Warren E. Burger: Mr. Derfner, I think you may proceed with a reduced audience here.
Armand Derfner: Thank you. Mr. Chief Justice, and may it please the Court: This case involves a school board election in Hampton County, South Carolina, in particular, a special election held in March 1983 without the preclearance that we think is required under Section 5 of the Voting Rights Act. Hampton County is a small, rural county in the lower part of the state, just across the river from the State of Georgia. It is approximately half black and half white. It is divided into two school districts. District 1 in the north is pretty well integrated, well financed because of a good tax base, including some industrial area, and has generally been fairly successful. District 2 in the south is mostly black, a very poor school district, suffering largely from a very poor tax base. These disparities between the two school districts have produced considerable political controversy in the county, especially controversy between supporters of a strong countywide board of education who have been mostly black, and those supporters of strong autonomous district boards who have been mostly whites, especially in the northern part of the county. In 1982 this controversy culminated in the General Assembly's passing Act 549. Act 549 abolished the county board and changed the district boards from appointed boards to elected district boards. It provided that the elections for the district boards would be held in November along with the general elections, and it also provided that the first filing, that is, for the elections in 1982, would be conducted in August, on specified dates between August 16 and 31. For reasons that will probably become clear, preclearance of this statute, which was passed in the spring of 1982, was not obtained until after the November election date, that is, until mid-November 1982. Because preclearance had not been obtained, the election did not go forward. However, despite the absence of preclearance, the Appellees, the election commission, had gone ahead with a filing period in August of 1982. After preclearance was obtained, in the middle of November, the election commission then set about to set a special election. They did so selecting a date in March 1983 without preclearing that date, and they also then selected a filing period also without preclearance. The filing period happened to be the same dates in August of 1982 that they had previously had the previous year at a time when the statute had not been precleared. In fact, that filing period was enforced in 1983 by turning away several candidates, including one of the plaintiffs, who appeared after the announcement of the March election and wanted to run in that election. Those people were turned away. This suit, therefore, was brought to stop the special election in March, chiefly because there had been no preclearance of the election date with filing period. The District Court upheld the Appellees in both the setting of the special election without preclearance, and the setting of the filing period without preclearance on the grounds essentially that election dates and filing periods are in effect not covered by Section 5 because they are ministerial, administrative, or things of that sort, and in the alternative, the District Court held that when the department had cleared the statute at 549 in November, that that clearance was essentially blanket approval of all that had gone before as well as all that might come afterward, even though at the time of the Department's clearance in November it was not even known whether or when there would be a special election or what filing arrangements would be made.
William H. Rehnquist: It was at least known then, though, that there would have to be a special election, wasn't it?
Armand Derfner: It was known that... it would have been known that if the county, if the state wanted to proceed with the enforcement of Act 549, they would have to have an election at some point. Whether they were going to have a special election or wait until the following November period in 1984, that wasn't known.
William H. Rehnquist: Well, do you think it was very likely they would wait two years?
Armand Derfner: I don't know. I don't think there's any basis for having any idea what was going to happen. There were people who had been elected because of a complicated procedural situation, and there were people there running the school systems who had been duly elected. Before I leave the facts, I would like to address briefly the question of what happened just before the preclearance because the date may be puzzling. The Act 549 was passed in April of 1982. It was not, however, submitted for preclearance for more than two months, for approximately two and a half months, in June. It was then, an answer was due in August, and at that time the Justice Department objected to Act 549 on the grounds that the abolition of the county board would dilute the votes of black voters in their attempts to exercise political influence over schools in Hampton County. A petition for reconsideration was made, and in November the Department withdrew its objection. That's when preclearance was first obtained. It withdrew its objection because it read state law to indicate that certain powers didn't reside in the county board. We happen to think that the Department misread the state law in that. That is neither here nor there because obviously we can't complain about the Department's decision. I mention it only to indicate that the objection that the Department had entered was quite a serious one, responding to a serious situation, and that therefore the time that passed before the department had finally precleared it was not simply an accident. The question before this Court then is whether there was any basis for the District Court to make its broad exceptions and in effect to, we believe, to read out of the law this Court's prior holdings and the clear language of the statute. In connection with the setting of a special election date, we think that there could hardly be anything which is more clearly a standard practice or procedure regarding an election. The specific language of the statute seems to cover that. The prior cases of this Court, the consistent practice of the United States Department of Justice, the potential for discrimination that resides in the ability to set an election date with essentially no standards, no guidance, and finally, we think that--
Warren E. Burger: Let me get your reaction.
Armand Derfner: --Yes, Mr. Chief Justice.
Warren E. Burger: In setting the time, what are the factors that could be used for or against? How would the time enter into it? I can see you wouldn't... sometimes time is a factor that the farmers can't come in if they are engaged in harvesting and things of that kind? What would be the factors here?
Armand Derfner: Okay. The question is, I gather you are asking that in what way could the setting of an election date be discriminatory? It could be set so quickly that nonincumbents had no right to campaign. It could be set so far back that other factors intruded. It could be set at a time when migrants... and there are migrants in Hampton County... were there or were not there. It could be set at a time when students were there or not there. And I should remark that in the last two categories, there have been cases in the lower courts, not from South Carolina, which have found election dates to be discriminatory because of those reasons, both cases from Texas, as I recall. So there is a lot of potential for discrimination in the setting of a date, and that is the factor which leads the Voting Rights Act to say that this is something that the Department of Justice ought to consider.
Warren E. Burger: So that a Section 5 inquiry would be a neutral eye cast on that?
Armand Derfner: Yes, although in this case the Section 5 inquiry I would think would also look at the conditions precedent to the election, specifically, what is the filing period? And I would think that the department could have found in this situation that holding a March election without a new filing period would make that election date itself discriminatory. So there are a world of ways. I should say that the Appellees, I think they do not really challenge this view because on page 27 of the Election... I'm sorry, the School Board's brief, they say we agree... they agree, in effect, that an election date set by statute would have to be precleared, and they seek to draw an exception for something which is set by simple administrative decision. I would think that there is certainly no exception, that this Court's cases have dealt with administrative decisions, informal, ad hoc decisions, as well as they have with statutes, and in fact, if anything is more of a danger under the Voting Rights Act, I should think it would be nonstatutory changes. As to the filing period, as to the filing period, I think it is equally clear, in fact, the cases of this Court make it clearer because the very first couple of cases, the Allen case, the Hadnott case, dealt specifically with filing periods. So I think there could hardly be an argument that setting a filing period is not something that has to be covered by Section 5. The Appellees say, though, following the District Court, that in this case the Attorney General did preclear the filing period because when he sent his letter in November of 1982, that letter precleared Act 549 which had an August filing period, and they said that's all we were doing, we were putting that same filing period back-- But the Attorney General says that he didn't preclear that filing period; he says that he precleared an August filing period for a November election, and I think that the Attorney General's view, first of all, is entitled to great weight. Congress has given him great weight. This Court has always accorded his views great weight. Moreover, what the Attorney General says about the inseparability of filing periods and elections makes, it seems to me to make all the sense in the world. If you said that a filing period can exist in the abstract without being tied to an election date, then I suppose we could have a situation, to use an example, of if this Court were to agree with us on the election date and not agree with us on the filing period, we could conceivably go back. The District Court could order a new election in 1985, and the Appellees could come back and say fine, we will still use the 1982 filing period. In addition to the Attorney General's statement with which we agree that the filing period was attached only to the November election, and that's all he precleared, we think there is another reason why the Appellees shouldn't have been able to use the old filing period, and that is that it would be enforcing a filing period or enforcing an act at a time when the act we believe was unenforceable because it had not been precleared. This is a problem that Congress has addressed most clearly in the most recent extension of the act because Congress frankly was fed up, no simpler way to say it than that, was fed up with the numerous instances of premature implementation of unprecleared statutes. The statutory language says unless and until, and that is not what happened here with the filing period. We believe the District Court made some broad exceptions to Section 5 in this case, that it mischaracterized the Attorney General's decision. This is, with all due respect, the third year in a row that this Court has been faced with a case from South Carolina involving much the same situation. Exceptions to Section 5 and mischaracterizations of the Attorney General's decision in the first two cases, Flanding v. Dubose and McCain v. Lybrand, this Court reversed the District Court unanimously. We believe this case is equally clear, and we would ask that the judgment below be reversed.
John Paul Stevens: May I ask just one question?
Armand Derfner: Yes.
John Paul Stevens: Supposing the Attorney General had cleared the Act 549 in October, would you make the same argument?
Armand Derfner: Yes, I think I would, Justice Stevens, because while it is true that there have been a number of instances in which filing periods or other situations have gone forward without somebody suing them, I think the law is clear that an act may not be enforced, and what you have is citizens who read the that Voting Rights Act says nothing can be enforced until it is precleared, and if a citizen is entitled to rely on the law, then I think a citizen should not be forced to the choice of going to file at a time when the law has not been precleared. So if what you are saying is that--
John Paul Stevens: But, see, presumably if that had happened, the Attorney General would have known the filing date, and he was advised that the procedure was followed that you did follow, that you told them to register, to file under both statutes.
Armand Derfner: --We don't know... no, with all due respect, Justice Stevens, there is nothing in the record to show what the Attorney General was advised of in the reconsideration. And I have looked through the Section 5 file in the Justice Department. There is nothing to indicate what the Attorney General knew had or hadn't happened in August. I have to think that the Attorney General is entitled to rely on the law and so that if anything--
John Paul Stevens: Let me change my hypothetical. Supposing he was fully advised, there was adequate advice, and the question was whether he could then approve of an election in November based on filings that had taken place just before the preclearance, and he knew all about what had happened.
Armand Derfner: --I think he shouldn't do that. If he did, then I think what we would have is a statute that is found by the constituted authority of the Attorney General to be nondiscriminatory, but I think we would still have the right to go to the equity court if we filed a lawsuit, as we did here, and say that because there was a procedural violation, we think it is unfair to have gone ahead, and therefore we are entitled to relief. I am not sure if that answers the question.
Sandra Day O'Connor: Oh, it does. Mr. Derfner.
Armand Derfner: Yes, Justice O'Connor.
Sandra Day O'Connor: Was evidence submitted before the District Court about the premature removal of the county superintendent?
Armand Derfner: Justice O'Connor, no. There was an affidavit, and I believe, the affidavit is in the joint appendix. Unfortunately, because of the way the opinion of the District Court addressed it and because of the limited record on that issue, I frankly am bound to believe that that case really isn't appropriate for consideration by this Court at this stage. We would prefer not to pursue the appeal on that issue.
Sandra Day O'Connor: Mm-hmm. Yes. I know the SG takes the position that it was precleared, but the position had just been abolished, and there wasn't any other evidence of some preclearing.
Armand Derfner: What was precleared was the abolition of the position as of this coming June, and so that it in fact, if the Court were to decide the question, it would be moot as of June. What there were... there is an affidavit in the record that indicates that in practice the position was effectively abolished before the time that was precleared, but that's what we didn't adequately--
Sandra Day O'Connor: So what is your suggestion that we do?
Armand Derfner: --My suggestion, frankly, is that we are... I would prefer not to pursue that portion of the appeal at this stage, and if the Court would like, I might even be, if you thought it appropriate, I could dismiss that portion of the appeal. But we don't... we think it is inappropriate to pursue it at this stage based on the record that we have.
Speaker: Thank you.
Armand Derfner: Thank you very much.
Warren E. Burger: Mr. Strauss?
David A. Strauss: Thank you, Mr. Chief Justice, and may it please the Court: Before I turn to the merits of this case, I would like to say a word about why the resolution of the questions presented can have an important effect on the Attorney General's ability to carry out his responsibilities under Section 5 of the Voting Rights Act. The major theme of the Appellees' argument and the District Court's opinion, as I read it, is that the Attorney General can be deemed to have precleared changes implicitly, that is to say, he can be deemed to have cleared them even though he was not aware that he was clearing them, and Even though in this case he did not know of the changes and could not possibly have known about the changes because they had not even teen instituted at the time he issued his preclearance. Now, this argument in one form or another has been made to the Court on several occasions in Allen, in Sheffield County, and jest last term in McCain, and as Mr. Derfner pointed out, it has been repeatedly rejected by the Court. But the point I would like to emphasize is that the practicalities of administering Section 5 make it very important that as the Attorney General's regulations require, covered jurisdictions make a clear statement in their submission of exactly what changes they are seeking to have precleared, and that no changes be deemed precleared except on the basis of such a clear submission. Now, the reason that is important is that as Congress recognized, and as our experience in administering Section 5 has shown, a lot of the threats to equality in voting occur at the level of low visibility nuts and bolts electoral decisions that can only be properly evaluated in a particular local context. For example, the legislative history of the Voting Rights Act mentions a change from paper ballots to voting machines as the kind of change that would have to be precleared, and in Perkins, an early decision, this Court held that a change in voting places had to be precleared. So when the Attorney General is presented with a scheme, he doesn't just decide in the abstract, on the basis of some broad presumption, whether the scheme is discriminatory. He has to look at whether the particular elements of that scheme, in the particular context, will have a discriminatory purpose and effect. And in doing so, of course, he has to rely to a large extent on input from people at the local level who are familiar with the scheme. Now, this whole process just can't operate unless the Attorney General and people in the local community know exactly what changes they are addressing and what problems they are examining in the local context. Here the jurisdiction did not specify the particular elements of the scheme that they now claim were precleared, and in fact, the election date, as I said, hadn't even been set at the time that the Attorney General precleared Act 549. Now, the jurisdiction... the Appellees, that is, point out that when the Attorney General cleared Act 549, the filing period had taken place. As Mr. Derfner said, it is net clear whether the Attorney General was even apprised of that, but even assuming he was, the most the Attorney General can be said to have cleared was the use of that August filing period with a November election. He did not preclear the use of that August filing period with a March special election, which he had no idea was scheduled, and he certainly did not preclear a situation in which local officials could look at the results of the August filing period, see who had filed and who hadn't, and on the basis of that make their decision about whether to use that filing qualification in a special election. The minor theme, it seems to me, of the Appellees' argument in this case is that essentially they did all they could to try to carry out the sudden change in the laws governing school governance in Hampton County, and they oct into a time bind because of confusion at the Attorney General's end, and that time binds like this, they suggest, will be fairly common in the administration of the Act, and some leeway should be allied the districts to deal with them. That I think is completely incorrect. There is no doubt that the Appellees were in a bind, but the reason they got in a bind was that they waited two and a half months after the first enactment of Act 549 before they submitted it at all. And since the Attorney General must act within sixty days, a delay of two and a half months was what put them in the predicament they found themselves in. The second contributing factor to the confusion in this case was the fact that the Attorney General initially interposed an objection. But as Mr. Derfner explained that objection, the interposition of that objection and subsequent withdrawal were not the result of confusion or bureaucratic ineptitude; there was a very serious, very substantial question whether that act was discriminatory, and that was the basis for the initial objection. I have one final point. The Section 5 was, of course, very controversial when the Voting Rights Act was first passed because it was thought by some to intrude unreasonably into state and local government affairs, but our experience suggests that now, almost 20 years later, the covered jurisdictions have accommodated themselves to Section 5 and find it to be an acceptable and minimal burden at most. The Attorney General has issued regulations specifying the form that submissions are to take. The covered jurisdictions know that all changes are submitted. They submit them routinely. The Attorney General acts very promptly, and nearly every change is promptly precleared. Ambiguities in the scope of the preclearance requirement, such as those that are said to exist here, are quite atypical. They are very much the exception and not the rule. But if the Appellees and others... excuse me... are successful in carving out exceptions to this preclearance regime, even though nothing in Section 5 supports the creation of such exceptions, not only would the result be inconsistent with Congress' intent, but in the long run, this disintegrating erosion of particular exceptions, as Justice Cardoza said, would not ever be of particular benefit to the covered jurisdictions because it would inject elements of uncertainty and confusion and litigation into what has become an essentially stable and mutually acceptable state of affairs under Section 5.
Byron R. White: You don't really think it is mutually acceptable, do you?
David A. Strauss: I think for the most part it is, Justice White. I think this is something that at least as far as our experience suggests the covered jurisdictions have adjusted to, and they find it to be very little of an interference anymore.
Lewis F. Powell, Jr.: Mr. Strauss, approximately how many applications for preclearance are now received by the Attorney General per week?
David A. Strauss: I can't do the arithmetic that quickly, Justice Powell.
Lewis F. Powell, Jr.: How many were received last year?
David A. Strauss: There were 8600 in the first six months of this year.
Lewis F. Powell, Jr.: 8600?
David A. Strauss: That's right.
Lewis F. Powell, Jr.: How many is that per working day?
David A. Strauss: That also, that's even a harder arithmetical problem, Justice Powell. 0 [Generallaughter.]
Lewis F. Powell, Jr.: It keeps the Attorney General busy?
David A. Strauss: Well, not all of these reach the Attorney General, or even the Assistant Attorney General in charge of the Civil Rights Division.
Lewis F. Powell, Jr.: The statute says the Attorney General.
David A. Strauss: Well, he has delegated his authority pursuant to the statute to the Assistant Attorney General. This is... this is--
Lewis F. Powell, Jr.: Well, may I ask you just one other question? I haven't given you time to answer my first yet. Is the number increasing or decreasing?
David A. Strauss: --I believe the number is increasing slightly.
Lewis F. Powell, Jr.: That's my impression.
David A. Strauss: Yes, I think that's right. There are differences depending on the rate of reapportionment changes in response to the Census and so on. So I am not sure a secular trend can be identified. Put to the extent it can, they are increasing. My understanding of the procedure for handling submissions, Justice Powell, is that if the staff people in the Justice Department in the Voting... in the Section 5 section of the Civil Rights Division, conclude that a change should be cleared, then that change reaches only the head of that section and does not reach the Assistant Attorney General. But if they are of the view that a change should not be cleared, that an objection should be interposed, then that objection is passed on personally by the Assistant Attorney General, so that his concentration really is on the very small percentage, although not insignificant number, of objections or possible objections.
Warren E. Burger: Mr. Strauss-- --Have you any idea what percentage of the total are pro forma?
David A. Strauss: I don't think any of them are pro forma in the sense that they are given no review.
Warren E. Burger: Well, I didn't mean... a lot f things are pro forma which get a review, but that they are in clear compliance, and they go back. There must be a substantial proportion of them that give no trouble at all at the first level.
David A. Strauss: My impression is that that is so, Mr. Chief Justice, a substantial proportion.
Harry A. Blackmun: Mr. Strauss, would you regard 1984 as an atypical year because this is an election year?
David A. Strauss: No, my impression is that it is not an atypical year.
Harry A. Blackmun: Do you anticipate 8600 more the first six months of '85?
David A. Strauss: We have no reason to think otherwise.
Byron R. White: So 40 a day?
David A. Strauss: Is that right?
Byron R. White: Whatever it is. How much of a staff is devoted to this, do you know?
David A. Strauss: No, I don't know the answer to that. Thank you.
Warren E. Burger: Ms. Ashworth?
Treva G. Ashworth: Mr. Chief Justice, and may it please the Court: The Voting Rights Act requires a county jurisdiction to submit changes before implementing those changes. There is no question but that the Act that created election law changes were submitted to the Justice Department for preclearance. This case arises purely over whether or not the preliminary step of filing, and whether or not an election date which must be postponed because preclearance comes too late to hold it at the time scheduled, must be submitted to the Justice Department for preclearance. The facts of this case involves two acts which were enacted within three weeks of each other which created substantially different governing bodies for the Hampton County School Board. The first act, Act 2... 547, excuse me... made the position for County Board of Education elective. This act was submitted and precleared by the Justice Department. Subsequently, Act 549 was enacted which abolished this board and devolved its powers and duties upon the second two boards of trustees. This Act, as has been pointed out, was not submitted for two and a half months. The reason, I have been told by our office, is because it took that long to gather the information necessary to comply with the requirements as to the information they want submitted with the act. This act was submitted and initially objected by the Justice Department. The Justice Department was requested to withdraw their objection, which they did, on November 19. The problems that are at issue in this case arise purely over the timing of this preclearance of the second act. The second act provides specific, one-time filings of August 16 to 31st, and required an election to be held on November 2. As of August 16, there had been no preclearance or objection from the Justice Department. The county election commission therefore was faced with the implementation of two conflicting acts, the second one, should it become precleared, would abolish the first act and abolish the board established by the first act. To comply and to create a good faith effort, they allowed filing to begin for both offices. This filing, pursuant to the second act, admittedly began before preclearance was received. The District Court found filing to not be a Section 5 violation in that filing did not constitute implementation of an act but merely an administrative or administerial action necessary to accomplish the act's purpose, and not a change from Section 5. The Court further found that even should this be a Section 5 change, it was precleared retroactively when the act was precleared. We would submit that filing is not implementation of an act. It is purely a preliminary step that will be null and void if the act is initially or subsequently... excuse me... subsequently objected to. It is an administrative or administerial step so that orderly elections can proceed. The Justice Department has until recently not objected to these preliminary steps occurring. Two months before filing began in Hampton County the Justice Department allowed filing to begin and include the county offices pursuant to an act which established filing dates before they precleared this one act. In Herron v. Koch, a Federal District Court case, the Justice Department, apparently as late as 1981, urged the Court to allow a primary to continue in the hopes that they would be able to preclear the act before the general election. The Justice Department has also retroactively approved changes that have happened, and this Court has acknowledged the possibility of retroactive approval. The actual implementation of the act, we would submit, would have been to have held the election before preclearance or in violation of an objection, but that did not happen. When the Justice Department interposed an objection, an election was not held pursuant to the second act, but the first act, even though that board would, of course, be abolished by the second act should preclearance come. And seventeen days after the general election, that's exactly what happened, the first board was abolished by an approval of the second act. Following preclearance of the act on November 19, the Election Commission set a March election date for an election to be held now pursuant to the now precleared act. The appellants claim this date should have been precleared. The District Court found that setting an election date and conducting this election was not a change in South Carolina law but an effort comply with the law and the precleared changes. Section 5 has been variously interpreted by this Court as having the effect of suspending, freezing, delaying, or postponing the implementation of an act. Submission of an act to the Justice Department is supposed to be a rapid alternative, a speedy method of enforcement. Setting an election date in this instance is simply an unfreezing of a postponed election. The election date is therefore a substitute election for an election that could not be timely held at the time provided for in the act purely because the act was not precleared timely. If now there is added on an additional requirement of preclearing the date every time approval should come later than the anticipated time for the election, the alternate remedy of a speedy alternative of submission to the Justice Department would never be realized. Certainly we would submit that the filing is not implementation of an act but merely a preliminary step that is null and void should the act be ultimately objected to. Likewise, the election date was simply unfrozen and reset following preclearance of this act. For these reasons, we would urge the District Court be affirmed.
Warren E. Burger: Do you have anything further, Mr. Derfner or Mr. Strauss?
Armand Derfner: I have a point or two. Although I don't think it is the central issue of the case, the issue came up about what the jurisdiction was doing in the two and a half months, and obviously there is no record of that. What there is, what there is a file of, although it is not in the record of this case, is the submission file, which is here on five microfiche cards. It is not in the record. And frankly, there is nothing in here that would take more than a couple of hours to put together. Thank you very much.
Warren E. Burger: Thank you, counsel. The case is submitted.
Speaker: The Honorable Court is now adjourned until Monday the 3rd.


William H. Rehnquist: We'll hear argument first this morning in Number 95-323, United States v. Thomas R. Noland. Mr. Jones.
Kent L. 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.
Sandra Day O'Connor: 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?
Kent L. 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--
Sandra Day O'Connor: Yes, but I took your position basically to be that in a particular case, no equitable subordination absent a showing of inequitable conduct.
Kent L. Jones: --That is correct. That is what the doctrine is designed--
Sandra Day O'Connor: And in theory the Government could engage in such conduct.
Kent L. 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.
David H. Souter: 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?
Kent L. 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.
David H. Souter: 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?
Kent L. 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.
Antonin Scalia: 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?
Kent L. Jones: That is my understanding, yes.
Antonin Scalia: I mean, it's almost like a committee report. The floor leader in both chambers reads exactly the same text. Do you want to--
Kent L. Jones: And in both statements what they say is that this is what existing case law does. Our point is--
Antonin Scalia: --That's a mistake, but--
Kent L. Jones: --Yes.
Antonin Scalia: --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.
Kent L. 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.
Ruth Bader Ginsburg: 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--
Kent L. Jones: Yes.
Ruth Bader Ginsburg: --and I was trying to envision such a case and couldn't come up with one.
Kent L. 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.
David H. Souter: 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.
Kent L. 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.
Antonin Scalia: Mr. Jones, am I correct that every lower court that has confronted this issue has come out the way the court came out here?
Kent L. 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.
Antonin Scalia: 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--
Kent L. 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--
John Paul Stevens: --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.
Kent L. 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--
John Paul Stevens: And did apply in this case.
Kent L. Jones: --And did apply, but I mean... but--
John Paul Stevens: So she didn't read that as requiring creditor misconduct.
Kent L. 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.
John Paul Stevens: Yes.
Kent L. Jones: And we--
John Paul Stevens: She joined the judgment.
Kent L. Jones: --She joined the judgment, and--
John Paul Stevens: And she did not rely on legislative history. She relied just on the text of the statute.
Kent L. Jones: --I didn't understand that she specifically discussed the question of how it applied, she was--
John Paul Stevens: Well--
Kent L. Jones: --addressing the question of whether it applied.
John Paul Stevens: --How did she get to join the judgment if she didn't... you know, if she agreed with you?
Kent L. 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.
John Paul Stevens: But she didn't have to discuss it, because she held that it did apply.
Kent L. Jones: Well, she certainly didn't disagree with anything that the panel--
John Paul Stevens: 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.
Kent L. Jones: --I think that--
John Paul Stevens: That's why I thought she wrote separately.
Kent L. 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.
Stephen G. Breyer: What is your position... all right, everyone seems to agree that principles of equitable subordination apply. Next question, what are those principles?
Kent L. Jones: That's correct.
Stephen G. Breyer: What are those principles?
Kent L. Jones: Those principles--
Stephen G. Breyer: 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.
Kent L. Jones: --I--
Stephen G. Breyer: 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?
Kent L. Jones: --That is a precise statement not only of our position but of this Court's position in the Comstock case.
Stephen G. Breyer: 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.
Kent L. 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--
Stephen G. Breyer: Yes.
Kent L. 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.
William H. Rehnquist: Brought as shareholder as opposed to brought as creditor?
Kent L. 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.
Stephen G. Breyer: Let's assume you're right about it. Credit Industrial?
Kent L. Jones: No, sir, I--
Stephen G. Breyer: Well--
Kent L. Jones: --Stirling Homex is the case we're talking about.
Stephen G. Breyer: --Yes.
Kent L. Jones: The reasoning in Stirling Homex--
Stephen G. Breyer: Stirling Homex.
Kent L. 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--
Stephen G. Breyer: 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.
Kent L. Jones: --Justice Breyer, we--
Stephen G. Breyer: And so there could be a case... I mean, there could be a case. That's the part that's--
Kent L. 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.
Antonin Scalia: --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--
Kent L. Jones: Well, that's--
Antonin Scalia: --and that's how they explained--
Kent L. Jones: --No--
Antonin Scalia: --the lack of any pre code development.
Kent L. 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--
Stephen G. Breyer: The answer to Justice Scalia was that prepetition tax penalties were out of the queue--
Kent L. Jones: --Were not allowed.
Stephen G. Breyer: --the absolute bottom.
Kent L. Jones: They weren't--
Stephen G. Breyer: The postpetition tax penalties were Number 1.
Kent L. Jones: --Number 1.
Stephen G. Breyer: 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.
Kent L. Jones: Here, it's not--
Stephen G. Breyer: Is that... I mean, I'm making work because I'm interested in that aspect of it.
Kent L. 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--
Stephen G. Breyer: 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--
Kent L. Jones: --Oh--
Stephen G. Breyer: --without any mood... room for flexibility, because that would be the effect of it, prepetition.
Kent L. 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.
William H. Rehnquist: Very well, Mr. Jones. Mr. Pikna, we'll hear from you.
Raymond J. 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.
David H. Souter: 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?
Raymond J. 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--
David H. Souter: 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.
Raymond J. 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--
David H. Souter: And Congress considered the nature of the claim when it established the categories, didn't it?
Raymond J. Pikna: --It did, Your Honor.
David H. Souter: I mean, this isn't something that Congress a) overlooked, or b) could not provide for.
Raymond J. 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.
David H. Souter: 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.
Raymond J. 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--
David H. Souter: 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.
Raymond J. 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.
David H. Souter: 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.
Raymond J. 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.
David H. Souter: 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?
Raymond J. Pikna: Your Honor, that would be a much broader statute which would permit the courts to--
David H. Souter: We would be citing Schechter if that had been the case, wouldn't we?
Raymond J. Pikna: --Your Honor, I don't recall which case specifically, but that would permit... that would eliminate the statute at that point.
David H. Souter: 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.
Raymond J. Pikna: Your Honor--
David H. Souter: It seems to me an example of what we both agree would have been improper.
Raymond J. 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.
Ruth Bader Ginsburg: 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?
Raymond J. Pikna: No, Your Honor, we're not urging that position.
Ruth Bader Ginsburg: 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?
Raymond J. 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--
Ruth Bader Ginsburg: 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?
Raymond J. Pikna: --Your Honor--
Ruth Bader Ginsburg: The same thing with a fine, a small fine, the Government--
Raymond J. Pikna: --Those are some of the factors, Your Honor. Those are not the exclusive factors.
William H. Rehnquist: --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?
Raymond J. 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.
William H. Rehnquist: So we'd have different outcomes all over the country, depending on the judgment of individual bankruptcy judges?
Raymond J. 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.
Antonin Scalia: 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.
Raymond J. Pikna: Your Honor--
Antonin Scalia: De minimis non corat lex. It's not an exception at all.
Raymond J. Pikna: --Your Honor--
Antonin Scalia: That applies across the board. But except for that, every time there's a fine you want us to say it is subordinated.
Raymond J. Pikna: --No, Your Honor.
Antonin Scalia: It is the fineness that causes the subordination, isn't that right?
Raymond J. Pikna: Not totally, Your Honor. Your Honor--
Antonin Scalia: What else?
Raymond J. 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.
Ruth Bader Ginsburg: 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.
Raymond J. 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.
Ruth Bader Ginsburg: So what I don't understand on your theory is, in a case where we know there is not enough to go around--
Raymond J. Pikna: Your Honor--
Ruth Bader Ginsburg: --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?
Raymond J. 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.
William H. Rehnquist: Then the court just decides for itself what types of claims are very important and what are less important?
Raymond J. 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.
William H. Rehnquist: 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?
Raymond J. 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--
Antonin Scalia: 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?
Raymond J. Pikna: --Your Honor, we believe that--
Antonin Scalia: Do you think the environment's more important?
Raymond J. Pikna: --Your Honor--
Antonin Scalia: I'm no sure our cases would support that.
Raymond J. Pikna: --Your Honor, I use--
Antonin Scalia: For better or worse.
Raymond J. Pikna: --I understand.
Antonin Scalia: But that's what our cases seem to say. Justice Scalia's opinion certainly wouldn't. [Laughter]
Raymond J. 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.
Stephen G. Breyer: 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?
Raymond J. Pikna: Yes, Your Honor.
Stephen G. Breyer: 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.
Raymond J. 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.
Stephen G. Breyer: 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.
Raymond J. 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.
Antonin Scalia: 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.
Raymond J. Pikna: No, Your Honor, because--
Antonin Scalia: Isn't a fine relating to a nonpayment of tax, isn't it always going to come from the creditors?
Raymond J. 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--
Antonin Scalia: 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?
Raymond J. Pikna: --That's true, Your Honor. The key word--
Antonin Scalia: So--
Raymond J. 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.
Antonin Scalia: --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.
Raymond J. 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--
Ruth Bader Ginsburg: 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.
Raymond J. 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--
Ruth Bader Ginsburg: Yes, but we're not concerned with priorities, are we, at that stage?
Raymond J. 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--
William H. Rehnquist: 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.
Raymond J. 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.
William H. Rehnquist: Well, is there any suggestion in those cases that that sort of a distinction would have been made by those courts?
Raymond J. 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.
Sandra Day O'Connor: 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?
Raymond J. 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.
William H. Rehnquist: Well, misconduct comes in through the language of 510(c), where it says, principles of equitable subordination, doesn't it--
Raymond J. Pikna: Yes, Your Honor.
William H. Rehnquist: --because it was those principles, the misconduct, that had been the dominant theme of those three cases that you referred to.
Raymond J. 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.
William H. Rehnquist: 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.
Raymond J. 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.
William H. Rehnquist: And the statute said that.
Raymond J. Pikna: Yes, Your Honor, it did.
William H. Rehnquist: 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.
Raymond J. 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.
Antonin Scalia: 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.
Raymond J. Pikna: Your Honor--
Antonin Scalia: Which is worthwhile.
Raymond J. Pikna: --Your Honor, it is not the trustees, it is the officers of the corporation.
William H. Rehnquist: Thank you, Mr. Pikna. Your time has expired.
Raymond J. Pikna: Thank you, Your Honor.
William H. Rehnquist: 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?
Kent L. 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--
Anthony M. Kennedy: I take it if you went after the officer, he'd then be just a general unsecured creditor against the corporation.
Kent L. 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?
Anthony M. Kennedy: No. I'm assuming a situation where the officer is solvent. The Government goes after him and gets the tax from him.
Kent L. Jones: Yes.
Anthony M. Kennedy: Does that officer then become a general unsecured creditor against the corporation for having paid the corporate--
Kent L. 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.
Anthony M. Kennedy: --The argument was there's no incentive because the penalty isn't passed through.
Kent L. 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.
Anthony M. Kennedy: 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.
Kent L. Jones: Oh, for the tax penalty.
Anthony M. Kennedy: Yes.
Kent L. Jones: Well, certainly for the... yes, that's correct. For the late payment penalty?
Anthony M. Kennedy: Yes.
Kent L. Jones: For the late payment or the underpayment penalties--
Anthony M. Kennedy: Only the corporation is--
Kent L. 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.
Anthony M. Kennedy: --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.
Kent L. 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.
Stephen G. Breyer: 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.
Kent L. Jones: I may--
Stephen G. Breyer: Now, that's what I'd raised before because I got that somehow out of the briefs. Now, that's what I wanted--
Kent L. 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--
Stephen G. Breyer: --Well, maybe I don't... yes.
Kent L. Jones: --If you're in a Chapter 11--
Stephen G. Breyer: Yes.
Kent L. 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.
Stephen G. Breyer: Right.
Kent L. Jones: In an 11, the court has to recognize it, too.
Stephen G. Breyer: 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.
Kent L. Jones: No, but you can't do that.
Stephen G. Breyer: I have that power, and therefore I don't have to count it against--
Kent L. 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.
Stephen G. Breyer: --Unless they could be equitably subordinated--
Kent L. Jones: Well--
Stephen G. Breyer: --but that's... see, what I'm trying to do is to find--
Kent L. 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--
William H. Rehnquist: Thank you, Mr. Jones.
Kent L. Jones: --Thank you.
William H. Rehnquist: The case is submitted.