Earl Warren: Number 650, John Nicholas, Trustee, the Estate of Beachcomber Motel, Incorporated, Petitioner, versus United States. Mr. Gunn.
John H. Gunn: Mr. Chief Justice and members of the Honorable Court. The importance of the matter that we have before you today is reflected by an analysis in the Government's brief with which we hardly concur showing the increase nationally in debtor's relief proceedings. Now, the Government also points out that in, what I compute to be about 60% of those instances, we're referring to the Chapter XI analysis, the arrangement proceedings. The proceeding results or the proceeding has failed and there is a resulting adjudication in bankruptcy with the replacement by the debtor of a creditors and the trustee. The question, therefore, of the case at hand is to what extent is the trustee or stated even more directly, to what extent is the general estate responsible for income taxes withholding taxes that is to say and other taxes, federal taxes which have been collected by the Debtor in Possession dissipated prior to the adjudication not handed over to the creditor's representative. And must the trustee respond on a claim and pay interest on those funds which he did not receive as well as paying the principal of the funds which we concede. And is he subject to penalties if he fails to return? Those are the problems of with which we're faced today. Problem receives a little added emphasis from the fact that in 1952, presumably because of this increase in debtor's reli -- debtors relief provisions and compositions of creditors, Congress changed Section 64 of the Bankruptcy Act. And in changing it, they subordinated the costs and expenses of the abortive debtor's relief provision to those of the liquidating bankruptcy. When the debtor was taken out after adjudication and the creditor's representative, the trustee replaced him. And in essence, these are the facts of the case of John Nicholas versus the United States that were before Your Honors on today decided coincidentally only ten days apart from an opposite decision on a virtually the same set of facts in the Eighth Circuit. In this case there was a voluntary petition by a motel in Miami for an arrangement with its unsecured creditors. For 40 days under court order, this debtor in possession managed its affairs. And then on a petition drawn by creditors, it was adjudicated as its plan could not succeed. It had in fact been dispossessed of the hotel premises. And a trustee was elected. The Government filed its tax claims subsequently. They claimed not only pre-petitioned interest or pre-petitioned taxes. They claimed as well certain taxes which had been withheld, had been collected as cabaret taxes and as unemployment and social security taxes by the Debtor in Possession but never handed over to the trustee. And presumably, used in the operations of the business or otherwise dissipated. Accordingly, when the Trustee in Bankruptcy took over as the record shows, he received nothing in the way of transferred assets. He subsequently was able by certain proceedings to gather together in the State. And now the Government in its tax claim as the principal of these taxes, as to assess the interest to the date that it filed its claim, as accrued interest thereafter up until the date of payment, and as to penalties against this trustee for his failure to make returns as to the Debtor in Possession's tax collection.
William J. Brennan, Jr.: Are there any of these come out of the trustees' own pocket or --?
John H. Gunn: No sir.
William J. Brennan, Jr.: Thank you.
John H. Gunn: The point that I first made, this is a fight between the general state and the United States rather than the trustee and the United States. Now sir, our briefs I believe contained more history than we can cover in on your summary calendar. They point out that for about 150 years under the English bankruptcy practice; there was a firm rule that there would be no grant of post-petition interest. That in 1911, Justice Holmes recognized that in Sexton versus Dreyfus and those cases are set out. That there was some confusion in the lower cases which we've discussed, which the Government has cited. But that, the principal of no post-petition interest was memorialized as the word we used in the Saper decision in 1949 where this Court said that for a variety of reasons spelled out in that decision, they were not going to allow on award of post-petition interest on pre-petition tax obligations. We believe that the reasons for the denial of this post-petition interest may merit the Court's attention for a few moments because we believe they are as applicable in the situation at hand as they are in the situation where the Government taxes are not incurred by debtor in possession but were incurred prior to the filing of the arrangement petition. We take strong issue with the Government on this point. First place, these decisions say that delay of distribution in bankruptcy is an act of law. It's not attributable to the fault of a court officer if there's a delay in distribution to the Government of its claim that these delays occur as necessary under the Bankruptcy Act. They say further that for the very practical reason, we must have a cut-off date. There's an 1893 decision by this Court, the Thomas case cited in our brief where it says that the cut-off date as to interest is a necessary incident to the settlement of estates. At some point, we must stop, compute all the obligations and pay them. Now obviously, and for a third reason, if the obligations bear different rates of interest, it's unfair to let that interest accumulate after the petitioner's file. It's unfair to the creditors whose claims bear a smaller rate of interest contractually. If they do not bear a rate of interest but you award a rate of interest under some statute as the Government here appraised then the fellow who suffers is the general creditor who finds that where he thought he had some dividend, where he thought he'd received some return on the money he's lost, in fact he receives nothing because that money is consumed in post-petition interest paid the Government. We do not believe either the Government or the entire class of creditors of which the Government is only one party should receive that advantage over the unsecured creditors, and indeed Justice Black, in the Vanston Bondholders case which we've quoted at some length at various places on our brief says that interest itself is a penalty on creditors. And it's a penalty we submit to the Court without any fault on the creditor's part. They suffered the burden as the question has just indicated, not the trustee from this delay. And then alluding again to the Saper case, the 1949 decision which must constitute the backbone of my argument to Your Honors today, the Saper case pointed out that the Bankruptcy Act sought to equate the Government as a participant in Bankruptcy proceedings with other creditors in the bankruptcy proceedings. That since the Government was a party to them, the Government must abide by the same rules and I submit that the Government, since Your Honors' pronouncement on the Spears case, I believe to be a warning that the Government must protect itself and avail itself from the statutory procedures at its command. And I hope by the time I reserve for closing, I can emphasize that point again if it requires emphasis. At any rate the Saper case said that tax claims were the same as other claims and that there was a pattern of distribution prescribed by the Bankruptcy Act that that pattern of distribution should not be varied by other federal legislation in other fields. Where there was a tendency in all the cases as we have cited them, a great many of the cases to find independent internal revenue regulations and to try to give those equality with or priority over a bankruptcy petition or Bankruptcy Act provision. Now, we submit to Your Honors that since the Saper case which did set up the rule that there'd be no post-petition interest, there has been a constant effort on the part of secured creditors and the Government to emasculate the Saper rule, to try to carve out exceptions to it which should have the effect of eating it up without belaboring those points, they're treated in the brief, but they're the type of situations where the estate proves to be solved then obviously interest should be given, the situation where the security itself produces substantial income. Then in that situation, the creditor who has that security should receive its benefit because the unsecured creditor behind him suffers no loss. We believe that each of those arguments is equally applicable here where the interest that is sought is against the general estate because of the failure of the debtor, its antagonist, we submit, to withhold the monies or return over the monies that it was required by statute to withhold and account for. We believe that the Government in the case at hand and were successful before the Fifth Circuit is attempting to create an exception in which it visits the vicarious liability on an innocent party, the unsecured creditor that stands behind the Government or the tax creditor who stands in the same -- on the same plane with the Government. And we believe that the Government by attempting to create a vicarious liability on that trustee which is the door into the general estate threatens to secure to itself an unwanted advantage, an advantage that it does not need if it tends to its own bankruptcy affairs. And that by doing so, it threatens seriously the whole fabric of bankruptcy administration; a fabric which the Saper case says provides an orderly rule of administration which should not be ordered because of internal revenue statutes which might be held. And we must say to Your Honors, we find nothing that would directly conflict --
Byron R. White: Well, why do you concede the principal there?
John H. Gunn: Sir, I -- what principal?
Byron R. White: Of the tax.
John H. Gunn: Well, we concede the principal of the tax because we believe that --
Byron R. White: I mean as an expense for administration.
John H. Gunn: Because sir --
Byron R. White: Why do you concede that the bankruptcy trustee must treat taxes incurred by his predecessors namely the debtor Chapter XI as an expense of his administration?
John H. Gunn: Because that bankruptcy statute requires it sir.
Byron R. White: And what -- what does it say?
John H. Gunn: Section 64(a) in setting up the first priority says there should be first paid out of bankruptcy estates, the costs and expenses of administration. The 1952 Amendment recognizing that we had a case -- that we could have a case in which the debtor relief action would use up all the costs and expenses of administration, there wouldn't be any funds available for anyone who administered a liquidating bankruptcy subordinated the costs and expenses of the abortive debtor relief position to those of the succeeding liquidating bankruptcy, so I'm conceding only what Congress has prescribed in the statute.
Byron R. White: Well, I know but you're conceding that -- that your bankruptcy trustee must treat -- must pay as an expense of his administration.
John H. Gunn: No sir.
Byron R. White: Taxes -- taxes incurred by Chapter XI.
John H. Gunn: No sir, I think the word there is his. I can see that he must pay as an expense of administration, as a post-petition administration expense. He must pay the principal of the taxes incurred by the Debtor in Possession.
Byron R. White: In a prior -- in a prior Chapter XI --
John H. Gunn: That's right sir because they occur after the filing of the bankruptcy petition.
Byron R. White: Well now, you wouldn't -- you wouldn't think for a minute that after there had been a difference here, if the debtor had himself filed that -- if the time for filing a tax return had occurred during the time the debtor has been in possession. And the debtor had filed his return without paying the tax, you would still say that bankruptcy trustee would have to pay that principal, wouldn't you?
John H. Gunn: Yes sir, I think either case he has to pay the principal.Our basic argument is the interest which is --
Byron R. White: Well, I understand that but I'm --
John H. Gunn: Because after the election of the trustee, the continuing interest to the date of payment and the penalties against the trustee for not returning it.
Byron R. White: Well, do you think the -- well then do you think if the -- do you think that the Trustee in Bankruptcy had an obligation to file a return?
John H. Gunn: No sir. I'll deal with that in just a moment when I get to the question of penalties.I too very strongly didn't know sir.
Byron R. White: You just -- you mean you only had -- he didn't even have an obligation to pay the tax on time.
John H. Gunn: No sir, he never had an obligation to pay the tax until he (Voice Overlap) until all the expenses -- until we knew where all the expenses of administration were. I think he fell in the trap that Your Honor has discerned quite clearly in the King case. He's paying subordinated taxes under 60 -- he's being asked to pay subordinated taxes under Section 64(a) before he pays those which the statute says are prior thereto. I think if he did do that, he might find himself in the same situation as Mr. King, the trustee in the case that I just mentioned Your Honor, which is in the briefs before Your Honor and which held him responsible for failing to pay the Government and when he had paid subordinate creditors.
Byron R. White: Well, what's the -- what's to keep you though from -- I know you've already conceded it but what's -- what's really -- would prevent a bankruptcy trustee in position of this trustee from arguing that Chapter XI taxes should be paid in a subsequent straight bankruptcy proceeding only if other pre-petition taxes are paid.
John H. Gunn: Well, I think sir that --
Byron R. White: What is that? What provisions of bankruptcy --
John H. Gunn: I believe it might well be argued. I think -- you mean what requires the immediate payment?
Byron R. White: No. What requires you're treating this -- the principal of this tax as an administrative expense instead of -- instead of as a pre-petitioned accrued tax obligation?
John H. Gunn: Section 64(a) of the Bankruptcy Act, sir.
Byron R. White: What does that say?
John H. Gunn: It says that -- it's under decisions understated that any expenses incurred subsequent to the filing of the petition in bankruptcy.
Byron R. White: Well, I agreed but this -- this was not incurred. This was not incurred after the petition in bankruptcy. Yes, it was.
John H. Gunn: It was -- it was incurred subsequent to the filing of the petition for the arrangement which is the petition --
Byron R. White: Well, do you concede then that we have to -- that you have to go back to the -- that the bankruptcy trustee himself has to go back to the original filing date?
John H. Gunn: Yes sir, for purposes of paying those subordinated administrative point. What my argument sir and we have --
Byron R. White: And you picked up -- do you pick up all the obligations then that the -- that the Chapter XI trustee or debtor possession had?
John H. Gunn: Insofar as the assets are sufficient to pay them after the payment of the expenses in the liquidating bankruptcy, Justice White.
William J. Brennan, Jr.: Well, let's see if I understand that you're turning these all into the 64(a) petition of the Chapter XI for that purpose.
John H. Gunn: Well sir, I'm saying that since 1952, when this Act was amended, it is our position that there are three classes of creditors rather than two with whom we're dealing this afternoon because we're not talking about wage claims or any of the other classes. We're saying that those claims which arise prior to a petition of any sort for relief under the Bankruptcy Act whether it'd be liquidation, reorganization, or arrangement, are entitled to certain estates. They're entitled to be paid under the fourth priority under Section 64. But insofar as other taxes are incurred subsequent to the filing of the petition where federal jurisdiction attach any petition --
William J. Brennan, Jr.: In this instance of Chapter XI --
John H. Gunn: That's right sir.
William J. Brennan, Jr.: Alright.
John H. Gunn: Because of the relation back part of Section 378 of the Bankruptcy Act, they are administrative expenses. The question is, since 1952 and we believe the Government overlooked in this situation and the Fifth Circuit overlooked it back that there are two -- there are priority -- there are two priorities within Section 64(a), a priority within a priority as it were by statute. And that is, one, the liq -- the expenses of the liquidating bankruptcy which comes first and this is unequivocally set out. And secondly, insofar as there's money left, then the administrative expenses of the abortive arrangement preceding the adjudication, preceding the liquidating bankruptcy are paid. Now, our position simply is this. We talk about this being an obligation of the trustee but as Your Honors have discerned from this question, it isn't an attempt to fix this on the trustee. This is an attempt to fix this on the general estate and subordinate general creditors take dividends away from them to pay the Government a tax claim that's running. And a tax claim that's running during a period of time when the cases have all said, tax claims cannot run because it's necessary to put a cut-off date to stop -- stop all obligations running so we can (Voice Overlap) distribution.
Byron R. White: One of the -- one of the Chapter XI proceeding had lasted long enough for the -- for the debtor to file but not pay the tax and to accrue some interest. And then the tap -- then the -- then the bankruptcy petition had been filed. Then I suppose the interest up to the date of the bankruptcy petition at least would be -- would go along with the principal.
John H. Gunn: Sir, with that I have no dispute and I do not dispute you -- that with you here this afternoon nor do I dispute that with the Government this afternoon. I think the interest right up until the date of adjudication should be paid. Our complaint is against interest after the date of adjudication, interest after the election of the trustee, and penalties against this trustee for his failure to report. Now, in this general connection, the Government has, in our judgment, ignored the three-time periods that I've told Your Honor about which are respectively pre-adjudication that that is -- forgive me -- pre-petition and then post-petition but pre-adjudication and then liquidating bankruptcy. They have ignored that and they have been in effect said everything must be pre-petitioned or it must be post-petitioned. And we say to Your Honors simply that this is not the case. We believe that this is the basis of the Fifth Circuit's decision. We believe it to be in serious error because we believe that the effect of this is to put -- to face a trustee in a liquidating bankruptcy within an insoluble dilemma. The first thing, he must stop now when the Government's claim is filed and he must pay it. And if he pays it, without ascertaining that they are liquidating bankruptcy expenses, he's subject to the surcharge we've mentioned. If he fails to pass and delays paying it, he pays interest which comes out of the pocket of his general estate. Now, let me say with respect to the penalties that Your Honors have asked about. In the first place, I consider and I believe that there were several decisions of this Court which say that interest is itself a penalty. The trustee has been penalized because he did not return these taxes. We find the only obligation in the statutes for our trustee to make a tax return to relate to income taxes. We do not find any statutory duty for him to return any taxes on behalf of this defaulting debtor in possession who is, we submit to Your Honors, a violent antagonist of the creditor's man of trustee. And we don't believe that the creditor should be visited in this particular case with these defalcations. We find that the only case which the Government seems to rely on is the Boteler case, a decision of this case. But we find that the Boteler case simply took a trustee who hadn't himself paid some California estate taxes on his own operation. And because he didn't pay them, they penalized him. But this is not our case. The Government seeks to penalize our general estate, our trustee for the shortcomings of his predecessor, debtor in possession. This, we submit, cannot be done. We further submit that the Government's other basis for this is judicial code Section 960 set out in the briefs and that particular section says only that an operating trustee must pay federal and estate taxes. I have held a few moments for rebuttal.
Earl Warren: Alright. Mr. Featherston.
C. Moxley Featherston: Mr. Chief Justice, may it please the Court. Before answering directly the argument which counsel has made that the Government's position is unfair and clearly inequitable, I think it's important to make very clear the period with which we're dealing the nature and character of the tax since which formed the basis of this dispute and to consider some of the tax collection statutes which are applicable in this circumstance. Now, the Debtor in Possession here operated the business from August 5th, 1958, the date on which the petition was filed, that is the petition for an arrangement to September 17, 1958 when he was adjudicated as bankrupt. The taxes which formed the basis of this dispute were incurred during this period while the Debtor in Possession was operating the business under the provision of the Court. We think this is important because what counsel is actually asking this Court to do is to extend the rule relating to penalties and interests incurred during the prebankruptcy with respect to prebankruptcy claims. He is asking the Court to extend that rule to penalties and interests which are incurred after the bankruptcy occurs, after the business has been placed under the supervision of the Court. Now, the taxes which formed the basis of this dispute fall into four general categories. First, the income tax withholding. The Debtor in Possession employed certain employees and subtracted from their wages, wages which he would otherwise and have to pay them, the amount of the tax -- the income tax which he was supposed to hold. Now, as a result of that withholding, the employees received the credit for the income tax and could in fact have received a refund even though that money never found its way to the treasury department. The same thing is true with respect to the social security taxes. Now as to the cabaret tax, the tax worked like this. The customer went into the cabaret and had a bill, let's say for $20. The statute laid a tax of 20% which meant that $4 was then added to the bill. Now, this $4 never really became any asset of the operator of the cabaret because it was always, if it fell in the place to which it was truly destined, it was always earmarked for the Government. These are the bulk of the taxes which are here in dispute. In addition, there were the employer share of the social security taxes and the unemployment compensation tax. Now, substantial part of the revenue which is collected by the federal government comes from withholding. And very substantial sums are in the hands of men who operate business. Congress accordingly has adopted extraordinary measures to see that these taxes are collected. Now, the basic theory of the collection of these taxes is that the employer or the operator of the business simply serves as a conduit of those taxes to the federal government. Even though he has a conduit, he has made personally liable however and becomes subjected to penalties and interest in appropriate circumstances. The purpose of imposing the personal liability as to permit the use of the summary collection procedures which are applicable with respect to other taxes, but more important, with respect to this controversy which is before the Court. Section 7501 of the Internal Revenue Code provides that any person who collects or withholds a tax and that money has to be paid over to the federal government, the amount of the tax so collected and these were the words of the statute, the amount of the tax so collected or withheld shall be a special fund in trust for the United States.
Byron R. White: Well then, why did you file a statement of expenses? Why didn't you file a petition for a turnover where there is a declamation particularly or something like that?
C. Moxley Featherston: There is the possibility, Mr. Justice White, that there were no funds available to be turned over at that particular time. They had filed the -- there were prebankruptcy taxes of course.
Byron R. White: But you don't mean to tell me that your -- that your trust there disappears because there's commingling.
C. Moxley Featherston: It does not. During the period of bankruptcy there is a distinction between the period that the business has operated under the supervision of the Court and the period in which it is not. The cases upheld that where the business is in the hands of the private individual, is not operated under the supervision of the Court, it is necessary to trace the trustee --
Byron R. White: This means you're bringing us here though under your own administration expense theory.
C. Moxley Featherston: Yes.
Byron R. White: And that's what it's up here on and I don't see how you can -- if you wanted to litigate it on another basis, you ought to go ahead and litigate it on then.
C. Moxley Featherston: Your Honors we're not contending that we're entitled to the -- to the interest and penalties here as a trust fund. That is not our position. I point this trust fund out to you to point it out that the -- that the Debtor in Possession was actually using money which belonged to the United States during this period.
Byron R. White: Well, what's that -- what does that have to do with priority here though?
C. Moxley Featherston: It has -- it has to do with priority because borrowed funds during the period that a debtor is in possession are funds on which the Debtor in Possession ordinarily has to pay interest. And if those directed to his -- to the contention which counsel has advanced to the effect that there should be no post-petition interest because during the -- the statute specifically provides that the Court, the Bankruptcy Court may authorize the borrowing of money and when the money is borrowed, it's necessary of course to pay interest. And so the idea of paying interest following a petition in bankruptcy is not as far as his counsel would have us -- have us believe. Now we believe that the answer to the question which is before the Court has been given by Congress in very explicit terms. Section 960 of the Judicial Code provides that any officers or agents conducting any business under authority of the United States Court shall be subject to our federal state and local taxes applicable to such business to the same extent as if it were conducted by an individual or corporation. Now, this statute was a subject to the decision written by this Court in 1941 in the case of Boteler versus Ingels which came out of California. In this case, the State of California claimed a 100% penalty against the Trustee in Bankruptcy who is engaged in liquidating the assets of a bankrupt corporation. The bankrupt corporation had been engaged in the operating of a dairy. It operated trucks. The state license fee was due on January 1st, 1937. It was not paid. The trucks were sold on February 27th, 1937. The State of California claimed a 100% penalty because those license fees had not been paid on time. The trustee offered the State the amount of the registration fees at the time the trucks were sold. The State insisted upon the penalty and this Court upheld the imposition of the penalty. The trustee there made precisely the same argument which the trustee is making here, namely, that penalties against prebankrupt claims were not allowable. Therefore, these claims were not allowable. This Court rejected that contention and held at Section 57(j) of the Bankruptcy Act did not prevent the imposition of penalties against the Trustee in Bankruptcy. The Court with respect to Section 960 says that Congress has here declared with vigor and clarity that a trustee who operates a business must do so subject to the state tax the same as it had business who were owned by an individual or corporation. Now, this -- this has been a landmark decision in the bankruptcy area. It has never been questioned. We feel that it controls here. The standard is this. If a private individual or corporation is subject to the tax, then the trustee operating the business would be subject to the tax. Now, counsel says that the trustee here did not operate the business, but the Debtor in Possession did operate the business and the Debtor in Possession is an officer of the Court. The debtor in possession is an agent of the Court, he files clearly within this statute.
Byron R. White: Well, nobody did really disputes you that if -- if the debtor had gone on operating the business and hadn't paid his taxes -- paid these taxes that it would have to pay interest. The real question is the -- that there is a straight bankruptcy that intervenes at some point.
C. Moxley Featherston: Yes, Your Honor and with respect to that --
Byron R. White: Well, by the way, could you tell me the provision in the Code, are there any, or the Bankruptcy Act which imposes on the bankruptcy trustee. The obligation to file a tax return for a debtor in possession --
C. Moxley Featherston: Your Honor --
Byron R. White: -- and incurred the taxes but which were not due or payable until after a bankruptcy petition had intervened.
C. Moxley Featherston: Your Honor please, there is no provision in the Bankruptcy Act specifically on that point.
Byron R. White: Well, how about --
C. Moxley Featherston: We --
Byron R. White: -- the internal revenue law?
C. Moxley Featherston: In the Internal Revenue Code, it say -- it's our position that Section 6011 which specifically provides that a person who is liable for a tax shall file a return. And as we understand the Bankruptcy Act, it makes the trustee who succeeds a debtor in possession liable for the tax. Section 342 of the Bankruptcy Act for example, says that the Debtor in Possession has title and exercises the power of a trustee, and is subject to all times of the control of the Court and Section 302 provides that when a bankruptcy proceeding follows an arrangement proceeding or a debtor in possession, the date of the adjudication is related back to the date of the filing of the petition. So you must view it from the time that the petition is filed in the Bankruptcy Act.
Byron R. White: So you say that the --
C. Moxley Featherston: Bankruptcy proceeding.
Byron R. White: You say the bankruptcy trustee inherited the obligation to pay the tax and to file a return.
C. Moxley Featherston: That is correct, Your Honor. That is correct.
William J. Brennan, Jr.: Well, I'm very explicit though with --
C. Moxley Featherston: It -- by adding one more section of the Bankruptcy Act, if I may, to this presentation, Section 3782 provide that upon the entry of an order that the bankruptcy shall be proceeded with, the proceedings shall be conducted so far as possible in the same manner and with the light effect as if a voluntary petition for adjudication had been filed and a decree of adjudication had been entered on the date when the bankruptcy petition was filed. So --
Hugo L. Black: Is that published in your brief?
C. Moxley Featherston: Yes, sir, I --
Hugo L. Black: Is that under your brief?
C. Moxley Featherston: 3782, yes sir. It's -- it's on page 30 of the appendix, sir. Now, the text writers and the decisions of the Court emphasized over and over again that where you have a bankruptcy trustee exceeding -- and a debtor in possession arrangement that there is no break in the continuity --
Byron R. White: Well, I might that even that just gets you though, that just gets you to the point to ensure the bankruptcy trustee owes the tax. He owes that principal of the tax then he has to pay it. And that's conceded by the other side. And -- but what's really an issue here is -- was when do they have to pay it and in what circumstance?Do you -- do you agree that -- do you agree that there are two categories of administration expenses under 64(a) or not?
C. Moxley Featherston: Your Honor, this is a -- that Section 64(a) sets up a sub-priority as we understand you to cover liquidation expenses. But that has nothing whatever to do with the question as we see it as to whether there is a liability for interest. This went in to the --
Byron R. White: Well, just a minute. Now, let's just assume for the moment that if you were the -- bankruptcy trustee has to pay the tax, the principal of the tax, but he only has to pay it as an administration of expense when in as administration expenses are normally paid. And he finds when he takes over as trustee, sure, I owe a tax. And under 64(a), I am liable to pay it as an expense of administration. When as and if, administrative expenses are allowed and paid, and that doesn't mean, and that this principal of this tax would be subordinate to my own administration expenses, and hence, I cannot pay it on January 20 or whatever date it was, because if I pay it now, I could never pay the priority administrative -- administration expenses.
C. Moxley Featherston: Well, Mr. Justice White, I think that that approach does violence to the concept that this is one continuous administration.
Byron R. White: Well, I don't think it does violence to it at all. It serves it.
C. Moxley Featherston: Well I -- if the claim which was in question --
Byron R. White: He accepts the claim, the trustee says I've -- we're all then proceeding here, I accept and I -- and I have to pay as an expense for administration the tax that is already approved.
C. Moxley Featherston: Suppose that the --
Byron R. White: And you want to go and say -- and not only that but you have to pay it on January 20 and file a return or else.
C. Moxley Featherston: Certainly there is no problem with filing the return. That creates no obligation, no problem for the Trustee in Bankruptcy. The law says that the return shall be filed --
Byron R. White: But it doesn't unless you don't.
C. Moxley Featherston: And --
Byron R. White: But it doesn't unless you don't file it.
C. Moxley Featherston: And so if -- the return can be filed without creating a hardship to anyone.
Byron R. White: Yes, but you wouldn't -- if he doesn't -- if he isn't liable to pay the tax on that date, you really wouldn't care whether he filed a return on it.
C. Moxley Featherston: Well, it's our view that you --
Byron R. White: That you want to go to the next step, don't you?
C. Moxley Featherston: It's our view that he must pay the tax. Now, of course there are situations where he doesn't have assets to pay the tax.
Byron R. White: Well, how about the situation where there's -- where there is only X dollars in the estate and the prebankruptcy petition, the Chapter XI tax obligation equals the amount of the assets. Now, what should the bankruptcy trustee should do to -- trustee do? Pay it on January 20 and then have no funds for priority administration service?
C. Moxley Featherston: For the immediate term about the liquidation expenses, in those circumstances, he is in exactly the same position as he would be with respect to any other liability incurred by the Debtor in Possession which bears interest. If he didn't have the money to pay it, he wouldn't pay it, of course, except that (Voice Overlap) except with respect to the trust fund.
Byron R. White: That doesn't -- that doesn't get you by the penalty, does it?
C. Moxley Featherston: Except with respect to the trust fund. The penalty is attributable or the penalty is due only if he fails to file a return. Now, he doesn't have to pay the tax when he files a return. And so --
Byron R. White: Oh no, or only at the expense of that same interest.
C. Moxley Featherston: That's right. That's correct. But he can -- that the penalty is laid for failing to file the return. The interest is applicable if he does not pay the tax on time. Now, bear in mind that these are -- these are trust funds also. These are -- these are monies which belong to the United States.
Byron R. White: When you say he had been on position that he would be involved with respect to any other obligation of the Chapter XI proceeding which bears interest.
C. Moxley Featherston: Yes sir.
Byron R. White: Well, I'm not so -- if he were, what he would do is subordinate. He would subordinate the Chapter XI administrative expenses to the expenses of the bankruptcy petition -- proceeding.
C. Moxley Featherston: If we're correct, of course --
Byron R. White: If there's not enough to pay both, who gets paid first?
C. Moxley Featherston: If there's not enough to pay them both, if we're correct with respect to the trust fund theory, then those money has never been --
Byron R. White: Well -- wait a minute now, you can't go back on that now. Let's talk about just administrative expenses.
C. Moxley Featherston: Alright. Then the expenses of liquidation would have to come first. If -- the trust fund, it doesn't apply.
Byron R. White: They wouldn't come first though if he had already paid them out on January 20 when they were due according to you. You would just reverse the priorities that were set up in 64(a).
C. Moxley Featherston: Well, if he have paid them out, if he -- if the Trustee in Bankruptcy had paid more, then the share in which the Government was entitled under the first priority --
Byron R. White: Yes.
C. Moxley Featherston: -- it would be possible for him to apply for a return to the Internal Revenue Service. And it's my understanding that this is a practice of the Internal Revenue Service to return money where more than the amount when it is received more than the amount to which it is entitled under the first priority. Certainly, if any creditor or any debtor can rely upon anybody, returning money, it should be possible to get it back from the United States. It doesn't -- you don't run the risk of bankruptcy in these circumstances and the inability to get it back on account of the inability to pay. We think that Your Honor if you -- I think that the approach that you're taking completely overlooks the continuing -- continuity which exists between the Debtor in Possession and the trustee.
Byron R. White: I find -- I just don't agree with you. I think if it accepts it, he walks right up to you and says, “I know that Chapter XI proceeding owe some taxes and I'm going to pay him as an expense of the administration according to the priority that they're given.” That's what he says and I don't know -- now how do you -- what do you mean that ignores the continuity?
C. Moxley Featherston: Well, if you -- if that is the position then I think that I've answered your question if there is and not enough, if we're correct with respect to the trust funds and the Government is entitled with the trust funds, if we're incorrect with respect to that and it is not in fact a trust, then the liquidation expense in the succeeding bankruptcy would come first. I think that that is quite clear.
Abe Fortas: Well, the cabaret --
C. Moxley Featherston: But that's not what we have here if, Your Honor please. Here, the record shows that there's $8,000 in the bank.
Abe Fortas: Yes.
C. Moxley Featherston: And I suppose that it's in a deposit in drawing money, drawing interest itself which eventually will increase the amount which may be distributed to the general creditors or which may --
Byron R. White: What if you were a bankruptcy trustee, and that you had the basic problem of it, what is the effect to pay the tax now and perhaps run out of money before you pay the priority administrative expenses and have to rely on getting the money back to the United States.And do you think you might be subject to some surcharge yourself as trustee?
C. Moxley Featherston: If --
Byron R. White: If I were a creditor for other administrative expenses, I wouldn't like that much because you'd already spend my money on somebody that I have priority over.
C. Moxley Featherston: One way to -- one way to do that, of course, would be to have a condition specifically stated in the order authorizing the payment to the effect that it is paid to the Internal Revenue Service on condition that it will be returned. The revenue service maintains the expense accounts in many circumstances where there have been conditional payments of taxes. So I think that the -- the risk of paying the Government would be just about as little as it would be possible to have any situation like that. We think that if you look at the Boteler versus Ingels that you have here a standard which has been laid down by this Court, by Congress to the effect that in determining whether or not a liability is to be paid and when it is to be paid, you treat a trustee in bankruptcy even though he succeeds a debtor in possession in exactly the same light as you would that if it were a private individual or corporation. Now, as to the Saper case relied upon so heavily by counsel, let me point out that this case involved claims which were incurred prior to the adjudication of bankruptcy. An interest was claimed by the Government on that. The Court there pointed out that it was historical. That there was a cut-off point and that after the cut-off point interest it was not paid on any claims which were outstanding against a bankrupt. And the Court explained that it would be unfair because of the varying rates of interest to allow interest against creditors in these circumstances. The Court was concerned with the effect of the 1926 and 1938 Acts amending the Bankruptcy Act. Under the Bankruptcy Act of 1898, taxes were given an absolute priority and they carried interest until they were paid. Under the 1926 Act, the taxes were concerned to a fourth priority. The Chandler Act of 1938 provided in Section 57(n) that the Government should be required to file a proof of claim just like other debtors. The Court concluded that the purpose of this legislation was to assimilate tax debts to other debts, and prebankruptcy interest was not allowable on other debts therefore it was not allowable on tax debts. But it's interesting to note that the opinion says nothing about Section 960. It says nothing about Boteler versus Ingels. It says nothing about the administration expense either. We believe that it has absolutely no applicability when you start dealing with the administration expenses. The reasoning of the opinion simply doesn't apply. We contend that it would be inequitable and unfair to allow a trustee in bankruptcy as this one has apparently done, to keep the money which under the trust fund theory actually belongs to the United States if --
Byron R. White: Mr. Featherston, you ask me this, let's assume that in Chapter XI proceeding, the Debtor in Possession incurs an obligation for this body under an invoice that says that this is not paid when due, it will draw 6% interest and it's due 30 days after the invoice. And before the 30 days is up, there is a straight bankruptcy if there's adjudication. And the bankruptcy trustee says, “Well, here I owed for this lumber,” or whatever it was, then that, “as a second class administration expense.” And he treats this as such but the claimant filed a statement of expenses and he wants interest. He wants that at 6% interest on that post-bankruptcy petition interest. First sought to the terms of the invoice, what's the answer?
C. Moxley Featherston: It depends upon whether he has obtained the authority of the Court to carry on the business at this time.
Byron R. White: Well, this was at Chapter XI.
C. Moxley Featherston: Well he had -- if the Court outlines the circumstances in which the --
Byron R. White: Alright.
C. Moxley Featherston: And the conditions under which the Debtor in Possession may carry on his business, he's under the supervision or --
Byron R. White: Alright, let's just -- let's just assume that the obligations to pay that the -- the lumber -- the purchasing of the lumber was authorized, and the terms were authorized by the Court, namely, if not paid when due it would draws 6% interest?
C. Moxley Featherston: It withdraws 6% interest.
Byron R. White: Right on -- right on through the bankruptcy.
C. Moxley Featherston: Yes sir. You say that --
Byron R. White: Well, you have to say that I suppose.
C. Moxley Featherston: Yes, well --
Byron R. White: Don't you?
C. Moxley Featherston: I think it's undoubtedly true. How else -- who would bar -- who would lend money to a trustee in bankruptcy or debtor in possession unless he's going to draw interest? The interest is tremendously important if the -- if the man is to be rehabilitated. And the interest is not at all far into the concept of a debtor in possession or a trustee in bankruptcy.
Byron R. White: But you -- what you're really getting at is you're not -- there's no basis for distinguishing the private claim from the Government's tax claims in this regard.
C. Moxley Featherston: No sir, we're not -- we're not making any special claim whatever on behalf of the Government. We're saying that the Government is entitled to equal treatment that -- that the money which has been used really belongs to the Government.
Byron R. White: What if the -- now just remember that the -- that this straight bankruptcy intervenes in this 30-day invoice. And the Trustee in Bankruptcy pays the invoice when it's due. Well, how about -- is he entitled to do that?
C. Moxley Featherston: Here again, it would depend upon the terms and conditions specified on the report. Assuming that they are not --
Byron R. White: Excuse me, you can't get me this time with that because all the Court did was -- all the Court did was approve the terms of the contract which was payment 30 days hence with 6% interest afterwards.
C. Moxley Featherston: Then it --
Byron R. White: That's all there is.
C. Moxley Featherston: Then it would be an administration expense on the Debtor in Possession.
Byron R. White: That's right.
C. Moxley Featherston: The liquidation expenses would come ahead of that.
Byron R. White: Well I know but I just want to ask you that. Can he pay it when it comes due?
C. Moxley Featherston: Yes, I would think so.
Byron R. White: And then why are you getting it back in that private creditor?
C. Moxley Featherston: Well, there are proceedings which are brought in connection with the recovery of excessive funds. I'm sure that the risk is far greater in connection with the private creditor.
Byron R. White: Could you think the Trustee in Bankruptcy would be entitled to pay that on and would have to do these the payment and indeed they have to do these payments.
C. Moxley Featherston: Well, I think that preterm would require him to wait and see whether or not -- whether or not, there would be sufficient assets that you continue to accrue (Voice Overlap) yes sir, interest would continue to accrue.
William J. Brennan, Jr.: There's really a dilemma.
Byron R. White: This really is a -- really a --
William J. Brennan, Jr.: It's barred.
C. Moxley Featherston: This is their product. It is having barred with funds in the first place.
Byron R. White: He didn't.
C. Moxley Featherston: So it's our conclusion that the Fifth Circuit was correct in the decision which it made.
Earl Warren: Mr. Gunn.
John H. Gunn: Sir, I'll be very brief. I do not believe that this trustee could safely pay the money on the administrative long that had been made with the Debtor in Possession period. I do not believe that in the conventional situation absent some untested expressed priority increasing language, the lender in a debtor in possession situation can consider himself protected on parity with liquidating creditors in the liquidating bankruptcy. Further, I say to Mr. Justice White who I believe asked the question on Mr. Featherston whether or not a turnover order could have been brought and a proof of claim framed along the line of this were trust fund to have the funds turned over. Mr. Featherston's answer, as I recall it, was that it may very well have been possible that there was no money there at that time. And I think if Your Honors will look at the record you will see that the government claim was filed in 1963 and that from 1961 on the trustee had in his possession the $8,842.13 that Mr. Featherston spoke to Your Honors about. That's at page 18.
Byron R. White: Yes. But what's you're answer to Mr. Featherston of this question, what banker or what lender in his right mind would ever lend a dollar to an operating trustee under Chapter X or Chapter XI situation if all that has to happen was a bankruptcy to intervene and can have a -- and he would never reflect another dollar of interest, who would ever done that?
John H. Gunn: None sir, I believe --
Byron R. White: You wouldn't, would you?
John H. Gunn: No sir. And I'm going to say so that I have advised lenders who have done so with disasters consequences. I would not do it.
Byron R. White: What you've been saying is that -- or what you're really saying is that you're just not going to have chapter -- effective Chapter X and Chapter XI borrowing that for --
John H. Gunn: No sir, I believe it can be done in one of two ways. And I certainly (Voice Overlap) it's even the point at hand. It can be done by a collateralizing instrument with the Court approving and so that the creditor has security to face the liquidating bankruptcy.
Byron R. White: But that doesn't solve the interest.
John H. Gunn: Well sir --
Byron R. White: Just giving collateral doesn't solve the interest.
John H. Gunn: They will safeguard him on his principal. And I have --
Byron R. White: Well, it's on the list, it's on the other. I don't -- now talking about his principal. I'm talking about if he'd be able to earn something from his money.
John H. Gunn: I doubt seriously that there is an effective way to do it. Secondly, I will say to Your Honor that -- I understand a little bit quite clear that these loans, these pre -- this debtor possession loans must be confirmed, must be covered and approved in the order of confirmation to enable them to stand up in subsequent proceedings. I believe the Bankruptcy Act were firmly ample. That is not in the briefs either.
Byron R. White: Yes, but the court approval of a -- of any of these transactions wouldn't be an answer to you -- wouldn't give you any answer of -- that's all you have to have you move this case.
John H. Gunn: No sir, I don't say that. I say that this man is not -- I'm apprehensive that this man jeopardizes the loan itself in a debtor in possession situation because he can only recover back in aliquot portion of what remained after the liquidating bankruptcy expenses are paid. I say the very loan itself is peerless. Then I say that interest is a matter of second regard there. And yes indeed, I believe that unless there's a court order collateralizing this man and certainly assuring that if he's interested up until the date of adjudication or confirmation whichever occurs and after working the case of confirmation, that the loan is very risky. Now, may I say so that I didn't believe that the trust fund argument was going to come up because I understood the Government to say that they were abandoning. Clearly, the trust fund argument has no application or whatsoever to interest collection. And it has no application whatsoever to penalty funds. And I don't think if there's no raise involved or if the raise has been dissipated, that there's any possibility of it applying to the situations that we're concerned with here. I want -- but my last point to say that the Boteler case clearly involves the case where the trustee himself operated the vehicles on the highway of California. It did not involve a situation where the trustee had to respond for the Debtor in Possessions operating the vehicles on the California highways. I think in fact this California statute has contrasted with the federal statute makes no difference. Now lastly, may I say that it is my hope or our hope in presenting this case that we can encourage the Government which is deriving considerable revenue from bankruptcy situations to be in and to start in this situation so that they are participants when the question of loans or advances or payments on tax accounts can be made so that they can ask the referee to compel the trust -- to compel the Debtor in Possession to post an adequate indemnity bond to prevent just what has occurred here. They can ask the trustee for payment and if he refuses and there's money available ask the referee for an order directing his payments then and seek the relief at that time. I do not believe the Government having great statutory privileges in this situation can sit back, rest on their position, and subsequently seek to penalize the general estate. And we submit to those reasons the Fifth Circuit should be reversed.