker: Well, do you agree that language doesn't always control, that something can be called a tax and, in fact, be a penalty?

Mr. Jones: --I agree that something can be called a tax that isn't, but there are two reasons why we think the designation of this tax as an excise tax is important, which I'll soon address, but I did want to make the point here that this tax does have the two features which are common to excise taxes, and by the way, excise taxes are probably the most common kind of tax there is.

Unknown Speaker: This section deals not just with the Federal Government, but with all governmental entities.

Mr. Jones: That's right, any State, Federal, or local excise tax.

Subtitles B through E of the Internal Revenue Code are all excise taxes.

There's the estate taxes, employment taxes, miscellaneous excise taxes, alcohol and tobacco taxes... Congress has a lot of excise taxes, but the common feature, what you can see if you go through them, is there are two common features.

They're not universally present, but they're the common characteristics of excises, and those are that it is imposed upon a specific act or event, in this case the act of maintaining an underfunded pension plan, and second is that it's imposed of a portion of the value of that act or event, in this case a portion of the value of the underfunding.

Now, 4 years after this tax was enacted, Congress, in restructuring the Bankruptcy Code, enacted 507(a)(7)(E), which provides a specific, unqualified priority for any State, Federal, or local excise tax.

The court of appeals reasoned in this case that that priority could not reach this tax, because this tax was designed to enforce another law.

It was designed to deter the violation of another law, and the court regarded it as a penalty, and as a penalty the court concluded it wouldn't come within the priority for an excise tax.

Unknown Speaker: Because it was a nonpecuniary loss--

Mr. Jones: A nonpecuniary loss penalty, which simply means that it's a penalty that doesn't recover money that would otherwise be owed, I guess.

Now, whether you look at the text of the statute, or its structure, or its history, the reasoning of the court of appeals cannot be sustained.

The text, of course, which under Ron Pair is what we're supposed to look at, says unqualifiedly that any excise tax, State, Federal, or local, is entitled to this priority.

It doesn't contain any suggestion that an excise--

Unknown Speaker: --Well, Mr.--

Mr. Jones: --that has a regulatory purpose is not.

Unknown Speaker: --Mr. Jones, it does have one qualification, and that is, it uses the word transaction, rather than act or event, and I mean, just in common uses that implies something more, doesn't it, than the passage of the deadline without payment?

Would we normally describe that as a transaction?

Mr. Jones: The transaction language in that code is designed to key off the, if you will, statute of limitations that applies to excise tax claims.

Respondents agree--

Unknown Speaker: Does it use the word transaction?

Mr. Jones: --Does which?

Unknown Speaker: Does the statute of limitations?

Mr. Jones: No, I didn't... I was not being precise.

I don't mean to say a statute of limitations, but if you look at 507(a)(7)(A), (B), (C), (D), (E), all of which address various kinds of tax claims, each of them has a limitation as to the scope of a claim to fall within the priority.

For example, the language in (a)(7)(E), if I'm paraphrasing it properly, is that the tax has to be with respect to a transaction for which a report is due within 3 years of the filing of the petition.

The word transaction has a broad meaning, and couldn't be reasonably understood to be a narrow meaning.

For example, estate taxes are excise taxes.

What's the bargained for exchange if you think of transaction that way?

There's no bargained for exchange there.

The transaction language is the act--

Unknown Speaker: These taxes you say are excise taxes, that's well established?

Mr. Jones: --Yes.

Estate gift taxes are excises.

Unknown Speaker: How is that established?

Mr. Jones: Well, it's not addressed in the briefs, Your Honor, but I think it's... it's established in the case law and treatises.

Unknown Speaker: Well, what cases?

Mr. Jones: I'm sorry, I'm not prepared... I don't have an answer to that question now.

I'm just speaking from, if you will, my general knowledge.

Excises are taxes that would include estate taxes, just as they include sales taxes.

They are at... this Court talked about the fact that excises, customs duties, and income taxes are really sort of the whole gamut, or as the Court said in the Steadman Machine case, the... all of the taxes appropriate to sovereignty, and you can track that through the way Congress--

Unknown Speaker: Are you saying that all taxes appropriate to sovereignty are excise taxes?

Mr. Jones: --No, sir.

I said that income, customs duties, and excises... the Court used the phrase, appropriate to sovereignty in the Steadman Machine case.

If you think about it, customs duties are in title 19, income taxes are in subtitle A of title 26, and as I said, subtitles B through E of title 26 are excises.

Unknown Speaker: So your theory is that the Court said customs, income, and excise taxes, and they were covering the waterfront there, and therefore if something isn't a customs duty and isn't an income tax, it is by definition an excise tax?

Mr. Jones: I think that the point the Court was making was that these are broad and flexible terms.

I don't think the Court in the case that I referred to was trying to be specific in the way that you're suggesting.

Unknown Speaker: Well, what if a State had structured its tax scheme differently than the Federal Government?

I mean, I take it we have to deal with State tax schemes here, too--

Mr. Jones: Yes.

Unknown Speaker: --and the Federal Government doesn't get any bigger a break than the State does in trying to figure out whether it's an excise tax or not.

Mr. Jones: Well, I wouldn't say any bigger a break, but I do think that the Mansfield Tire court was probably right in saying that when Congress expressly designates something as an excise tax there's no reason to think it didn't intend to have its excises included within the priority that it adopted for excise taxes.

Unknown Speaker: Well, does that really make much sense?

I mean, the same committees of Congress don't draft bankruptcy bills as draft tax bills.

Mr. Jones: It makes sense if you think about it from two perspectives.

It makes sense if you think about the fact that Congress is the one... I mean, if you're trying to decide what is the excise tax, the best evidence of that is... would be to go through the Internal Revenue Code and to see what Congress has done.

I mean, when I suggested that there are two common characteristics for excises, I think that was correct, and that's based on observation of what Congress has done.

Congress has probably enacted as many, if not more taxes than anybody.

Unknown Speaker: Mr. Jones, the section doesn't purport to include all excise taxes.

It includes an excise tax on a specific kind of transaction--

Mr. Jones: Well, on--

Unknown Speaker: --and what is the transaction we're talking about here?

Mr. Jones: --The transaction that we're talking about here is the act of maintaining an underfunded pension plan.

Unknown Speaker: Act of maintaining over a period of time.

Mr. Jones: That's right.

Unknown Speaker: Not a... it talks about a transaction occurring on a specific date.

Mr. Jones: Well, the report on that is due on a specific date.

It's an end of year event.

There are other excise--

Unknown Speaker: Isn't it the failure to fund on by that date which is the event?

It is not the mere maintenance over some period of time, it's the failure to bring it up to the proper level--

Mr. Jones: --It's the maintaining on the reporting date--

Unknown Speaker: --on that reporting date.

Mr. Jones: --Yes.

It's the act of, on that date, of maintaining that tax.

It is a specific event.

There are other excise--

Unknown Speaker: It seems to me a more natural term would be to describe that as an omission rather than a transaction.

Mr. Jones: --Well--

Unknown Speaker: Or a failure rather than a trans... normally, a transaction is the event of death, or you sell something.

I mean--

Mr. Jones: --Well--

Unknown Speaker: --it's an unusual use of the word transaction.

Let me put it that way--

Mr. Jones: --It's a broad use of the word transaction, and you can only understand it in a broad context when you understand the broad concept of excises.

Unknown Speaker: --Of course, maybe the point for your side is that no one has come up with a reason why Congress would want to draw the line between an excise payable, excise tax payable on a failure to do something as distinct from an excise tax payable because of some affirmative action.

Mr. Jones: Well--

Unknown Speaker: At least, I don't have an idea.

Mr. Jones: --I don't think there's any reason to think Congress thought it was drawing such a line.

It spoke quite broadly that it's priority would extend to any State, Federal, or local tax expressly treated or generally considered to be an excise.

Unknown Speaker: Mr. Jones, there is an additional so called tax under the ERISA scheme.

Where the initial tax isn't corrected within a certain time, then there's imposed a tax equal to 100 percent of the accumulated funding deficiency.

Now, what's the transaction there?

Mr. Jones: The... there's a lot of issues that I want to talk about in answering that question.

The first, of course, is that this Court isn't going to be asked to decide that question, but I will--

Unknown Speaker: Well, come on, we have to have that in mind.

It's in the very next section--

Mr. Jones: --I understand that.

Unknown Speaker: --and you know we're going to face it.

Mr. Jones: The United States has never pursued in an appellate court the question of the priority of the subsection (b) tax, and there are reasons to think that the treatment to be accorded to those taxes is different than the treatment to be accorded to the 10-percent priority.

There are two differences that I think can be addressed at this point.

There are others that may also exist.

There is, of course, the facial difference between a 10-percent tax that conforms to the, if you will, ordinary concept of an excise as a tax on the portion of the value, and a 100-percent tax, which is--

Unknown Speaker: Which looks something like a penalty.

Mr. Jones: --Which would be, I suppose, a whopping big excise tax.

Whether Congress can enact a whopping big excise tax is something that I don't think that there's any reason to think it can't, but I think it's something we'd have to address if we ever argued that case.

Unknown Speaker: Well, if an estate tax is an excise tax, certainly estate taxes are whopping big, 65 percent.

Mr. Jones: That's right, estate taxes can get very high.

Now, the other point that I think is a more problematic distinction between those two taxes--

Unknown Speaker: More problematic than whopping big?

Mr. Jones: --Yes.

[Laughter]

More problematic even than whopping big is the fact that the (b) tax, unlike the (a) tax, and unlike, if you will, many other excise taxes in the Internal Revenue Code, is expressly subject to waiver by the Secretary of the Treasury on any grounds that he thinks is appropriate.

That's a... that kind of discretionary enforcement would raise a question about whether Congress has treated this as a tax.

Unknown Speaker: Is the (b) tax expressly labeled an excise tax?

Mr. Jones: No, it's labeled... expressly labeled in the statute a tax.

Unknown Speaker: But it doesn't... the word excise is not in that section, is that right?

Mr. Jones: No, it's... nor is it... nor is it within the (a)--

Unknown Speaker: It's not in the other, the 10 percent, either.

Mr. Jones: --Nor is it within the section that imposes most congressional excise taxes.

Congress designates this as an excise tax both by its location within the code, of course, which Congress is cognizant of--

Unknown Speaker: Which also applies to (b).

Mr. Jones: --Which also applies to (b).

Unknown Speaker: So if we buy (a), I think we're buying (b).

Mr. Jones: Well, I'm... what I'm trying to say is, I think there are reasons why you would certainly want to reserve the question, but even if you were later to address it, there are reasons why you might draw a distinction.

Unknown Speaker: Okay.

In any event, your point is not that the designation is controlling.

The designation is important, but it's not controlling--

Mr. Jones: It's very important, and it's the... in the words of the legislative history, which I think are useful guides, it says, if Congress has expressly treated it as an excise, or has... or if it's commonly understood to be one, and so the question that I'm noting about the (b) tax is that, well, it hasn't been expressly treated as an excise when it's subject to waiver on any grounds the Secretary considers proper.

Unknown Speaker: --Okay, but one thing we can't do is adopt a rule of decision which says (a) has been designated by its location as an excise tax, end of issue.

We can't decide on that basis.

Mr. Jones: You could, if you wished, use the language which the legislative history contains, which is what has been expressly treated as an excise by Congress.

Unknown Speaker: Well, depending on how narrowly you read that, this either is or is not--

Mr. Jones: Yes.

Unknown Speaker: --expressly treated, but we couldn't take the designation rule without picking up (b) as well, is that--

Mr. Jones: I really don't mean to try to use the word designation as, as the one court said, a label.

I think the labeling is important, but it's the treatment of this as an excise tax, and the fact that it shares common--

Unknown Speaker: --Mr. Jones, could you help me, because I frankly... I had thought it was... this was expressly described as an excise tax, but it really is not, is it?

What is the closest thing to express language in the Internal Revenue Code... forget about legislative history for a moment... that would say the label for this thing is an excise tax?

Mr. Jones: --Well, in terms of labeling, Congress located this within--

Unknown Speaker: It just located in the particular section--

Mr. Jones: --In subtitle D, which is called Miscellaneous Excise Taxes.

The legislative history describes it as an excise tax.

Unknown Speaker: --But your textual argument is that it's in a section of the code that's entitled Miscellaneous Excise Taxes.

Mr. Jones: I'm not sure.

Relatively few Federal excise taxes have the word excise in them.

I mean, it's just not a legislative draftsmanship thing.

Unknown Speaker: But this one doesn't have the word excise in it.

Mr. Jones: No, it doesn't, and very few do.

Most excise taxes are like this.

They're taxes, like the estate and gift taxes.

Unknown Speaker: Most of them are on a... you know, you can say you're being taxed on a specific event, like a death or a transaction or something, but this is a nonevent.

I mean, if you're right on whether a nonevent is the same as event--

Mr. Jones: There are--

Unknown Speaker: --of course, you don't--

Mr. Jones: --There are... there's an excise tax on maintaining a trust with excessive amounts of undistributed income.

There are other kinds of excise that follow this pattern.

Unknown Speaker: --But again... again, I don't want to just lose this one thought.

The only language in the code, other than looking at the tax and trying to decide whether it fits the category, is the title of this section says miscellaneous excise taxes, and it's in that section, is that right?

Mr. Jones: That would be the only language, if you will, in the code.

Unknown Speaker: Yes.

Mr. Jones: Now, in answering that question, let me point out something that we haven't addressed.

We don't think it's relevant, but I do want to point it out.

In 7806 of the code, it says that in interpreting statutes you're not to look at captions, basically.

I'm summarizing.

Unknown Speaker: Right.

Mr. Jones: We're not suggesting that this is a question of interpreting the statute.

It's a question of understanding how Congress has treated this statute to determine whether it's an excise.

Unknown Speaker: Yes, but you're not willing to stand by the proposition, which sort of makes doubtful whether the proposition is correct... you're not willing to stand by the proposition that everything included within that title is an excise tax.

Mr. Jones: I think everything--

Unknown Speaker: It happens to bear that title, but you're... well, the 100 percent tax you're willing to say is not.

Mr. Jones: --Justice Scalia, what I've said is that to the extent that possible distinctions exist elsewhere, we're not trying to answer those questions,--

Unknown Speaker: Well, you have answered it--

Mr. Jones: --and I've answered--

Unknown Speaker: --if you're going to rely on the fact that this in a title that bears the caption, Excise Tax.

If that is going to be the... you know, the North Star of your argument, the 100 percent is covered.

Otherwise, you have to abandon that and say, well, it's not determinative.

Mr. Jones: --We have to look for some evidence to answer the question of what is an excise tax.

Unknown Speaker: Okay.

I mean, so you say this is just part of the evidence.

This alone isn't enough to get you there.

Mr. Jones: If Congress has expressly treated it as an excise, then it is, and all I'm--

Unknown Speaker: No, but that begs the question.

It has not expressly treated it.

In the section itself, the closest to express treatment, as I understand your argument, is its placement in subsection D, which has an excise tax label, and therefore, if we use the placement in subsection D as the ground of decision, then we're going to pick up the (b) tax as well as the (a), and you don't want us, I take it, to be forced to decide on that ground.

If I'm wrong, if you say look, I'll take... I want the whole hog, and you should decide on the ground of that placement, then I want you to tell me.

Mr. Jones: --Congress has done more than just locating it in this section.

It's made it a fixed and determinate excise tax, and to understand why I'm emphasizing that, I want to point out that under the Bankruptcy Act the decision... our position in this case was endorsed by this Court in the case of United States v. New York.

Unknown Speaker: No, but may I just interrupt you, because I want to get clear on one thing.

It's the same thing that Justice Scalia and Justice Stevens wants to get clear on.

Yes or no.

You should decide this case under a rule of decision that says, if it's placed under D, it's an excise tax, end of issue.

Is that the position that you take, or is it not the position that you take?

Mr. Jones: I have two answers to that.

One is, you make take that--

Unknown Speaker: No, it's yes or no.

You can only have one answer.

[Laughter]

Mr. Jones: --The Court could reach that decision.

I think that the Court could also have an analysis that also looked to the question of whether the treatment of the tax is--

Unknown Speaker: So I guess the answer is no.

Mr. Jones: --an excise--

Unknown Speaker: I guess the answer is no.

But see, Mr. Jones, the court of appeals seemed to think it really is clearly labeled an excise tax, but they said, we apply a four part test from Cassidy or some earlier case, and you're saying don't apply a four part test, apply an act or event test.

You're just saying they applied the wrong test.

Mr. Jones: --I think that's the test that Congress applies--

Unknown Speaker: But it is correct, in your view--

Mr. Jones: --in creating excise taxes.

Unknown Speaker: --to apply a test to decide whether we think it's an excise tax.

Mr. Jones: I think in deciding what's an excise tax, we should apply the test Congress applies, but may I please--

Unknown Speaker: Wait, but what test does Congress apply?

They have included the 100-percent tax within this section entitled Excise Taxes.

Mr. Jones: --And then they made it waivable.

I'm simply saying that in a future case, not in this case, the Court might want to consider whether that's relevant.

I don't think the Court has to address it here.

I wouldn't expect it to.

Unknown Speaker: It seems to me once you abandon... once you're not willing to answer yes to Justice Souter's question, we're just quibbling about what the test ought to be, whether it's the four part test used here, or we should make up another one.

Mr. Jones: There's really another point--

Unknown Speaker: And there's really no alternative.

You--

Mr. Jones: --There's another--

Unknown Speaker: --Can I ask a question... at some point, when you can... a technical question.

Mr. Jones: --May I just make one more point?

Unknown Speaker: Yes.

You bet.

Mr. Jones: Thank you.

In United States v. New York, the court addressed the same question that it has to address here.

It did it under the Bankruptcy Act.

The question in that case was whether an excise tax that is designed to enforce some other law is no longer an excise tax.

It's no longer qualified to the priority as a tax, it's a penalty, and what the Court said in United States v. New York is that the mere fact that a tax is designed to enforce some other, in this case State law doesn't make it, in the words of the Court, any the less a tax, doesn't remove it from the statutory priority.

If this case were being decided under the Bankruptcy Act, that analysis in United States v. New York would prevail here, because--

Unknown Speaker: That was a State tax.

Mr. Jones: --No, sir, that was a Federal tax--

Unknown Speaker: That was a... in this same section?

Mr. Jones: --That was a Federal employment tax that was designed to enforce a State unemployment contribution law.

The tax did not apply if the State law had been complied with.

Unknown Speaker: Was it included in this same section of the code?

Mr. Jones: I believe the Federal employment taxes are in subtitle C, the immediately preceding section, which is also an excise tax.

The Court specifically said this excise tax does not lose its priority.

It's not any the less a tax because it's designed to do something else.

Unknown Speaker: What's the caption of subsection C, if subsection D is Miscellaneous Excise--

Mr. Jones: I think it's called Employment Taxes.

Unknown Speaker: --Not Excise Taxes.

Mr. Jones: That's not its caption.

Unknown Speaker: Mr. Jones, one characteristic of many excise taxes is that they are deductible from income, and then that might be one way you could distinguish an excise tax from a penalty.

This is not deductible, this... whatever you want to call the--

Mr. Jones: It's hard for me to answer that question.

This is a tax owed by the pension.

No, this is a tax owed by the employer.

Unknown Speaker: --By the company, because it didn't make the contribution.

Mr. Jones: This is owed by the employer.

I... you're asking me whether it's deductible.

I don't know.

I have no reason to think it would... would not be.

Unknown Speaker: But how... is that something that can help us distinguish an excise tax from a penalty, excise taxes or--

Mr. Jones: Yes, I agree, that would be some evidence.

If Congress... Congress as a general proposition doesn't allow the deduction of penalties, allows the deduction of ordinary necessary business expenses.

I don't know how the... I don't know what the treatment is here.

In Mansfield Tire, the Sixth Circuit made the point that many, if not most Federal excises have a punitive or regulatory purpose.

If Congress had intended to exclude all of its excises like excises on gambling, on green mail, on unregistered securities dealings, you would reasonably expect to see some evidence of that in the text or the legislative history.

But the text and the legislative history contain the unqualified statement that any excise, Federal, State, or local, that has been expressly treated or generally accepted as an excise is entitled to priority, and as the Court said in United States v. New York, the fact that this excise is designed to enforce a penalty doesn't make it any the less a tax.

Justice Breyer--

Unknown Speaker: --Thank you.

Mr. Jones: --I'm sorry.

Unknown Speaker: Thank you... that's all right.

Suppose, just for the sake of argument that I thought because it's regulatory in nature, it's object is zero dollars, it doesn't want to collect revenue, and because it doesn't seem to be on an activity, though there are things on your side, too, which you very well argued, but suppose for the sake of argument that I were to say it was an excise tax, then we'd get to the next part of the case.

Now, the technical question on the next part of the case, assuming that for the sake of argument that we got there, under section 7 priorities, I would have decided that this was a penalty, right?

Mr. Jones: Under Chapter 7 priorities?

Unknown Speaker: Yes.

Yes, under Chapter 7 I would have decided this was a penalty.

Mr. Jones: If you deny the priority on the grounds it was a penalty--

Unknown Speaker: Yes, okay.

Mr. Jones: --and you're now in a 7--

Unknown Speaker: Then it would have come in the fourth priority after unsecured creditors, is that right?

Mr. Jones: --It's a prepetition claim.

Unknown Speaker: Yes.

Mr. Jones: Yes.

Unknown Speaker: All right.

So why in this section, in this Chapter 11 case didn't the bankruptcy judge just say, this is a penalty, therefore I put it in a different class.

I put it in a class which would be the class it would be in if this were a Chapter 7.

I put it in a class below unsecured creditors, and therefore I don't have to worry about equitable subordination or not, and since he could have just as easily done that, which would have come to the identical thing, he just used the wrong words to describe what he did, and therefore that issue drops out of the case.

That's my question.

Mr. Jones: Right.

Of course, as you've already pointed out, that question isn't presented here.

Unknown Speaker: Yes, but what are we supposed to do--

Mr. Jones: If it had been presented--

Unknown Speaker: --Yes.

Mr. Jones: --If it had been presented, what the answer that some courts have given which we think would be correct is that when you cram down, if you will, the priorities from the 7 into the 11, what the courts have pointed out is that you don't do that to the extent that Congress expressly intended that the rules that are applicable to 7 should not apply to 11.

Unknown Speaker: But wait, we've assumed in this, we've assumed in this for the sake of my question that this is nothing other than a simple penalty--

Mr. Jones: Right.

Unknown Speaker: --of a nonpecuniary nature.

Mr. Jones: Yes, sir, and in... and my point is that in a Chapter 11, Congress made the express determination that pecuniary... nonpecuniary loss, prepetition penalties would be treated as general unsecured claims--

Unknown Speaker: Oh--

Mr. Jones: --and not be treated as--

Unknown Speaker: --Where does it do that?

Mr. Jones: --We discuss that in our brief.

I'm sorry, I don't remember the page, but if you compare the bills as they progressed through Congress--

Unknown Speaker: No, but where in the language of the statute does it do that?

Anywhere?

Mr. Jones: --It's in the history of the statute.

Unknown Speaker: Is there any case... is there any case which has said that we lack the power in Chapter 11 to treat--

Mr. Jones: Yes.

Yes, sir.

In two cases that we cite in a footnote addressing this in our reply brief--

Unknown Speaker: --Thank you.

Mr. Jones: --that general point is made, and we also point out the history in our opening brief.

I would like to reserve the balance of my time for rebuttal.

Unknown Speaker: Yes, Mr. Jones.

Mr. McCardell.

Is that the correct pronunciation?

Argument of Steven Jack McCardell

Mr. McCardell: It is, Your Honor.

Unknown Speaker: Mr. McCardell.

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

The IRS claim to tax priority in this case rests on the single assumption identified in the questions of the last argument.

That is, that every exaction labeled a tax in section 4971, because of its placement under the heading, Miscellaneous Excise Taxes, is automatically and without further consideration entitled to the tax priority in bankruptcy.

The questioning in the last argument I think revealed that the 100-percent exaction imposed under sub (b) of section 4971 is indistinguishable from the exaction under sub (a) on the basis of its labels, and if the IRS can concede that the label alone does not control with regard to sub (b), that concedes the case, if label is the IRS' sole argument, which it must be in this case, because of the concessions that the IRS made in the lower court.

Unknown Speaker: Is there anything else that comes under sub (b) and therefore bears the label, Miscellaneous Excise Taxes, which you would assert is obviously not an excise tax, as you do the 100 percent, and as you do the 10 percent, for that matter?

Mr. McCardell: If I understand Your Honor's question, the only exaction under sub (b) is the 100 percent item designated as a tax.

Unknown Speaker: Whatever comes within that section of the code that bears the caption, Miscellaneous Excise Taxes.

Now, there are a lot of things embraced within that, are there not?

Mr. McCardell: Yes, there are, Your Honor.

Unknown Speaker: What else besides this 10 percent and 100 percent strikes you as obviously not an excise tax?

Mr. McCardell: Well, there are other tiered penalties.

For example, section 4941 tiered tax on self dealing.

It imposes a first tier penalty and a second tier penalty.

Both of them are designated as taxes.

Those are the exactions that the Fourth Circuit and the Fifth Circuit ruled under the Bankruptcy Act were not entitled to tax priority.

Unknown Speaker: Well, do you say that every exaction adopted under 26 U.S. Code section 4971, subtitle D, is a penalty, not a tax?

Mr. McCardell: We do, Your Honor, because both were asserted in this case.

The (a) provision which is before the Court today is in the amount of approximately $1.2 million, the (b) provision for about another $40 million, was in the amount emphasized... asserted in this case.

The reason the IRS must rely on its labels govern argument is that the IRS conceded in the lower court that it would not be able to sustain the position that these exactions are not penalties.

That concession is found at pages 48 and 49.

Unknown Speaker: To what extent are we bound by a concession like that?

We do not accept, for example, concessions on points of law as being conclusive, ordinarily.

Mr. McCardell: Your Honor, the IRS did not come forward with any evidence in the bankruptcy court to satisfy the court's traditional test for the tax priority in bankruptcy.

Having failed to meet its burden to prove its entitlement to the priority, I think the IRS is bound by that failure.

Unknown Speaker: Well, it's one thing to be bound by a failure to offer proof, another thing to be bound by a concession.

Mr. McCardell: And both occurred in this case.

The traditional test for tax priority requires that the exaction have the purpose of supporting the Government.

Unknown Speaker: But that can't be the case.

Suppose it's a tax on alcohol or cigarettes.

It's a tax designed to encourage people not to smoke or not to drink, some kind of a sin tax.

Do you say that those aren't excise taxes?

Mr. McCardell: We do not, Your Honor.

The rule adopted by the--

Unknown Speaker: I mean, aren't there plenty of excise taxes that are designed for the very purpose of encouraging certain behavior, or discouraging certain behavior?

Mr. McCardell: --There are, and in the cases of those taxes they have a mixed purpose, both regulatory and to raise revenue.

Section 4971 is distinct in that regard, in that it has only a function of coercing and punishing the failure to--

Unknown Speaker: Well, it raises revenue for Uncle Sam.

Mr. McCardell: --If it's ever paid, it certainly goes into the Treasury.

However, it's not used to fund pensions or to otherwise address the question of retiree claims.

Now--

Unknown Speaker: But I think what--

--Well, but we've never required that.

That would be constructing some other new--

--What Justice O'Connor is suggesting is, how can we tell whether the purpose of... it's easy to say that this tax has a, you know, an encouraging or discouraging function.

How can we say that it isn't for the purpose of raising tax revenue?

I don't know how to figure out whether it is or isn't.

I know that it does raise tax revenue.

Mr. McCardell: --Certainly.

First, if I might address the end of Justice O'Connor's question, which I think addresses the question of what the Bankruptcy Code does with regard to penalty claims, subsection (G) of section 507(a)(7) the Court has before it today distinguishes between penalties that have a pecuniary loss, and penalties that are not based on a pecuniary loss.

Now, it's clear that if there could never be... if the simple fact that it's paid into the Treasury of the Government always made it a tax simply because the Government receives revenue, then there never could be such a thing as a nonpecuniary loss penalty, but (G) demonstrates that there is such a distinction, and that's why, in looking at section 4971, to answer Your Honor's question, the Court can look at objective characteristics of this tax that demonstrate that it does not satisfy the traditional test for taxes.

It was... first, the United States is not liable for the pensions that are guaranteed.

They are guaranteed by the Pension Benefit Guaranty Corporation, which operates on private funds.

The penalty, if paid, goes to the IRS, but not to the PBGC or to the plans or to the retirees.

If the section 4971 penalty is paid, the underlying obligation to fund the plan remains, and in that regard it's different from the responsible officer penalty addressed in the prior case, which can only be collected once.

This one is collected twice.

It says to the employer, you fund your pension plan, or if you don't you're still going to have to fund it, or the next year you're going to have to fund it at 110 percent, you have to pay 110 percent penalty, or the next year 220 percent, and so on.

Unknown Speaker: Well, it doesn't call it a penalty.

Mr. McCardell: That's correct.

Unknown Speaker: I mean, you're calling it a penalty.

That's what we have to decide, and what's the test?

Mr. McCardell: The test, Your Honor, is whether it qualifies as a tax.

The Court has distinguished taxes from penalties by defining it--

Unknown Speaker: Well, yes.

What is the test for determining that?

Mr. McCardell: --The test is that stated in United States v. New York, that a tax is a pecuniary burden laid upon individuals or property for the purpose of supporting the Government, by whatever name it may be called.

That's the test.

Unknown Speaker: Mr. McCardell, I don't know why the issue isn't... forgetting these general tests about taxes and penalties, why isn't the issue simply whether it's a... whether you call it a tax or a penalty, it is imposed on a transaction occurring on a certain date.

If that is the test, do you win or lose?

Mr. McCardell: If the Court addresses the question of transaction, which we think it should, because that is encompassed within the question before the Court today, it's an element of qualifying for tax priority, the IRS loses.

There was no transaction.

Unknown Speaker: Well, they would say... I think Mr. Jones would say, well, the statute imposed an obligation to file... make a determination as of the end of the plan year and know exactly what the underfunding was, and I suppose the transaction might be described as making a determination with red figures in it... bing... and then you pay 10 percent of the red figure.

Mr. McCardell: The IRS's proof of claim in this case identified when this tax arose, and that date was September 15, 1990, at the end of that day, when no payment was made... at midnight on September 15, 1990.

At 11:59 p.m. on that day, there was no tax.

At 12:01 the next day, there was a tax.

What happened in between?

Unknown Speaker: I take it that's the end of the plan year, that--

Mr. McCardell: That's the end of the period within which the debtor could have made that final payment, and in between those two--

Unknown Speaker: --Was that the end of the plan year?

I want to be--

Mr. McCardell: --Yes.

Unknown Speaker: --Because they use the term plan year, I think, in the statute.

Mr. McCardell: Yes.

Your Honor, the end of the plan year was December 31, 1989, but ERISA allows the funding payments for that year to be made up until September 15 of the following year.

Unknown Speaker: So they treated the transaction date as the date the payment was due, rather than the date the determination was made.

Mr. McCardell: That's what their proof of claim says, Your Honor.

Unknown Speaker: Why would Congress want to draw that distinction between a tax which becomes payable as a result of nonaction and the expiration of time, and the tax which becomes payable because of an affirmative act, or perhaps even an affirmative agreement, if that's applied by one sense, a transaction.

Why draw that kind of line?

Mr. McCardell: I'm not sure, Your Honor, but it's apparent from the language of section 507(a)(7)(E) that that line, indeed, was drawn because of the language, transaction occurring, and perhaps it's based on the distinction the Solicitor General points to that most excise taxes are based on an act or event, or a transaction.

Unknown Speaker: Well now, wait, act or event or transaction, you're willing to read transaction to include event?

Mr. McCardell: We are not.

Unknown Speaker: You're not willing to include it.

Or act?

Can it be an act?

Mr. McCardell: Nor--

Unknown Speaker: Not an act.

Mr. McCardell: --Nor an act, Your Honor.

Unknown Speaker: It has to be... a transaction involves... you then do not think that estate taxes are excise taxes.

Mr. McCardell: I wondered that as I studied for this case, Your Honor, and although it's not cited in the briefs and I don't have the statute here today, my recollection of the estate tax statute is that it's imposed on the transfer into the estate, which is a transaction.

Unknown Speaker: If I impose a tax on the sale of, or the purchase of jewelry, that would be an excise tax, but if I impose a tax on the ownership of jewelry, that would not be an excise tax.

Mr. McCardell: Under the ordinary standard--

Unknown Speaker: I mean, above a certain amount.

If you own more than a certain amount of jewelry, that would--

Mr. McCardell: --Ordinarily, it would be understood as a property tax.

Unknown Speaker: --A property tax.

How about a stamp tax on documents?

Mr. McCardell: I don't know, Your Honor.

Unknown Speaker: How is the transfer of property into an estate the result of a transaction?

It's the result of a disposition by someone who is now dead, and it's the result of an acceptance, I suppose, by an administrator, but the two in their respective capacities never meet, so there isn't any real transaction in the sense of the characteristically consensual act of two parties.

Mr. McCardell: There is an exchange in the sense of the death creates an estate, and to the estate goes the decedent's property, and that is described in the code as a transfer.

Unknown Speaker: But we're getting a little bit attenuated.

Mr. McCardell: Yes, Your Honor, and with regard to the section 4971 imposition, it's made not based on any transaction, simply in this case on the failure to make a payment.

Unknown Speaker: Mr. McCardell, do you know the answer to my question about the deductibility of this?

Mr. McCardell: I do, Your Honor.

These impositions are not deductible, and the cross reference in section 4971 is to section 275.

Unknown Speaker: There's a whole slew under these miscellaneous excise taxes, and I know one has to do with charitable foundations.

It seems to operate the same way this one does.

You're supposed to do something that doesn't relate to tax.

You do it, and there's what's called an excise tax.

Mr. McCardell: That's true.

Unknown Speaker: I'm trying to understand what else, since this is... there are many, many things that come under this huge title, would be affected by our answer to the question in the context of 4971, what other animals there are like it in this collection.

Mr. McCardell: There are very few just like this one, because this one is imposed only when another statute is violated.

Section 302 of ERISA requires that a plan sponsor fund its pension plan, and it's only in violating that statutory obligation that this exaction is imposed, so that many of the other excise taxes imposed under the code which may have a regulatory or a deterrent effect simply wouldn't be covered by this case because they're not based on... they're not exacted on unlawful conduct.

Unknown Speaker: May I ask you this, are all taxes deductible by the person paying the taxes if they're engaged in business?

Mr. McCardell: Section 162 of the Internal Revenue Code, which we have addressed in our brief, generally provides for the deductibility of taxes but not penalties.

Unknown Speaker: And penalties are not.

Mr. McCardell: That's correct.

Unknown Speaker: And it's your position that neither the 10-percent exaction nor the 100-percent exaction in this ERISA section are deductible.

Mr. McCardell: That's correct.

They are expressly made not deductible.

Unknown Speaker: The Government suggested that as to the 100-percent tax it has an equitable component within the tax.

That is to say, the Government is free to waive the collection of the tax.

Mr. McCardell: That is a distinction--

Unknown Speaker: Are there any other taxes that are in the excise subtitle that have this equitable waiver, or equitable feature built into them?

Mr. McCardell: --I don't know, Your Honor.

It seems to me, however, that the capacity of a creditor to waive its claim always exists with regard to any claim, and that applying that as a distinction really would allow a creditor to determine--

Unknown Speaker: Well, I don't... I think the Government would tell you that it has no discretion to waive its taxes, other than in the one instance we're discussing, the 100-percent tax, and so it would seem to me plausible enough for the bankruptcy court to say, well, there's an equitable component to this tax which can be waived, and I am going to equitably subordinate it.

Mr. McCardell: --And that, in fact, did occur in this case.

The bankruptcy court--

Unknown Speaker: As to the 100 percent.

Mr. McCardell: --did subordinate under section 510(c) both the 100-percent and the 10-percent penalties.

Unknown Speaker: But that would at least be an excise tax that has an equitable component, which is not like other excise taxes.

Mr. McCardell: It's true that the... only the (b) portion of this exaction is waivable by the Government.

Unknown Speaker: Can I ask the same question I asked the Solicitor General, because assuming that I agreed with you, assuming for the sake of argument that I agreed it was not a tax, but rather it was a penalty, because it collects zero dollars as its objective.

Assume that.

Now, on that assumption, I found it very difficult to reach the question of equitable subordination without deciding whether or not the bankruptcy judge would have the power to create a subcategory that would rank this kind of penalty below the unsecured creditors, or you raised that.

They replied, I take it, in footnote 14 of their reply brief, and they cite a bunch of cases, but they cite them for the proposition that you cannot set up a subclassification of claims within a class of equal priority.

Of course that's true--

Mr. McCardell: It's--

Unknown Speaker: --but I would like to know what you think of that particular argument.

Namely, they deny that the bankruptcy judge would have the power in Chapter 11 to create a subclass of the penalties below the unsecured creditor, and I don't know if these cases stand for that specific application of the general proposition, or if they do not, and I don't know enough about bankruptcy law to know how well settled that kind of question is, and that kind of question seems to me to be prior to a definition of the word equitable.

Mr. McCardell: --Those cases do not stand for that proposition, Your Honor, and I should acknowledge that this... in this case, the IRS's claim was subordinated in two independent ways, not just equitable subordination under 510(c), but also was subordinated under the plan.

There was a subordinated class created for nonpecuniary loss penalties.

Into that class the IRS's claims were placed, so that the IRS, by never objecting to that class, really left the issue as having been resolved by the--

Unknown Speaker: All right.

If, in fact, since I'm... I have to... we have to decide this case, and if you win on the first issue, and then I get to that, and I read the cases, and I think they're indeterminate, what am I, or what would you think this Court should do?

Shouldn't we... I mean, to answer the question of what's equitable without hanging in the air seems difficult.

Should we remand the case?

Should we then say, go back and work this out, because we don't need to decide whether it's equitable or not when you have a perfectly good ground for reaching the same result.

What is it, in your opinion, we should do?

Mr. McCardell: --Your Honor, the Court need not look to equitable grounds if it reaches that question, because two statutes in Chapter 11 both permitted and required the subordination that occurred here.

Unknown Speaker: You didn't really argue... I mean, it's come up here under this other pretense.

That is, the question presented was... so it would be rather hard to affirm on that ground, wouldn't it?

Wouldn't we have to send it back?

Mr. McCardell: The court of appeals affirmed the confirmation order, which is one of the three orders.

The order approving the plan is one of the three orders on appeal today, so that by affirming the confirmation order, the Court will approve the subordination that's provided for in the plan.

It's difficult for us to understand why the IRS doesn't want to address it, but it is an independent ground for subordination that really does exist in the plan, and really was... really occurred in this case, so that by reaching... by simply considering the confirmation order as one of the three orders, the Court does have that issue before it.

The two statutes which provide for that subordination are section 1122, which provides that claims may not be placed in a class unless they're substantially similar.

Well, these claims are not substantially similar to the general unsecured claims, first because they don't represent a pecuniary loss, and second, because they have different priorities in the liquidation.

Further, section 1129(a)(7) of the code gives them... requires that the Bankruptcy Code consider, in confirming a plan, what the liquidation results would be, and as the IRS has conceded in the Chapter 7 case, penalty claims not entitled to priority would be subordinated.

Thus, that result is required in a case of this nature, and those two statutory grounds, rather than any outside equitable factors, would be appropriate grounds for affirmance in this case.

Unknown Speaker: Mr. McCardell, do I understand correctly that you are not making the argument that was made in the prior case?

That is, if you lose on the first question, if this is characterized in the bankruptcy context as an excise tax and therefore would have priority, you're not saying that even though it has priority status it can be subordinated.

Mr. McCardell: We're not saying that, Your Honor, and that's because Chapter 11 has a specific requirement that a Chapter 11 plan pay in full all taxes, which this plan says it will do.

That's found in section 1129(a)(9)(C) of the code, so that we are not making that argument.

Our argument, then, simply rests on the Court's traditional longstanding, well accepted test for the definition of taxes.

The IRS has never explained why Congress intended to legislatively overrule the Court's precedents defining taxes.

There's no definition for tax in the Bankruptcy Code.

Where the Bankruptcy Code intends to incorporate a specific definition from the Internal Revenue Code or any other Federal statute, it does so expressly so that... and a further significant factor in this case is that the kinds of claims we're dealing with in this case were simply disallowed entirely under the Bankruptcy Act, and to suggest that by saying nothing Congress intended to suddenly elevate those claims to the seventh priority is quite a stretch, as we view the development of the law.

The legislative history on which the IRS relies time after time in its brief simply says that exactions that are taxes may... are covered by this priority if they're excises, but they must be taxes first, and so we ask the Court to consider with regard to this exaction the traditional test, which the IRS conceded in the lower courts it did not satisfy, and did not... never came forward with any evidence that it satisfied that test, which was its burden as the claimant in this case.

Unknown Speaker: You know, Sheppard's Tax Dictionary does have a definition for minimum funding excise tax which, it refers to this particular provision, so the tax community as reflected by the tax dictionary calls it an excise tax.

Mr. McCardell: Your Honor, it certainly has been treated in various ways as an excise tax, but not even the tax practitioners would agree that a tax of this nature is a tax for all purposes under the Internal Revenue Code.

We've cited the conflicting line of cases on similar taxes in the Third Circuit and the Eighth Circuit, the Latterman case and the Rockefeller case, where there is disagreement that taxes like this may not even be taxes for purposes of the Internal Revenue Code, so that in view of that kind of a disagreement in a tax of this nature, it's difficult to say that you then import that concept into the Bankruptcy Code when the tax code does not settle bankruptcy priorities.

That's settled by the statute and the court's decisions interpreting the meaning of the statute.

Unknown Speaker: Mr. McCardell, I understand the big difference it makes in the bankruptcy context whether it's classified as one or the other.

In terms of the IRC, does it make any difference whether it's labeled excise or penalty, since, as you have said, there's a specific provision that makes this particular excise tax nondeductible.

Mr. McCardell: I don't know that it does make a difference, Your Honor, although, as I said in addressing taxes of this... penalty excise taxes of this nature, the Third and Eighth Circuits have disagreed on the question of whether they are taxes even for purposes of the Internal Revenue Code's provisions calculating interest on those taxes.

Unknown Speaker: There's some discussion in the briefs... I think it's 507(a)(7)(G)... relating to a penalty related to a claim of a kind specified in this paragraph and in compensation for actual pecuniary loss.

Mr. McCardell: Yes.

Unknown Speaker: Can you give me an example--

Mr. McCardell: Yes, I can.

Unknown Speaker: --of a tax to which that would apply?

Mr. McCardell: I can, Your Honor.

An example would be the responsible officer penalty exacted under 6672.

It represents an assessment of 100 percent against the officer, responsible officer, of the taxes that should have been paid by the corporation.

The Government gets what it would have received if the law had been obeyed and, indeed, the Senate Finance Committee report, which we've cited in our brief, in describing pecuniary loss penalties, describes them as any fine or penalty, however denominated, which actually represent the collection of a tax.

That's the concept we believe is codified in section 50--

Unknown Speaker: Is... withholding taxes, that's... is that... the corporation withholds its employees taxes, then it doesn't pay them, and the person who owes the tax is the employee, and the code refers to the money that the corporation should have withheld, which, of course, is the tax that the employee owed, as a penalty, is that right?

Mr. McCardell: --That's correct.

Unknown Speaker: And that's the idea of pecuniary penalties?

Mr. McCardell: It's what the Government would have received if the law had been... the tax that would have been collected if the law had been obeyed.

Unknown Speaker: And so the only things that are pecuniary penalties are these instances where a corporation is to withhold a tax that somebody else owes, and the code refers to that as a penalty, or those as penalties?

Mr. McCardell: I can think of another example of possible pecuniary loss penalty, and that is an exaction under the Internal Revenue Code that simply represents interest on a tax that should have been paid and compensates--

Unknown Speaker: Yes.

Mr. McCardell: --for the delay in payment.

That would be a... but this kind of exaction is distinct.

--It doesn't compensate any delay in payment.

It doesn't compensate any tax that was not collected.

Congress did not enact section 4971(a) with the idea that individuals would not fund their pension plans and that the IRS would then collect revenue.

Instead, it passed the statute with the idea that individuals who had sponsored pension plans would fund them, and that that funding would go to pay retirees.

Unknown Speaker: They're required to fund them?

Mr. McCardell: Yes, they are.

That's found in section 302 of ERISA.

Unknown Speaker: Is there any other penalty for not funding them?

Mr. McCardell: They... there's no criminal penalty, Your Honor, but that under section 502 of ERISA the failure to fund may be enforced by a civil action, including injunctive proceedings, so that it is a statutory obligation which, if violated, gives rise to these escalating penalties.

Now, in this case, the... not only did the IRS fail to meet the traditional test for taxes, fail to establish that a transaction had occurred, but in asserting these claims, would have taken funds right out of the pockets of the creditors, and many of those creditors include the very retirees who are intended to be protected by this statute.

We don't think, all other things being considered in this case, it makes sense for the Court to adopt a rule which would reach that result.

Nothing in the statue requires that the court read section 507 to require that any label in a nonbankruptcy statute governs priority in bankruptcy.

The Court's cases, from the Embassy Restaurant case, to the Nathanson case, to the Simonson case, all clearly specify that the Court's mode of analysis over many years has been to say that it's bankruptcy law that establishes bankruptcy priorities, and labels or meanings or understandings in nonbankruptcy statutes while, perhaps, evidence, are not controlling.

That was the basis of the court of appeals decisions in this case, and we believe the Court should affirm the court of appeals.

Unknown Speaker: Thank you, Mr. McCardell.

Mr. Jones, you have 2 minutes remaining.

Rebuttal of Kent L. Jones

Mr. Jones: I have two brief points I want to make.

The claim that a tax that effects a penalty loses its priority was exactly what this Court rejected in United States v. New York under the Bankruptcy Act.

The Bankruptcy Code simply makes it easier to understand that that's the correct answer, because knowing full well that many of its excises are penalty or regulatory in nature, Congress adopted an unqualified priority for excise taxes.

We have to establish only that it's an excise tax.

Whether it's also regarded as a penalty is not relevant for applying the plain language of the statute, and the court held in United States v. New York it was not relevant under the Bankruptcy Act.

The other point--

Unknown Speaker: Mr. Jones, do you know whether it makes any difference for the IRC purposes alone, forgetting bankruptcy, whether something is labeled excise or penalty, assuming... forgetting about the deductibility, because this one is not deductible.

Mr. Jones: --You mean, in applying the excise tax priority?

Unknown Speaker: That... no.

No, not--

Mr. Jones: I'm sorry.

Unknown Speaker: --Forget bankruptcy.

Just for the purposes of the Internal Revenue Code, does it make any difference whether something is labeled an excise tax or a penalty?

Mr. Jones: Other than what we've already discussed, I'm not familiar with any circumstances.

I hate to make categorical statements, but I'm not familiar with any.

And the other point that I want to address very briefly is the suggestion that this... the priority for this excise tax is unfair because it comes in front of claims of employees for residual retirement benefits.

In saying that, the court of appeals looked at only the cost of the tax, and utterly ignored its benefit.

These employees not only get the promise of insurance, they get the fact of insurance.

The Pension Benefit Guaranty Corporation comes in and pays benefits, guaranteed benefits.

The employees are much better off with this guarantee system in effect, including the priority tax, than they would be without it.

No one doubts--

Unknown Speaker: They don't insure all of them.

They don't insure all.

There are a lot of people who have pensions whose pensions won't be paid, right?

Mr. Jones: --That's... but for the insurance, they wouldn't be paid at all.

Unknown Speaker: Without insurance.

Mr. Jones: Oh, without--

Unknown Speaker: That is to say, aren't there some people here, employees, who won't get paid, and the reason they won't get paid their promised benefit is because the IRS is going to collect this tax?

Mr. Jones: --No, sir.

They're getting paid the guaranteed benefits under the pension benefit system.

The IRS tax, which is designed to enforce the ability of the United States to honor the promise to ensure benefits, only comes in in front of residual claims.

The employees, on balance, are better off.

They're going to get millions of dollars in benefits by the insurance function.

Chief Justice Rehnquist: Thank you, Mr. Jones.

Mr. Jones: Thank you.

Chief Justice Rehnquist: The case is submitted.

Unknown Speaker: The Honorable Court is now adjourned until tommorow at ten o'clock.

Attribution:

The OYEZ Project

Featured:

United States v. Noland - Oral Argument

Fri, 09 Jan 2009 14:49:47 +0000

Case:

United States v. Noland

Media File:

95-323_19960325-argument.mp3

Related Transcript:

1995_95_323_argument.xml

Transcript:

Argument of Kent L. Jones

Chief Justice Rehnquist: We'll hear argument first this morning in Number 95-323, United States v. Thomas R. Noland.

Mr. Jones.

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

This case involves the detailed statutory priorities that Congress has enacted to govern the payment of claims in bankruptcy cases.

Section 503(b)(1)(C) of the Bankruptcy Code provides that postpetition tax penalty claims are to be treated as administrative expenses of the debtor's estate with a first priority in payment.

The statute codifies this Court's 1966 decision in Nicholas v. United States, which reached precisely the same conclusion under prior law.

In this case, however, the court of appeals stated that it did not see the fairness or the justice of the first priority for postpetition tax penalty claims.

The court stated that it would be more fair and more just for general commercial creditors to be paid in advance of tax petition claims and therefore reverse the statutory priorities, changing the priority for postpetition tax penalty claims from first to last.

The court stated that its restructuring of the statutory priorities was justified by the principles of equitable subordination that Congress codified in 1978 as section 510(c) of the Bankruptcy Code, but the principles of equitable subordination do not confer such a broad power of statutory nullification on bankruptcy courts.

The principles of equitable subordination were designed to provide a remedy for the individual misconduct of a creditor in acquiring or pursuing his claim.

As this Court stated in the Comstock case, the doctrine deprives the wrongdoer of the fruits of his wrong.

Prior to the enactment of the Bankruptcy Code, the courts have consistently held that in the absence of creditor misconduct, courts were not permitted under the principles of equitable subordination to simply disregard a statutory priority that they disagreed with.

They were not permitted to say, as the court said in this case, that the statutory priority is a mistake and will not be enforced.

The court of appeals recognized in this case that under the traditional judge made principles of equitable subordination, that doctrine served the limited function of providing a guarantee against creditor misconduct, but the court reasoned that when Congress codified these principles in 1978, Congress somehow radically altered the scope of the doctrine, and that it is now appropriate for the court to disregard a statutory priority when the court concludes that it is just to do so.

Unknown Speaker: Mr. Jones, do you agree that a tax penalty claim in theory could be subordinated if there were some sufficient reason for finding fault with the Government... misconduct?

Mr. Jones: I agree that the principles of equitable subordination can apply to all claims.

Our understanding of those principles and the understanding that this Court stated in the Comstock case and that all other courts had stated prior to the enactment of the Bankruptcy Code was that what those principles did was to prevent a creditor from acquiring or pursuing a claim based upon misconduct.

The legislative history of the Bankruptcy Code states, but we think it is obvious, that these principles of equitable subordination would rarely apply to a tax claim, but if--

Unknown Speaker: Yes, but I took your position basically to be that in a particular case, no equitable subordination absent a showing of inequitable conduct.

Mr. Jones: --That is correct.

That is what the doctrine is designed--

Unknown Speaker: And in theory the Government could engage in such conduct.

Mr. Jones: --In theory, it could.

Again, I think it would be rare that we could think of a situation where that would happen, and the Senate report on this bill made that very point, but certainly, if the United States acquired a claim through misconduct, it would be subject to equitable subordination.

Unknown Speaker: Of course, those of us who look to legislative history have got one problem from your standpoint, and that is, it may be that the person who made the statement about the intent was wrong in describing what courts had been doing, but the intent still seems to be there, and what is the tie breaker?

Do we look to the person's mistake, or to the person's intent in making the statement?

Mr. Jones: Well, let me... that is... the court of appeals relied on what you're referring to, which is a fragment of a single sentence of the floor statements of the sponsors of the bill, but let's consider that statement in its context.

The sponsors made several points.

First, they pointed out that the principles of equitable subordination that were being codified were those expressed in existing case law, and certainly that represents an intent to incorporate, not to significantly alter the preexisting doctrine.

Second, the sponsors stated that under existing case law, the principles of equitable subordination served as a remedy for creditor misconduct much in the same way that this court had said in the Comstock case.

Now, the third thing they said, and this is the point that the court of appeals relied on, was that the principles of equitable subordination would also permit subordination of a claim of a status susceptible to subordination such as a penalty.

That statement was not a correct description of existing case law.

There was literally no case law of that type prior to the adoption of the Bankruptcy Code and, indeed, as I have already mentioned, in 1966 in the Nicholas case this Court held that postpetition tax penalty claims were entitled to a first priority in bankruptcy.

The Senate report does not contain the misstatement that is in this fragment of the sentence from the floor statements.

Unknown Speaker: But isn't there also a statement in that report that is not simply case law frozen as of a point in time but case law as further developed?

Mr. Jones: We certainly agree that when Congress codified these principles it intended for the courts to continue developing them, and it is appropriate for the courts to continue devising rules that guard against creditor misconduct and that deprive the wrongdoer of the fruits of its wrong, but nothing in those ordinary, equitable principles provide any support for the novel contention that a court in equity can simply disregard a statute that it disagrees with.

As the Ninth Circuit said in the Stebbins case, neither general equitable principles nor the specific principles of equitable subordination authorize a court to simply say a statutory priority is a mistake and will not be enforced, and that is in essence exactly what the court of appeals held in this case.

Unknown Speaker: The same statement, Mr. Jones, appears... I mean, it was obviously carefully drawn up.

It appears verbatim in both the House and the Senate, is that correct?

Mr. Jones: That is my understanding, yes.

Unknown Speaker: I mean, it's almost like a committee report.

The floor leader in both chambers reads exactly the same text.

Do you want to--

Mr. Jones: And in both statements what they say is that this is what existing case law does.

Our point is--

Unknown Speaker: --That's a mistake, but--

Mr. Jones: --Yes.

Unknown Speaker: --insofar as it shows what the expectation or the intent of Congress is concerned, it seems to Congress expected and intended that a penalty would be subject to this doctrine.

Congress is not in the business of figuring out what case law says.

It is in the business of figuring out what disposition should be made.

Mr. Jones: I think read in its entirety, which, of course, if we're going to read the legislative history we have to do that, read in its entirety, what the history manifests is an intent to incorporate existing case law and then a misdescription of one aspect of that case law.

The intent to incorporate existing case law is manifest in the Senate report which doesn't contain the misdescription of the existing case law, but beyond the question of intent and description is just the simple logic of the situation.

It is improbable that Congress intended, by adopting such a broad concept of equitable subordination, to have rendered all of its substantive statutory priorities essentially meaningless, which is a construction that would result from the opinion in this case, and let me see if I can explain that.

Unknown Speaker: Before you do, Mr. Jones, could you give us an example of the rare case in which a tax penalty claim could be subordinated, and you quoted the legislative history to that effect.

You said that it would be a rare case--

Mr. Jones: Yes.

Unknown Speaker: --and I was trying to envision such a case and couldn't come up with one.

Mr. Jones: Well, the situation that would exist with respect to private creditors is a situation where the claim was obtained by fraud or by ruse, or was obtained through some unfair manipulation of the bankruptcy process.

It's hard for me, as it is for you, Justice Ginsburg, to put a concrete concept to apply those rules in a concrete way to tax collection.

Unknown Speaker: Well, what about a case in which some factotum of the Government said the payment, let's say to an ERISA plan or whatever it may be, is due in January, and in fact it was due in December and the Government is not estopped?

I suppose you could say that's not a case of malicious wrongdoing, but it would be a case in which the taxpayer relied detrimentally on the Government and then ends up with perhaps a nonwaivable penalty.

That would be a case, I suppose, in which there could be subordination.

Mr. Jones: I certainly believe that there are situations that could occur, and I'm obviously not here to try to anticipate all of them.

I will agree with you that if there was a situation where an authorized representative of the United States had taken some action that was unfair to other creditors in achieving a preference for a Government claim that wouldn't otherwise have been factually appropriate, that would be the kind of context in which equitable subordination might apply.

I think actually equitable subordination is a broad doctrine when it applies.

It broadly is designed to prevent misconduct in any of its manners of manifestation, and we don't intend to suggest that it doesn't have this broad objective, but we think it reasonably clear it doesn't have the broad objective of making the statutory priorities essentially meaningless.

It is obvious, we think, that if the only effective priority rule in bankruptcy cases turned on a concept as elastic as fairness, that extraordinary uncertainty would exist for all creditors.

For example, on grounds of fairness should a tort claim for pain and suffering be subordinated on a rationale applied in this case that it's not a pecuniary loss resulting from an extension of credit.

What do we make of the fifth priority for claims based upon stored grain?

Is that more fair than the new seventh priority for alimony and child support?

Now, these kinds of categorical determinations are exactly what Congress does when it enacts these statutory priorities.

With respect to tax penalty claims alone, Congress has four separate rules.

Postpetition tax penalty claims are given a first priority, some types of prepetition tax penalty claims have a seventh priority, other types of prepetition tax penalty claims are treated as general unsecured claims in a Chapter 11 and are subordinated to general unsecured claims in a Chapter 7.

Unknown Speaker: Mr. Jones, am I correct that every lower court that has confronted this issue has come out the way the court came out here?

Mr. Jones: No... well, there has been a recent set of cases that have said equitable subordination doesn't require proof of creditor misconduct.

There has been a long, much more substantial history of cases that says that it do, and the cases... that it does require creditor misconduct.

Unknown Speaker: I mean, under this statutory provision, under the provision we're dealing with here, is there any case that comes out the way you say this case should come out, denying the subordination on the grounds that the statute says otherwise?

I thought--

Mr. Jones: Since the enactment of the Bankruptcy Code, I believe that the courts of appeals that have addressed this issue have agreed with the proposition that we don't agree with, and that proposition is that this fragment in the Senate... in the floor statement changed the law when Congress said they were intending to--

Unknown Speaker: --Well, of course, it isn't just the... the concurring opinion didn't rely on that in the court below, am I correct?

She just relied on the plain language.

Mr. Jones: --Well, the concurring opinion I don't think ultimately reached the question that we're reaching here.

The concurring opinion concluded that principles of equitable subordination can apply to--

Unknown Speaker: And did apply in this case.

Mr. Jones: --And did apply, but I mean... but--

Unknown Speaker: So she didn't read that as requiring creditor misconduct.

Mr. Jones: --The point of the... you and I might draw different understandings of the concurring opinion.

My understanding was that the concurring opinion was satisfied that equitable subordination applied.

Unknown Speaker: Yes.

Mr. Jones: And we--

Unknown Speaker: She joined the judgment.

Mr. Jones: --She joined the judgment, and--

Unknown Speaker: And she did not rely on legislative history.

She relied just on the text of the statute.

Mr. Jones: --I didn't understand that she specifically discussed the question of how it applied, she was--

Unknown Speaker: Well--

Mr. Jones: --addressing the question of whether it applied.

Unknown Speaker: --How did she get to join the judgment if she didn't... you know, if she agreed with you?

Mr. Jones: The court perceived... no, she... I didn't mean to say she agreed with us.

I said, I don't think she specifically reached the question of how it applied.

The Government addressed two contentions in the courts below, at least as reading the majority opinion you would think they did.

The two contentions that the majority opinion addressed were that equitable subordination simply cannot apply to a priority claim, and I think... and, of course, we don't take that position.

We agree it can.

It's just a question of how it applies, and my understanding of the concurring opinion was that she was addressing the question of can it apply and didn't specifically discuss how it applied.

Now, that was my reading of it.

Unknown Speaker: But she didn't have to discuss it, because she held that it did apply.

Mr. Jones: Well, she certainly didn't disagree with anything that the panel--

Unknown Speaker: No, but her basic point, as I read it, the reason she wrote was she didn't think it was necessary to look at legislative history because she thought the plain language of the statute covered the case.

Mr. Jones: --I think that--

Unknown Speaker: That's why I thought she wrote separately.

Mr. Jones: --Justice Stevens, I don't mean to be arguing with you or quibbling with you, I just had a slightly different perception of what point she was addressing.

Unknown Speaker: What is your position... all right, everyone seems to agree that principles of equitable subordination apply.

Next question, what are those principles?

Mr. Jones: That's correct.

Unknown Speaker: What are those principles?

Mr. Jones: Those principles--

Unknown Speaker: Yes, all right.

The first thing, you might take the position those principles are that, a) you never can equitably subordinate unless the holder of that particular piece of... the creditor, that particular creditor has done something bad.

I take it that that is not your position.

If it is your position, I take it that that is contrary to the case in which they said that some stockholders who were asserting a claim of fraud who did nothing wrong were equitably subordinated.

Mr. Jones: --I--

Unknown Speaker: So is the... is it your view that, no matter what, if you didn't do something bad and you're a creditor you cannot be equitably subordinated?

Mr. Jones: --That is a precise statement not only of our position but of this Court's position in the Comstock case.

Unknown Speaker: All right.

So you're saying that the 5 to 4 decision in Comstock, which was basically a matter of the words used in that opinion, which were very eloquent, you think that those words overruled, sub silentio, the earlier case in which shareholders who had asserted a claim of fraud against the corporation had their claim subordinated to others, I take it, because the judge felt this is simply a way in which shareholders that should be absolutely at the end of the queue have worked out to jump a lot of other people who would otherwise have been ahead of them, so they assert their claim in the form of a claim for fraud.

Mr. Jones: Justice Breyer, I think that you have the timing and the courts wrong in your description of those two cases.

The Comstock case was a decision by this Court--

Unknown Speaker: Yes.

Mr. Jones: --and it held that the doctrine is designed to deprive the wrongdoer of the fruits of his wrong, and that every case prior to the Bankruptcy Code held the same thing, except there was a Second Circuit decision that you were referring to involving the subordination of a shareholder's claim against the corporation.

Now, that Second Circuit decision in our view has both... was a correct result, and contained some incorrect reasoning.

It was a correct result because what the court concluded was that these shareholder claims were brought as shareholders, and that a claim of a shareholder brought as a shareholder is subordinated by statute.

It's subordinated by the long tradition of making shareholder interests at the bottom of the heap.

Unknown Speaker: Brought as shareholder as opposed to brought as creditor?

Mr. Jones: Yes, sir, brought in their capacity as a shareholder is a shareholder interest which is the last to be paid.

Now, there was some reasoning in that case which... I'm trying to remember the name of it.

Unknown Speaker: Let's assume you're right about it.

Credit Industrial?

Mr. Jones: No, sir, I--

Unknown Speaker: Well--

Mr. Jones: --Stirling Homex is the case we're talking about.

Unknown Speaker: --Yes.

Mr. Jones: The reasoning in Stirling Homex--

Unknown Speaker: Stirling Homex.

Mr. Jones: --that was manifestly incorrect is, you will notice toward the end of the court of appeals opinion in that case they relied on a bill that had been past the House.

The bill that had been past the House said the claims could be subordinated on any equitable grounds, a much broader concept than the principles of equitable subordination.

The Court in Stirling Homex said, this is good reasoning, this is the reasoning we're applying, but Congress, when it got around to passing the Bankruptcy Code rejected the House bill, adopted the Senate bill.

The Senate bill says that only principles of equitable subordination can be used to... not just... to justify subordination, and the Senate report in describing its bill accurately describes the existing case law that was being incorporated as cases that remedy creditor misconduct, so we believe that creditor misconduct is, indeed, what Congress--

Unknown Speaker: It always... let's assume it always has been.

As I nonetheless read the words of the statutes, and so forth, isn't... you reply to that by saying, yes, but the doctrine was a common law doctrine developed by judges, and there was no intent by Congress to freeze its contours.

Just continue as you're continuing.

You find over the course of time, very slowly, that it needs to be shaped a little bit, that's what courts do.

We don't want to change the law.

We don't freeze it as it was at the time of, you know, Henry IV or whatever.

Mr. Jones: --Justice Breyer, we--

Unknown Speaker: And so there could be a case... I mean, there could be a case.

That's the part that's--

Mr. Jones: --Justice Breyer, we agree completely that what the courts are disposed to continue to develop are the principles of equitable subordination, and we don't think that developing them would be to take a doctrine that all understand at the time of its incorporation into the code was based solely on creditor misconduct and specifically did not permit courts to disregard priorities it agreed with, and then, quote, develop this doctrine into a polar opposite, which is what we've ended up with in the court.

Unknown Speaker: --What the court here says is that the doctrine didn't develop into this area before the code, because before the code nonpecuniary loss tax penalties did not exist--

Mr. Jones: Well, that's--

Unknown Speaker: --and that's how they explained--

Mr. Jones: --No--

Unknown Speaker: --the lack of any pre code development.

Mr. Jones: --Justice Scalia, they said that pre... well, I'll accept that terminology didn't exist, but actually what had happened were the decisions of this Court, three decisions of this Court.

In, I believe, San... San something versus Granquist... I'm sorry, I'm trying to remember a lot, and I'm not doing a good job.

Simonson v. Granquist, the Court had said that the Bankruptcy Act did not allow penalty claims, and the Court in this case read that for everything it was worth, but it didn't really stand for that, because both before and after Simonson v. Granquist this Court had held in the Nicholas case, in the Boteler case that postpetition tax penalty claims were allowed and were entitled to first priority.

Now, that is our... that is really the essence of our point here.

The court of appeals misunderstood the history of tax penalty claims, it misunderstood the history of equitable subordination, and I am reminded, Justice Scalia, that I misspoke earlier when you asked me whether other courts had... whether, after the Bankruptcy Code all courts had taken this perspective.

I am reminded of two situations where that didn't occur, the Mansfield Tire case, which really relates to the second case we're going to be arguing, the courts said that a penalty claim... rather, that a statutory priority claim could not be subordinated on grounds of fairness, and also Judge Alito's concurring opinion in, I believe, the Burden case I think is a very accurate description of what Congress was about in enacting the Bankruptcy Code and the fact that, to take the perspective that creditor misconduct is not what equitable subordination is about is really to say that all the other substantive priorities in the Bankruptcy Code don't have any meaning, that Congress did a meaningless act in writing the substantive provisions of the code.

If the only effective rule is fairness, then we don't have an effective rule.

In our view, we--

Unknown Speaker: The answer to Justice Scalia was that prepetition tax penalties were out of the queue--

Mr. Jones: --Were not allowed.

Unknown Speaker: --the absolute bottom.

Mr. Jones: They weren't--

Unknown Speaker: The postpetition tax penalties were Number 1.

Mr. Jones: --Number 1.

Unknown Speaker: All right, so then that supports an argument that, sure, creditor misconduct is perhaps not always required.

Suppose this were a prepetition tax penalty.

But here, there's no good reason for the equitable subordination.

Mr. Jones: Here, it's not--

Unknown Speaker: Is that... I mean, I'm making work because I'm interested in that aspect of it.

Mr. Jones: --As I will discuss in the next case to be argued, we think the principles of equitable subordination are the same in both contexts.

We think--

Unknown Speaker: Well, if they're the same, it's pretty weird that Congress, without even mentioning it or thinking about it, where there's a prepetition tax penalty would have decided without saying a word to jump them from the absolute bottom, behind shareholders, to absolute Number 1--

Mr. Jones: --Oh--

Unknown Speaker: --without any mood... room for flexibility, because that would be the effect of it, prepetition.

Mr. Jones: --They didn't jump prepetition tax penalty claims from bottom to Number 1.

Number 1 is just postpetition tax penalty claims.

Prepetition tax penalty claims were, as you say, jumped only to seventh priority or to general unsecured in 11, and in a 7, they're still subordinated.

Congress has gone to great pains to give us a very detailed, highly articulated set of statutory priorities.

Congress did not undermine its... all of its work by allowing courts to then say, well, let's just do what's fair.

We believe that principles of equitable subordination that were incorporated into the Bankruptcy Code are designed as a remedy for creditor misconduct.

It is unquestioned that the claim of the United States in this case is innocent, was not based on misconduct, and we believe that the court of appeals therefore erred in subordinating the claim that Congress gave the first priority to.

I'd like to reserve the balance of my time for rebuttal.

Unknown Speaker: Very well, Mr. Jones.

Mr. Pikna, we'll hear from you.

Argument of Raymond J. Pikna

Mr. Pikna: Mr. Chief Justice, may it please the Court:

This is a Chapter 7 case.

It is critical to remember that fact, because section 726 of the Bankruptcy Code, which controls the order of distribution in Chapter 7 cases, in order to assure the equality to all creditors begins with the clause, except as provided in section 510 of the Bankruptcy Code.

What the Government seeks to do is to effectively eliminate that section.

It also seeks to eliminate the distinction between nonpecuniary loss tax penalties, which are the types of penalties which we have in this case, from pecuniary loss tax penalty claims.

The difference is critical.

In a prepetition context, for example, section 726(a)(4) of the Bankruptcy Code expressly subordinates nonpecuniary loss tax penalty claims to the claims of general unsecured creditors.

In this particular case, we have a plan that was confirmed.

The vast majority of the penalties in issue arose very near the time of confirmation.

There was no time for anybody to respond to determine... for the creditors to react and say, gee, we ought to stop this.

When the case converted, the tax was owed, the penalties were owed, but these are not for financial loss.

These are penalties that are punitive, or to deter, and as the Court stated unanimously in Simonson v. Granquist, the majority of the Court stated that the purpose of penalties is to punish, and the burden would fall on the innocent creditors in the case.

The dissent agreed with that proposition, that the punitive aspect of penalties was contrary to the intent of the Bankruptcy Code and the equality of distribution which was contemplated.

The Bankruptcy Code also distinguishes between nonpecuniary and pecuniary loss penalties in section 507(a), now (8), formerly (7), which deals with the priority to be accorded to prepetition tax penalties.

In the context of section 503(b)(1)(C), where the Court... where the statute refers to penalties, it does not draw that fine line distinction, because Congress did not have to.

By section 726, they expressly made 510 applicable to those penalties and stated that they may be subordinated under section 510.

Unknown Speaker: Mr. Pikna, the problem that I have in the case is a very broad conceptual one.

That is, I can understand why Congress would say, there are cases which we cannot envision and cannot provide for by law because they turn on individual wrongdoing, or individual conduct in any event, and we want you, the courts, to provide for them.

I can understand why Congress would do that.

What I cannot understand, and what would worry me very much, would be why Congress would say, we want you, in effect, to reorder the priorities that we have set, and to do so as a categorical matter because you think certain priorities are unworthy of the position that we have given them.

That is statutory amendment.

I mean, that is delegation, to put it another way, without any standard at all.

It is just saying, go out there and reshuffle the cards as you think right.

That's the conceptual problem that bothers me.

What is your answer to the seeming impropriety, perhaps even unconstitutionality of saying to a court, we have established priorities, but you go out and do anything you want to?

Mr. Pikna: Your Honor, this is not a categorical rewriting of the statute.

This is merely looking at individual elements to be applied with the test of--

Unknown Speaker: Yes, but the individual elements determine what goes into the category, and you are saying that certain category members should not be given the priority that their categories give them.

Mr. Pikna: --Your Honor, we're merely saying that in order to evaluate equitable subordination, one of the elements which a test may consider is the nature of the claim.

In this particular case, a nonpecuniary loss--

Unknown Speaker: And Congress considered the nature of the claim when it established the categories, didn't it?

Mr. Pikna: --It did, Your Honor.

Unknown Speaker: I mean, this isn't something that Congress a) overlooked, or b) could not provide for.

Mr. Pikna: Your Honor, if we were to take the position that Congress, by establishing categories, determines definitively the priority to be accorded, then Congress has stated that general unsecured claims are to be paid in order of distribution under 726.

Unknown Speaker: No, but one doesn't say that, and that's not what the Government is saying.

The Government is saying that in fact a court may consider the kind of individual circumstances that bear on the conscience of equity that simply cannot be provided for in a categorical way in advance by a legislature, and that is all it has done, and once you get beyond that, you have basically gotten into statutory redrafting, or a claim of delegation not only without standards but standards quite contrary to those that Congress adopted, and that would seem to be an illegitimate interpretation of the statute.

Mr. Pikna: Your Honor, if the court ruling were that all nonpecuniary loss tax penalty claims are automatically subordinated without more, we would agree that there is a new--

Unknown Speaker: Well, you're just saying we're only going to attack a portion of the category rather than the whole category, but it's still a category mistake, in effect, that you're claiming on Congress' part, and at least a partial categorical reordering that you're claiming for the court's authority under the statute.

Mr. Pikna: --Your Honor, it is a category, if the Court seeks to call it that, in the same sense that claims that were arising through misconduct are categories.

Unknown Speaker: But the distinction is that each misconduct claim is judged on its merits as a particular misconduct claim, and it is the kind of claim that simply cannot be provided for any more precisely in advance.

These claims, indeed, could be provided for more precisely in advance, and if the courts of appeals have their way, there will be a constant, categorical reordering.

There won't be any individualized inquiry in a particular case.

You'll simply say, is this the kind of penalty, whoops, no priority for you, and it seems to me that those are fundamentally different enterprises... processes.

Mr. Pikna: Your Honor, the nonpecuniary loss tax penalties we agree are fundamentally different from pecuniary loss tax penalty claims, and we believe that in the context of administrative expense claims Congress chose not to expressly draw the distinction because the vast majority of cases that are filed are not just Chapter 11 cases.

Chapter 11 cases comprise approximately 1-1/2 to 2 percent of all the bankruptcy filings in the country.

Unknown Speaker: No, but I think... with respect, I think your answer doesn't go to my categorical problem.

Let me ask you this question.

What if Congress had passed the Bankruptcy Act in its present form with one exception, and the exception is that in place of the provision that we're fussing over this morning Congress had simply said, we've established these priorities, but the courts can, in fact, rearrange them if they want to, would that statute be in any kind of trouble?

Mr. Pikna: Your Honor, that would be a much broader statute which would permit the courts to--

Unknown Speaker: We would be citing Schechter if that had been the case, wouldn't we?

Mr. Pikna: --Your Honor, I don't recall which case specifically, but that would permit... that would eliminate the statute at that point.

Unknown Speaker: That's right, and it seems to me that to a degree, the degree being only the one category that you're arguing about, that is what you are arguing that the courts are able to do in this case.

Mr. Pikna: Your Honor--

Unknown Speaker: It seems to me an example of what we both agree would have been improper.

Mr. Pikna: --Your Honor, it is an example of one part of the test of the elements of equitable subordination that we believe it is appropriate for courts to consider, and the reason... the courts have already recognized that penalties by their very nature are punitive.

They are intended to punish or deter.

Here, the burden of the punishment falls not on the wrongdoer, the debtor in this case, it falls on the creditors, because in order to... what you are doing is, you're taking financial loss, you're taking funds from the parties that would normally share due to their financial loss.

Unknown Speaker: Mr. Pikna, the first item under any tax, under 503, is any fine, so Congress was certainly thinking in terms of penalty, so we have fine, and then penalty, and you are not urging any... in any case, where there was a fine or a penalty, on your theory wouldn't there be equitable subordination as long as the State didn't have enough to pay all the general creditors?

Mr. Pikna: No, Your Honor, we're not urging that position.

Unknown Speaker: Well, give me a circumstance in which the estate does not have enough money to go around, that has been a nonpecuniary tax penalty.

When would it not be subordinated on your theory?

Mr. Pikna: Your Honor, if, for instance, the postpetition claims in a case are $1 million, all of the postpetition claims, and the nonpecuniary loss tax penalty claims are perhaps $10,000, a very small portion, and if there is a small amount of funds to distribute, perhaps $100,000 in the case, the impact of the nonpecuniary loss tax penalties relative to the other claims that are recognized is de minimis, and that is the concept that was in part adopted by the majority in Nicholas v. United States.

That was a very narrow 5-4 decision--

Unknown Speaker: So if it's a small penalty it comes out in top and the Government gets it, but if it's a large penalty the Government doesn't?

Mr. Pikna: --Your Honor--

Unknown Speaker: The same thing with a fine, a small fine, the Government--

Mr. Pikna: --Those are some of the factors, Your Honor.

Those are not the exclusive factors.

Unknown Speaker: --Well, could one bankruptcy court decide a case like that one way, and another bankruptcy court decide the case the other way?

I mean, is it a matter of just individual discretion on the part of the bankruptcy judge?

Mr. Pikna: Your Honor, equitable subordination by its nature requires that the court exercise its discretion, and if one court views the discretion to be applied in a different manner than another court, it's possible that the same fact pattern could result in two different outcomes.

Unknown Speaker: So we'd have different outcomes all over the country, depending on the judgment of individual bankruptcy judges?

Mr. Pikna: It's possible, but it's unlikely, Your Honor, and we do not believe it is likely because we believe that the courts of appeal will establish standards as they have generally, and the courts of appeal are uniform in their position that nonpecuniary loss tax penalty claims do not require misconduct as a necessary element in order to reach the subordination question.

Unknown Speaker: Do you have any other exceptions, other than de minimis, which I don't consider much of an exception.

I mean, that's an exception to everything in the law.

Mr. Pikna: Your Honor--

Unknown Speaker: De minimis non corat lex.

It's not an exception at all.

Mr. Pikna: --Your Honor--

Unknown Speaker: That applies across the board.

But except for that, every time there's a fine you want us to say it is subordinated.

Mr. Pikna: --No, Your Honor.

Unknown Speaker: It is the fineness that causes the subordination, isn't that right?

Mr. Pikna: Not totally, Your Honor.

Your Honor--

Unknown Speaker: What else?

Mr. Pikna: --in a reorganization context, if the company is in Chapter 11 and operating, there may not be a reason to subordinate penalties even though they are punitive by nature.

The distinction here is that we are in a Chapter 7 case, and that we are in liquidating Chapter 7 case.

Unknown Speaker: Mr. Pikna, do you say that because in the Chapter 11 the company may survive, may come out?

But when I put the question to you I said, we have to make the assumption that there's not enough to go around.

If there's enough to go around, it doesn't matter whether you're priority 1 or priority 10.

Mr. Pikna: Your Honor, if there's not enough to go around the creditors would have to vote for the plan.

A company could still survive.

It does not require, if there's not enough money to go around, that the company automatically liquidate, although that is likely to follow.

Unknown Speaker: So what I don't understand on your theory is, in a case where we know there is not enough to go around--

Mr. Pikna: Your Honor--

Unknown Speaker: --like your Chapter 7 case, is there any situation in which a fine would not be subordinated, a fine or a penalty, nonpecuniary penalty would not be subordinated to the claims of the general creditors?

Mr. Pikna: --Your Honor, an environmental fine may be an example of such a fine or penalty.

A reason for that is that this... as this Court exemplified through its ruling in the Mid Atlantic case, the environmental claims are of a different nature, and they are very important to the policy to promote avoiding harm or damage to the environment.

Unknown Speaker: Then the court just decides for itself what types of claims are very important and what are less important?

Mr. Pikna: Your Honor, it does that through reviewing other decisions of higher courts and through the policy expressed through the Congress through its enactments, through the statutes, and through the legislative history they can review.

Unknown Speaker: What if Congress has made different findings... you know, I think Congress probably thinks that most of its laws are pretty important and deserve priority, and the bankruptcy court just sorts it out depending on the recital at the beginning of the statute as to how important it is?

Mr. Pikna: Your Honor, the bankruptcy court has to consider all of the claims, not just the Federal claims.

For instance, in this case there are also a number of State tax law claims, there are Workers Compensation claims, there are highway use tax claims that are other Federal tax claims--

Unknown Speaker: You can correct me, but I find it hard to imagine any policy that has traditionally been considered stronger than the policy of collecting taxes.

I mean, we even allow property to be seized before the issue is resolved.

I mean, is there anything that we've given higher priority to than the ability of Government to get the money in order to run?

Mr. Pikna: --Your Honor, we believe that--

Unknown Speaker: Do you think the environment's more important?

Mr. Pikna: --Your Honor--

Unknown Speaker: I'm no sure our cases would support that.

Mr. Pikna: --Your Honor, I use--

Unknown Speaker: For better or worse.

Mr. Pikna: --I understand.

Unknown Speaker: But that's what our cases seem to say.

Justice Scalia's opinion certainly wouldn't.

[Laughter]

Mr. Pikna: Your Honor, we express that as an example.

However, we do not believe that the tax penalty claim for this type of tax, the trust fund taxes, these are the types of taxes that give rise to the responsible officer liability.

If the tax penalty claim is that important, then if the debtor does not pay it, that tax penalty should pass through and be transferred to the responsible officer.

That is the party to be deterred.

Unknown Speaker: Can you just answer two technical questions that I... one was Justice Scalia's initial question, which the Government said... is this correct, do you agree with the Government in this, and do I understand this correctly that, prior to the Bankruptcy Code a penalty on a postpetition tax did, in fact, receive a first priority?

Mr. Pikna: Yes, Your Honor.

Unknown Speaker: All right.

Thank you.

The second question that I had is just as technical, and I want to know how it works.

Imagine that you are in Chapter 11, and we don't really have a lot of money, but we're trying to struggle to keep the company.

I would imagine that the president of the company and the executives who are there running it ought to pay their taxes, and if they don't, I don't know why they shouldn't have to pay penalties the same as anybody else, and I don't know why that isn't an administrative expense like anything else, postpetition.

But I did imagine from what you're saying that there could be a case where we're finding it hard to get unanimous agreement among unsecured creditors, and the bankruptcy judge works out that if I could subordinate the penalty on the tax below the unsecured creditors there will be enough money for them under a section 7, and therefore I don't need the unanimity, and that might be why he wants to subordinate in the Chapter 11.

He wants the authority to have subordinated the penalty in the hypothetical Chapter 7.

Now, I raise that to know if that's technically right, or if it's not, just say no, and I will erase it from my mind.

Mr. Pikna: Your Honor, the subordination provisions are applicable in all chapters.

The amount, the degree of subordination varies based on the facts of the case.

Now, in the context of a Chapter 7 case, we believe that the policy of equitable... of equal distribution, excuse me, is critical, and the court looks to what is to be accomplished.

Unknown Speaker: All I'm trying to do is to explore if there's any circumstance, other than de minimis, in which it would make sense, given all the equitable authority in the world, to subordinate a postpetition tax penalty, and I'm struggling to think if there's any such circumstance, and so far, given your answers, I think the answer is no, there is no such circumstance that would be special.

So I'm trying to think, I'm struggling, is there any circumstance in which it would make sense, equitably, and your answer to that, which you have a strong interest in saying I'm wrong, all right, why am I wrong?

That's what everybody's been asking you, I think.

Mr. Pikna: Your Honor, it will also vary on the nature of the debtor and who bears the penalty.

What we are expressing is that the penalties are subordinated not because they're just nonpecuniary loss, but in this particular context it is a corporate debtor, it is a debtor in Chapter 7, and there are insufficient funds to go around.

Now, the degree of subordination that the bankruptcy court stated subordinate to general unsecured claims, if that is error would be harmless error.

The court could have said, just subordinate the nonpecuniary loss penalty to other administrative expense pecuniary loss claims, so there is a degree, a range of discretion that can be exercised by the bankruptcy court.

The creditor body may be comprised primarily of shareholders who made loans to the corporation and who are also in control, and that might be another context where the court would feel that it is not appropriate to subordinate, but the court starts with the position that the claim has priority.

It is up to the moving party to establish that it is entitled to subordination.

Perhaps the correct remedy here would have been for the Internal Revenue Service to have asked for the tax to be subordinated, because the responsible officers under section 6672 of the Internal Revenue Code are responsible for the tax and interest, but it does not state that they're responsible for the penalties.

So there's no deterrent effect on section 6672 of the Internal Revenue Code, which is really what this particular case and these particular taxes are about, for the officers to not go ahead and not pay the taxes.

What do they care?

They don't have to pay it.

It's the creditors, the innocent creditors who are giving value to the debtor, who are trying to assist the corporation in reorganizing, who find out after the debtor fails to pay taxes that they are now also being hit with this large penalty, a penalty for which the Internal Revenue Service gave nothing, but which the statute says, debtor, if you do something wrong, you will be punished.

The taxpayer is the party to be punished, but in this particular case it is not the taxpayer that bears the burden of that punishment, it is the innocent creditors, the same creditors which this Court recognized in Simonson v. Granquist, both the majority and dissenting opinions recognized.

Unknown Speaker: But isn't that always the case?

I mean, what you're arguing is, Congress should not have said in 503(b)(1)(C) any fine, penalty, or reduction in credit relating to a tax.

Mr. Pikna: No, Your Honor, because--

Unknown Speaker: Isn't a fine relating to a nonpayment of tax, isn't it always going to come from the creditors?

Mr. Pikna: --Your Honor, a fine may, but 503 applies to not just liquidation cases, it applies to Chapter 9, Chapter 13, Chapter 11, Chapter 12, all cases in which the debtor operates.

In this particular context, we have a very narrow category of cases.

We have a very small number of cases--

Unknown Speaker: Those other cases, when you take the money away from the debtor you're effectively taking it away from the creditors.

The debtor is still operating in a bankruptcy context, isn't he?

Mr. Pikna: --That's true, Your Honor.

The key word--

Unknown Speaker: So--

Mr. Pikna: --there is operating, and when it's operating, it should be punished for what it is doing wrong.

It still exists.

It is there to punish.

Unknown Speaker: --I see.

You view it as being taken away from the creditors in the title VII context but not in other contexts.

I'm not sure that's realistic.

Mr. Pikna: Your Honor, it's being taken away, we recognize that, but we believe that there is certainly a vital distinction in the liquidation context, and the--

Unknown Speaker: You're saying--

--But while the business is ongoing you wouldn't get to the Bankruptcy Code and it's priorities, so the only time you get to these priorities is if the thing is postpetition and you're in a bankruptcy and you're distributing and there's not enough to go around.

Mr. Pikna: --That's not totally correct, Your Honor.

In the bankruptcy context, when the company is operating, it will pay taxes on a regular basis, and section 503(b)(1) recognizes that the taxes--

Unknown Speaker: Yes, but we're not concerned with priorities, are we, at that stage?

Mr. Pikna: --Your Honor, we are in the sense that you can only pay during the operation costs and expenses incurred in the ordinary course of business, and that's what 503(b) states.

It deals with administrative expenses, and there are certain types that you can pay in the ordinary course, and other types that you have to ask the court for the authority to pay.

For instance, if you are going to be leasing property, you have to go to the court to expect to assume the lease if you intend to keep it, and then once it is assumed you can pay that rent in the ordinary course.

Part of the assumption process requires also that you bring current lease payments which normally would be a prepetition claim, which would be paid with general unsecured creditors.

There's a different category of claim that there the Congress has said you have to bring these things current and place them together.

In this particular case, we have a liquidation context, which is something that Congress contemplated when it started off section 726 of the distributive provisions and stated, except as provided in 510.

Yes, section 726 certainly recognizes the priority to be accorded to administrative expense claims generally.

That's a given.

The next thing, though, is that it also expressly provided that there may be situations under section 510 that it is appropriate to equitably subordinate.

The body of law that existed at the time the Bankruptcy Code was enacted focused on pecuniary loss penalty claims.

The trilogy of cases in this Court, Taylor v. Standard Gas and Electric Company, Pepper v. Litton, and the Comstock case, each dealt with pecuniary losses in the context of parties--

Unknown Speaker: That wasn't the factor emphasized by the Court in those cases, was it?

I thought it was misconduct on the part of the claimant.

Mr. Pikna: --Your Honor, the factor that was emphasized by the Court was misconduct in a... in terms of trying to promote its claim for financial loss ahead of other claims for financial loss, but from that there was a silence on nonpecuniary loss claims.

That issue was not addressed in any of those cases, and that's why this Court at this time is writing on a blank slate.

Unknown Speaker: Well, is there any suggestion in those cases that that sort of a distinction would have been made by those courts?

Mr. Pikna: Your Honor, we do not believe that particular concept was addressed, other than, in Pepper v. Litton the Court recognized the broad equitable powers of bankruptcy courts to adjust the debtor creditor relationship, and that same policy has also been recognized by this Court in the energy resources case when, in dealing with the context of trust fund taxes, this Court recognized in an operating Chapter 11 case the importance of permitting the designation of the responsible officer type of trust fund taxes to be paid ahead of the nonresponsible officer types of taxes and interest.

Unknown Speaker: Mr. Pikna, it does appear that the Members of Congress had in mind the requirement of misconduct as a principle of equitable subordination, doesn't it?

Mr. Pikna: Your Honor, that is one of at least two or three things that Congress had in mind.

The legislative history states very clearly that it intends the courts to continue to apply the principles of equitable subordination, which are first, misconduct, or claims of a status susceptible to subordination such as penalties.

The legislative history did not define penalties, but Congress was aware of certainly the Simonson case as well as any other case which it might refer to where this Court expressed the repugnance of penalties generally, not just nonpecuniary loss penalties, but all penalties, and how that adversely affected the policy of equality of distribution to creditors, a policy which is critical to the opportunity for courts to reorganize.

The requirement for misconduct in order to subordinate is not in the Bankruptcy Code.

To the contrary, in the context of prepetition, nonpecuniary loss tax penalty claims, those would normally be general unsecured claims under 507(a), now (8), of the Bankruptcy Code, and if those are to share equally, you could not get a confirmed Chapter 11 plan.

Unknown Speaker: Well, misconduct comes in through the language of 510(c), where it says, principles of equitable subordination, doesn't it--

Mr. Pikna: Yes, Your Honor.

Unknown Speaker: --because it was those principles, the misconduct, that had been the dominant theme of those three cases that you referred to.

Mr. Pikna: Yes, Your Honor, that comes in, but that is not a limitation, that is an example.

That is how the subordination principles began to evolve at that point in time.

Unknown Speaker: Yes, but certainly in each of those three cases it seemed to me when I read them that the stress was on the conduct of a particular individual in pursuing the claim, not on any general transposition of the priorities that had been given by Congress.

Mr. Pikna: Your Honor, they were looking at the conduct, but those were the facts presented in that case.

There was no prior case before this Court dealing with a nonpecuniary loss until the Simonson case, where it was dealt with by the statute, where the statute stated that non... prepetition nonpecuniary loss of tax penalty claims were disallowed.

Not just subordinated, totally disallowed.

Unknown Speaker: And the statute said that.

Mr. Pikna: Yes, Your Honor, it did.

Unknown Speaker: Well, so that really isn't much of a precedent for your argument here.

I mean, if the statute says something, that's pretty much the end of it.

Mr. Pikna: Your Honor, the statute said that, but the Court interpreted the statute, and in interpreting the statute stated that all penalties... it did not just say these particular nonpecuniary loss tax penalties, and that is the critical theme.

It is the nonpecuniary loss nature, rather than the timing of the penalty, which is one of the elements to be considered.

It may be the primary element, but it is not the sole element.

And it is up to the bankruptcy courts, through the exercise of their discretion, with the guidance from this Court and other courts, to determine under what circumstances is it appropriate to subordinate.

Certainly, Congress could not contemplate all of the circumstances.

When it drafted section 510 of the Bankruptcy Code it was intended to apply across the board to all chapters, not just Chapter 7 cases.

When it drafted section 510 of the Bankruptcy Code, it was intended to apply to all chapters, not just bankruptcy cases, and in this context we have a very narrow set of facts.

We have a Chapter 11 case, where a debtor was permitted to operate.

The position of the Government is that the creditor should act as private Attorney General in order to prevent the nonpayment of taxes.

We submit that's not realistic.

The creditors don't know that the taxes are not paid until the return is not filed, or is filed, and then the taxes are not paid and the penalty is not paid.

By that point in time, the damage is done.

The creditors cannot change what has already transpired.

There may be a distinction, in fact, between a failure to file penalty and a failure to pay penalty.

Unknown Speaker: Well, it won't help the creditors in that case, but future trustees will know that by not paying taxes they're not going to make more money available to the creditors.

In fact, they'll make less.

Mr. Pikna: Your Honor--

Unknown Speaker: Which is worthwhile.

Mr. Pikna: --Your Honor, it is not the trustees, it is the officers of the corporation.

Unknown Speaker: Thank you, Mr. Pikna.

Your time has expired.

Mr. Pikna: Thank you, Your Honor.

Unknown Speaker: Mr. Jones, you have 5 minutes remaining.

Mr. Jones, could you tell me, how does it work if the officers are liable for the tax?

Does the Government have a choice of whether it goes to the officers first or the corporation first?

Rebuttal of Kent L. Jones

Mr. Jones: A choice in the sense that each are liable separately, but when either pays, it reduces the liability of the others.

I mean, we can't collect... they are separate liabilities under the code, but administratively they're set off against each other, but let me--

Unknown Speaker: I take it if you went after the officer, he'd then be just a general unsecured creditor against the corporation.

Mr. Jones: --Congress has dealt with that specifically.

I mean, you're assuming a situation where the employee... where the officer is in bankruptcy, is that correct?

Unknown Speaker: No.

I'm assuming a situation where the officer is solvent.

The Government goes after him and gets the tax from him.

Mr. Jones: Yes.

Unknown Speaker: Does that officer then become a general unsecured creditor against the corporation for having paid the corporate--

Mr. Jones: I frankly don't know whether the officer... what the nature of the officer's claim against the corporation would be.

It would be some kind of common law indemnity claim, I assume.

Unknown Speaker: --The argument was there's no incentive because the penalty isn't passed through.

Mr. Jones: Well, the penalty that's been discussed, the responsible officer penalty, only applies in narrow... in particular situations.

It only applies where the officer is responsible for the withholding and paying over of a specific tax.

It applies to trust fund taxes.

Unknown Speaker: But I understood that the officer's not liable for the penalty, and counsel's point, counsel for the respondents, said, well, there's no incentive here because the officer is never liable for the penalty.

Mr. Jones: Oh, for the tax penalty.

Unknown Speaker: Yes.

Mr. Jones: Well, certainly for the... yes, that's correct.

For the late payment penalty?

Unknown Speaker: Yes.

Mr. Jones: For the late payment or the underpayment penalties--

Unknown Speaker: Only the corporation is--

Mr. Jones: --Only the corporation would be liable for those penalties.

The liability under 6672 is for a failure to turn over a tax that's been collected, and it's only trust fund taxes.

It's not... it doesn't generally apply to all different kinds of taxes.

Unknown Speaker: --So the point was that there was no inducement, or no incentive, because the officer's never going to be liable for the penalty anyway.

Mr. Jones: Well, this Court addressed, of course, the question of whether this is a fair result in the Nicholas case, and the Court said that the first priority for postpetition tax penalties is necessary to ensure that the debtors abide by the same rules that all other people conducting business abide by.

The priority, if you will, is fair in this broad legislative sense, because it deprives the debtor of an unfair advantage vis a vis everybody else who's out there conducting business.

The contention that it's unfair to specific creditors in this bankruptcy case is just another way of saying that they think the Congress made a mistake, that it's not a good idea to have this priority.

We think that when Congress goes to the trouble of drafting these priorities, they do it for a reason.

The reason is because they think this is a good idea in a general, abstract way.

We don't think that there's anything in the Bankruptcy Code that permits courts to reassess those general fairness questions.

Unknown Speaker: He's identified, I take it, not this case but a very unusual situation.

You're in Chapter 11.

The penalties amount... postpetition tax penalties amount to $10 million.

If you must give them first priority in a section 7, you're not going to get agreement of the unsecured creditors on the 11 plan.

But if the bankruptcy judge could say, ha ha, in a 7 I could subordinate the $10 million to you, unsecured creditors, then there would be enough under the 11 plan to give them what they would have gotten in section 7, and therefore the bankruptcy trustee can get approval without unanimity.

Mr. Jones: I may--

Unknown Speaker: Now, that's what I'd raised before because I got that somehow out of the briefs.

Now, that's what I wanted--

Mr. Jones: --I heard you ask that question, and even hearing you describe it again I'm not 100 percent sure I understand the question, but let me tell you what I think the answer is as I understand it.

If you're in--

Unknown Speaker: --Well, maybe I don't... yes.

Mr. Jones: --If you're in a Chapter 11--

Unknown Speaker: Yes.

Mr. Jones: --And the question is, can you get unanimity, and the answer is no, but is there some way to cram it down?

1129(a)(7) specifies that if you want to cram it down on the nonconsenting creditors you've got to give them the same treatment they'd get in a 7, and so in a 7, under 726(a)(1), the first priority of this postpetition tax penalty claim is recognized.

Unknown Speaker: Right.

Mr. Jones: In an 11, the court has to recognize it, too.

Unknown Speaker: Right, and that's why what the bankruptcy trustee wants to say, well, were I in a 7, I'd take the $10 million and put it at the end of the queue.

Mr. Jones: No, but you can't do that.

Unknown Speaker: I have that power, and therefore I don't have to count it against--

Mr. Jones: You don't have that power in a 7, because in a 7 we're talking about postpetition tax penalties.

Postpetition tax penalties in a 7 are a first priority.

Unknown Speaker: --Unless they could be equitably subordinated--

Mr. Jones: Well--

Unknown Speaker: --but that's... see, what I'm trying to do is to find--

Mr. Jones: --If they could be equitably subordinated, I agree.

If you could ignore a priority by subordinating it, you can always advance the interests of other creditors, and so if that's your question, I--

Chief Justice Rehnquist: Thank you, Mr. Jones.

Mr. Jones: --Thank you.

Chief Justice Rehnquist: The case is submitted.

Attribution:

The OYEZ Project

Featured:

United States By And Through Internal Revenue Service v. Mcdermott - Oral Argument

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Case:

United States By And Through Internal Revenue Service v. Mcdermott

Media File:

91-1229_19921207-argument.mp3

Related Transcript:

1992_91_1229_argument.xml

Transcript:

Argument of James A. Feldman

Chief Justice Rehnquist: We'll hear argument first this morning in No. 91-1229, United States, by and through the Internal Revenue Service v. Bruce J. McDermott.

Mr. Feldman.

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

This case concerns the relative priority of a Federal tax lien and a private state law lien as to a specific piece of real property that was acquired by the debtor after the date the Federal tax lien was filed.

It is after-acquired property in that sense.

The relevant facts can be summarized simply.

The Federal tax liens at issue in this case arose on December 29, 1986 at the time the taxes against the debtor were assessed.

On July 6, 1987 respondent Zions docketed its judgment against the debtors.

That judgment under state law constituted a lien against the debtors' real property, then owned and after-acquired.

On September 9, 1987, about 2 and a half months later, the IRS filed a notice of Federal tax lien.

And finally about 2 weeks after that on September 23, 1987 the debtors acquired the subject property known as the South Street property, the right to which are at issue in this case.

The order therefore was the Federal tax lien arose, then the state judgment was docketed, then the Federal tax lien was filed, and then the debtors acquired the property.

And the question is whether the IRS's lien has priority as to that piece of after-acquired property.

The general rule as to the priority of a Federal tax lien is that a Federal tax lien has priority over all competing interests unless at the time the Federal tax lien arose the competing interest was specific and perfected.

The rationale, I think, of that rule is that the Federal tax lien can only take so much of the property as is the debtors' and if at the time the Federal tax lien arises some other lien has come and essentially grabbed a part of that property, the Federal tax lien can only take the balance of the interest that was the debtors'.

Now, there are exceptions to that rule and one of the exceptions is section 6323(a), and that provides that a Federal tax lien is not valid against a judgment lien until the Federal tax lien is filed.

Now respondent claims that in this case, this case arises, he is entitled to the benefit of 6323(a), and the effect of that provision therefore is just to move the date from the date of assessment, from the date the tax lien arises on which you determine priorities, to move the date until the date the tax lien was filed, which in this case was September 9, 1987.

I think there are thus two issues in this case.

The primary question and the one that the court of appeals got wrong was whether the debtors' interest was specific and perfected as of September 9, 1987.

In our view, I mean, in our view the lienholder's interest was not specific and perfected as of that date, and accordingly the tax lien would have priority.

There is a second question which the court of appeals didn't rely on, but I think maybe the district court did, and that is whether the fact that the Federal tax lien attached to the property at the same time as the state tax, as the judgment lien, whether that alters the result that would follow from a finding that the state lien wasn't specific and perfected as of the date of filing of the Federal tax lien.

Unknown Speaker: May I ask, Mr. Feldman, now, if we weren't dealing with after-acquired property but had a judgment lien on all property of the debtor, would you think a subsequently filed Federal lien would take priority?

Mr. Feldman: If, well, I think that that is exactly what this Court decided in the case of United States against Vermont.

Unknown Speaker: Yes, I thought so too.

Mr. Feldman: And the issue in that case was whether a lien is sufficiently specific, that is if it just identifies all of the debtor's property rather than giving a specific legal description of the property.

Unknown Speaker: That's pretty specific, if it attaches to all.

Mr. Feldman: Right.

And this Court held that that was sufficiently specific.

And I think the task that is derived from Vermont is whether, on the date of filing of the Federal tax lien whether, if you can determine on that date that a particular piece of property was subject to the judgment lien, then it was specific and perfected on that date.

If you can't--

Unknown Speaker: Well, is it enough that you can say it's clear that any subsequently acquired property will be immediately covered by the judgment lien?

And it is clear that it would be, isn't it?

Mr. Feldman: --Yes, I don't think... there's no question under state law that judgment lien--

Unknown Speaker: So specificity isn't a problem.

Mr. Feldman: --Right.

We don't think specificity is a problem.

The problem is that under the settled task for whether a judgment lien is specific and perfected is whether the identity of the lien or the amount of the lien and the property subject to the lien were established.

In this case the property subject to the lien was not established as of the date on which you measure the priorities, which is September 9, 1987.

Unknown Speaker: Well, whose lien attached first in your view, or were they simultaneous?

Mr. Feldman: Well, that actually gets to the second question I mentioned.

Both liens attached to the property at the same time, but there's nothing hinges on when the Federal lien attached to the property.

The case turns on, the question is whether as of the date of notice whether the state lien had already attached to the property.

And since, in our view since it hadn't--

Unknown Speaker: Well, what's the statute designed to protect, reliance interests--

Mr. Feldman: --Yes.

Unknown Speaker: --of the creditor?

Mr. Feldman: Yes, primarily.

Unknown Speaker: And does the creditor have the judgment lien credit or have any reliance interest on property subsequently acquired, do you think?

Mr. Feldman: I don't think he does.

I think actually if you look at the statute and you look at what Congress did in 1966 when it overhauled the statute and passed the Tax Lien Act, it specifically dealt with the question of after-acquired property and it looked at all the types of after-acquired property and types of security interests and made a narrow exception to the general rule of Federal priority as of the date of notice was filed, a narrow exception to that rule for certain kinds of commercial financing transactions, only as to certain kinds of property, and only for a limited period of time, that is 45 days after the tax lien was filed.

Unknown Speaker: If there had been no Federal Government here but we had a situation of private parties, what would be the result under the Uniform Commercial Code of state law generally for after-acquired property?

Mr. Feldman: It's a little bit hard to answer that question because the Federal Tax Lien, I'm not sure what, how, that is not something that is governed by the Uniform Commercial Code.

There would be some interest in property, certainly the interest of a purchased money lender or the interest of an inventory financier or an accounts receivable financier, just the parties who are protected by the Tax Lien Act.

Those interests under the UCC as a general matter, although it's quite complex, would have priority over a judgment lien creditor as to the after-acquired property.

But, on the other hand, a Federal tax lien itself is not subject to the UCC and it's difficult to say what, there's no, really no other way to answer that question.

Unknown Speaker: Is your argument that nothing turns on when the Federal tax lien was perfected?

Mr. Feldman: Nothing turns on when it attached, and I think that follows from a number of--

Unknown Speaker: Well, is that the same as perfected?

Mr. Feldman: --Yes, I think that's part of perfection.

If you look at the test for perfection it's whether the identity of the lienholder, the amount of the lien, and the property subject to the lien was established.

And I think part of establishing that the property was subject to the lien was establishing that this particular lien had taken hold of this particular property.

Unknown Speaker: So everything turns on when the judgement creditor's lien perfected, but nothing turns on when the Government's lien was perfected?

Mr. Feldman: Right.

The relevant thing you do is take, what you do is you take a snap shot of the situation as of, in ordinary cases as of the date the Federal taxes were assessed, but in cases under 6323(a) at the date that the tax lien was filed.

You take a snap shot of that situation and say as of that date had the judgment lien attached to the property at, was a definite amount, was the identity of the lienholder specific.

If it wasn't, then the tax lien takes the property and the judgment lien is junior to it.

If it had already attached to that property and was established as of that date that that particular piece of property was subject to the lien, then that lien would be superior to the Federal tax lien.

Unknown Speaker: What happens with the proceeds in a title company?

Suppose the judgment lien creditor is superior to the Government because its lien was perfected before the assessment and before notice of the lien, and then the property is sold and money is sitting in the escrow company.

Does the judgment creditor's lien follow that money, or is this after-acquired property so that the Government's subsequent lien could now attach and be superior?

Mr. Feldman: The question there would be whether you trace the proceeds of the property, whether the lien on the property attaches also... you trace the priorities through to the proceeds.

I can't tell you for sure.

I think that you do, but I can't give you a firm answer on that.

Unknown Speaker: What if the South Street property here had been purchased with an exchange of other real property to which the judgment creditor's lien had attached, then surely it would carry over to the South Street property, would it not?

Mr. Feldman: Right.

I would think it would.

In this case it wasn't, the debtor had no rights in the South Street property to which the judgment lien could attach as of September 9.

Unknown Speaker: Well, how was the, what was the consideration for the acquisition of the South Street property?

Mr. Feldman: The debtor had previously owned the property and had sold the property.

He had essentially what amounts to a mortgage, except that under Utah state law in this circumstance it was considered an interest in real property, in personal property and not real property.

Unknown Speaker: And therefore the judgment creditor lien didn't attach?

Mr. Feldman: It didn't attach because it was personal property at that time and the judgment lien only attaches under state law to real property.

It was only when that interest became a real property interest of the debtors, which was on September 23, after the Federal tax lien was filed, it was only then that the judgment lien attached to the property.

Unknown Speaker: Mr. Feldman, in a case of simultaneous perfection do you take the position that 6323(a) breaks the tie?

Mr. Feldman: I think our position is that, if you mean a case of simultaneous attachment, if we're talking specifically about that type of perfection--

Unknown Speaker: Yes.

Mr. Feldman: --It would be our view that both the amendments, the clear intent of the amendments which is to limit the extent of a security interest in after-acquired property for a period of 45 days and only in certain given cases which did not include judgment liens, it would be our position that both that and 6323(a) and (c), I'm sorry, 6321 and 6323(a), all of those support our position.

6321, which is the basic rule, says that the Federal tax lien arises at the time the taxes are assessed.

It doesn't say at the time the taxes are assessed or attached, whichever is later, or if there is some kind of perfection that it arises at a different time.

That states a Federal rule that for purposes of, for Federal law the Federal tax lien arises at the date the taxes are assessed.

Now, 6323(a) switches that, moves that, just simply moves that date back to the date that the notice is filed, but you still do the same thing on that date that you would do in one of the other cases under 6321, which is you look as of that date as to whether the judgment lien had attached.

Unknown Speaker: What does that tell you about simultaneity, when two of them attach at precisely the same moment?

Mr. Feldman: I guess, I think the import of our argument is that the date that the Federal tax lien attaches in an after-acquired property case is not a legally significant date, that Congress set those legally significant dates as being either when they're assessed or when the tax lien is filed.

The fact that it attached at a later date is not legally significant.

And in fact when Congress considered the after-acquired property issue, in all cases of after-acquired property you're going to have situations similar to this in which the state lien and the Federal lien, or the judgment lien and the tax lien attach at the same moment to the property.

Congress wanted to limit the cases in which a private party could have superiority over the Federal tax lien among those cases of after-acquired property in very limited ways, only for a period of 45 days, for example.

If the court of appeals were right here the judgment creditor has a far superior interest to those the Congress specifically wanted to give priority to in the Tax Lien Act because the judgment lien would be good indefinitely for after-acquired property.

If the debt... it's true in this case it was 2 weeks, but if the debtor had acquired the property a year later under the court of appeals' opinion the result would have been exactly the same.

And I don't think that's consistent with what was Congress' decision to limit very carefully the classes of after-acquired property that would have, as to which a private creditor would have superiority over the Federal lien.

Unknown Speaker: Mr. Feldman, are you talking about Congress' decision... you're talking about the 1966 decision?

Mr. Feldman: Yes, because that's where it--

Unknown Speaker: Is it your view that the law with respect to the issue that's before us today changed in 1966?

Mr. Feldman: --No, it's not.

I think--

Unknown Speaker: So we really, the 1966 act really does shed any light on the problem that we have before us, does it?

Mr. Feldman: --Well, let me put it this way.

The, I think the rule of law that we're suggesting governs this case was clear long before 1966.

Unknown Speaker: So you don't need to rely on it.

Mr. Feldman: I don't have to rely on that, but I do think Congress then enacted those amendments in 1966 in reliance on that.

Unknown Speaker: In other words you're relying on what you perceive to be Congress' understanding in 1966 as to what the law then was?

Mr. Feldman: That's correct.

And I think that by enacting the statute that it did in 1966 it really adopted that prior law, and the exceptions to the rules about after-acquired that it enacted in 1966 wouldn't make any sense if it turned out that other, all kinds of other security interests other than the ones Congress named had a priority over the Federal lien that was so much more substantial than the priority that Congress chose to give the particular classes of creditors.

Unknown Speaker: Where do you first quote the 1966 statute in your briefs or cert petition?

Mr. Feldman: In the brief... excuse me?

Unknown Speaker: Where do you first quote it in your papers, the 1966... I know it's in the reply brief.

Was it in the--

Mr. Feldman: Oh, no, it was in our brief.

It was on about page 15, the section from 15 to 18 addresses the 1966 act.

I think there is another line of cases that--

Unknown Speaker: --Oh, I had the wrong brief.

Yes, thank you.

Mr. Feldman: --There's another line of cases that also suggests the same result, and that is this Court has never specifically addressed a case involved after-acquired property but it has addressed cases involving a very closely analogous situation, and that is what might be called after-acquired debt or after-incurred debt.

In the cases of United States against Pioneer American Insurance, United States against Equitable Life Insurance, those cases involved mortgages that included clauses providing that if the mortgage was foreclosed that the attorneys' fees for the foreclosure would be added to the principal amount of the debt due secured by the property.

In both of those... and so those cases involved after-incurred debt, a debt that is added on to the secured amount.

In both of those cases those attorneys' fees were incurred after the Federal tax lien was filed, and in both of those cases this Court held that that after-incurred debt, that the security interest as to that after-incurred debt was junior to that of the Federal tax lien.

I think the same result, there's no reason not to adopt the same reasoning and the same result--

Unknown Speaker: What was the reasoning in those cases?

Would interest that accrued later be junior too?

Mr. Feldman: --You know, I'm not sure what the rule was before 1966 as to interest.

I believe that in 1966 Congress specifically provided for interest and actually provided for some other kinds of costs that were attendant, for instance on a mortgage, to be included in the principal amount as a specific exception to the general rule.

But the point was that these after-incurred debts in this Court, this Court decided in two different decisions that these after-incurred debts, even if they were relatively certain in amount and relatively certain to be incurred, that the security interest as to those debts was junior to the Federal tax lien.

Unknown Speaker: What was the reasoning of the Court?

Mr. Feldman: It was applying the test for perfection that I have suggested here, which is, in those cases the amount of the debt... you remember the test requires the identity of the lienholder, the amount of the debt, and the property subject to the debt be established.

Unknown Speaker: That would go for interest too, I would think.

Mr. Feldman: It probably would, yes.

I think that's right.

Unknown Speaker: It seems a rather strange ruling.

Mr. Feldman: That's right.

Well, Congress did take care of some of those situations elsewhere in the amendments in provisions other than those that I was talking about before.

In any event, I don't, there's no reason why the, why if the amount of the debt was not clear because the debt hadn't actually been incurred at the date of filing, therefore the interest in that, that after-incurred debt was not superior to the Federal tax lien, there's no reason why the court of appeals ruling that after-acquired property should be treated any better.

I think those cases provide a close analogy to the decision that should be reached here.

Unknown Speaker: You agree, don't you, Mr. Feldman, that if the South Street property had been owned by the debtor here at the time that the judgment lien was filed in Salt Lake County, then the judgment creditor lien would be prior?

Mr. Feldman: Yes.

If the taxpayer acquired an interest in that property, a real property, an interest in the property recognized by state law between July 9, 1987 and September 9, 1987, at any point during that time, that interest, the judgment lien would have a superior interest in that property to the Federal tax lien.

But it's our, in this case because the debtors' interest in the property was not acquired until after the Federal tax lien was filed, the Federal lien should be superior.

If there are no other questions I'd like to reserve the balance of my time.

Unknown Speaker: Very well, Mr. Feldman.

Mr. Davis, we'll hear from you.

Argument of T. Richard Davis

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

In 1827 Justice John Marshall enunciated what was, he deemed, a cardinal rule, which was a prior lien gives a prior claim entitled to prior satisfaction from the subjected binds.

This has become known as the doctrine of first in time as first in right, and it has become the general Federal common law in the area of competing lien claims.

This has also been adopted and codified by use of the, for the Government in establishing the competing liens between a Federal tax lien and certain competing liens as provided in section 6323.

Because of a contractual stipulation which preceded the litigation in this matter and the acquiescence by the IRS in the Tenth Circuit opinion in all but one issue, the facts of this case are very simple and make a singular issue presented to this Court.

That is will this Court apply the first in time rule in favor of a prior perfected judgment lien over a subsequently filed Federal tax lien when property purchased by the, as against property purchased by the debtor subsequent to all the liens, the after-acquired issue.

The facts are not in dispute.

It is important to note that Zions Bank did everything that was required of it to perfect under state law a general lien on all real property owned by the debtor located in the County of Salt Lake.

Section 6232 does not explicitly resolve the issue of after-acquired property, but it provides the framework which, very compatibly with prior decisions of this Court and with the intentions of Congress as shown since the institution of the Federal tax lien in 1866, allows a consistent pattern of recognizing the integrity of a judicial judgment lien obtained by a private party.

Unknown Speaker: The Government's argument, Mr. Davis, as I understand it, is that the property used to purchase the South Street property was property to which the judgment creditor's lien did not attach under Utah law.

Do you dispute that?

Mr. Davis: I do not.

That is correct.

Unknown Speaker: So that when the South Street property came into the hands of the debtor it had not been previously subject to any lien under state law.

Mr. Davis: Not pursuant... that is correct as the facts in this case have been shaved down.

Both parties have, they abandon whatever rights they had to any property of Mr. McDermott, or any rights they had to this property until the property was repurchased by McDermott at the foreclosure sale.

Then both liens attached to that property simultaneously.

The question is whether the prior entry of the judgment lien has any effect at all as against a subsequent filing of the notice of tax lien.

We believe it does.

The choateness doctrine, as it has been declared by this Court, was codified by the Treasury Department in its regulations.

It requires, it sets forth, as counsel has stated, a requirement of the establishment of the amount of the lien, the identity or the lienor, and the establishment of what property is to be liened.

The property, being general in nature, is sufficient under prior pronouncements of this Court.

Unknown Speaker: I don't know... I don't see how the third requirement is met.

You don't know what property it attaches to until some property is after-acquired.

If other real estate had been acquired it would have attached to other real estate.

If this real estate had not been foreclosed upon, this real estate, it would not have attached to this real estate.

How can you possibly say that the property has been identified?

Mr. Davis: This issue, I think it's a difference between the word identified and established.

The standard is not now, nor ever has it been through this Court or by statute, that the property must be identified, merely that it must be established.

That was the issue which came before this Court in both the New Britain and Vermont cases.

Both of them sought... well, the most relevant one would be the Vermont case wherein a prior state lien which was general in nature was attacked by the general Federal tax lien, which was also general.

This Court held that the fact that the state lien was general in nature, covering all of the property, it identified no property in particular, was sufficient.

Unknown Speaker: It was all, it covered all extant property.

If you ask what property is covered you could have pointed, you say it's this property or this property or the other property.

In your case if you asked what real estate is covered by this lien you'd say well, gee, I, I, it covers this current real estate, but what future real estate I can't tell you until he acquires it.

That's quite different from the Vermont case, it seems to me.

Mr. Davis: There's no question the facts are different, and I agree, but I think this is not an illogical step to say that a general lien which is established upon all property, either now or hereafter acquired, is still on all property, whether now or hereafter acquired.

And the establishment is set forth.

It's not the identity that's important, but it's the establishment of that property, the fact that it's all property.

That's how I read that case.

Unknown Speaker: Well, I don't find, I find that not only not in accord with the 1966 understanding of Congress, but not in accord with what in general commercial law is regarded to be the perfection of a lien.

I think just the common law understanding is that the lien doesn't attach until the property is identified, and that's why the provision of the Uniform Commercial Code containing an after-acquired property clause was a real innovation, because it was generally understood in the common law that you can't attach until you know what the property is.

It's simply--

Mr. Davis: I believe that's the case with the Uniform Commercial Code.

I believe there is a distinction between personal property and real property, and we're only dealing with real property.

The common law in the State of Utah and the Federal common law is predicated upon first in time and first in right and does not require that that property be specifically identified.

All property which is covered by a lien is subject to that lien when it states all property.

I believe that the Uniform Commercial Code is directed only to personal property because of its nature, which can, it can be consumed or transported and other issues that way.

As far as real property it stays and is subject to permanency as set forth in the recorder's office in the relevant county.

Unknown Speaker: --I understand, of course the UCC applies only to personal property, but what I'm suggesting is that it made an innovation with respect to personal property, and that the old law with respect to personal property was the same as the old law with respect to real property, that you don't have a perfected lien until you know what the property is.

Do you think in common law it was, there was a distinction between personal and real property, you could perfect a lien before you knew what the property was?

Mr. Davis: Certainly there could be no lien until the property was established upon which that lien could be set.

Unknown Speaker: Sure.

In the Vermont case, Mr. Davis, the, as I understand it under Vermont law the lien attached to all of the debtor's real property and it wasn't any more specific than that, but you could at least go into county or I guess in Vermont town recording offices and find out what property the debtor had as of the time.

Here in July there was no way to identify the South Street property as property of the debtor.

Mr. Davis: The debtor had no real property interest in that, in the South Street property, that's correct.

Unknown Speaker: Well, no... yeah, no real property, so this is certainly a case that is not in any way controlled by the Vermont case.

Mr. Davis: It's not controlled by it, it's just the same reasoning that I would put forth that a specific lien is not required, a general is sufficient.

Unknown Speaker: Well, but, but in, the words may not be all that important but under Vermont law as of the time the lien was filed you could, you knew what specific pieces of real property that lien attached to.

Mr. Davis: It would be discoverable, that's correct.

Unknown Speaker: Yeah.

And under your theory certainly that wouldn't be the case.

Mr. Davis: Generally that is correct.

This case had specific facts which made it different as a matter of fact.

Zions did understand and the fact that it would, that the debtor would be obtaining title to that property soon or there was a good chance that was happening, because--

Unknown Speaker: But that doesn't, that doesn't affect the lien.

Mr. Davis: --That did not affect the lien, but it gave, Zions had knowledge that that would be coming into, that the property would be coming into Mr. McDermott's hands because of the nature and the assessing of the foreclosure notices.

Unknown Speaker: But that can't bind another judgment and it certainly can't bind the Government, the fact that Zions may have had knowledge.

Mr. Davis: All parties had knowledge because that was recorded.

For the foreclosure a lien, a notice of the foreclosure had to be filed.

That was why, and it's that issue of reliance which was addressed earlier which is important.

Reliance was important to a judgment lien.

A creditor who has a lien or who has a claim against a party will not pursue that party if he knows the party is impecunious, if he knows there will be no property thereafter to obtain.

In this case and in many cases where the creditor understands that the party is going to be obtaining property either through foreclosure or gift or devise or some such way, there would be a reliance that was exercised on the half of that judgment lien creditor.

Unknown Speaker: But how does that fit into the congressional statute here, the fact that the competing judgment lien creditor may have relied on the judgment debtor to eventually acquire property?

Mr. Davis: I think the statute is silent as to after acquired property.

I think the framework which allows the recognition of a general lien is as far as we can go in looking at the statute to find whether this will fit within the choateness doctrine.

Unknown Speaker: I didn't know that choateness had anything to do with reliance.

Mr. Davis: I think the reason for, the choateness doctrine requires that the lien be, that the lienor be identified, the amount be ascertained, and the property be established.

I believe the reason for that is so that anyone else can rely upon what that lien is all about.

I think the service is entitled to reliance also upon the actions of other entities.

I think that Congress, not only in 1966 but beginning in 1913 and again in 1939, began not to cut back on private competitors with Federal tax liens, rather to allow those liens to compete fairly as on an equal footing with the Federal tax lien.

I think the, it's important to understand the time of perfection in either lien or both liens is important in any case, whether it's before or after the acquisition of property to which that lien will apply, to encourage the diligence of filing, the diligence of enforcement of claims and liens upon property.

If that does not happen the secret lien doctrine, which was the beginning doctrine which was used in 1866, then carries over.

Basically what we have here is a secret lien of the United States which comes in and primes a lien which was placed by a private lien claimant.

I believe that the congressional intent clearly, under 1966 acts and prior to that as reviewed by various Federal courts, states that the purpose of that act was merely to put them on equal footing and encourage both parties to act diligently in obtaining what rights they are going to receive.

Only two circuits have looked at simultaneous attaching or perfection.

Those are the Fifth Circuit in the Southern Rock case, and the Tenth Circuit in McDermott.

Both circuits saw that it was important to encourage the diligence, encourage that parties can rely upon record title acts in the various counties in which the liens are set.

Zions acted diligently.

It performed all acts required of the bank to perfect its general lien on all of Mr. McDermott's real property located in Salt Lake County.

It is neither logical nor equitable to allow a 2 month later lien come and prime and subordinate the bank's lien.

The integrity of the record title acts throughout the county or the country relies on the consistent judicial support of preferring a prior recorded lien to those subsequently recorded.

The judicial and legislative preference for Justice Marshall's cardinal rule over the IRS's current desire to resurrect the secret lien doctrine must continue to protect all creditors and preserve confidence in the system.

If I might digress a bit on the 1966 act, as the, as counsel mentioned, that several amendments to that act showed that Congress tried to cut back on private rights.

Basically those concerned issues which are not relevant to this matter.

The UCC issue, the purchased money security interest, neither of those are relevant to this case nor the issues at this Court.

Basically the Congress gave the judgment lien creditor a priority to act on an equal footing requiring recording, perfection in a traditional manner of perfection of real estate liens, equally, without regard to the supreme rights of the sovereign.

This Court can accomplish the reaffirmation of the principle of first in time by reaffirming, by affirming the decision of the Tenth Circuit and allowing the general lien to have attached effectively to the after-acquired property.

Thank you.

Unknown Speaker: Thank you, Mr. Davis.

Mr. Feldman, you have 12 minutes remaining.

Rebuttal of James A. Feldman

Mr. Feldman: I just wanted to mention, Mr. Chief Justice section 6323(e), in response to your question before, would give the holder of a security interest that's superior to a tax lien a right to the interest that accrues even after the tax lien was filed.

That's 6323(e).

Unknown Speaker: Thank you.

Mr. Feldman: If there's no other questions--

Unknown Speaker: Mr. Feldman, I do have a question.

I meant to ask this before.

At page 14 of your brief you address the hypothesis that the liens were, became, were perfected simultaneously, and you say in effect that the statute says that if the private lien were not, did not attach first then the Government, the Government wins a tie.

And you seem to be quoting the statute, but I don't think the statute says that.

And I wonder could you comment a little bit on what, why you would say if there were a tie you wouldn't somehow or other share the proceeds or something, but rather would give the Government priority?

Mr. Feldman: --Yeah, I mean, there's two, I think there's two distinct questions there.

One is where there really is a tie would be a case, I would regard a case as for instance the Fifth Circuit case, the Southern Rock case, where there really was simultaneously with the Federal filing there was a state filing, and that would be a real tie case.

I think the underlying rationale, even in a case like that the Government should win, because I think the underlying rationale is that unless the prior, is that the Federal tax lien is a very potent form of lien and unless at the time the Federal tax lien either arises or is filed, if at that moment the other lien hasn't already taken the property the Federal tax lien is what attaches to the debtor's property and has a superior interest then.

Unknown Speaker: But this is, there's no specific statutory provision addressing the question, is there?

Mr. Feldman: I think that you could read the word until in 6323(a) to accomplish that.

Unknown Speaker: That's what you'd rely on?

Mr. Feldman: Yes.

Unknown Speaker: Is there a regulation specifically on the point you're making?

Mr. Feldman: I don't think there's a regulation specifically on the point I'm making.

There is, the regulation does make clear that in a case like this the respondent is not a judgment lien creditor because in order to, it can't take advantage of the 6323(a) exception because under the statute you're not a judgment lien creditor unless, as this Court has said repeatedly, your interest, the identity of the lienholder, the amount of the lien, and the property subject to the lien are established at that point in time.

Unknown Speaker: You say in this case there wasn't any tie at all--

Mr. Feldman: No, in this case there wasn't a tie.

In this case--

Unknown Speaker: --because your lien was filed earlier.

Mr. Feldman: --That's... well, we were... no, we filed later than they filed, but as of the time we filed they didn't have any interest in this property at all.

In fact it's a stronger case than the numerous cases--

Unknown Speaker: But you, your lien, you think your lien attached to this after-acquired property as of the date that you filed, first filed your lien?

Mr. Feldman: --That would be one way to put it.

I think that the--

Unknown Speaker: Well, that's the only, that's what you're claiming.

Mr. Feldman: --Right.

Unknown Speaker: Otherwise there would be a tie.

Mr. Feldman: I think the question of when our lien attached to the property is not a legally, there's nothing that makes that a legally significant question.

If it... then that is really to say the same thing as the date of attachment was as of the date that it was filed, or in the case that didn't come within one of the 6323(a) exceptions it would be when the Federal tax lien arises, which Congress provided was the date of assessment.

Unknown Speaker: And why did your, why did the Government's Federal tax lien in September attach to the South Street property when the earlier July lien didn't?

Mr. Feldman: Again, I think the key point is that the date--

Unknown Speaker: Well, answer my question.

Mr. Feldman: --Right.

We did, we attached to the property on September 23, 1987, on the same date as respondent--

Unknown Speaker: Why?

Because your lien covered personal property as well as real property?

Mr. Feldman: --Well, that's a separate question.

We, our lien did cover real property as well as personal property.

It was the holding of the district court that we waived our rights to the taxpayer's personal property.

We think that was mistaken, but we didn't, don't challenge that here.

Unknown Speaker: So when did your lien take effect?

Mr. Feldman: Our lien attached to the property on, at the same time as respondents', on September 23, 1987, but the priority of the Federal lien should be determined as of the date of filing.

The question is whether as of the date we filed, whether at that point respondents' lien was specific and perfected, and it wasn't in this case.

Unknown Speaker: So you say your lien as of the date of filing covered the South Street property?

Mr. Feldman: Yes.

I mean, that would, legally that would be, that would have the same effect as the--

Unknown Speaker: Obviously, you know, you're not, you don't feel comfortable saying yes.

Why not?

Mr. Feldman: --Well, I think the Federal lien attached on September 23, 1987.

I just don't think that attachment is a relevant question to ask in determining who has, attachment of the Federal lien--

Unknown Speaker: Well, permit me an irrelevant question then.

[Laughter]

Mr. Feldman: --Yes.

I'm comfortable in saying that on September 23, 1987 that was the date that the Federal lien attached.

Unknown Speaker: Attached to the South Street property.

Mr. Feldman: That's right.

But that the priority of the United States, as is the case with many of the exceptions in the Tax Lien Act and elsewhere in the UCC when you're dealing with prior, with private creditors, it is frequently the case that the priority is not measured from the date of attachment but is measured from some other date.

And it's our position that under Federal law the priority is measured from the date of filing in the 6323(a) case.

Unknown Speaker: Well, this is, you know that there is no such word as choate, but choate is to inchoate as sult is to insult.

I mean-- [Laughter]

Mr. Feldman: Have I used the word?

Unknown Speaker: Somebody has used it around here.

I heard it.

Mr. Feldman: I've been trying not to.

Thank you.

Chief Justice Rehnquist: Thank you, Mr. Feldman.

The case is submitted.

Attribution:

The OYEZ Project

Featured:

Begier v. IRS - Oral Argument

Fri, 09 Jan 2009 14:49:19 +0000

Case:

Begier v. IRS

Media File:

89-393_19900327-argument.mp3

Related Transcript:

1989_89_393_argument.xml

Transcript:

Argument of Paul J. Winterhalter

Chief Justice Rehnquist: We'll hear argument now on No. 89-393, Harry P. Begier v. Internal Revenue Service.

Mr. Winterhalter.

Mr. Winterhalter: Thank you, Your Honor.

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

Good afternoon.

The third case before the Court today involves whether a debtor's pre-bankruptcy payment alone from its general operating account for trust fund tax obligations excludes that property from a bankruptcy estate subject to avoidance as preferential transfers under Section 547.

For the reasons which I shall present to this Court, I would respectfully present that such transfers are, in fact, avoidable.

The Petitioner in this case is the court-appointed Chapter 11 bankruptcy trustee in the matter of American International Airways.

The debtor was a commercial airline carrier that provided scheduled passenger and air cargo service throughout the eastern and central United States.

As a carrier, the debtor had many employees and was required to pay wages to those employees and was further required to withhold taxes from those employees' wages, was required to withhold individual income taxes, the employer's... the employee's share of Federal Insurance Corporation taxes, and was further required to retain certain excise taxes which it collected from the passengers' tickets.

By the first quarter of 1984, the debtor had become... had experienced financial difficulties in the payments of its... of its debt... of its debts.

Similar to many companies in this type of situation, the debtor failed to file and pay its tax returns on a timely basis.

The debtor funded only net payroll.

The IRS imposed extraordinary remedies for the enforcement of the collect... for the enforcement of these taxes.

It issued a notice changing the debtor's tax filing requirements from a quarterly basis to a monthly basis.

It also required the debtor to make deposits into a certain designated depository.

The debtor followed these guidelines and on April 30th transferred two checks to the government, one out of the specially designated account and the second check in the amount of $734,797 from the debtor's general operating account.

The debtor and the IRS agreed to specific application of these funds.

Two further payments were made out of the general operating account just prior to the bankruptcy.

One for $200,000, which was applied to 941 withholding taxes and the second in the amount of $11,636 which was applied to Federal unemployment taxes and also to Form 11 taxes for the year 1982.

Unknown Speaker: All the payments you've described, Mr. Winterhalter, were within the preferential period?

Mr. Winterhalter: That is correct, Your Honor.

The debtor's financial difficulties continued, whereby on July 19th, 1984, the debtor filed its petition under Chapter 11.

Problems persisted and a trustee was appointed two months later.

During the administration of the bankruptcy proceeding, the trustee instituted this instant action, seeking to avoid the three transfers made out of the debtor's general operating account.

Following a trial, the bankruptcy court ruled that the trustee was entitled to avoid $700,410.

The District Court affirmed.

On subsequent appeal to the Third Circuit, the United States Court of Appeals for the Third Circuit reversed the bankruptcy court and district court findings.

The Third Circuit, relying principally on the dissenting opinion of the D.C. Circuit in Drabkin v. The District of Columbia, found the ability of the debtor to make the pre-petition payment of withholding taxes regardless of the source of those funds impressed those funds with trust characteristics, removing the property from the debtor's estate.

Unknown Speaker: What particular funds was the court of appeals talking about?

Mr. Winterhalter: Your Honor, I'm not certain I understand your question.

The funds... the funds which the court of appeals was discussing were the funds that the debtor used to pay the Internal Revenue Service.

Unknown Speaker: Simply money drawn on its general operating account?

Mr. Winterhalter: That is correct.

They were written on a regular check that the... that the debtor would pay any other creditor.

It is respectfully presented that the holding of the Third Circuit is incorrect and should be reversed.

The circuit's reasoning is wrong on four specific points.

First, the court relies on the wrong legislative history to support its contention that Congress intended to preclude the avoidability of tax withholding payments.

Unknown Speaker: Well, what about the language of the statute?

Mr. Winterhalter: My second point would be that the clear language of the statute--

Unknown Speaker: Well, you had better start with that, hadn't you?

[Laughter]

Mr. Winterhalter: --I would believe, Your Honor, that the clear language... the plain wording of the statute expressly requires that for this trust to be created the taxes must be withheld or collected.

In this situation, we did not have that situation.

Unknown Speaker: Well, what does it... doesn't the... doesn't the law say that these withheld taxes are to be held as a trust fund?

Mr. Winterhalter: Yes, it does.

Section 7501 of the Internal Revenue Code--

Unknown Speaker: Yes.

Mr. Winterhalter: --provides that--

Unknown Speaker: Yes.

Mr. Winterhalter: --Justice White, provides that any taxes which are collected and withheld shall be held in trust.

The wording of the statute... the plain wording of the statute expressly indicates that the... expressly indicates and is written in the past tense that the funds must be collected and withheld.

There must be some type of segregation.

This segregation does not--

Unknown Speaker: Well, it doesn't really say that, does it?

It says, the amount of tax so collected or withheld shall be held to be a special fund in trust.

Mr. Winterhalter: --That--

Unknown Speaker: It... it provides automatically by statute that whatever amount is withheld for these taxes is automatically in trust for the government.

Isn't that what it says?

Mr. Winterhalter: --The statute says expressly that, Justice O'Connor.

I would represent--

Unknown Speaker: So why does it have to be segregated to comply with the statute?

Mr. Winterhalter: --I would represent to the Court, as has this Court on other occasions, that there must be a trust raised for a trust to be established.

There must be something there.

If... here the government suggests that they need do nothing, that payment alone is a sufficient designation to establish this trust.

But there is no trust existence.

Unknown Speaker: You're... you're not now saying that it has to be segregated.

You're just saying that it has to exist, that when somebody pays an employee $80 and fails to withhold the $10 or put that aside for the government, there... there is no $10 to... for the trust to attach to.

Mr. Winterhalter: That is exactly correct.

Unknown Speaker: Now, that would be different for a sales tax, I suppose.

If you collect a sales tax and it's provided that the sales tax shall be held in trust, you would actually get the sales tax and that could be held in trust.

Mr. Winterhalter: That is exactly correct.

Unknown Speaker: But with the withholding of... of wages there's--

Mr. Winterhalter: The property is--

Unknown Speaker: --there's nothing to identify.

Mr. Winterhalter: --That is correct.

Unknown Speaker: You just paid him... paid him 80.

You were supposed to put 10 aside, but there is no 10 that we know of that's an identifiable 10.

Well, obviously there was money though, because they paid him.

Mr. Winterhalter: Yes, there is money.

But there is no--

Unknown Speaker: Well, whatever the law says... that... that amount is going be held in trust, and the money was there to be held in trust.

Mr. Winterhalter: --Not necessarily so.

Unknown Speaker: Well, it was paid.

Mr. Winterhalter: Yes, it was paid.

Unknown Speaker: Mr. Winterhalter, let's go back to that second clause of 7501 that Justice O'Connor referred to.

The amount of tax so collected or withheld shall be held to be a special fund in trust for the United States.

Now, certainly Congress can legislate in a way that says a... a particular fund shall be treated in a particular way even though under the classic law of trusts there might not be any res, can't it?

Mr. Winterhalter: Yes, it can.

But--

Unknown Speaker: You... don't you think that's... might be what it intended here?

Mr. Winterhalter: --No, I do not believe it did.

I believe the... when Congress enacted Section 7501, which was back in 1934, it had contemplated providing some protections for the government in the collection of their taxes.

They have provided other statutes which expressly empower the government to enforce its collection efforts.

Section 6672 would be an example.

Unknown Speaker: Well, suppose what the company did in this case with respect to monies that was paid from the general account, drew one check to the general account and then immediately... pardon me... drew one check from the general check to the special account--

Mr. Winterhalter: Yes.

Unknown Speaker: --then a second check special account to the government.

Does that create the trust?

Mr. Winterhalter: Absolutely.

I think there is the act of the segregation itself.

Unknown Speaker: And... and you couldn't set it aside as a preference that putting it in the trust was a preference?

I mean, how would that would be any different from the argument you're making now?

Mr. Winterhalter: Well, I think in the situation which you have raised in your hypothetical, there is the... there is the designation.

There is the creation of the trust res which allows it to come into existence.

There is oftentimes suggested that the normal business operates properly--

Unknown Speaker: But it's not... it's not a preference to create a trust res?

Mr. Winterhalter: --No, I do not--

Unknown Speaker: But it... but it... but it is... but it is a preference to directly to pay the IRS?

Mr. Winterhalter: --Let me correct that statement.

Unknown Speaker: That... that doesn't make sense.

Mr. Winterhalter: I believe that it would be a preference to create a trust res for any party.

But I believe under Section 7501 Congress had enacted a provision which gives the IRS special treatment under certain circumstances.

And that is when the trust money is properly withheld.

Unknown Speaker: Mr.... Mr. Winterhalter, it... it seems to me... I don't... I don't understand why you say... why you say that there has to be a res in order for a trust to be created.

But if the statute, as the Chief Justice pointed out... if it says it shall be created, the Federal Government can make it happen.

I should think that... that the problem here is not whether it's created, but how you identify it, that when the government says in this statute that it will be a special fund in trust, you don't know what the res is.

You don't know whether it's the bank accounts or the corporate... the corporation's real property or any of the other assets of the corporation.

And, therefore, when it comes to... to identifying something that... that is subject to this special privilege, you can't identify it.

It isn't that it couldn't be created, it's that it's not identifiable later.

Isn't that your... your point?

Mr. Winterhalter: My point is, Justice Scalia, that there must be some act, some separation.

It does not have to be the deposit into the designated account.

It does not have to be the deposit into the approved tax depository in the normal business sense.

But there must be something.

The... for the, for the trust to be created, there must be something to set aside.

It can't just... it's not an abstract, as the government suggested in their brief.

There must be the creation that the--

Unknown Speaker: It could be created in the abstract, but you can't give it effect in the abstract.

Unless you can identify a res, you can't identify the trust corpus.

Mr. Winterhalter: --I don't believe I disagree with that.

Unknown Speaker: But when must it be created?

I'm not sure I understand your position on that.

Supposing 30 days before bankruptcy they have $1,000 payroll and $200 withholding obligation.

They have $1,200 in the bank and they pay $1,000 to the... to the employees and don't do anything to with the two hundred until after the bankruptcy.

Or they pay the 200.

Would that be... would that be a preference?

Mr. Winterhalter: If they held the 200 in their general operating account?

Unknown Speaker: Yes.

Mr. Winterhalter: And then paid it directly to the government?

Unknown Speaker: Yeah, a week later, but still within the preference period.

Mr. Winterhalter: Presuming that the other elements of a preference have been satisfied, I would believe that that... I would believe that that would be a preference.

I believe that's the situation here.

We have funds being used which were in the account, but no connection being made between the $200 in your hypothetical and the $700,000 in this hypothetical which would connect the monies collected with the trust being created.

Unknown Speaker: Other than the fact that they did use the money to pay the government?

That's not enough, of course.

Mr. Winterhalter: That is... that is correct.

Unknown Speaker: Well, what do they... they have to put it... you're... they have to put in a separate account before the... in... in... before the preference period begins.

Mr. Winterhalter: I'm... I'm not saying to create the segregation itself or to create the designation it has to be placed in a separate account.

Again, many businesses operate under a three bank account system.

They have their general operating account which they collect their revenues.

They then have their payroll account and they have their tax account.

They would collect revenues from the normal operation of their business, place them in their... place them... place those monies into their general operating account.

Use the general operating account to pay their normal expenses, which would include their payroll and their wages.

And once they provide gross wages into the payroll account, they then, in turn, would transmit the requisite funds to satisfy the withholding tax obligations.

Upon doing that, I think the 7501 would come into effect.

Unknown Speaker: Well, what if the statute... this clause we've been talking about... said any paid amount of tax so collected or withheld shall become the property of the United States?

Mr. Winterhalter: I... I still don't believe you have reached that threshold of identifying the trust res.

There is... the statute does not say--

Unknown Speaker: But this statute would not have... the statute I'm talking about says nothing about a trust.

It simply says the money that was withheld shall become the property of the United States.

Mr. Winterhalter: --If there has been no withholding, Mr. Chief Justice, I do not believe that the trust... well, you're... instead of putting the property in trust, you're creating a statute which would in effect transfer title to the property directly to the government--

Unknown Speaker: Yes.

Mr. Winterhalter: --upon the operation of the statute.

I'm not certain how that would work, Mr. Chief Justice.

I would believe that if... if Congress specifically enacted that statute and expressly stated such in a statute, then, in fact, that would be controlling.

Unknown Speaker: Well, I... I have the feeling that the statute Congress did enact is not far different from--

Mr. Winterhalter: I would respectfully disagree with Your Honor.

Unknown Speaker: --I'm sure you do.

[Laughter]

Mr. Winterhalter, it's... it's my understanding of trust law that if you declare yourself to be a trustee of a res which is not in existence at the time, but later declare the res, it is effective.

That is, if I tell my nephew I am putting in trust $500 for you and in fact I don't, but several weeks later I set aside the $500 and I say this is the... this is the trust corpus for my nephew, that's effective.

So, you can do it later.

Right?

Mr. Winterhalter: I believe that Hornbook trust law would... would look to the intent to the trustee in that situation.

Unknown Speaker: Well, that's right.

But I can do it later.

Mr. Winterhalter: Yes.

Unknown Speaker: I don't have to do it at the moment that it's created.

Mr. Winterhalter: Yes.

That is correct.

Unknown Speaker: Now why isn't it... and it's also Hornbook trust law, as I understand it, that you can declare in trust a portion of a fungible account.

So you can say $500 of this bank account is held in trust for my nephew.

Mr. Winterhalter: Yes, you can.

Unknown Speaker: Okay.

Now, when you put those principles... two principles together, why is it not the case that as soon as the corporation wrote out this check to the United States it identified a portion of that bank account as being the trust corpus that was owed to the government before it was transmitted to the government.

Mr. Winterhalter: You would be talking... I... my... my response to that would be it would not be a trust because you would be transferring title to the funds to the government on that time.

Unknown Speaker: I'm not using it as check.

I'm not using it for its conveyance purposes.

I'm using it for its declaration of what is the corpus of the trust.

As soon as you sign that check you have effectively expressed your intention that this is indeed the portion that belongs to the United States.

Mr. Winterhalter: What in effect as--

Unknown Speaker: As opposed to my real estate.

I agree with you, before that we have no idea what portion of the corporation's assets belong to the United States.

We don't know that it was a real estate or whatever and I'm sure the government would use whatever... whatever was convenient at the time.

But once the... once the corporation signs that check, the corporation has acknowledged a particular corpus.

Mr. Winterhalter: --Mr. Justice Scalia, I would present to you that the trust which is required to be created in order for 7501 to be attached... to attach, this trust to be created, must relate to the funds collected from employees' wages.

If these funds are dissipated... if the bank account goes down to zero, then you cannot take funds unrelated to the employees' wages and recreate them in a trust.

Those funds will never be affected with the trust characteristics if in fact they came from funds which were not generated from employees' wages.

Unknown Speaker: There is no... there's no... how do you identify... look the statute applies not only to... to funds collected but also to funds withheld.

There is no identifiable dollar withheld.

When I pay you $80 and withhold $10 for Federal income tax, what identifiable dollar is that?

It's no identifiable dollar.

It is money I have not paid you.

Mr. Winterhalter: But this is--

Unknown Speaker: So, you have to rely on my declaration of a fund later, it seems to me.

Mr. Winterhalter: --I would respectfully disagree.

Unknown Speaker: That's for a sales tax.

Yes.

When I get the tax, you say that's it, that's what the trust attached to.

But not for a withholding tax.

The withholding tax never exists.

There... there is no dollar it... it ever attaches to.

It's just money I do not pay you.

Mr. Winterhalter: The trust language, Mr. Justice Scalia, under 7501 does not suggest that the trust attaches to monies collected and which should have been collected.

It only says that the trust attaches to monies which were collected.

Unknown Speaker: Or withheld.

Mr. Winterhalter: --or withheld.

Unknown Speaker: xxx the problem?

Mr. Winterhalter: But if we fund only net payroll, if the employer pays only net payroll while the... the employee takes the advantage of the tax credit, the employer does not pay it.

He does not fund gross payroll.

He does not withhold the monies.

Unknown Speaker: Well, he withholds by the act of paying the employee only the net, I would think.

Withhold means deduct.

Mr. Winterhalter: Yes.

I agree.

Unknown Speaker: So, he is with... if I... if I hire you for $100 a week and your gross is $100 and your net is $80, when I pay you $80, I have by definition withheld $20, even though I don't have the $20.

Mr. Winterhalter: That's correct.

But, Mr. Chief Justice, if you don't have the $20, then how can the trust attach to those funds?

Unknown Speaker: Well, if you're looking for something that meets all the requirements of Bogurt on trusts, I agree that it can't.

I... my view is that this statute does not require those.

It cannot attach immediately, but I thought you conceded before that... that the res does not have to be in existence at the time.

You can establish the res later.

And why didn't that happen when the check was written, even using Bogurt?

Mr. Winterhalter: Because there's been no connection between the funds withheld from the employees and the trust funds paid to the government.

Unknown Speaker: There doesn't have to be a connection.

Mr. Winterhalter: I believe that there does.

Unknown Speaker: The res was created later.

But you acknowledge that you can put it into a special account and that that creates a trust without a preference.

And I just don't see how that follows from your argument.

Mr. Winterhalter: I would represent to Your Honor that if there is the designation... if you... if you go through the steps to establish the existence of a trust res--

Unknown Speaker: But... but why isn't the payment to the government the designation?

Mr. Winterhalter: --Because--

Unknown Speaker: Why... why is doing something directly less of a designation than doing it indirectly?

Mr. Winterhalter: --Because in the payment to the government you are transferring title to the property.

What the government wants to say is allow us to be preferred over every other creditor.

We should be preferred.

We should have some loophole.

If that is what Congress intended when it enacted the Bankruptcy Code, it should have expressly stated so.

But it didn't state that.

It stated that the... that the IRS, that the government was going to be subject to the preference laws.

It was going to be subject to the... a trustee in bankruptcy or the debtor himself from avoiding payments to the government.

Unknown Speaker: Well, the Congress set up a scheme whereby avoidance could be had for items that were property of the debtor.

These monies weren't property of the debtor.

They were the property of the United States the minute they are withheld.

It doesn't belong to the debtor anymore.

Mr. Winterhalter: I would respectfully disagree.

Unknown Speaker: Well, that's the statutory scheme.

Mr. Winterhalter: But there is no nexus between the funds collected and the monies paid to the government.

There is no... in this case, there is absolutely no proof that the funds used to pay the Federal Government were those funds collected from the employees' wages.

Unknown Speaker: Well, there is no tracing problem here.

Once the check is drawn, that solves that.

They've set it aside.

Mr. Winterhalter: At that time they transfer title.

They don't establish the trust.

What you are enabling by such a ruling would be for the... for the principals of the corporation to in effect... to in effect avoid 6672, 100 percent penalty liability.

You are, in effect, carving out an exception that does not exist in the statute... while it may have existed in the proposed Senate statute, it does not exist in the statute as enacted to allow a debtor corporation to avoid 100 percent penalty payments, to allow the Internal Revenue Service to be preferred over other creditors.

This Court stated in United States v. Whiting Pools that the government should be treated no differently.

That... it stated in United States v. Slodov that there must be a connection... there must be some nexus when discussing this trust.

If the Court finds in favor of the government of today, it would be reversing the principles established by this Court in those two cases.

It would be obviating the need for the government to impose any tracing whatsoever.

It would just say that the trust arises by operation of law without anything further.

The legislative history... the statute itself does not describe either way whether the government can or cannot avoid transfers of property.

Several courts have attempted to interpret whether Congress intended when enacting the Bankruptcy Code to permit the government to do just this, whether a bankruptcy trustee can avoid a transfers of the government to a governmental authority if the property was properly withheld.

Each of the courts have looked to the statute and said it's not clear and referred to the legislative history.

The legislative history was... as this Court has recognized, was a long time in making.

The statute involved 10 years of congressional debate.

Unknown Speaker: This is the Bankruptcy Code you're referring to?

Mr. Winterhalter: That is correct.

That is correct.

And this... that is correct.

The... when... when the statute was enacted, the House originally proposed House Resolution 8200.

The House resolution was approved by the House Judiciary Committee, voted out of committee and a report was filed.

The language in the report is the language referred by the Third Circuit in their opinion.

The House bill was sent to the House floor, subject to several amendments and passed.

It was then sent to the Senate.

The Senate at the time was considering their own legislation, Senate Bill 2266.

Senate Bill 2266 would have specifically authorized... would have specifically carved out an exception that the government desires today, that preference payments to the government are not avoidable.

The Senate Bill was approved by the Senate Judiciary Committee.

What they did, though, is they took... they tabled the bill, Senate 2266, put their language into House Resolution 8200 and sent it back to the House.

Because of the lateness of the term, the two parties... the... the managers, the House leader and the Senate leaders, got together and, in lieu of formal committee, came up with this new statute, came up with a... with a hybrid which imputed parts of the Senate bill and parts of the House bill.

This hybrid bill is reflected in the conference committee report, which is also attached to the legislative history.

That... that language specifically references the fact that the provision in the Senate bill which allowed the government to have the ability to avoid taxes was specifically excluded.

Senator DeConcini's statements stated that Section 547... 547(b)(2) of the House amendment adopts a provision contained in the House bill and rejects the alternative contained in the Senate amendment relating to the avoidance of preferential transfers, that is, the payment of a tax claim owing to a government unit.

What in effect this says is that the... what the Senate proposed and what the government is proposing today was expressly not adopted.

Unknown Speaker: Of course, Congress could have rejected that because it would have extended to state and local government units, too, the way you have expressed it, couldn't it?

Mr. Winterhalter: That is correct.

In Section... but what Congress did do in enacting the Bankruptcy Code in its final text, it provided under Section 106, which is sovereign immunity section, clear language that the government would be subject to the avoidance of preferential transfers.

In this case, if the Court adopts the position as espoused by the government, you would in effect be overruling what Congress had expressed in the legislative history.

Unknown Speaker: Only as to the extent of trust funds, though.

It wouldn't be as to all tax obligations... corporate... income tax, for example.

Mr. Winterhalter: Yes.

That is correct.

There... there is a difference in those taxes, Mr. Justice Stevens.

The problem, however, is that there was no express exclusion in the statute for the non-avoidability of even trust fund taxes.

And certainly Congress was cognizant of that fact by its... by its protection of those... by the protection of those taxes in both Section 507, which is the priority section, and Section 523, which is the discharge section.

What Congress said there is that we want to protect both taxes which were collected and which should have been collected.

Unknown Speaker: Well, on that basis it wouldn't do you any good to segregate these funds that you've withheld.

Mr. Winterhalter: Under the Section 507 or 523 analysis?

Unknown Speaker: Well, I thought you said a while ago if you actually segregated these withheld funds, they would not become property of the estate.

Mr. Winterhalter: That is correct.

Unknown Speaker: And there could be no avoidance.

Mr. Winterhalter: That is correct.

Unknown Speaker: Well, but the argument you've just made from that other provision of the law on the preference I would think it would... I would think that would cover the withheld funds that are segregated also.

Mr. Winterhalter: Mr. Justice White, under those sections they clearly had contemplated taxes which should have been collected and which were not collected.

In the final draft of the... of the statute as enacted under 547, they did not include this type of reference and in the legislative history they equally did not include such a reference.

Justice Marshall noted in the case in... in this Court that under 6672 they do in fact recognize taxes which were collected or which should have been collected.

Under 547 and 7501 they do not.

If the Court has no further questions, I will reserve my remaining time for rebuttal.

Unknown Speaker: Very well, Mr. Winterhalter.

Mr. Martin.

Argument of Brian J. Martin

Mr. Martin: Thank you, Mr. Chief Justice, and may it please the Court:

I'd like to begin where Mr. Winterhalter left off.

In fact, Congress did pass the House version of Section 547, the Preference Bill, H.R. 8200.

It rejected the Senate version which would have made all tax payments non-avoidable.

It did that to reach corporate income taxes, unemployment taxes.

It's plain that taxes held in trust and turned over to the government cannot be a preference.

Every court has recognized that.

The joint floor statements recognize that.

So, the question in this case is whether a trust was created and maybe whether a trust was dissipated.

The petitioner has argued that no trust was ever created.

He has not contended that one was created and somehow spent and... and rendered unavailable.

His argument has been that there was withheld taxes placed in a segregated account.

In the first place, it's... it's plain that taxes were withheld.

At trial IRS Forms 940 which detail the amounts of withholding were placed into evidence.

And it's roughly about $350,000 withheld each month of... of the relevant months in questions.

On the question of whether taxes--

Unknown Speaker: May I... may I interrupt you right there?

Mr. Martin: --Yes.

Unknown Speaker: Those forms proved that that's the amount that should have been--

Mr. Martin: No.

Unknown Speaker: --set aside?

Mr. Martin: No.

It's... it's a statement of these were withheld.

It's not--

Unknown Speaker: But where were they withheld?

Were they... could you... were they actually... there were actually funds there that were placed in a bank account?

Mr. Martin: --There were no funds placed in a bank account.

They were net wages in other words.

Unknown Speaker: I know, but when you have a... when you file a form that says gross wages X--

Mr. Martin: Uh-huh.

Unknown Speaker: --and net wages X minus the tax, that isn't proof that the amount withheld was actually withheld.

It's just a proof they filed a piece of paper that said they were doing it.

Mr. Martin: The filing a piece of paper their identifying it court as genuine, and the document says--

Unknown Speaker: It's genuine.

Mr. Martin: --And it says... it says we did it.

It says we withheld.

It doesn't say we were required to withhold it.

It said we did withhold it.

Unknown Speaker: Well, withhold means simply not paid.

Mr. Martin: Exactly.

Unknown Speaker: Well, okay.

That doesn't suggest the existence that they've put a deposit of monies--

Mr. Martin: Not at all.

Unknown Speaker: --just that they did not paid that amount.

Mr. Martin: Not at all.

I'm just saying if you had an employer... not AIA, but another employer who paid... who paid gross wages, so there was no withholding in the first place, then we would have trouble reaching... finding a trust under 7501.

Unknown Speaker: Oh, I see.

Mr. Martin: But when there is a withholding, that's my simple point.

Unknown Speaker: xxx.

Mr. Martin: Right.

Unknown Speaker: I still don't... maybe I'm stupid.

Say, they have enough money to pay net wages and they file a return that says we withheld the difference between net wages and gross wages.

Would that be... but they actually didn't have any money.

They have... it's a no-asset business.

It's a sales operation of some kind, and all the money they had in... available to them they used to pay net wages, but they filed the return suggesting that we withheld this amount and we recognize an obligation to pay it when we get the money.

Mr. Martin: There has been a withholding in that case.

If--

Unknown Speaker: What has been withheld?

Mr. Martin: --Well, they've have had to pay less... they've have had to pay less than they would have paid... they had to reduce... they cannot pay gross wages.

In other words, if they only have enough money, they have to make payroll, and they have to deduct on the forms at least from the paycheck.

A person's paycheck... the stub would say withholding of $105.

The government cannot go after that $105 with respect to that taxpayer if there's been that much of a withholding.

Maybe the individual would have a claim for wages against its employer.

Unknown Speaker: But there is no asset representing the amount withheld?

Mr. Martin: Well, that's right.

On... on the books, they didn't have to borrow the money either.

Perhaps they could borrow the money if you wanted to find an asset.

Withholding is just a deduction from gross wages.

That's all it means.

Unknown Speaker: You just mean not paid.

Mr. Martin: Not paid is all I mean.

Unknown Speaker: All right.

So, the trust consists... the trust res consists of a liability?

[Laughter]

That's what you've said.

Mr. Martin: That's basically right.

And this is the liability that if the law is followed, will be satisfied usually within about three to five days by a check to the IRS.

It wasn't--

Unknown Speaker: You're... you're not suggesting that in the strict sense of trust law, the filing of a withholding... a return showing tax withheld creates any sort of a res, are you?

Mr. Martin: --No.

No.

I... I'm saying under 7501 whenever a trust is created and the amount of tax withheld... the amount of tax withheld shall be held to be a special fund in trust for the United States.

It's a statutory trust.

The trust is created by operation of law.

It's in the amount of not paid.

It's in the amount of withheld.

Unknown Speaker: Mr. Martin, I'm... I'm willing to concede that you can create a trust by law.

You can just say by law there is a trust.

Mr. Martin: Right.

Unknown Speaker: But you... you know, you can't make black white by law.

You can't pass a law that makes black white.

And what you're trying to do is to enforce a trust and... and... and that is an objective reality.

You are trying to move on some corpus.

Mr. Martin: Uh-huh.

Unknown Speaker: And you can't decree the existence of a corpus by law.

Mr. Martin: I agree.

Unknown Speaker: So, we... we... we have to find some corpus to identify for the legal consequences that you want to attach.

Mr. Martin: I agree.

Unknown Speaker: Now, at... until the check was written at least, that corpus could have been anything.

It could have been the company's plant.

It could have been any asset whatever of the company.

I wouldn't know how to apply a trust law theory to that kind of a situation.

Mr. Martin: And with that--

Unknown Speaker: But you... you would apply it even before the check was written.

You... you would say that somehow you would have a preference on the corporation's assets even before there was any identification.

Mr. Martin: --Yes.

I think that we would... wherever we found... found in the commingled accounts of the withholder the amount of tax withheld, that that would be the trust.

Unknown Speaker: Wow, boy, that--

--We don't have to decide that in this case.

Mr. Martin: But you don't have to decide that... fortunately.

[Laughter]

But let me just... you know, there is evidence that Congress thought that too in 1978.

The joint floor statements addressed the question of commingled accounts and said that the IRS could use reasonable assumptions, with one such assumption being any amount remaining in commingled accounts is the IRS' money.

Unknown Speaker: I... I assume that what you assert the Federal Government can do by using the device of trust law, you are willing to acknowledge that state governments can do as well.

Mr. Martin: Absolutely.

Unknown Speaker: So, a state government could say, henceforward, any taxes owed to the state shall be a trust and they would... they... they would acquire a preference under bankruptcy law.

You think about that for a minute.

Mr. Martin: If... if they have a parallel system, sure.

I mean, if... if a trust is created under law, under private instrument, whatever it is, payments of trust funds cannot be preferences because they're not properties of the debtor.

That's right.

Let me go back to the question you asked about... okay, a trust has been created, but how do we know that the payments are payments of trust fund taxes.

Well, we know in this case because of the black letter law that a trustee may designate any funds, its personal funds, its corporate funds, whatever it wants to, as trust funds taxes or... as the trust property.

If they wrongfully dissipated the trust, they can restore it with any funds they want.

So when they write a check that clears, as in this case, that's sufficient to identify the... the trust.

And I think that's what Congress contemplated in the House report which this Court has viewed as authoritative of Congress' intent in 1978.

When it said, in the House report... and this is at page 26 of our brief... that the payment of withholding taxes will not be a preference if they have been properly been held for payment, as they will have been if the debtor is able to make the payments.

So, we think that Congress thinks that if the debtor is able to make the payments, if the tax withholder can make the payments, the checks clear, that no further connection is required.

Now, there may be cases if... where trust fund taxes are not paid over, they file for bankruptcy, when the IRS wants to identify the funds.

In that type of case, we would be entitled to use reasonable assumptions.

One of the assumptions is that any... any amounts remaining in commingled accounts are the taxes.

But here we have more than that.

We know that there were amounts remaining.

The checks cleared.

And we also have the identification of the payments as trust fund taxes by the trustee... in this case, AIA.

Unknown Speaker: What other purpose is 7501 used for?

I mean, it... it seems to me it might be possible to read the first sentence of 7501(a) as... as its whole purpose is simply to... to lay the basis for the second sentence.

That is, the... the only reality that this fund has in the world is to enable the assessment, collection and payment in the same manner as the taxes out of which it arose.

Mr. Martin: Well, that's... that's not what Congress was doing in '34.

Until 1934, this liability was just a tax debt and had to be treated as such.

And Congress wanted to... to say no, once the withholding has occurred, it's our money.

There can be no higher secured interest.

You know, if it's... it's secured, creditors can't take the money.

It's our money.

You can use trust concepts to segregate and collect.

I think that's clear.

Unknown Speaker: There was no withholding in 1934.

That must have been added later, wasn't it?

Mr. Martin: Yeah, in '34... it dealt with the excise taxes only and said that... that money was held in trust.

It was added... I think it was '39 or '40.

Whenever withholding began is when it was... 7501 was amended to apply to withholdings in addition to excise taxes.

I think the last sentence of 7501(a) just means that the that the IRS can use the notice and assessment and levy and lien provisions with respect to trust fund obligations if it wants to.

And we have to in many cases.

So, just to summarize our position, we think a trust is created when there is a withholding, when... when net wages are paid.

No segregation is required.

We can require it under Section 7512 of the Code if there has been a poor performance by the employer.

But we don't have to require a segregated account.

Unknown Speaker: Mr. Martin, in... in the case of the special fund that is created that is a separate earmarked bank account, if the employer coming upon hard times decides to change his mind or its mind and takes the money back, is... is there some kind of criminal liability?

Mr. Martin: Yes.

Yes.

6672 is the 100 percent penalty provision for every responsible officer, and I think there would be a 100 percent liability there.

And there is also a criminal penalty for willfully violating the trust fund obligations.

And I think that would fall within that.

It's a... I believe it's a misdemeanor punishable up to one year.

Unknown Speaker: And... but that... but that special liability, that special criminal liability doesn't apply if there is simply a failure to earmark funds that are in the general account and those funds would then disappear or what?

Mr. Martin: It could apply for willful--

Unknown Speaker: If it's a trust in either event--

Mr. Martin: --Right.

No, it could apply in this... in this type of case as well.

If... if... the IRS policy is to use the 100 percent civil penalty before it would use the criminal penalty.

But there are criminal penalties for the failure to turn over the amounts of withholdings to the IRS.

Unknown Speaker: --But... but is the gravamen of the offense the invasion of an identified trust corpus?

Mr. Martin: No.

No.

It's not.

Unknown Speaker: In other words, it's just failure to withhold?

Mr. Martin: Failure to turn... to deposit--

Unknown Speaker: Failure to deposit.

Mr. Martin: --into the U.S. Treasury the amounts of withholding.

If there are no further questions--

Unknown Speaker: Very well, Mr. Martin.

Mr. Winterhalter, do you have rebuttal?

Rebuttal of Paul J. Winterhalter

Mr. Winterhalter: I do, Your Honor.

The government suggested that the record before the bankruptcy court reflected that in fact deposits or tax payments were made and referred to Form 940 returns.

Form 940 returns would reflect Federal unemployment tax obligations.

That is not at issue in this case.

What is at issue in this case is 941 taxes which would be reflected on the 941 returns.

Government Exhibits Number 11 and Number 12, which were attached to the supplemental brief filed with the Third Circuit, clearly indicated that while the tax liability of the debtor corporation was identified, there were no tax deposits made during this time period.

In addition, the record, the joint appendix, which has attached to it a copy of the record, clearly indicates when the Internal Revenue Service, Mr. Alan Zlatkin, the Revenue Officer, was being questioned at the trial, he clearly indicated--

Unknown Speaker: Thank you, Mr. Winterhalter.

Mr. Winterhalter: --Thank you.

Chief Justice Rehnquist: The case is submitted.

Unknown Speaker: The honorable court is now adjourned until tomorrow at ten o'clock.

Attribution:

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Featured:

United States v. Ron Pair Enterprises, Inc. - Oral Argument

Sun, 06 Feb 2011 03:44:54 +0000

Case:

United States v. Ron Pair Enterprises, Inc.

Media File:

87-1043_19881031-argument.mp3

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87-1043_19881031-argument.xml

Transcript:

ORAL ARGUMENT OF LAWRENCE G. WALLACE ON BEHALF OF THE PETITIONER

Chief Justice William H. Rehnquist: We'll hear argument first this morning in No. 87-1043, United States v. Ron Pair Enterprises.

Mr. Wallace, you may proceed whenever you're ready.

Mr. Wallace: Thank you, Mr. Chief Justice, and may it please the Court:

This case presents a narrow question of statutory construction dealing with the rights of secured creditors under the Bankruptcy Code in the collateral securing their claims.

The question is to be distinguished from any question of priorities under the Code because the Code treats secured claims separately, and to the extent the collateral is consumed meeting the rights of secured creditors, it does not pass into the general assets of the estate available for distribution to other creditors, priority or general creditors.

The particular question concerns post-petition interest allowed to holders of secured claims by Section 506(b) of the Code.

The general rule under the Code is that all claimants who would have a basis for it in the absence of bankruptcy are allowed pre-petition interest.

This is memorialized by negative implication in Section 502(b)(2), and the general rule further is that the right to interest is then cut off upon the filing of the petition in bankruptcy, except as the Code otherwise provides.

The right to interest, incidentally, resumes again after the confirmation of the plan of the debtor in possession or of the trustee by the Bankruptcy Court.

This is provided by Section 1129 of the Code, which created the possibility of stretching out payments under the plan, and in return for that, all creditors whose payments are stretched out are given a right to interest, and the right to interest for federal tax creditors under the tax liens is in 1129(a)(9)(C).

So what we are really talking about is whether there is a right to interest during this intervening period, the post-petition, pre-confirmation period.

And that's what we mean by post-petition interest.

Now, the provision at issue is set forth on page 2 of the government's brief, and Section 502(b) is one of the provisions, and indeed, the most important provision in the Code that allows post-petition interest, and the precise question here which... and the Code in this provision deals with this question by statute for the first time.

It was previously just a matter of judge-made rules.

The question is whether Section 506(b) applies to all secured claims with respect to the right to post-petition interest, or whether it carries forward a distinction that had been recognized by some courts of appeals prior to the Code between consensual and nonconsensual secured claims, with only the consensual ones being awarded post-petition interest.

The consensual ones are those created by contract, typically, secured claims of financial institutions or other business institutions.

The nonconsensual claims, in addition to the tax lien claims such as are involved here, would include mechanics' liens or workmen's liens or liens arising from the execution of a judgment, in favor of a judgment creditor such as a tort victim.

And the question is whether this category of claimants, including the government tax liens, benefit from the same rule that some courts previously applied only to claims created by agreement.

In the particular case it is stipulated that the collateral securing the government's tax lien which has been perfected is amply sufficient to cover both the claim and any interest that would be accrued under Section 506(b).

Unidentified Justice: Mr. Wallace, to what kinds of property does the government's tax lien extend?

Mr. Wallace: Well, typically to real property and any other assets to which a security interest could attach, the same as is true of many commercial liens today that are created by agreement.

There was a time when it was typical for the commercial lien to attach to only one particular piece of property, but it is much more commonplace in commercial practice now for the lien to be as oversecured as the secured creditor can make it.

And this is what is known in the pariance as an oversecured claim as well because it is secured by more than the value of the claim plus any interest that would be accrued.

The starting point for any question of statutory interpretation is, of course the statutory language, and if we look at Section 506(b), it seems apparent from the language that two categories of rights to payments are set up in the final several lines of the provision.

There shall be allowed to the holder of such claim interest on such claim, set off by commas then from

"and any reasonable fees, costs or charges. "

provided for under the agreement under which such claim arose.

Facially, that seems to provide for two different categories, a more comprehensive right to interest on any oversecured claim, and a qualified right to fees, costs or charges provided under an agreement, if the claim arises from an agreement, if those fees, costs or charges are reasonable.

That would be the ordinary way to read the language.

The Respondent, in order to adapt the language of--

Unidentified Justice: Mr. Wallace, can I interrupt for just a second?

It is true that the words "such claim"... you are saying there are two kinds of such claims, and you use the same words, "such claim", to describe both of them.

Mr. Wallace: --Yes.

Unidentified Justice: The words "such claim" are used repeatedly in the sentence.

Mr. Wallace: I believe that the "such" refers back to the fact that the claim has to be an oversecured claim--

Unidentified Justice: Correct.

Mr. Wallace: --to put it in the shortest verbiage.

The beginning part of subsection (b) explains that we're talking only about oversecured claims and only to the extent that the oversecured aspect would cover the interest payments.

So the "such" really has to refer back to that.

Otherwise, that limitation on the right to post-petition interest would be lost in the subsequent clauses.

Unidentified Justice: Mr. Wallace, you do concede that the majority rule before the new Code was to the contrary, that interest would not be allowable?

Mr. Wallace: We concede that indeed.

Unidentified Justice: Isn't... is it a little odd that there is nothing in the legislative history and nothing more explicit than the placement of commas to change a rule like that?

Mr. Wallace: It's a little odd that there's nothing in the legislative history.

I would not say that there's nothing more explicit than the changing of commas, which I will get to in a moment, but I do, I do agree that the case probably never would have reached this Court if the legislative history had addressed this precise question, which it did not.

If anything in the legislative history had said we are now rejecting the rule that several courts of appeals had adopted, there would be no basis on which any court would have ruled against the holders of a claim like ours, a nonconsensual, oversecured claim.

And I don't think the case would be here.

So it is--

Unidentified Justice: I suppose most of the government's claims would fit in this oversecured category.

Mr. Wallace: --That is correct.

Unidentified Justice: Certainly if taxes are due, the government asserts a lien on everything the taxpayer owns.

Mr. Wallace: That is correct, and it is also correct with respect to judgment liens, and for the most part, workmen's or mechanics' liens would be similarly oversecured.

Unidentified Justice: Yes, but there is a difference in mechanics' liens because they do just attach to a limited number of assets, I presume.

Mr. Wallace: That is correct, and that is--

Unidentified Justice: Whereas the tax lien will... covers the whole estate.

Mr. Wallace: --But there is no basis to distinguish them from tax liens under this provision.

Unidentified Justice: Right.

Mr. Wallace: They are nonconsensual liens, and if nonconsensual liens are not entitled to post-petition interest, mechanics' liens would fall along with ours for that purpose.

Unidentified Justice: May I ask, isn't it true that customarily in a mechanic's lien foreclosure that under most state statutes, doesn't the lienor get attorneys' fees and costs?

Mr. Wallace: Insofar as I am aware--

Unidentified Justice: And if so, I wonder why there is a distinction in this statute between interest on the one hand and fees.

Does it make any difference to anybody except in a tax case?

I don't... it's kind of a strange--

Mr. Wallace: --Well, I read the last provision of subsection (b) as indicating that the Bankruptcy Court is to see whether fees provided for in an agreement are reasonable--

Unidentified Justice: --Right.

Mr. Wallace: --because otherwise those fees should not be paid to the detriment of other creditors.

Unidentified Justice: Right.

Mr. Wallace: But this is way of protecting other creditors from some extravagant term written into agreements.

Unidentified Justice: Well, I understand, but I was thinking in a mechanic's lien case there probably is no agreement for fees, but the practice, apart from bankruptcy, might well be to recover fees, and I just wonder why they should get interest but no fees.

Sort of a strange distinction in the statute, because I gather they would get... under your view they would get interest but not fees or other reasonable costs.

Mr. Wallace: Well, I don't see... I don't see a basis for them to get fees.

There may be assets that survive the estate from which they would have a right under state law.

I don't know whether that would be discharged.

I'm sure you could instruct me about mechanics' liens because I have never been involved in that kind of practice.

In any event, in order to fit their contentions within the language of the statute, Respondents say that the commas should be erased, and then Section 506(b) can be read their way.

There are several difficulties with this contention, as we see it.

In the first place, we should not start off erasing either words or punctuation as the approach to interpreting what Congress has enacted.

Punctuation marks are put into statutes to clarify their meaning, and they should not be lightly discarded or ignored.

In the second place, and I think of very considerable importance, erasing the commas at issue here would create an ambiguity rather than resolve an ambiguity.

It seems to us that while the statute is quite clear as written, there would be an ambiguity without the commas as to whether the doctrine of the last antecedent, a maxim of statutory construction that we discuss on pages 16 and 17 of our brief, would still require the same reading that we say is plain on the face with the commas.

We have cited several cases there in which courts have held that the modifying language under the doctrine of the last antecedent applies only to the words or phrases immediately preceding the modifying language.

The very first case that we cite there, Quindlen v. Prudential Insurance Company, is one in which there were no commas between the provisions of the statutory language at issue.

It was a section of the Louisiana insurance Code that said this section shall not apply to temporary life insurance binders nor to contracts of live or health and accident insurance which do not contain a provision for cancellation prior to the date to which premiums have been paid.

And the question is whether that modifying language related back to the beginning language or not.

There was no comma there.

So the suggestion is one that would introduce an ambiguity.

The third problem with their suggestion is that it would be an awkward way to draft this provision to accomplish the result for which they contend, not only because of the ambiguity that would then exist, but because the Code elsewhere, when it wants to refer only to consensual secured claims, uses a term of art, security interest, which is defined in the definitions section of the Code, in Section 101(45), as "a lien created by agreement".

So there would have been a way provided for in the definitions section of the Code itself to accomplish that result.

And the fourth and also quite important fault with the suggestion that we need only erase the commas, is that under their reading of the language, it would still constitute a departure from the prior cases, as we explain in our reply brief.

It just would be a departure from the prior court of appeals cases that they would favor to the one that the language appears to suggest because they would prevail in this case.

But under the prior cases, the distinction was based entirely on the method under which the security was obtained.

It was a distinction simply between consensual and nonconsensual liens.

But those cases did not hold what the language of 506(b) obviously would require, that a court would have to look to the terms of the agreement in the consensual lien to see whether the agreement provides for interest.

If the lien was consensual, it didn't matter whether the agreement specified interest under the old cases.

So they would still be contending for a departure from the law unless the words the Congress enacted are to be totally ignored, contrary to every principle of approaching statutory construction.

Now, in addition to the language of the statute, the context rather strongly suggests that oversecured claims are referred to comprehensively in Section 506(b).

It is part of Section 506, which is the general provision that defines the determination of secured status for all categories of secured claims, and as we explain in our brief, each of the other subsections obviously refers comprehensively to all categories of secured claims.

So there is no reason suggested by the context for reading Section 506(b) more narrowly.

Then if we look to the legislative history, it simply does not address this question, which seems on balance to be to our advantage to us because this could not qualify as one of the rare cases in which literal application of the statute will produce a result demonstrably at odds with the intentions of the drafters.

There's nothing to show that the drafters did not intend this.

And it seems to us that the Court of Appeals and Respondents are trying to give more weight that can be borne by the mere absence of an explicit indication in the legislative history that Congress intended to change the role that had been adopted by some courts of appeals but in which the Service, incidentally, had never acquiesced.

And that's why the question had continued to be litigated up to the time of the enactment of the Code.

Unidentified Justice: Mr. Wallace, can I interrupt you with another question, because I've been puzzling with this language as I've been listening to you.

Mr. Wallace: Sure.

Unidentified Justice: Am I correct in understanding your argument to advise us that in the pre-Code law, the liens that were consensual and evidenced by a written agreement really could have been of two kinds... one, they didn't have to mention interest in order to have interest be allowable on such claims, but they did have to mention fees or costs for fees or costs to be allowable.

Mr. Wallace: Well, I really don't know whether they had to mention fees or costs, but I don't know any other basis on which fees or costs could have been allowed.

So I suppose they would have had to.

But interest was allowed not on the basis of a term in the agreement specifying it, but solely on the basis that it was a consensual lien.

Now--

Unidentified Justice: It seems to me that that distinction that you identify perhaps provides an explanation for the two kinds of such claims, both of which would be written claims, but one of which would say nothing, and therefore you could get interest on it, and the second of which might refer to fees and costs, and therefore require the language at the end to fit.

And that might explain the commas.

Mr. Wallace: --Conceivably that distinction could have been written into the law that way.

The difficulty is that the language used by Congress does not in any way restrict the--

Unidentified Justice: Well, it would fit this language if one read the words "such claim" to refer only to consensual claims.

Mr. Wallace: --But there's no antecedent for that, if I may say so, Mr. Justice.

There's nothing for the "such" to refer back to the first time the word "such" is used other than the explanation that it has to be an oversecured claim.

There's no other possible antecedent.

There's no--

Unidentified Justice: No, but the language at the very end refers to the agreement, the agreement under which such claims are proposed--

Mr. Wallace: --Yes, but such is used--

Unidentified Justice: --which seems to think that there is an agreement in all of the claims referred to in the sentence.

Mr. Wallace: --Well--

Unidentified Justice: Well, that's the--

Mr. Wallace: --One would have to read that back and say that the "such", the first time it's used, does not have a prior antecedent, but that the whole thing should be read sort of from the back to front.

It's a strained reading of the text that would not occur in the absence of an effort to preserve prior law beyond what would seem to be justified by the text.

We have discussed the legislative history in some detail to show that Congress was well aware of reasons why the rationale that had been expressed in the prior cases had become largely outmoded by changes in commercial practice and by the Federal Tax Lien Act of 1966 which adopted an approach to notification of other creditors of federal tax liens and clarification of filings that was quite comparable to the protection afforded by the Uniform Commercial Code for consensual liens, so that the two main rationales that had been expressed in the older cases, that it was harder for creditors to find out about tax liens, and that consensual liens typically applied only to one piece of property, had both become largely obsolete, and Congress was aware that they had become obsolete.

So there is considerable reason why Congress would not have wanted to preserve the old rule.

And then on the last two pages of our reply brief, pages 13 and 14, we explain an anomaly that would be introduced into five... Section 506 itself if the old rule were read into 506(b) because 506(d) gives a secured claimholder the right to skip the bankruptcy process altogether and preserve his claim, and that way he would have a right to interest, and he would have an incentive to skip the bankruptcy process if he had to sacrifice his right to post-petition interest in order to invoke his rights under 506(b).

So all of these reasons add up to us to the proposition that the proper course for the courts here in interpreting this provision is to take Congress at its word and give effect to the provision as Congress enacted it.

That is what the Fourth Circuit quite properly concluded in the Best Repair decision that is in conflict with the decision of the Sixth Circuit in this case, and that is the judgment we submit this Court should reach.

Unidentified Justice: --Mr. Wallace, you say that the government hadn't acquiesced in the prior decisions that had not allowed interest on involuntary liens.

Were there any decisions that agreed with the government?

Or was it--

Mr. Wallace: We had not managed to win that point.

We've collected the prior decisions on page 25 of our brief.

You'll note that they were not uniform.

The Harrington case, as we explain in the footnote on page 25, really deviated quite substantially from the other pre-Code decisions.

The last of the decisions, the First Circuit decision in Boston and Maine Corporation, was decided after the Code was enacted, but it still dealt with pre-Code law.

And it's an indication that the government was continuing to contest the issue in additional circuits.

So the law had not been entirely settled, but the Service's view had not prevailed.

We were unable to find any cases in which it had.

Unidentified Justice: --Could I ask you, this was a reorganization?

Mr. Wallace: Yes, Chapter 11, a reorganization with a debtor in possession.

Unidentified Justice: And you think the secured creditor can just stay out of the reorganization proceeding and foreclose his property?

Mr. Wallace: Later on, that's right.

He can preserve his claim for the... to assert against the reorganized--

Unidentified Justice: He can preserve his claim without filing, but does that... does it follow that he may then foreclose on property that may absolutely frustrate the reorganization?

Mr. Wallace: --Under 506(d) he can preserve his claim, I mean, but the timing of it--

Unidentified Justice: Well, I know what you say but I don't... but that's different than saying he may stay outside and foreclose his... foreclose on his security.

Mr. Wallace: --He may not be able to do it while the reorganization is in progress.

Unidentified Justice: Well, if he may not be able to do it outside and he has to... he can preserve his claim, and the reorganization... the reorganization court is bound to recognize his secured claim, but then the question still remains about post-judgment interest.

Do you have... do you have some instruction--

Mr. Wallace: I have some information that a creditor could be forced in by the debtor himself filing the claim on his behalf, as these things work.

That is, you know, a point that we make at the end of our reply brief.

Which is something of a make way point.

I think our case stands quite strongly without it, and I'll reserve the balance of my time, if I may.

Unidentified Justice: --Thank you, Mr. Wallace.

We'll hear now from you, Mr. Cohen.

ORAL ARGUMENT OF I. WILLIAM COHEN ON BEHALF OF THE RESPONDENT

Mr. Cohen: Thank you, Mr. Chief Justice, and may it please the Court:

The Court of Appeals correctly followed the decisions of this Court when it concluded that Section 506(b) of the Bankruptcy Code does not overrule pre-Code law, and that the language of the statute does not provide for the payment of post-petition interest on oversecured, nonconsensual liens.

The decision of the Court of Appeals followed three recent decisions of this Court which focused on the proper rule of statutory construction in this situation.

The normal rule of statutory construction is that if Congress intends for legislation to change the interpretation of a judicially created concept, it makes that intention specific.

Unidentified Justice: Is that true, Mr. Cohen, in a case where you have the Bankruptcy Code of 1978 that really was out to change a whole lot of things?

I mean, that isn't simply like a single law changing an earlier decision.

Mr. Cohen: We believe, Your Honor, that Section 506(b) did codify pre-Code law.

It codified the entitlement of secured creditors to interest if they were consensual secured creditors.

It didn't abrogate--

Unidentified Justice: But that's not how it reads.

What do you do with Mr. Wallace's point that there is no way to read this to codify pre-Code law if you consider these cases standard pre-Code law?

This language, no matter how you read it, requires that interest be provided for in the text of the agreement, and the pre-Code law didn't divide between whether it was provided for in the text or whether it was not, but rather, it divided between voluntary and involuntary liens, whether interest was explicitly provided for in the voluntary lien or not.

Mr. Cohen: --Well, the voluntary lien, Justice, was a lien that would be created by agreement, and the reason that the Section 506(b) adopts the pre-Code law is the rationale behind that was to allow secured creditors only if they negotiated for, only if they bargained for interest to be entitled to interest.

And--

Unidentified Justice: Are you saying the pre-Code law did require that the agreement contain a provision for interest?

Mr. Cohen: --Yes, I am.

Unidentified Justice: Which of those cases say that?

Mr. Cohen: The five court of appeals cases, all the courts of appeal decisions that dealt with the issue of whether or not a tax lien was entitled to interest stated that it was required to be included in the agreement.

All the courts of appeal decisions required that.

The Bass case, the Kerber case--

Unidentified Justice: They certainly have a basis to--

Mr. Cohen: --The Bass case; the Boston and Maine Corporation case, which was a First Circuit case; the Kerber Packing Company Case, which was the Seventh Circuit case; the Harrington case, Fourth Circuit; and the Mighell case, which was the Tenth Circuit.

All cases required a secured creditor to have a provision for interest in his agreement, required him to be a consensual secured creditor in order to be entitled to interest.

Unidentified Justice: --May I ask you, because you seem to disagree with Mr. Wallace on what the pre-Code law was, are the cases that you just called our attention to cases in which the government was making a claim for interest, or are those cases in which a private secured creditor was asking for it?

Mr. Cohen: Always, in all of those cases, the government is making a claim for interest.

The courts of appeals decisions--

Unidentified Justice: Do you have any cases involving private creditors who were claiming interest, and they said... and the court said no, you can't have it because it's not in your agreement.

That's what Mr. Wallace says their cases so hold.

Mr. Cohen: --I'm not aware of any, Your Honor, but I believe that the reason that Mr. Wallace is making the distinction is that he is overlooking the rationale for the decision, the rationale for the requirement that a creditor must be a consensual creditor in order to be entitled to interest.

Unidentified Justice: What is the rationale?

I don't understand.

Mr. Cohen: That in order to be able to share interest, to be entitled to interest before other creditors get paid, you have to have bargained for interest.

The courts universally recognized that if a party did not bargain for interest, he ought not be entitled to it because the result of giving a creditor interest who didn't bargain for it is to deprive all of the creditors below that creditor of their right to share in the distribution.

In most insolvency states, estates, there's barely enough to pay the principal of claims let alone interest, and if the assets of the estate are consumed by the payment of interest, it's likely that there will be no distribution to the creditors below.

Unidentified Justice: Gee, but that doesn't seem to me in accord with what the law usually does.

If I make a contract with you and under that contract money is due on a certain date, and I don't provide in the contract that if you don't pay it on that date you'll have to pay me interest, the law would still give me interest, wouldn't it?

Mr. Cohen: The general rule is that interest stops on the date of bankruptcy, Your Honor.

Interest stops for secured creditors and unsecured creditors, and that's been the law of this Court.

Unidentified Justice: That's what you're telling me.

Mr. Cohen: Yes.

Unidentified Justice: But I'm saying that seems to me contrary, the fact that it has to be spelled out in the agreement and that it's not enough that the agreement is simply consensual, so that it would be an implied term.

Wouldn't it be an implied term of any agreement because the law always gives interest?

Mr. Cohen: No, it is not.

Unidentified Justice: No?

Mr. Cohen: It is not.

Unidentified Justice: --wouldn't say that if they were claiming interest before the bankruptcy petition was filed.

Mr. Cohen: No, because the--

Unidentified Justice: Well, even if it, even if it isn't stated in the agreement, you're going to get interest under the law up til the time of the petition in bankruptcy.

It may be the general rule that after that you don't get interest, but you do before.

Mr. Cohen: --You would only be entitled to interest, Your Honor, if the agreement provided for it, or if a particular statute--

Unidentified Justice: Wait a minute, wait a minute.

Up til the time of the petition.

You mean, you're not going to get interest in bankruptcy unless it's specified in the agreement?

Mr. Cohen: --Only if the agreement provides for it or if a statute gives you interest.

There are many creditors, Your Honor, who do not get interest even up to the date of bankruptcy.

But--

Unidentified Justice: Well, that may be, that may be so, but how... in an ordinary contract case?

Mr. Cohen: --If the statute that created the contract, or the contract between the parties entitled that creditor to interest, he would be entitled to interest up to the date of bankruptcy.

Unidentified Justice: What about a, what about a seller of goods who delivers the goods and the payment is due, and it is not paid, and there's no provision in the contract for interest, and then the buyer goes into bankruptcy, and interest... if you had gone to court, the... no doubt that you would have gotten prejudgment interest.

Mr. Cohen: If the law of the jurisdiction, Your Honor, gave you interest--

Unidentified Justice: Well, it doesn't?

Isn't it... as Justice Scalia asked you, isn't it normally that courts give you interest up to the date of judgment?

Mr. Cohen: --Yes, but it's different here, and the reason that it's different is because this Court has seen fit to say on many occasions that interest stops on the date of bankruptcy.

In the New York v. Saper case this Court--

Unidentified Justice: Well, let's assume in a state, in a state where the law is by judicial decision that in the contract case I gave to you--

Mr. Cohen: --Yes.

Unidentified Justice: --interest accrues up to the date of judgment.

Mr. Cohen: Okay.

Unidentified Justice: Now, surely in a bankruptcy case, wouldn't you... if there hasn't been any judgment, nevertheless, here comes bankruptcy, a claim is filed, wouldn't the claim be allowed if it claimed interest up to the date of bankruptcy?

Mr. Cohen: Yes, up to the date of bankruptcy.

Unidentified Justice: Thanks.

Well, isn't the reason for cutting off interest with bankruptcy a statutory provision rather than judicial decision?

Mr. Cohen: It's a... it was originally a judicial decision, Your Honor.

Originally in the--

Unidentified Justice: But isn't it now... didn't the '78 Code provide by statute--

Mr. Cohen: --It did.

It codified that prohibition against the accrual of interest, and really, the situation that we have today is precisely the same.

The case law developed exceptions to the general rule.

The general rule, as you have suggested, Chief Justice, is in Section 502.

That section says that interest does not accrue after the date of bankruptcy.

The exceptions to that rule were discussed in the case law, and there were three exceptions that were developed as a result of the cases that discussed the issue.

The first exception said that interest was allowed in those estates where the debtor was solvent; where there was enough to pay all creditors both principal and interest, interest was allowed to be paid.

The second exception arose in the situation where the secured creditor was in possession of the collateral, and the collateral earned income after the date of bankruptcy.

In that situation the secured creditor is entitled to interest.

The only exception that the government says applies today is the third exception, and that's the exception that evolved that allowed interest in situations where the collateral exceeded the debt.

But all of the courts of appeal that decided the issue before the adoption of the Bankruptcy Code stated unequivocally that interest is not to be paid to an oversecured tax claimant.

And those are the decisions that we've cited in our brief, and there are a number of reasons for that.

First of all, as an aside, I think it's important to note that the Internal Revenue never asked at the time of the adoption of the Code and at the time of all of the revisions to the Code after that in 1978, never asked that interest be paid on the oversecured claims due Internal Revenue.

Unidentified Justice: --They never asked them.

Mr. Cohen: They have never asked for that.

Unidentified Justice: Congress, asked Congress?

Mr. Cohen: That's correct.

As a matter of fact, they cited, the Commissioner of Internal Revenue cited the Nicholas case.

The Nicholas case stands for the general proposition that interest stops, and it cited the decisions of this Court that interest stops on the date of bankruptcy.

That case specifically referred to New York Saper, and the New York v. Saper case was a case that extended that general rule to tax claims.

That case was cited by the Commissioner of Internal Revenue.

The table of derivation of House Rule 8200 stated that the present law, in reference to Section 506(b), was In re Black Ranches.

Well, In re Black Ranches was an Eighth Circuit Court of Appeals decision which said that interest is payable to an oversecured consensual creditor, not to a nonconsensual creditor.

Unidentified Justice: Consensual creditor or creditor where it's provided for in the agreement.

Mr. Cohen: Yes.

A--

Unidentified Justice: Yes what?

Mr. Cohen: --A consensual creditor is a creditor whose secured claim arises by agreement.

Unidentified Justice: Oh, I have no doubt it arises out of the agreement.

Is it provided for in the agreement?

This case that you're quoting, did this case say that the provision for interest has to be in the agreement, which is how the statute reads?

Mr. Cohen: I am not aware of the answer to that, Your Honor.

Unidentified Justice: Mr. Cohen, let me just be sure... you've cited us the Nicholas case and the Black Ranch case.

Mr. Cohen: Yes.

Unidentified Justice: Are these cited in your brief?

Mr. Cohen: Yes.

They are cited in the amicus brief and, I believe the Black Ranches case is cited in our case.

The Nicholas case is cited in the amicus brief.

Unidentified Justice: But not in yours.

Mr. Cohen: I would have to check, Your Honor.

Unidentified Justice: Does this case involve post-petition interest?

Mr. Cohen: Yes.

Unidentified Justice: Is the government entitled to interest on its claim up until that time?

Mr. Cohen: It's only entitled to interest up to the date of bankruptcy.

Unidentified Justice: But it is entitled to that.

Mr. Cohen: Yes, it is, and it's entitled to interest after the date of confirmation.

And the reason that the law has denied--

Unidentified Justice: So the oversecured, the oversecured creditor is one whose security is greater than the principal plus interest up to the date of the petition.

Mr. Cohen: --Yes.

The reason that the law has denied the government's right to interest after the date of bankruptcy is based on the equitable rule that where the exaction and collection of interest is not fair to other creditors because of the initiation of the insolvency proceeding, in other words, the power to pay, the power to pay the claim is stopped as a result of the bankruptcy proceeding, it unfairly penalizes other creditors because there is rarely enough to pay the principal amount of the claim, let alone interest.

And as I said earlier, the City of New York v. Saper stood for the proposition that this general rule which applied to all claims, secured and unsecured claims, also applied to tax claims.

The three exceptions to the general rule we've discussed earlier, and the five courts of appeals decisions were also discussed.

There is nothing in the statute itself or in the legislative history that reflects an intention on the part of Congress to change the existing law.

Unidentified Justice: Well, how about the placement of the commas?

Mr. Cohen: Well--

Unidentified Justice: Certainly that gives at least a presumption, doesn't it, that--

Mr. Cohen: --Except that this Court, Your Honor, has held on several occasions that punctuation should not be a part of the law, that if the punctuation is confusing, if the punctuation--

Unidentified Justice: --Well, what's confusing about this punctuation?

Mr. Cohen: --If you look at Section 506(b), you see that the last clause in that section, provided for under the agreement under which such claim arose, qualifies the word "interest" just as it qualifies the terms

"reasonable fees, costs or charges. "

Unidentified Justice: Well, but that certainly isn't at all apparent to me just by reason of the placement of the commas.

Mr. Cohen: Well, I realize, Your Honor, that we all read the statute differently, and I also realize that there's no way that the ambiguity in the statute for one person is necessarily going to exist for another person.

Unidentified Justice: No, but our decisions are not based on subjective understandings.

There is supposed to be some general rule as to how one reads an English sentence.

Mr. Cohen: I appreciate that, and the cases have talked about that.

But there were two courts of appeal decisions after the Code that said that that language is ambiguous.

The Sixth Circuit and the First Circuit found the language ambiguous.

Unidentified Justice: But we now have it before us and can determine for ourselves whether it's ambiguous or not.

Mr. Cohen: And that's precisely why we're here today.

The courts have split on this issue.

It's the opinion of many, including legal scholars who have discussed this section, that the language is ambiguous, and as a matter of fact, when you apply the rules of construction that the government asks the Court to adopt today, you find that the cases that have discussed those rules of construction have used language that we have in this case and found exactly the opposite,--

In the Moore case, Justice Brandeis found that language, exactly the same as we have in this case today, should be interpreted in an opposite way.

He said that when you apply a clause to words that would make as much sense if you applied it to all the words as it would if you applied it to just a few words, it should be applied to all of the words.

And in this case, if you applied that principle discussed in the Moore case by Justice Brandeis, you would find that the term "provided for in the agreement" applies to interest as well as fees.

And that's the position that the courts of appeals have said, and that's the position that we believe is the appropriate decision for this Court to make.

The--

Unidentified Justice: Counsel, the government points out that Sections (a) and (c) apply to nonconsensual liens.

I suppose Section (d) does also?

I am not--

Mr. Cohen: --506(d), Your Honor?

Unidentified Justice: --I'm sorry, subsection (a) of 506--

Mr. Cohen: Yes.

Unidentified Justice: --And (c) apply to nonconsensual liens?

Mr. Cohen: Yes.

Unidentified Justice: How about (d)?

I'm not--

Mr. Cohen: I believe it does, yes.

Unidentified Justice: --I believe it... so under your view, only Section (b) applies to consensual liens only.

Mr. Cohen: No.

What I am saying is that 506(b) has to be interpreted in light of the pre-Code decisions.

The pre-Code decisions can be read consistently with this section, and that is that interest is not allowed under the pre-Bankruptcy Code decisions--

Unidentified Justice: Well, how is that different from saying that only Section (b) applies to consensual liens only?

Mr. Cohen: --Well, only Section (c) applies to... I'm sorry.

(b) applies to oversecured consensual liens, and if a lien is oversecured, Your Honor, then it falls within subsection (b).

Subsection--

Unidentified Justice: I understand that, but I simply want to see if it's correct... maybe it isn't... that under your view, the only section, the only subsection in 506 that applies exclusively to consensual liens is subsection (b).

Mr. Cohen: --I'm sorry, exclusively to--

Unidentified Justice: Under your view, subsection (b) applies only to consensual liens, correct?

Tell me if it's incorrect.

Mr. Cohen: --I believe that's correct.

Unidentified Justice: All right.

And that's... and all of the other subsections apply to consensual and nonconsensual Iiens, correct?

Mr. Cohen: I believe so.

Unidentified Justice: All right.

Now, that is somewhat of an anomalous statutory scheme, is it not?

Mr. Cohen: Well, it would be, Your Honor if you were not reading (b) in light of the pre-Code decisions.

So what I am asking the Court to--

Unidentified Justice: Well, but at the outset we look at the words of the statute, and you're telling us that it's ambiguous.

Certainly in the context of the entire section it seems that the government's reading of the statute is eminently plausible.

Mr. Cohen: --It's plausible, but it disregards the prior law, it disregards the fact that there is no legislative history to explain why the law would be changed, and it disregards the rationale for the law which we believe was carried over into the Bankruptcy Code.

We believe that this section should be read to carry over the prior law that existed before 1978.

Unidentified Justice: Why do you need legislative history to show that a change is made?

Congress can surely make a change in a statute without even having a committee meeting, can't it?

Mr. Cohen: It can, Justice Scalia, but when that change is going to be made, there's usually a reference in the legislative history to explain the reason that the change is going to be made.

Unidentified Justice: Sometimes, not always.

Maybe the explanation is simply that the Justice Department didn't like the prior rule, they hadn't acquiesced in the cases, and they, they got to the--

Mr. Cohen: But that's precisely the point I--

Unidentified Justice: --they got to the right Senators or Members of the House and got it changed.

Mr. Cohen: --That's precisely the point I was trying to make a moment ago.

The Internal Revenue Service never requested Congress to make a change.

They specifically cited a case that stood for the proposition that we believe stands for the law that we're asking you to confirm today, and the Justice Department never asked Congress to make a change on this issue.

The reason that they never asked is because they recognized that the law was continued and would continue as it had been pre-Code.

They had asked the courts five times to change the law so that they would be entitled to interest, and in all five times they were rebuffed.

Unidentified Justice: Mr. Cohen, can I get back to the text and ask... my problem with the text is not just the comma, although I do tend to read commas since they are written there.

It's also, it's also the text itself.

What is the... it seems to me there's no utility in repeating the phrase "such claim" unless you mean to separate the meanings the way the government has contended.

That is to say, if the passage meant what you say, why wouldn't it have read, leaving out the comma, there shall be allowed to the holder of such claim interest and any reasonable fees, costs or charges provided for under the agreement?

But it doesn't say that.

It says interest on such claim and any reasonable fees, costs or charges provided for under the agreement under which such claim arose.

I don't see any reason for the first "on such claim".

You know, what else would it be interest on?

Mr. Cohen: There are legal scholars who have discussed that issue, and probably the leading treatise on bankruptcy law is Collier's on Bankruptcy, and he specifically discussed this point.

Collier suggests that the reason for the comma is to interpret this section in a way that would eliminate the right or prevent interest being charged on anything but principal.

There are some contracts that provide that interest can be charged on top of the costs, the fees, and the charges, and it is Collier's interpretation that it was precisely the intention of the crafters in inserting the comma here to make sure that interest would only be included or charged on the claim and not on the other items.

Unidentified Justice: That's, that's a good explanation.

Not just... that's not just the reason for the comma; it's the reason for saying "on such claim".

Mr. Cohen: Correct.

Now, the government suggests that the doctrine of the last antecedent is an answer to the issue if the Court is not satisfied with the grammar, with the construction, or with the placement of the words in the sentence, but the doctrine of the last antecedent, as we have suggested, is nothing but an aid to construction, and the Moore case specifically discussed that same doctrine and came to an opposite conclusion.

We're asking you really not to rely on the comma in interpreting the law, but rather, to look to the law as this Court has interpreted it in other decisions and as five courts of appeal decisions before the adoption of the Bankruptcy Code interpreted it, and as two courts of appeal decisions since the Code was adopted have interpreted that decision.

If there was no pre-existing law, I think that the government's argument would be more persuasive about the rules of statutory construction, but the decisions of this Court which the government overlooks in discussing this issue are diametrically opposed to what they're saying.

The government is saying that there is no precedential value in the prior decisions of this Court, and yet you recently said in United Savings v. Timbers of Inwood that Section 506(b) codifies pre-Code law.

You said in Midlantic v.... in Midlantic National Bank and Kelly v. Robinson that it's presumed that Congress is aware of judicial precedent and that it's a normal rule of statutory construction that if Congress intends to change judicially created concepts that are in existence at the time a statute is adopted, it makes that intent specific.

What the government does in this case is they twist and turn in an attempt to get out from under those three decisions.

They specifically forget that all three cases, the Midlantic case, Timbers of Inwood, and Kelly v. Robinson, dealt with the statutory construction of the Bankruptcy Code, and Timbers dealt with the meaning of Section 506(b).

Unidentified Justice: Mr. Cohen, just so I know what you're urging upon us as the principle we should adopt, you want, you want us to adopt, and you say this is what the pre-Code law was, the principle that if you have a voluntary lien, you can get interest, post-petition interest if, but only if your agreement specifically says I am entitled to interest, and if it doesn't specifically say that, although in a normal lawsuit, outside of bankruptcy, you'd be allowed interest, you can't get it.

Mr. Cohen: Well, I think, Your Honor, that you may be mixing up two concepts.

You talked about an involuntary lien.

I am distinguishing between a consensual lien and a nonconsensual lien.

Unidentified Justice: All right.

I said a voluntary lien, I believe, and if you want to say consensual, that's fine.

It's a consensual lien, right?

Mr. Cohen: Yes.

Unidentified Justice: Pursuant to an agreement in which you lend me... I lend you money or whatever.

Mr. Cohen: Right.

Unidentified Justice: And you would allow... you want us to interpret this language so that post-petition interest would be allowed only if the agreement by which I lend you the money specifically says I'm entitled to interest if you don't pay me the money.

Mr. Cohen: That's correct.

Unidentified Justice: If it doesn't specifically say that, then there would be no post-petition interest.

Mr. Cohen: That's correct, because the general rule is that interest stops on the date of bankruptcy.

It's only the three narrow exceptions that we spoke about in our brief and that the amicus brief addresses, only in those three narrow exceptions that the general rule changes.

Unidentified Justice: Mr. Stein, there's a little bit of a problem with the language under your reading because the interest on such claim, it seems to me, is not necessarily just interest on the principal, but it also could be interest on the principal plus interest that accrued to the date of the petition.

Mr. Cohen: I am suggesting that the language of 506(b) is ambiguous, and that's why we--

Unidentified Justice: What is allowable?

Is it interest on the principal or interest on the amount of the claim at the time it's allowed?

Mr. Cohen: --Interest on the amount of the claim up to the date of bankruptcy.

Unidentified Justice: But it has to be supported by a provision in the agreement that says you get interest on the principal.

Mr. Cohen: It has to be supported by an agreement that says you get interest.

Unidentified Justice: Without saying what it's on?

That would be an unusual agreement.

Mr. Cohen: It would be, Your Honor.

Most agreements specifically define what's... what interest is calculated on.

It's Collier's that made the distinction that that's how it saw the comma, that the comma, was really intended to limit the accumulation of interest only on that portion of the claim that was the claim itself, and not costs and fees.

Unidentified Justice: Does Collier say that the agreement itself must provide for interest, or does he make simply the distinction between consensual and nonconsensual liens?

Mr. Cohen: He says that the precedent suggests that it has to be provided in the agreement.

He believes that the precedent, the pre-Code precedent is the proper interpretation of this section.

Unidentified Justice: Is the person who writes Collier's still named Collier?

[Laughter]

Mr. Cohen: No, he's not, Your Honor.

Unidentified Justice: --J. W. Moore.

Mr. Cohen: Several people who are contributing authors to Collier's.

In the Kelly v. Robinson case, this Court told us that of course the starting point in every case involving construction of a statute is the language itself.

In citing Justice O'Connor, the Court said in expounding a statute, we must not be guided by a single sentence or a member of a sentence, but look to the provisions of the whole law and to its objects and policy.

It's our belief that the objects and policy of this law mandate that the Court looks to the general rule that would deny the payment of interest as of the date of bankruptcy, and only in the three narrow exceptions which the courts have dealt with should the government be seen as a party that potentially would be entitled to interest.

In the face of the confusing comma and the patent ambiguity of Section 506(b), as well as the absence which the government admits of any indication whatsoever that Congress intended, considered or even contemplated changing the case law which had preceded 506(b), we respectfully urge you to look at the pre-Code cases and to continue to make the decisions based upon the reasons that were enunciated in those decisions.

At the very least, the government's--

Unidentified Justice: Mr. Cohen, your time has expired.

Thank you.

Mr. Cohen: --Thank you.

Unidentified Justice: Mr. Wallace, you have two minutes remaining.

REBUTTAL ARGUMENT OF LAWRENCE G. WALLACE ON BEHALF OF PETITIONER

Mr. Wallace: The very first of the pre-Code cases we cite on page 25, In re Kerber, is one in which the court of appeals said that the exception has been recognized by the courts to the extent of allowing post-bankruptcy interest to creditors who are deemed to have bargained for collateral to secure not only the principal obligation but the interest thereon as well.

As the questioning has suggested, the law ordinarily deems that when a payment is due on a certain date and it isn't made on that date, that interest is then implied to the creditor.

Now, this Court's decisions in Midlantic and Kelly quite properly were cautious about affecting areas other than bankruptcy, important areas such as abandonment of property to the detriment of health and safety or obligations to make restitution to victims of crime, which Congress could not have, may not have anticipated.

But here we are dealing with a core bankruptcy matter, and to refuse to give effect to what Congress enacted because of an absence of legislative history is not easy to reconcile with Article I of the Constitution which goes not require legislative history in order for Congress to make a change in the law.

A majority vote in each House and the signature of the President is enough to supersede prior judge-made law.

Unidentified Justice: Mr. Wallace, am I correct that you no more can point for us to a pre-Code case which denied interest on a consensual secured claim because interest was not specified in the agreement than can the other side point to a case which granted it?

Mr. Wallace: I cannot, Mr. Justice.

We locked at--

Unidentified Justice: So that's sort of a standoff.

Mr. Wallace: --at cases which denied post-petition interest to nonconsensual claims and said that they were available for consensual claims.

We were not examining cases that might have distinguished between consensual claims.

The pre-Code law did not have the kind of flat rule that Congress has provided.

The courts were always saying, well, the bankruptcy referee can do what's equitable in the particular case.

So all of the--

Unidentified Justice: Thank you, Mr. Wallace.

Mr. Wallace: --rules were malleable.

Chief Justice William H. Rehnquist: The case is submitted.

Attribution:

The OYEZ Project

Featured:

United States v. Rodgers - Oral Argument

Wed, 18 Feb 2009 07:11:16 +0000

Case:

United States v. Rodgers

Media File:

81-1476_19821206-argument.mp3

Related Transcript:

81-1476_19821206-argument_transcript.xml

Transcript:

ORAL ARGUMENT OF GEORGE W. JONES, ESQ., ON BEHALF OF PETITIONERS

Chief Justice Burger: We will hear arguments next in United States against Rodgers.

Mr. Jones... Do we have someone missing here?

Mr. Jones: No.

Chief Justice Burger: Mr. Jones, I think you may proceed whenever you are ready.

Mr. Jones: Mr. Chief Justice, and may it please the Court, broadly stated, the controlling issue in these cases is whether the homestead rights of a delinquent taxpayer's spouse preclude enforcement of a federal tax lien against the delinquent taxpayer's interest in the homestead property.

The Internal Revenue Service made substantial tax adjustments... tax assessments against Respondent Rodgers' husband as well as the husband of Respondent Ingram.

This litigation arises from the government's efforts to collect those taxes.

The pertinent facts are undisputed.

Respondent Rodgers and her former husband, Philip Bosco, were married in 1937.

In 1955, they purchased the real property involved in this case.

The property was community property, and Respondent and her husband claimed the property as a homestead under Texas law.

In 1971 and 1972, the Internal Revenue Service made assessments against Philip Bosco in excess of $900,000 for federal wagering taxes.

Bosco died in 1974.

The assessed taxes remain unpaid.

Respondent Rodgers remarried, and she now occupies the property with her new husband.

The government filed this action in the United States District Court for the Northern District of Texas, seeking to reduce its assessments against Bosco to judgment to enforce the liens, the tax liens against any property belonging to Bosco, and to secure a deficiency judgment for any unpaid tax liability or unsatisfied tax liability.

In the other case, Respondent Ingram and her husband, Donald Ingram, acquired real property during their marriage that they claimed as a homestead.

As in the Rodgers case, the property was community property.

In 1972 and 1973, the Internal Revenue Service made assessments against Donald Ingram for unpaid taxes withheld from the wages of the employees of a company of which Donald Ingram was the president.

The unpaid balance of the assessments is about $9,000.

In connection with their subsequent divorce, Donald Ingram conveyed his interest in the homestead properties to Respondent Ingram.

After unsuccessfully attempting to dispose of the properties, Respondent Ingram and the trustee for the properties filed this action against the United States and several other Ingram creditors in state court to quiet title to the property and to remove any liens encumbering the property.

The United States removed the action to the United States District Court for the Northern District of Texas, and filed a counterclaim seeking enforcement of its tax liens.

Donald Ingram was added as a defendant on the government's counterclaim.

Without explanation, the district court refused to enforce the tax liens in the Rodgers case, but the same court enforced the tax liens in the Ingram case.

On appeal, the two cases were consolidated for oral argument.

The court of appeals held that because the homestead interest of a spouse is characterized as a property interest under Texas law, the government cannot enforce its tax lien against the homestead property while the delinquent taxpayer's spouse chooses to maintain her homestead interest in the property.

Accordingly, the court affirmed the judgment for Respondent Rodgers in pertinent part and reversed the judgment for the government against Respondent Ingram in pertinent part.

The questions in these cases are matters of statutory interpretation.

The relevant provisions of the Internal Revenue Code are Section 6334, which exempts certain classes of property from the reach... from levy for federal taxes, Section 6321, which creates a lien against all property belonging to a delinquent taxpayer and in favor of the government, Section 7403, which provides for a civil action to enforce a tax lien against any property in which a delinquent taxpayer has any right, title, or interest.

Except for the very narrow exemptions set out in Section 6334, all of the delinquent taxpayer's property and rights in property are subject to levy to satisfy federal tax liens, federal tax claims.

Homestead property is not mentioned in Section 6334, nor does any other federal statute purport to exempt such property from federal tax claims.

State laws exempting property from the claims of private creditors are wholly ineffective against the federal government.

The Internal Revenue Service's regulations are quite explicit on this point.

No provision of a state law may exempt property or rights to property from levy for the collection of any federal tax.

Thus, property exempt from execution under state personal or homestead exemptions... exemption laws is nevertheless subject to levy by the United States for collection of its taxes.

Under Section 6321, the United States has a lien on all property and rights to property belonging to any person who fails to pay his taxes after appropriate demand.

Whether the taxpayer--

Unidentified Justice: Let me get the government's position straight.

I don't think any of us question the susceptibility of a homestead to the enforcement of a federal tax lien, but is it the government's position that if the delinquent taxpayer owns any interest in a homestead, any partial interest, that it may proceed to sell the entire homestead?

Mr. Jones: --Our position is that Congress has authorized the Attorney General to file suit against any property in which the delinquent taxpayer has an interest, and our position is that there may be circumstances, not present here, in which it would be appropriate to sell only the delinquent taxpayer's interest, but where that can't be done, the government is entitled to sell the entire property with division of the proceeds as the means of accommodating the interest of any other parties who have interest.

Unidentified Justice: So that here you would, in effect, sell the homestead under Mrs. Rodgers, who continued to occupy it, and who under state law had the right to occupy it for the balance of her lifetime.

You would in effect evict her and give her her share of the proceeds?

Mr. Jones: That's essentially correct.

Unidentified Justice: Well, essentially?

Isn't it correct?

Mr. Jones: That is absolutely correct.

Unidentified Justice: Now, then, let me ask you this.

Suppose your delinquent taxpayer is a person who holds a mortgage on my property, and the government moves in to enforce the lien, the tax lien on the mortgage.

Does that mean that it can sell my property?

Mr. Jones: Well, I am not clear that the mortgagee's interest in your property would be sufficient for the government's tax lien to attach.

Unidentified Justice: Well, it is an interest in property.

It is an interest in my homestead property, isn't it?

Mr. Jones: Well, if it is, Congress has said that under Section 7403, the government may proceed against any property in which the taxpayer has an interest or in which the government has a lien.

Now, the district director or the Secretary certainly may take into account your interest in the property or any other interest in the property in determining whether to proceed against the property by means of foreclosure under Section 7403 or by administrative levy, but once the district director or the Secretary of the Treasury has made that determination, Congress has provided for enforcement of the tax lien.

Unidentified Justice: Well, I am just suggesting that I think the ultimate... your argument taken to the ultimate conclusion means that they can sell my property in order to foreclose the lien on the mortgagee's property.

Let me put it another way.

Suppose that my next door neighbor has an easement over my homestead property, and he is delinquent in taxes.

May the government foreclose on his easement and hence sell my property?

Mr. Jones: Well, the easement might be marketable independent of the property, and it might be permissible to attempt to sell the easement without selling your property as well.

Unidentified Justice: Well, isn't that in fact what the government does, is sell the interest of their holding of the easement?

Mr. Jones: Where that is possible, where there is a separate market for the property, the government may indeed decide to proceed in that manner.

Unidentified Justice: Why can't the government in this case sell Mr. Rodgers' interest, Mr. Rodgers' estate's interest in the homestead, which is basically an interest that will become possessory after Mrs. Rodgers either dies or gives up the homestead?

Mr. Jones: The reason is that there is no separate market for Mr. Rodgers' fractional interest--

Unidentified Justice: Well, how do you know that?

If Mrs. Rodgers is elderly, and isn't going to live long, and the property has substantial value, how can you say there is no interest?

Mr. Jones: --Well, I said there is no separate market for a fractional interest of the sort involved in this case.

The sale--

Unidentified Justice: You just told me that that is not the government's position, that you want the whole bundle of was.

You want to sell the whole homestead, and give her her share of the proceeds.

Mr. Jones: --Well, this case is quite different from the hypotheticals you posed, because under Texas law community property under the joint control of both spouses is subject to the claims of creditors of either spouse for debts incurred during the marriage, and therefore our position is that Mrs. Rodgers isn't entitled to any part of the proceeds in this case.

Unidentified Justice: Well, under Texas law, Mr. Rodgers, while he lived, could not sell that homestead.

Correct?

Mr. Jones: That's correct, without Mrs. Rodgers' consent.

Unidentified Justice: Consent.

Why should the government in asserting its lien against him for delinquent taxes have any greater right than he had?

Mr. Jones: Because in enforcing its lien, the government doesn't simply step into the shoes of the delinquent taxpayer.

Unidentified Justice: Well, then again I say, the government wants the whole hog.

It wants to sell the property out from under Mrs. Rodgers' life occupancy.

Mr. Jones: Justice Blackmun, the government's position is only that Congress decides what property is exempt from levy.

Congress has not provided an exemption for homestead property.

Under the facts of this case, Mrs. Rodgers is being denied nothing that she is entitled to.

Unidentified Justice: You say that the government, though, doesn't simply stand in the shoes of Mr. Rodgers.

Whose shoes does it stand in?

Mr. Jones: The government is entitled to the rights Congress has provided.

Under Section 7403--

Unidentified Justice: What rights has Congress provided other than the rights that belonged to Mr. Rodgers, against whom the lien--

Mr. Jones: --Well, Congress created a lien on the property for the payment of the taxes, and under Section 7403, the government is entitled to enforce that lien by forcing sale of the property and division of the proceeds in accordance with the respective interests of any other parties who have claims against the property.

Unidentified Justice: --What is your definition of the word "property"?

The husband's interest or the entire fee?

Mr. Jones: Well, state law defines--

Unidentified Justice: Apart from state law, what is your definition of the word "property" in the federal statute?

It is the husband's interest, isn't it?

It has to be.

Mr. Jones: --I am not sure I understand the question.

State law says that the husband had a property interest, and the court of appeals held that each of the delinquent taxpayers in these cases had an undivided one-half interest in the property.

In addition, however, under Texas law, community property is subject to the claims of creditors for debts incurred during the marriage.

It appears therefore that in Texas both spouses have a sufficient property interest in all community property to subject it, the property to the claims of any creditors of either one of them.

To further answer Justice O'Connor's question, where there is no interest, or no separate market for a fractional interest, both the taxpayer and the government would be harmed or suffer detriment by attempting to sell just the fractional interest.

Unidentified Justice: What if you have A and B, tenants in common under state law, not related by marriage or otherwise, and the law of the state is that one tenant in common cannot force another tenant in common to sell the property.

All you can do is sell your interest.

And the government has a tax claim against A.

Do you think under the statute that you are claiming under that the government can force both tenants in common to sell the property, to sell the physical property rather than just the tenancy in common interest of the one against whom it has a tax lien?

Mr. Jones: If there were a separate market for A's half of the property, then there wouldn't be any need to sell both interests, but if there wasn't, the government would be entitled to have the entire property sold and division of the proceeds in accordance with the interests of A and B.

Unidentified Justice: So it is almost a separate inquiry in each one of these cases whether there is a separate market, as you put it?

Do you find that in the statute somewhere?

Mr. Jones: No, the focus of the 1936 amendments was on providing... amendments to Section 7403 was on providing an effective remedy for foreclosure against personal property, and Congress--

Unidentified Justice: Can I interrupt you?

To put this on a little broader proposition... I guess some of the other questions the same way... in the Rodgers brief at Page 18, they rely on a rather broad principle that the collector has rights no greater than those of the taxpayer whose rights to property he seeks to foreclose on, that you can't go beyond the shoes of the taxpayer in fact, and you didn't respond to that in your reply brief.

I just wonder if other than this case, has the government ever asserted a greater right than the taxpayer himself could have asserted?

Mr. Jones: --Well, I don't know how many cases.

There is at least one.

In Herndon, the government levied on homestead property even though under the law of the state the taxpayer would have no right to sell his interest in the property without the consent of his spouse.

The government in enforcing a lien exercises the rights Congress has provided.

It is not an assignee of the taxpayer.

And contrary to the suggestion of the Fifth Circuit in the case of Folsom, the government is not obliged to first acquire the taxpayer's interest and then attempt--

Unidentified Justice: Let me change my question just a bit.

Herndon was another homestead case.

Mr. Jones: --Right.

Unidentified Justice: Which we didn't review.

And the question here is, what are the government's rights in a homestead context.

And I am asking outside of the homestead context, is there any precedent for the government asserting a greater right, greater property right than that of the taxpayer against whom the government seeks to foreclose.

Or of... and take that... go beyond the government in a tax situation.

Any lienholder having a greater right than the property right of the lienee.

In any context.

Mr. Jones: It is somewhat difficult to answer that question, because the rights of a lienholder would be, except for the federal government, would be determined by state law, and that would depend of the law of the particular state in which the lien is asserted.

Unidentified Justice: I just wanted to give you a broader range.

Let's leave it then with the government.

Any time the government has done this.

Mr. Jones: I am not aware of any circumstances where the question has come up, but it is fairly well established that state exemptions don't provide any obstacle to the government's attempts to enforce its tax liens.

Here, there is assertedly a joint owner of the property.

The government is attempting to enforce its lien against the property interest of the delinquent taxpayer.

In order to do that, the entire property must be sold, because, as I mentioned before, there is no separate interest or separate market for the homestead property which a tax sale purchaser couldn't do anything with under state law.

Unidentified Justice: That brings me back to my easement hypothetical.

Mr. Jones: Well, for an easement, there... an easement, as I remember from law school, may well be of value to individuals other than the person holding it, and they are transferrable, unless there is a limitation in the document granting the easement, and it may well be that an easement can be sold without interfering with your interest in the property at all.

Unidentified Justice: And if it can't?

Mr. Jones: And if it can't--

Unidentified Justice: You are driven right back to Justice Rehnquist's inquiry.

But you can never keep any more than the value of the easement.

Mr. Jones: --That's right.

Unidentified Justice: Which may not be very much.

If you can't sell it, it is not worth anything.

Mr. Jones: That is absolutely right.

Unidentified Justice: But you probably wouldn't be selling the property anyway.

Mr. Jones: True, and all of those factors are--

Unidentified Justice: Well, if you can't keep any more than the value of the easement in the Rodgers case, you couldn't keep any more then than the value of Mr. Rodgers' estate's interest.

Mr. Jones: --That is--

Unidentified Justice: Which you have asserted is very small.

Mr. Jones: --No, there is a difference, I think, between saying that a property... that a particular fractional interest is unmarketable because no one would be willing to buy it and saying that the taxpayer's interest is without value.

Here, it is clear beyond any question that both of the delinquent taxpayers had an undivided one-half interest, 50 percent interest in the homestead property.

In addition, and just as to that, the... well, and in addition, the Rodgers homestead is estimated to be worth about $150,000, so the government is entitled to at least 50 percent of the proceeds of any sale.

Our point is that attempting to sell Mr. Rodgers' one-half interest that a tax sale purchaser couldn't do anything with until Mrs. Rodgers decided to abandon the homestead or for some other reason terminated, because nobody would be interested in buying this one-half interest, or at least there is no established market for it, because of the limitations on its use, we say that the only way the government and the interests of the taxpayer can be served is by selling the entire property and dividing the proceeds among the respective claimants to the property.

And it is our position that that is the accommodation Congress intended under the circumstances of this case, or these cases.

The Fifth Circuit has taken the position that under 7403, the only thing that can be sold is the taxpayer's interest in the property.

Every other court of appeals that has considered that question has rejected the Fifth Circuit's position.

The Fifth Circuit's reading of 7403 is based, we submit, on a misapprehension of the rights of the government under 7403.

The Fifth Circuit--

Unidentified Justice: Are you speaking of the Folsom case?

Mr. Jones: --Excuse me?

Unidentified Justice: Are you speaking of the Folsom case?

Mr. Jones: Yes.

Unidentified Justice: Of course, the Folsom case isn't before us.

Mr. Jones: That's right, but in this case the court of appeals--

Unidentified Justice: It may well be wrong if it had come here.

Mr. Jones: --And in this case, the court of appeals adopted the exact... exactly the same reasoning, and applied it in this case.

Unidentified Justice: Except you have different facts.

You have homestead interest as distinguished from a tenancy in common, as I understand the Folsom case was.

Mr. Jones: That's right.

But it is well settled that state laws exempting property from the claims of private creditors are simply ineffective against the federal government.

So this case in pertinent part, the facts in this case, the relevant facts in this case are no different from Folsom.

What you have are joint owners of property, one of the joint owners being a delinquent taxpayer, and the question is to what extent the government is entitled to sell the interests of the non-delinquent taxpayer in order to maximize the return of the sale or the proceeds of its sale to the benefit of both the government's tax collection efforts and the interest of the taxpayer in satisfying his tax liability.

The court of appeals in this case focused on the non-delinquent taxpayer's interest in the property.

According to the court of appeals, if the delinquent taxpayer's homestead rights are characterized as property rights under state law, the government cannot enforce a concededly valid lien against the property until the delinquent taxpayer's spouse decides to abandon his homestead.

Whatever the amount of the taxpayer's liability, and however valuable the property, the government is, according to the Fifth Circuit, powerless to enforce its lien against the property.

We submit that this Court's decisions establish the proposition that if the delinquent taxpayer has an interest that constitutes property under state law, the federal lien attaches, and the lien is enforceable under 7403.

The--

Unidentified Justice: The question here isn't whether the lien is good.

The question is, when can it be enforced.

Mr. Jones: --Whether it is enforceable.

Here, the--

Unidentified Justice: No, no, not whether.

It ultimately and inevitably will be enforced.

The lady has, under state law, has a life estate in the property.

She has got the right to occupy it during her lifetime.

When she dies, the lien will still be good, won't it?

Mr. Jones: --Well--

Unidentified Justice: And if she wants to sell it, the lien will have to be satisfied.

Mr. Jones: --It is not clear that that is true but--

Unidentified Justice: Why isn't that true?

Mr. Jones: --Well, there's--

Unidentified Justice: Is anybody suggesting that the lien is invalid here?

The lien will have to be satisfied up to his share of the value of the property.

Mr. Jones: --Well, whatever that is, but--

Unidentified Justice: Well, that is all you can get anyway.

Mr. Jones: --That's right.

There are some... The court of appeals recognized that the delinquent taxpayers here owned at least 50 percent of the property.

The other question is, how much more than that the government is entitled to.

But although the court of appeals purported to... how much... under state law, whether his rights in the community property are sufficient to constitute property, and whether the government's tax lien would attach to the entire property because of the rights accorded--

Unidentified Justice: It would attach to the entire property, but you... if you were allowed to foreclose this lien, all you would get to satisfy your lien is the value of his interest in the property.

Mr. Jones: --That's right, and although the court of appeals purported to leave open the possibility that at some point the government might be allowed to enforce its lien, there is no guarantee that the value of the liens won't be substantially eroded in the meantime, and furthermore, the liens might be lost altogether, either because the government fails to keep track of this woman, the taxpayers' spouses, or fails to keep track of the proceeds of any disposition of the properties.

Unidentified Justice: Well, if you filed... if you actually recorded your lien, anybody who is going to buy that property is not going to... they are either going to pay a lesser price if the property is going to be subject to the lien, or they are going to insist on its being satisfied so they can get clear title.

Mr. Jones: That is true, but it is not quite clear how... which of those alternatives would be pursued, and whether the government would ever be paid without reasserting its rights.

The court of appeals suggested that the lien attached to the homestead, and that the homestead rights of the spouse would continue to protect the homestead from enforcement of the lien for as long as Mrs. Rodgers maintained the homestead, even if she maintained her homestead by substituting another property, okay, or selling this property and then investing the proceeds in something else.

Unidentified Justice: Does the homestead interest attach in Texas law to the property acquired in substitution for the original homestead property?

Does the homestead roll over into the new property?

Mr. Jones: That is what the court of appeals said, and--

Unidentified Justice: What is your view of Texas law on that point?

Mr. Jones: --I have no basis for disagreeing with that assertion by the court of appeals, and that is not a question... that is no anything to question--

Unidentified Justice: Well, the court of appeals didn't rule that if there was a substitution, that your lien would have to attach to the substituted property.

They didn't say you couldn't collect on your lien right then, did they?

Because there was no occasion to rule on that.

Mr. Jones: --That's right, and that's why I was not quite as sanguine about the possibilities of the government collecting upon the sale.

Federal tax liens are enforceable against all of the delinquent taxpayer's property.

Congress has provided for the sale of any property in which the delinquent taxpayer has an interest and for division of the proceeds as the means of accommodating the interest of any co-owners of the property.

Unidentified Justice: Mr. Jones, suppose the taxpayer had the fee interest in a piece of property, and he gave his wife or someone else a life estate in the property, and thereafter the lien attached.

Could you evict the life tenant?

Mr. Jones: For purposes of selling the property?

Unidentified Justice: Correct.

Mr. Jones: I think so.

Unidentified Justice: You think you could evict the life tenant?

Mr. Jones: Subject to division of the proceeds for whatever value the life estate would have had.

Unidentified Justice: Even though the fee owner could not have evicted the life tenant.

Mr. Jones: That's right.

Unidentified Justice: I imagine you had a little difficulty finding any cases that hold that.

Mr. Jones: Well, Congress has provided for the means--

Unidentified Justice: I understand.

Mr. Jones: --of accommodating the interests of any people who have interest in the property other than the taxpayer.

Unidentified Justice: This is a life estate case, isn't it?

Among other things, a homestead interest entitles a person, the lady in this case, to occupy the property for her lifetime.

Mr. Jones: It is not precisely a life estate case, because--

Unidentified Justice: Well, I know it isn't precisely, but she has an interest during her lifetime that her heirs will not have.

Mr. Jones: --Right, for so long as she chooses to use it, and she could move and abandon it.

Unidentified Justice: She has both a life estate and a 50 percent interest in the remainder, whereas in my case she didn't even have the 50 percent interest in the remainder, is the only difference.

Mr. Jones: Well, in order to maintain her life estate in the property, she has to continue to occupy the property.

Unidentified Justice: She has to stay there.

Mr. Jones: So it is different in that respect.

Chief Justice Burger: Mr. Elliott?

ORAL ARGUMENT OF WILLIAM D. ELLIOTT, ESQ., ON BEHALF OF RESPONDENTS RODGERS, ET AL.

Mr. Elliott: Mr. Chief Justice, and may it please the Court, in this case, the government takes the awesome position that the property of one may be used to satisfy the tax liability of another.

To this claim, we make two arguments.

First, there can be no foreclosure of the separate homestead property because in Texas it is indivisible, it is individual to her, and it is indefeasible during her lifetime or until her earlier voluntary relinquishment.

Secondly, that the district court's judgment not ordering foreclosure in the Rodgers case should not be disturbed here, because the government has made no claim of abuse of discretion, and hasn't even attempted to overturn that finding on that ground.

Since the Congress defined the source from which tax liability may be enforced, that is, property and rights to property of the taxpayer, it is clear here that the government is simply attempting to attack and utterly destroy the property of someone else.

It is imperative that we examine not only the property and rights to property of the taxpayer here, the deceased husband, but similarly we must examine those property interests of others who would be affected or who own individually property that doesn't belong to the taxpayer.

In Texas, it has been a venerable policy for over 100 years, Texas constitutional law since 1876, and statutory law for many years before that, that each spouse is entitled to use and possess the homestead for as long as they want to or until their death.

Unidentified Justice: That is an interest over and above a half-interest in the property, as Justice Stevens indicated.

Mr. Elliott: Yes, it is, Justice White.

It is important to understand the peculiar nature of the Texas homestead law.

In fact, homesteads originated in Texas.

Each spouse can own a community one-half interest in the home, or one spouse may own it all as separate property.

But each spouse is given a separate property right, a homestead right, to use and possess, as that term is defined in the Texas Constitution, for their entire life.

Unidentified Justice: Now, under Texas law, I suppose the survivor needn't even live on the homestead in order to preserve it, but could rent it out to others.

Mr. Elliott: That is correct.

Abandonment of the homestead--

Unidentified Justice: And still maintain the homestead.

Mr. Elliott: --That is correct.

Abandonment of the homestead does not occur even in those situations where there is a rental.

Unidentified Justice: What if it is sold?

Mr. Elliott: It is abandoned.

Unidentified Justice: That is an abandonment, if it is sold?

Mr. Elliott: Yes.

It is a voluntary relinquishment.

Whether she leaves the home with no intention to return or sells it, it is a--

Unidentified Justice: And if there is a divorce, it is terminated.

Is that right?

Mr. Elliott: --Yes, but the terms of the property settlement agreement have a bearing on it, and each spouse... for example, in the Woods case, the Texas Supreme Court, the Texas Supreme Court there held that each spouse has an indivisible, individual, both, property right in this homestead, and in that case the husband was claiming that even though he had had a divorce, and even though his children had left the home, he was still entitled as a spouse of the marriage to continue in that homestead for as long as he lived, and the Texas Supreme Court in 1929 said, yes, clearly, this property right, this homestead right is his.

In this case, we are claiming it is hers.

And the fact that her husband died, or if he had gotten a divorce from her, it makes no difference.

It is her property right.

And it is that which the government seeks to foreclose.

Unidentified Justice: How do you distinguish the joint tenancy?

Mr. Elliott: Right of possession, Justice White.

In all those cases that the government claims are inconsistent, Folsom, Trilling, Washington, Kosher, they all involve joint tenancy cases where the taxpayer has a right of possession.

Here, the taxpayer is deceased.

His heirs cannot compel the non-taxpayer spouse to leave the property, nor do they have any right to possess it with her.

What they have is simply a remainder in one-half.

That will become possessory upon her death or voluntary relinquishment.

Therefore, it is unnecessary for this Court to consider the alleged conflict in Folsom and the other circuits.

Unidentified Justice: Is that the same with undivided interests, other undivided interests in property?

Mr. Elliott: Yes, sir.

Unidentified Justice: Tenants in common?

Mr. Elliott: Yes, sir.

Unidentified Justice: And you say it is the peculiarities of Texas homestead law.

I suppose if they had the same provisions with respect to some other estates on joint tenants, that each party... they gave the same rights to each of the... What if a joint tenant has died?

Mr. Elliott: Who would be the taxpayer, Your Honor?

Unidentified Justice: Well, the taxpayer... the joint tenant dies when he is a taxpayer.

He owes some taxes when he dies.

Mr. Elliott: Then Section 7403(c) would entitle the district court to have the equitable discretion to compel foreclosure or not, as it chooses to do so.

Unidentified Justice: Well, the taxpayer no longer has a right to possess.

Mr. Elliott: His heirs would.

Unidentified Justice: Under a joint tenancy, with right of survivorship?

No, no.

Mr. Elliott: I didn't understand you to say right of survivorship, Your Honor.

I understood you to say joint tenancy.

Unidentified Justice: Well, I say a joint tenancy with a right of survivorship then.

Mr. Elliott: In that situation, that interest expires and the survivor takes the property.

Unidentified Justice: Yes, but it was subject to a lien.

Mr. Elliott: That's true.

Unidentified Justice: You wouldn't say that the lien is destroyed, would you?

Mr. Elliott: No, but the underlying property that supports--

Unidentified Justice: So you say your rationale is going to support... you get the same result in joint tenancy with a right of survivorship as you will in this case.

Mr. Elliott: --That's right, Your Honor, and we would also have the same result in a tenancy by the entirety.

Unidentified Justice: Well, then there is a conflict among the circuits.

Mr. Elliott: Yes, there is, Your Honor.

It is clear that the Fifth Circuit is taking a position different from the other circuits, but we are not relying on the Folsom decision.

We don't believe that the Folsom decision was central to the Fifth Circuit's opinion.

Unidentified Justice: Well, most joint tenancies are with right of survivorship, and so you are really talking about that category of cases, too, as well as homesteads.

Mr. Elliott: Yes, Your Honor, it would be included within that category.

Unidentified Justice: And tenants of entirety?

Mr. Elliott: Yes, Your Honor.

Unidentified Justice: Mr. Elliott--

--Is that really correct?

Because during the lifetime of the joint tenants, is it not true that the taxpayer would have had the right to sell and have a partition of the proceedings in the event of a dispute with the joint owner?

Mr. Elliott: As I understand property law in other states other than Texas, a tenant in common would have the right to compel partition because he has the right to possess.

Unidentified Justice: Well, that is true of joint tenancy, too, isn't it?

Mr. Elliott: But with the right of survivorship, I am not sure that is the law, Your Honor.

I understand it to be that the right of survivorship does not compel one of the tenants--

Unidentified Justice: How about before the death of the taxpayer?

They are joint tenants and own property.

You are suggesting that neither one of them could compel the sale in the event of a dispute between them?

Mr. Elliott: --We don't have Texas law that is as active in the survivorship area as other states, so I am speaking without a great familiarity with the total command of the survivorship rule, but I understand it to be that neither spouse can sell the property because of the survivorship feature without the consent of the other.

Unidentified Justice: Or without a partition proceeding?

Mr. Elliott: If it is jointly agreed to, Your Honor, yes.

Unidentified Justice: It has to be jointly agreed to in a joint tenancy situation?

Mr. Elliott: With right of survivorship, I understand that to be the case.

It is certainly the case in Texas homestead law applicable here.

Texas law is absolutely clear that neither spouse can partition, sell, or affect the other spouse's interest in the homestead without that spouse's consent, and here--

Unidentified Justice: I understand the homestead, but--

Mr. Elliott: --This Court has said, Aquilino, and Durham Lumber Company, and Busse, authored by Justice Brennan, that this Court must examine the rights defined by the states that the taxpayer has in the property, and only then will we attach consequences federally defined to those state interests.

Here, we think this case is very analogous to the Durham Lumber Company decisions and the Aquilino decisions.

There, the taxpayer was a general contractor who was owed money allegedly from the owner of the building.

He owed, in turn, subcontractors who claimed the property as well.

This Court held in both instances, in Durham Lumber Company and Aquilino, that under state law, having examined it, that the relative states, New York and North Carolina, did not give the owner, the taxpayer... I mean, the general contractor, the taxpayer, any property or rights to property in that chosen action owed from the owner.

In fact, under state law, the subcontractors had a superior, either direct right of action against the owner for that money or in the other case, the general contractor held it in trust.

In both case, this Court held that because the general contractor taxpayer, the IRS could not enforce its tax lien against it.

Only after the subcontractors claims were fulfilled could the IRS collect its money from the, in essence, excess chosen action.

That is analogous to the situation here.

We have another related party, the spouse.

Her interest is individual to her.

Only after her interest expires through death or voluntary relinquishment may the government enforce its lien.

Unidentified Justice: --Why couldn't, under your theory, the government at least try to market the non-possessory interest of the taxpayer, sell it and use the proceeds of that sale to satisfy its lien?

Mr. Elliott: They could, Your Honor.

They have not sought to do so.

Well, in that case they would just selling the lien.

They would be selling the future possessory interest in one-half of the community, Your Honor.

Unidentified Justice: Well, you don't suggest at all that... nothing in your position would indicate that the lien is invalid?

Mr. Elliott: Oh, not at all, Your Honor.

Unidentified Justice: Or that it would ever become invalid?

Mr. Elliott: The lien attaches to his interest in the underlying homestead, which is--

Unidentified Justice: And it is going to be collectable no later that the end of her life.

Mr. Elliott: --She is 70 years old, and it will be, you know, her life expectancy is soon.

Unidentified Justice: Or when she sells it, You say that--

Mr. Elliott: Or abandons it, Your Honor.

Unidentified Justice: --Or abandons it.

Mr. Elliott: She could swap homestead, to answer your question, Justice O'Connor, and would lose the protection we are seeking here.

Unidentified Justice: If she swapped.

Mr. Elliott: Yes, Your Honor.

Under Texas law--

Unidentified Justice: But she would have a homestead in the substitute property?

Mr. Elliott: --That's exactly right.

Unidentified Justice: But it wouldn't be protected against this lien.

Mr. Elliott: That's right, because her second homestead would not have arisen prior to the attachment and assessment of the tax.

In this case, she acquired the homestead in 1955, certainly long before the tax lien arose.

Unidentified Justice: And you are saying that there is nothing here that will defeat the federal government's right to collect the tax.

It merely is deferring the date, deferring the time.

Mr. Elliott: That is precisely what we are saying, Your Honor, Mr. Chief Justice.

Unidentified Justice: What is the interest these days on federal delinquent taxes?

Mr. Elliott: I think they just lowered it to 16 percent, Your Honor.

It was 21 percent last year.

Unidentified Justice: Mr. Elliott, what about Mr. Rodgers, the second husband here?

Does he have a homestead interest in the property?

Mr. Elliott: He does, but it is subject to this federal tax lien, Your Honor.

Unidentified Justice: Subject to the lien.

Mr. Elliott: Yes, sir.

In this case, there have been various courts of appeals that have considered these cases involving one taxpayer liable but a homestead affecting two states... affecting both spouses.

There is a consistent patter, we think, in all of these decisions.

There are not the Folsom line of cases.

These are those other cases, such as Herndon, Hershberger, Hefron, Weitzner; in all those cases the courts of appeals have exhibited a consistent theme: does the state give the non-taxpayer spouse a property right, as we have in Texas, as Hershberger sought in Kansas, or is it simply an exemption form creditors, as the Fifth Circuit witnessed in Weitzner?

We suggest that that is the proper rule.

As this Court said repeatedly, as we pointed out earlier, Busse, Durham Lumber Company, and others, it is a proper balance, a logical and sound position to rely on the state law and what is that law insofar ad the taxpayer is concerned, and then attach consequences federally defined.

All of those decisions, even the Herndon decision, allowed the wife to live on the property for the remainder of her life if the wife was given a property right.

Unidentified Justice: Well, let's go back to the joint tenancy with right of survivorship.

You say the law of Texas is that the one joint tenant can't force the sale of the property and the partition.

Mr. Elliott: Yes, Your Honor.

That is my understanding.

Unidentified Justice: Suppose both joint tenants are alive.

The government has a tax lien on the property by virtue of the unpaid taxes of one of the joint tenants, and it wants to foreclose.

May it?

Mr. Elliott: No.

Unidentified Justice: So you are talking about not only where a joint tenant is deceased, but at any time there is a joint tenancy with right of survivorship, the government may not foreclose on the property.

Mr. Elliott: That's correct, because the underlying property interest, Justice White, expires.

It does no longer exist after the death of the first spouse to die.

Unidentified Justice: Well, certainly there are a lot of... there are plenty of cases, aren't there, or maybe not so many, that so permit the government to foreclose during the lifetime of one of the joint tenants.

Mr. Elliott: Section 7403 (c) gives the district court the power compel foreclose in those cases where the taxpayer and the non-taxpayer share an interest in the property.

We contend that Section 7403 does not apply because there is no joint interest here.

The wife, or the interest of the--

Unidentified Justice: Well, talk about the joint tenancy.

I don't understand now.

May the government foreclose to collect its taxes where there is a joint tenancy and a right of survivorship?

Mr. Elliott: --It would be our view that if under state law first spouse to die's interest in the property expired and extinguished and became defeasible on his death, then no, because his property--

Unidentified Justice: All right, but how about during his lifetime?

That is what I to know.

Mr. Elliott: --Yes, they would be empowered to foreclose, Your Honor.

Unidentified Justice: Even though the joint tenant who owes the taxes could not force a sale of the sale of the property?

Mr. Elliott: Yes, but the interest of the government would also expire on the death of the taxpayer.

The underlying property interest to which the lien attached is all that the government gets, and it gets no more than that.

And for the government to be able to take a possessory interest in this survivorship property, and have it continue beyond the life of the joint tenant, means that the government's property interest is stronger than that of the underlying fee owner, and we claim that that is not what the government is entitled to do.

Unidentified Justice: What if a fee owner conveys property to the Ford Foundation or through his local church, reserving a life estate in himself, and then incurs the tax liability.

Is the tax... well, what is the consequence in terms of the tax lien?

Can it be asserted only against his life estate that he has reserved?

Or is the burden on the whole fee?

Mr. Elliott: The scope of Section 7403(c), Your Honor, does not make clear to me that the government would take any more than what life estate owner had, and what the life estate owner had was merely possession and the normal right and duties attributable to the life estate tenant during his lifetime, and since the Ford Foundation in your case was the transferee of the property before the time the tax lien a rose, I would say that all that the government gets in that case is what the life estate owner had, and expires at this death.

Unidentified Justice: Now let me change the hypothetical.

He conveyed it to one of his children, reserving a life estate, which is fairly common among... a very common transaction among people with small estates.

Mr. Elliott: I don't believe, Your honor, that the identity of the transferee makes any difference, except in those instances where under state law the transferor father might have some possibility of reversion after the children expired, which of course is theoretically possible.

In the Ford Foundation hypothetical, I assume that under state law, he has nothing more than what the normal rights and duties of the life estate tenant, and they expire at his death.

Unidentified Justice: May I go back to Justice White's question, because I didn't understand your answer.

Assume a joint tenancy, an ordinary joint tenancy, no homestead overlay, and one of the joint tenants is tax delinquent.

May the government under Texas law, is there any provision of Texas law that prevents the government from moving in and selling the delinquent taxpayer's interest in the joint tenancy?

Mr. Elliott: No, Your Honor, but right of survivorship in Texas is not common.

It is not something that we experience regularly.

It is more--

Unidentified Justice: If the government did move in, isn't the joint tenancy thereupon destroyed?

Mr. Elliott: --Yes, in the absence of a right of survivorship, I think it is important to distinguish the two.

Justice White, I understood, was asking me about right of survivorship.

In the absence of the right of survivorship, clearly, the government can cash out the other joint interest owners, but in the instance of a survivorship, we submit no, because--

Unidentified Justice: Well, again I am confused by your terms.

Do you have such a thing as joint tenancy in Texas without right of survivorship?

Mr. Elliott: --I call it a tenancy in common.

Unidentified Justice: Of course.

Of course.

That is a tenancy in common.

But if you have a joint tenancy, you have a right of survivorship.

Mr. Elliott: Then in that in instance I would say that the government does not get any more than the taxpayer had, and his interest expires on his death, and absent a possibility of reversion.

Unidentified Justice: Well, we are not talking about his death.

We are talking about moving in before he died.

Mr. Elliott: Then the government can take his interest.

They can cash out the non-taxpayer, and all that they get is the value attributable to his term.

Unidentified Justice: Well, you are now suggesting that if one joint tenant who owes the taxes dies, the government lien ends.

A while ago you said the government never loses its lien.

And that it would just attach to the property.

It was only a question of time.

Now you are suggesting that in joint tenancy cases, the government's interest expires.

Mr. Elliott: I am suggesting, to clarify, Justice White, that his underlying property interest expires.

The lien does not expire, but the lien attaches only to those property interests that the taxpayer has.

Unidentified Justice: Well, when he is dead, he doesn't have any property interest, you say.

Mr. Elliott: In that particular property, that is correct.

Unidentified Justice: Well, then, the lien expires.

Mr. Elliott: Insofar as that property is concerned, yes, Your Honor.

Unidentified Justice: Well, that is the only property that it attached to.

So now you are saying that your rule means the government loses its lien upon the death of a joint tenant.

Mr. Elliott: Yes, Your Honor.

Under your hypothetical, that is correct.

Unidentified Justice: Unless it has foreclosed during his lifetime.

Mr. Elliott: That is correct.

Unidentified Justice: You've got a hard row to hoe there.

Chief Justice Burger: Mr. Elliott.

ORAL ARGUMENT OF L. LYNN ELLIOTT, ESQ., ON BEHALF OF RESPONDENTS INGRAM AND BATES

Mr. Elliott: Mr. Chief Justice, and it may it please the members of the Court, I had announced I had a voice problem.

I didn't know that it was this serious.

Can I be heard?

Can you hear me?

Unidentified Justice: Yes.

Mr. Elliott: All right.

Unidentified Justice: Barely.

Barely.

Mr. Elliott: I will try very hard, sir.

I represent, of course, Mrs. Ingram, the companion case to the Rodgers case, and Mr. Elliott has stated for me and on our behalf our position with regard to the homestead rights as they are interpreted under Texas law, and as they have been interpreted by this Court, and by the Supreme Court of Texas in making determinations that the homestead right is a separate estate in property under the Texas Constitution, which differs considerably from a joint tenancy or a tenancy in common, which are not estates or property rights that are popular or known in Texas, unless it be as a part of a partnership, part of a written agreement.

We do not have those characteristics of real property in Texas.

The homestead right--

Unidentified Justice: Mr. Elliott--

Mr. Elliott: --Yes, Your Honor.

Unidentified Justice: --your predecessor, Mr. William Elliott, indicated that under Texas law the homestead terminates on the divorce.

Why then in the case of the Ingram situation would the government be precluded from reaching the taxpayer's interest?

Mr. Elliott: Your Honor, specifically, by constitutional amendment, a single person in Texas was given the same homestead right as a married person, and to say that Mrs. Ingram's homestead rights ceased on her divorce is an inaccurate statement with regard to the law in Texas.

That is not the law in Texas.

Unidentified Justice: So you disagree with Mr. William Elliott on that point?

Mr. Elliott: If that's what he said, I would disagree, Your Honor, yes.

The homestead right of the divorced spouse in this particular case happened to be the subject matter of a property settlement agreement which granted that property to the wife in that case... in this particular case.

The taxpayer, Don Ingram, we are not... there has never been any contention that his interest is not... in the property is not subject to the government's lien.

Likewise, there was a matter of some $288 worth of joint tax liability which we have no problem with, and their money is on deposit in a bank in Dallas to pay the joint tax liability to the extent of $288.

The... I wanted to point out in relation to questions asked by perhaps Judge Blackmun that we do not feel that the marketability of the property is a problem for the taxpayer.

The marketability of the interest should be the government's exclusive problem.

In this case, at the district court level and at the Fifth Circuit level, the government has taken the position not that they want one-half of the proceeds of the sale.

They want to be able to sell these properties and take whatever they are in... the lien amounts due, and it might be more than 100 percent even of the proceeds of the sale of the property.

The question is not before the Court as to whether or not the property is to be sold and the proceeds divided equally.

We tried to make that kind of a deal, and--

Chief Justice Burger: We will resume there at 1:00 o'clock.

You may continue, Mr. Elliott.

ORAL ARGUMENT OF L. LYNN ELLIOTT, ESQ., ON BEHALF OF RESPONDENTS INGRAM AND BATES -- RESUMED

Mr. Elliott: Thank you, Your Honor, Mr. Chief Justice.

I would like to say to the Court that Mr. Bill Elliott and I have conferred with regard to Justice O'Connor's question regarding the effect of a divorce on community property, and Mr. Bill Elliott agrees with me that a divorce will... could affect a... the homestead right of a party if in effect, as in this case, Donald Ingram gave up his homestead right by conveying it to his spouse, but a divorce as such does not per se affect the homestead rights of either parties.

It is something that must agreed to or disposed of at time of the divorce.

Obviously, if one party moves to another place, it would probably be said that that party has abandoned the homestead, in light of the rule that one person may have only one homestead, not two.

The party remaining in the home would have... the homestead rights would continue with the residency and the possession of that property, unless by some affirmative act they, the party disavows the homestead right.

Again, in this particular case, the author of the opinion in the Fifth Circuit, Judge Jerry Williams, was a University of Texas professor before he was appointed to the bench, and taught real properly, among other courses there, and when he... in his opinion he describes the homestead right as being one that was actually remanded to the district court for determination of whether there was abandonment or not.

That was the decision in the Fifth Circuit.

It may be a question that, why did the district court, the same judge, the Honorable William Mac Taylor, heard both of these cases within a two weeks' period of time, and had a different result.

He granted the government's motion for summary judgment in the one case, and the taxpayers or the non-taxpayer spouse motion in the other case.

It had already been predetermined that the case, both cases would be appealed.

His attitude was, I've got to be right in one of the cases, so that is why it was done that way.

He announced that at the time.

0 [Generallaughter.]

Unidentified Justice: A 500 ball player.

Mr. Elliott: Yes.

And Taylor didn't want to try any more jury cases because he is going to be leaving the bench, and he didn't want to get strung out in a long jury trial.

In this case, the government's position has been, he announced that that was not my opinion.

That is what he announced at the time.

The government's position is, we are going to sell this property, and we are going to take your interest, Mrs. Ingram, and although you owe no taxes, we are going to take your interest, and we are going to pay your husband's tax bill.

That is really what this case bottoms out on.

And we don't believe that to be the law in this country, and we do not believe that that is consistent with the Constitution in Texas.

We think the effect of a decision supporting the government's position as it is very narrowly stated would have the effect of abrogating the Texas constitution in its pure language, and the Texas Supreme Court decisions in the Semonet cases.

Judge Taylor's father sat on the Texas Supreme Court.

That is the case that held the Texas homestead right to be a separate vested right in property, and not subject to being divested except in those manners prescribed.

And with that, I conclude.

Thank you, Your Honors.

Chief Justice Burger: Thank you, gentlemen.

The case is submitted.

Attribution:

The OYEZ Project

Featured:

United States v. Kimbell Foods, Inc. - Oral Argument

Sun, 20 Jun 2010 20:42:54 +0000

Case:

United States v. Kimbell Foods, Inc.

Media File:

77-1359_19790108-argument.mp3

Related Transcript:

77-1359_19790108-argument.xml

Transcript:

Argument of Stephen R. Barnett

Chief Justice Warren E. Burger: Case is submitted.

We will hear arguments next in United States against Kimbell Foods.

Mr. Barnett, you may proceed whenever you are ready.

Mr. Stephen R. Barnett: Thank you and Mr. Chief Justice and may it please the Court.

The question in this case is whether a private lien that has not become specific and definite, that has not become choate before a federal lien attaches to the same property take precedence over that federal lien.

Justice William J. Brennan: Well, I get it Mr. Barnett that specific indefinite, simply synonymous with choate?

Mr. Stephen R. Barnett: Well, I use the words Mr. Justice Brennan so as not to rely completely on the technical term developed by this Court, but for functional purposes I think choate is the word for better or worse.

Justice Lewis F. Powell: Does this mean that the claim must be reduced to judgment?

Mr. Stephen R. Barnett: No, Mr. Justice Powell, we do not take that position, the Crest Finance case, which we distinguish here may clear that when a lien -- when the amount of a lien is evidenced by notes, notes bearing face values, that lien is choate as the government conceded and as the Court held in that case, even though it was not reduced to judgment.

Thus if the future advances that Kimbell made in this case, the future advances had been evidenced by notes as where the inventory advances that Kimbell made in 1966 and 1968, this would then be a different case and Kimbell then would have a choate lien with respect to those future advances.

But the future advances here were not evidenced by notes that the lien does not have to be reduced to judgment when it is this kind of a lien, but there is a significant -- a crucial difference between having a dead evidence by notes and having a simply be an open account where the amount is indicated perhaps in one amount on the sellers books and another amount on the purposes books where there are all sorts of uncertainties and possible differences with respect to the amount that are not ironed out until there is a judgment.

Justice William H. Rehnquist: Mr. Barnett, would it be an equally appropriate phrasing of the question to say that this is a case where the government requests that this Court extend the choateness doctrine that is previously applied in tax areas to non-tax activities of the federal government to give it priority there?

Mr. Stephen R. Barnett: To apply, I would accept your statement Mr. Justice Rehnquist except for the last phrase to apply in those cases, the same rules, the first in time and choateness to give the government priority therefore when it prevails under those rules to give the other party priority when it prevails under those rules.

Justice William H. Rehnquist: Well, do you think that Fifth Circuits decision in this case was the violation of the first in time, first in right?

Mr. Stephen R. Barnett: In this case?

Justice William H. Rehnquist: Yes.

Mr. Stephen R. Barnett: Not a direct violation, but this Court has made clear in its decisions that the -- there is a violation of this Court's interpretation of the first in time, first in right rule as embodying the choateness approach to determining when a lien arises.

Justice William H. Rehnquist: But that is previously been applied by this Court only in the tax area.

Mr. Stephen R. Barnett: That is correct.

Justice William H. Rehnquist: So, you are asking us to extend it in this case from the tax area to the field of commercial lending.

Mr. Stephen R. Barnett: That is correct.

That is correct and as we point out, commercial lending is an activity of the federal government.

The SBA is not as the Court below said and as respondent says, simply another commercial lender.

The SBA makes loans for matters of policy not simply to make a profit.

The SBA authorized under a statute, which provides that it shall make loans 15 U.S.C. 636(a)(1) to small business concerns where financial assistance is not otherwise available on reasonable terms from non-federal sources.

In the record of this case on the SBA loan guarantee application at A73, that policy has stated as the first of the SBAs loan policies "the SBA will not extend financial assistance if the funds are otherwise available on reasonable terms from normal lending sources or the personal resources of the principles".

Justice Potter Stewart: Mr. Barnett, at what way does that argument cut?

What you are saying I suppose is the government is willing to take greater risks in lending than private lenders do.

So, why should have then the greater protection?

Mr. Stephen R. Barnett: Well, it takes greater risks but it needs protection that is consonant with those risks.

This Court in the area of tax liens decided bringing the rule over from the Insolvency Statute that the government needed the kind of protection reflected in the first in time, first in right rule as adumbrated by the choateness principle.

We submit that unless Congress says otherwise, it is appropriate to give the government the same protection here, a dollar coming in on recovery of an SBA lien is the same to the government as a dollar collected on taxes.

In fact, Congress replenishes the amount that the SBA loses, this is not in the record but Congress as in every year, since the establishment of the SBA as I understand it, appropriated at least enough to cover the amount that the SBA lost.

So that if the SBA does not recover on its security and it does in fact take security for almost virtually all its loans, Congress ends up appropriating that money.

Justice Potter Stewart: Yes, but it takes security that would not be sufficient to induce a commercial lender to advance the fund.

So, then just it starts from the promise that it is willing to take some additional risks.

Mr. Stephen R. Barnett: That is true and the question here is you are correct to what extent that would justify imposing on the government, this Court imposing on the government when Congress has not done so risks greater than had been imposed on the government in the context of federal tax liens.

Justice Potter Stewart: Well, no with the rule I suppose would be that it has to follow the same precautionary procedures that any other lender has to follow, have to search the title and if it is searched here, it would have found there was a perfected lien --

Mr. Stephen R. Barnett: That is the rule that is contended for here but the rule that has previously been established with respect to interest of the federal government by this Court --

Justice Potter Stewart: Yeah but the difference there is I understand it is that the government has no way of protecting itself from the tax case, he doesnt know who is going to fail to pay his taxes.

But here before they advance the money, they cant go out, make a title research like any other lender can.

Why shouldnt they have that obligation?

Mr. Stephen R. Barnett: Well because Congress has not said so for one thing, the rule was laid down by this Court and the tax lien area has been followed by the Courts of Appeals was unanimously followed by the --

Justice Potter Stewart: But you just told Mr. Justice Rehnquist, you are asking us to extend that rule --

Mr. Stephen R. Barnett: I'm asking this Court to extend this since this Court has not done so but the Courts of Appeals found no difficulty at all in concluding that the reasons this Court had given for the rule and the tax lien contacts were equally applicable to contractual liens.

Justice Potter Stewart: Well, I suggest you they are not equally applicable because in one case the government can check title and in the other case it cant.

Mr. Stephen R. Barnett: That was not one --

Justice Potter Stewart: It is not a justification for rather different approach to the problem?

Mr. Stephen R. Barnett: It maybe.

It was not one of the rules this Court gave for its doctrine in the tax lien area.

Justice William H. Rehnquist: Doesn't the government expect to lose some money on its SBA loan?

Mr. Stephen R. Barnett: Indeed it does, it loses approximately 4% in the latest year.

The question is whether it should lose more because of a rule adopted by this Court or whether Congress should make that decision.

Justice William H. Rehnquist: Well or whether this Court should confine the rule to the tax area where it now let Congress determine whether it should be extended further?

Mr. Stephen R. Barnett: Well, but the question from what basis would Congress start?

This Court has to make some federal law today.

Does it apply the previous rule or does it reach out and apply for example state law or the UCC or one of the concoctions of the Fifth Circuit and then tell Congress to go from there.

Justice William H. Rehnquist: Does the government in theory at least so far as the statutes are concerned, expect to collect all its taxes?

Mr. Stephen R. Barnett: Expect to collect all its taxes, I'm sure as a matter of practical prediction doesn't expect to.

Justice John Paul Stevens: It knows that some tax payers are going to be bankrupt?

Mr. Stephen R. Barnett: True.

Chief Justice Warren E. Burger: And some are going to evade and never be caught.

Mr. Stephen R. Barnett: Right and despite that this Court by laying down certain rules prior to the Tax Lien Act of 1966 gave the government a certain measure of protection.

Now the Congress in that Act limited the protection in certain very specific ways.

Our position here is that if that the government with respect to its contractual liens should be accorded the same traditional protection and if Congress wants to specifically limit that Congress is the body that should do it.

And it is quite significant as we contend that when Congress did act in the Tax Lien Act in 1966, it dealt specifically with the question of liens for future advances, which is involved here and it gave only very limited protection to those liens.

It provided that a lien for future advances is protected only if the advances are made that is as given priority.

Chief Justice Warren E. Burger: Couldn't Congress do the same thing in this area?

Mr. Stephen R. Barnett: Well, it could precisely but what the Court below has done and what respondent urges this Court to do is something very different, something that would give much less protection to the federal lien than Congress decided to give to the federal tax liens in the 1966 Act.

Justice Thurgood Marshall: Mr. Barnett, along with what my brother Steve told about, you don't want us -- you say that the SBA loses a lot of money.

Well, you don't want us to encourage it to lose more.

Do you?

Mr. Stephen R. Barnett: Exactly, not.

Justice Thurgood Marshall: Well, what may be doing that if we tell them, do not use normal choate?

Mr. Stephen R. Barnett: I do not think the court --

Justice Thurgood Marshall: Well, I am checking to see if there is lien outstanding?

Mr. Stephen R. Barnett: I don't think the Court would be telling them not to use normal choate.

The SBA does check the question is what rules it must check under in this case, if it had checked, it might well have decided to make the loan anyway indeed, it was aware.

Justice Byron R. White: Well, Mr. Barnett, would not that if they check, it would have required that the other lien be waived.

Mr. Stephen R. Barnett: It might have, but Kimbell might have --

Justice Byron R. White: (Voice overlap) lender to do, is that?

Mr. Stephen R. Barnett: It might have made that request or demand and is equally possible that Kimbell would have refused.

Justice Byron R. White: Oh, that's highly unlikely on these facts, don't you think, because --

Mr. Stephen R. Barnett: No I don't think.

Justice Byron R. White: -- you have the outstanding indebtedness they could have easily said to cancel your outstanding lien and it gets really very unrealistic to assume that they would not have been able to clean it up.

Mr. Stephen R. Barnett: And then Kimbell would have continued to make loans on the same basis, I don't --

Justice Byron R. White: Or ask for an additional security like any outstanding balance, I think that's highly unrealistic.

Mr. Stephen R. Barnett: Well, but Kimbell here concededly might have said, if you pay us off we will release our collateral, but Kimbell here was also demanding that it keep its collateral with respect to the future advances.

Now it is not --

Justice Byron R. White: Is they demanding, they just did not talk about it.

As I understand that footnote and the opinion that they didn't really have a very sophisticated understanding in what was going on.

Mr. Stephen R. Barnett: But there is no reason to assume that Kimbell would have agreed to make future advances without keeping some collateral for that.

Justice Byron R. White: Perhaps not.

That they surely, the government surely could have said we are going to give you $300,000 we want to use $20,000 to pay off the existing indebtedness, which they did and we also want you to terminate that perfected lien and I'm sure that will happen, don't you?

Mr. Stephen R. Barnett: But maybe if the borrower okay, we are not assured of be able to purchase future inventory on credit.

Justice Byron R. White: So, we are going to turn down that $300,000 because we may need to borrow $5,000 in the future, that is very outstanding.

Mr. Stephen R. Barnett: Well, I concede that the SBA here could have demanded of Kimbell that it released its collateral.

It is not entirely cleare to me and certainly there would be cases in which it would not be cleared that the private lender would be willing to release collateral.

So, it is not simply a question of making the SBA be more careful but protecting some of the loans, the admittedly risky loans that the SBA does make because that its business to make risky loans and the question here is the measure of protection that the SBA will have and whether that measure is to be reduced as the Court of Appeals rule here would reduce it to a much greater extent than Congress and the Tax Lien Act reduce the protection of federal tax liens.

And indeed we find it ironic that the reason why the choateness rule is said here to be no longer worth following.

The reason why two Circuits the Fifth and Ninth have abandoned it is said to be the Tax Lien Act of 1966 which modified it in the area of tax liens, but yet, the very rule that act adopted for a future advances, which are involved here is much more protective of the government's interest than the rule that is proposed here.

Justice Byron R. White: But the rule you want Mr. Barnett which you defend certainly gives the government more protection than the Tax Lien Act.

Mr. Stephen R. Barnett: It does and Congress is fully --

Justice Byron R. White: Importantly more not only in right across the board expect with respect to this future advances.

Mr. Stephen R. Barnett: That is true, Mr. Justice White and Congress is fully able to --

Justice Byron R. White: And can I ask you another -- shoot a question, if a private lender had made this same loan that the SBA did in the face of an inventory financings scheme, how would the private lender have come out on these facts under the Uniform Commercial Code.

Mr. Stephen R. Barnett: On these facts the private lender would have lost, would have had its liens subordinate --

Justice Byron R. White: So, it would have under the Uniform Commercial Code, if a perfected inventory arrangement calling for future advances would take precedence over a later perfected mortgage?

Mr. Stephen R. Barnett: Over an intervening perfected mortgage.

That is correct.

Justice Byron R. White: Later perfected mortgage.

Mr. Stephen R. Barnett: Yes, later to the initial agreement prior to the advances.

Justice Byron R. White: Yes and so that the private lender, if he had to lend under these conditions here would have been on notice that there would be future advances and he would take subordinate to that.

Mr. Stephen R. Barnett: Would have been on notice that there could be future advances, these were optional but yes, would have taken subordinate to those future advances if they were made.

That is correct.

Justice Byron R. White: Well, if is that a rule in some all the states under state law or is it 49 states or what?

Mr. Stephen R. Barnett: Well that raises the question of how uniform is the Uniform Commercial Code.

It is the rule in Texas the Court here held, it is fairly clearing the rule under the 1972 Amendments to the Uniform Commercial Code, but as I understand that those amendments have been adopted by only some 21 states today.

So, it is not at all clear that is the rule in the 49 states that have adopted these codes.

Justice Byron R. White: But it says they I suppose if the question is, is it of course federal law applies here, the question is from what sources do you draw the federal law I suppose?

Mr. Stephen R. Barnett: Well, the proposal of response --

Justice Byron R. White: You are saying just take the Tax Lien law and apply it but you don't want the Tax Lien law because that's now been replaced by statute.

Mr. Stephen R. Barnett: No, no, no, we are saying take the common law principles that this Court developed on the basis first of the Insolvency Statute and then of the Tax Lien law.

The Court of Appeals --

Justice Byron R. White: But calling it common law does not give it any greater or less substance.

Mr. Stephen R. Barnett: I agree.

Justice Byron R. White: And so that it's a federal rule that was crafted in this Court.

Mr. Stephen R. Barnett: That's true, that's true.

Justice Byron R. White: So, the question is now in the ordinary commercial settings, what source should have be drawn?

Mr. Stephen R. Barnett: Well that's true.

The Court of Appeals didn't decide that question.

Justice Byron R. White: My comparison with some area that Congress is already discarded, I mean the rule for Tax Liens, Congress has already put aside.

Mr. Stephen R. Barnett: We don't agree with that characterization of it.

We would say that Congress has --

Justice Byron R. White: What it supposed to, what does the Congress did there?

Mr. Stephen R. Barnett: Congress has modified it and limited it.

There are indeed as the --

Justice Byron R. White: Well, so you now look to the statute not to our cases?

Mr. Stephen R. Barnett: No, not in all cases.

There are certain lacuna in the statute as the Second Circuit pointed out in the MacArthur Village case that might still be governed by this Court's previous decisions.

But Congress, against the background of this Court's previous decisions the choateness ruled the first time in time rule crafted limited exceptions in the statute.

The question here is whether the Court should take a quite different approach and adopt the UCC as the governing federal rule in this case.

Justice Byron R. White: Right, right.

That is the choice.

Mr. Stephen R. Barnett: That's the choice although it's not the choice to Court of Appeals show after all.

Justice William H. Rehnquist: No, I would disagree with apparently both my brother White and you Mr. Barnett.

I would think the Court of Appeals opinion can be justified on the base of following the law of Texas.

Mr. Stephen R. Barnett: Well, but the law of Texas is the UCC.

Justice William H. Rehnquist: Right.

But that it was followed not because the UCC was in existence in 49 states, but because this particular federal question of lien priority should be determined by reference to state law of the federal rule.

It's a federal rule, but it can be a reference to state law rather than to UCC.

Mr. Stephen R. Barnett: The reason why that is not a good idea we would submit is because state law is varying and the varying reason why this Court decided in Clearfield Trust that the choice of law question here was a federal question in the first place was primarily the need for uniformity.

The Court has since emphasized that in the Little Lake Misere case and in Miree versus DeKalb County.

A rule --

Justice John Paul Stevens: Have the Yazell's case on the other side of the scale.

Mr. Stephen R. Barnett: Yes.

Justice William H. Rehnquist: On household finance does --

Justice John Paul Stevens: Household finance.

Mr. Stephen R. Barnett: Yeah, but a rule that a rule that simply incorporate into the law at various states with respect to this question which is very much a question of the nationwide operation of a program and which is rather close to questions of commercial paper would undermine the purpose of uniformity.

Justice John Paul Stevens: Was the Yazell case and SBA case?

Mr. Stephen R. Barnett: I think it was, Mr. Justice Stevens.

Also would undermine here when we submit another reason for the application of federal law in the first place, which is the principle of federal supremacy if you well recognized by this Court in the New Britain case, the federal property interest should not be subjected to the sway of state law and --

Justice John Paul Stevens: Mr. Barnett, are you familiar with the position the government took in the argument of Butner case arising out of the second mortgage situation in North Carolina?

Mr. Stephen R. Barnett: I am not Mr. Justice Stevens.

Justice John Paul Stevens: The question is whether in determining whether the second mortgagee has to reduce the property to possession whether they should be governed by a federal rule or by reference to state law and the United States in that case, where it's a creditor, argued that the reference should be to state law, the federal rule should be that we should refer to matter to state law and it's one of those any basic difference between the two kinds of situations in connection with the need for uniformity.

Mr. Stephen R. Barnett: I'm sorry that I'm not familiar with that case.

So, I cannot say, even with respect to the UCC when it is argued here that the UCC should be adopted, there are various kinds of uncertainty that that would create, which I think the Court should be aware of.

For example, in addition to the fact that the UCC rules may vary very considerably in different states, there is the question of what would be the scope of this asserted adoption of the UCC.

For example, the Court of Appeals here said we are adopting the UCC with respect to when the state lien arises, we are not adopting it at least not yet with respect to the relation that question and we leave for another day, the question of whether we would apply the UCC in cases of other kinds of liens, mechanics liens, repairman's liens, which the Court said raise entirely different questions.

Well, if the UCC is to be embraced by this Court as the governing code of federal law in these cases where does the embrace stop?

Does it or does it not include those repairman's liens and mechanics liens and state tax liens and the questions that they raise.

The respondent would apparently say that this Court should limit the embrace to what consensual liens, which arise under the UCC.

On what basis would that limit be established with this Court be telling the other federal courts that they cannot use the UCC with respect to those other liens that they must or what?

There would be considerable uncertainties engendered, which are illustrated, of course by the Crittenden case, which I'll have occasion to discuss in greater detail later.

Justice William H. Rehnquist: Aren't they greater there than in this case because in Crittenden as I understand the Fifth Circuit's opinion we don't know what the Georgia law was, but here I thought that Judge Gee was quite clear as to what the law of Texas was.

Mr. Stephen R. Barnett: Well, but even if we knew what the Georgia law was the proposal would might be to adopt the UCC, even if the Georgia law is different.

Justice William H. Rehnquist: I certainly don't read the Fifth Circuit's opinion in this case is saying that in Kimbell Foods.

Mr. Stephen R. Barnett: Well, with respect to when the state lien arises, I read the opinion as saying we will follow UCC principles on that.

It happens that Texas here had adopted the UCC, but I find nothing in this case to indicate that the Fifth Circuit is saying we will follow state law, if that law happens to diverge from the UCC.

And well, I agree Mr. Justice Rehnquist that the problems in Crittenden are more complicated, my point is where would adoption of the UCC stop, would it not engender, all sorts of such problems, which to adopt where the UCC varies from state law to what extent to follow the UCC.

Justice Byron R. White: What would be in that respect, if you just follow the law of each state at least you might have some common understanding in the state what the rule was.

Mr. Stephen R. Barnett: You would have in the state but you would a complete overturning of the principle of uniformity, which --

Justice Byron R. White: What principle is that?

That's the question in this case.

One of the questions in this case whether to have a uniform rule and why shouldn't the SBA in operating in various states as a lender act any other lender?

Why should somebody a bank furnishing inventory financing have to say well, I guess we are good against every kind of a lender except the federal government with the SBA?

Mr. Stephen R. Barnett: Well because Congress has not said so for one thing, if that precise approach was a prose to --

Justice Byron R. White: I know that is bootstrapping.

You do not know?

Mr. Stephen R. Barnett: No, that precise approach was made to Congress in the drafting of 1966 Tax Lien Act as cited in our brief here.

It was proposed that federal tax liens be --

Justice Byron R. White: That's taxes.

That's taxes.

That's a distinctive area.

Mr. Stephen R. Barnett: Well, is it or isn't it?

That's the case here.

We say that's the federal government --

Justice Byron R. White: Of course, it isn't.

Mr. Stephen R. Barnett: Well, then we would cite the need for uniformity, which this Court rely.

Justice Byron R. White: What need is that, I don't see understand that need?

Mr. Stephen R. Barnett: Well, one need is that a federal agency operating a nationwide program has to have some ability to rely on nationwide standards, it uses --

Justice Byron R. White: It obeys the speed limits where it's employees in every state, it doesn't want it national speed limit?

Mr. Stephen R. Barnett: No, it uses similar forms.

Its attorneys are transferred from one state to another --

Justice William H. Rehnquist: Household Finance managers in all 50 states.

Mr. Stephen R. Barnett: It is not the federal government.

Justice William H. Rehnquist: But you are saying there is a need, not that the government sovern but that the government needs it because of some peculiar difficulties of operating in all 50 states.

Mr. Stephen R. Barnett: And also because this Court has recognized that that is a reason for applying federal law in these states.

Justice Byron R. White: Not yet, not yet.

Mr. Stephen R. Barnett: No.

In Clearfield Trust, this Court --

Justice Byron R. White: Not yet in this commercial area.

Mr. Stephen R. Barnett: True, but in Clearfield Trust the proposition was that the need for uniformity is the reason for making it a question of federal law in the first place in a commercial area such as this.

I would like to reserve the remainder of my time.

Thank you.

Argument of Vernon O. Teofan

Chief Justice Warren E. Burger: Mr. Teofan.

Mr. Vernon O. Teofan: Mr. Chief Justice, may it please the Court.

Well, it may not have seen readily apparent from the government's abbreviated statement of the issue presented in this case.

This isn't simply a case of a choate federal lien versus an inchoate private lien.

This case is entirely different from any other cases on which the government relies.

The two competing liens that you have in this case were both created and perfected under the uniform commercial code of the State of Texas in favor of private lenders.

This wasn't a government lien from the inception, one lien the first lien was created in favor of Kimbell Foods.

It was perfected in 1966 and 1968 long before, the second party Republic National Bank acquired its security interest much less had it perfected and at least two years prior to the time that the SBA purchased an undivided 90% interest.

Chief Justice Warren E. Burger: Are you arguing, Mr. Teofan that if Texas was the only state that had this code and the other 49 states had a different uniform code.

The case would be the same?

Mr. Vernon O. Teofan: Yes, based on United States versus Vermont.

What the SBA is arguing in this case is that in 1961 five years after Kimbell perfected its lien when it purchased its 90% interest in the Republic National Bank security interest that invested that Republic National Bank security interest with federal lien rights and sovereign prerogatives, which related all the way back to when the lien was first taken by the Republic National Bank and by applying the choateness test at that point in time bootstraps the Republic National Bank security interest into a first position.

The Fifth Circuit rejected that logic and refused to extend the choate lien test into this kind of situation.

Now, when I was reviewing this Court's opinions in United States versus City of New Britain and United States versus Vermont, I realized that I had missed a very basic point in briefing the situation for Kimbell.

In United States versus City of New Britain, in that case you had competing local water rent liens and local tax liens competing with the federal tax lien.

The Court there laid down the basic rule that in determining what is first in time and therefore first in right you must determine which lien attached first and which lien became choate.

It didn't say that that test only applied to the private lien and not the government lien.

So, then you come to the United States versus Vermont, unanimous decision by this Court, the opinion written by Mr. Justice Stewart.

In that case, the two liens you had competing with each other was a federal tax lien and a Vermont tax lien, which arose under a statute that was patterned after the federal tax lien and whose reading was identical.

The Vermont tax lien had been assisted first, the federal lien some months later.

The government in that case argued that the Vermont lien was inchoate and urged that a different standard of choateness be applied to the state lien than to the government lien.

Will this Court rejected that?

Both liens rose under identical statutes and this Court held the Vermont lien first in time and prior in right.

The basis of the Vermont case essentially is this; when you have two competing liens, which arise under the same statute such as we have here are substantially identical statutes, the reasonable rule is to look to the statute for priority and that's uniform.

I submit that this Court can dispose off this case in favor of Kimbell just by reiterating that the federal common law rule is that with the liens arise under the same statute are under substantially identical statutes, you look to the statue for priority.

That's uniform, that's non-discriminatory and unquestionably just.

That point is not specifically covered in that brief and neither is the point was in relation to some subsequent congressional action.

After the brief --

Justice Potter Stewart: Does the SBA make direct loans or --

Mr. Vernon O. Teofan: Yes.

Justice Potter Stewart: And under what law do you suppose it the lien that arises, when it makes a direct loan?

Mr. Vernon O. Teofan: The basic proposition, we have no quarrel with it is that it is federal law governs but when the SBA enters into a field of consensual loans, it should be governed by the same law as all the rest of these cases.

Justice Potter Stewart: Well, let's say in this case, it was a direct loan by the SBA.

Mr. Vernon O. Teofan: It should be.

Justice Potter Stewart: And let's assume that it had been under what law would the lien arise?

Mr. Vernon O. Teofan: It would have arose under Texas law.

It would have its security agreement, it would have perfected it under Texas law.

Justice Potter Stewart: What makes you think so?

Mr. Vernon O. Teofan: Because the SBA when they make these kinds of loans --

Justice Potter Stewart: Was it the statute said it should be perfected when the money is paid out, it would be perfected with that.

Does the statute indicate that the SBA should follow the state law or not?

Mr. Vernon O. Teofan: I think yes, I think and I'm not positive on that, but I think the SBA statute says that the lien shall be recorded and perfected in accordance with state law.

Justice Potter Stewart: It does say that?

Mr. Vernon O. Teofan: I think so.

I know that they do and I know that the SBA Congress has admonished the SBA to make --

Justice Potter Stewart: I would think that would be a rather important in that if we would argue, if that were true in this case that Congress certainly intended to accommodate the laws of each individual state.

Mr. Vernon O. Teofan: Well, I think that the regulations may direct the SBA offices to file their liens in accordance with state law, perhaps so government can --

Justice Potter Stewart: Well, that it seems -- sounds to me like a rather substantial matter.

Mr. Vernon O. Teofan: I would be happy to look it up and submit something to this Court on that with your --

Justice Potter Stewart: Well, maybe, Mr. Barnett, will have something to say in response.

Mr. Vernon O. Teofan: Yes, but with relation to the --

Chief Justice Warren E. Burger: Perhaps, you can do it while you are having lunch.

Mr. Vernon O. Teofan: I will try.

The question came up what standard is supposed to be applied by the SBA in making loans?

Are they expected to have great losses?

Congress has admonished the SBA to make only loans of such sound value or so secured as to reasonably assure repayment.

It is pointed out by this Court in Yazell.

SBA activity is very localized, it is done by local offices and by agents who are experienced in the law of those localities but just before lunch, I want to point out one of the piece of legislation the Fifth Circuit in refusing to extend the choateness rule to this area look to, reconnect of Congress is a barometer of what was going on in the commercial world and also what federal intent was with relation to federal priority.

And that referred to the Tax Lien Act of 1966, which abolished a lot of the priorities established by the choateness rule.

Well, after the brief was filed in this case in November of last year, there was enacted the new Bankruptcy Act, which goes into effect for the most part in October of 1978.

In that Bankruptcy Act, Congress has done away completely without federal priority except for taxes accruing within three years of the filing of the petition.

The old subsection 64 (a)(5) giving the federal government priority for non-tax debts has been abolished.

Justice William H. Rehnquist: But that doesn't have retroactive effect in this case?

Mr. Vernon O. Teofan: No sir.

This is not a bankruptcy case.

I refer to that merely as an indicator of governmental policy on federal priority status.

Justice William H. Rehnquist: That doesn't get to how a government priority is to be established.

It didn't do away with priority for example that the government would have under a perfected lien in bankruptcy did it and it didn't answer how but to what law would you look to determine whether the lien is perfected?

Mr. Vernon O. Teofan: No, it does not answer those questions.

I just referred to what is an indicator that the priority, the super priority, which has been furnished to the government in previous cases, has been done away with and does not carry the same import that it did previously.

I'll resume after lunch.

Thank you very much.

Chief Justice Warren E. Burger: We will resume then at 1 o'clock at this point.

Mr. Teofan, you may continue.

Mr. Vernon O. Teofan: Mr. Chief Justice, may it please the Court.

During the lunch hour, I did run up to the library and attempt to find the basis for my belief that SBA loans are perfected in accordance with state law.

I knew that I had seen it somewhere and I knew that they did it.

What I did finally remember was that in the United States versus Yazell, which is an SBA case arising out of Texas, this Court in that case said there is no problem in complying with state law in fact SBA transactions in each state are specifically and in great detail adapted the state law and it refers to note 35.

Note 35 is the financial assistance manual of the Small Business Administration, SBA 500 is replete with admonitions to follow state law carefully.

Thus section 401.03 reads compliance with applicable laws.

When the United States disperses funds and is exercising a constitutional functional power and its rights and duties are governed by federal rather than local law.

However, it is frequently necessary in the obtaining of a marketable title or enforceable security interest and property to follow local procedural requirements and statutes.

Accordingly, care should be used in following or meeting all applicable requirements in statutes of the state in which the property is located including the filing and refiling, recording and rerecording of any documents and then to --

Justice Byron R. White: State or rather a SBA regulation with this --

Mr. Vernon O. Teofan: Yes, it's the financial assistance manual of the Small Business Administration.

In the short time that I had that was the best that I could up with.

Justice Byron R. White: That's not bad.

Mr. Vernon O. Teofan: Thank you.

Chief Justice Warren E. Burger: Hope you manage and get it done (Inaudible).

Mr. Vernon O. Teofan: Yes.

Justice Thurgood Marshall: Whereas in this case no defensible reason governed by the state law.

Mr. Vernon O. Teofan: That's exactly our position in this case Your Honor.

Justice Thurgood Marshall: As the last paragraph in the Yazell says?

Mr. Vernon O. Teofan: Yes.

Justice Thurgood Marshall: I know how to argued with.

Mr. Vernon O. Teofan: In their brief and in the argument, the government here strongly insist that there is a coherent, well-established, well-understood body of president that would establish that the choateness rule should be applied in this case.

And therefore urges this Court to not deviate from that rule but extend it into this new field of consensual security interest under Uniform Commercial Code.

First of all, such contention is not well taken.

There exists no such coherent, well-established, well-understood body of president.

This court has never extended the choate lien test rule outside the context of the federal Insolvency Statute or the federal Tax Lien Act.

In both of those fields, Congress has greatly reduced federal priority.

This Court has never held in any case that the choate lien test applies to a consensual security interest held or acquired by the government.

Neither this Court or any lower court has ever held a choateness test that applicable in a case involving a federal consensual lien versus a private consensual lien, a federal security interest under the Uniform Commercial Code versus a private security interest under the Uniform Commercial Code.

There has been no extension of that choate lien test into this area.

Consequently, there is no evil for the government to correct by legislation, they are just this field has not been covered.

The Five Circuit Court of Appeals cases relied on by the government is establishing this president at the time the transactions were entered into, all involve a competing statutory special interest lien created by a state statute, which either grants that lien super priority or relates it back to a point in time that has no reasonable connection with the establishment of the lien.

We don't have that in this case.

The choateness rule was developed primarily to prevent the special interest lien creditors from getting their leg up on the government in the collecting of its taxes in the exercise of a sovereign power.

Now what the government is trying to do in this case is to take the choate lien test and relate it back and give the government a leg up on the private lender and it's not required.

What they are attempting to do is to perpetrate a reverse evil that the choateness rule was originally fashioned by this Court to prevent.

Such coherent, well-established body of president was not even well understood by the attorneys and the representatives of the government and the SBA at the beginning of this case.

And the government's answer to Kimbell's complaint and then the detailed pre-trial agreement that was filed with the Court absolutely no mention whatsoever is made of choateness.

No issue is reserved as to whether or not Kimbell's lien is choate.

During the trial with this case counsel for the government stood up and announced to the trail court that its position was the same as the Republic National Banks.

The primary line of defense had nothing to do with choateness or federal super priority.

It was one Kimbell had either expressly or implyably agreed that its lien would be inferior to the lien of the Republic National Bank or number two that under applicable state law, future advances were not covered under the security agreement.

That was rejected by the Fifth Circuit, is not here before the Court.

It was not until after the case was actually tried and briefs were submitted to trail court that the issue of choateness was ever raised.

So, if it was such a well established, well understood body of president, why did it appear in the case so late?

I think the law review articles that had been written by the authorities with relation to the choateness rule demonstrate that it is not a clear body of law.

Even counsel in this case is somewhat unclear as to what is or is not a choate lien.

In the original brief, he took the position that Kimbell's lien could not be choate because it was not reduced to judgment.

Justice William H. Rehnquist: Of course you could say that by lots of groups of decisions in this Court currently in other fields of the law.

Mr. Vernon O. Teofan: Say, what Your Honor?

Justice William H. Rehnquist: That it isn't all that clear.

Mr. Vernon O. Teofan: Yes, yes and what?

Justice Byron R. White: (Inaudible)

Mr. Vernon O. Teofan: Yeah and what we are trying to do here is to fashion a federal rule that is a little bit clear at least clear and fair than the choateness test.

Justice Potter Stewart: I notice you dint say crafted, but it's the word that you use before.

Mr. Vernon O. Teofan: Alright, the word is fighting with me Your Honor.

Even the government doesn't know when a lien is choate.

They say, there is a big difference between a security interest that secures a debt owing on a promissory note, which it now says it maybe choate because of its concession made into the Crest Finance case but that doesn't apply where the debt is secured by an open account.

It says if you have got a piece of paper that says it's a promissory note that's good it's choate.

If your pieces of paper are invoices submitted on a weekly basis plus statements of account, they say that's not good, that's inchoate.

And why do they say that, they say that because there are many challenges that a creditor who purchases goods on open account can make and therefore there are many contingencies and until it's reduced to judgment, it can't be choate.

But that's what a specious reasoning, the same applies to a promissory note in the Crest case, you had a series of promissory notes.

Payments have been made on those notes, additional interest had accrued.

The debt secured was not the face of the promissory note, you had to go to the books and records of the government and you had to go to the books and records of the finance company to determine what the balance outstanding was on any given day.

And anybody who has tried a case on a promissory note knows that ingenious counsel can come up with as many defenses to suite for the balance of a promissory note as he can for a suite based on an account.

So, if a suite we submit Your Honor that if a security interest securing the balance on promissory notes is not choate so also should be held for the purpose of choateness in this area if it applies is the balance owing on an open account.

Even t any given point in time, you can determine the amount of the lien, the property to which it attaches the name of the secured party and the name of the debtor.

The other point with relation to security interest under the code is that some of the cases that indicated that a lien will be "if it's enforceable by summary proceedings, it is to be noted under the Uniform Commercial Code that upon default, a security interest can be enforced by summary proceedings.

The creditor goes up, picks up the property and sells it, no judicial action is required.

The government argues that what we really need to do here is take a rule that will give us this stability and certainty so that people who are engaged in commercial lending will know where they stand.

And they say that we can get that way through the choate lien test.

Now we submit that is not correct.

If you take their argument that a lien becomes -- that a private lien becomes a federal lien when it's acquired by the government and it relates all the way back to when it was first created and then you will apply the choateness test there, which you have is uncertainty foretold.

First of all, the man who makes a loan or who is extending credit, first he will not know if the government will ever come in and guarantee a loan, insure a loan or buy somebody's loan or get a direct loan sometime in the future three or four years.

If the government does come in and acquire a loan some years in advance then that creditor will not know to what date that lien relates back because there is absolutely nothing that requires the recordation of a government guarantee or a government security interest even after the government acquires it, nothing need really be filed off record.

And as far as the commercial community is concerned, there is absolutely no notice to anybody that there maybe a federal lien floating out there somewhere.

The other uncertainty, the third uncertainty is to what collateral will a federal lien attach when it relates back?

Property is sold, a lot of people have shipped in additional merchandize to the debtor like Kimbell did in this case, Kimbell's security interest is a purchase money security interest.

It secures the payment price of merchandize, which Kimbell actually shipped in, if the lien relates back prior to that time and Kimbell's lien is no good that's an uncertainty.

And the other uncertainty would be the amount of the debt that would be secured at the time the federal lien was given effect.

The amounts balance if the loan was originally $300,000 it could be down to 20, if it were originally 300 and it had future advances, clauses that could go up to 600.

Too much uncertainty would be created by applying the choateness rule in this concept of consensual liens.

The performance of a proprietary or a commercial function by the government is distinguished from a sovereign function such as collecting taxes.

You just wouldn't know where you stood.

Now, they make an argument in their brief that, this will not create any economic adverse effects on private loans to small businesses.

Now, common sense and experience tells every one of us that whether you are loaning money or selling product, if a private lender sells to a specific portion of a market and loses money, one or two things is going to happen.

He is either going to increase the cost of that service to the customer or he is going to curtail doing business in that segment of the economy.

The government has intimated that if this Court were to adopt the priority rules that have been incorporated by Congress in the Tax Lien Act of 1966 that Kimbell would lose because the advances were made more than 45 days after the federal lien, well, that argument is based on the premises that the federal lien was filed when it was originally filed in favor of Republic National Bank.

We submit that at that time it was not a federal lien under the decision of this case in Markson and there is no debt do an owing to the government.

Justice Byron R. White: Do you know what the SBA practice is when they buy a participation in the loan, is there any filing done under the state law then?

Mr. Vernon O. Teofan: Naming the SBA?

Nothing naming the SBA.

Justice Byron R. White: Could any lender ever discover that to what he thought was a good lien against the Republic National was now no longer good lien because the government has bought part of it.

Mr. Vernon O. Teofan: He would have to search the records daily.

Justice Byron R. White: Well, what records?

Mr. Vernon O. Teofan: In the case of the Uniform Commercial Code, he could search the record --

Justice Byron R. White: I know but I just asked you would the SBA do any filing whatsoever when it bought into the republic loan.

Mr. Vernon O. Teofan: It need not.

Justice Byron R. White: Well, does it or doesn't it?

Mr. Vernon O. Teofan: It does.

In this case, it did.

Justice Byron R. White: It did.

It filed under state law.

Why did it file?

Mr. Vernon O. Teofan: When it acquired undivided 90% interest in Republic loan in 1971 on I believe it was January 18th or 28th the later part of January 71.

It filed a UCC-3, which is an assignment statement with the Secretarial State of Texas.

Justice Byron R. White: Yes, why did it do that?

Mr. Vernon O. Teofan: Well, the reason you file those kind of things Your Honor is.

Justice Byron R. White: I don't know the reason private people did, and I wonder why that SBA did?

Mr. Vernon O. Teofan: Well, they may not have trusted Republic National Bank after their initial encounter in this case and didn't want Republic National Bank to be put in a position to either release or prejudice that lien.

The reason you file a UCC-3 is to prevent the original secured party from doing anything that would affect the assignee's rights.

The UCC-3 doesn't create any rights, it is purely a notice instrument.

Now, in this case the SBA --

Justice Byron R. White: But it needn't have?

Mr. Vernon O. Teofan: It needn't have because it did.

Justice Byron R. White: In which event the person making future advances might think that it was perfectly good against Republic, which it were.

Mr. Vernon O. Teofan: Yes.

Justice Byron R. White: They were but not against the United States.

Mr. Vernon O. Teofan: Right and that's exactly what happened to Kimbell in this case.

Kimbell wrapped along that they were owed $18,000 when the Republic lien was created and at the end of the road they were still owed $18,000, there was no big increase or decrease in the amount of debt that was secured.

But Mr. Justice White you are perfectly right.

There is no way that a private lender out there making a loan feeling that he is first insecure can ever know that five years later, the government is going to come in and assert some rights, relate them back and make themselves superior to his lien.

Justice William H. Rehnquist: Kimbell is not an insolvent in this case.

Isn't it?

Mr. Vernon O. Teofan: Okay, Supermarket Your Honor was the debtor, it is not an insolvent.

Insolvency is not a issue in this case neither is bankruptcy, neither a federal tax loans.

Thank you very much.

Rebuttal of Stephen R. Barnett

Chief Justice Warren E. Burger: Very well, do you have anything further Mr. Barnett?

Mr. Stephen R. Barnett: Yes, I do, Mr. Chief Justice.

May I borrow that, these all things?

Well, I don't need it.

The statements from the SBA manual that my brother quotes makes clear that the rights and that were quoted in the Yazell makes clear that the rights of the SBA arise under federal law quote when the United States disperses its funds, it is exercising a constitutional functional power and its rights and duties are governed by federal rather than local law.

However, it is frequently necessary in the obtaining of a marketable title or enforceable security interest in property to follow local procedure requirements in statutes and so forth really it's a --

Justice Byron R. White: Are there anything in the SBA Act it says when this precisely when and what a federal lien arises?

Mr. Stephen R. Barnett: The only thing in the SBA Act that relates to liens is the section that we have quoted in our brief and discussed which provides that SBA liens are specifically subordinated to state and local liens for property taxes.

Justice Byron R. White: Yes.

Mr. Stephen R. Barnett: Congress specifically did that --

Justice Byron R. White: So what makes you think that it is by virtue of the federal law that a lien arises, I mean by some specific provision of the federal law?

Mr. Stephen R. Barnett: Well, a lien does not arise under state law or the UCC.

A lien arises as in this case from the security agreement, the security agreement is filed under state law of the UCC but the UCC does not create the lien and that is the policy in my brother's argument.

Justice Byron R. White: What gives that a rank in the priority?

Mr. Stephen R. Barnett: Well, that is the question in this case whether the federal law does and the question in this case --

Justice Byron R. White: Well, there isn't anything in the federal law that just says that is in.

Mr. Stephen R. Barnett: Well, this Court has relied on the first in time rule as federal law for one thing and the --

Justice Byron R. White: There is nothing in the SBA Act?

Mr. Stephen R. Barnett: There is nothing in the SBA Act except that specific provision which does subordinate SBA liens but only for a carefully tailored exception.

And as you were pointing out Mr. Justice White the SBA may not have to file under state law but it does and that is the answer to my brother's contention that people may never know when they are dealing with the SBA.

Justice Byron R. White: If that's also an answer to your argument about uniformity, they don't seem to be put so much store in the uniformity if they instruct all their local people to be awfully careful about the state law?

Mr. Stephen R. Barnett: Well, as a matter of convenience and as a matter of allowing other people to rely in the commercial world, they do file, but it doesn't follow that their lien is thereby created under state law and it doesn't follow the state law should govern their priority rights.

Chief Justice Warren E. Burger: What if they didn't file?

Mr. Stephen R. Barnett: That is not this case.

We are not here defending a situation in which the SBA lien has not been trialed.

Chief Justice Warren E. Burger: On a practice so.

Mr. Stephen R. Barnett: Yes that is the practice.

Chief Justice Warren E. Burger: But what if they didn't trample their practice in the legitimate case, what about the other -- rights of other people?

Mr. Stephen R. Barnett: We would have or at least would have difficulty defending that situation Mr. Chief Justice.

Justice William H. Rehnquist: Why, the lien is a reason under federal law?

You tell me.

Mr. Stephen R. Barnett: Well, I think there are reliance rights that the government would have to respect, and I think it is the government's practice and should be the government's practice to comply --

Justice Potter Stewart: To look to state law, to look to state, to not to look to non-uniform state law, so that people operating in that commercial market will know where they are.

Mr. Stephen R. Barnett: To comply with the local procedures and forms is all not to follow or not to be bound by state law as to government rights and priorities and I see my time is up.

Justice Thurgood Marshall: It would be the time to watch the state laws and follow them.

Mr. Stephen R. Barnett: So far as procedures and forms are concerned.

Justice Thurgood Marshall: In drafting service provisions, counsel should carefully consider the applicable laws of the states, that's what this regulation says.

Mr. Stephen R. Barnett: True, but not that does not imply that state law governs the rights as the earlier part of the regulation says the state law governs the governments rights.

Justice William H. Rehnquist: Mr. Barnett, the second sentence of that footnote 35 from the Yazell case, which you just read however it is frequently necessary in the (Inaudible) of a market rule title or enforceable security interest and property to follow local procedural requirements and statutes.

Now what do you take it, what does that carve out from the general federal principle that you are talking about?

Mr. Stephen R. Barnett: I don't think it carves anything out except as a matter of the government's discretionary decision to follow the state procedures.

Justice William H. Rehnquist: But it says that's frequently necessary to obtain an enforceable security

Mr. Stephen R. Barnett: Well, this is an abundance of caution in a manual that the SBA is directing towards employees, it is not a statement of applicable law being made in court or elsewhere.

Thank you.

Chief Justice Warren E. Burger: Thank you gentlemen the case is submitted.

We will hear arguments next in United States against Crittenden.

You may proceed whenever you're ready Mr. Barnett.

Mr. Stephen R. Barnett: Thank you Mr. Chief Justice and may it please the Court.

This case too involves competing liens in a tractor.

The federal government this time through the Farmers' Home Administration of the Department of Agriculture had a lien in the tractor as security for loans it made to the farmer.

After this lien had been established, the farmer took the tractor to respondent for repairs and the question is whether respondent statutory repairman's lien takes precedence over the earlier federal lien under principles of super priority or on the other hand whether the government's lien prevails under the principle of first in time, first in right.

The FHA makes loans pursuing to what is now the Consolidated Farm and Rural Development Act to farmers, who are unable to obtain sufficient credit elsewhere to finance their actual needs at reasonable rates in terms.

Thus like the SBA, the FHA is engaged in lending not to make a profit but to serve a policy interest of the federal government.

The distinction that my brother in the former case tried to make between sovereign and commercial functions of the government, he submitted it is not a valid distinction and this Court made that clear in cases such as Indian Towing when the government lends money through the FHA it is performing a governmental, a sovereign function for reasons of policy.

Justice William H. Rehnquist: Indian Towing arose on the Federal Tort Claims Act, didn't it?

Mr. Stephen R. Barnett: Yes, it is cited in our brief in Kimbell.

Indeed the provisions of the FHA's policy is written into the security agreement in this case at appendix page 10 in the security agreement it expressly provides that if at any time it appears to the FHA that the debtor can obtain a reasonable loan elsewhere, that is a loan on reasonable terms elsewhere, the debtor will at the FHA's request apply for that loan and pay off the FHA.

This was apparently quite a tractor in this case because between November 1972 and July 1973, the farmer brought it into respondent for repairs a total of seven times.

In each case respondent made the repairs and returned the tractor to the farmer, who did not pay his bill.

By July of 1973 the amount of the bill was $1,600.

When the respondent brought the tractor and again for the eighth time in December 1973 this time for repairs that raise the account to $2100, the respondent kept possession of the tractor while awaiting payment.

When the tractor was finally sold in 1978 incidentally it was sold for $1,500, less than the repair bill although admittedly this was three years after the or this was five years after the repairs had been made.

Well the --

Justice Potter Stewart: Are tractors like automobiles, passenger automobiles, is there artificial obsolescence.

Mr. Stephen R. Barnett: I don't know Mr. Justice Stewart, I'm not a farm boy.

Justice Potter Stewart: That's the reason I asked the question.

Mr. Stephen R. Barnett: Well, the Court of Appeals in Kimbell Foods rejected the choateness rule for determining lien priority.

The Court of Appeals in this case rejected the even more fundamental rule of first in time, first in right.

A rule that goes back in this Court to the 1827 decision in Rankin versus Scott in which Chief Justice Marshall stated that the principle is believe to be universal that a prior lien gives a prior claim, which is entitled to prior satisfaction out of the subjected banks.

Justice William H. Rehnquist: The Fifth Circuit also rejected the principle that federal law would refer to state law in this case, didn't they?

Didn't they say, we don't have to cite what Georgia law is in this case because we are going to follow a general common law with UCC principle?

Mr. Stephen R. Barnett: Yes, it did, not quite a UCC principle, the court here took a rather hybrid approach, it's started with the UCC but the UCC in this case incorporates state law the Court then looked to see what Georgia law was decided that either Georgia law was unclear or it was unfavorable, the Court then looked back to the UCC decided that it would adopt the UCC provision but without the part of the UCC provision that says unless Georgia law -- unless state law provides otherwise and then finally the Court picked up a piece of the Federal Tax Lien act of 1966 to complete its collage.

Justice William H. Rehnquist: What if this Court were to decide that as a matter of federal law the reference would be the Georgia law in this case.

Does the government agree that Judge Elliott's opinion that District Court or does the government think it should be sent back for a consideration by the Court of Appeals for the Fifth Circuit as to what Georgia law is?

Mr. Stephen R. Barnett: Well, we take the position that Georgia law is that the District Court was wrong that under Georgia law there is no such super priority here but it's not a position we rely on, it's not a question of state law.

But to answer the broader implications of your question Mr. Justice Rehnquist if the Court here were to take the position that state law governs we think it would have all, we think there would be all sorts of problems with that rule.

For one thing, it would destroy the uniformity, which we insist that this Court has recognized beginning with the Clearfield Trust case, in Clearfield Trust and the Court here recognized that the Fifth Circuit here relied on Kimbell and in its earlier Hicks case, the Fifth Circuit in stating that federal law governs stated the principle reason supporting the application of federal law is a need for uniform rule of decision to govern the rights of the United States and the administration of a large scale program.

Now that need for uniformity would be particularly destroyed in a situation of this case where the states are quite split on the question of super priority for repairmen's liens.

As we note in our brief page 27 no 24 there are at least 13 states that have been held to have statutes, which deny the repairmen the super priority those are 13th cited cases, I am sorry, to find the 13, the ALR annotation cited their list ten and our citations include three more.

Those are cases that have held that states have such statues, there may be other states that do.

Thus they would be quite a divergence in what the rule is under state law and recent method this would make it quite difficult for federal agencies to administer their programs.

Now the Yazell case, which has been cited in opposition to this principle, was a case involving a state law of Marital property and while the Court there followed that law, there is a statement in the opinion saying that if the SBA regulations worked to the contrary, the result might be different.

The SBA regulations now are to the contrary.

We submitted that case is very far from questions of commercial law as are involved in this case.

In Little Lake Misere as well this Court pointed out that the land acquisition there although it was an acquisition of land, the kind of thing traditionally governed by local law, quote is, when arising from and bearing heavily upon a federal regulatory program.

Choice of law is therefore a federal decision.

In Miree versus DeKalb County, in applying state law, the Court said the question here does not require decision under federal common law since the litigation is among private parties and no substantial rights or duties of the US hinge on the outcome.

Well, in this case substantial rights and duties of the US do hinge on the outcome, the litigation is not between private parties but the United States is involved and we submit that not only does Clearfield Trust apply but the principle of uniformity that's imbibed in Clearfield Trust would be inconsistent with borrowing or adopting state law as well.

Justice Byron R. White: Mr. Barnett, I take it you think that the SBA by regulation could subordinate its lien to purchase money mortgages and has?

Mr. Stephen R. Barnett: It has.

Justice Byron R. White: And I take it that you think that by regulation it need not -- it could have come out with other result on purchase money mortgages.

Mr. Stephen R. Barnett: Yes, I think it could by regulation.

Justice Byron R. White: And similarly here it could have if it wanted to provide by regulation that their liens would not be subordinate to mechanics liens clause?

Mr. Stephen R. Barnett: I think it could by regulation of --

Justice Byron R. White: And but it has been silent on that.

Mr. Stephen R. Barnett: Yes, it has the specific security agreement here gives that the specific authority to subordinate its lien if it wishes to in this case.

Justice Byron R. White: Yes, but you think by regulation the SBA could protect itself.

Mr. Stephen R. Barnett: I don't see, well, I don't could protect itself, yes.

Justice Byron R. White: In a situation -- from developing mechanics liens.

Mr. Stephen R. Barnett: Oh, no, no I'm sorry.

Justice Byron R. White: We will say it, it has an lien; it has a lien on a piece of property that the borrower sends to a mechanic and he does some work on it and he says pay the bill and the owner says I cant pay, so he just holds this.

Now could the SBA provide that its existing lien nevertheless is prior to the mechanics lien.

Mr. Stephen R. Barnett: No, I don't think so I misunderstood, I thought you are asking whether it could subordinate its lien by regulation and in this case it tried to protect itself that provided in the security agreement that the borrower may not encumber the tractor without its permission, I don't think the SBA could do that simply by regulation.

Justice Byron R. White: But Congress could I suppose.

Mr. Stephen R. Barnett: Congress could.

Justice Byron R. White: But you don't think that you don't think under the statute the SBA will have the authority to provide so provide by regulations.

Where did they get the authority to subordinate its interest to purchase money mortgages?

Mr. Stephen R. Barnett: I don't know, I will have to recheck my statement Mr. Justice White, I simply don't know whether would have the authority under regulation to do that or not to protect itself, to enact the rule that we are saying here is a rule of federal common law.

Justice Byron R. White: Well, you mean that a rule that this Court would enact?

Mr. Stephen R. Barnett: Yes, would recognize as federal common law.

I don't know, I rather doubt but I do not want to say where the SBA would have that authority under regulation.

Justice William H. Rehnquist: What if the FHA here at foreclose, or its during the shoes of the tractor owner and the tractor was being held by the repair people pursuant to the mechanics lien and the only claim made was the amount owed for that particular repair by the eighth time.

Do you think that the FHA could have gotten the Writ of Replevin or something that enforce the tractor owner to surrender -- the repairmen to surrender it?

Mr. Stephen R. Barnett: Yes, yes, as I was saying the first in time rule goes way back in this Court and has been uniformly applied by this Court.

The Second Circuit for example recognize that in the MacArthur Senior Village case, the Congress in the Tax lien Act of 1966 did of course make some exceptions to the rule in the case of federal tax liens but as the Second Circuit pointed out those exceptions were carefully tailored.

In particular the Second Circuit in the MacArthur Village case noted one such exception in the Tax Lien Act 26 U.S.C. 6323(b)(7) which applies to mechanics liens for the repair or improvement of a personnel residence containing not more than four dwelling units, occupied by the owner of such residence but only if the contract price is not more than $1000.

Well, now if the decision of the Court of Appeals here were appalled the decision that relies in part on the federal Tax Lien Act, one may wonder among other things, what the law would be with respect to this particular kind of mechanics lien or any other particular kind.

Would the Court here gives super priority to the that kind of lien even though the Tax Lien Act would not, would it give super priority only up to the amount of a $1000, would it incorporate to a limited of only four dwelling units in the residence.

This is we submit an example of the kind of uncertainties that are created by the decision here and we submitted wouldn't help to adopt any of the alternatives to the Court of Appeals ad hoc Eclecticism here for the reasons I noted a few moments ago on response to Mr. Justice Rehnquist, we submit that we are not held to adopt state law for one thing state law is very inconsistent on the précised question here for another thing uniformity is important we think and for yet another thing the policy that state law should not be able to hold sway over federal property interest is involved, now of course it can be said that if this court were to borrow or to adopt the rule borrowing state law, the Court is of course always free to examine a particular state law to determine whether its hostile to federal interest or aberrant.

But we submitted that would be a lot of ad hoc law-making for this Court to do and would involve supervision and criticism of state laws in a very large area the whole of commercial law, which would be approaching inferior to that of adopting or adhering to the clear federal rule first in time, first in right.

It is --

Justice Byron R. White: Unless that happened to be varied by an agency regulation?

Mr. Stephen R. Barnett: Well, again I don't know about an agency regulation but certainly it could be varied by Congress.

Justice Byron R. White: Well, didn't the SBA regulation on purchase money mortgages vary that?

Mr. Stephen R. Barnett: It varied by subordinating its claim.

My point is I'm not sure that the yes the agency regulation can subordinate its claim, I'm not sure whether it can strengthen or protect its claim.

The result reached by the Court of Appeals here is one that no one could have predicted and one we submit should not be appalled because it would create havoc with commercial transactions.

Now it may be suggested, it has been suggested that the model UCC should be adopted instead because it is suppose that the uniform has state law isn't on this question and because it would not be such a unique concoction as the Court of Appeals reached here.

However, we submit that alternative would not be acceptable either.

Justice Byron R. White: Well, Mr. Barnett, I take it from what you said while ago I just want to check that, you say 13 states would permit the lien or the credited lien or to replevin the property from the mechanics lien holder.

Mr. Stephen R. Barnett: Yes, at least 13 states have statutes that had been held to give priority to the earlier lienor against the subsequent repairmen and I assume that would allow replevin as well as --

Justice Byron R. White: Without paying his bill?

Mr. Stephen R. Barnett: Yes.

If the UCC is looked to one problem was that here and it is a problem that implicates the Kimbell case as well is that the UCC here itself refers to state law, so that if state law is inconsistent the resulting rule would be inconsistent as well and as I mentioned in the Kimbell argument that it seems to us as a problem with a adopting the UCC in the Kimbell situation how do you exclude the situation in mechanics liens that is presented here, just what is the scope that the of the rule that is being adopted, how would one know to what extent and with respect to what kinds of liens Court should use the UCC or should not.

Justice William H. Rehnquist: Don't state Courts also frequently differ in their interpretations of provisions with the UCC?

Mr. Stephen R. Barnett: That is another respect in what the UCC is inconsistent, it is not uniform, it has not been adopted everywhere, it has not been adopted in the Louisiana at all, the provisions of the original UCC the 1962 version have themselves not been adopted everywhere as illustrated by Georgia's failure to adopt the provision in this case.

Amendments are not adopted immediately if at all and judicial interpretations vary and as the First Circuit pointed out in the Chicago title case with respect to mechanics liens in particular there are many local eccentricities.

We see no way in which those eccentricities could fail to lead to confusion and uncertainty in the situation of this case and we see no way in which if the UCC were adopted in the Kimbell situation, those uncertainties would not creep into the rule to create havoc in the general rule and we submit that it is for Congress to determine to what extent federal contractual liens and in what precise respects federal contractual lien should be subordinated to the UCC to state law or anything else and again we find it significant to what Congress did in the 1966 Tax Lien Act was to reject the proposal that it simply adopt state law and place federal tax liens on the same basis as other liens under state law but instead adopted a carefully crafted set of federal rules for federal tax liens.

Justice William H. Rehnquist: You need the transposition of choateness from the tax insolvency field under the commercial loan field in this case to win for you?

Mr. Stephen R. Barnett: No, not in this case because in this case our lien is first in time by any definition.

We don't have to rely on the choateness rule in this case at all.

Justice Potter Stewart: Choateness really isn't an issue here, the lien simply didn't exist choate or un-choate until later?

Mr. Stephen R. Barnett: Exactly, whatever choateness means a lien is presumably inchoate when it does not yet exist.

Justice Potter Stewart: Right.

Justice Byron R. White: But what's really being challenged here is the first in time rule?

Mr. Stephen R. Barnett: Yes, exactly, exactly.

Well, now respondent has made an equitable argument that it is somehow unfair to the -- unfair for the first lienor to be given priority on the basis of first in time, first in right that the repairmen contributes value to the chattel and it is unfair to deprive him of a prior lien for that value.

We think there are several reasons why that argument should not be accepted, one is it significant that it has not been accepted in a number of states at least 13, the equity that is so clear to respondent is apparently not so clear to legislatures in that state.

In addition it should be noted that in reality we are not the first in time rule does not mean that the first lienor has an unchangeable primacy, it simply sets a starting point from which the parties made deal, a clear starting point.

If it is true that the value of the repairs would increase the value of the chattel more than the price of the repairs then it follows the first lienor would presumably consent to release of the portion of the collateral for the repairs and indeed the FHA in the security agreement in this case we take precisely that option in the record at A9, the security agreement on one hand requires the debtor to careful and maintain the collateral in good and husband like manner and goes on to provide in paragraph 3F that the FHA has the right to advance funds for the preservation or protection of the collateral with such advances to be added to the amount of the note at the same way of interest, so the question really is who decides whether the repair will increase the value of the chattel and is provident thing to do.

The first lienor the FHA here has tried to maintain to retain that right of decision and we submit that under the rule of first in time that right appropriately belongs to the first lienor and that there is nothing inequitable about that case.

The repairs may well be reasonable is conceivable however that they are not reasonable without suggesting that they are unreasonable in this case and might be pointed out that we have more than $2000 worth of repairs on a tractor that was eventually sold for only 5000.

It is conceivable that the FHA if asked, as it was entitled to be asked, would have decided nor might be better for the farmer to buy a new tractor.

Justice Byron R. White: But how much the Court below say the mechanics lienor had a first lien for?

Mr. Stephen R. Barnett: The Court of Appeals said only for the $500 worth of repairs.

Justice Byron R. White: That's all you are appealing, that's all you are appealing?

Mr. Stephen R. Barnett: That's all we are appealing in this case.

Unknown Speaker: And that was the latest.

Mr. Stephen R. Barnett: That was the last trip to the shop.

Unknown Speaker: (Voice overlap) trip to the shop?

Mr. Stephen R. Barnett: Yes the last trip to the shop.

Well, that's all we are appealing in this case Mr. Justice White the principle of whether the --

Justice Byron R. White: But in the Fifth Circuit that's all that you are subordinated to and any other transactions?

Mr. Stephen R. Barnett: Well, yes but the repairmen might keep possession from the very start.

Justice Byron R. White: Well -- and I will guarantee you never run up $2,000 that certainly wasn't on the first score around, he isn't going to use it.

Mr. Stephen R. Barnett: Well, one may wonder here why he went through -- went up $1,500 returning the tractor each time without doing anything to see whether the farmer would ever be able to pay.

Indeed that raises the question of the so called of the practical problems that respondent cites arguing that there is no way for repairmen to protect themselves if the first in time.

Justice Byron R. White: Mr. Barnett, how do you suggest relieve the matter to Congress, either way we decided we will obviously leave it to Congress, you just want us to decide it your way and then leave it to Congress?

Mr. Stephen R. Barnett: Well exactly and we say that our way is the way that of course was the first in the time rule that this Court has followed since 1827 and that is not only the traditional way but we suggested as the clear uncertain way rather than a way which would cause all sorts of uncertainty and complications but it is certainly true that one way or the other --

Justice Byron R. White: What is the rule under the Model Uniform Commercial Code?

Mr. Stephen R. Barnett: The Model Uniform Commercial Code says that the repairman in possession has super priority unless the repairmen's lien is created by a state statute and that statute provides otherwise at least 13 state statutes do provide otherwise, and thus the rule under the Model Code depends on the rule in the states.

Thank you I like to reserve the rest of my time.

Argument of Howell Hollis

Chief Justice Warren E. Burger: Mr. Hollis?

Mr. Howell Hollis: Mr. Chief Justice, may it please the Court.

The broad impact of this case is reflected in the amicus briefs filed both in this case and in the Kimbell case but the impact is broader than that because the individuals with the federal loan programs would design to protect and to benefit or the indirect are going to be affected by the decision of this Court if it overrules the Fifth Circuit and this is true because the utilization of the first in time choate lien doctrines ultimately creates a situation where a lender or where a mechanic will not be with one who has previously always going to deal with the federal government.

Apparently the government has abandoned the choate lien concept in the context of this case.

In their brief they utilized the Kimbell argument as their first argument and I gather today the counsel is admitted to the Court that choateness is not a concept or not a doctrine this Court may consider in determining whether or not to extend or amplify the first in time rule.

However the first in time rule incorporates and embraces the concept of choateness, so it's somewhat difficult to separate too.

The question is whether to expand a rule that was developed in the context of tax lien statute and the insolvency statute into a commercial arena.

Justice William H. Rehnquist: So the first in time rule was applied by courts long before the term choate was claimed, wasn't it?

Mr. Howell Hollis: The choateness test was -- my understanding was developed to determine that point in time at what you are competing lien was entitled to compete with the federal lien.

So you need to utilize it, when you consider on the first in time doctrine to determine that point in time at which you are competing lien may or may not compete.

Justice William H. Rehnquist: But if you go back to 1827 to the case that applied the first in time, first in right rule as the federal rule.

The Court adopted it wasn't creating a federal rule, it was just adopting what it thought was the common law rule was not it?

Mr. Howell Hollis: That's correct.

Notwithstanding that fact the government attempted to apply the concept of choateness in this case and did so in the brief.

Justice Thurgood Marshall: I understand in Georgia if it's been private there would be no problem other than the FHA, I mean if it had been a private loan or private instrument, they would had no problem.

Mr. Howell Hollis: There would be no problem if we were in a state court but there is a problem in as much as the government contented in the Fifth Circuit that state law is not clear as to whether or not the mechanic would have a priority under split Georgia statute.

Justice Thurgood Marshall: Do you say it is clear?

Mr. Howell Hollis: I say it is clear by virtue of the argument which we made in the later portion of our brief and which the District Court Judge applied in this case.

Justice Thurgood Marshall: Do we have to buy that in order to affirm?

Mr. Howell Hollis: No this Court can affirm the Fifth Circuit court by adopting the federal common law rule based upon the Uniform Commercial Code that the Fifth Circuit adopted.

You start from the proposition as the Court has suggested that it will that federal law must pertain.

Then the next question is what law of what will be the rule of law has been suggested that you can go directly to state law and so we will apply state law period or we will fashion a federal rule based upon something, whether the state law or in the case of the Fifth Circuit upon the Model Uniform Commercial Code.

The rule so fashioned at least does this, it is a commercial rule that was designed and developed for using a commercial transaction, it is not a rule that was designed to determine tax priorities and it is a rule that composed with 1962 instead of late 1800s, it's a recent rule.

The other aspect of utilizing a federal common law rule based upon the Uniform Commercial Code as we have indicated a little earlier and as the Court has become a way of respect to SBA and FHA the regulations in sales direct the lending offices and direct the agencies to utilize and incorporate and take advantage of and consider local law and local enterprise, when determining how to transact their business on a local level on the Uniform Commercial Code, does embrace a concept of locality the very same law, which the government relied upon in this case to a originally perfected security interest.

This Court has never applied the first in time rule of any area of commerce, it's been restricted to the Tax Lien area and the insolvency statute though the government is prevailed upon some of the lower courts to extend and amplify that doctrine.

No statutory basis at all for extending the doctrine and again the FHA regulations rely to the point that the federal government makes in its brief, they contend that the first in time rule is a uniform universal rule and that there are no exceptions.

Justice Byron R. White: Does FHA act or statute say that whenever money is advanced the government shall have a lien?

Mr. Howell Hollis: No, the statute itself requires that FHA advances be secured as the secretary deems necessary and appropriate so directs that FHA conduct himself as a commercial lender that they take back security for moneys advance.

The regulations --

Justice Byron R. White: Well you know the tax law say that at a certain time in the process of collecting taxes, a lien shall arise and specifically gives the government creates the lien.

Is there anything similar to that in the FHA, nor in any other regulation, do the regulations say that what kind of paper the FHA takes to evidence its lien and that sort of thing?

Mr. Howell Hollis: The reading the regulations is somewhat experience from reading Uniform Commercial Code, you have the concept of a security agreement, which was developed in the --

Justice Byron R. White: So, all this is right in the regulations I think?

Mr. Howell Hollis: Yes, sir it goes it's part and parcel.

For example there is even one portion of the regulations that informs the local lender about an esoteric farm loan for less than $2500, which is a Modern UCC provision, it's really --

Justice Byron R. White: So what if you found in these set of regulations they provision that, that is strictly in conflict with a the Uniform Commercial Code, the Model Act and b the way its enacted in a particular state.

Would you think that the regulation would govern?

Mr. Howell Hollis: Under the government's position --

Justice Byron R. White: Well, talking about your position, if say the regulation was flatly contrary to a provision in the Uniform Commercial Code as adopted in the relevant state, would the regulation govern or not?

Mr. Howell Hollis: To determine priorities.

Justice Byron R. White: Yes for example.

Mr. Howell Hollis: We contend that it would not that the uniform.

Justice Byron R. White: Because of what?

Mr. Howell Hollis: Because the Court should apply a federal rule such as the one fashioned by the Fifth Circuit as you --

Justice Byron R. White: You apparently concede that it would be federal law?

Mr. Howell Hollis: I don't concede that this Court should apply federal law but apparently the Court has already indicated that the base question is whether or not to consider this as a federal case or a purely state case.

Justice William H. Rehnquist: Well, aren't there two different questions.

One is whether it is a federal question as to the priority of the lien and another question is conceding that it is a federal question does the court deciding that federal question referred to a body of state law, to a body of federal common law or to some other body of law?

Mr. Howell Hollis: I think that's exactly what I'm attempting to say is that those are the two questions.

First we are going to decide it conceptually as a federal rule and then we have fashioned a federal although directly to state law as a federal rule.

Justice Byron R. White: But if it is a federal law then, if it is a federal question and then agency regulation was issued covering the disputed issue precisely wouldn't it take precedence over the state law?

Mr. Howell Hollis: I suppose if the regulation was not in conflict with the federal rule that was adopted that it would.

Justice Byron R. White: And if it working conflict with the statute as well, with the federal statute.

Mr. Howell Hollis: Well, in this instance, it would have to be in conflict with the case law because there is no statute.

Justice Potter Stewart: If we decide in this case that it was the duty of the Court stating federal to apply state law for example that as a matter of federal law whatever the duty was to apply state law then the FHA could hardly come out with regulations since to the effect the state law would be disregarded, could it?

Mr. Howell Hollis: Well, I understand it and the way that understood the discussion early, the FHA can issue almost any kind of regulations it wants to.

Justice Potter Stewart: Quite and defines of what might be decided in this case by this case, that's my question?

Mr. Howell Hollis: I'm not sure, whether they --

Justice Potter Stewart: Let's say this Court should decide in this case and its predecessor that what is applicable is the body of state substantive law in this area, whatever the state might be of all -- each of the 50s wherever the transaction is made.

Could the FHA in this case and the SBA in the previous case then come out with rules or regulations saying that state law shall be wholly disregarded and that our liens show, have this or that in the other priority regardless of the provisions of state law, I'm just referring in order to my brother White's question.

Mr. Howell Hollis: I don't, I think they could but it would not seem to me that they will be enforceable regulations.

Justice William H. Rehnquist: Why not unless we put our decision on a constitutional basis saying that this is the only way the government can run its business is constitutionally is by following state law but its never -- non of our cases ever suggested that first in time rule and choateness was a constitutionally with it and it just been a sort of a federal common law that Congress is perfectly free to preempt and supercede and similarly I suppose one of its agencies if it was authorized by a statute to do so.

Justice Byron R. White: Yes, but isn't the question whether there is any statute giving it any such authority.

You are not assuming there is some statutory basis for the FHA to draft one set of priority rules and the SBA to draft another set and then each government agency to draft rules or the things will help in these priority lien situations are you?

Justice Potter Stewart: And also shows inconsistent with whatever the Court says in these two cases.

Mr. Howell Hollis: Well, I don't know I think there is partially relying on it because the FHA has already subordinated some of its liens to some state liens when it didn't have to, hasn't it?

Justice Potter Stewart: Yes.

Mr. Howell Hollis: Yes.

Justice Potter Stewart: If the first in time rule is applicable it has.

Justice William H. Rehnquist: But in case, you feel like an innocent bystander, do you agree with the implication contained in my brother Steven's question that the agency would have either employed or expressed authority under the statute to draft the regulations which my brother White has referred to?

Mr. Howell Hollis: The way I read the regulations, The Enabling Act, the agency has given the authority to do specific things which is to make farm loans or operating loans and the entitle to draft legislation of regulations to implement that.

There is nothing in the enabling statute which would give the government the authority to have a super priority.

So I would not think that the drafting a regulations which granted the government super priority over mechanics liens and purchase money security interest and so forth would be a valid exercise of the congressional agent, of the agencies power.

We have drawn two statutory, two pieces of legislation to support our position that the first in time rule should not be extended one is the Uniform Commercial Code and the other is the Tax Lien Act of 1966, which is the Court indicated the in Kimbell argument earlier, eroded the basis for the extension of the first in time rule and in fact makes a specific exception with respect to mechanics liens and those who would retain possession of personal property for the purpose of asserting a repair lien.

Justice William J. Brennan: With respect to federal tax claims.

Mr. Howell Hollis: With respect to federal tax claims alone, we contended in our brief that the logical extension of the first in time rule would mean that the government would take superiority over purchase money security interest and its reply brief, the government notes that in analyzing that contention that the purchase money security interest would fail, it relies upon the Tax Lien Act of 1966 and the Uniform Commercial Code and some tax revenue rulings.

Importance of this is that the government turns to statute and state law and tax law to determine that it may or may not as it chooses to do so have a priority over purchase money security interest.

So the government flounders for a basis for this exception but it cannot be found.

First in time prevails, it has no exceptions, so what we are asking this Court to do is number one not extend the doctrine in the first instance and number two to call that an exception if it is so extended such as that exception found in the Tax Lien Act but more particularly we would wish that this Court apply the rule of law that the Fifth Circuit apply that of a federal common law based upon commercial rules.

Justice William H. Rehnquist: Aren't there some problems Mr. Hollies with if you apply a federal common law presumably the reason that you are doing it as to achieve some sort of certainty and yet if you resort to the UCC as interpreted by the states, you run into quite a variety of interpretations of some provisions.

Mr. Howell Hollis: Well, the policy question from the other side of the coin is are you putting certainly in the commercial business arena, certainly it is it is certain and sure and claim for the government but it is reasonable to anticipate that people would attempt to make an effort to work within the confines of the choate lien doctrine the first in time rules.

So if the first in time rule is expanded, so that the government has a super priority over after acquired liens.

The private sector, well then come in and make an effort to work with those rules.

So you have complexity on the private level which is of course counterbalanced by the uniformity and simplicity on the federal side.

Justice Potter Stewart: Oh, it's quite apart from differing constructions of the UCC by the various state courts you have in this context the UCC itself gives this super seniority to mechanics liens of this type unless the lien is created by state law and unless that state law provides that there should be no super seniority and were told to some 10 to 30 states don't give super seniority, so you wouldn't get anything likes uniformity in this area, wouldn't you under the UCC itself?

Mr. Howell Hollis: Under the UCC itself you would not.

Justice Potter Stewart: No, he would get defers to state loan in this respect.

Mr. Howell Hollis: Under the Fifth Circuit rule you would get uniformity.

Justice William H. Rehnquist: But you don't know where the Fifth Circuit is going from one case to another under Judge Goldberg's opinion, do you?

Mr. Howell Hollis: Well, they will face with the mechanics lien and the priority these are the affected security interest by the government and they decided that one question.

Justice William H. Rehnquist: Then where do we go next?

Mr. Howell Hollis: Well.

Justice William H. Rehnquist: John (Inaudible).

Mr. Howell Hollis: Alex Chalmers (ph).

Justice William H. Rehnquist: With somebody name Jack Crittenberg is the mechanic.

Mr. Howell Hollis: Where you go, there are traditional exceptions to a first in time rule as the Lehman would know it, who ever gets their first wins.

Some of the exceptions of the purchase money security interest, others are these statutory liens that state recognize.

Those are traditional in nature.

So you are talking about a rule of the Fifth Circuit fashioned to deal with a very traditional kind of case, a very normal kind of transaction on a very local, low level from the standpoint of the Tax Lien Act of 1966 they carved out a similar exception for repairmen and for an attorney's lien and for a perfected security purchase, money security interest.

So you are talking about exceptions to the time (Inaudible) first in time rule and you are talking about traditional exceptions nothing unusual or esoteric about the mechanics lien, it has been around for years especially one that is possessory in nature.

Chief Justice Warren E. Burger: What is the situation with respect if it's possibly relevant and if you know in most of the states as to a lien of a materialman, a painter or anyone else who paints a house which has a mortgage on it in all the states I know about firsthand, which should be 5 or 6 or 7.

The materialman's lien was superior to the lien of the mortgage even though the mortgage was first in time.

Is there any relationship between these two in terms of doctrine?

Mr. Howell Hollis: There is the relationship, the concept of the materialman or the mechanic is the he is one who improves and enhances value of property.

Chief Justice Warren E. Burger: He has preserved well if he didn't answered it, he is at least preserving the security, isn't he?

Mr. Howell Hollis: At least -- at least and as the Fifth Circuit rule fashioned in this case provides protection for one who says that it does not preserve it.

Chief Justice Warren E. Burger: Let me put it another way if you know, do you know of any state in which the materialman's lien would be subordinate to the first lien of the real estate mortgage and the circumstances I mentioned.

Mr. Howell Hollis: There are.

I cannot name the states but there are states that do not for example have a statutory materialman's lien in the first instance or that do not give it priority to a prior perfected first mortgage and these the similar situation is true with respect to personal property apparently because the government has cited some and also some 13 states, which do not give a super priority to the repairs of a mechanic.

So the rule would vary depending upon the state.

And its brief the government seem to elevate the importance of its lending programs to a constitutional level and whatever the underlying or underpinnings of the government lending programs are, they are certainly different from the functions that performs as a taxing entity and the tax arena the government is an involuntary creditor and the debtor is simply a neutral party.

However in a government lending program, the government participates with, bargains with, considers with, talks with is prospective borrower.

It's a voluntary enterprise and it is characterized by a commercial business dealings.

A rule, which comports with commercial business dealings is one fashioned by the Fifth Circuit.

A federal common law rule based upon the Uniform Commercial Code but the utilization, expansion and amplification of a first in time rule which does not comport with commercial expectations and as much as it does not recognize any exception, but is all encompassing and of course in conjunction with the choate test is one buying through which as the Fifth Circuit said the government always wins.

So, the utilization of a commercial doctrine as opposed to one that it does not recognize realities and the practicalities of dealing with the business world would be in a more appropriate rule for this Court to fashion in the absence of any congressional legislation at the contrary.

It's been suggested that the government needs to fulfill a particular interest in protecting its property.

However, as the exceptions to the Tax Lien Act of 1966 reflect the attorney's lien, the repairman's lien, the government is not hurt by the recognition of exceptions to the first in time rule.

And so far as a purchase money security interest is concerned, the government never had it, if the government was not on the scene the debtor would not have had an opportunity to ever obtain additional collateral.

But, the proprietary interest that the government has and the debtor's collateral and debtor's property is not defeated, divested, defaced, eroded by the failure to apply the first in time rule.

The government, in fact is better-off in this case after the tractor is repaired than before it was repaired.

Justice Potter Stewart: Could I make sure did you say earlier you sought the District Court was right on Georgia law?

Mr. Howell Hollis: I believe the District Court was correct and with respect to that.

Justice Potter Stewart: And so you think under Georgia law this lender, if the FHA had been a private lender having perfected its lien the way it was perfected here.

It would have been subordinate to the mechanics lien.

Mr. Howell Hollis: No.

I think that under Georgia law it would have the -- yes, yes it would have been subordinated to the mechanics lien.

Justice Potter Stewart: Not only for the last bill but all of them.

Is that right?

Mr. Howell Hollis: As I contend that and I contend it in the Fifth Circuit.

Justice Potter Stewart: But is not what the District Court did?

Mr. Howell Hollis: And that's what the District Court did.

Justice Potter Stewart: And you think that's consistent with Georgian law?

Mr. Howell Hollis: It was the Fifth Circuit noted no case where anybody ever -- property back and then were wouldn't got it again.

Chief Justice Warren E. Burger: Well, the District Court expressly found that whether under Georgia law or under a federal law?

Mr. Howell Hollis: Federal law state.

Justice Potter Stewart: Did the District Court so find with respect to the first six repair jobs?

Mr. Howell Hollis: In the entire pay bill.

Justice Potter Stewart: Entire but you are no longer asking, I mean you are just trying to defend the last $400 as I remember.

Could you have any cross petitioned?

Mr. Howell Hollis: I have not cross petitioned if --

Justice Potter Stewart: So that you do not know I have a claim for the first five repair bills, I understand.

Mr. Howell Hollis: By virtue of not having cross petition.

That's true.

Justice Byron R. White: That's true, but it is a matter of the rule to be adopted.

It really makes a difference whether you say you adopt the Uniform Commercial Code without the reference to state law or whether you will just adopt the Uniform Commercial Code?

Mr. Howell Hollis: We would adopt that we believe the Fifth Circuit rule where adopted the Uniform Commercial Code with reference to state law is the appropriate rule.

Justice Byron R. White: Yeah, I know you.

But then, it didn't follow that.

It didn't go to the -- it did not follow Georgian law in that --

Mr. Howell Hollis: It did not decide the whole case.

In fact, the District Court held that we had an equitable lien on the tractor.

The Fifth Circuit said that it didn't feel compelled to reach that question in light of the view that it was taking over the case.

And then so far as the Georgia law is concerned, the Fifth Circuit look to see whether or not a mechanics lien was available under Georgia law and determining that it was made reference to the Uniform Commercial Code, the federal Tax Lien Act the question of complete and total possession the Fifth Circuit noted if it find no case on the subject and we couldn't either.

Chief Justice Warren E. Burger: You clarify for me if you will, what you say is the status now here in this Court of the District Court finding about Georgia law.

Mr. Howell Hollis: I believe that the District Court's decision with respect to Georgia law could be the basis for this court upholding its interpretation of Georgia law in granting Crittenden the super priority in this case.

Chief Justice Warren E. Burger: What the Fifth Circuit do about that?

Mr. Howell Hollis: The Fifth Circuit did not need to reach the question of --

Chief Justice Warren E. Burger: Should we decide that here when the Fifth Circuit is assuming thought we should reach it, should we decided here and the Fifth Circuit did not reach it?

Mr. Howell Hollis: I don't believe that this Court should decide it first of all or second that it need to that it can either remand it to the Fifth Circuit or that it can adopt the opinion of the District Court.

Chief Justice Warren E. Burger: But I take it to agree with if the Court concluded we needed to decide that, we needed to decide that, we shouldn't decide it here when the Fifth Circuit didn't reach it.

Is that right?

You say we don't need to reach it, but going hypothetically now.

Mr. Howell Hollis: I don't believe you need to decide that.

In conclusion, the choate lien test in the first in time rules transport at the end of the commercial area cannot to help to create -- I see my time is running.

Rebuttal of Stephen R. Barnett

Chief Justice Warren E. Burger: Thank you.

Do you have any further Mr. Barnett?

Mr. Stephen R. Barnett: Just one single point, Mr. Chief Justice.

The question has been suggested that the Clearfield Trust case and the policies inherent in it perhaps need reconsideration by the Court.

I would simply point out that the Court below in both of these cases explicitly held that federal law governs the cert petitions present and no question on the score.

And if the Court were to be interested in reconsidering Clearfield Trust, we would be interested in submitting a brief on that question now.

I know that it hasn't been suggested that Clearfield Trust be reconsidered with the spect of the question of whether it's a decision of federal law or not, but we would submit that if state law is to borrowed on a wholesale basis that implicates the policies embodied in the Clearfield Trust decision.

We submit that the main policy embodied there is uniformity and if state law is to be borrowed on a wholesale basis, one is going to encounter on certainty, sacrifices of the federal interest and perhaps even more uncertainty than one would have if one decided that it was a state question in the first place.

Justice Potter Stewart: It doesn't remove the matter from congressional reach or from agency reach if Congress gave the agency the regulatory authority.

Mr. Stephen R. Barnett: That is true.

I simply wish to suggest that if that question is to be reconsidered, we would be willing to submit a brief on it.

Thank you.

Chief Justice Warren E. Burger: Thank you, gentlemen.

The case is submitted.

Featured:

United States v. Moore - Oral Argument

Thu, 23 Aug 2012 18:29:37 +0000

Case:

United States v. Moore

Media File:

74-687_19751015-argument.mp3

Related Transcript:

74-687_19751015-argument

Transcript:

Argument of Harriet S. Shapiro

Chief Justice Warren E. Burger: We will hear arguments next in 74-687, United States against Moore.

Mrs. Shapiro you may proceed when you are ready.

Ms Harriet S. Shapiro: Mr. Chief Justice may I please the Court.

This case is here on the Government's petition for Certiorari to review the judgment of the Court of Appeals for the Fifth Circuit.

It involves the interpretation of 31 U.S.C. 191 which provides that when a person indebted to the United States becomes insolvent, the debts due to the United States shall be paid first.

The issue here is whether that priority of the United States, applies only when the precise amount of the debt is established before insolvency or whether all debts due to the United States since insolvency, whether liquidated or not, are to be paid first.

The fact here were stipulated.

Emsco which is a Texas Corporation breached three contracts with the Defense Department.

After they had breached the contracts, it assigned all its property to respondent to be sold for the benefit of its creditors and that act of course established its insolvency.

Shortly thereafter, the Government re-let those contracts that Emsco had breached and the amount of Emsco’s debt to the Government was determined.

It was determined by settlement of two of the contracts and by charging Emsco for the excess costs of re-procurement on the other.

The priority statute requires that when a person indebted to the Government becomes insolvent, the debts to the United States shall be paid first.

And a voluntary assignment for the benefit of creditors is the one of the ways in which insolvency can be shown under the statute.

It is -- that is also an act of bankruptcy.

So that when there is an assignment for the benefit of creditors, the creditors have a choice.

They can either consent to the assignment and take their share of the debtor's estate under the conditions in the assignment or if they prefer the protection of Bankruptcy Laws, they can petition to have the debtor declared a bankrupt, in which case the assignment is void.

If there had been a petition in bankruptcy here, it is clear that the Government's claims on this contract would have been debts provable in bankruptcy because the Bankruptcy Act expressly defines debts to include un-liquidated or even contingent claims.

These are provable debts and so long as they are liquidated or can be estimated soon enough, so that they can paid without unduly delaying the Administration of the estate, they are allowable.

In addition, the bankruptcy Act gives a priority to debts owing to any person, including the United States entitled to a priority under Federal Law, so that the Bankruptcy Act incorporates the priority statute by reference.

A number of cases, both in this Court and in the Courts of Appeals have assumed that this priority applies to claims like the ones here which were un-liquidated when insolvency occurred.

So that if there had been a bankruptcy, we submit that these claims would not only have been provable, but would been entitled to a priority.

But there was not any petition in bankruptcy here.

The Government simply asserted its claims to priority under the priority statute.

When the claim was denied, the Government brought suit in the District Court following the established principle, found that the Government was indeed entitled to its priority, but the Court of Appeals reversed.

It interpreted, it is a 175 year old statute without considering any of the previous cases which it had construed, the policy it was designed to serve or even the long-standing practice under it.

The Court held that before its debts due means only those debts which would have been entitled to be recovered under Common Law Action of Debt.

Since the claims here were not for fixed and certain amounts presently payable at insolvency, they were not debts due at Common Law, and therefore, the Court held they were not entitled to priority.

We submit that that decision is simply wrong, both on the basis of precedent and because it was undesirable, practical effects.

The precedents are entirely clear in holding that the priority statute applies not only to debts which are due in the sense of being presently payable, when at the moment that insolvency occurs, but it also applies to debts where the obligation has accrued, but the time for payment has not yet arrived.

In fact the respondent does not really dispute this, but we submit that that fact alone should demonstrate the Common Law Action for Debt which requires that the debt be presently payable is not an appropriate standard for defining debts due.

Indeed if the standard were strictly applied, there could be some question about whether taxes would be within the priority at all.

Since there are some precedent indicating that taxes are not Common Law debts.

And of course the status of taxes which have accrued, but which are not payable at the precise point of the insolvency would still more uncertain.

There is not any such uncertainty now.

Priority statute clearly applies to all accrued taxes, including un-liquidated ones and to those which have accrued but are not yet due, when the insolvency occurs.

The priority statute also has long been assumed to apply to contract debts of the sort involved here where the obligation has been established by the time that the insolvency occurs, but the precise amount of the obligation is not settled until later.

The effect on Government Revenues of altering this long-standing interpretation of the priority statute is hard to estimate.

Indeed for the tax applications, we really have not been able to get any estimate because the effect of the decision is so unclear.

What it does is create questions, but there is really no way of telling what the precise impact of it would be.

On the contract applications, the Defense Department has estimated that in a typical year, perhaps some $20 million in Government claims in Defense contracts alone might be affected.

There is a further reason why the decision below should be reversed, in addition to its precedent and its effect on Government revenues.

It provides a practically unworkable standard for the person who must distribute the insolvent's estate.

He must decide whether a given Government claim is entitled to priority and if he guesses wrong, he may be personally liable to the Government for the amount paid to the other creditors.

It is therefore very important to have clear standards for determining when the priority applies and the limitations of the Common Law Action for Debt are certainly not the kind of clear standards that are appropriate.

The respondent seems to agree that the decision below cannot really mean exactly what it says.

He suggests that nevertheless, this Court should limit the debts to which the priority statute applies to ones which have been liquidated before the insolvency occurs.

But that limitation too is unsupported by precedent and it is also unrelated to the purpose of the priority statute.

The Courts have consistently interpreted the statute as applying to all types of debts.

They have recognized that its broad purpose is to protect the Federal Revenues and when a particular debt is liquidated, is not significant in terms of that policy.

The Government's interest in assuring that the debts owed to it will be paid is not related to the time of the precise amount of the debt is determined.

But there is an appropriate source of guidance for determining the meaning of the debts in the priority statute.

That source is the Bankruptcy Act, which uses the precise term and as used in the Bankruptcy Act, the term “debts” explicitly includes un-liquidated and contingent claims.

Unknown Speaker: Of course the Bankruptcy Act came along a hundred years later and on the statutes on which this case is based?

Ms Harriet S. Shapiro: That is right.

The current Bankruptcy Act did.

There was an earlier Bankruptcy Act about 1800 which also recognized certain contingent claims as debts.

And the priority statute refers in effect to the Bankruptcy Act since one of the types of in -- one the acts which makes it applicable or any is any kind of bankruptcy.

And moreover the Bankruptcy Act refers to the priority act in defining debts which are entitled to priority.

So there is a distinct cross reference.

Both Acts deal with insolvency and protect Federal interests by providing Federal priorities.

So both reflect similar policies and moreover they are overlapping in the sense that a case involving one statute will very often also involve the other.

So differences in interpretation of identical languages under these circumstances almost certainly will lead to confusion and such differences should be avoided unless they are clearly required by the statute's language or by it is purpose and no such difference is required here.

Un-liquidated claims are debts under the Bankruptcy Act and for that reason they also should be considered debts under the priority act.

This interpretation of the Act has an entirely practical advantage, not only to the Government, but also to those who contract with it.

From the Government’s point of view, the priority should attach when the contract is breached.

If it does not, the debtor can manipulate the time at which he becomes insolvent in order to avoid the Government’s priority and he may very often want to do that in order to prefer creditors with whom he may want to deal later.

Manipulation is not -- it would not be difficult.

He would have simply have to make an assignment for the benefit of creditors or file an involuntary petition in bankruptcy, promptly after he has breached his contract before the Government has a chance to liquidate its damages.

But to try to protect itself from having its priority defeated in that way, the Government in its turn would have to liquidate its claims as rapidly as possible even perhaps by terminating contracts where it had doubts about the contractor’s insolvency and that certainly is not a policy that would benefit contractors.

It might very well lead to increased litigation over contract terminations and it could increase business instability by tending to push border line companies in insolvency.

Justice Potter Stewart: Well, unless if you are right that debts due does include un-liquidated claims, certainly it is in the interest of the disposing of these insolvent's estate for the Government to liquidate its claims as rapidly as possible, otherwise this insolvency estates are going to be tied up indefinitely, if you are correct in your basic premise?

Ms Harriet S. Shapiro: Certainly the Government does have a very strong interest in liquidating the claims as promptly as possible.

Justice Potter Stewart: You had direct interest.

You just told that your interest is going the other way, but however would that may be, the interest of settling the insolvency estate history is very strong in favor of getting these claims liquidated and then handled?

Ms Harriet S. Shapiro: That is perfectly true.

All I am saying is that it is important not to have the Government’s priority turn on the speed with which it can liquidate the estate.

There certainly is no chance that the Government is going to delay liquidation if its priority does not turn on that.

All I am saying is you should not have a rule that says, “Okay, the minute you think that there may be insolvency, you have to rush in and liquidate immediately on pain of loosing your priority.

The Government certainly does not have any interest in delaying liquidation and it is not going to do so, it certainly did not do so here and in fact under --

Justice Potter Stewart: Six years after the assignment?

Ms Harriet S. Shapiro: Well, no.

in fact --

Justice Potter Stewart: Liquidated?

Ms Harriet S. Shapiro: In fact I think that the respondent would agree that the point of liquidation is when the contract was re-let and here the last one, well the first contract was re-let within the period within which the non-priority creditors could submit there claims, before December 1, 1966.

The second one was liquidated within the time which -- within which the assignment could still have been avoided by a petition in bankruptcy.

And the final one was liquidated within, assuming there had been a petition in bankruptcy, then you have six months to file claims and now that --the final claim was liquidated within that six months so the Government has not delayed and it does not normally.

As I have said, all I am saying really is that you should not put a penalty on the Government of loosing its priority if it fails to liquidate before there is an assignment for the benefit of creditors.

Justice Lewis F. Powell: Was not one of these claims contingent as well as un-liquidated, contingent in the sense that it was complicated -- there was a controversy as to whether or not there was a claim, a valid claim?

Ms Harriet S. Shapiro: The respondent or Emsco did maintain that and I believe all three of the contracts were terminated for the benefit of the Government rather than breached by Emsco.

Justice Lewis F. Powell: Your position makes no distinction between claims that are contingent and those that are merely un-liquidated, does it?

Ms Harriet S. Shapiro: Well, in -- what we claim is that this claim was un-liquidated, but were not contingent.

Certainly the fact that there was litigation concerning the type of breach, does not we believe make it -- makes the claim contingent when the conclusion of a Court of -- Contract Appeals Board was that in fact there had been a breach as of the time the breach occurred, that -- the finding of the Board relates back to the moment of the breach.

Certainly, so long as the obligation of the debtor is fixed, so long as the cause of action has accrued by the time there is an assignment or other act of insolvency, we --

Justice Lewis F. Powell: So long as the Government makes the claim because if the claim is contested at the time of the assignment the obligation would not be necessarily be fixed that way?

Ms Harriet S. Shapiro: Well, I think it makes a difference about what happens to the result of the contest if in fact there is a determination that the Government’s claim was valid.

Justice Lewis F. Powell: Suppose it were a tort claim, contested?

Ms Harriet S. Shapiro: I don’t believe that makes any difference as I know that it had -- as long as it is a -- the result is that the Government’s claim is upheld then --

Justice Lewis F. Powell: But it may not be upheld, say for six to seven years as result of litigation, what happens during that period of time?

Ms Harriet S. Shapiro: Well, the other provision that is in the Bankruptcy Act which we believe certainly might well be applicable under to this -- to the priority statute is that if the claim cannot be either liquidated or estimated within a time which would permit the reasonable prompt -- reasonably prompt administration of the estate then it is not a provable claim.

Justice Byron R. White: But that provision is not applicable to this.

It is applicable to the bankruptcy and that is the very problem of your case.

If we had such a provision here that in a manageable situation, but that provision is not.

You are really seriously submitting that that provision is applicable to this statute, are you?

Ms Harriet S. Shapiro: There is no real reason why it could not be --

Justice Byron R. White: It would be nice if it were, that is your point?

Ms Harriet S. Shapiro: Well, the other possibility of course is that the respondent or the assignee can set aside an amount necessary to meet the Government’s claims.

This is --

Justice Lewis F. Powell: But in this case that would have required the setting aside of assets that would have deprived other creditors of any recovery at all, would it not?

Ms Harriet S. Shapiro: Yes.

That is true, it would have.

This is --

Justice Lewis F. Powell: The administration problem is really very puzzling, you know?

Ms Harriet S. Shapiro: Well, the Court in United States v. Barnes faced up to that and decided that the priority statute in fact applied -- provided that the Government did have a priority and in those circumstances the Government -- there is a policy of giving the Government a priority is that -- Congress has decided that it applies, that it should prevail.

Justice Byron R. White: Well, certainly there is no question about the Government having been given a priority by statute.

It is given a priority with respect to debts due to United States and the question in this case is what is the meaning of, not only debts, but debts due, is not it?

There is no question about its priority, question is only how --what it covers?

Ms Harriet S. Shapiro: Well, yes, that certainly is just correct, yes.

Well, I am -- and my conclusion really is that the decision permitting private creditors to get a larger share of the assets of the insolvent's estate is a change for Congress to make.

Justice Byron R. White: I notice on Page -- Footnote on page 17 in your brief, you say that if there is no priority, the other creditors will receive substantial portions of their debts and the United States will receive nothing?

Ms Harriet S. Shapiro: Yes.

Justice Byron R. White: And I see that on page 3 of the -- of your opponent's brief, it is said that if there is no priority, the United States will receive 40%?

Ms Harriet S. Shapiro: I do not know how they got to the 40%.

Justice Byron R. White: Whatever it was, do you still maintain that the United States will get nothing?

Ms Harriet S. Shapiro: Under the terms of the assignment, that provided for the payment to the non-priority creditors who submitted claims by the first of December 1966.

The government did not submit a claim as a non-priority creditor by December 1, 1966, so under the terms of the assignment, the government would get nothing.

Chief Justice Warren E. Burger: And that is something you could have (Inaudible)

Ms Harriet S. Shapiro: We could have, but we thought we had a priority on the basis of the practice up to that point.

Justice William H. Rehnquist: Could the government have improved its position in that regard by filing a petition for bankruptcy upon the occurrence of the assignment?

Ms Harriet S. Shapiro: The government cannot by itself file a petition for bankruptcy when there are more than 12 creditors.

It cannot --

Justice William H. Rehnquist: It cannot, (Voice Overlap) it can join as one of the three or whatever?

Ms Harriet S. Shapiro: It takes 12.

Justice William H. Rehnquist: It takes 12?

Ms Harriet S. Shapiro: It takes 12 if there are more than 12 creditors.

Oh! I am sorry, you are right, it is 95 (b), it is by three or more.

Unknown Speaker: (Inaudible)

Ms Harriet S. Shapiro: [Laughter] I would like to reserve my -- rest of my time.

Chief Justice Warren E. Burger: Well very well.

Mr. Harris.

Argument of Thomas Osa Harris

Mr. Thomas Osa Harris: Mr. Chief Justice and may I please the Court.

The question in this case is whether un-liquidated contractual claims of the United States constitute a debt due within the meaning of priority statute.

Now, we differ with Ms. Shapiro.

Several times she said, “All debts” and the Court says, “the question we are talking about right now is whether this type of claim is a debt within the meaning of the statute.”

It appears to me that there are four factors very important to the resolution of this case and two of those factors would indicate a narrow decision, a narrow interpretation of the statute.

Two of them would indicate a more expansive interpretation of the statute.

The first two involve the meaning of the term debt due at Common Law at that time approximately when this statute was first written.

The statute was first written in the 1780’s and has been carried forward substantially unchanged is that term.

The second factor again which I think would indicate and lead to a narrow interpretation of the statute is the concept to the fairness of all the creditors in this situation, including the Government, including the other creditors who dealt with Emsco.

The factors favorable to the Government’s position or a line of cases indicating that this particular statute should be construed liberally for the purpose of protecting the Government’s purse.

Also a line of cases in which the matter of priority has just been assumed with no real discussion.

Ms. Shapiro has adequately related the facts giving rise to this controversy.

The only thing I might add was that this company, Emsco Screen Pipe Company was in a failing financial situation when it entered into these contracts with the Government and managed to sort of prolong its existence on for another couple of three months and then ultimately went into the assignment for benefit of creditors.

Chief Justice Warren E. Burger: (Inaudible)

Mr. Thomas Osa Harris: Well, yes sir, it does because it has a bearing on it in my view because the second factor that I think is important is the matter of fairness to all creditors.

In this case the Government was dealing with Emsco on a business basis just like each other creditors and it seems to me that we have got a different situation from a taxing authority dealing with the tax recipients and tax payers.

I might raise a question --

Chief Justice Warren E. Burger: Would not your theses put a burden on the government to make a careful inquiry into the potential solvency of everyone of its contractors --

Mr. Thomas Osa Harris: Yes, sir.

That inquiry is required, generally in making --

Chief Justice Warren E. Burger: (Voice Overlap) on their own, but -- and that means that it has got to affect their priorities, the government is going to probably disfavor the great many contractors who need the business, are they not?

Mr. Thomas Osa Harris: That was one of the disputes that arose in this particular case, Your Honor, not this trial, but at the trial of the Navy’s claim because the company argued that there was a misunderstanding between the government and the company at that time and that the company was not really financially able to perform this contract and the government was required to make a determination that it was and there was just some confusion in that and the company thought it was, but a wrong standard was applied and it should never been awarded this contract in the first place.

These arguments are kind of detailed a little bit in the brief, but the main point that I wanted to cover was whether the idea of this un-liquidated claim was debt due within the statute in accordance with the Common Law definitions.

There was a question as to the time of the time of the liquidation of the Government’s claim and the claims were liquidated soon after the time of the assignment for benefit of creditors and this lawsuit was generated to determine the applicability of the priority statute to un-liquidated claims.

The first that I think the most important factor in the resolution of this case and the interpretation of the term debt was what the term meant to the framers of the legislation.

And to get some indication of that, we’re going back to look at the particular meanings of the term “debt” and “debt due” in the Common Law.

And our argument is that the Common Law did not comprehend a debt as an un-liquidated claim that you could have it.

A debt where the matter was, say on a promissory note, it might not be presently payable, but it was readily ascertainable and it was a sum of certain.

Some force was given to this argument by a case from this Court in 1948, Massachusetts versus the United States.

In that case, Massachusetts was arguing with the United States over, again the proceeds of an assignment for benefit of creditors.

There were two taxes that were owed.

There were Federal unemployment taxes owed and there were State unemployment taxes owed.

And the assignee took the position that he was entitled to pay the State unemployment claims to the extent of 90% of the Government’s, of the Federal Government’s claims because there was a provision in Federal Government statute that you could get 90% credit for any amounts payable to a State Fund that you have been provided.

And the Federal Government took the position that they could not do that, that at the time of the insolvency all rights were fixed and you had to pay the full amount of the unemployment tax claim.

This background is important because it bore on the resolution of the problem by the Court in that case.

The Court said that you had to look to the moment of insolvency as to what the situation was at that time in order to determine whether priority applied.

You could not look to events that happened after insolvency in order to determine whether there was a debt.

Justice Thurgood Marshall: There was a little difference in Massachusetts case.

There were these people disputing liability, were they not?

Mr. Thomas Osa Harris: I beg your pardon, Sir.

Justice Thurgood Marshall: In the Massachusetts case they were disputing the liability?

Mr. Thomas Osa Harris: That is correct.

Justice Thurgood Marshall: In this case there is no dispute here?

Mr. Thomas Osa Harris: Well, there is no dispute as to the liability, only to the whether it was a debt that time.

Justice Thurgood Marshall: But not (Inaudible)?

Mr. Thomas Osa Harris: Yes sir, not mail.

At the time of the insolvency, of course there was no way of knowing what the amount was owing to the Government and at that particular time it could have worked out in a number ways so that --

Justice Thurgood Marshall: Only one judge on the Fifth Circuit followed that theory?

Mr. Thomas Osa Harris: Yes sir.

Actually two judges on the Fifth Circuit said that you -- what you have to do is look to see the time of insolvency as to whether it was a debt, presently payable or not.

I think that was to some extent erroneous in making the debt be presently payable because that was not a necessary requirement of the Common Law term “debt” because the Common Law term included debts that were presently payable and debts meaning a sum certain that would be payable at a designated time in the future and the only thing he had to do was wait for the time to pass.

There was no happening of the subsequent event that would liquidate the damages.

In the Massachusetts case, the language that we rely on is as following.

It says it is at least doubtful on the statute's wording that obligations wholly contingent for ultimate maturity and obligation upon the happening of events after insolvency can be said to fall within the reach of debts due at the time of insolvency.

And further it says that Congress drew the line for the operation of the statute close to, if not at, the commonly accepted meaning of debt as distinguished from other forms of obligation.

Chief Justice Warren E. Burger: Do you think that statement was necessary to the holding in that case or was it just a side observation by way of the dictum?

Mr. Thomas Osa Harris: Well, when I first got involved in this, I thought it was just dicta but then as I become more closely acquainted with the case, I think that that was an integral part of the holding or at least an integral part of an alternative reasoning because the --

Chief Justice Warren E. Burger: Does not the taking of this part of the holding mandate, now does not it refer to the maturity and obligation in the conjunctive?

Is there any doubt about the obligation in this case?

Mr. Thomas Osa Harris: Well, I think that the focus of the inquiry that was indicated in Massachusetts was that you look at the time that the events, at the time of the insolvency and if you have to look to subsequent events, contingent advances as cause them in that language, then it was not, it would not be at debt due in the Common Law.

Chief Justice Warren E. Burger: The contingency that the Court was referring to in that language you rely on, has both elements, maturity and obligation, does it not?

Mr. Thomas Osa Harris: That is correct, yes sir.

Chief Justice Warren E. Burger: There is not.

That is not true here, is not it?

Mr. Thomas Osa Harris: Well, there is no --

Chief Justice Warren E. Burger: There is no doubt about the obligation?

Is that the (Voice Overlap)

Mr. Thomas Osa Harris: That is correct.

The obligation was fixed, but the thing that I want to emphasize is that you have to look at events beyond the time of insolvency in order to determine, really whether there was any obligation because damages could have been zero on the thing on that, and I suppose that maybe a metaphysical way of approaching it, but if you have to look at events subsequent to the time of question then it would not be a debt in accordance with the Common Law thinking.

Another case that we think bears on this case is the case of United States versus State Bank of North Carolina which was decided in 1832.

That case involved a customs bond which was executed before the insolvency, payable after the insolvency.

And Justice Story said that this was nonetheless a debt due, even though it was not presently payable.

To get to that result, he went to some Common Law thinking and he said, “You know, if you want to know what debt means, look to the Common Law and we are going to apply it in the sense of the Common Law term, meaning a debt presently payable, excuse me a present a debt, that is presently obligated, but payable in the future.”

The emphasis was that you did not look to subsequent events.

Keying in on that particular language, it is in Latin, I could not pronounce it too well, but it is debitum in presenti, solvendum in futuro or something, keying in on that language, I looked at other cases and brought them before the Court in my brief and those other cases also stress the importance that to the -- in the concept of the language at that time that it was written in the statute, you could not look or you should not look to events after the time of the insolvency to determine if it was a debt or not.

Debts and I am convinced that debts in the terms of the statute meant things like promissory notes, bonds, that type of fixed sum sort of obligation.

There has been some discussion as to taxes, as to whether they are debts or debts due, there have been previous cases out of this Court that have indicated taxes are certainly a debt due within the meaning of the statute.

Chief Justice Warren E. Burger: Would you have settle though as to (Inaudible) of the tax payers testing the --

Mr. Thomas Osa Harris: Yes sir because the events that have generated the tax have happened at the time of the particular insolvency.

They may be disputed, take a net worth case.

Chief Justice Warren E. Burger: (Voice Overlap) the events which is precipitated the liability here all happened before the insolvency?

Mr. Thomas Osa Harris: Yes sir.

Chief Justice Warren E. Burger: It is just the amount that is not actually determined.

How that is different from a tax case?

Mr. Thomas Osa Harris: Well the tax case, at the time of the insolvency, you have got all the facts you need.

You can work out the dispute.

You can figure out what the tax is as of that particular moment whereas in the instant case, you cannot do that until the subsequent event after insolvency takes place and that subsequent is a repurchase of the contract.

It could be that there would be no damages.

I would --

Justice William H. Rehnquist: Well, does that exclude all contractual type claims supposing that there is a promise to deliver the Government a thousand bricks and that promise is breached, so that you have a clear breach.

The only question is assessing damages.

Now, I suppose you, the Government could go about proving damages by simply producing testimony as to what to those bricks would have been worth without necessarily letting a contract for new bricks and that by your test might simply focus on the events that have occurred prior to the breach, would that then be a debt due?

Mr. Thomas Osa Harris: Well, I do not think that it would be a debt due because you still have to look to the subsequent event.

Justice William H. Rehnquist: What is the subsequent event?

Mr. Thomas Osa Harris: Proving up what the damages were.

Justice William H. Rehnquist: Well, then you say, even though the testimony of the proof talked about events that had occurred prior to the breach, the mere fact that the proceeding took place after the breach is enough to take it out of the debt classification?

Mr. Thomas Osa Harris: No, sir.

Let me back up a second.

I think that if you have a liquidated damages clause within the contract then you would have a debt due as of the time of the insolvency.

If you did not have a liquidated damages clause, your damages are going to be fixed in some sense by the loss of value to the Government, either a repurchase or some other way of determining what the value of that contract was.

You have to have a determination after a subsequent event, after the insolvency, so you have to determine whether there was any money damages at all.

To distinguish that from a tax case, you have to have a hearing of course, but you know what the numbers are.

In the leading case of this Court which talked about taxes as a debt due, the Court was very careful to use the language that taxes were a sum certain or a sum that could be reasonably and quickly ascertained.

And I think by that sort of mathematical calculation type thing, it was bringing, it was being careful not to get away from whatever the Common Law concept of debt was for the statute.

That case is Price versus United States, which was cited by both counsels.

I would like to, there is been some questioning of the Court and I understand the problem of the difference between a contingent event and a mere disputed event.

Now, I want to say, and the Government has raised a point in their reply brief, and I say that in the event, say taxes, are disputed at the time of the insolvency, but they are not necessarily contingent because you are not looking to subsequent events.

I think the second factor that is of importance in this case is the concept of the fairness to all the creditors and I raise a question again, why in this situation should the Government be given particular special treatment because they were in a business relationship with Emsco.

If you take the situation that Emsco had never bid on this contract, then the contracts would have been re-let or they would have been let to other parties at a higher price perhaps, but it would have been the same price that the Government are not paying anyway rather than coming in to this.

Chief Justice Warren E. Burger: How can we speculate about that?

It’s a --Mr. Harris, useful, is not it?

Mr. Thomas Osa Harris: In the instant case there is some evidence in the record that at least there in respect to the Navy’s contract, the contract was re-let to the second bid.

The second lowest bidder at there being priced, it is on the page 44 of the appendix, I believe.

But the point I am trying to make is whatever the second bid would have been at that time if Emsco had not bid, the Government would have been paying a higher price if they eventually, they would up paying a higher price anyway, but the fact that Emsco bid on the case and eventually went insolvent works in this case to the Government's advantage because they are getting a lien on all the assets that Emsco had at the time.

It was pointed out in our brief that if the priority is extended to the Federal Government, the other creditors get nothing and that is of course the large part that we think it is -- at least you can say it is harsh on the other creditors, perhaps not unfair but harsh.

Ms. Shapiro has indicated that the Government gets nothing if the priority statute is interpreted in such a way that un-liquidated claims are not debts due.

And I think she’s probably wrong on that because under the Texas Law of the assignment to the benefit of creditors, the assignee is compelled to recognize creditors, even late filing creditors, if they just notify the assignee of their claim and elect to be treated as a participating creditors.

We have always in this situation treated the Government as a claimant, another creditor and I never really even thought that if priority did not extend, that the Government would not receive its prorated share of the indemnities we have briefed the case all along in that vein.

The question of the practical aspect of the manipulation by the creditor of the Government by somehow running into bankruptcy or running into an assignment for creditors soon after the contractual default and other in order to curry favor with the remaining creditors is a specter that I suppose is possible.

But I think that you need to balance that horrible example or that horrible imaginable against the situation of the present harshness on the credit of creditors.

As I indicated there are two factors that I think are favorable to the Government in this case and those are the cases that indicate that this case, this statute is supposed to be construed liberally to protect the Government's purse and my only response to that is, is what limits are involved in this.

If you look to the State Bank case, United States versus State Bank of North Carolina, Justice Story said, “Well, this language in here has to be applied reasonably.

You have to give it a reasonable interpretation” and in order to give it that reasonable interpretation he said, “Look to the Common Law meanings.”

He did not say, “Extend it to all claims or all obligations.”

He said, “Look to the Common Law meanings” and we were talking about a present debt. Other factors that militate for our decision for the Government would be the cases in which priority has been assumed even though there has been no real confrontation of the issue.

There are a number of those cases.

This is -- to follow that approach would be sort of law by accident, you know, because I do not think there is any real, there was no clear argument of the question.

In closing, let me say that I believe this is a narrowly drawn statute.

The statute did not, in its terms apply to torts, did not apply to obligations, did not apply to claims.

It was drawn in terms of debt and as the term was used, I believe that the Common Law would indicate it did not comprehend un-liquidated claims.

Chief Justice Warren E. Burger: Do you have anything further Mrs. Shapiro?

Rebuttal of Harriet S. Shapiro

Ms Harriet S. Shapiro: Two points, sir.

The first -- my first point is that the Massachusetts case really was deciding that a debt is not due when the debtor can at that point of insolvency decide whether he is going to pay the United States or the State.

That in that kind of situation you have a contingent debt that which -- it is -- that is much harder to say it is a debt due.

Tax claims can be contingent in the sense of uncertain.

For example, you can have an accrual basis tax payer who has gone a mind, the results of the -- the profits from the mind will not be determined for a period of time or when there is a sum in litigation or when there is a sales contracts where the amount payable is not determined until the end.

And finally, in the standard liquidated -- standard contract terms for damages, the liquidated damage clause is ordinarily not the exclusive remedy either, also a provision for contingent for consequential damages or other damages that result that it -- the damages here could have been determined at the moment of breach, there is no necessity to wait for the re-contracting.

Chief Justice Warren E. Burger: Thank you, Mrs. Shapiro.

Thank you, Mr. Harris.

The case is submitted.

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Phelps v. United States - Oral Argument

Thu, 23 Aug 2012 18:27:50 +0000

Case:

Phelps v. United States

Media File:

74-121_19750416-argument.mp3

Related Transcript:

74-121_19750416-argument

Transcript:

Argument of Dennis E.quaid

Chief Justice Warren E. Burger: We'll hear arguments next in 74-121, Phelps against the United States.

Mr. Quaid I think you may now proceed when you're ready.

Mr. Dennis E.quaid: Mr. Chief Justice and may it please the Court.

This case comes before the Court to review the judgment of the United States Court of Appeals for the Seventh Circuit reversing the District Court's order affirming the bankruptcy court's finding that it had summary jurisdiction over the controversy before it and adjudicating that controversy in favor of the receiver in bankruptcy over the United States and its claim to a tax lien.

The case arose in the year 1971 when the Internal Revenue Service made four assessments of taxes against Chicagoland Ideel Clieners Company, the first in March and the last in June of 1971.

Thereafter, the directors of the taxpayer made and a general assignment for the benefit of creditors on June 28 of 1971.

Nearly months later, the Internal Revenue Service filed its -- or recorded its known as a tax lien with the recorder for -- recorder of deeds of Cook County and on the same day served a notice of tax levy upon the assignee for the benefit of creditors.

Sometime thereafter, an involuntary petition for bankruptcy was filed against Chicagoland Ideel Cliener, the company was adjudicated, the receiver appointed and the petition which initiated this proceeding filed.

The petitioner feels that the essential question presented in this case is the one of jurisdiction, the summary jurisdiction of the bankruptcy Court to proceed to the merits of the controversy before it.

We feel that there are three independent and alternative basis of summary jurisdiction for the bankruptcy court in this case.

The first is Section 2 (a) Subsection 12 of the Bankruptcy Act and the second is Section 70 (a) Subsection 8, also of the Bankruptcy Act.

Although slightly different that we believe that they stand for the same principle that the bankruptcy court enjoys and can exercise summary jurisdiction over an assignee for the benefit of creditors and property in his hands.

The bankruptcy court being of course a cooperage proceeds in rem, we believe that having summary jurisdiction over the assignee and the property in the possession of the assignee.

The bankruptcy court can go on and to adjudicate property rights and interests in the property which it has gained summary jurisdiction over.

Justice William H. Rehnquist: The property we're -- talking about is money in a bank account?

Mr. Dennis E.quaid: Well the property initially started out its tangible property being the fixtures and equipment of the bankrupt, the Chicagoland Ideel Clieners.

The assignee liquidated by sale pursuant to a power of sale contained within the assignment, that equipment and fixtures, he reduced it to cash and when the levy was served it was cash.

But before then and a subject or during the time when the assessments existed, it did consist of tangible personal property and was capable of physical seizure at that time.

Justice William H. Rehnquist: It does make some difference, doesn't it as to whether the property is a pure intangible or whether as you say it's personal property subject to reduction the possession or seizure?

Mr. Dennis E.quaid: Well the courts have recognized a difference whether it's tangible or intangible property, personal property and we feel that if the Government had acted to assert its rights more promptly when it was more tangible personal property, this would have been an entirely different case.

However notwithstanding that fact, even when it was intangible property, we feel that the Government really never acted promptly to perfect its rights and reduce what there was to its possession and even of its intangible property, cash in a bank account.

They can still can compel the turnover of that money to them if they went forward with their rights.

Justice William H. Rehnquist: Can they actually no levy on a bank account but force the bank to turn over the money to them physically in the face of an adverse claim by the person who says, I don't owe the Government?

Mr. Dennis E.quaid: Well, I believe the Government is making that claim in this case that ones they served their levy, they seem to feel that they have ownership, not only possession but actually ownership of this ones and the power to require anyone to turn it over to them on the pane of penalty.

Justice Byron R. White: Well, it's perfectly clear it was a discern --

Mr. Dennis E.quaid: That would be --

Justice Byron R. White: As a matter of federal law.

Mr. Dennis E.quaid: True, yes.

Justice Byron R. White: So it's effectively parallel?

Mr. Dennis E.quaid: Well it's frozen until there's a determination if there is any contest of ownership or rights in the property.

Justice Potter Stewart: That is upon the service of the notice of levy?

Mr. Dennis E.quaid: Yes sir.

Chief Justice Warren E. Burger: In that respect, we're talking to something like a jeopardy assessment in the tax cases, isn't it?

Mr. Dennis E.quaid: Well I think it performs a different function although it does act to preserve of whatever rights the Government would have in it and protect those rights.

Chief Justice Warren E. Burger: It preserves not only the right, preserves the resource, does it, to satisfy claim.

Mr. Dennis E.quaid: Well that's correct.

Chief Justice Warren E. Burger: Which is the function of a jeopardy assessment in part at least, isn't it?

Mr. Dennis E.quaid: Yes it is.

Justice Harry A. Blackmun: Well aren't we really talking about place where the merits of the controversy shall be determined whether by the referee on the one hand or in a plenary proceeding in court on the other?

Isn't this the argument?

Mr. Dennis E.quaid: Yes.

The question is one of jurisdiction, who should decide, the referee or a -- another Court, the District Court in a plenary proceeding although the merits of the controversy in a question of the summary jurisdiction of a bankruptcy court at least in part enter into the merits, enter into the determination of the summary jurisdiction as I think as adequately reviewed in the briefs on the part of both parties but what we're dealing with is a case where you have an assignee for the benefit of creditors who is holding the fonts.

The Bankruptcy Act makes special provision and special rights of the bankruptcy representatives to that assignee.

In Section 2 (a) Subparagraph 21, summary jurisdiction are at least jurisdiction as given over that representative which this Court has held to be summary in nature in order to provide a prompt and expeditious remedy for the bankruptcy trustee to reach whatever property or assets are in the hand of the assignee.

And also Section 70 (a) goes on to give summary jurisdiction by creating a theory or a fiction that the assignee is a mere agent or bailee for the purpose of the exercise of summary jurisdiction to enable the bankruptcy representative to reach the property.

The third basis and the one which is the heart of this case is whether there is constructive possession by the bankruptcy court supporting its summary jurisdiction.

And again we have to go back to the special relationship which has been created in the Bankruptcy Act which gives the bankruptcy representative these powers to compel a turnover on the part of an assignee for the benefit of creditors of whatever property or assets he has in his hand to reduce the delay and the cause in the bankruptcy proceedings and to simplify and ease their administration for the benefit of all creditors.

Now, the United States claims that they obtained constructive possession due to the service of their notice of levy upon the assignee for the benefit of creditors.

I will contend that constructive possession in this case due to the nature of the relationship provided by the bankruptcy act over the assignee went to the bankruptcy court upon the filing of the bankruptcy petition and that the Government would have to show its actual possession of the funds in question or the property before the liquidation in order to defeat this one basis of the Court's summary jurisdiction.

The levy does not give to the United States actual possession of the funds.There are some cases saying that it's a seizure of a property interest.

The case of United States versus Ivan that says that is was in a transfer of ownership of the asset and that case was a pure debt that chosen action and there is no tangible property involved.

But in this case, we feel that these cases are not well founded and that the case in fact said it in the Government's brief of In Re Bruister versus Raymond Corporation correctly sets forth the better rule that the service of the levy even upon a -- what the Government claims was their federal tax perfects the property interest of the Government in the property.

Justice William H. Rehnquist: What if you had in the possession of the assignee for the benefit of creditors while it was conducting American deal operation, property on consignment from the third party which under state law, the state -- the third party's rights would prevail over the assignees, now would you say that the bankruptcy court upon the -- the bankruptcy court had summary jurisdiction to adjudicate title of that kind of property?

Well I would say that it would but that is a different situation because here what we have is a tax lien which under Section 67 is postponed to the costs of administration and priority wage claims.

Mr. Dennis E.quaid: In the situation that you suggest, you have a different situation where there is no postponement provision, no subordination of the lien to any of the priorities of Section 64 of the Bankruptcy Act.

Justice William H. Rehnquist: Any property that's physically in the possession of the assignee even though he doesn't assert any ownership claim to it become subject ot the summary jurisdiction of the bankruptcy court?

Mr. Dennis E.quaid: I would believe so, yes.

Justice Potter Stewart: Property of the bankrupted, formally of the bankrupted --

Mr. Dennis E.quaid: Yes.

Justice Potter Stewart: -- that's assigned to the assignee.

Mr. Dennis E.quaid: Of course in a -- on a consignment situation, you would not have a question of a lien but you would have a question of title residing in the consignor.

Justice Potter Stewart: But generally that would property of the bankrupt still, would it not, if he were the only consignor rather than assignee?

Mr. Dennis E.quaid: Well I would say that --

Justice Potter Stewart: Assignor, I mean.

If you were a consignor rather than assignor, he would -- the consignor, he would still have the property, wouldn't he?

Mr. Dennis E.quaid: I don't believe he would have title to the property but only have the right to sell that subject to the authority of the consignor, the consignee would have that -- would not have title to it.

Justice Potter Stewart: No, the consignor would.

Mr. Dennis E.quaid: Yes.

Justice Potter Stewart: We don't discreet.

Mr. Dennis E.quaid: Right.

Justice William H. Rehnquist: Well, then you -- you read Section 70 (a) of the Act, that subsection 8 which appears on page 5 (a) of your brief where it says property held by an assignee for the benefit of creditors.

You read assignee for the benefit of creditors very broadly as not modifying property at all so that any property held by an assignee for the benefit of creditors regardless of whom the property belongs to become subject to the summary jurisdiction of the bankruptcy court?

Mr. Dennis E.quaid: I believe that it would become subject to the summary jurisdiction of the bankruptcy court but I think that in that case, the rights in the third party would probably prevail and be superior to that of the bankruptcy representative.

Justice William H. Rehnquist: But that would be decided by the bankruptcy court.

Mr. Dennis E.quaid: Yes.

Justice William H. Rehnquist: Well supposing, I'm the assignee for the benefit of creditors of Joe Dokes who becomes the bankrupt and I have chair in my house that never belonged to Joe Dokes, it's nonetheless held by me, is that subject to the summary jurisdiction in that proceeding?

Mr. Dennis E.quaid: Well I think the question is who is the property party or proper Court to decided these questions and I think that the bankruptcy representative and the claim of any party to title or lien to property in the possession of -- in the possession of assignee for the benefit of creditors that someone who is now bankrupt.

If there had to be a plenary proceeding on every such claim that a very heavy burden will be cast upon the administration of bankruptcy states.

Justice William H. Rehnquist: So possession by the assignee confers the same sort of summary jurisdiction on the bankruptcy court as possession by the bankrupt does.

Mr. Dennis E.quaid: What's the -- it's a different situation because the Bankruptcy Act creates special provisions for the assignee for the benefit of creditors but if we've come involved with the tax lien and the levy at this point where the levy upon the property in the hands of the bankrupted would give to the United States greater rights and it does upon a levy upon the assignee for the benefit of creditors.

Justice Byron R. White: United States claims that ones it serves as levy, it isn't -- the assignee isn't holding any longer for the general benefit of creditors.

Mr. Dennis E.quaid: Well they claim that and that is the point that we dispute.

Justice Byron R. White: I suppose you would concede that if the assignee for the benefit of creditors took possession of a piece of property that have been mortgaged by the bankrupted to his creditor in which the bankrupted claim some equity and the mortgagee then repossess the property, took it from the assignee benefit of creditors and held it under a claim of right under his right to foreclose that the bankruptcy court would have no summary jurisdiction over that property and over the claim of the secured creditor.

Mr. Dennis E.quaid: Oh, in that case the property would be in the actual possession of the mortgagee.

Justice Byron R. White: I know but it was and it had been and was in possession of the assignee.

Mr. Dennis E.quaid: Yes but it no longer is.

Justice Byron R. White: So -- and the United States claims that the lien, the levy achieves that very same purpose.

Mr. Dennis E.quaid: Well that is the point that we contest that it does not.

Justice Byron R. White: That's the issue in this case.

Mr. Dennis E.quaid: Yes it is.

We feel that the levy does not transfer ownership to the Government but it merely perfects their rights to property interest in the property now in the hands of the assignee for the benefit of creditors.

As I mentioned in the case of In Re Bruister versus Raymond the -- where there was a tax lien upon the bankrupt, prior bankruptcy and the levy upon a debtor of the bankrupted, the court held that the property was still subject to the administration of the bankruptcy court and the bankruptcy state.

We feel that this is the better decision and that it gives affect to brining together the decision making powers in the bankruptcy court who is the court that is going to administer the assets of the bankrupted in these proceedings and who is a court who is familiar with these problems and we also serve to protect costs of administration and the priority wage claims that Congress is seeking to protect.

Now the Government is claiming in this case, availed it to tax lien upon the property or rights to property of Chicagoland Ideel Clieners.

We do not believe that they did have availed it to tax lien since the lien attaches to property or a right to property belonging to the tax payer with the assignment by Chicagoland Ideel Cliener to the assignee for the benefit of creditors.

There was a trust created for the benefit of all creditors.

The assignor no longer had any property interest in the property and that there was a transformation of the assets of the property at that time which deprived the tax lien of any property or right to property belonging to the tax bear upon which it could attach.

We believe that this principle has been recognized in the case of United States versus Bess where they held that a tax lien existing upon a tax payer did not attach to the proceeds of his life insurance policy after his debts do not attach to the full face value of that policy but rather only to the cash surrender value which was a fund which was being accumulated and held to him and which he could have reached.

In this case after the assignment, the only interest remaining in Chicagoland Ideel Cliener was the possibility that there would be an excess in the value of the property which he had assigned over his total indebtedness and in this case where the Government's tax lien is in the sum of $141,000.00 and there's only one claim against the state and the proceeds of the sale to bankrupts property that monitors trust over $31,000.00.

There's obviously no revert or interest which could have comeback to the -- comeback to the tax payer of the assignor Chicagoland Ideel Clieners.

Justice Harry A. Blackmun: Let me see if I understand you then, did your position that this subordinates the tax collector to the general creditors?

Mr. Dennis E.quaid: It subordinates him to the cost of the bankruptcy administration and priority wage claims.

Chief Justice Warren E. Burger: But not over creditors.

Mr. Dennis E.quaid: No, not over the creditors.

It could not have that effect because they will be contrary to the priorities established in the Bankruptcy Act in Section 64.

Justice Harry A. Blackmun: I want to get that straight because as I understood your argument, I thought you went farther than that.

Mr. Dennis E.quaid: No, the United States will be protected in these proceedings since the -- even if they had it no lien, they would have a fourth priority preference under Section 64 of the Bankruptcy Act to payment.

There -- the priorities ahead of them are costs of administration, the priority wage claims and certain costs of creditors in defeating plans of arrangement and wager in their plans and as far as the third priority is concerned, there are no such claims.

So the United States will except to the extent that they are subject to costs of administration and priority wage claims, both of which exist, they will not be subordinated to the claims of general unsecured creditors or put into the same category as those creditors.

Justice William H. Rehnquist: Even if the referee were to decide against them as to the perfection of their lien?

Mr. Dennis E.quaid: Yes, they would still enjoy their priority under Section 64 whether or not they have a lien or not.

Of course if they do have a lien and if they are subordinated under Section 67, they end up in the same priority slot.

Turning to Section 67, Congress has expressed its concern over the fact that tax claims are eating up diminishing the assets of bankruptcy estates at the current time and for the last several years.

Consequently, they have established a provision subordinating tax liens although no other liens to the first two priorities of Section 64 being costs of administration and priority wage claims.

This Court has held that when the tax lien and the words of the statute is not accompanied by possession that that possession is being defined as actual possession in the case of Gorgon versus the Department of Labor Enforcement of California.

They stated that the purpose of this provision was to give a public warning to all parties, rights may be affected by the tax lien which is unknown to third parties and is characterized as a secret lien that if the United States takes actual and physical possession of the assets, third parties and in particular general unsecured creditors who may extend further credit to such a company will be warned or forward and can take measures to protect themselves and sell which what they can form this relationship.

However the United States did not do this, they served the notice of levy and took no further steps, instead they waited after the assignment for the assignee to perform the liquidation of the tangible equipment and fixtures which were in the hands of the assignee.

Therefore we feel that the assets -- I'm sorry, that the tax lien is subordinated and postponed to the first two priorities being caused of administration and priority wage claims.

We feel that this Court should be guided by the policy of the Bankruptcy Act or the policy expressed by Congress in the Bankruptcy Act that tax claims should be subordinated and that there should be something else for other parties in the bankruptcy administrations or bankruptcy estates at least to provide the bare minimalist being the costs of administration and the priority wage claims earned by wage earners within three months preceding the initiation of the bankruptcy.

We feel that the Bankruptcy Act is a one statute which deals with all of these problems not only with the administration of an insolvent corporations assets but also with the treatment of the tax liens or other claim for taxes of the Internal Revenue Service.

We also feel that this is not an action to restrain the collection of taxes since we are dealing here with the Government's lien and levy, not taxes and that the Government's claim that this is not appropriate for a summary proceeding, is not applicable since the case of New Hampshire Fire Insurance Company versus Kan and recognized as a -- an expressed statutory exception to that rule, the summary jurisdiction of the bankruptcy court.

After the argument of counsel for the United States, we'll have a short time for rebuttal.

Chief Justice Warren E. Burger: Very well.

Mr. Jones.

Argument of Keith A.jones

Mr. Keith A.jones: Mr. Chief Justice and may it please the Court.

United States did not oppose the grant of certiorari in this case for it was hope that the case would serve as a suitable vehicle for the resolution of the question of substantial importance to the Federal Government's powers over internal revenue collection.

That question is whether the Government's interest in tangible property that had as levied upon and tangible properties such as bank accounts is terminated or impaired by the taxpayer subsequent bankruptcy.

Unfortunately for purpose of clarity of exposition, that is not the only question that has been raised in this case.

The petitioner has raised at least two major subsidiary issues that do not relate to the Government's general power to levy or its power to rely upon the effectiveness of its tax levies or rather relate only to the factual peculiarities of this particular case.

And since this is so, I would like at the outset of my argument to focus the Court's attention on what we feel to be the more important issue in this case, that is the question of the Government's right to rely upon its tax levies not withstanding the taxpayer subsequent bankruptcy and then I will at the end of my argument address the subsidiary questions that the petitioner has additionally raised.

I think that the case can be initially understood more clearly if it is taken in form of a hypothetical example that is somewhat less complicated than the actual facts of this case.

I would post it as that example, a common situation where the Government levies upon a bank at which the tax payer has a bank account in order to seize the account of the taxpayer.

Now, under the Internal Revenue Code and the accompanying regulations as our brief discusses at some length.

The service of such a notice of levy upon the bank imposes upon the bank in affirmative duty that is enforceable by personal liability to turn over the entire amount of the account to the United States and there is no doubt that this form of levy is generally effective for internal revenue purposes.

I say that is no doubt about it because this method of seizing intangible property, the method of serving a notice to the person that holds the intangible rights has been used by the Government and approved by this Court at least since the civil war and I would refer the Court to the cases of Miller against United States at 11 Wall.268 which we did not cite in our brief by is cited by the Court of Appeals and also to the more recent cases, Sims against United States at 359 US 108.

As to this much of the case, I take it that there is no dispute between the parties.

The petitioner does not contend that as a general matter such a levy would be invalid.

Where we part company with the petitioner is over the consequence to be derived from the tax payer subsequent bankruptcy after the levy.

Now, our view in the hypothetical example on using the banks duty to pay over the moneys to the Federal Government is not affected by the intervention of subsequent bankruptcy proceeding, such proceeding should not terminate or impair in any way.

The government's right to reduce that account to its actual possession and those right should not be subject or the rights and obligation to establish by the levy should not be affected by the subsequent bankruptcy proceeding.

Now, in taking this position, we do not rely upon any special preference for the Government or upon any special exigencies in favor of federal tax collection although of course we feel it that should be taken into account but our reliance here is upon a long established and sound rule of bankruptcy practice that this Court has applied on many occasions in the past.

That rule is that a bankruptcy court lack summary jurisdiction over property held by a third party as custodian agent or bailee for a third person who is an adverse party to the bankrupted.

The property so held is not subject to administration in bankruptcy unless the adverse claimant so consents to that administration.

Now compilation of --

Justice Byron R. White: Let the property away from --

Mr. Keith A.jones: That's right.

Justice Potter Stewart: And it's not subject to summary proceedings.

Mr. Keith A.jones: It's -- in a summary proceeding, the property would be turned over without regard to the validity of the adverse claimants claim and then he would have to rely upon his rights as a creditor in the bankruptcy proceeding.

Justice William H. Rehnquist: Well he filed a petition for reclamation, can he?

Mr. Keith A.jones: I suppose so and by his co-counsel that he could but in a plenary proceeding, the question turns exclusively upon the rights of the adverse claimant if he have rights in the property the it belongs to him and is in subject to administration of bankruptcy at all so that the distinction between a summary proceeding and a plenary proceeding is not merely a matter of the elaborateness of the procedures but it affects the substantive rights as well.

Justice William H. Rehnquist: We didn't quite get that last Mr. Jones, why do you say it affects the substantive rights as well?

Mr. Keith A.jones: Well in this case for example in a plenary proceeding, the only issue before the Court would be whether the Government's levy was valid and whether the tax payer owed a tax, if so then the moneys would be paid over to the Government in full.

In a summary proceeding the -- I take it that petitioner's position is the question is whether those properties had been the properties of the tax payer, if so they are turned over to the bankruptcy court and then the United States only has an interest as a creditor in whatever is left after the payment of expenses in bankruptcy.

Justice William H. Rehnquist: That's the consequence of what's going into the jurisdiction in the bankruptcy court for any kind of problem.

Mr. Keith A.jones: That's right.

Well as I say, the general rule upon which we rely here is a property held by a third person on behalf of an adverse claimant is not subject to the summary jurisdiction of the bankruptcy court and a compilation of the cases applying this rule is set forth at volume two, paragraph 23.06 bracket 1 of colliers treaties on bankruptcy and I stress that paragraph because although we adverted to a number of related paragraphs and colliers, we did not include that one in our brief, I repeat it's paragraph 23.06 bracket 1.

I will discuss just two of those cases here for purposes of example.

In Taubel against Fox, 264 U.S. 426, a sheriff had pursuant to a judgment levy seize the property of a debtor and while the sheriff was still holding the property, the debtor was adjudicated a bankrupt and the bankruptcy court sought to require the sheriff to pay over the property to the receiver in bankruptcy, and this Court concluded that since the property was being held by the sheriff on behalf of an adverse claimant, that is the judgment creditor, it was not subject to summary turnover instead the sheriff was free to release the property to the judgment creditor.

In this connection, I would like to refer to page 23 of our brief footnote 10 where we mis-discribed Taubel against Fox to our own disadvantage.

We stated in that footnote that in that case, Taubel against Fox, this Court merely held that property and so forth and we should have said this Court merely stated that property in the hands of a nonadverse third person who is not holding a decision for any adverse claim was subject to turnover.

In face the Court in Taubel went on to hold that since the sheriff in that case was holding for an adverse claimant then the property was not subject to summary turnover.

The other case of this Court that I would mention was First National Bank against Title and Trust Company at 198 U.S. 280 and in that case, the third party in possession was ware housemen who was holding the property for a third person who was an adverse claimant to the bankrupted to whom the bankrupt had assigned the warehouse receipt and once again, the Court held that the property in the warehouse men's hands was not subject to summary turnover.

Now, we believe that this general rule annunciated and applied in these cases governs this case as well.Property held for the United States pursuant to a levy like property held by other third persons for other adverse claimants is beyond the reach of the bankruptcy court summary turnover orders and a hypothetical example I propounded, a bank upon which the Government has served a valid notice of levy holds the taxpayer's account for the Government as the Government's agent.

Government as an adverse claimant is entitled to receive the moneys in that account.

The moneys in the account like the property sees by the sheriff in Taubel against Fox.

It should be payable to the Government as an adverse claimant and not to the receiver in bankruptcy for distribution and accordance with the priority rules of bankruptcy.

Justice William H. Rehnquist: Well how about the provision of subsection 8 that Section 70 (a) of the Act so that equates the possession of the assignor to the possession of the bankrupt.

You don't have that in your hypothetical example.

Mr. Keith A.jones: That's true, that's why I used that hypothetical because I wanted the Court's attention first to be focused upon the general case of the Government's levy and I intended at a later point to address the special considerations that arise when the person upon him, the levy has been served is a general assignee and I hope to get to that point in a moment.Well,

The petitioner here as we understand it does not challenge the general rule upon which we rely, is not challenged the rule that a third person in custody for an adverse claimant is not subject to summary turnover.

His argument on this aspect of the case is simply the taxing authorities unlike all other similarly situated adverse claimants are unable to avail themselves of the benefit of this general rule.

The basis of this argument exclusively upon Section 67 (c) 3 of the Bankruptcy Act but as we read that statute, it has absolutely nothing to do with the issue in this case.

The petitioner's argument has confused the question of inclusion of property into the bankrupt estate with that of distributing property out of the bankrupt estate.

This case is one of inclusion that is the issue is whether the property that has been levied upon is to be included in the bankrupt estate by virtue of the bankruptcy court summary turnover orders.

Section 67 (c) 3 does not address that question at all.

It is addressed to the separate and distinct question of distribution of whether -- of what priority various claimants have to the property that is being distributed out of the estate.

Nothing in Section 67 (c) 3 was intended to treat the Government any less favorably than other adverse claimants in constructive possession as we have seen such claimants are entitled to reduce their property to actual possession without any interference from the bankruptcy court.

Well, this are the basic legal consideration as to the general issue as we feel is involved here.

I think I should also call the Court's attention however to certain practical considerations.

It is of great importance that the United States in its capacity as a collector of taxes be able to rely upon its notice of levy.

If the internal revenue service cannot so rely, that will be forced to resort to more summary collection procedures and to enforce more immediate compliance with its notices of levy.

And this would entail the use of hasty collection devices that inevitably will cause disruption would be burdensome and annoying to taxpayers and to the third parties with whom they deal.

We see no social objective that would be achieved by forcing the Government to scramble in this way for actual possession.

All the legitimate concerns of bankruptcy administration and internal revenue collection can be served by giving to the United States the same rights as are presently held by all other similarly situated adverse claimants.

In short, both for practical reasons of internal revenue collection and as a matter of established bankruptcy procedure, the Government's levy should be honored whether or not the taxpayer subsequently becomes bankrupted.

The United States is entitled to rely upon its valid pre-bankruptcy levy is placing the property levied upon beyond the reach of the bankruptcy Court.

Now, this completes my presentation of the Government's position on what we believe to be the central issue in this case, the issue that the Court presumably took the case to decide that as its evident, there are other subsidiary issues in this case and I now turn to the consideration of those issues.

As Mr. Justice Rehnquist has noted, the petitioner contends that this case was governed by a special rule in favor of general assignees.

He contends that regardless of the effect that a notice of levy might have in other circumstances that the property held by a general assignee must be turned over to the receiver in bankruptcy whether or not there has been a levy and he relies both upon Section 70 (a) 8 of the Bankruptcy Act and also on Section 2 (a) 21 of that Act.

That although those provisions do state that the bankruptcy court has jurisdiction to require assignees for the benefit of creditors to deliver the property in their possession to the receiver in bankruptcy, they have never been construed as running the bankruptcy court summary power to reach property held by the assignee in a manner adverse to the bankrupted and to the general creditors.

The bankruptcy court summary jurisdiction under those provisions extends only to the property that the assignee was holding for the exclusive of general creditors at the time of bankruptcy.

For example, in Galbraith against Valley at 256 U.S. 46, this Court was presented with the contention by a receiver in bankruptcy that property held by an assignee adversely to the bankrupt was subject to summary turnover.

In that case, the assignee had incurred certain expenses of administration applied to bankruptcy and he claim that he was entitled to take the property that -- or take property in the value of the amount of his expenses and hold those for himself as an adverse claimant and this Court upheld the assignees contention.

The Court held that as to property with respect to which the assignee had himself an adverse claim, that property was not subject to turnover to the receiver in bankruptcy that it was outside the bankruptcy courts summary jurisdiction.

Justice William H. Rehnquist: That wasn't modified by the Chandler amendments.

Mr. Keith A.jones: Section 2 (a) 21 was enacted after the decision in Galbraith Valley but it was generally considered as being merely a codification of prior law and collier and his treaties as we indicated in our brief so treats that enactment and I don't think that anyone has construed as being a general requirement that the assignee turnover the property in his possession willingly without regard to any adverse claims then I believe that after the passage of the Chandler Act, lower courts, not this Court but lower courts have had the opportunity to apply Galbraith against Valley to a situation such as the one involved here and they have done so to bar the summary turnover of property held by the assignee for his own self or as custodian or agent for a third person from summary turnover to the receiver in bankruptcy.

Justice Byron R. White: Was the levy made before bankruptcy?

Mr. Keith A.jones: That's correct.

Justice Byron R. White: And the levy wasn't -- and the -- but -- the levy was made after assignment?

Mr. Keith A.jones: That's also correct.

Justice Byron R. White: And so the assignee for the benefit of creditors who acquired -- who took possession to property before bankruptcy and sold it then was subjected to a levy.

Mr. Keith A.jones: That's right, that's right.

Justice Byron R. White: And then came bankruptcy and any right to the Bankruptcy Act that the assignee may have had any rights to trustee or the state against the assignee only arose with the filing of the bankrupt.

Mr. Keith A.jones: Well any rights that they had in bankruptcy arose at that time.

It's correct of course that they were creditors prior to the --

Justice Byron R. White: And you are asserting any rights to the United States arose before bankruptcy.

Mr. Keith A.jones: Well, let me distinguish between various kinds of rights.

Of course the Government had a right to payment of its taxes longer for --

Justice Byron R. White: But your levy arose before bankruptcy.

Mr. Keith A.jones: The levy was served upon the assignee before bankruptcy.

One of the petitioner's arguments in this case a second subsidiary kind of argument is that the assignee wasn't holding any property subject to levy.

He claims that the proceeds in the assignees hands were in subject to levy under the Internal Revenue Code.

We believe that contention is plainly wrong.

The assignee -- let me backtrack.

The taxpayer was holding a property subject to the Government's lien.

When the taxpayer sign the property to the assignee, the assignee took the property subject to the lien.

Now, petitioner concedes that much.

Justice William O. Douglas: May I interrupt at that point?

What did happen up to that time had been -- that notice of a deficiency assessment as I understood it.

Mr. Keith A.jones: There was an assessment of taxes to, that's correct.

Justice William O. Douglas: Right, but did that create a lien?

Mr. Keith A.jones: It did.

Justice William O. Douglas: Not a lien which gave any notice to other creditors though, did it?

Mr. Keith A.jones: No and that lien until perfected would not have been valid as against for example a bona fide purchaser.

It only became perfected when the notice of lien, not the notice of levy but the notice of lien was properly filed.

Justice William O. Douglas: And that was filed with the assignee?

Mr. Keith A.jones: No that was then -- the notice of levy was served upon the assignee.

The notice of lien was served -- was filed in the appropriate state office but they were both filed after the assignee took possession of the property.

Justice Potter Stewart: And the notice of levy was filed if I understand it after he had sold the channels for the benefit of creditors.

Mr. Keith A.jones: After he'd reduced the property to proceeds, to cash, that's correct.

Justice Potter Stewart: For the benefit of creditors who under 4741 the beneficiaries of the trust, is that right?

Mr. Keith A.jones: That's right, that's right.

Of course our argument is that federal law supervenes.

Justice Potter Stewart: Yes but also the federal law talks about property rights to property of the tax payer.

Mr. Keith A.jones: Oh, yes, you're talking about Section 63 31.

Justice Potter Stewart: Which is the whole basis of this lawsuit.

Mr. Keith A.jones: Yes it is but one aspect to that provision that the petitioner has consistently overlooked in this case is the fact that the Government's levy does not reach only property of the tax payer seemed to be searching in vain for the statutory language.

It's Section -- Section 63 31 (a) which is set forth at page 12 (a) of the petition for a writ of certiorari provides that if any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice in demand shall be lawful for the secretary or his delegate to collect such tax by levy upon all property and rights to property belonging to such person or on which there is a lien provided in this chapter for the payment of such tax and it is our contention that the Government's lien in this case be attached to the proceeds in substitution and --

Justice Potter Stewart: That's really the question.

Mr. Keith A.jones: Well that's one of the three questions and I regard that as a subsidiary question.

Justice Potter Stewart: It's not the big question that you hope to.

Mr. Keith A.jones: That's correct.

Justice Potter Stewart: That you did not oppose certiorari to be because you hope the court would decide that that is more particularized question in this case.

Mr. Keith A.jones: That is an important question and -- that's true.

Now in our brief, we cited Justice Stewart's opinion in Shepherd against Tailor as an example of this Court's application of the federal common law rule that a lien does attached proceeds and substitution.

That is also the rule under Illinois law as we cited number of Illinois cases in our brief that stand for the proposition that when a -- an assignee under Illinois law takes property subject to a lien and sells that property, the lien reattaches to the proceeds.

Same rule under both Federal Common Law and Illinois Common Law.

Petitioner sole reliance for alleged contrary authority is upon United States against Bess but in that case, that case holds at the very most that the government's lien will not reattach proceeds that were not fully realizable by that -- in the taxpayer's hands.

In that case, the Government had a lien on a taxpayer's insurance policy and after the death of the taxpayer, the moneys face amount policy was paid to the beneficiary and the Government claim the face amount.

This Court held that as to the proceeds that would have been realizable in the taxpayer's hands, that is the case surrender valued, the Government's lien reattached as to the proceeds that were not realizable in hands of the taxpayer, that is the additional insurance proceeds above and beyond, the cash surrender value lien would not reattached.

Now petitioner tries to fit himself within this narrow exception to the general rule of the lien that reattaches to proceeds and substitution that I frankly don't see how he is able to do that.

The taxpayer in this case could just as easily as did the general assignee convert the property into cash.

Taxpayer could have sold off the property, liquidated its receivables and receive cash in exactly the same manner as the general assignee.

There is no reason whatsoever in this case why the taxpayer -- why the Government's lien should not reattach to those proceeds and substitution and since we believe that lien clearly did so reattach to those proceeds.

There was property subject to a lien on which there was a lien which under Section 63 31 of the Code was subject to levy and it is clear that the Government's levy serve notice upon the assignee that not only all property of the taxpayer but also all property on which there was a federal tax lien was thereby seized on behalf of the United States for the payment of taxes and demand was made upon the assignee for the payment of those amounts to the United States.

If there are no further questions, I ask that the Court affirm the judgment below.

Thank you.

Chief Justice Warren E. Burger: Do you have something further Mr. Quaid?

Rebuttal of Dennis E.quaid

Mr. Dennis E.quaid: Just very briefly Mr. Chief Justice.

The assignee was not holding for adverse claimants as in the cases cited by counsel for the Government.

He was holding for the benefit of general creditors who is not holding for a particular creditor as was the sheriff in 5327 Fox case cited by the Government.He was holding as a state appointed receiver or representative of creditors.

Justice Byron R. White: What would you say if there ever been a bankruptcy?

Mr. Dennis E.quaid: Well then it would be an entirely different situation.

Justice Byron R. White: Well I know but the -- could they -- who would have gotten -- who would -- would the levy have been good?

Mr. Dennis E.quaid: Well, I think it would have become a moot question because the United States would have had a first priority under Secition 34 66 of the revised statutes.

Justice Byron R. White: That maybe so when the assignee finally distributed and paid its expenses out of it.

Mr. Dennis E.quaid: Well only its expenses --

Justice Byron R. White: My question here was even if it have to turn the proceeds over to the Government.

Mr. Dennis E.quaid: Oh I think he may have in that situation to the fact that bankruptcy did not subsequently occur and alter the situation and the relationship --

Justice Byron R. White: So you should -- except to the Bankruptcy Act, you would say the assignee was subject to he levy and would have had to turn the proceeds over.

Mr. Dennis E.quaid: Oh, I think the important factor in this case is the Bankruptcy Act and the policy that Congress has set forth in the Bankruptcy Act.

Justice William H. Rehnquist: Yet that case, the case of Galbraith against Valley does seem to say that where the assignee holds adversely to the interest of the general creditors there is no summary jurisdiction of the bankruptcy court.

Mr. Dennis E.quaid: Well there, he was holding in his own personal sense adversely.

Justice William H. Rehnquist: But here the Government says as a matter of tax law, the levy had proceeded to such a stage that he was holding for the benefit of the Government.

Mr. Dennis E.quaid: Well we feel that tax laws wrong and inappropriate in bankruptcy situation where there is another federal statute more comprehensive and which considers the rights of all parties which are involved.

Justice Byron R. White: Yes but they admit for bankruptcy, you say the government levy is good and that you would have to turn it over and that bankruptcy had 5538 that the assignee was not going to take benefit solely 5547

Mr. Dennis E.quaid: But the bankruptcy did come and did change the rights of the respect of parties.

I thank you gentleman for your consideration.

Chief Justice Warren E. Burger: Thank you gentleman.

The case is submitted.

Featured:

Otte v. United States - Oral Argument

Thu, 23 Aug 2012 18:26:36 +0000

Case:

Otte v. United States

Media File:

73-375_19741015-argument.mp3

Related Transcript:

73-375_19741015-argument

Transcript:

Argument of Howard Karasik

Chief Justice Warren E. Burger: We will hear arguments next in William Otte against the United States and others.

Mr. Karasik, you may proceed whenever you’re ready.

Mr. Howard Karasik: Thank you, Mr. Chief Justice and may it please the Court.

Justice Potter Stewart: Mr. Karasik, how do you pronounce your client’s name?

Mr. Howard Karasik: Otte.

Justice Potter Stewart: Otte.

Mr. Howard Karasik: I represent William Otte, the Trustee in Bankruptcy of Freedomland, the petitioner before the Court today.

This case is here on a writ of certiorari to the Court of Appeals for the Second Circuit.

The facts of this case are relatively simple.

Freedomland filed a petition under Chapter XI of Bankruptcy Act.

It was subsequently adjudicated as bankrupt.

413 priority wage claimant's file proofs of claim for a priority wage claims in the bankruptcy proceeding during the six month period, during which claims could be filed.

The United States government and the city of New York did not file any claims for withholding taxes or related taxes in connection with those priority wage claims.

As a matter of fact, they did not file any proofs of claim pursuant to the bar order entered in the proceeding which directed the taxing authorities to file proofs of claim, if they had any claims for withholding or related taxes.

During the course of the proceeding, the bankruptcy judge entered an order authorizing the bankruptcy trustee to make a priority wage claim distribution, without the necessity for withholding taxes.

This order was appealed to the District Court and the District Court held that it was incumbent upon the bankruptcy trustee to withhold taxes and that the withheld taxes were subject to the fourth priority of Section 64 (a) of the Bankruptcy Act.

On further appeal to the Court of Appeals, the Court of Appeals held that the withheld taxes were subject to the second priority under Section 64 (a) of the Bankruptcy Act.

Now, the issues before the Court are first; whether a bankruptcy trustee is required to withhold taxes in connection with a priority wage claim distribution.

Second, whether those withheld taxes are entitled to a priority.

Third, whether the ruling of the bankruptcy judge that it was not incumbent upon a bankruptcy trustee to prepare the W-2 forms and related forms because it was consistent with the general rule that a bankruptcy trustee need not incur unnecessary expenses in connection with the administration of mistake whether that ruling was clearly erroneous.

And fourth, whether it was incumbent upon the taxing authorities to file proofs of claim in this proceeding or be barred from asserting their claim in the proceeding.

Essential, absolutely crucial to an understanding of this case is that it is a bankruptcy case, it is not a tax case.

Every appellate court that has dealt with the issues before the Court today, has viewed the issues in terms of the Internal Revenue Code and has viewed the cases before them as tax cases.

I submit to the Court that this is a bankruptcy case and that if this Court recognizes that it’s a bankruptcy case that it will overrule all of the appellate courts that have dealt with the issues before the Court and will overrule the court below.

Section 64 (a) (2) of the Bankruptcy Act establishes a priority wage claim for wage earners.

Justice Potter Stewart: Where is that page?

Mr. Howard Karasik: It’s in the appendix Your Honor.

Justice Potter Stewart: It's not in your brief?

Mr. Howard Karasik: No, it’s not in the brief.

It’s in the appendix.

And it’s at 94 (a) and 95.

Now, this Court has dealt with Section 64 (a) (2) in two significant cases.

The Embassy Restaurant case and the Joint Industry Board case, this Court ruled, decided that Congress when it passed Section 64 (a) exempted to establish an economic cushion for wage earners who lost their jobs as a result of their employer's bankruptcy.

Now, I ask this Court in light of the obvious congressional purpose related to Section 64 (a) (2) whether withholding taxes in connection with a priority wage claim distribution would fulfill that purpose.

I say that it would not.

Moreover, in interpreting Section 64 (a) (2), this Court has said that it was incumbent upon a bankruptcy trustee to make a prompt distribution of the priority wage claim dividends.

Yet, if a bankruptcy trustee is required to workout the computations and prepare the W-2s and 941s and the related forms, it is inevitable that there will be delay in the distribution and again I say, that any requirement that would cause a bankruptcy trustee to delay a distribution would not fulfill the congressional purpose.

And that brings --

Justice William H. Rehnquist: Under your theory Mr. Karasik, would the employees be nonetheless credited with having paid the withheld taxes?

Mr. Howard Karasik: No, Your Honor.

My theory is this, they would receive their money.

If they owe money to the government on account of taxes, at the end of the year, they would pay the Government.

They would be clerical cost associated with the preparation of the W-2 forms and the related forms.

I don’t know how much that would be and obviously it would vary from case to case.

But it would cost something, some clerical personnel would have to be hired, some accountants would have to review the computations.

The amount of money that’s spent, might very well eat into the amount of money available for purposes of paying out the priority wage claim dividend.

Justice Potter Stewart: You mean that every time a tax return is filed, an accountant has to be employed, do you do that for your personal one?

Mr. Howard Karasik: I retain the accountant in my personal case and in this particular case, Your Honor.

Justice Potter Stewart: Do you think all tax payers do?

Mr. Howard Karasik: No, all taxpayers do not.

But most bankruptcy trustees do.

In this particular case we have an account, the accountant testified in the court below.

That he would ordinarily review the work product of the junior accountants, and any clerical staff that would prepare the computations and the related forms.

Justice Potter Stewart: So now, you have not only an accountant but junior accountants also?

Mr. Howard Karasik: Well, this District Court --

Justice Potter Stewart: Suppose there is just one employee here, is he still an accountant?

Mr. Howard Karasik: It might not have to be an accountant.

But nevertheless there would be an expense and it's possible under some circumstances that the expense would eat into the amount of money available for the priority wage claim dividend.

Justice William H. Rehnquist: They will show of any cost of administration isn't?

Mr. Howard Karasik: That’s correct.

But this would be an unnecessary cost of administration because if no deduction were made, if the tax payer, the recipient, the wage earner actually owed taxes, at the end of the year he would pay it, just like every other businessman who happens to receive a dividend in a bankruptcy proceeding.

There’s no deduction for that businessman.

Justice Potter Stewart: Well, if that were so, why do we have withholding?

Mr. Howard Karasik: Withholding applies to the ongoing relationship between an employer and an employee.

The government wants to collect money at the source on a pay as you go basis.

Justice Potter Stewart: Do you think that’s the only reason for withholding?

Mr. Howard Karasik: I think that’s the primary reason for withholding, unless the government assumes that the ordinary wage earner is going to default and not make the payment.

And I don’t believe that’s a valid assumption, because our --

Justice Potter Stewart: Do you have to assume that, can’t you assume that a recognizable proportion will?

Not the ordinary one.

Wasn’t the delinquency of accounts a reason for withholding as well as currency --

Mr. Howard Karasik: That maybe.

But in this particular type of situation that suggestion would be inapplicable because all of the priority wage claimants would have filed piece of claim in the proceeding.

The government would be completely aware of which people are receiving dividends and if these people do not pay taxes, if taxes turn out to be due and they very well not turn to be due, because after all, you’re dealing with wage claimants who receive a meager amount of money, $600.00.

If a man who’s earning $600.00 loses his job, perhaps by the end of the year, he may or may not have gotten a new and they have been hiatus.

At the end of the year, he may owe no taxes, whatsoever, and I submit that it’s unfair to deduct taxes when he receives a priority wage claim dividend.

It’s unfair to him, and it servers no valid purpose, the Brookings Institute report in its study indicates that taxes collected in connection with bankruptcy proceedings have a minuscule effect on the treasury.

Absolutely minuscule, but a very significant effect on the dividends that are paid out in bankruptcy proceedings.

Moreover, as I indicated before, the taxpayer, the wage earner, when he receives money, it’s incumbent upon him to pay a tax.

If he owes a tax at the end of the year, and I submit that the government would lose no money if that procedure were followed in this particular type of case.

Chief Justice Warren E. Burger: I’m not sure, I’m sure that I follow the theory behind your comparison, it doesn't hurt the government very much but it does hurt the creditors a great deal.

How is that relevant to issues here?

Mr. Howard Karasik: I'm just talking generally in terms of the Brookings report.

Brookings report indicated that taxes as a general proposition collected in bankruptcy proceedings have a minuscule effect on the treasury.

Chief Justice Warren E. Burger: That’s simply because we have a $300 billion or $400 billion I've forgotten what it is, now, $300 billion or $400 billion budget but what's that got to do with the creditor.

Creditors would vary from small creditors to large, many creditors to a few creditors.

Mr. Howard Karasik: Well, I was just suggesting that it's a general policy, the revision -- the proposed revision of the Bankruptcy Act suggested by the Brookings Institute that the amount of taxes collected are minuscule.

Suggested to them that priority taxes in general should be abolished in bankruptcy proceedings.

I’m further submitting that the government will not really be hurt in this particular case if we follow the suggestion that the trustee is making that no money be withheld, and that the wage earner at the end of the year if owes a tax, pays a tax.

Now, the government has recognized that the trustee might have some difficulty computing the deduction, and accordingly, they have established a bureaucratic practice that as far as I am concerned has no basis in law and not subject to any particular regulation but there is some kind of practice that the bankruptcy trustee take 25% off the top.

Well, the withholding tax statutes run from 14% on upwards and I submit that in the kind of cases we’re talking about where they are all wage earners and you are not talking about principles of business, or businesses, or salary personnel but just wage earners that 25% is excessive.

Justice William H. Rehnquist: Does that include social security as well as income tax too?

Mr. Howard Karasik: That’s correct!

That’s, that's the practice.

But even including social security at 5% and you end up with 20% as the total deduction, and I submit that the kind of people we’re talking about might not pay 20%.

Certainly, they’re not going to be paying 25%.

In this particular case you have got 413 people.

Many of whom are simple day laborers.

They need their money and they need their money quickly.

And to deduct 25% off the top or any, or any specific amount off the top is detrimental to them and does not fulfill the congressional purpose which was to establish an economic cushion for these people.

Now, the court below spoke in terms of control, that is that the bankruptcy trustee controlled the wage claim - -

Chief Justice Warren E. Burger: We’ll resume there right after lunch.

You may continue Mr. Karasik.

Mr. Howard Karasik: In order for the Court of Appeals of the Second Circuit to reach the conclusion, a bankruptcy trustee was required to withhold taxes.

It had to conclude that the bankruptcy trustee was in control of wage claim dividends.

Much like the other appellate courts, the court below simply ignored the bankruptcy context of this case and the point of fact, the bankruptcy trustee does not control the distribution of wage claim dividends, it’s the bankruptcy judge.

The bankruptcy judge appoints the trustee, the bankruptcy judge has a right in certain instances to remove the trustee, the bankruptcy judge declares the dividends, the bankruptcy judge must countersign the checks, and the bankruptcy judge mails out the checks.

So it is not the bankruptcy trustee whose in control, it’s the bankruptcy judge.

The government says, well if it’s the bankruptcy judge then perhaps the bankruptcy judge should withhold the taxes and prepare the W-2s and the related forms.

I say that this is ludicrous, that Congress never intended the withholding tax statutes to apply to bankruptcy judges and that the government is merely trying to force the issue as I will show in connection with the priorities.

Each court --

Chief Justice Warren E. Burger: Why would that be anymore true of the bankruptcy judge and a receiver for example, in a federal or a state proceeding trustee and bankruptcy?

Why would it be anymore true that the bankruptcy judge -- I don’t quite get your answer --

Mr. Howard Karasik: Well, the bankruptcy judge, under the Internal Revenue Code, it is only the person who is in control of the payment who is deemed to be the employer and it is only the employer who must withhold the tax and prepares the W-2 forms and the related forms.

Chief Justice Warren E. Burger: There are certain derivative responsibilities that follow the funds, are there not?

Mr. Howard Karasik: No, the Internal Revenue Code speaks in terms of the parties not the funds.

It’s only the employer and the employer is the one who withholds.

There’s nothing to do with the money that’s withheld.

Each of the appellate courts dealing with the issues before the court has come up with -- well, I shouldn’t say each of them, there have been divergent opinions as to what is to be done to the taxes that are to be withheld.

The government contends that the withheld taxes, taxes withheld on the second priority are bootstrapped to the first priority.

This is illogical.

And in addition to that, it’s not only illogical but it's contrary to the holding of this Court in (Inaudible) case.

The withheld funds are taxes that are withheld from the employees.

They are not expenses of the state and it’s only the expenses of the state that can be deemed to be administration expenses and would entitle the government to priority.

The city of New York says, as to the court below, that the withheld taxes are entitled to a second priority because they are “carved out” of the wages.

Yet this Court in the Embassy Restaurant case said that, “If anything is paid to a third party to someone other than the wage claimant that the moneys that are paid are not wages for purposes of the Bankruptcy Act.

So you cannot conclude that withheld tax is paid to the government can fall in to the second priority.

The Connecticut Motor Lines case says, “that the withheld taxes fall into the fourth priority.

Well, the taxes here are not the taxes of the bankrupt and the fourth priority only relates to taxes of the bankrupt.

Now, the petitioner does not concede that any taxes should be withheld at all, but if taxes are withheld and if the taxes do not fall within the priority category of Section 64 (a) (4) then perhaps they fall into the proviso that follows Section 64 (a) (4) which says that if a tax is not entitled to a priority that it falls into the general unsecured claim category.

Justice Byron R. White: What proviso is that?

Mr. Howard Karasik: That’s the proviso that follows the priority Section under 64 (a) (4) of the Bankruptcy Act.

Justice Byron R. White: I don’t find it in the act.

Mr. Howard Karasik: All right, Your Honor.

Chief Justice Warren E. Burger: It’s in the appendix --

Mr. Howard Karasik: It’s in the appendix of page 95 (a) it says provided however that no priority of a general unsecured claim shall pertain --

Chief Justice Warren E. Burger: Now Mr. Counsel hold on until we find the place here.

Mr. Howard Karasik: Yes, excuse me.

Justice Byron R. White: The bottom three lines.

Chief Justice Warren E. Burger: Yes.

Mr. Howard Karasik: That’s correct.

Justice Byron R. White: Thank you.

But Counsel as I understand that it’s your position that the wager should be paid in gross?

Mr. Howard Karasik: That’s correct.

Justice Byron R. White: And?

Mr. Howard Karasik: They’re not wages Your Honor.

They’re wage claim dividends, it's a significant difference.

Justice Byron R. White: I don’t care what you call them.

But anyway, you want them paid in gross?

Mr. Howard Karasik: That’s correct.

But if they’re -- if there is to be a withholding then at best the taxes should fall into the unsecured category.

The government will argue that this constitutes a windfall for the unsecured creditors but I submit to the court that this is what the statute says that the Congress when it promulgated this particular statute expected a certain “windfall” unsecured creditors.

At the risk of being repetitious, I say to this Court that we’re dealing with the bankruptcy case and not a tax case.

When this Court dealt in the Randall case with the conflict between the Internal Revenue Code and the Bankruptcy Act, this Court ruled that in the event of a conflict the Bankruptcy Act takes precedence and I submit that in this particular case if the Court finds that the Bankruptcy Act does take precedence and I submit that it should find that it takes precedence that it will also find, the bankruptcy trustee need not withhold any taxes in connection with priority wage claim dividends.

Justice Byron R. White: Do you have any of authority supporting your position flatly at all?

Mr. Howard Karasik: No.

Justice Byron R. White: You have an array of cases internally inconsistent, first, second and fourth, but none of them support your position at this point --

Mr. Howard Karasik: Well, the only indirectly.

The Connecticut Motor Lines case said that if the government failed to file a proof of claim that the withheld taxes would be entitled to a fourth priority but by virtue of the failure to file a proof claim that the taxes would fall into the general unsecured category.

But for the general proposition that a bankruptcy trustee is not required to withhold taxes, I have no authority at all except the Bankruptcy Act, and I request and respectfully submit to this Court that all of those appellate decision which rule that a bankruptcy trustee should withhold taxes, should be overruled.

Justice Byron R. White: Do you think that if you said that this tax claim was the fourth priority or unsecured at all, or not secured at all, or no priority at all.

Would it necessarily follow that the trustee would not have to file and withholding tax to pay?

Mr. Howard Karasik: Well, if they were no wages paid.

Justice Byron R. White: Yes.

Mr. Howard Karasik: Then the trustee would not have to file any returns.

These would not constitute wages.

Justice Byron R. White: But when you pay them?

Mr. Howard Karasik: These would be wage claim dividends, where it's this --

Justice Byron R. White: Well, I know, I know that he got to be paying wages, he is going to be paying $600.00.

Mr. Howard Karasik: He’s going to be paying $600.00 but these are not wages.

He’s not an employer, the recipients are not his employees.

Justice Byron R. White: Well, I know but it still could be held that he’s paying wages.

And if --?

Mr. Howard Karasik: If he is held -- if it is held that he’s paying wages --

Justice Byron R. White: Yes.

Mr. Howard Karasik: Then I would assume that it would -- that he would have to prepare the appropriate forms.

Justice Byron R. White: Well, I know but the -- the people by whom wages are owed, or owed by bankrupt up to $600.00 you’re going to paid, don’t you?

Mr. Howard Karasik: That’s correct.

Justice Byron R. White: The trustee is going to pay them, isn’t it?

Mr. Howard Karasik: Well, the trustee in conjunction with the bankruptcy judge.

Justice Byron R. White: With the judge?

Mr. Howard Karasik: Yes.

Justice Byron R. White: Yeah, well, so those are the distributions that are going to be made?

Mr. Howard Karasik: That’s correct.

Justice Byron R. White: And I suppose you could say that the trustee can withhold them -- can withhold the money?

Mr. Howard Karasik: There are several threshold questions, if we’re talking about a wage and if you’re saying that the bankruptcy trustee is the one in control and if you’re further saying that the Internal Revenue Code comes into play at this point.

Justice Byron R. White: But the claims that are going to be filed to pay their wage claims?

Mr. Howard Karasik: The claims or wage claims.

What is paid is a wage claim dividend.

Justice Byron R. White: Yes, I understand.

Mr. Howard Karasik: And there’s a difference I submit respectfully between a wage claim dividend and a wage.

Justice Byron R. White: Well, a fellow was owed this $599.00 and he gets it all, I suppose he thinks he's got his wages?

Mr. Howard Karasik: Well, if he got it several years after the event, I don’t know what he would consider it and he might considerate it a “windfall”, I don’t know Your Honor.

Justice Byron R. White: Don't you usually pay wages or wage claims pretty fast?

Mr. Howard Karasik: We attempt to do it.

In this particular case, there was a hiatus between the date of adjudication and the date of payment.

The reason for that is that first these estate must be liquidated, second, as in this particular case, there were liens that had to be invalidated, and third, in this particular case, the attorney who was handling the case (Inaudible) he was ill for several and then died.

Justice Byron R. White: But if you're right -- if you’re right that these wage claims, that these tax pay might be -- had no priority at all, what the trustee would do is to withhold the money and that would go into the unsecured --.

Mr. Howard Karasik: That’s correct – and that's illogical, Your Honor.

Justice Byron R. White: Well, -- is that what you claim here?

Mr. Howard Karasik: Well, it’s not my claim.

The illogicality of that and the fact that you have so many divergent opinions as to what is to be done with the withheld taxes, demonstrates to me and I hope to the Court that Congress never contemplated that withholding taxes would be applicable in a situation such as the one at bar.

If there were no further question, I respectfully reserve my time for rebuttal.

Chief Justice Warren E. Burger: Very well, Mr. Jones.

Argument of Keith A. Jones

Mr. Keith A. Jones: Mr. Chief Justice and may it please the Court.

I represent the United States in this case.

Mr. Warms who would follow me, represents the city of New York.

Three related questions are presented to you.

First, whether a trustee in bankruptcy must withhold income and social security taxes on the distribution of the wage claims.

Second, whether the taxing authorities must file formal proofs of claims with respect to these withholding taxes, and third, whether such taxes are entitled to first priority of payment or are payable in some other manner under the Bankruptcy Act.

As to the first question, the trustees' duty to withhold, not withstanding the trustees arguments here, the law is quite clear.

The Internal Revenue Code squarely requires the trustee in bankruptcy to withhold federal income and social security taxes on all wage claim distributions and to prepare and submit appropriate information returns and reports to the Internal Revenue Service and to the wage claimants.

The evidence in this case shows that contrary to the petitioners position, the cost of complying with these withholding and reporting requirements are trivial.

And in any event, even if the costs were more substantial they would not justify the trustees' failure to perform a statutory duty.

Our arguments to this effect are set forth in our brief and if there are no questions on this point and in the rest of time, I will go on to the other questions in this case.

As to the second question in this case, the filings of proofs of claims, we believe that it is also clear that no filings of proofs of claims are required with respect to withholding taxes that arise after bankruptcy as in this case.

The Bankruptcy Act requires the filing of formal proofs of claims only with respect to debts for which the bankrupt is or maybe liable and the bankrupt will never become liable for the withholding taxes in this case.

These taxes arise only after bankruptcy and their obligations incurred by the state in the course of administration and not by the bankrupt.

In this respect, they’re just like the expenses incurred by the trustee and employing clerical assistance to help administer the estate indeed are just like the costs incurred by the trustee in conducting this litigation.

Withholding taxes like other expenses incurred in a course of administration or obligations of the state which -- as I say which are incurred in the course of administration and the Bankruptcy Act does not require the filing proofs of claims with respect to such debts of the state as distinguished from debts of the bankrupt.

Moreover, the purpose of filing proofs of claims is simply to inform the bankruptcy trustee and the other creditors of the total amount of claims outstanding against the bankrupt.

Proofs of claims of withholding taxes here in question but not serve that purpose.

These withholding taxes do not add to the total amount of claims against the bankrupt or the estate, they arise only when the wage claims are paid out, they're deducted from the wage claims, paid over to the United States and they don’t reduce the fund remaining for payment to other creditors.

Therefore, filing the proofs of claims would serve no purpose under the Bankruptcy Act.

Moreover, any filing requirement of that kind for the government would be impracticable.

As we showed in our brief, the Bankruptcy Act requires proofs of claims to be filed as to debts of the bankrupt, within six months of the first date set, the first meeting of creditors.

No taxing authority could comply fully with that requirement.

Until the expiration of the six month period, it would be impossible to know just how much wage claims in fact were to be payable out of the estate.

Moreover, the actual amount of the tax that they would be due cannot be known until the actual amount of wages has been calculated and distributed because withholding rates fluctuate over time and the effective withholding rates at the time of bankruptcy maybe very different from those that are in effect at the time of the distribution of the wage claims.

Therefore, for all of these reasons, we believe it’s clear that Congress did not intend to require the filings of proofs of claims with respect to these withholding taxes.

With that in mind, I now turn to what we believe is the most important and substantial question in this case and that is the priority to which the United States is entitled or more generally a manner in which these withholding taxes are to be paid over to the United States.

Under Section 7501 of the Internal Revenue Code an obligation is imposed upon all persons responsible for collecting taxes to hold those taxes in a special fund and trust for the United States.

Under that provision, withholding taxes of the kind here in question or indeed any other withholding taxes are directly payable to the United States as a trust fund without regard to the provisions of the Bankruptcy Act.

However, the trustee in this case is not complied with the Section 7501, and we've recognized that under this court's holding in United States against Randall.

The trustees' duty to pay over cannot be enforced as against third party creditors.

The issue that arises in this case therefore as to what priority of payment if any, the United States is entitled when the trustee defaults on his duty to pay over the withholding taxes as a trust fund, and I turn now to that question.

Our position, simply put is that the United States is entitled to payment of these withholding taxes as the first priority administrative cost and expenses.

We reach this conclusion, both because such withholding taxes analytically fall within the category of administrative expenses and also because they don’t fit within any other priority or indeed non-priority category.

Justice Byron R. White: Well are you -- you’re supporting the judgment below?

Mr. Keith A. Jones: We’re supporting the judgment below in the sense that we’re supporting the distribution of assets ordered by the court in its judgment.

We’re not supporting the expressed holding that these wages claims are -- excuse me, of these withholding taxes.

Justice Byron R. White: But if you were -- but if you were --

Mr. Keith A. Jones: Are distributable as second priority objects.

Justice Byron R. White: If accept your argument, the result below might be different.

I mean in terms of who gets what?

Mr. Keith A. Jones: That’s true and you bring up the point I assume that --

Justice Byron R. White: But you're -- but you really want to secure more than you got on judgment below?

Mr. Keith A. Jones: Yes and no.

We want --

Justice Byron R. White: Did you petition or not?

Mr. Keith A. Jones: We didn't petition, but as we pointed out in our brief, the question of first priority was opened up, opened up by the petitioner in his petition.

The question presented in the petition, I will read it to the Court -- is whether -- this is question number two at page two of the petition.

Assuming arguendo that such a distribution is subject to the withholding tax and reporting the requirements of the Internal Revenue Code etcetera.

Should the monies withheld in connection with the distribution be accorded, the fourth priority tax claims status, first priority administration claim status, second priority wage claims status or a trust fund status.

Justice William H. Rehnquist: Well of course, it goes further than that?

Doesn’t it, Mr. Jones it isn’t just a question of what maybe raised here but it’s a question of whether if you want to get a more favorable result than the Second Circuit gave you whether you don’t have to cross petition.

Mr. Keith A. Jones: Well, I don’t think that’s true in this case Mr. Justice Rehnquist.

On that point, I would say that since the question in this case is how the monies are distributable.

Necessarily, the court has to consider whether the taxes are a first priority item.

Now, I would say that if the question were not properly before the Court were not presented by the petitioner then we would be entitled utmost to an affirmance of the judgment below, although we might also be entitled to a ruling that as a matter of law, such taxes are first priority claims --

Justice William H. Rehnquist: But that?

Mr. Keith A. Jones: In other words, you could if you saw fit determine that as a matter of law with these withholding taxes are the first priority items but that in the absence of a cross petition -- we were entitled only to an affirmance of the judgment below.

In this case, we would be perfectly satisfied by such an affirmance because the distribution of assets in this case is the same whether it’s a first priority or a second priority item.

That is I say, I think that in this case under the peculiar circumstances where the question necessarily is presented to the court in the petition and by the question raised by the petitioner that it’s open to the court to consider it and dispose off it.

Justice Byron R. White: I don’t know that -- it says you're not only, not entitled to the administration expenses but you’re not entitled to the priority (Inaudible).

So, I don’t know that the -- it's a very good position to or you're in a very good position to say that he's raising the issue.

He leaves you of the necessity to cross petition.

Mr. Keith A. Jones: I think analytically there are two separate questions, the first is whether the issue is properly before the Court and the second separable question, is whether this Court can modify the judgment of the court below in the favor of the respondent and as to the first question, I think it's clear that this issue is before the Court, as to the second question, I'm less clear in the circumstances of this case whether we really are entitled to a modification of the judgment.

Justice Byron R. White: And you're suggesting that surely we're not required by the failure of the government to cross petition, to affirm what we think is an erroneous holding the Court of Appeals.

Mr. Keith A. Jones: That's correct.

Justice Thurgood Marshall: Mr. Jones, it over simplifies, suppose you go a judgment for $15,000.00 in the Court of Appeals, and the other side brought it up and you didn't cross petition, would we be right in giving $25,000.00?

Mr. Keith A. Jones: I'm sorry what was the last question?

Would we be right in--

Justice Thurgood Marshall: You've got in the affirm judgment of $15,000.00 for damages.

Mr. Keith A. Jones: I say and --

Justice Thurgood Marshall: And the other side appealed that we say, you should have gotten $25,000.00.

Mr. Keith A. Jones: Well, and we don't cross appeal or cross petition.

Justice Thurgood Marshall: Right.

Mr. Keith A. Jones: But we present an argument which if accepted logically would entitle us to a judgment of $25,000.00.

And our position.

Justice Thurgood Marshall: Do they give it to you?

Mr. Keith A. Jones: No, and we have spelled out our position at greater length on this point.

Justice Thurgood Marshall: Yeah.

Mr. Keith A. Jones: In our reply brief in the Western Edition case which was filled last week.

Justice Potter Stewart: The fact is if you look at the petition for certiorari in this case, the question two doesn't raise the question that you raised.

Mr. Keith A. Jones: That's correct and it was in reliance upon that we acquiesced in this petition.

Justice Potter Stewart: And, we granted certiorari across the board.

Mr. Keith A. Jones: That's correct Mr. Justice.

Justice Potter Stewart: Pleasantly accepting the proposition that these questions were --

Mr. Keith A. Jones: And for that reason we believe that this case really doesn't even present the issue that we discussed in our reply brief in Western Edition.

So we think that this issue is before the Court and can be adjudicated in our favor and the judgment below be modified.

Justice Potter Stewart: Just two basic questions are these wage claim dividends subject to -- does a trustee have the duty to withhold at all and secondly, if it does what priority if do they dividend fall into?

Mr. Keith A. Jones: That's correct.

Justice Byron R. White: And would you expand for me the Government's theory as to why they should be first priority?

Mr. Keith A. Jones: Yes, Mr. Justice White, and I would be delighted to do that.

As I have already indicated --

Chief Justice Warren E. Burger: Contrasted was the Second Circuit's conclusion that they were derived from wages and therefore belong in the second priority.

Mr. Keith A. Jones: That's right.

Well, in the first place this is as I've already indicated an expense that's incurred by the state in course of administration.

And it seems clear to us that such expenses are administrative expenses entitled to first priority.

Justice Harry A. Blackmun: Now, why is that?

What is the state for -- as contrasted say with the trustee's fees or some --?

Mr. Keith A. Jones: Well, these are very much like the expenses of hiring secretaries to mail out the wage distributions, the state really doesn't get anything for it, it's just an obligation that incurs in the course of administration.

Justice Harry A. Blackmun: Well, I'll buy the obligation part but I wonder why it is a cost of administration?

Mr. Keith A. Jones: Why?

If it's an obligation and it's incurred, I'm not sure why it wouldn't be a cost.

Justice Harry A. Blackmun: I think the first priority originated in the Eight Circuit Fogarty case, isn't not?

Mr. Keith A. Jones: That's correct.

Justice Harry A. Blackmun: And I look at this, this was a tag ambition because there were other primary issues there such as the --

Mr. Keith A. Jones: That's right.

Fogarty did not devote much time to -

Justice Harry A. Blackmun: And as all that I see that Judge Wood had said, is that the taxes should be allowed and classified as an expense of administration having priority, they were not payable at the time the petition was filed by the bankrupt and only approved as and when they paid.

That is on that actual payment of 25% of the wage claims, during the administration of the estate pursuing to the orders of the bankruptcy court.

Well, I don't find much reason in that, it merely says that was paid pursuant in order of the court.

Therefore, it is a cost of administration.

Mr. Keith A. Jones: Well, we're not relying necessarily from the reasoning set forth from the Fogarty opinion.

Justice Harry A. Blackmun: I guess I'd like to know what reasoning then you are relying?

Mr. Keith A. Jones: Well, I'm not sure exactly what your question is, Mr. Justice Blackmun.

You're distinguishing between cost and taxes it seems me and it's clear that the taxes incurred in the course of the administration are the first priority items, whether or not they are of any substantial value to the state, I would quote in regards to that from call your you're on bankruptcy, paragraph 62.14 (3) “to the extent to which a receiver or trustee is under a duty to pay taxes, his expenses or tax liabilities are to be classified as necessary costs of operation, preservation, or administration and within the first priority.”

In other words, these are items, expense items, taxes, however you describe them, there are obligations that are occurred in course of administration.

Justice William H. Rehnquist: Is that Collier you're speaking or are there some cases to support it?

Mr. Keith A. Jones: That's Collier speaking.

There are many cases to support it, he addresses -- he is there addressing the question of the whether administration expenses have to be preservation cost, and he points out that clearly they do not, that why you are concerned about in the first priority administration expenses or the broad category expenditures that are made by the trustee without regard to whether they maybe directly related to the preservation or development of the state.

Justice Byron R. White: And that (Inaudible) the taxes which improve during the administration?

Mr. Keith A. Jones: Like this tax.

Justice Byron R. White: Well, yes but this tax had to be related to wages earned before bankruptcy and arguably these taxes would all be treated like real property taxes that were due and owing in kind of bankruptcy.

Mr. Keith A. Jones: I don't know Mr. Justice why they can't treated that way because they were not legally due and owing before bankruptcy.

And they were not legally due and owing by the bankrupt.

They only arise after bankruptcy and they are due and owing by the state and you can't fit that into fourth priority.

Justice Byron R. White: Did it say I would put it in the fourth priority.

It can't just that I would put it in the administration expenses.

Mr. Keith A. Jones: Well --

Justice Byron R. White: And I was also saying that Collier was directed to the taxes incurred in the operations of the business.

Mr. Keith A. Jones: Oh, no he was speaking more generally --

He was speaking more generally of taxes there.

Justice Byron R. White: Oh, there weren't lot of cases holding there for that statement?

Mr. Keith A. Jones: Well, of course this Court had spoken on it.

Justice Byron R. White: You say that word and you probably wouldn't be here.

Mr. Keith A. Jones: That's correct.

And my time has expired, I turn over the remaining appellee's time to Mr. Warms.

Chief Justice Warren E. Burger: Mr. Warms.

Argument of Samuel J. Warms

Mr. Samuel J. Warms: Mr. Chief Justice, and may it please the Court.

I shall confine my argument to the priorities question and support the holding of the court below which held that the withholding tax claims in question were wage claims.

Now, while the United States government's argument suits our book as well, we would fair just as well a distribution would be precisely that which was ordered by the court below.

We feel that the court's position which was our position there and is our position here is more logical and it also better answers the arguments of the trustee against any priority status.

Justice Byron R. White: Well, in some other case it can make a difference whether it was administration expense or second priority?

Mr. Samuel J. Warms: I can concede none under the way we rush --

Justice Byron R. White: Well, they've got to some reason for making this argument.

Mr. Samuel J. Warms: I beg your pardon?

Justice Byron R. White: I should have asked the government this question.

They must have some reason to be making the argument.

Mr. Samuel J. Warms: Yes, they do, Mr. Justice White they do, because they are afraid that in the case where after the payment of administration expenses other than these they will not -- and where there's nothing enough left to execute a payment in full, that there will be diminution in the amount of tax claims.

Now they set that forth in a very complicated example on page 40 and page 41 of their brief.

Justice Byron R. White: So where there's not enough assets to pay the wage claims they would suffer too if the court --

Mr. Samuel J. Warms: I don't believe so, Your Honor.

Justice Byron R. White: Well that's what their claim.

Mr. Samuel J. Warms: That's their claim, but I've analyzed the argument and I analyzed the example, what they say is this, if in a state where there is $40,000.00 worth of wage claims, there are are only $20,000.00 to pay them.

They would be paid in this way.

Justice Byron R. White: Well, you would say that as far as you can see it doesn't make that much difference in the state?

Mr. Samuel J. Warms: I would say it doesn't make any difference because in such a case -- the residue would be paid if we assume 25% is the rate, 75% to wage earner and 25% on his behalf to the government not half of 25% as they argue in their brief.

Justice William H. Rehnquist: But nonetheless it's 25% of a smaller amount in the total wages claimed, isn't it?

Mr. Samuel J. Warms: Well, that would be true in any case Your Honor.

Justice William H. Rehnquist: In other words, you tax only what is paid up.

Mr. Samuel J. Warms: That's correct Your Honor.

Withholding is based on the actual gross amount of wage distribution.

Justice William H. Rehnquist: Well, but so far as net receipts to the treasury is concerned, if you pay a $100,000.00 on a $100,000.00 wage claim, and subtract 25% for tax, the government is getting more money than it would if you pay $50,000.00 on a $100,000.00 wage claim and pay $12,500.00 to the government?

Mr. Samuel J. Warms: Well, that's absolutely correct, Mr. Justice Rehnquist because the wage claimants is getting half -- the wage claimants is getting less --

Justice Byron R. White: He is now got therefore, the only thing is the administration expense would be 25% of $50,000.00.

Mr. Samuel J. Warms: That is correct.

Justice Byron R. White: So it wouldn't, and you say that wouldn't make any difference.

Mr. Samuel J. Warms: It would make a slightest bit of difference.

You see, the government's example indicates that 25% of the $50,000.00 would be cut in half because it's 50% dividend.

It wouldn't be.

It'll be calculated on the amount of each wage paid.

Now, another reason we for our argument is it avoids the trustees' argument but in the administration expense mostly in the preservation of the estate or in connection with the acquisition of assets, we don't have to argue against that in presenting it as a second wage, a second priority wage claim.

Now, I don't do -- I've worked some of Mr. Justice Blackmun's questioning concerning the Fogarty case because that was the leading case and that was the case on which from this notion of administration expense priority.

Actually, I'm not sure that the Fogarty case wasn't correct because in the Fogarty case, there was no withholding as far we can see.

I believe the wage distributions were made without any withholding of tax and that the taxes were actually satisfied by offsetting them against the claim which the bankrupt had against the government for some ships that had built.

Now that means, probably that they were rightfully decided to be administration expenses because they weren't carved out of the wages.

The wages went 100% to the wage claimants.

The other came out of the estate and so, although the case was followed in Lines against California and then in the Curtis case in Ninth and Sixth Circuits which both held that the administration expense status was accorded to these claim.

I think we should bear in mind that Fogarty which was the father of all these cases is perhaps reconcilable with our view in this case.

Now, we say that the wage claim status depends on this.Withholding taxes are derived from and carved out of the actual wages paid to an employee and the wage distribution paid to a wage claimant.

There is if there an in envisioned assignment by the wage claimant to the governments involved.

Of that point of his wages which might reasonably be assumed to cover his taxes, the minute these taxes are withheld, he gets a credit on the books of the governments, for these withholdings.

If he (Voice Overlap) satisfying his taxing indebtedness if for example he's made estimates, he'll get those withholdings back in the form of the refund.

So he will ultimately realize in that case, what essentially his wages is.

He is required to include them in gross income, his income tax returns and this shows too that the amount of the withholding part of his salary and therefore are wages.

Justice Byron R. White: Mr. Warms, is this like a prior theories which I think emerged first time in this case in the Second Circuit, is this your argument below that the court pick it up on it's own clear argument?

Mr. Samuel J. Warms: I am sorry to say that it was my argument.

I say that because it makes me to appear to be very veined of try to support that in the case were I need not necessarily do so.

But it was indeed my argument and the Court was very kind and flattering me doing about this.

Part of an argument also is that proper segregation was made of these funds, they would also enjoy a trust funds status within the second -- within the range of the second priority.

Now, I've spoken about what I consider to be the unfounded fears of the federal government in the event that second wage -- second priority status has accorded these wage claims.

Finally I think I should point out that there is an anomaly in computing them, if that to be considered as administration expenses because administration expenses have to be computed before you can determine how much money is left in the state to pay wage claims, and it's only after you have determined how much you have left to wage claims that you can compute the taxes on them.

Justice Byron R. White: Mr. Warms, have you ever studied calculus of differential equations?

Mr. Samuel J. Warms: No, Your Honor, I haven't and I was wondering whether this was a case of them of the multiple variables.

Justice Byron R. White: Well, it just seems to me that here you have two dependent of variables with one constant which you've forgotten to with the amount of money.

Mr. Samuel J. Warms: That's correct.

Justice Byron R. White: I think it's a routine problem in either differential equations or calculus -- I don't go along with this argument and I'll be trying to say that it is capable of solution I'm sure.

Mr. Samuel J. Warms: Oh, just as the problem of the employer who pays the income tax on the employees' income is capable of solution, in a similar manner.

Justice William H. Rehnquist: (Inaudible)

Chief Justice Warren E. Burger: Thank you very much, you have two minutes left.

Do you have anything further?

Mr. Samuel J. Warms: If there are no further questions I will quit my time.

Chief Justice Warren E. Burger: Thank you gentlemen.

The case is Submitted.

Featured:

United States v. Randall - Oral Argument

Thu, 23 Aug 2012 18:10:10 +0000

Case:

United States v. Randall

Media File:

125_19710222-argument.mp3

Related Transcript:

125_19710222-argument

Transcript:

Argument of Richard B. Stone

Chief Justice Warren E. Burger: We'll hear arguments next in United States against Randall, number 125.

Mr. Richard B. Stone: Mr. Chief Justice and may it please the Court.

This case which is here on a writ of certiorari to the United States Court of Appeals for the Seventh Circuit raises a fundamental question as to the legal status of taxes which an employer withholds from the wages of his employees and specifically the case raises the proper treatment of those withheld funds in the event that the employer becomes bankrupt or in is to a Bankruptcy Procedure.

The facts of the case are relatively simple.

Halo Metal Products, Inc. filed a petition for an arrangement under Chapter 11 of the Bankruptcy Act and that is the provision which allows operation of the business to try to stow up the Bankruptcy.

It was allowed by the referee of the Bankruptcy Court to remain in possession of the business and to carry on the business' operation subject to the referee supervision during the Chapter XI arrangement.

As is the custom in such an arrangement, the referee entered in elaborate order requiring the debtor in possession to file periodic reports and to maintain full records of its operations during the arrangement period.

And in addition, the referee ordered the debtor to open up three bank accounts.

First of these accounts was to receive all revenues, received by the business during the operation in the arrangement period.

And the second account was to receive periodically from the funds deposited in the first revenues account the amount necessary to pay all employee wages and disbursements from this payroll account were to be made at proper intervals with the approval of the referee.

The referee ordered that simultaneously with meeting the debtor in possession's payroll obligations that the debtor deposit into a third special account the amount of tax and social security deductions that the debtor was required to withhold from his employee's wages and withdrawals from this third account were to be allowed only for payment of withheld taxes and welfare benefits as those payments became due to United States Government.

The debtor failed almost entirely to comply with the referee's orders with the orders of the Bankruptcy Court with respect to this withheld taxes.

Although the income in social security taxes were withheld from the employee wages, the withheld funds were not placed in the special account nor would they pay over the United States at the proper time as required by the arrangement court.

During the arrangement, the United Stats filed the proof of claim for payment of a thousand and seventy-five dollars that is $1,075 of FICA in income taxes withheld from employees salaries on the ground that this amount was a special trust for the United States benefit under Section 7501 (a) of the Internal Revenue Code of 1954 and about the Section, I shall elaborate shortly.

Subsequently, about three months after the filing of the original arrangement petition, Halo was adjudicated a bankrupt.

In a month later on December 22, 1967, the United States filed the petition in the Bankruptcy Proceeding asking that the withheld taxes at which it claim as the Trust Fund under Section 7501 be paid over to the United States just as any Trust Fund would be paid over prior to payment of the cost and expenses of administration of the Bankruptcy Proceeding and the referee denied the Government's petition, the District Court and the COurt of Appeals upheld the referee's denial of the petition and it is that which we are here on the writ of certiorari to contest now.

Both of these courts held essentially that Halo's obligation to pay over to the Government the taxes withheld from employee wages was merely an administrative expense of the bankrupt estate and was thereby subject to the scale of priorities established by Section 64 of the Bankruptcy Act with which I am sure this Court is quite familiar.

And I think it would be helpful to view the issue presented here which is whether the Government is entitled to recognition of a trust fund for the amount of taxes withheld from the salaries of the bankrupt's employees during the arrangement period.

As breaking down essentially into two parts, two questions.

The first question is and this is as really the question is construed by the Court of Appeals whether the trust fund concept is simply inapplicable altogether as both courts below seemed to have felt in a Bankruptcy Proceeding.

And the second question which neither court reached but which I believe was the focus of the bankruptcy referee's decision is whether assuming that the trust does not disappear merely by virtue of the withholding employer's bankruptcy.

Whether the trust is nonetheless defeated or enjoinment of the trust is defeated by virtue of the Government's inability to trace the race of the trust and I will address myself to both of these questions.

Justice Potter Stewart: Does the Government in this case really is not a matter of priorities at all?

Mr. Richard B. Stone: That's right Mr. Justice Stewart, it's not.

Justice Potter Stewart: And by contrast, the way the Court looks at it, that's all it was?

Mr. Richard B. Stone: That's right.

Justice Potter Stewart: And priorities.

Mr. Richard B. Stone: That's exactly right and prior to several years ago, I believe in 1965 when the Third Circuit decided the Connecticut Motor Lines case, every court that had looked into this and all the commentators as I shall shortly view the question as not one of priorities but simply the recognition of a trust and not a matter of relative priorities.

I think it's --

Justice Potter Stewart: I think the question becomes to the trust to be --

Mr. Richard B. Stone: Yes, is it --

Justice Potter Stewart: It is here because they raise --

Mr. Richard B. Stone: Exactly, exactly that is precisely what I think is important to show and what we are really alarmed about in this decision is the fact that the Court of Appeals viewed these trust assets as debts and viewed this case as a matter of priorities between conflicting administrative expenses.

Now, --

Justice Harry A. Blackmun: Mr. Stone, on your theory the bankrupt estate is really enjoying the windfall if it prevails here is it not?

Mr. Richard B. Stone: That's right Mr. Justice Blackmun though it is hard to trace as I intend to discuss at length that is hard to trace precisely what happen to the funds one likely illogical assumption is that this trust fund has simply been added to the amount of assets available to the collection of the bankrupt's creditors and therefore collection from those assets would be windfall to those creditors.

Justice Harry A. Blackmun: But the trust fund you're talking about is in every case of this kind is a fund that arises from the bankrupt's asset themselves, from the bankrupt's own assets.

Mr. Richard B. Stone: That's right.

Justice Harry A. Blackmun: It's just something that he paid wages but he wrote checks to his employees for an amount left than they're -- what they were --

Mr. Richard B. Stone: That's right.

Justice Harry A. Blackmun: -- paid and so he just kept the rest.

Mr. Richard B. Stone: That's right and so --

Justice Harry A. Blackmun: And so there's never been a transfer creation of the trust fund?

Mr. Richard B. Stone: No, though it was ordered by the referee and it was ordered by the referee that the trustee make a transfer at the time he paid the wages.

Justice Harry A. Blackmun: He never did.

Mr. Richard B. Stone: In fact, he never did.

Justice Harry A. Blackmun: He never did.

Mr. Richard B. Stone: And one of the points which I plan to address myself to is whether the enjoyment of the trust ought to be defeated by the fact that the trustee never did make these deposits and so that all that we're really talking about is whether a trust ought to be imposed on general assets of the bankrupt estate.

That is the question in this case as we view it.

But that is not the question as Court of Appeals viewed it and I think it is very important to see exactly how the Court of Appeals did identify this question and to make sure that what I consider the gross misconception on the Court of Appeals opinion be corrected.

Chief Justice Warren E. Burger: But on your theory, this statute along with the order of the court impresses a constructive trust on the total receipts of the bankrupt and regards him as having done what he had been ordered to do, is that --

Mr. Richard B. Stone: That's exactly right.

It's exactly right Mr. Chief Justice that is our theory.

And that is the theory of Professor Scott and that is the theory of all the courts which have directed themselves to this aspect of the case and the theory which these courts have gone on and ever since we've gotten into this, I might as well anticipate what I expected to be a later stage of the argument.

The theory that these courts have gone upon is that yes, in a situation where the raise of a trust cannot be traced where you are simply talking about general assets, it is you run a risks in either imposing the trust or disregarding the trust you run a risks that loss in the -- that the actual proceeds have been lost in the accounting procedure, there is no record to say where the assets went and so that either the trustee, either the beneficiary of the trust or the general creditors may have suffered in some way.

Now, this seems to me the most likely assumption is that the estate has been fattened by the failure to pay over these funds at the designated time.

And though we want to protect the creditors with respect to the general assets, the estate has been the view of all the courts that have considered this.

That because of the fact that the referee, the debtor in possession is himself an officer of the bankruptcy court and because the debtor in possession is the person who buy his negligence failed to segregate these funds and failed to setup the trust for the benefit of the Government that we ought not to make the beneficiary of a trust suffer because of the negligence of an officer of the Bankruptcy Court.

We ought to give that a beneficiary the right to rely on the fact that an officer of the Bankruptcy Court is going to do what the Bankruptcy Court tells him to particularly when the Bankruptcy Court states in the order that it shall supervise all these operations on a weekly or monthly basis.

So that all have -- all who have considered this question have felt that the equitable considerations which militate in favor of recognizing this right to rely on the Bankruptcy Court doing what it says its going to do should eliminate the requirement of tracing the raise of the trust.

But I want also to make clear is that this is not the ground.

This issue which I consider to be the crucial issue of the case is not the issue that the courts below went upon.

The courts below in my opinion fundamentally misconstrued the whole nature of withheld taxes and the interrelation of the bankruptcy Act with this trust fund.

Chief Justice Warren E. Burger: Mr. Stone, let me test your argument with the hypothetical case.

Mr. Richard B. Stone: Yes.

Chief Justice Warren E. Burger: If I may.

Suppose the money had been indeed put in the segregated account and had build up to many thousands of dollars over a period of time and if the weekly check had been made and money was always there, then the officer of the company having control of the account suddenly withdrew it all of the segregated account, the tax -- the trust account that you're arguing about.

Withdrew all of it out in currents -- got it in currency and flew to Argentina.

Then would you say that you could impress any trust -- constructive trust on the other assets of the company?

Mr. Richard B. Stone: That is a very different case from the one we're facing Mr. Chief Justice, for it.

Chief Justice Warren E. Burger: Oh!

Yes, I realize.

Mr. Richard B. Stone: But -- and I think that I'm not sure what the answer to that question is perhaps not but I don't think that controls the instant case for the following reason.

Chief Justice Warren E. Burger: No, what I'm driving at is, I was trying to setup a hypothesis where you could identify --

Mr. Richard B. Stone: If you can identify the raise of this trust --

Chief Justice Warren E. Burger: You can trace it all the way to -- you can trace it all the way to Argentina now.

Mr. Richard B. Stone: If you can identify the raise of this trust, I at the moment find no argument against the proposition that the general assets of the creditors of this company ought then to be subject of the Government's tax claim.

I would not want to go on record is committing the Government to that position.

But it seems to me that if you can trace the raise of the trust then the Government ought to be required to go after trace of a raise and the person has clearly responsible for the ways of the raise of that trust.

Justice William J. Brennan: Incidentally Mr. Stone, I gather the employees get credit for the amount--

Mr. Richard B. Stone: That's right.

Justice William J. Brennan: -- on the books indicated as withheld from the --

Mr. Richard B. Stone: That's right Mr. Justice Brennan, their liability with respect to those withheld funds is discharge that the time wages are paid and taxes withheld from those wages which we think identifies --

Justice William J. Brennan: Without payment over by the employer.

Mr. Richard B. Stone: That's right there and similarly if any refund is owed.

If the employer although withholds it is the employee who has the --

Justice William J. Brennan: Well, the point is that nothing in the way of the trust involved here for the employees.

Mr. Richard B. Stone: No, it's a trust for the Government.

Justice William J. Brennan: Only for Uncle Sam.

Mr. Richard B. Stone: Only for the Government.

Now, that trust is set forth in Section 7501 of the Internal Revenue Code which is quoted on page 26 of our brief to which I refer the Court and that provision states as follows.

“Whenever any person is required to collect or withhold any Internal Revenue Tax from any other person and to pay over such tax of the United States, the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States.”

Now, I take it that neither respondent nor the courts below would dispute it by virtue of Section 7501 an employer who withholds income and social security taxes from his employee's salaries is the trustee of a trust at least up until the point that the employer becomes insolvent.

Now, let us consider the case of the employees -- of the employer's insolvency and look briefly at Section 64 of the Bankruptcy Act which is set forth in relevant part of page 23 of our brief.

That Section entitled “Debts which have Priority” establishes those debts of the bankrupt which have priority over general unsecured creditors in the Bankruptcy Proceeding and that Section reads as follows, “The debts to have priority, in advance of the payment of dividends to creditors, and to be paid in full out of bankrupt estates, and the order of payment, shall be (1) the costs and expenses of administration including the actual and necessary costs and expenses of preserving the estate subsequent to filing the petition.”

And then follows a general enumeration of expenses considered to be administrative expenses of the bankrupt estate followed by four other categories of debts which have priority.

And I note in that regard just for the sake of clarity that the fourth category of Debts with Priority includes “taxes which became legally due knowing by the Bankrupt to the United States or to any State or any subdivision thereof” and this priority for tax debts includes essentially tax debts which are incurred by the employer prior to the institution of bankruptcy proceedings and it is not disputed that tax debts incurred by the bankrupt during the bankruptcy proceeding are administrative expenses of the bankrupt estate in sharing the first priority but that would not in our view include these taxes for the reason I am about to state.

Justice Harry A. Blackmun: Mr. Stone, we're really in a situation here of tension between the two statutes, aren't we?

Mr. Richard B. Stone: My precise point Mr. Justice Blackmun is that we are not in the state of tension between these two statutes for the reason that though the Court of Appeals certainly felt we were for the reason that Section 64 of the Bankruptcy Act has nothing to do with trust funds.

Justice Harry A. Blackmun: Well, this --

Mr. Richard B. Stone: It deals with administrative expenses of the bankrupt estate and unless you can at some point identify withheld taxes as tax debts of the employers, there is no tension because Section 64 has no bearing on those amount.

Justice Harry A. Blackmun: This has to be your position.

I think you have no alternative.

The question I wanted to ask however is there anything in the chronology of the two statutes which is that is of help here, which is the older of the two?

Mr. Richard B. Stone: Section 64, The Bankruptcy Act is the older of the two.

Justice Harry A. Blackmun: So that the other one which is I recall came in about 1934 is the newer one?

Mr. Richard B. Stone: Right.

Justice Harry A. Blackmun: Does this lend you any support at all?

Mr. Richard B. Stone: Well, it lends -- I think it does lend us some support.

Of course, there have been -- it lends us some support but the trust was still congressionally enacted even though Section 64 is already on the book and the trust is not, the trust provision Section 7501 does not refer in any way to a limitation arising from bankruptcy.

Justice Harry A. Blackmun: Do you know what prompted at its birth (Inaudible)?

Mr. Richard B. Stone: The institution of the trust fund?

Justice Harry A. Blackmun: Yes.

Mr. Richard B. Stone: Provision?

Yes, as far as we can tell, there is the Senate Report and the House Report of both are unlimited in terms of explaining the purpose but as far as we can tell, the trust impose in Section 7501 was designed to forestall the possibility that courts would limit the Government to mere debt collection procedures and would not allow either trust collection or tax collection extraordinary procedures against those withheld funds.

Justice Harry A. Blackmun: Am I correct that this statute come in to being before withholding was established?

Mr. Richard B. Stone: Withholding of income tax was after.

Yes, it came between before the withholding of income tax and before the withholding of FICA but there was already on the Board's withholding a various excise taxes and it was this particular taxes which the original predecessor Section 7501 was designed to take care of.

Chief Justice Warren E. Burger: Well then your view isn't the Trust Section imperative to the integrity of the Social Security Act structure?

Mr. Richard B. Stone: It is imperative to the structure of the Social Security Act and to the withholding of income taxes.

Yes it is, Mr. Chief Justice.

Our view is that the entire legislative scheme which we discuss at length at pages 7 to 10 of our brief, the entire legislative scheme behind withholding of all taxes shows that the Government serves merely as a collection agent with respect to these taxes that these are tax debts of the employee to the Government and not of the employer to the Government.

And therefore, that these are neither taxes nor debts of the bankrupt to the Government and therefore don't come under the provisions of the Bankruptcy Act which establish priorities for the debts and expenses of the bankrupt estate.

Essentially, if employees paid $100 in wages, he receives $85 and he is considered to have discharged the $15 a tax liability, and the employer at that point merely holds as the Tenth Circuit recently said holds as a collection agent for the Government.

He holds it for a brief period of time and is required to pay it over and it's my submission to this Court that regardless of how strong a policy Section 64, The Bankruptcy Act embodies this to the equal priority of administrative expenses does nothing in that provision which converts trust funds into administrative expenses or which deals in any way with the bankrupt's obligation to handle the funds which it is receive in the capacity of collection agent and neither of the Court's below nor the respondent trustee has attempted to answer this what I considered to be a crucial threshold question of what interplay it all to Section 64 have on this funds.

Unknown Speaker: You think the Nicholas case bears on your problem here?

Mr. Richard B. Stone: Yes, I think that it certainly needs to be discussed.

Of course, this Court reserved in Nicholas the question before us here.

Nicholas involved the question where the interest on withheld taxes accrues past the period of bankruptcy or whether it stops with the institution of bankruptcy proceedings or the actual institution of bankruptcy.

And the court in Nicholas held that interest did not accrue, it held on the broad general principle that interests during a bankruptcy proceeding ought not to accrue it all because it eats away it creditors, assets, and creditors ought not be disadvantaged merely because of delays attributable to the long length of the Bankruptcy Proceeding.

Justice Byron R. White: Does the Government have a lien for this access?

Mr. Richard B. Stone: A lien?

Not a special lien Mr. Justice White, it does not file a special [Voice Overlap] trust rather than --

Justice Byron R. White: The Government doesn't have the same lien for these withheld taxes as it would for the income taxes of the employer himself owed?

Mr. Richard B. Stone: That is a question that hasn't been tested.

It hasn't -- it can go in I suppose, this hasn't been tested but I suppose it go in under --

Justice Byron R. White: Well, let's assume the Government has a protected lien for income taxes and the employer goes bankrupt.

What's the relative position of the Government vis-à-vis of taxes and where it's got a lien for income taxes, how do they stand as against administrative expenses?

Mr. Richard B. Stone: I don't know the answer to that question Mr. Justice White except that I believe that if the lien is perfected that they stand ahead of all and secured obligations including administrative expenses but I'm not sure about the answer to that.

I want to point out that the Court in the Nicholas case cited the sentence of Section 7501 and I think it is important since no doubt the Nicholas case will -- does have to be examined to determine the outcome of this case.

The second sentence of Section 7501 after the trust is declared says as follows, the withheld taxes shall be “assessed, collected, and paid” in the same manner and subject to the same provisions and limitation including penalties as are applicable with respect to the taxes from such fund arose.

Now we think that as we've discussed in our brief that the legislative history of that statute makes it clear that it was not designed really though it says limitations, it was not designed to limit remedies but to expand Government revenues but even the quoted language taken at its face value is I think of anything favorable to our position in this case because the phrase “taxes from which such fund arose” clearly refers to the income and social security taxes owed by the employees and withheld by the employer.

And these taxes on the employees would not subject to any collection limitation by virtue of the employer's bankruptcy.

Now they would be subject in any bankruptcy proceeding to a limitation on the accrual of interests during the bankruptcy proceeding but they would not be subject to a limitation by virtue of the employer's bankruptcy and there and I think lies the essential distinction even given the fact that the Court relied on the second sentence of Section 7501 in the Nicholas case.

That is the essential distinction between Nicholas and this case.

Justice William J. Brennan: Mr. Stone, I gather that generally, employer not a bankrupt, an employer doesn't have to or does he keep withheld taxes in the separate fund?

He may use them, can he in the business ordinarily?

Mr. Richard B. Stone: That is also an (Inaudible), Mr. Justice Brennan.

Justice William J. Brennan: Well, --

Mr. Richard B. Stone: I think that that --

Justice William J. Brennan: If he absconds with it.

Mr. Richard B. Stone: He has --

Justice William J. Brennan: Is he prosecuted as embezzlement?

Mr. Richard B. Stone: He could be.

Justice William J. Brennan: Oh really?

Mr. Richard B. Stone: He could be.

Justice William J. Brennan: On the federal law?

Mr. Richard B. Stone: I would think he could be.

It is embezzlement because he is required --

Justice William J. Brennan: But is he prosecuted as an embezzlement?

Mr. Richard B. Stone: I don't know of any cases that have raised that.

Justice William J. Brennan: What do they prosecute him that under?

This must happen doesn't it that an employer absconds with the money?

Mr. Richard B. Stone: Mr. Justice Brennan, I will have to say that the Government has not attested at all the whole range of permissible activity that an employer can conduct with respect to these withheld funds.

They are due so quickly.

In the ordinary case, they're paid over so quickly because they are due --

Justice William J. Brennan: Yes, but what if they're not and it has to be a prosecution because he absconds with it.

Under what do you prosecute?

Some special provision of the income tax law?

Mr. Richard B. Stone: I don't know of any special provision that would cover that.

Justice William J. Brennan: So then it would have to be as an embezzlement?

Mr. Richard B. Stone: I would think that the embezzling remedy would be available but I suppose the willful, a criminal prosecution for willful avoidance of a tax payment under the normal criminal provision of the revenue code.

For these reasons, I believe first that this Court are too definitely make it clear that this are withheld funds are expenses are not expenses and eats of the employer to the Government but are held in trust by the Government and that the mere fact of bankruptcy does not defeat the trust set forth in Section 7501 and that in addition, the trust in this case ought to be recognize even though the raise is not specifically traceable and for the reason set forth in our brief in which I have collaborated on.

I would like to save whatever remaining time I have for rebuttal.

Chief Justice Warren E. Burger: Mr. Gillogly.

In order to avoid interrupting you, Mr. Gillogly, let me put a hypothetical question to that may help further something on my mind.

Argument of Kevin J. Gillogly

Mr. Kevin J. Gillogly: Yes, sir.

Chief Justice Warren E. Burger: Suppose I would assume that a large employer like General Motors or others of that category probably have it any given day millions of dollars in the segregated account.

Now hypothetically, assume the impossible which is that Congress acted very swiftly with simply abolished the whole statutory scheme.

Whose property would that account to the fund?

Who would be the owners of that fund?

Mr. Kevin J. Gillogly: I would say under the existing law it would be the United States Government.

Chief Justice Warren E. Burger: And would they be the legal owner only or the equitable?

Mr. Kevin J. Gillogly: Well, I would say the legal owner under the trust theory.

Chief Justice Warren E. Burger: Yes.

Mr. Kevin J. Gillogly: The legal title of course is in the holder of funds and the equitable title would be in the United States Government.

Chief Justice Warren E. Burger: Well, don't you think the equitable title would vest in the employees if the Act had been repealed?

The employees had made this contributions --

Mr. Kevin J. Gillogly: Oh!

If the Act had been repealed.

Chief Justice Warren E. Burger: That's right.

The Act is repealed.

Mr. Kevin J. Gillogly: I'm sorry.

If the Act had been appealed, I think then that the equitable title would be in the employees.

Chief Justice Warren E. Burger: Employees.

In other words, had have (Inaudible) an accounting procedure to unscramble this very large omelet and give to each employee what he had according to the records of the employer contributed to that fund.

Mr. Kevin J. Gillogly: Yes, sir.

Unknown Speaker: That would just be unpaid wages then, wouldn't it?

Mr. Kevin J. Gillogly: I -- if the law were repealed?

Yes.

Unknown Speaker: Subject to the limitations with regard to priorities of unpaid wages have under the Bankruptcy Act.

It certainly don't take over administrative expenses.

Mr. Kevin J. Gillogly: But we're now talking about a Bankruptcy Proceedings.

I understood Mr. Chief Justice to be talking about in any given situation exclusive of bankruptcy.

Chief Justice Warren E. Burger: I was thinking at one step at a time.

I have just taken the first stage and then you can pursue it with Justice White's illustration and see where you'd come out and see whether that has any bearing on this case?

Mr. Kevin J. Gillogly: Well, I would say that once the case is in the Bankruptcy Court either by a chapter proceedings or by an adjudication, then the entire Bankruptcy Act prevails and then the systems of priorities are set forth by Section 64.

Chief Justice Warren E. Burger: Well then.

Mr. Kevin J. Gillogly: If this law were rescinded or if it were repealed, or if the courts were to strike it down and there were no bankruptcy then I think there'll be no question as to where it would go.

The equitable title would be in the employees.

Chief Justice Warren E. Burger: Let me pursue with the hypothetical a little bit beyond that.

Take a Trust Company Bank that has a large trustee fund and the bank becomes insolvent and goes through these processes, are they accounts of the Trust Department or the Trust Company segregated accounts?

Would they ever find there way into a Bankruptcy Proceeding of the corporate trustee?

Mr. Kevin J. Gillogly: I think by the nature of the Bankruptcy Act, I believe that the Trust Company is specifically excluded by the Act.

Chief Justice Warren E. Burger: This is all hypothetical.

Mr. Kevin J. Gillogly: All hypothetical, assuming --

Chief Justice Warren E. Burger: All hypothetical.

Mr. Kevin J. Gillogly: That it went, so I understand you fully that it -- the Trust Company became insolvent or bankrupt.

Chief Justice Warren E. Burger: Right.

Mr. Kevin J. Gillogly: I don't think there's any question at all that the Bankruptcy Act would prevail assuming that it did go and come in the Bankruptcy Act either voluntarily or involuntarily.

Chief Justice Warren E. Burger: You mean the general creditors could reach into the segregated accounts of the beneficiaries of the trust?

You don't mean that?

Mr. Kevin J. Gillogly: I would say in so far as I understand trust companies, they hold some of them in trust pools where they commingle funds. (Voice Overlap) I think they get a different problem there.

Chief Justice Warren E. Burger: This is not a trust pool.

Mr. Kevin J. Gillogly: Or the individual.

Well then again, I think you have an entirely different situation here.

Chief Justice Warren E. Burger: The equitable owner in the Trust Company hypothetical is the beneficiary of the trust, isn't it?

Mr. Kevin J. Gillogly: Yes sir, that's correct.

Chief Justice Warren E. Burger: Well, I'm taking you off enough -- track.

Mr. Kevin J. Gillogly: Yes.

The Government seems to be relying rather heavily upon the trust fund theory and the theory of trust and trust ex mal officio and question why the Seventh Circuit Court did not address itself to this.

And I think it's very obvious that the reason why the Seventh Circuit Court did not address itself to this particular argument of the Government, is that it wasn't necessary for it to do so because the court there interpreted Section 64 (a) to the same as the Connecticut General case did and the same as the Green case is that number one, they were not in conflict with one another that Section 7501 (a) and 64 (a) (1) could be read separately and by the second sentence in 7501 (a), it provided that the trust have the same limitations on it as the taxes from which the fund arose and then went on to say that the taxes arose from and by virtue with the Bankruptcy Act and therefore the Bankruptcy Act would prevail and there goes Section 64 (a).

But further, if these were not the case, that the strong policy of 64 (a) of the Bankruptcy Act would prevail over the general provisions and the general policy of Section 7501.

I would like to review rather briefly the history of these cases starting out with the Guaranty Title Company case, an opinion in 1912 where the Section 3466 of the Internal Revenue Code provided for a priority as opposed to 7501 which provides for trust fund.

There the Supreme Court held that it was a beneficent policy that 64 (a) should prevail especially in that case that pertain to wage earners.

This was reaffirmed by this Court in Davis versus Pringle in 1925.

Now, this line of cases goes undisturbed up until the time of U.S. versus Nicholas or Nicholas versus U.S. which was decided in this Court in 1964.

The problem arises with the line of cases under the City of New York versus Rassner and then the Rassner case.

The first case in 1942 in which this trust fund was found to apply.

The Rassner case provided or the Rassner case said that it was a general provision of the Bankruptcy Act in Section 64 (a) as opposed to the specific provisions of the trust.

And the Rassner case went on to say that if it could be shown that the policy or if the provisions of 64 (a) were other than general then the result would be different.

And this Court has shown in Nicholas versus United States in express language said that it is a strong policy that prevails in 64 (a).

That being the case than the perhaps fall from underneath the Rassner case and all of the cases that follow it fall like dominoes.

This is the theory of the trustee.

This has been the position of the trustee from its very -- the very inception of this case.

In the Nicholas case, the Court went so far as to say that the taxes that were incurred during the Chapter XI, and this is precisely what we're talking about here, come within the first priorities of Section 64, the Bankruptcy Act.

That is the cost of administration.

The history of the administrative and cost of administration provisions of the Bankruptcy Act have constantly worked towards allowance across of administration and the way from tax collecting.

When you trace the history in the Bankruptcy Act is enacted in 1800 and 1841, 1867 and 1898.

All gave top priority to taxes.

It wasn't until 1926 that the priorities were changed, the cost of administration was advanced and that the taxes were reduced to a sixth priority.

Then under the Chandler Act of 1938, the system of priorities was retained and further the tax collector was further restricted but being required to file this claim within the limitation set on all other claimants.

And again in 1952, the Act was again amended to give further priority to cost of administration by providing that cost of administration in a superseding bankruptcy takes priority over the cost of administration in the superseded chapter proceedings, further strengthening the position of cost of administration.

And lastly in 1966, the most recent amendment which changed the priorities further or limited further the claim for taxes by holding that the taxes could only be claimed for a three-year period prior to the filing of the bankruptcy.

So we see historically, this picture of the reducing of the tax claim in advancing the cost of administration.

And I think as the court below in the very scholarly opinion by Mr. Justice Hastings points out and refers to the congressional or rather the Senate Reports and the House Conference Reports as it apply to the cost of administration.

And the need to preserve this cost of administration because let's take just what could happen very easily in this case.

We are only -- the Government is only seeking to impress the trust on those taxes that were collected by the debtor in possession.

But if you were to read Section 7501 that says any person who collects taxes that would also mean the bankrupt prior to filing.

Further and following the Rassner line of cases, if you have every state and every municipality enacting trust fund legislation, there's nothing left to administer in these cases or were still, you have a trustee who is going to wait and to see if anyone is going to assert his trust rights and the estate is going to go unadministered during this period of time.

And as the House Reports and the House Conference Report and the Senate Report, I believe it was in the 82nd Congress emphasized the necessity to protect the trustee in order to have orderly administration of the estate.

If you don't protect the trustee, if you don't give him the first priority, then you are not going to have orderly administration of estate just the normal routine that's employed by the trustee.

First of all, he ceases the property in order to protect it and so doing here immediately in first liabilities.

He's got to post the bond as required by Court.

He's got to assume rent liabilities for use in occupancy.

He's got to employ inventory clerks.

He has got to employ appraiser by rule of court.

These are all obligations that he himself must pay.

Justice Byron R. White: Could I ask you a question about ordinary taxes the Government -- that a bankrupt owes a Government -- a bankrupt company owes a Government.

Let's assume the Government has perfected a lien on the prior to bankruptcy on the assets of the individual or the company.

What is the status of that lien in bankruptcy with respect to administration expense?

Mr. Kevin J. Gillogly: If the lien has been perfected the same as any lien under the Uniform Commercial Code.

If it has been perfected, it is a valid and subsisting lien.

And that property is excluded from the bankrupt estate.

But that's by separate statute though, sir.

Justice Byron R. White: Well, so is this?

Mr. Kevin J. Gillogly: Yes, sir.

Justice Byron R. White: So as this.

It's excluded in the bankrupt estate and yet the trustee takes position of it at the outset.

Mr. Kevin J. Gillogly: Usually does has some accommodation, sir.

Justice Byron R. White: Well, know, it it's still -- it's still the bankrupt's property just subject to the lien that's all it is.

It's just a protective lien.

The Government has to take possession of it.

Now the trustee takes position of the properties as the bankrupt's property just subject to the lien.

Now, does the lien holder have to share administrative expenses?

Mr. Kevin J. Gillogly: No, sir.

Justice Byron R. White: Not even if there is any other funds?

Mr. Kevin J. Gillogly: No sir, there is no provision in the Bankruptcy Act, Mr. Justice White.

The usually an accommodation is worked up.

Justice Byron R. White: Well --

Mr. Kevin J. Gillogly: But if the --

Justice Byron R. White: Let me ask you the question that I asked Mr. Stone.

Is this -- under 7501, it says that these amounts owing the withholding taxes shall be assessed, collected, and paid in the same manner and such the same provisions limitations, as other as applicable with respect to taxes from which said fund arose?

Now, does that mean that the Government did not want to lien if it wants some priority over other creditors if it wants the position of the lien holder, must it perfect its lien and what else could that language mean?

I mean it may be a trust fund but it says it's collectible in the same manner as other taxes?

Mr. Kevin J. Gillogly: Well I -- you're speaking now of the second sentence of 7501 (a).

Well, I feel that after the interpretation put on that language in the Connecticut Motor Lines case and the Green case and also in this case in the court below is that the trust has a limitations placed upon it by that as a taxes from which the fund arose and that is the Bankruptcy Act and therefore the Bankruptcy Act would apply.

Now, I think in the hypothesis that you gave me is it pertains to something entirely different Mr. Justice White.

Justice Byron R. White: Why?

Why would it?

Mr. Kevin J. Gillogly: Because it is again a separate statutory procedure.

Justice Byron R. White: Well, yes but the Government didn't take the position.

It didn't take the normal steps to perfect its tax claim here in order to give it priority over administration expenses.

There's no claim that the Government has perfected any lien in these cases.

Mr. Kevin J. Gillogly: No, there is none sir.

They did not protect or perfect the lien.

Well, as a practical matter Mr. Justice White, if that were the case, the trustee wouldn't take possession of the property and there be no estate to administer.

He would file a “no assets” report and that would be the end of the case.

Justice Byron R. White: If that's all the assets.

Mr. Kevin J. Gillogly: If that's all the assets there were, certainly.

And that happens in any number of cases not only in tax liens, but on Uniform Commercial Code liens.

This is very common place.

(Voice Overlap) But there you have it, you have it set forth with clarity in the law and if they have protected their position, then there is nothing to administer for the title --

Justice Byron R. White: Would you say that if a trustee is appointed before a company that has been adjudicated and he finds that the only sizeable assets the company has, is made up of withholding taxes and haven't been paid over to the Government.

He won't treat that as a no asset case?

Mr. Kevin J. Gillogly: He would treat that, sir.

I --

Justice Byron R. White: Why?

Mr. Kevin J. Gillogly: No --

Justice Byron R. White: Under your position?

Mr. Kevin J. Gillogly: No, because if I understand you Mr. Justice White, you're talking about funds that have been segregated.

That there any withholding tax account --

Justice Byron R. White: I'll just say.

I'll just say that you find some bank accounts and you find that the total amount owed for withholding taxes exceed the money in the bank.

There hasn't been any segregation or anything.

The only assets are bank accounts but the obligation here withholding taxes exceeds the amount in the bank.

Now, would you make that a no asset case or not?

Mr. Kevin J. Gillogly: No, I would not because the Government has not perfected its lien rights in that instance.

And it becomes the general funds of the estate.

Justice Byron R. White: Yes.

Mr. Kevin J. Gillogly: Then if you get back again to 7401 and 64 (a), where does the priorities lie?

Justice William J. Brennan: Now, let me – you said that --

Mr. Kevin J. Gillogly: Yes, Mr. Justice Brennan?

Justice William J. Brennan: I understand where the Government has perfected the lien you say that's treated exactly as you would on the other lien case (Inaudible)?

Mr. Kevin J. Gillogly: Yes, sir.

Justice William J. Brennan: But suppose it has not perfected the lien, take Mr. Justice White's hypothetical except that money in the bank is earmarked on the account title as withholding taxes belonging to United States, what then is this?

Mr. Kevin J. Gillogly: Well, I think you have a different situation.

As a matter of fact --

Justice William J. Brennan: Well, with this -- would you say that is a no asset case?

Mr. Kevin J. Gillogly: That's exactly what we did sir in this case.

What we did -- let me change that.

That's exactly the way the trustee treated funds that were on deposit in the bank account that was created and set up in this case for deposit of tax moneys.

There was an account that was set up here.

And I refer you to abstract 39 which show in the petition that when the president of the corporation was questioned about the assets, he said that a bank account had been set up and this was -- this was set forth in the petition paragraph 1 in abstract 44. Paragraph 1 of the referee's orders makes an order with reference to that bank account.

Justice William J. Brennan: But what we're dealing with here I gather are with taxes withheld after the petition had replied.

Mr. Kevin J. Gillogly: That's precisely what I'm talking about.

Justice William J. Brennan: I know the taxes withheld have not been deposited in any bank account --

Mr. Kevin J. Gillogly: I'm afraid I --

Justice William J. Brennan: I mean had not been segregated.

They have not been segregated in an account as had the -- with the taxes withheld before in filing of the petition?

Mr. Kevin J. Gillogly: They were filed during the Chapter XI proceedings by the debtor in possession.

Justice William J. Brennan: Now, what did they do with money when he withheld it?

What did he do?

Mr. Kevin J. Gillogly: He deposited them in a special account in the State Bank of Elk Grove Village in Elk Grove, Illinois.

Those moneys may still be there for all I know.

We exercise no jurisdiction over them.

Justice William J. Brennan: Then what are talking about then?

Mr. Kevin J. Gillogly: We're talking about separate funds that were -- when the debtor went into possession, an order was entered ordering him to open up three accounts.

He did open up an account in the Elk Grove Bank for the purpose of withholding taxes and FICA he did make some deposits in there.

Justice William J. Brennan: He did make some.

Mr. Kevin J. Gillogly: He made some deposits.

Justice William J. Brennan: But not enough.

Mr. Kevin J. Gillogly: But not enough.

That's right.

We haven't touched these funds.

We had -- we don't claim that.

Justice William J. Brennan: So to the extent that they created a separate fund you make no claim --

Mr. Kevin J. Gillogly: I make no claim.

Justice William J. Brennan: -- and that but the Government makes a claim with respect to the total he should have deposited.

Mr. Kevin J. Gillogly: That's right.

And they want to impress the trust on property, on capital assets of the corporation that existed long before the Chapter XI proceedings and in no way traceable and there's no question of commingling.

There is no question of trust ex mal officio as it provide -- as it pertains to the capital funds.

Justice Byron R. White: (Voice Overlap) round numbers taxes withheld by debtor-in-possession total amount.

Mr. Kevin J. Gillogly: I would say roughly maybe $200 to $300.

Justice Byron R. White: How much was deposited in the trust fund?

Mr. Kevin J. Gillogly: Oh!

Excuse me, the total amount that was withheld I'm sorry was $10,075.52, the amount that was deposited that was maybe $200 to $300.

Justice Byron R. White: So he found $700 that he didn't deposit, is that what we're trying to --

Mr. Kevin J. Gillogly: No, the Government wants the entire sum.

Unknown Speaker: Well, and did you say the $200 or $300 on deposit --

Mr. Kevin J. Gillogly: Actually that would be it and would be whatever is in that account.

Chief Justice Warren E. Burger: Who would you say has benefited by the money which should have lawfully been put in to the segregated accounts but which was not put in according to both the statute and the directions?

Mr. Kevin J. Gillogly: I would say the wage earners at least to the extent that credit is given to them for the moneys that should have been deposited.

I can't see in no way at all that the estate has been enhanced.

Chief Justice Warren E. Burger: Doesn't the Government stand in the shoes -- since the Government has had to take on the responsibility of discharging the employees for that obligation?

Doesn't the Government stand on the shoes of those employees?

Shouldn't they preferably?

Mr. Kevin J. Gillogly: You mean as subrogees, I don't know any statutory provision.

I know of no case law.

Chief Justice Warren E. Burger: As a matter of equitable -- established equitable principles relating to trusts?

Mr. Kevin J. Gillogly: Well except that that is -- I would say under ordinary circumstances, I would have to buy your argument.

However, I feel that what we're here before this Court to interpret is the effect of 7501 and that's in the relationship with 64 (a) (1).

And I'm just asking the Court to follow the precedent that's here before have been sent is that it is a strong policy of 64 (a) that must prevail over 7501 if there is a conflict.

In other words, this 7501 (a) applies up until the moment that the bankrupt -- any proceeding on bankruptcy is filed.

Then the Bankruptcy Act takes over completely.

I don't think you can have the bankruptcy applied just piecemeal and have collateral legislation that is going to interfere with the administration of the estates which is what 7501 does because you're in real serious problems when it comes to the administration of estates.

If you're going to ask a trustee whose worth is sought to come in and to expend money, his own money and incur personal liabilities and not know whether or not there is a trust that is going to be exerted by the United States Government and I suggest later on if the Court is to reverse the courts below.

All the municipalities that would pass that legislation and all the states that would pass that legislation you would have no orderly administration of the estate until the Congress of the United States would untangle it.

Now, I would say that there would be irreparable damage done to the system during that hiatus.

Unknown Speaker: Excuse me.

Mr. Kevin J. Gillogly: Yes, sir?

Unknown Speaker: If the Government loses this case, your right its claims still administration expense, isn't it?

Mr. Kevin J. Gillogly: Oh!

No, sir.

Unknown Speaker: What is it?

Mr. Kevin J. Gillogly: They are claiming over and above --

Unknown Speaker: No, no.

What do you think the -- what priority does the Government's claim at?

Mr. Kevin J. Gillogly: They enjoy a fourth priority under Section 64 (a) (1).

Excuse me, no.

I'm sorry.

They enjoy a first priority.

They enjoy --

Unknown Speaker: Administrative expense?

Mr. Kevin J. Gillogly: Administrative expense after -- the administrative expense of the proceeding bankrupt.

Unknown Speaker: So they have -- because these are taxes accruing during the operation of the business?

Mr. Kevin J. Gillogly: Yes, sir.

That would the cost of administration.

Unknown Speaker: And so it's an administrative expense?

Mr. Kevin J. Gillogly: Yes, sir.

Unknown Speaker: And if they don't have -- that postpone to their usual position with respect to taxes?

Mr. Kevin J. Gillogly: That's right.

They do enjoy that first priority with the subject to the one condition that I stated.

Unknown Speaker: That is only two -- about $700 of it, $200 or $300 like 100%?

Mr. Kevin J. Gillogly: Yes sir, but I think the principle is much larger than that what could be done to the entire system.

Chief Justice Warren E. Burger: Mr. Stone, you have four minutes remaining.

Rebuttal of Richard B. Stone

Mr. Richard B. Stone: Yes, I'll just take a minute Mr. Chief Justice.

I want to clarify one point.

I have been informed by my co-counsel that as to the Government's lien on these taxes if it is on real property, it comes ahead of administrative expenses.

If it's on personal property reduced to possession, it comes ahead.

But if it is on personal property not reduced to possession, it comes behind for preferred expenses.

However, in a lien in the Chapter XI proceeding cannot be perfected against the trustee in any circumstances.

The Government is --

Justice William J. Brennan: He doesn't need it, has he?

Mr. Richard B. Stone: Has a trust.

It doesn't need it because it has trust fund anyway.

Justice William J. Brennan: Or you can say that he doesn't need it because of his estate?

Mr. Richard B. Stone: That I suppose is an undesirable but albeit an alternative.

Justice William J. Brennan: How about this (Inaudible)?

Mr. Richard B. Stone: Oh!

Mr. Justice Brennan, there is some reference.

There is a report filed after the institution of liquid -- of the applicable liquidation have occurred which refers to a special account in a bank of special tax account but the referee specifically found and I guess this is the facts for the purposes of this case that no such moneys have in fact been entered and it's unclear from the little record we have about this $200 to $300 that it was in fact a special Government account.

And I would say that for purposes of this case, we have to assume that that we're going simply at the general funds of this estate in imposing the trust with respect to those funds.

I want to say in conclusion only that, I think that respondent's argument in this case merely affirms my prior statement that neither the courts below nor the respondent have dealt with the issue of what is the nature of these debts.

Are they tax debts of the employer owed to the Government or does the employer hold them merely as collecting agent for debts of the employee.

I don't see on the theory of that either the court below or respondent has gone on how they would recognize this trust fund even if the amounts -- the proper amounts have been segregated.

It seems to me that under their theory which precludes operation of 7501 trust when a Bankruptcy Proceedings starts, the trustee would not have been authorized to pay over segregated funds even if he had segregated them because they simply would he no trust in the time of bankruptcy and that is a totally unacceptable holding form our point of view.

Justice Byron R. White: What do you say about subject liable in so far as it says that taxes withheld by the employers will be collected by the same procedures?

Mr. Richard B. Stone: We have dealt with that in length in our brief Mr. Justice White.

Briefly, to reiterate, we say that first of all that the legislative history shows that the real purpose of that second sentence was to make sure that it would be clear that the tax remedies were available altogether to the Government.

There was a fear on Congress' part that absent that ordinary tax remedies would not be available precisely because this was not a tax debt of the bankrupt and the Congress wanted all available procedural remedies, trust, tax, and debt to be --

Justice Byron R. White: Accumulated?

Mr. Richard B. Stone: Right.

Right.

But even if it is viewed as restrictive and I suppose it must be said that the Nicholas Court and I believe the Court went perhaps further than ahead to as an alternative ground, the Nicholas court invoked this sentence to the proposition that interests couldn't be supported during this time to the extent that it is limiting.

I believe this case is distinguishable because even though interests would have been precluded on any debt -- tax debt including the employee's tax debts and a Bankruptcy Proceeding, the employee's tax debts would at no time have been subjected to collecting limitation of being placed in the bankrupt employer's estate and his funds available to general creditors.

Thank you.

Chief Justice Warren E. Burger: Thank you Mr. Stone.

Thank you Mr. Gillogly.

The case is submitted.

Featured:

United States v. Key - Oral Argument

Thu, 23 Aug 2012 18:13:38 +0000

Case:

United States v. Key

Media File:

402_19700121-argument.mp3

Related Transcript:

402_19700121-argument

Transcript:

Argument of Lawrence G. Wallace

Chief Justice Warren E. Burger: Number 402, United States against Key.

Mr. Wallace, you may proceed whenever you're ready.

Mr. Lawrence G. Wallace: Mr. Chief Justice and may it please the Court.

This case is concerned with the single aspect of the proceedings under a voluntary petition for corporate reorganization originally filed in 1954 pursuant to Chapter X of the Bankruptcy law by the debtor, Hancock Trucking Incorporated.

In the petition, Hancock alleged that it was unable to meet its debts as they became due and requested the appointment of a trustee to operate its business and manage its property.

The respondent here is that trustee.

The claims of the United States against the debtor are for unpaid income withholding, employment and excise taxes in the total amount of more than $375,000.00.

Because of the narrow focus of the questions presented by the Government's petition for a certiorari, little of the lengthy history of these reorganization proceedings need be recounted here.

The issues in this Court concerned an amended plan of reorganization filed by the trustee in June 1967 and approved by the courts below over the Government's objection.

The amended plan reflected in agreement approved by the District Court and by the Interstate Commerce Commission for the sale of the debtors principle asset, its Interstate Commerce Commission operating rights for truck freight services to Hennis Freight Lines Incorporated.

The purchase price of $935,000.00 was to be paid in accordance with the schedule requiring $300,000.00 to be paid within 90 days of the Commission’s approval of the sale and the balance in 78 monthly installments.

The amended reorganization plan reflecting this sale agreement did not contemplate that the debtor Hancock Trucking would continue to exist.

The amended plan is in effect a liquidation plan.

The Government made no objection to the terms of the sale agreement, its objections relates solely to the provisions for payment to creditors in the amended reorganization plan.

Justice Byron R. White: You say this was basically a liquidation plan and not a continuing?

Mr. Lawrence G. Wallace: That is correct.

Justice Byron R. White: Where were the installment payments going to be generated?

Mr. Lawrence G. Wallace: The payments being made by Hennis Trucking Company which has purchased the Interstate Commerce Commission rights to operate the freight line.

Justice Byron R. White: Based on the capital equipment?

Mr. Lawrence G. Wallace: Now, the capital equipment had previously been disposed off.

Justice Byron R. White: I see.

Mr. Lawrence G. Wallace: The major remaining asset was simply the --

Justice Byron R. White: Was the license?

Mr. Lawrence G. Wallace: The license.

That is correct.

Chief Justice Warren E. Burger: While youre pausing for a moment could you answer this for me.

If the plan had provided for equal participation across the board, would you still be objecting to it on a priority basis for the tax claims?

Mr. Lawrence G. Wallace: We would be entitled to object to it but the secretary also would have had discretion to accept for the plan if he wishes.

Chief Justice Warren E. Burger: He can and sometimes does accept, does he not?

Mr. Lawrence G. Wallace: Yes, he does sir specially when it will contribute to rehabilitation of the debtor and enable the debtor to continue in business.

Chief Justice Warren E. Burger: But you regard this is simply a voluntary waiver by the Government of the priority claim.

Mr. Lawrence G. Wallace: That is our view, yes Mr. Chief Justice.

The Government contends that the provisions for payment of creditors in the amended plan do not satisfy its statutory priority of payment rights and the respondent trustee admits in its brief that the Government is entitled to priority but contends that its rights are fully satisfied under the plan and that is the issue is this Court.

The contested plan provides for an initial payment of 100% of certain wage claims and certain state and local tax claims.

20% of the claims of the general unsecured creditors which is all they will receive and 10% of the Government’s tax claims and of the remaining state and local tax claims.

The remainder of the amount due to the Government and to state and local tax authorities was to be paid in 78 monthly installments secured by an assignment of the note and chattel mortgage Hennis had executed on its purchase of the debtor’s operating rights.

This amounts to an initial payment on the Government’s total claim of some $375,400.00 of approximately $37,500.00 and 78 equal monthly installments thereafter of approximately $4,330.00 each.

No interest was to be paid on the monthly installments which together with the initial payment would simply total the $375,400.00 owing to the Government.

As we point out in our brief, at the time of the initial payment when lower ranking creditors were to be paid in cash the discounted present value of the right to these future payments to the Government plus the initial payment to the Government would amount to approximately $317,000.00, some $58,400.00 less than the $375,400.00 owing to the Government.

The Government's position is that this does not satisfy its priority rights not because the Government has a right to immediate payment of all cash that is on hand up to the limit of its claim in a Chapter X proceeding which we do not urged and not because the Government has a right to the payment of interest for any part of the post petition period preceding cash payment to lower ranking creditors.

We recognize that there isn't a right to such interest on the Government’s claims.

Our contention is simply that the Government as a priority creditor cannot be required at the time when non-priority creditors are being paid in cash to accept IOU's payable only in the future the part of its claim.

Justice Potter Stewart: I thought, I guess I misunderstood.

I thought your claim simply was that you're entitled the full payment?

Mr. Lawrence G. Wallace: (Voice Overlap) It's admitted that we're entitled to full payment.

The issue is when?

Justice Potter Stewart: Oh!

No, you're not getting it.

Out of $374,000.00 tax claim to get $317,000.00 is not a full payment.

You don't admit that you're getting full payment at all, you're not getting it.

Mr. Lawrence G. Wallace: I meant to say it's admitted by the respondent that they were entitled to full payment.

That is the issue between us.

Of course we contend is that what --

Justice Potter Stewart: I don't understand that.

I thought that you would be satisfied if you would get an installment payments which added up would equal your full tax claim as discounted?

Mr. Lawrence G. Wallace: There is an alternative contention that we have a right to take the discounting into account.

Justice Potter Stewart: The only right is to full payment, isn't it on circumstances in this case?

Mr. Lawrence G. Wallace: Well, we also contend that we have a right to be first satisfied under Section 3466 of the Revised --

Justice Potter Stewart: But you just said you don't claim a right to be paid now in cash simply because cash is available, haven’t you?

Mr. Lawrence G. Wallace: What I just said was in Chapter X proceedings.

We do not claim a right to the immediate disbursement of cash that is not being paid to creditors.

Justice Potter Stewart: So what --

Mr. Lawrence G. Wallace: We don't claim that because cash is on hand and we are creditor we have a right to the immediate payment of our claim.

Justice Potter Stewart: That's what I understood you to say so, what are --

Mr. Lawrence G. Wallace: But when cash is being paid to creditors, we claim the right to be satisfied first.

Justice Potter Stewart: Now on fully in cash?

Mr. Lawrence G. Wallace: To the limit of what's being paid to creditors, yes Mr. Justice.

We claim a right to be paid to ahead of nonpriority creditors when payments are being made to creditors.

We do not claim a right to insist that the payments be made when other uses are being made of the money that the trustee holds.

Justice Byron R. White: Now, you should contend or 3466 gives you a priority, is that right?

Mr. Lawrence G. Wallace: And that is what we understand to be the meaning of the priority.

Justice Byron R. White: Well, you contend that's applicable in this case but so does the Bankruptcy Act give priorities.

Under Chapter X, there's certain creditors who have priority just by virtue of the provisions of the Act, aren’t there?

Mr. Lawrence G. Wallace: There is no general priority provision in Chapter X Mr. Justice, the only comprehensive --

Justice Byron R. White: What about administrative expenses?

Mr. Lawrence G. Wallace: There is a provision for administrative expenses.

It’s the only other provision --

Justice Byron R. White: What about wages?

Mr. Lawrence G. Wallace: There is no wage priority in Chapter X.

Justice Byron R. White: Either --

Mr. Lawrence G. Wallace: There is a wage priority in Section 64 of the Act which by Section 102 of the Act is expressly inapplicable to Chapter X.

Justice Byron R. White: What about your creditors in Chapter X?

Mr. Lawrence G. Wallace: There is nothing granting them priority in Chapter X, but there has been lengthy litigation about whether they have a priority ahead of the 3466 priority.

Justice Byron R. White: I thought you relied on the cases on strict priority -- strict priority doctrine that you have to pay -- that you really have satisfy priority creditors like the Case against Los Angeles?

Mr. Lawrence G. Wallace: Well, we do contend that you have to abide by the classes of priority creditors.

Justice Byron R. White: You really wouldn’t suggest to that -- you really wouldn’t suggest to the secured creditor does not have some priority to Chapter X, would you?

Mr. Lawrence G. Wallace: No.

It’s been held in equity reorganization equity receivership proceedings that secured creditors at least the mortgagees have priority ahead of the Government’s priority under 3466.

There has been disagreement about other secured creditors.

Justice Byron R. White: Alright.

Let's take mortgagees then.

You say they have priority in the Chapter X?

Mr. Lawrence G. Wallace: We believe that the standards of priority that prevail in equity receiverships have been carried over into Chapter X, yes sir.

Justice Byron R. White: Alright, let's take a mortgagee priority over unsecured creditors, would you suggest that the mortgagee may not be postponed in payment to unsecured creditors who say have been scaled down to 25% of their claim?

Let's assume the plan calls for satisfying the secured debt over a period of 10-year.

But unsecured creditors are paid off after when you value the property and you find out what interest the unsecured creditors have, you find out the only assets that are left for them are 25%.

25% of their claims are going to be paid and they have to cash to pay you and they decide just to get rid of it and they pay him off in cash in the plan but secured creditors who are going to be paid in full are postponed for 10 years.

Mr. Lawrence G. Wallace: Our understanding of the fair and equitable rule is that if the secured creditors object to that, they have a right to insist on their payments being made first, but --

Justice Byron R. White: And that is essential for your case, isn’t it?

Mr. Lawrence G. Wallace: It’s not essential for your case Mr. Justice because we have a statutory right and revised statutes.

Justice Byron R. White: I know but although you say that give this priority.

Mr. Lawrence G. Wallace: Moreover, we have an explicit right in Section 199 in Chapter X to object to the plan if it doesn’t satisfy our rights.

Justice Byron R. White: Yes.

You can object to the plan but then the question is what provisional will be made for none dissenting creditors and whether it’s fair and equitable to do that but you don’t claim it.

Do you think 3466 gives you some kind of a priority that’s different from other priority creditors?

Assuming it’s applicable to this case it does give you a priority.

But is there any different priority than a secured creditor has?

Mr. Lawrence G. Wallace: Well, I think it’s more explicit that it’s a right to have our claim first satisfied that’s the language used in Section 3466 where there’s no explicit statutory language giving the secured creditors such a right.

They will have to draw their rights from the judicial interpretations of the fair and equitable rule and equity receivership proceedings and their arguably would be more leeway for the courts to consider making exceptions to some of the rules that have been established in those proceedings.

Justice Byron R. White: I take it that if you really do then find it essential to rely on 3466 in this case.

Mr. Lawrence G. Wallace: Not essential because we don’t think we received the full payment right granted in Section 199 since the discounting of our claims was never taken into account.

Justice Byron R. White: Except for that point so you aren’t just relying on being a priority creditor under Chapter X or relying of being a priority creditor under the other Section 3466.

Mr. Lawrence G. Wallace: Well, we also rely on the idea that Chapter X grants two priorities only.

There are only two explicit priorities in Chapter X and I'll turn into that right now.

One of them is reproduced on Section 43 of our brief and that is Section 216, number three -- subsection 3 a plan oft reorganization under this Chapter shall provide for the payment of all cost and expenses of administration and other allowances which may be approved or made by the judge.

That is the only statutory basis for the priority for administrative expenses in Chapter X.

If the terminology used is the same terminology used for the Government’s tax claim priority that the plan of the right is to have the plan provide for the payment.

And we believe that Section 199 which is the provision in Section -- in Chapter X which gives us our priority rights in so far as they can be followed in that chapter also in body a notion of priority.

Everyone has assumed and tried along in the administration of Chapter X that administrative of expenses are entitled to be first pay.

They do have that priority.

Justice Byron R. White: The cases have certainly adjudicated a whole system of priorities in Chapter X, aren’t they?

They may not be set out in the statute --

Mr. Lawrence G. Wallace: That is correct.

Justice Byron R. White: But the cases have certainly adjudicated including administrative expenses.

Mr. Lawrence G. Wallace: No one to my knowledge has contested that the administrative expenses have the priority.

Justice Byron R. White: Or that nobody is contesting that you have a priority?

Mr. Lawrence G. Wallace: It’s just what is meant by priority that's being contested here, that is correct.

Well, our claim is that as a priority creditor admittedly a priority creditor the Government cannot be required when the lower ranking creditors are being paid in cash to accept a deferral without interest of a portion of its payments or they put the matter in other way we contend that no lower ranking creditor can over the Government’s objection be paid until the Government’s claims have first been satisfied which is what we understand to be the normal meaning of priority in bankruptcy.

In the alternative, we do contend that the Government has at least entitled to interest from the time of the payment to the lower ranking creditors until the time of the deferred payment to it to compensate it for the deferral.

But out principle contention is that the Government as the priority creditor should not be the one to bear the risk that the deferred payments will not materialized but should instead be paid first.

In making our contention, we rely on several different guide posts because as I have already said Chapter X does not include a specific comprehensive provisions setting for the hierarchy of priorities as Section 64 does for ordinarily liquidating bankruptcy proceedings.

The most venerable source of the Government's priority rights in this case is Section 3466 of the revised statutes which is on page 41 of our brief and in Title 31 of the United States Code.

This provision originated in acts of Congress of the late 18th century which they had their roots in the sovereign priority of the crown.

The statute expressly provides that the debts due to the United States shall be first satisfied whenever as is the undisputed case here that debtor is insolvent and has committed an act of bankruptcy.

Decisions of this Court as cited in our brief have established that tax debts owing to the United States or among those covered by the broad language of this provision.

The plan upheld by the courts below plainly does not comply with this statutory requirement of the Government's claims shall be first satisfied.

And there is on the face of things no reason why this provision is not controlling.

It manifests the continuous congressional policy that the claims of the federal treasury and the important public needs to be served by the funds in that treasury are to be placed ahead of the also just claims of unsecured creditors who did business with the debtor for profit.

In light of this important public purpose of the priority statute, this Court has repeatedly said that only the plainest inconsistency would warrant the finding of an implied exception to the clear command of Section 3466.

It was said most recently in United States Department of Agriculture against Redmond in Volume 330, United States.

These considerations and others led the Court of Appeals for the Fifth Circuit to conclude five and a half years ago in a thoughtful opinion by Judge Reeves that Section 3466 is fully applicable to Chapter X proceedings that's United States against Andersen which is discussed in our brief and the same conclusion had earlier been reached by the Court of Appeals for the Second and Third Circuits in cases cited on page 13 of our brief.

This Court has not previously had occasion to decide whether this provision is applicable to Chapter X.

The court below came to the contrary conclusion that Section 3466 is superseded by the provisions of Chapter X.

And our contention is that the other Court of Appeals were correct in deciding that this statute is entirely compatible with Chapter X and we go beyond that and contend that the provisions of Chapter X themselves in the light of their legislative history and as interpreted by this Court independently provide a priority right for the Government’s tax claims which the plan here did not satisfied.

The principle provision in Chapter X that is pertinent is Section 199 on page 42 of our brief and the second sentence is the pertinent language beginning at the end of line 7 of Section 199.

If in any proceeding under this Chapter, the United States as a secured or unsecured creditor on claims for taxes or customs duties and the parenthetical may be omitted.

No plan which does not provide for the payment thereof shall be confirmed by the judge except upon the acceptance of the lesser amount by the Secretary of the Treasury certified by the Court followed by a proviso which is irrelevant here.

Nothing in this language which gives the Secretary the right to demand or to forgo full payment is inconsistent with the command of Section 3466 as to the relative priority of that right to payment as against other claims.

The command of the Government's claim shall be first satisfied.

The history of the evolution of Section 199 recounted in detail in our brief shows that Congress knew that Section 3466 had been applied in equity receivership proceedings involving insolvent corporations.

And that in enacting the statutory successors to equity receivership which culminated in Chapter X.

Congress manifested no intention to diminish the Government's priority rights and rejected a specific recommendation that is do so, but instead was concerned to provide for protection for the Government in Section 199 not only as insolvent debtors to whom Section 3466 applies, but more generally, as to all debtors involved in Chapter X reorganizations.

Justice Byron R. White: Compensating (Inaudible)

Mr. Lawrence G. Wallace: Of course Congress also provided specifically in Section 199 in its predecessor that the Secretary of the Treasury may compromise the Government's rights and in appropriate cases this enables the Secretary to contribute to Chapter X’s objective of fostering rehabilitation of the debtor when feasible.

But the granting of this power to compromise does not imply that the rights themselves are diminished and as I already mentioned on the face of the statute -- this language providing for payment is the only language used when Congress wish to provide for a priority right in Chapter X.

And in any event the contrast within Section 199 between payment and acceptance of a lesser amount shows to us under face of the statute that the Government’s rights were not satisfied in this case.

There is another basis for the decision of the court below namely the provisions in Chapter X requiring that the reorganization plan be fair and equitable.

But these provisions do not lead each District Court free to get a fact to its own notions of what is fair and equitable.

In this field, the words “fair and equitable” are terms of art which acquired their meaning through judicial interpretations in equity reorganization proceedings that is what this Court held with respect to Chapter X unanimously in opinion by Mr. Justice Douglas some years ago.

And one aspect of the meaning of fair and equitable is broadly stated that creditors of a junior class may not be given something of value at the expense of non-consenting creditors of a senior class so called rule of absolute priority which we believe as equally applicable to the difference between the Government’s statutory right to full payment and the claims of creditors who do not have such a right as it is to the classes of creditors to which it has been applied by this Court.

But whether or not, the decision below actually violates the fair and equitable provisions of Chapter X.

Those provisions surely do not justify the refusal of the courts below to afford the Governments the rights specifically granted by Sections 3466 and 199.

I'd like to reserve the balance of my time please.

Chief Justice Warren E. Burger: Mr. Beck.

Argument of Sigmund J. Beck

Mr. Sigmund J. Beck: Mr. Chief Justice, may it please the Court.

It's always been my view that all cases ought to be viewed in the light of their facts and certainly it's true in this instance in an equitable proceedings.

The facts are more fully elaborated in our brief but there are some highlights and I think should be brought out.

It's true that this case in May of 1954, the original plan was confirmed in 1957 under the terms of that plan without going into details.

The reorganized debtor took over the assets and property from the trustee in June of 1958.

It began operating without a control of the court.

In December of 1961, the trustee filed a petition for final decree.

Hearing was to be held on that in March of 1962.

In February of 1962, there became a change in the directors, the corporation had had financial difficulties and they then entered into a contract of sale with Hennis Freight Lines for $1 million principal and interest included over a period of time of 78 months.

Prior to the hearing on final decree, three creditors who had come into being subsequent to the reorganized debtor taking over the assets asked the court to have the trustee retake the property and assets alleging insolvency.

This took place hearing was held and the court vested the trustee with the assets and property of the debtor corporation.

Investigations are placed to trustee then moved to affirm the contract of sale with Hennis.

The court affirmed that contract in August of 1962.

It took three years for the Interstate Commerce Commission to finally approve the sale.

When it did approve the sale, it entered a restriction upon the rights.

Now, the restriction have entered was a sort of limited restriction.

It did not include a reduction of mileage.

The original contract provided that should the ICC reduced the mileage then Hennis would be entitled to a reduction.

There was dispute between the trustee and Hennis as to what the price should be.

We finally reached an agreement whereby the maximum amount of the sale was to be viewed as $935,000.000 instead of a million and again is inclusive of the interest payable over the same period of time.

Then in addition, the trustee would offer in the plan a 20% compromise to unsecured creditors and any reduction of price would rip down then to Hennis.

Now, that of course are the facts right bearing up to this.

The plan then of course was approved subsequently hearing on approval subsequent hearing on conformation, the plan was confirmed.

The United States --

Justice Byron R. White: The unsecured creditors were to get only 20% --

Mr. Sigmund J. Beck: That is correct.

Justice Byron R. White: -- on their claims or 20% reduction of their claim?

Mr. Sigmund J. Beck: 20% of their claims.

Justice Byron R. White: Total?

Mr. Sigmund J. Beck: Total.

Justice Byron R. White: Uh-huh.

Mr. Sigmund J. Beck: Now, the Government is correct, this is a plan for liquidation.

Now bearing in mind that it's a plan of liquidation something else comes into play here and that is what would happen in the event of liquidation.

I would like to point out two matters before I --

Justice Byron R. White: It's still a -- it’s still of reorganization plan even though it provides for complete liquidation?

Mr. Sigmund J. Beck: It is still a reorganization -- that is correct.

Justice Byron R. White: So, it's judged by the rules of Chapter X of bankruptcy?

Mr. Sigmund J. Beck: No question about.

It is our view however Mr. Justice White that in valuing the assets in this case, we obviously cannot value the assets on the basis of a growing concern but only on the basis of liquidation the value of the assets which is being transferred.

Justice Byron R. White: Or should (Inaudible)

Mr. Sigmund J. Beck: No.

The Government takes its view point but they are entitled to absolute priority of the 3466.

We don't understand what they mean by absolute priority, frankly.

Absolute priority is set forth in the Case case -- Case against Los Angeles Lumber has to do with the relative priorities of the senior creditors.

We contend that the priority granted by -- to the United States is incorporated in Chapter X, in Section 199 and that is the priority that they get.

Now, we never contend that they are not entitled to priority.

They are.

We contend that they're getting it.

Now, we contend that the major question here is whether or not Section 216 (7) is applicable to the United States.

Justice Byron R. White: Well, do you -- let me ask you.

Do you think the United -- that a plan reorganization could take this particular claim of the United States and provide that it be paid in full 10 years from the date of conformation of the plan.

No payments prior to that time and all other unsecured creditors are paid in full at the time of conformation?

Mr. Sigmund J. Beck: No, I do not think so.

Justice Byron R. White: Why not?

Mr. Sigmund J. Beck: Because I don't think in that particular point that would be fair and equitable because at that particular point you would be using money which rightfully belongs to a senior creditor for the benefit of a junior creditor.

Justice Byron R. White: Would you think then that fair -- that fairness and equitable -- fair and equity applied to be fair and equitable and not really recognized in full or priority?

Mr. Sigmund J. Beck: I don't think that's quite true.

Well, I think it must recognize in full a priority and I think this plan does recognize in full a priority.

Justice Byron R. White: Well, there's available cash it’s paid to junior creditors and not paid to a senior creditor.

Mr. Sigmund J. Beck: That is not quite true.

The available cash that's available comes in on installments.

There will be available cash.

Justice Byron R. White: Well, at the first distribution there is $18,000.00 paid to -- for miscellaneous taxes and $14,000.00 paid for another tax claim and certain damages for cargo loss.

They have larger amounts of money are paid out that are available and not paid to the senior creditor.

Mr. Sigmund J. Beck: Well, let me put it this way then.

I don't believe that the senior creditor is any more senior in this particular program than the other tax claimants though the wage claimant and remember that in this particular case it is not just the United States that is being deferred there are three other tax creditors that are also being deferred and they are being protected by the asset, by the fund which has been set aside.

Justice Byron R. White: Where is the priority in the statute for Ohio use taxes?

Mr. Sigmund J. Beck: There is no priority in the statute.

In this particular point, I would say that in my view we have to go on what the Congress has enacted and it would appear --

Justice Byron R. White: So the United States tax claims is senior to this Ohio use tax claim?

Mr. Sigmund J. Beck: In a straight Chapter X, I would say yes.

I would not disagree.

Justice Byron R. White: Wasn't this in Chapter X?

Mr. Sigmund J. Beck: Yes, but I think we must view in the light of liquidation and what the bankruptcy priorities would be because what the alternative to this is, is the bankruptcy.

Justice Byron R. White: Well, so you're -- you're really saying that the priority rules and the rules of reorganization shouldn’t apply to this case?

Mr. Sigmund J. Beck: I am saying that the rules of reorganization are equitable rules and they are flexible and that this Court has decided time and again that the rules in equity proceedings must be flexible depending upon the type of situation and I think we have such a situation here.

Chief Justice Warren E. Burger: What do you think about the holdings in the Case opinion and in Consolidated Rock?

Mr. Sigmund J. Beck: I think that we follow them.

I think there is no question --

Chief Justice Warren E. Burger: I noticed that -- unless I missed it in the Court of Appeals’ opinion they didn't refer to them or cite them.

Did I miss them?

Did I overlook them?

But don't stop now.

Did you have a recollection of that or did you not?

Mr. Sigmund J. Beck: My recollection is I don't recall whether they cited the case in them or not.

I didn't think --

Chief Justice Warren E. Burger: They cited four or five case but they didn't mention either of those if I read it correctly.

I was a little puzzled by that?

Mr. Sigmund J. Beck: Well, I can't answer that.

We've cited it.

We think we followed and we believe that this actually fits the Case against Los Angeles.

Dictum or even not dictum really is the policy and that is equity proceedings in Chapter X reorganizations must be governed by flexible rules.

Chief Justice Warren E. Burger: But even if the Court of Appeals thought they were following these cases which would certainly be [Sneezes] that’s curious they don't think to cite them.

Mr. Sigmund J. Beck: I can't answer of course for the judges of Court of Appeals.

Chief Justice Warren E. Burger: You might -- even though your lunch hour is short you might check that out to see if I missed something.

Mr. Sigmund J. Beck: I'll be happy to do that.

With your honest permission, I see we have got about 30 seconds left and I will defer my chance until the opening of the recess.

Chief Justice Warren E. Burger: Very well.

[Recess]

Chief Justice Warren E. Burger: Mr. Beck.

Mr. Sigmund J. Beck: Mr. Chief Justice, you asked before the recess as to the Circuit Court's opinion with respect to this case.

In looking at it, the only reason that I can believe that they did not cite the case or consolidated proceedings was that they based their decision one, on the grounds of 3466 did not apply at Section 199, 216 (7), and 221 are the provisions of Chapter X which apply.

And in talking in terms of even the absolute priority rule, their view was written on page 79 of the appendix in which they stated that in the case at bar, the approved plan contemplates that the United States will be paid in full.

Going on further they cite we hold that the trial court did not urge in permitting lesser ranking creditors to receive payment simultaneously.

Under the plan, the Government does not surrender its right to full payment.

Now, nowhere in the Act in fact nowhere can we find that the Government or anyone else is entitled to cash payment in a Chapter X proceeding.

I think perhaps, it best can be shown as to why we think that the absolute priority rule --

Justice Byron R. White: But that isn't whether they're entitled to cash payment may not be the question is whether they're entitled to payment before a junior creditor?

Mr. Sigmund J. Beck: I don't believe there is any place in the Act which says they must be paid before a junior creditor.

Justice Byron R. White: Well, is the United States a senior creditor or isn't it?

Mr. Sigmund J. Beck: I would state in my view whether the United States is a senior creditor or a junior creditor.

They are not entitled to get paid before any other creditors receive anything.

They are entitled to be assured of satisfaction and ensured of their payment and this is done in this instance.

Justice Byron R. White: And you must take that position I -- by thinking the way (Voice Overlap)?

Mr. Sigmund J. Beck: Oh!

Yes, I do.

Justice Byron R. White: Yes.

Mr. Sigmund J. Beck: I don't have any qualms about taking that.

Justice Byron R. White: That a senior creditor may be postponed in payment for 10 years as long as he's assured -- he’s being paid but junior creditors can be paid immediately?

Mr. Sigmund J. Beck: No, junior creditors may not take something from the senior creditor.

But in this case, they're not taking anything from the senior creditor.

In fact, they are giving something up and that's what I think we have to show.

Justice Byron R. White: Well, let's just take the case where a senior creditor is provided for in the plan by a promise and security that he'll be paid for full 10 years in the date of conformation of the plan.

Mr. Sigmund J. Beck: Yes.

Justice Byron R. White: And junior creditors are paid in full in cash upon the date of conformation?

Mr. Sigmund J. Beck: I'm assuming now we have valued correctly and that they are entitled to that payment.

Justice Byron R. White: Apparently.

Mr. Sigmund J. Beck: I would say I find nothing wrong in terms of that.

There were other factors have to be considered as to other reasons for equitableness.

It's just not the question of whether they're going to be paid.

It's a question of how it's going to be.

How the security is fashion?

How it's going to be paid out?

And that fact that the creditors are paid out in full --

Justice Byron R. White: Well, the senior creditor doesn’t question in my example the fact that he will be paid in 10 years.

Mr. Sigmund J. Beck: Then I say it's --

Justice Byron R. White: As I agree, all will be paid, there's plenty of security there but he says, I want my money now before these junior creditors get it.

Mr. Sigmund J. Beck: I don’t think he's entitled to it.

Justice Byron R. White: Uh-huh.

You have to take that position.

Mr. Sigmund J. Beck: I think I'm correct in view of all the other cases.

Chief Justice Warren E. Burger: Well, if that isn't your position, you are in difficulty aren't you?

There is not alternative position for you to take.

Mr. Sigmund J. Beck: No, I wouldn't say that necessarily but I will stick by that position.

Chief Justice Warren E. Burger: Well, another thing isn't it possible that taking Justice White's hypothetical case that the payment out to all the unsecured general creditors in full at the outset has at least the potential for so undermining the position of the debtor that they might never get to paying the United States or the deferred creditors at the end of the line.

Mr. Sigmund J. Beck: I agree.

I agree, that's why you cannot take it out of context.

Chief Justice Warren E. Burger: Well, isn’t that why the priority was granted to the United States for tax purposes?

Mr. Sigmund J. Beck: No, I think that's not the historical reason to bear in mind.

The historical reason for the priority at least 3466 was the right of the sovereign to see to it that its taxes were obtained in order for the benefit of everybody.

Chief Justice Warren E. Burger: Well, isn't that just what I have said?

I thought I said it.

Mr. Sigmund J. Beck: Well, I must have misunderstood.

Chief Justice Warren E. Burger: (Voice Overlap) priority to see that the United States is paid.

Mr. Sigmund J. Beck: Yes and there's nothing in this case that says they won't be nor other cases where I can see where solvency is at issue.

Now, any true reorganization involving that situation that Mr. Justice White contemplates would necessarily have to have a solvent corporation coming out or the senior creditor would be jeopardized.

Let me indicate to you the practicalities of this and why I say this is true in this instance and I can think of many others where it might not be.

This is the plan.

The plan provides for a total payout of $925,600.00 under the plan, that's the total cost.

No one disagrees that the administration claims are entitled to be paid first.

There is some disagreement as to the why do the wages should be paid first in a true Chapter X.

There is no such quarrel in a straight paragraphs.

This is the United States claim for $375,000.00.

These are the other form or taxing authority, these three class three, four and five received are in the same position as the United States.

The first distribution indicates what happens.

The United States receives $37,500.00 or 10%.

Indiana then the Broward County and Ohio also received their 10%.

The miscellaneous taxes incidentally some 30 other taxing authorities received this $14,000.00 or 100%.

Thus, these two which would ordinarily in bankruptcy at least have the same established priority or out in the way in order to solve the problem.

Chief Justice Warren E. Burger: But that last item 100% tax claim is to just to get rid of the cats and dogs?

Mr. Sigmund J. Beck: That's correct, but in bankruptcy that they entitle to pro rate with the United States.

Now, these are all the general claims and they're receiving 20%.

It will take under the plan.

This is how it will go, at the end of 54 equal monthly payments the United States together with the other three will have receive 72.3% of their debt.

And at the end of the six and a half years, I suppose they have received the whole 100%.

The question is whether or not the value was there.

I will come to it in a minute.

What I would like at this particular point to show the other chart and what would happen in the alternative in the bankruptcy.

Justice Hugo L. Black: Before you leave that chart, may I ask you one question.

Is it the general creditors they're getting 20% and the other is getting 10%?

Mr. Sigmund J. Beck: At the initial distribution.

Justice Hugo L. Black: Why is that?

Mr. Sigmund J. Beck: Because Your Honor the 20% is a compromise of their claims as I will show in liquidation.

They would be entitled to anywhere from 26% to 36% depending upon the cost of administration in the straight bankruptcy.

Justice Hugo L. Black: For settlement in full of their claims?

Mr. Sigmund J. Beck: That is correct.

Justice Potter Stewart: And that's all they ever get?

Mr. Sigmund J. Beck: That's all they ever get.

Justice Potter Stewart: That's the end of the line for them?

Mr. Sigmund J. Beck: That's the end of the line.

Justice Potter Stewart: Whereas all the others ultimately you say get a 100%.

Mr. Sigmund J. Beck: Get 100%.

Justice Hugo L. Black: Get 100%?

Mr. Sigmund J. Beck: Yes sir, everybody else receives 100% except the creditors.

The stockholders of course are wipeout.

Chief Justice Warren E. Burger: That is if the company is still in business at the --

Mr. Sigmund J. Beck: Well, let me put it at this way.

There is no question in so far as the record is concerned as to the capability of Hennis to continue to pay it.

The testimony in the court indicates not only that the asset itself has increased in value.

Remember, that the asset which is being sold to Hennis is still belonging to those four creditors under a general mortgage, a security agreement.

And their addition to which Hennis is shown by the record is continually making a profit and it continues to grow.

Now, here is the alternative to the plan because there is no question that in so far as the sale of this asset is concerned I cannot foresee how the District Court is going to go back on the sale that took so long to be approved.

Here's what happens in bankruptcy.

This is the order of priority.

The administration cost $60,000.00 again 100%, $15,000.00 for the wages a 100%.

Remember now that the United States on the bankruptcy shares equally with the remainder of the taxing authorities.

They therefore, will receive at the initial distribution 42.5% nothing gets paid to the general creditors.

At the end of January 1975, in other words about four and a half years, the United States then gets paid in full.

So it takes four and a half years under bankruptcy for the United States and the other taxing authorities to be paid in full.

At that point, the general creditors then have 30.04% which will be distributed to them in the remaining two years.

At that point, that's what they're giving up.

If the administration expenses go up to a maximum in our brief of $90,000.00 and we don’t anticipate it.

That would indicate they still get 26%.

Chief Justice Warren E. Burger: But counsel, if the United States is right on their argument about the priorities, then these matters become irrelevant because the wisdom of their challenging the plan is not for us if indeed there is a priority.

Mr. Sigmund J. Beck: But I contend that even with the priority they are still bound by Section 216 (7) of the Act which indicates that a dissenting creditor can be satisfied by various means and in this case they are satisfied by two means.

One, the sale of the property has been sold with their rights attaching to it and in this case the United States does not have a specific lien against it.

Chief Justice Warren E. Burger: But there you're arguing the wisdom of it again?

Mr. Sigmund J. Beck: No, I'm talking of terms of 216 (7) and I'm talking in terms of 216 (7) which is pointed in the appendix to our brief.

We're talking in terms any plan of reorganization under this Chapter shall include in respect to creditors generally or some class of them means or provisions for overruling or modifying their rights.

This 216 was placed in there under Chapter X for the very reason that we're here, a dissenting class of creditors could not insist upon being paid out in cash as the all in equity receiverships require.

Now, under the all equity receivership there was no way for this to happen because the senior creditors had to be paid out in cash if they insisted.

We contend that that's what 216 (7) was for and we also believe that there is nothing that excludes the United States as a claimant from the application of 216.

Now, this is where we disagree with the Government and we contend that this is true with in other cases and other security cases where they are been secured creditors on a particular piece of property.

There hasn't been any question that other claimants could get paid and if the security or secured creditor’s rights would be altered in one of the many ways of 216 (7).

Now, I think the big question here is the interest question because there, we're talking in terms of a question that Mr. Justice Stewart asked.

Are they getting a discounted value?

I contend they are not and the reason I'm contending they are not is because post petition interest is not available to tax claims.

Justice Potter Stewart: That really isn't the point, is it?

Mr. Sigmund J. Beck: Well, I think it is.

Well, I think --

Justice Potter Stewart: Do you concede that they're entitled to full payment?

Mr. Sigmund J. Beck: I do.

Justice Potter Stewart: And full payment of $375,000.00 now is not made by paying installments that add up -- that arithmetically add up to that sum over a period of many years, that’s not full payment.

Mr. Sigmund J. Beck: Well, if Justice will allow me I would say this; I think the question is one of substance not a form.

If we were to continue these proceedings and begin to payout as the money has come in then the United States will not receive interest and it will receive its full principle as we go along.

There is nothing as a matter of fact even in these first seven chapters of the Bankruptcy Act which provide that the United States must be paid before anyone else.

It provides that there must provisions made for the payment of the United States.

Now, that to me is the real crux of it when we’re talking in terms of substance or form.

I would go further of course and that is this; the Government insists that 3466 applies.

The Circuit Court held it did not.

I am convinced that 3466 does not apply in Chapter X proceedings.

I believe that Section 199 provides the priority that the legislature granted the United States.

They indicated that this was to make certain of the United States was going to be paid its taxes and custom duties and I just don’t think that that's the question.

Now, I don't even believe that there's a conflict between U.S. against Andersen and this case.

I think that the Court stated the difference and that was in the United States against Andersen case.

They were talking about non-tax debts.

We're not talking about non-tax debts here.

We're talking about the priority granted by 199 because all of these taxes.

I think the question of the interest is important only from one reason if I am correct that just thought of these proceedings and continuing on, there's only one step in the way than the Saper case applies and the Edens case applies and the Government is not going to be entitled to the interest on its money.

And for that reason, I contend that it isn't discount and true one more thing.

There isn't any question that if interest has to be paid the United States then it has to come out of the pockets of the general creditors.

Now, that to me is the real crux of it here.

If there are no further questions from the Court, I will rest.

Chief Justice Warren E. Burger: Thank you Mr. Beck.

Do you have any thing further counsel?

Rebuttal of Lawrence G. Wallace

Mr. Lawrence G. Wallace: I would just like to make two brief points, Your Honor.

In the first place, it seems apparent to us from counsel's own chart that somebody is taking something away from the United States in this case compared to what we would have had in a liquidated distribution where the initial payment would have been $160,000.00.

Now, it’s $37,500.00.

It's not fair and equitable under established principles for the priority claimant to have to suffer the expense of giving something of value to claimants with less priority against its will.

Justice Byron R. White: It rather begs the question, doesn’t it?

I mean, that you assume as the result must be exactly the same in Chapter X is it isn’t straight bankruptcy and that is the question to this case.

Mr. Lawrence G. Wallace: Well, this is not my assumption.

The contention is being put by the respondent that this is the appropriate comparison.

I wish to point out also that depending on the cost of administration perhaps the unsecured creditors would in fact eventually get more but then that some really should be discounted by the period of waiting for it in addition to taking into account the risk that it will not materialize which would be born by unsecured creditors in that situation.

Now, this Court has recognized in a recent opinion, Mr. Justice White’s Protective Committee against Andersen that in Chapter X there is authority in the Secretary of the Treasure to bargain to compromise and that bargain and compromise among claimants place a very important role in accomplishing the objects of Section 10.

And while it may seem that in this case we are arguing for a rigid rule of priority.

The fact is that it is the priority that gives the Secretary to bargaining power to induce others to enter into these compromises and accomplish the objectives.

We did bargain previously and accept the plan in 1957 in this very case which shared our rights with others.

Thank you.

Chief Justice Warren E. Burger: I don't know whether this record contains it but is there any indication of what the discounted value of $375,000.00 paid over that basis.

I suppose it's somewhere 7 years somewhere on $225,000.00 at 6%.

So, in effect, the Government is saying to us I take it that as a matter of judgment being aside of priority judging the equitable aspect of the plan.

The Government's preference is to get $60,000.00 now then $225,000.00 over period of seven years with the attendant risks that they might not get all of it

Mr. Lawrence G. Wallace: That is correct sir.

Our own contention would have been that we should be paid now what was being paid under the plan that we have the right to be paid what was being under the plan to the junior creditors rather than this particular comparison.

We would look at the distribution as being made under the plan and certain of those we had a right too if we insisted on it.

Chief Justice Warren E. Burger: Suppose it's not relevant here but from what you said before I take it that some plan less than the distribution under bankruptcy but more than the one offered might have been acquiesced by the Government.

Mr. Lawrence G. Wallace: There is the authority to do that.

We did previously acquiescence such a plan 1957 in this case.

At that time, that plan had rehabilitative purposes and that is a factor in our acquiescence.

Chief Justice Warren E. Burger: Thank you Mr. Wallace.

Justice Hugo L. Black: Counsel, the other counsel stated to me that payment to thereto other creditors at the first line was the payment in full but it looks like over the last line it was a not a payment in full, what is that?

Justice Potter Stewart: That was the other chart, Mr. Counsel.

Mr. Lawrence G. Wallace: In the other chart, I think his contention was that eventually there would be payment in full even though the initial payment was only 10%.

His contention is that our right is satisfied so long as the Government will eventually be paid 100% by the end of the 78 months.

Chief Justice Warren E. Burger: 100% without interest?

Mr. Lawrence G. Wallace: Without interest, I think that was the point he was making when he said we would get 100%.

Justice Potter Stewart: And that the other creditors get 20% now and that's all they ever got under the plan?

Mr. Lawrence G. Wallace: That was the contrast he was trying so that even though initially under the plan, we get only 10% compared to their 20%.

We would get the additional payments.

Justice Hugo L. Black: I don't understand still then.

You say that that's all the creditors will ever get?

Mr. Lawrence G. Wallace: The general unsecured creditors well, this is not the plan.

This is the --

Justice Hugo L. Black: Yes, I understand it but what is that figure over here for?

Mr. Lawrence G. Wallace: This is the hypothetical figure that counsel suggest as what the -- are general unsecured creditors would eventually get if these were not at Chapter X proceeding but an ordinarily liquidation.

Justice Hugo L. Black: Yes.

Chief Justice Warren E. Burger: Thank you Mr. Wallace.

Thank you Mr. Beck.

The case is submitted.

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