Warren E. Burger: Next case on for argument is number 678, Nash against the United States. Mr. Apolinsky' you may proceed whenever you’re ready.
Harold I. Apolinsky: Mr. Chief Justice and may it please the Court. This is an income tax case on the writ of certiorari to the United States Court of Appeals for the Fifth Circuit. The question is whether the balance in a reserve for bad debts maintained by a partnership and stipulated by the parties to be reasonable must be taken into ordinary income or not by the partnership when it incorporates its business under Section 351 of the Internal Review Code. Section 351 providing that no gain or loss will be recognized if property is transferred to a controlled corporation and it’s agreed by the parties that the transfers' the incorporations here are within the purview of Section 351.
Warren E. Burger: What would have happened to this reserve if they have liquidated Mr. Apolinsky?
Harold I. Apolinsky: If the partnership had liquidated --
Warren E. Burger: They just liquidated it would've -- would it have gone into ordinary income then?
Harold I. Apolinsky: No, Your Honor, under the partnership concept, liquidating to the various partners, each would have taken his pro rata part of the receivable with the reserve and it would not have come into the income of the partners.
Warren E. Burger: It wouldn't have entered the transaction at all?
Harold I. Apolinsky: No sir. Because you have come straight through.
Potter Stewart: He should have taken his pro rata part of the receivables plus -- and his pro rata part of the reserve, is that right?
Harold I. Apolinsky: Yes, Mr. Justice Stewart --
Potter Stewart: The partnership probably has to report as an entity, it isn’t a taxable entity basically?
Harold I. Apolinsky: That’s right.
Potter Stewart: It’s a group of individuals?
Harold I. Apolinsky: That's right and in this situation, this partnership operated 10 finance businesses, two in South Carolina and eight in Alabama. It made loans to the public and it used the accrual method of accounting under which it would take into its ordinary income the profit on a loan, the receivable in the year in which the loan was made and the receivable established. It accounted for its bad debts by the use of the reserve method for the bad debts allowed under Section 166 of the Code. Actually, a taxpayer can use either of two methods. It can use the direct charge-off method which allows you to charge against income in the year that the account goes bad or a taxpayer can anticipate its losses as far as specific accounts are concerned and establish a reserve for bad debts and based on its experience, estimate the amount of the accounts receivable which will go bad and charge that amount against income when it establishes its reserve. The reserve is reviewed annually and any additions to the reserve are likewise charged against income as a deduction and they're limited of course to the reasonableness of the reserve which in our situation is stipulated. On May 31, 1960, the partnership had about approximately $487,000.00 worth of receivables in these eight Alabama offices and approximately a $73,000.00 balance in its reserve for bad debts applicable to those eight offices. It then on June 1 transferred to eight separate corporations for it attained a benefit under the Alabama loan licensing statutes by have eight separate corporate offices that could lend money and it transferred to those eight offices the receivables applicable to the eight corporations. The furniture and fixtures applicable to the eight corporations, cash applicable to the eight corporations and liabilities taking back stock and security solely for the net value transferred to the partnership to the corporations. It continued the same businesses in the eight corporations and what it did, the corporations then set up the reserve, they had an opening balance which they reflected in their reserve for bad debts in total and we’re dealing here in both briefs with the total concept. The total amount of the reserves reflected in the opening balance sheets of these eight corporations was $73,000.00. In 1962, the Commission of Internal Revenue issued his Revenue Ruling 62-128 where he first expressed the position that the reserve for which being maintained by a partnership would be taken back into the ordinary income of the partnership when it transfers its assets even though such transfer being under the tax free rules generally of Section 351 and thereafter, the Commissioner's agent examined the returns of the partnership which made a determination that the $73,000.00 of reserve should be restored to the ordinary income of the partnership in its year which ended in 1961. This increased the distributive share of income to the partners and therefore the partner’s income increased in 1961. They paid their tax, filed a claim for refund and filed suit in District Court, the District Court upholding the taxpayer's position that the reserve would not be restored to income relying on the Ninth Circuit Court of Appeals case of the Estate of Heinz Schmidt. The Government’s appeal to the Fifth Circuit where the Fifth Circuit said they disagreed with the Ninth Circuit and agreed with the Tax Court and sustained the Commissioner's position and hence this writ of certiorari. We maintain that the clear legislative history of Section 351 precludes this end rule, this creation of income to the partnership when it incorporates its business under that Section. It came into the law. Section 351 came into the law in 1921 at the same time Congress first enacted the reorganization provisions and also enacted the tax free exchanges of real estate provisions. And the Senate's Finance Committee in its report in 1921 said that they had been -- they recounted that the prior law, under the prior law before 1921, this would have been a taxable event, a reorganization or the organization of a corporation as we have here would be in a taxable event before 1921 and they said there had been no provision which had more seriously interfered with necessary business readjustments than these prior laws and therefore they put in these tax free exchange provisions. They said they specifically sought to eliminate technical constructions which are economically unsound and interfered with necessary business readjustments. In 1924, Congress considered the carryover basis sections of the code which are the corollary to tax-free exchanges, the corporation taking a carryover basis and they had an opportunity to express their views again, the House Ways and Means Committee as to the purpose of the predecessor of Section 351 of the Code where they said that this Section 351 and the reorganization sections were not intended to be exemptions from taxation. That they were recognitions that these changes were merely changes in form and not in substance and would not be given to recognition of income, that any recognition of income would be postponed until there was an actual sale or a taxable exchange.
Potter Stewart: What would be the, under your theory your client's partners should not have added back into their income the amount there before set up as a reserve for bad debt and what would be the result vis-à-vis the newly created corporation?
Harold I. Apolinsky: We would say the result is what did happen in our situation. The corporation set up a reserve for bad debts. It had a balance --
Potter Stewart: Which was identical?
Harold I. Apolinsky: Identical.
Potter Stewart: In amount, I mean.
Harold I. Apolinsky: It's open. In amount. It's had $73,000.00 in it. Now, that amount was not charged against corporate income for the first year as a reduction of income which is the Government’s position. The Government says take it into the income of the partnership and give the corporation a new deduction in its first year for $73,000.00.
Potter Stewart: And you say, don’t take it into the income of the partnership and don't give the corporation a deduction on its first year?
Harold I. Apolinsky: Yes, Mr. Justice.
Potter Stewart: And I suppose also the basis of the stock received by the partners in return for the transfer of the partnership assets would be reduced, it would be a net, it would be the amount of assets represented by the accounts receivable less the reserve would it not?
Harold I. Apolinsky: That’s right.
Potter Stewart: It will be a net figure.
Harold I. Apolinsky: The net figure.
Potter Stewart: And that -- so the basis in the hands -- of the stock in the hands of the partners would be lowered, therefore on any subsequent sale or taxable transfer, their capital gain would be higher, is that right?
Harold I. Apolinsky: That's right.
Potter Stewart: Is that what would follow?
Harold I. Apolinsky: Yes.
Potter Stewart: In your theory.
Harold I. Apolinsky: Yes, Mr. Justice Stewart.
Byron R. White: And the corporation would never get a deduction.
Harold I. Apolinsky: For that $73,000.00.
Byron R. White: For that $73,000.00 in the first year or any other time?
Harold I. Apolinsky: Or any other year.
Potter Stewart: Because on this year, they haven’t paid anything for that $73,000.00 worth of accounts receivable.
Harold I. Apolinsky: That's right, that it was just a mere change in form. The Government in their brief cast this poll of an expected double deduction that the Code is to be construed to prevent double deductions. We took no double deduction. We set it up on the corporate books without deducting against corporate income. Our taxpayer considers his stock to be worth net. The section’s both the reserve for bad debts came into the Section coincidentally in 1921. The same year that the predecessor of our tax-free organization Section 351 came in, we have found no case, nor has the Government cited any case since 1921 where any corporation has so a second deduction or any taxpayer has tried to take a second deduction.
Byron R. White: I take it the Government would take the same position as the corporation that paid the partner's cash for the accounts receivable in their face amount less the amount of the reserve.
Harold I. Apolinsky: If they pay the partner's cash in the face amount?
Byron R. White: If they just bought -- if they bought the accounts receivable, paid cash in the face amount less the $73,000.00.
Harold I. Apolinsky: They would take -- well, that’s a difficult question to immediately answer for this reason, they would say that if you had a non -- if you had a taxable sale of the receivables at net, face amount less the reserve that under -- that there is no income because they seek to offset a return of the reserve to income by a loss on the receivables. Now if you had, they say however in our situation, this is a tax-free exchange which precludes recognition of gain or loss and therefore there is no loss that can be recognized to the transferring partners to offset the return of the reserve to income so that their position in a taxable exchange would be that there would be no income but if we had a transfer of the receivables in exchange for cash in a nontaxable environment, then their answer would probably be the same.
Byron R. White: Do you think it’s different then if it's a corporation and the partners had in valuing the assets to be transferred and specifically allocated a value to the accounts receivable, the face amount less the amount of the reserve?
Harold I. Apolinsky: Their result would not be any different.
Byron R. White: Even though the corporation didn't purport to pay you any more than the net amount?
Harold I. Apolinsky: Had the corporation instead of turning up a reserve simply established on its books receivables at the net amount of $414,000.00, the net amount, their answer would have been the same.
Byron R. White: They still think you have realized income?
Harold I. Apolinsky: They still think we realized income. Now, they cite which I think is a good case and I wish I had cited it, the Skelly Oil opinion where they say that the court will not permit any double deduction and I believe that with that decision, it would be inconceivable that if a corporation tried to come into court later on, or a taxpayer tried to come into court to get a second deduction that that would ever be allowed.
Warren E. Burger: I might test your position from another angle. Suppose, this is a large hypothetical because it wouldn't happen, but suppose after the corporate reorganization was completed, the corporation was taken over, someone came along and offered to buy all of the receivables of the new corporation which had just been transferred to it for 100 cents on the dollar, then what would happen to the reserve?
Harold I. Apolinsky: This is what would happen, Mr. Justice Burger. The corporation would then have recovered the full amount of its receivables.
Warren E. Burger: Would it be charged all of the bad debt loss, the reserve would go into income then wouldn’t it?
Harold I. Apolinsky: Would go into income by the corporation.
Warren E. Burger: And this hasn't happened and never will happen unless some fairy godmother comes along and buys these at 100 cents on the dollar, isn’t that right?
Harold I. Apolinsky: That's right, and if that happened quite soon after the incorporation, I think the Commissioner would come in and say the reserve wasn't reasonable in amount and would probably seek to have the partnership pay some income tax on it because if the reserve is not reasonable, he’s got other rules that they would apply and we would not argue with it but in our situation, it stipulated that the reserve is reasonable.
Byron R. White: If somebody talked to the -- the accounts receivable would have at their face amount and not for that amount, you would realize income?
Harold I. Apolinsky: We would realize income. We would say --
Byron R. White: Not that you would have to do --
Harold I. Apolinsky: That's right, we would say that the tax benefit rule which the Government espouses in their brief correctly but doesn’t apply, would apply. The tax benefit rule which they say is the basis for the Revenue Ruling 62-128 says that if you take a deduction in a prior year, it is of tax benefit in the prior year and you subsequently recovered the deduction, then you have to take into income the amount of the recovery in the year of the recovery.
Byron R. White: That reserve really just makes you a tax basis taxpayer with the amount of that reserve. It will pay off if you collect some of those.
Harold I. Apolinsky: If you collect those accounts in, then you do have -- in other words, you have a recovery of the reserve. We say in this nontaxable situation was a mere change in form that there is -- and this was the philosophy I think of the Ninth Circuit. The Fifth Circuit ignored Section -- well, they mentioned it but they did not give a lot of weight to Section 351. The Ninth Circuit didn't either but they grounded their opinion on the fact that there was no recovery, that the philosophy of the government in using the tax benefit rule to take -- to recover the bad debt in some future point should be based on the fact that there is a recovery at some later year of the amount of the reserve and that when you get back stock certificates representing the net value of the assets transferred, the accounts receivable less the value, that there was no recovery.
Byron R. White: But at least that there is some recovery in this reserve account, the result of your position of being a corporation that would pay a corporate --
Harold I. Apolinsky: That's right.
Byron R. White: -- tax rate rather than you would have called it paying individual.
Harold I. Apolinsky: Well, you would pay a -- you would not have an immediate recognition at the beginning where you could have a higher rate or you could have a lower rate I imagine. At that time -- either way at that time, the corporation takes it back into its income depending on the two rate structures.
Byron R. White: What’s the result of the government's position? Assume the government prevails and you have to take -- the partners have to take the $73,000.00 into income, then what -- I suppose that $73,000.00 worth of accounts receivable could be recovered by the corporation for nothing.
Harold I. Apolinsky: That's right, you see what would happen, we would take it --
Byron R. White: Does the Government conceive that?
Harold I. Apolinsky: I don't -- we really not put it to --
Byron R. White: You mean the tax would then have been paid on those accounts receivable?
Harold I. Apolinsky: If we had to take -- if the partners took the $73,000.00 worth of receivables into income, then they would -- they say in their brief that the corporation would then be entitled to set up a $73,000.00 reserve for bad debts in its first year. Now if the corporation chose to do that and take a deduction of $73,000.00 in its first year and later recovered the $73,000.00 --
Byron R. White: Tax has already been paid on it.
Harold I. Apolinsky: That's right, it’s been paid but you could have -- if you had a second deduction under their theory you could have a second tax to pay on it. We say that would just really distort the income of the new corporation giving it a whopping big deduction in the first year when it has no earnings necessarily, it's not related to any business activity and creates an income item to the partnership. I see that I'm going to reserve the balance of my time for rebuttal, Your Honor.
Warren E. Burger: Very well, Mr. Apolinsky. Mr. Zinn.
Matthew J. Zinn: Mr. Chief Justice and may it --
Warren E. Burger: Before you get underway, would you clarify perhaps for all of us but at least for me, what has changed here in your judgment by this transfer except the form and structure of doing business?
Matthew J. Zinn: That is precisely all that has changed Mr. Chief Justice, just the form in which the business is carried on.
Warren E. Burger: There's no change in substance?
Matthew J. Zinn: That's correct although as we pointed out in our brief, Section 351 transfers can apply where an entire business becomes a corporation or where a single asset on account receivable or any other single asset is transferred from an individual or partnership to a controlled corporation.
Hugo L. Black: What goodness has this partnership engaged in?
Matthew J. Zinn: It was engaged in the business of financing, Mr. Justice Black.
Hugo L. Black: Lending money?
Matthew J. Zinn: I believe so.
Hugo L. Black: Is it a challenge to the question as to the amount they have tried to set aside for bad debt?
Matthew J. Zinn: No, Mr. Justice Black. If I understand your question, the reserve that was on the books of the corporation at that time of the transfer, on the books of the partnership, excuse me, at that time of the transfer, was reasonable if the partnership continued in business. But the fact is that the partnership didn't continue in the business. The partnership was terminated and all of its assets including its accounts receivable which were transferred to the corporation.
Hugo L. Black: But why did that change the situation with reference to the reasonableness of the amount?
Matthew J. Zinn: Well, we think that when a partnership terminates or when an entity terminates, the tax benefit principle requires that a deduction be restored to income because subsequent events have demonstrated that that entity is not entitled to the deduction.
Hugo L. Black: Does the record show that? At subsequently event?
Matthew J. Zinn: Well, if the partnership and corporation are considered to be separate entities, I don’t think there can be much question that the partnership’s need for the reserve ended. The Ninth Circuit in the Schmidt case upon which petitioners rely determined that the need --
Hugo L. Black: They had changed their --
Matthew J. Zinn: The form of the business as the Chief Justice asked.
Hugo L. Black: -- in form from a partnership to a corporation?
Matthew J. Zinn: That’s correct and Mr. Apolinsky this morning and in his brief has relied heavily on the legislative history of Section 351 which provides for the nonrecognition of gain or loss. But he did not read the language of the statute to this Court and I would like to do that. It says that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities. And immediately after the exchange such person is in control of the corporation. No gain or loss shall be recognized. Gain or loss is a statutory term of art. It can arise only when property is transferred. The reserve for bad debts is not property. It is merely a bookkeeping entry on the books of the partnership. It cannot be transferred and nothing in Section 351 bars the application of a tax benefit principle in this case.
Byron R. White: No, but it's reported to be transferring reserves.
Matthew J. Zinn: They are transferring only the receivables.
Byron R. White: All that it's saying is that they're transferring the accounts receivable at face amount less the amount of the reserve. They're transferring only the net amount of the -- because everybody stipulates that these transfers are only worth so much.
Matthew J. Zinn: Yes, but Section 351 only prohibits the recognition of gain or loss and restoring the reserve income under the tax benefit principle is not a recognition of gain or loss.
Byron R. White: That may be so.
Matthew J. Zinn: Well, there’s no -- I think the point is Mr. Justice White that there is no provision in the statute that precludes the application of the tax benefit principle in this case. That principle is well established. The need for the reserve here we think has terminated because the partnership has terminated.
Byron R. White: Well, just because there’s nothing in the statute doesn't -- that suggests the application of the tax benefit principle doesn’t agree. That principle is applicable here.
Matthew J. Zinn: I would respectfully disagree, Mr. Justice White.
Byron R. White: What possible then it has -- has come out of this transfer to the partners?
Matthew J. Zinn: They have received -- the partnership has received the benefit of a deduction to which they are no longer entitled.
Byron R. White: They received the benefit of it because the Government agreed that the accounts receivable of the books weren't all collected? Now, you are saying that you must pay taxes though all of these accounts receivable were --
Matthew J. Zinn: That is correct.
Byron R. White: And that we are no longer entitled to view this bundle of accounts receivable worth less than the face?
Matthew J. Zinn: That's right. I think the accounts receivable are separate from the reserve. Let me point out Mr. Justice White that when a corporation --
Byron R. White: What's so attractive about that? Let's say somebody must treat his collectible, his accounts receivable and we all agreed worth the collectible, and he must pay taxes on it?
Matthew J. Zinn: I don't know if there's anything attractive about it. As we tried to point out in our brief, we view the problem here as initially one of avoiding a double deduction.
Byron R. White: What possible double deduction can anybody ever get?
Matthew J. Zinn: Well, the concern we have initially, Mr. Justice White is that a deduction will be granted to the partnership as it was here and then that it will pay second deduction will be granted to the transferee corporation.
Byron R. White: (Inaudible)
Matthew J. Zinn: I think they would try not to Mr. Justice White but I don’t think we can rule out that possibility. Judge Duniway in his opinion in the Schmidt case specifically left open the question as to --
Byron R. White: Because the corporation might have taken in, in fact that’s when it must make sure to charge somebody else more than it should.
Matthew J. Zinn: No, I don’t think that's the case. It seems to me that we want to ensure against the double deduction. The Code doesn’t specifically tell us which way to do that.
Byron R. White: It was unsure, I guess?
Matthew J. Zinn: Right.
Byron R. White: By taxing someone on some income that they haven't received yet and are --
Matthew J. Zinn: Well, we say they have received it Mr. Justice White.
Byron R. White: That's only my picture of the full basis accounting anywhere?
Matthew J. Zinn: But the deduction for a reserve for bad debts is a fiction too. We are allowing a deduction --
Byron R. White: This isn't fiction at all. Let's say, we're going to -- your only full basis, you're going to have to pay as soon as you take in the income and the face amount in receivables for the collected amount, except we won’t make you take an income now in certain percentage of it. Let me take out the balance.
Matthew J. Zinn: That's right but nevertheless, there is a recovery. If we view the partnership as a separate entity, there is a recovery of that deduction and we think that the Code --
Byron R. White: In case that the -- if the corporation had never taken place --
Matthew J. Zinn: That’s right.
Byron R. White: -- the partners would never pay the nickel on that $73,000.00 unless they had actually collected some of those accounts receivable. Now, you're saying nevertheless they should pay that $73,000.00 although they have not yet received any –
Matthew J. Zinn: That's correct.
Byron R. White: And they never will.
Matthew J. Zinn: That's correct. In the case of a corporation that liquidates tax free under Section 336, and distributes all of its assets to its shareholders in liquidation, it is clear that the corporation must restore the reserve to income even though it didn't collect the amount of the reserve for bad debts. All it's getting back are pieces of paper just like the partners are receiving here.
Byron R. White: We've -- we've held that here?
Matthew J. Zinn: You haven't held it but such holdings as they are, are consistent with that and petitioners conceived that in their brief that on a liquidation of a corporation, there is a restoration of the reserve to income.
Warren E. Burger: Mr. Zinn, when this transfer occurred, I assume that in the eight offices of the corporation and partnership later the corporation, they had typewriters, desks, chairs and a lot of office equipment. Let's assume just hypothetically that that equipment was worth and had an original cost of $50,000.00 and then have been depreciated down to $25,000.00. Would you say that now that it’s transferred to the corporation that depreciation which is a hypothetical recognition or a prophesy as is the bad debt deduction should now be charged back as income to the partners?
Matthew J. Zinn: No, we would not Mr. Chief Justice but that is because Section 1245 and Section 1250 of the Code specifically so provide.
Warren E. Burger: Well, but the function of the bad debt loss is essentially in principle the same as the function of a depreciation for obsolescence isn’t it?
Matthew J. Zinn: They are similar although some of the cases that we have cited including the West Seattle Bank case draw a distinction between the two. Insofar as I can understand the distinction and it’s rather murky, it is that with respect to accounts receivable and a reserve for bad debts, you cannot be certain that any particular account will become worthless, whereas you have some greater degree of assurance that wear and tear and obsolescence will gradually diminish the value of an asset.
Warren E. Burger: But that isn't necessarily true as a matter of reality, in a period of rising costs, it frequently occurs that assets long since depreciated down to zero become worth a great deal and then the Government on liquidation recovers that, do they not?
Matthew J. Zinn: I agree that they would and I think that they would recover it here but for the fact that we have specific statutory provisions that apply. I think it would be helpful if I point out to the Court that in the investment credit area, the Government wouldn’t be taking a position that it’s taking here because Section 47 (b) of the Code provides that property shall not be treated as ceasing to be investment credit property with respect to the taxpayer by reason of a mere change in the form of conducting the trade or business. Had a provision like that been included in the Code in Section 351, we wouldn't be here in Court today. But the fact is, that Section 351 only prohibits the recognition of gain or loss and we are not seeking to tax gain or loss in this situation.
Hugo L. Black: Is your argument based on the fact, somehow somebody didn't put down there what they had intended?
Matthew J. Zinn: No, Mr. Justice Black.
Hugo L. Black: And that the Government is going to get this payment although it shouldn't have it but nevertheless the letter of the law doesn’t allow it?
Matthew J. Zinn: Well, our position here is that the Internal Revenue Code doesn’t tell us which way to handle this double deduction problem. That the Commissioner has determined that the proper way to handle it is to restore the bad debt reserve to income under the tax benefit rule. That application of a tax benefit rule here is entirely consistent with all statutory provisions and that under decisions of this Court, so long as the Commissioner’s solution to the double deduction problem is reasonable, that that is the end of the case.
Hugo L. Black: Well, is it your position that in all truth and fact and justice that this is not going to require a taxpayer to pay taxes on income that he did not receive as income?
Matthew J. Zinn: Yes, but when he --
Hugo L. Black: You admit that?
Matthew J. Zinn: Yes, but when he obtained the deduction for the reserve for bad debts Mr. Justice Black --
Hugo L. Black: But he will have to pay income tax on income that he did not get.
Matthew J. Zinn: We say he received it because he obtained a deduction when he set up the reserve for bad debts for a loss he did not suffer. For a loss that would be --
Hugo L. Black: Then you are saying that this would be a double benefit to him?
Matthew J. Zinn: No. No, we're saying that when he set up the reserve for bad debts, he got a deduction for a loss that he had not yet suffered and now since the partnership is terminating and since the partnership never incurred those losses, he must restore the bad debt reserve to income.
Hugo L. Black: Then what happens suppose they don't collect it? The sale turned out to be bad.
Matthew J. Zinn: We think that the corporation would be entitled to take a deduction because it would have suffered the losses.
Hugo L. Black: I take it. It would be entitled to take a deduction later?
Matthew J. Zinn: Yes, because it suffered the losses.
Hugo L. Black: That's your argument as to why it's fair for the Government to pay.
Matthew J. Zinn: That's right. The corporation is entitled to the deduction because it suffered the losses. It actually suffered them. The partnership here did not suffer the bad debt losses which obtained through creation of the reserve. The reserve is an estimate of future losses and the partnership never suffered those losses and for that reason, we don't think it’s entitled to retain the benefit of the deduction.
Hugo L. Black: Your argument is in fact is it that the Government would get this I mean the taxpayer would be getting this reduction twice?
Matthew J. Zinn: No, our concern is that if that -- the partnership has already gotten the deduction.
Hugo L. Black: That's right. You say it’s already gotten.
Matthew J. Zinn: There is a possibility that the corporation will get a deduction for the same accounts receivable.
Potter Stewart: As I had understood your argument, Mr. Zinn, it was this that the statute itself does not explicitly tell you or the taxpayer how this situation should be handled and that your submission is that the way you handle it is a reasonable way of handling it under the statute and that that should be the end of the case and as I further understand it, neither you on the one hand, nor your adversary on the other are claiming that either, there should be double taxation or a double deduction. You both recognize that however this is worked out, that there shouldn't be a double deduction and that these same items should not be taxed twice.
Matthew J. Zinn: That’s right, which way to avoid the double deduction.
Potter Stewart: And as I understand it further, you’re not saying that the way you decided to handle this is the only proper way of doing it. You're just simply saying it’s a reasonable way of doing it and that under the decisions, that should be the end of the case. Am I wrong about that?
Matthew J. Zinn: That's correct, except that I would add to that that we think our way --
Potter Stewart: Is the best thing?
Matthew J. Zinn: -- is more consistent with the provisions of the Internal Revenue Code, particularly those of subchapter C which this Court recognized last term and Commissioner and Gordon are very, very technical.
Potter Stewart: Yes.
Matthew J. Zinn: Now, we think that Mr. Apolinsky’s arguments are very persuasive in terms of perhaps revising the Internal Revenue Code and making Section 351 read the same way that Section 47 (b) reads that if it’s so long as the same business is continuing, no income will be recognized.
Potter Stewart: Right.
Matthew J. Zinn: But that's not what the Code says.
Potter Stewart: I understand that.
Hugo L. Black: But you don't claim it would be reasonable for the Government -- for taxpayer be denied this deduction twice.
Matthew J. Zinn: No, we don't seek to deny it twice, Mr. Justice Black. We would allow it to a corporation.
Hugo L. Black: Now, do you think it would be reasonable for them to get it twice?
Matthew J. Zinn: That’s correct.
Hugo L. Black: It's just once is all the deduction they should get?
Matthew J. Zinn: Yes, and tha'’s all they seek.
Hugo L. Black: And no scheme will do that whether you call it reasonable, you wouldn’t call it reasonable if it didn’t accomplish that, would you?
Matthew J. Zinn: I'm not sure I follow you.
Hugo L. Black: You wouldn't call it reasonable would you if it was making this taxpayer be denied of privilege over a deduction for a loss he had had.
Matthew J. Zinn: Oh! No, but the petitioners here didn’t suffer the loss that they are claiming. The corporation suffered the loss and that's whom we want to allow it to.
Potter Stewart: Neither side in this case is, your adversary is not claiming it is going to be taxed twice and you're not claiming that it's going to be deducted twice.
Matthew J. Zinn: At which way?
Potter Stewart: It’s just which accounting matter --
Matthew J. Zinn: Which way. Now, Mr. Apolinsky has pointed out both in his brief and here this morning that the corporation set up a reserve for bad debts on its books and therefore didn’t claim it twice. I should point out to the Court that we have confirmed that but is extra record information. It does not appear in the record. I don't think it makes any difference except as a matter of tidiness. Mr. Apolinsky also mentioned this morning that on a liquidation of a partnership, there would be no restoration of the reserve to income. There is no case law on that question. There is as I have mentioned earlier, a case law on the question of liquidation of corporation which indicates that there would be a restoration of the reserve and it seems to us that there would be a restoration of the reserve if this partnership liquidated.
Byron R. White: What would you -- if someone bought from the partners the accounts receivable for cash at the net value, face less the amount of the reserve, I suppose the partners would be realize income?
Matthew J. Zinn: Well, they might realize. They would realize no net income, Mr. Justice White because presumably the restoration of the reserve in the hypothetical that you posited.
Byron R. White: Restoration? You mean restoration?
Matthew J. Zinn: Yes, we think there would be restoration of the reserve.
Byron R. White: And as to the fact of the income on the $75--$73,000.00?
Matthew J. Zinn: That's right.
Byron R. White: Even if they -- nobody paid it?
Matthew J. Zinn: That’s right. But then they would be entitled to a loss deduction for $75,000.00 because the basis of the receivables in their hands would be the face amount of the receivables, we think, not the net amount.[Recess]
Warren E. Burger: Mr. Zinn, you may pick up where you left off.
Matthew J. Zinn: Mr. Chief Justice and may it please the Court. In the few minutes I have remaining, I should like to discuss the two proposed solutions of petitioners to the double deduction problem here. That is the carryover solution and the adjustment of basis solution. Section 381 of the Internal Revenue Code is the principal provision which allows for carryovers in certain transactions. That provision does not apply to transactions such as the one here which is described in Section 351. It applies only to certain intercorporate transactions. In addition to the fact, the absence in Section 381 of a specific congressional authorization for a carryover, it is well established that a transferee in a Section 351 transaction is a new taxpayer and can adopt its own accounting methods and its own taxable year including in this specific case the specific charge off method of accounting for bad debts. We think therefore that there is a real risk of a double deduction if this Court should hold that the tax benefit principle is not applicable here. Third, we point out that Congress has been quite specific when it wanted items to be carried over in a Section 351 transaction. Thus, Section 362 of the Code provides that the basis of property shall be carried over. As I attempted to outline for the Court this morning a reserve for bad debts is not property similar carryover rules --
Warren E. Burger: Well, would you distinguish it in that respect from a depreciation reserve?
Matthew J. Zinn: No, a depreciation reserve is not property either but under Section 1016 of the Internal Revenue Code, a depreciation reserve is specifically provided to reduce the basis of the depreciable asset. That's under Section 1016 (a) (2), Mr. Chief Justice. There is no specific provision that is comparable to that allowing a basis reduction for a bad debt reserve. I should also point out that in attempting to analogize a Section 351 transaction and to bring it within the spirit if not the specific language of Section 381, that Section 381 applies only to transfers of entire businesses. Whereas Section 351 as I mentioned before the recess can apply to a transfer of an entire business as in this case or to transfer of a single asset.
Byron R. White: Let’s assume that this wasn't a 351 transaction, the corporation was organized and assets were transferred to it for consideration and the corporation bought these receivables for cash. I suppose its basis would be on face amount?
Matthew J. Zinn: That's correct. In that case, the basis would be what it paid for it but --
Byron R. White: What do you think the corporation paid for here? Assume this wasn’t a taxable transaction, it was a nontaxable transaction.
Matthew J. Zinn: Right.
Byron R. White: But it did issue stock?
Matthew J. Zinn: Well, its basis would be.
Byron R. White: And receivable?
Matthew J. Zinn: But it issued stock and cash?
Byron R. White: No, it issued stock and receivable.
Matthew J. Zinn: But it was a taxable transaction? Well, then its basis would be the net value --
Byron R. White: What is that?
Matthew J. Zinn: The face amount of the receivables less the reserve. That would be the corporation's basis but that’s not the corporation's basis in this case according to the specific provisions of Section 1016 (a) of the Code.
Byron R. White: Do you think the Code requires the corporation in this kind of a transaction to take into plus the receivable to be paid?
Matthew J. Zinn: I don't know if I can go so far as to say it requires Mr. Justice White. It seems to me that the overriding principle that’s applicable here is no double deduction, the principle that this Court reaffirmed last term in Skelly Oil.
Byron R. White: You mean that requirement is only a requirement if you’re right under --
Matthew J. Zinn: No, we say that the Code doesn’t specifically answer the question that’s presented here, how to avoid the double deduction. Now, we think the better way to answer the question is to answer it by applying the tax benefit principle but if the Court says that isn’t the better way to do it, then we think that the basis adjustment should be made. The Code just doesn't speak specifically to the point and we have to comply with the --
Byron R. White: Basis would just be made, what does that do to the partnership?
Matthew J. Zinn: Well, the partnership, if the Court should hold that the tax benefit principle doesn't apply here, then the basis of the receivables should be reduced to net in the hands of the corporation so as to avoid a double deduction.
Byron R. White: What -- if you're on the buying side rather on the receiving side on the corporate side and basically under the receivables that that value was the face, how would you pay any more than the true value?
Matthew J. Zinn: No, you wouldn't pay more than the true value for them, you pay the net amount. Then your basis would be what you pay.
Byron R. White: But what you're saying is that we must -- what we should do to save the corporation is to really pay the face -- for the face value for the seizable to debt and hence the transfer in stockholders actual recipient?
Matthew J. Zinn: I don't think we have to say that the corporation paid the face amount. It seems to me that the Section 351 provides -- Section 362 provides that the basis of property in the hands of the transferee corporation shall be the same as in the hands of the transferor. That basis at least so far as good interpretation of the Internal Revenue Code is concerned would be the face amount of the receivables.
Warren E. Burger: This partnership could have sold and assigned accounts receivable independently of this tax free transfer couldn't they?
Matthew J. Zinn: Yes, in our position, if it had done that would be precisely what it is here that the reserve for bad debts has to be restored to income.
Warren E. Burger: If they sold it for the net amount?
Matthew J. Zinn: If they sold it for the net amount and if they are entitled to a loss measured by the difference between the face amount and the net amount because that is a sale of property and on a sale of property, accounts receivable with a basis of let’s say $100.00, for a net value of 90, they’re entitled to a loss of $10.00.
Warren E. Burger: Would that be a wash transaction?
Matthew J. Zinn: It would be in most cases Mr. Chief Justice because accounts receivable under Section 12214 of the Code would be an ordinary income asset. But if the accounts receivable happened to be a capital asset in the hands of the selling entity in the hypothetical that you posited, then the gain or the loss would be a capital loss and the restoration to income would be a restoration to ordinary income.
Byron R. White: In here they thought of the partners that they have to take this in the income. If they don't get any income out of it, it won’t be a title alone, the loss would be the corporation's.
Matthew J. Zinn: That's right because the corporation will suffer the loss. I think I should point out that the purpose of the reserve method of accounting for bad debts is to better match costs against revenue just as it has been pointed out in the briefs but that purpose was never intended to provide a loss to an entity that didn't suffer it and that once we know that the partnership entity is terminated, the partnership should not wind up with any more bad debt deductions than it would have wound up would had it been on the specific charge off method of accounting for bad debts. And had it been on this specific charge off method, it would not have gotten this deduction for future losses which it took and which we submit has to be restored to income when the partnership terminates.
Warren E. Burger: Thank you Mr. Zinn. You have some time left to -- Mr. Apolinsky?
Harold I. Apolinsky: Mr. Chief Justice and may it please the Court. I think that the statement of Mr. Zinn points up the problem they have in applying the tax benefit rule realistically. They set forth the rule but they don’t apply certainly in the taxable exchange area when there's a cash sale of accounts receivable. The rule as set forth in their brief says you restore to income a deduction when you recover it. Well, If you have a sale for the receivables at gross, that’s a recovery and it would come in income. If you have a sale at net, the most logical conclusion seems to me is that you have no recovery under the tax benefit rule and therefore there’s no income to the taxpayer selling in a taxable transaction. The Government in order to bend the rule to fit our tax free situation sets up a hypothesis that they have a loss realized on the receivables which counteracts the return to income of the reserve and the wash result is a net of zero. We say that's an incorrect approach to the problem. The loss occurred when the taxpayer got the deduction for the reserve. When you set it up, that's when the deduction occurred. The fact that later on, he sold it net was merely a realization that his estimate, his loss was correct, not a subsequent loss down the road to offset some artificial inclusion in income. We further say that we do not agree in our brief and our brief, I think shows that, that there is a different rule to apply in Section 337 liquidations. We don't -- I did not cover that because it’s covered in my brief but Mr. Zinn said that we did agree and we do not. In fact, the revenue ruling in 1957 where the Government covered the liquidation under a one year liquidation rule specifically set up the hypothesis that the corporation sold its receivables at face. And they said, therefore the reserve comes back into income. Well, that seems to be the tax benefit rule in its proper application and I've set out that entire revenue ruling in the last page of my appendix. I also take issue with Mr. Zinn when he disputes whether upon the liquidation of a partnership the reserve comes into income of the partners. In my judgment, in a pro rata liquidation of a partnership under Section 736, there is no recognition of income to the partners. I would just focus our attention if I will on the question, the Government has assumed as we said that there is a problem of a double deduction. We maintain that there is no problem of a double deduction because there has been no, in our case, no one has tried to take a second deduction and in no case discussed today or in any of the brief has any taxpayer attempted to take a second deduction at any stage. So that the basis hypothesis for the need for the revenue ruling it seems to me unfounded that there is not second deduction to guard against and therefore, without that problem, there’s no need to even travel under 7805 but under that Section, the solution if we were to assume for argument there’s a problem. Under that Section, the solution has to be consistent with the statute. We say that Section 351 which says no gain or loss if property is transferred, if, it doesn’t say from property, it’s not tied to the property. It says if property is transferred, that the legislative history of that Section points out that that’s not a taxable event, it’s just a change of form and in 1924, Congress in reviewing it said, no gain or loss and in the next sentence, it says, this is not a time for the realization of income. So we say there is no magic in saying what we have over here is income and the statute said no gain, loss or income because in 1924, they used the two terms interchangeably. Certainly, the cure to the illness should not be worse than the illness itself and that’s what’s going to happen if we restore to the partnership this income. It creates artificial tax planning. Partners, proprietors, transfer into corporations can't put receivables into their corporations because if that mature the reserve for bad debts, they would not then have any cash to pay the income tax with. So what's happened since 1962 is that people with reserve for bad debts have been artificially holding out their receivables, or else possibly making cash sales at nets to third parties to create what the Government says is a wash situation. That -- and this is a recurring problem. The Government in their petition for certiorari agrees that we have incorporations of businesses everyday and it just seems to me that we should not visit the need for some artificial planning. Congress in 1921 said, to order, to encourage business readjustments and even spoke of artificial transactions that they were going to place this tax free environment. The simplest thing I think is not to look to a specific solution to a double deduction, we say there isn’t or to simply for the court to remind the tax bar is we don’t need reminding of your decision of Skelly Oil. There is just not going to be any second deduction allowed irrespective of which particular route is followed and we urge that the Fifth Circuit be reversed and that the District Court's decision be affirmed so that the partnership in this situation would not take into its income the reserve for bad debts.
Warren E. Burger: Thank you Mr. Apolinsky. Thank you Mr. Zinn. The case is submitted.


Earl Warren: Number 117, the Gas Service Company, petitioner versus Otto R. Coburn, etcetera. Mr. Wormhoudt.
Gerrit H. Wormhoudt: Mr. Chief Justice, may it please the Court. This action was commenced in the United States District Court for the Court of Kansas also as a class suit under the newly amended Rule 23 of the Federal Rules of Civil Procedure. The plaintiff brings the action on behalf of themselves an 18,000 other consumers of natural gas at retail upon the petitioner in this case who was a public utility in Missouri corporation qualified to do business in Kansas. The petitioner claims that or complains that the -- I beg your pardon, the respondent claims that the petitioner in this case illegally exacted from the plaintiff and from the members of the class which the plaintiff seeks to represent and illegally imposed franchise charged exacted by the City of Arkansas City in Cowley County Kansas that this charge was not maintainable beyond the city limits that the respondent in this case resides beyond the city limits along with 18,000 other members of his class. Diversity did exist, jurisdictional amount was pleaded. The petitioner then moved in the District Court to dismiss the action, the motion to dismiss was supported by an affidavit indicating that during a probable time period involved here, this particular respondent's claim would have amounted to $7.81. During the course of argument, counsel for the respondent frankly stipulated that the respondent's claim could not equal $10,000.00 and that they had no knowledge of any other member of the class whose claim would equal or exceed $10,000.00. The District Court however overruled the motion to dismiss. It did in its order make the necessary determination and findings permitting petitioner to apply to the Court of Appeals for the Tenth Circuit for an interlocutory appeal, that application was granted and the Tenth Circuit Court of Appeals affirmed the order of the District Court at approximately the same time within a month or two of the affirmation of the District Court's ruling in Snyder versus Harris. I would like to address myself to what I think have been straw men raised in the brief of the respondent. It has been suggested that the petitioner in this case is seeking to confine the construction of the amendments to the rules to the language of the formal rule alleged Rule 23 and the horrible parade of Norman Clayture that developed under that rule, it references to two class actions, hybrid class actions, and superior class actions. I think it is perfectly abundant, perfectly clear that the real problem involved here is not one of the construction of prior Rule 23. So far as we're concerned, that rule has nothing to do with the present action. We don't rely on it. We find it unnecessary to refer to it. We do think that jurisdictional standards first as adopted by Congress and the body of case law which has developed around those jurisdictional standards is one set of rules and one body of law. The rules of practice adopted by this Court from time to time for itself and for the district courts have to do with an entirely different set of proceedings and entirely different set of standards are involved under those circumstances. There are many, many cases of course that are filed in federal courts everyday where jurisdictional amount is not involved, fair labor standard cases, I think some cases under the Securities Act, civil rights cases and others. And under those circumstances the district courts need not be bothered with the $10,000.00 jurisdictional amount as they are in ordinary diversity and in ordinary federal question cases. And in those cases I trust as well as in the diversity cases and the federal question cases. The amendments to Rule 23 will make class actions easier to handle, easier process, easier to understand the results but simply because we now have before us an attempt to improve upon formal Rule 23, it seems to me it has nothing whatsoever to do with that preexisting body of law which deals with jurisdiction which has developed two decisions of this Court since 1789 and which has always been a problem or a matter than any complainant in federal court must meet regardless of what the rules and practice are which have prevailed in that court from time to time. I would call the Court's attention, the opinion of Mr. Justice Story in the Alexander case which was well over a hundred years old so far as I know, that's one of the first cases dealing with the jurisdictional questions in the matter of aggregation and the court pointed out in that case and although Congress had authorized seaman to bring in effect class actions or joint suits for unpaid wages in the federal district courts that because this Court at that time had an appellate jurisdictional limit of $500.00 as the matter in controversy or the amount in controversy, therefore there was no appellate jurisdiction of any seaman's wages when those wages did not amount to an excess of $500.00 and so far as I know, there has been an unbroken string of decisions following that case and applying it both to the appellate jurisdiction of this Court and to the jurisdiction of the federal court. That District Court --
Potter Stewart: I haven't read that opinion of -- that Story opinion but it seems to enter with appellate jurisdiction rather than diversity jurisdiction of --
Gerrit H. Wormhoudt: That is correct Your Honor.
Potter Stewart: -- the language as quoted in your brief.
Gerrit H. Wormhoudt: That is correct. It seems to me the principle is identical however.
Potter Stewart: It didn't directly have to do with diversity jurisdiction?
Gerrit H. Wormhoudt: No Your Honor, it did not.
Potter Stewart: So it was in admiralty, right?
Gerrit H. Wormhoudt: That's correct. I would point out that there are numerous situations where a class action was appropriate under the old rules and will be -- just as appropriate if not more appropriate under the new rules. I do think it maybe some help in analyzing the question to really ask what we mean when we use the term aggregation, I think it was Judge Frankel in an article mentioned in our brief who suggested the term aggregation has probably been a complete misnomer from the beginning and his analysis may have some bearing upon the question put by Mr. Justice Fortas earlier since as he points out in a traditional class action where the claim is common or undivided or joined. In effect you have but a single claim and while numerous people may be interested in, claims are not being aggregated where the claim itself joined or common or undivided. And in those cases where the total claim itself passing the derivative suit is in excess to $10,000.00. There really is not an aggregation or a joinder of claims and the jurisdictional problem simply doesn't exist.
Byron R. White: What's your view with the case where a single stockholder (Inaudible)?
Gerrit H. Wormhoudt: Is he bringing this on behalf of the stockholders or the corporation Your Honor or he himself has a claim in excess of the jurisdictional amount? I do not know of any decisions of this Court which say that under those circumstances, he could then if this were simply a joinder device include all the other members of the class unless their claims also exceeded. Yes?
Potter Stewart: Each individual claim.
Gerrit H. Wormhoudt: I think in Clark against Paul Gray and I'm sorry I'm not more conversant with that case for this Court on its own motion to dismiss several claims. As I recall, the plaintiff in that case had the requisite jurisdictional amount and this Court directed however that the other parties to the action be dismissed from the suit. This is my recollection --
Potter Stewart: But you do not need to go that far to win your lawsuit, do you?
Gerrit H. Wormhoudt: No, Your Honor I don't.
Potter Stewart: It's not of this, so far as you know nobody here has a claim of as much as $10,000.00.
Gerrit H. Wormhoudt: I think it's conceivable than any of them would. I would point out that neither the District Court nor the appellate court characterizes this as a (b) (1), (b) (2) or (b) (3) class action.
Abe Fortas: Well you would say then that the only judgment the court can render here, let's assume that you got all the jurisdictional amount hurdle, the only judgment the court could render here would be on the base -- would be based on the claims of the individual claimants.
Gerrit H. Wormhoudt: Yes Mr. Justice, I'm confident that the court would --
Abe Fortas: So there are ten more with a $7.00 each or total amount of a judgment be $70.00.
Gerrit H. Wormhoudt: Yes sir. And I assume that several decrees would have to be entered in each case or I mean as to each party defining the exact amount that he had assuming that he paid his cash -- gas bill at the time and there were aren't any set offset.
Abe Fortas: You don't think that the purpose of the amendment for the rules was to overcome precisely that situation?
Gerrit H. Wormhoudt: Not Your Honor in diversity suits. I submit it was not. I think the main thrust of my argument would be along these lines. Rule 82 says the rule shall not be construed to extend or limit jurisdiction.
Abe Fortas: It doesn't really matter whether it's diversity or not, suppose somehow rather that this were -- suppose some other than diversity, the jurisdictional amount were not available, you just think that this is not a proper class action. You think this is not a proper class action?
Gerrit H. Wormhoudt: No Your Honor, Mr. Justice. I think it may be a proper class action as a class action was now defined, I simply submit that doesn't tell you whether or not you have jurisdiction.
Abe Fortas: And you don't and it doesn't tell you or does it have any bearing on how much can be repaired ultimately what the judgment can be, it's a judgment limited to the individual plaintiffs who have joined.
Gerrit H. Wormhoudt: I think it depends not on the total amount of the aggregate judgment but on the nature of the claim of the plaintiff himself and of the claim of the class. I would merely like to refer very briefly to Rule 82 which says that the rules in this Rule was also amended in 1966 shall not be construed to enlarge or diminish the jurisdiction of the federal courts. The Circuit Court conceded in its opinion and I think counsel will concede here. This action simply was not maintainable prior to the amendment of the rule that being so although I may be supposedly geared to errors that dealing in logic if the action could not have been maintained for jurisdictional reasons prior to the amendment of the rule but it may now be maintained because of the amendment of the rule then it seems to me that is only because of a construction which does enlarge a jurisdiction of the federal district courts. Thank you.


Warren E. Burger: We’ll hear arguments next in number 1182, Mattz against Arnett. Mr. Sclar you may proceed whenever you’re ready.
Lee J. Sclar: Mr. Chief Justice and may it please the Court. This case is here on a writ of certiorari to the California Court of Appeal. The issue presented is whether an 1892 federal statute terminated prior of an Indian reservation, and thereby made that area subject to state fishing laws. The area in question is a strip 1 mile in either side of the Klamath River from the Pacific Ocean inland for 20 miles. This area together with the next 20 miles up the Klamath River has always been the center of Yurok Indian life. Petitioner Raymond Mattz is a Yurok. He and his family, and his ancestors have always fished along this stretch of the Klamath River and they have done so with large nets including gill nets. In September of 1969 petitioner Mattz had five gill nets stored at a location approximately 200 feet from the Klamath River and about 10 miles from the Pacific Ocean. The land belonged to the Simpson Timber Company but it adjoined an allotment of petitioner Mattz’ mother, and the nets were on the Simpson Timber Company land by mere inadvertence.
Harry A. Blackmun: Is that a factor of any importance here the fact that it was on land owned by Simpson?
Lee J. Sclar: In view of other rulings by this Court in Seymour and by lower courts, no it isn’t Your Honor. However if it had proved to be on allotted land of petitioner’s mother, then the issue presented by this case would not arise since the land would then be Indian country even if it wasn’t in an Indian Reservation. A game warden came by from the State of California, saw the nets, and confiscated them. The respondent Director to the Department of Fish and Game then instituted a proceeding to forfeit the nets to the State. Petitioner Mattz intervened and asked for returns of his nets saying the state law did not apply because the nets had been seized in Indian country. The trial court ruled for the State ruling that although the area had at one time been a private Indian reservation, but that reservation had been terminated by an 1892 statute which opened the land for public purchase. The decision was affirmed on the same grounds by the California Court of Appeals and the California Supreme Court declined to hear the case. In order to understand why the decisions by the California courts were wrong, it’s necessary to understand the legal history of this area, and I would ask if the Court could refer to the maps supplied by the Solicitor General in this argument. The first reservation created in this area was the Klamath River Reservation. It’s not, excuse me Your Honors, it is not in the brief of the Solicitor General, but it was supposed to have been supplied to the Court, especially this morning. They’re relatively small maps, wait.
Warren E. Burger: You may continue and we’ll --
Lee J. Sclar: Okay, well I would try to describe it without the maps. The first reservation created was a strip 2 miles wide on either side of the Klamath River from the Pacific inland for 20 miles. That is the same area in dispute here. It’s shown on the little maps in --
Harry A. Blackmun: If you like you can use these ones here?
Lee J. Sclar: Oh, I’m perfectly familiar with it. I just thought that every member of the Court would like to be able to look at when while I discuss this.
Warren E. Burger: They don’t seem to have been delivered to all the --
William O. Douglas: Isn’t it one of the --
Lee J. Sclar: I’d also appear -- no, I don’t think it’s actually in any of the briefs. It was supplied separately.
Speaker: (Inaudible)
Lee J. Sclar: Right, that’s the map.
Speaker: Some of us don’t have it.
Lee J. Sclar: I apologize to the Court for that situation. I understood that nine copies had been delivered and that each --
Warren E. Burger: Well, if nine copies were delivered to the clerk then it’s not your responsibility.
Lee J. Sclar: The area that’s in dispute that is the 2-mile strip from the ocean inland for 20 miles was first established as a reservation in 1855, and it was done by a Presidential Proclamation and called the Klamath River Reservation. In 1864, Congress passed the statute authorizing the creation of four reservations in California. Pursuant to the statute, the four reservations were created by 1876 and one of those reservations was the Hoopa Valley Indian Reservation. That reservation is shown on the little map as the green square. It’s an area approximately 50 miles down stream on the Klamath River and approximately 12 miles square. The result of that is that there between the Klamath River Reservation and the Hoopa square, there’s a gap of Klamath River that at that time was not part of a reservation. The federal government however continued to recognize the existence of the Klamath River Reservation as an Indian Reservation until 1889. At that time a federal court declared that the Klamath River Reservation was no longer a reservation because it had not been included in one of the four reservations authorized by the 1864 Act. It did that on a basis of a statute which said that reservations, a provision in the 1864 Act saying that “Reservations not included in the four reservations should not be retained for Indian purposes”. So in 1889, the situation was that you have the Hoopa Valley Indian Reservation that is the square and no other reservations recognized by the courts in that area. However, in 1891 the President moved to correct the situation caused by the court decision in 1889, and the President issued an Executive Order extending the Hoopa Valley Indian Reservation from the Hoopa square all the way up to the Klamath River to the Pacific Ocean in a 2-mile strip, 1 mile on either side of the river. That Executive Order extending the Hoopa Valley Indian Reservation was upheld by this Court in U.S. v. Donnelly in 1912 and the extension that is the addition to the Hoopa Valley Indian Reservation, the 2-mile wide approximately 50 mile long strip became known as the Hoopa extension.
William J. Brennan, Jr.: Now, on that map is that what this yellow and red?
Lee J. Sclar: The combination of the yellow and red together constitute the Hoopa extension. That is correct. Then we come to the Act of 1872 which is the crux of this case. That Act had three significant provisions. First of all, it provided that Indians living on the red area that is the lower 20 miles of the extension should receive allotments of land there in priority over anybody else, including white settlers who may have innocently settled in that area thinking that it was not part of a reservation anymore. Secondly, the Secretary of the Interior was authorized to set aside Indian villages in that area. And thirdly, the area that was not allotted and not reserved for Indian villagers was opened up to non-Indian purchase under the general land laws of United States. However, one exception was made to the general land law disposition and that was that the proceeds of the money instead of accruing to the United States were to be used solely for the benefit of the Indians. That statutory pattern in the 1892 Act is in our opinion not distinguishable from the pattern of the South Colville Reservation Act which this Court in Seymour said did not abolish the south half of the Colville Reservation. It is we feel, completely different from the North Colville Reservation Act which Seymour held did abolish the north half of the Colville Reservation. The two really significant differences that we’ve seen between the Hoopa Act and the North Colville Act is that the North Colville Act expressly vacated and restored the north half of Colville to the public domain. There is no such provision in either the South Colville Act or in the Hoopa Extension Act. Additionally, the North Colville Act allowed for public use of the proceeds of the sale surplus land. There is no such provision in the Hoopa Extension Act. In fact as I pointed out quite to the contrary, the Act specifically provides that only Indians are to be the beneficiaries. In addition to the statutory language differences, the legislative history also shows that Congress have no intent to terminate the lower 20 miles and the Hoopa extension by the 1892 Act. The Senate deleted from the House Bill provision that would’ve allowed the sale proceeds to be used to remove the Indians from the reservation. The Congress as a whole concurred in the Senate move. Additionally, the provision giving Indians allotments with priority over all other settlers was added in the Senate after no such provision was in the House Bill. Thirdly, this Bill is clearly reflected in the legislative history, came out of the Senate and substantially the form recommended by the Interior Department. And it is simply inconceivable that the Interior Department had recommended an 1892 Bill that would have the effect of terminating a Reservation which the President had only created in October of 1891 at the request of the Interior Department. There are also references in the legislative history to an abandoned reservation, but if you read the legislative history closely, especially the House Committee Report, you find that those references are to the Klamath River Reservation which is we pointed out had been declared to be nonexistent back before in 1889, because it was not one of the four reservations under the 1864 Act. Finally, I would like to point out as far as the legislative history goes that there is no mention whatsoever in any of the legislative history of the 1891 Hoopa extension. And it seems totally inconsistent with this Court’s holding in United States versus Celestine that a clear intent is needed to terminate a reservation that Congress not even mentioning the reservation, could’ve intended to terminate it. There’re also subsequent acts which show that this area was not intended to be terminated. In 1893, 161 allotments were made to the Indians pursuant to the 1892 Act. Those allotments constituted 40% of the lower 20 miles that is the area that had been over it. The 161 allotments were described in the 1893 report of the Commissioner of Indian Affairs as being on Reservation. The Commissioner’s report had two sections. One for on Reservation allotments, one for public domain allotments these reservations were in it. These allotments were in the on reservation section.
William J. Brennan, Jr.: Incidentally Mr. Sclar, on this map how much is involved in this lawsuit?
Lee J. Sclar: The area covered is the red area. The --
William J. Brennan, Jr.: That’s all?
Lee J. Sclar: That is all. The red area is the area that was opened up after being allotted and having villages reserved.
Potter Stewart: And all the Yurok Indians centered in this area today?
Lee J. Sclar: No, Your Honor. Many of them do not live on the reservation as such but the live -- a great number of them live in surrounding area and come to this area to fish. The area is very difficult to inhabit because it’s very difficult to get in and out of it. About half, it has no roads at all. People come there on summer vacations. They come there on fishing expeditions, but the area is still regarded as the center of Yurok life.
Potter Stewart: How many Yurok Indians are there approximately today?
Lee J. Sclar: Roughly 3000.
Potter Stewart: And most of them are, in this area of Northern California, aren’t they?
Lee J. Sclar: Yes. Yes, virtually all of them so far as I know. Additional subsequent things which we think tend to show that this area was intended to remain as an Indian reservation are maps of the Commissioner of Indian Affairs reports showing the area continued to be a reservation. Testimony in 1932, the Congress by the Hoopa agency superintendent saying that all of the extension from the square to the ocean as well as the square was all one of the reservation and under the jurisdiction of the Bureau of Indian Affairs. And I point out that a census done on the same year, apparently the last census done on this basis by the BIA showed that there were more Indians living on the lower 20 miles of the extension than on either the other part of the extension, or on the square. There’re also acts from 1920, 1942 and 1958 which confirm the reservation status of this area there explained on the brief, I won’t detail them here. In the National Atlas, the official Atlas of the United States and the 1971 Bureau of Indian Affairs map of Indian land areas both show this area as being part of an Indian reservation. In conclusion, I think to say that the 1892 Act terminated this Indian reservation would go contrary to the requirement of Celestine that there be a clear intent to terminate, would be contrary to the decisions of this Court in Choate v. Trapp, Alaska Pacific Fisheries and Squire v. Capoeman that was -- that are ambiguous, or be it construed in the Indian’s favor. It would be contrary to the holding of this Court in Seymour as the Act of 1892 applying to the Hoopa extension is like the South Colville Act and not like the North Colville Act. And it would work a great injustice on the Yurok Indians whose life is centered here, and who received very small reservation to begin with. Thank you.
Warren E. Burger: Mr. Sachse.
Harry R. Sachse: Mr. Chief Justice and may it please the Court. The United States agrees with the position taken by Mr. Sclar, by the petitioner in this case. And what I want to try to do is put this 1892 Act into a little bit of historical perspective. As Mr. Sclar said, the Yuroks had always lived in that area. They twice had had their reservation recognized by Executive Order 1855 and 1891. The 1891 Act was an obvious reaction to the legal problems that had been recognized in 1889 Court of Appeals case. In 1892, it may be that the House of Representatives set out to take from these Indians much of what had been theirs. But what the House set out to do, the Senate corrected and there’s a varied market contrast between the Bill as it was Act as it was finally passed. And the Act as it was introduced it the House, and the Act as it was finally passed in our view is quite clearly a special allotment Act similar to a number of other allotment Acts that was passed in that general time, and which did not terminate the reservation in question. I’d like to first mention something about the General Allotment Acts. I think that’s important than this. By the 1880’s, most of the Indian reservations had been created, but there was a pressure by the settlers around those reservations to get some of the land in the reservations because they felt the Indians were not utilizing that land. And on the other hand, there was a pressure to keep faith with the Indians and not to take from them what had recently been given to them. A sort of compromise was worked out in the General Allotment Act in 1887 it’s called the Dawes Act. It subsequently been repudiated in the Indian Reorganization Act in 1934. The Dawes Act setup this system that whenever the President thought it was wise to do so, he could require all the Indians within the reservation to take allotments of a particular number of acres each. This would usually leave considerable land in the reservation that was not allotted. President then with the consent of the Indians which was assumed in those days he could obtain would open the rest of the reservation for homesteading. But the fees charged to the homesteaders would be used for the benefit of the Indians who lived on the reservation. Now, that was the General Allotment Act. The General Allotment Act did not require the President to open any particular reservation in this way, and Congress passed a number of special allotment acts. We’ve listed those that have been in litigation on page 22 of our brief, footnote 18. The special allotment acts would take the matter out of the hands of the President and the tribe and Congress would say “We want allotments made on a particular piece of land. We want -- once the allotments are made, we want to open the rest of it to settlement and we want the funds collected from the settlers to be administered by the Government for the benefit of the Indians that lived on that land.” Many of the special allotment acts made a particular reference to the General Allotment Acts, saying that the allotments would be made under the terms of the General Allotment Act. It’s very significant that the funds obtained in such an Act would be used for the benefit of the Indians who remained in the reservation, and this matter of course continued federal involvement with that reservation, both in handling the land transactions and administering the funds that would be created by this procedure. In our view, the 1892 Klamath River Act is that kind of special allotment act, and in our brief when we cited the language of the Act, we put in dark provisions that part added by the Senate which together with the final paragraph that been there all along make this Act exactly a special allotment act of the area of that reservation that was affected. Now, --
William H. Rehnquist: Then the ultimately homesteaded lands would be within the reservations?
Harry R. Sachse: That’s correct. Now, this Court early acted --
Byron R. White: Then you would think to think that even if some would want it, some was homesteaded and the people and all the restriction on the allotments have expired in allotted land dispensable to what?
Harry R. Sachse: Unless Congress had in some -- we don’t reach that issue here because there still is allotted restricted land in this reservation.
Byron R. White: Well, let me ask you, can an Indian reservation that’s along the river belong to the base bed of the river?
Harry R. Sachse: Well, in this case, this Court in Donnelly has already held that the Indians owned the bed of that river, and that river has never been taken from them.
Byron R. White: And that has never been allotted to anybody?
Harry R. Sachse: That’s never been allotted to anybody. That’s still communally held Indian land as far as we’re concerned, and there’s not a word in the 1892 Act to take that away.
Byron R. White: Whether that reservation exists or whether it doesn’t, and respect in regards of who owns the river bed, is there some treaty or some law that claiming Indian fishing right? Or is it just ancestral fishing right?
Harry R. Sachse: It’s some way of between the two. They were ancestral fishing rights but this Court in Donnelly held specifically that the 1891 extension that ran snaking 20, 40 miles down the river, was done specifically to preserve the fishing rights that the Indians had in that --
Byron R. White: With what?
Harry R. Sachse: I think the exclusive right to fish in that river?
Speaker: And when did they have exclusive right to fish?
Harry R. Sachse: Since it was made an Indian reservation, the purpose of which is that this area is to be reserved for the Indians, and since all that was --
Byron R. White: Now what --
Harry R. Sachse: -- surplus lands were sold but nothing was done to take it.
Byron R. White: Well, you think that you would be saying that I suppose, since the Indians owned then and still owned the bed of the river that even if all the carrying land was in other foreign ship? The Indians would have the exclusive right to fish in the river?
Harry R. Sachse: I would say, yes -- I would say that but I don’t think this case requires it.
Byron R. White: Would they have whole land because there are some river referring land its own, but in --
Harry R. Sachse: Well, here’s the way I would analyze this case, and then I -- but I think what you’ve raised is also a possible analysis, a possible way to handle the case. The 1891 Act established an Indian reservation for a mile on both sides of the river including the river and going all the way down to the sea. This Court in Donnelly held that one of the primary purposes of establishing that reservation was to secure to the Indians the fishing rights of that river. That reservation has never been abolished. The 1892 Act which let other people than Indians settle in this area while preserving also Indian settlement simply did not abolish the reservation. So the reservation is still an area of federal jurisdiction and protection, except to the extent that Public Law 280 has given the State of California certain criminal and civil jurisdiction within it, but Public Law 280 specifically reserves federally granted fishing rights, and these were granted by the Executive Order as this Court held in Donnelly.
Speaker: But it still may lead to the question of what you said exclusive. The Indians to keep everybody out --
Byron R. White: Well, this issue let me say this, we have -- the issue was not argued below as to exactly what the consequences of this being held to be an Indian reservation would be the court went off on the question that it was not a reservation.
Byron R. White: So for the Indian right and whether or not the kind of fishing the Indian town would do, is the kind of a fishing right that --
Harry R. Sachse: We’ve asked --
Byron R. White: -- totally exercised has not been settled.
Harry R. Sachse: That’s correct. And we’ve only asked this Court to determine the question of whether this remains Indian country. Whether this remains an Indian reservation with the remand after that has been determined to the California courts.
Byron R. White: Do you think that it may be irrelevant whether the reservation existed or not if it’s true that the Indians still own the bed of the river?
Harry R. Sachse: I don’t think it would be irrelevant because I think it would matter from the standpoint of criminal and civil jurisdiction. It would only be irrelevant if the Court were to find that Public Law 280 had granted such total jurisdiction to the State of California that even if it is a reservation all that is left is the ownership of the river. So I think that it still is relevant. I’d like to get back to the specific point that this Court is faced with, and that is has this allotment process terminated the reservation? And because I’m running out of time, I’ll just mention this very quickly. That in United States versus Celestine, the Court first had to determine this problem 215 U.S. and in that case, Court held in a careful opinion that the General Allotment Act is inconsistent with termination of a reservation that allotments under that Act and even disposal of land to non-Indians does not terminate a reservation. In United States versus Nice, at 241 U.S., these are all in our brief. The Court held that a special allotment act should be interpreted in pari materia in accordance with the policy of the General Allotment Act, and that a special allotment act on the Sioux reservation, though it required the Sioux to take on that reservation, to take allotments, required the President to dispose of the extra land, did not terminate federal jurisdiction, did not terminate the reservation, did not terminate federal jurisdiction even as to the land that was disposed of to non-Indians. This same policy was recognized more recently by this Court in Seymour versus Superintendent, and also has been codified by Congress in its definition of Indian country, as including all the land within the boundaries of an Indian reservation whether patented or allotted or not. I want to -- there’ve been two very recent cases we mentioned in our brief also, one in the Eighth Circuit, City of New Town and another one the Supreme Court of South Dakota, State versus Molash that have the same consistent interpretation of special allotment acts indistinguishable from this 1892 Klamath River Act. And in closing, I would, since I assume I’m out of time. I refer the Court to page 17 of our brief where we have samples of language that Congress used when it did want to discontinue a portion of a reservation. “The Smith River Reservation is hereby discontinued” Congress said, or “the Reservation lands of the Ponca, Otoe and Missouria Indian reservations be and they are hereby, abolished.” There’s been no confusion between an Act that simply opens a reservation to allotment and settlement, and one that abolishes the boundaries of a reservation. Thank you.
Warren E. Burger: Thank you. Mr. Walston I think we won’t ask you to divide your argument. We’ll let you begin fresh in the morning.
Roderick Eugene Walston: Okay thank you, Your Honor.