Opinion ID: 382765
Heading Depth: 2
Heading Rank: 1

Heading: Pre-Petition Penalties and Post-Petition Interest

Text: 21 The district court held that the IRS was equitably estopped 5 from collecting pre-petition penalties and post-petition interest from the debtors in this action because of the failure of the government to reveal its intention to make such claims in the Chapter XI proceedings, thereby misleading all participants in the arrangement who relied to their detriment upon the finality of the Proof of Claim. The IRS contends that the district court erred in applying the doctrine of equitable estoppel, and that the judgment of the district court, at least in this respect, should be reversed. 6 22 It is well-established that obligations for pre-petition penalties and post-petition interest that accrue on a tax debt comprise personal liabilities of the debtor, and survive payment of the principal debt pursuant to an arrangement. In Bruning v. United States, 376 U.S. 358, 84 S.Ct. 906, 11 L.Ed.2d 772 (1964), the Supreme Court, confirming that post-petition interest on a nondischargeable tax debt was not allowable against a bankruptcy estate, 7 held that such claims could be asserted against the discharged bankrupt. The Court reasoned that the policies underlying the prohibition against the collection of post-petition interest claims against a bankruptcy estate-avoidance of diminution of the amount payable to competing creditors and administrative convenience-are inapplicable where the personal liability of the debtor is involved. Id. at 362-63, 84 S.Ct. at 908-09. In Hugh H. Eby Co. v. United States, 456 F.2d 923 (3d Cir. 1972), we held that the rule of Bruning is applicable to a Chapter XI arrangement. 8 On the basis of Bruning, we declared that Congress, in determining that tax debts were nondischargeable, 9 had made a judgment that the importance of financing the government outweighs the value of giving the debtor a fresh start. Id. at 925. Eby extended the Bruning rationale by declaring that the rehabilitative purpose of the Bankruptcy Act was not an obstacle to holding the Chapter XI debtor personally liable for post-petition interest on a tax debt where the debtor had acquired assets subsequent to confirmation of a Chapter XI arrangement. 23 In similar fashion, although claims for pre-petition penalties on a tax debt are not allowable against a bankruptcy estate, 10 debtors may be held personally liable for such penalties following confirmation of a Chapter XI plan of arrangement. In World Scope Publishers, Inc. v. United States, 348 F.2d 640, 642 (2d Cir. 1965), the Court of Appeals for the Second Circuit found support for this result in the principle that there is no reason to believe that (the) deterrent function achieved by the imposition of tax penalties is less worthy than the rehabilitative function served by Chapter XI proceedings. 24 With these principles in mind, we turn to the question whether IRS should be estopped from asserting liabilities for penalties and interest against the debtors in this case. Traditionally, an equitable estoppel has been imposed when one party has relied to its detriment on the conduct of the other party, and such reliance was justified. The record supports the conclusion that the debtors relied on the conduct of the IRS during the arrangement as signifying that the IRS would not assert claims for pre-petition penalties and post-petition interest following completion of the plan. The IRS does not deny that the debtors so relied. 11 25 Nor does the IRS question that the debtors' reliance would work to their detriment if collection of the claims at issue here is permitted. That conclusion is also supported by the record and follows from an understanding of a Chapter XI proceeding. The debtors in the present action borrowed a substantial sum in order to effectuate the arrangement. This enabled them to satisfy debts and to continue to operate as a business enterprise, albeit on a smaller scale. Inasmuch as that portion of the debtors' estate which survived distribution was the minimum that could support the smaller scale enterprise, it may well be that collection of the claims at issue here will render continued operations impracticable. Had the debtors known that substantial claims would be asserted in addition to those listed on the proof of claim form, the plan might not have been proffered and the loan obligation might not have been incurred, since the purpose of the plan sustaining the business might not have been achieved. 26 What the IRS contests on this appeal is the conclusion of the district court that, as a matter of law, the conduct of the IRS justified the debtors' conclusion that the proof of claim form represented all tax claims that the IRS would assert against them. In so concluding, the district court pointed to the failure of the IRS to inform the debtors during the arrangement proceeding of its intention to assert claims for pre-petition penalties and post-petition interest reasonably induced the debtors' conclusion that the IRS would not seek to collect such sums after completion of the plan. Inasmuch as claims for pre-petition penalties and post-petition interest are nondischargeable, however, a reasonable debtor should expect that the IRS will seek to enforce such claims. Since the applicable caselaw provides that these claims may be asserted only as personal liabilities of the debtor, a reasonable debtor should also expect that, where such debts have been incurred, the IRS will assert the claims against the debtor personally, and not against the estate. The inverse assumption espoused by plaintiffs here-that the IRS would assert claims for pre-petition penalties and post-petition interest against the estate, or not at all-runs counter to the Supreme Court's decision in Bruning and our decision in Eby, which make clear that such claims are not allowable against a debtor's estate. 27 Were we to hold that the IRS was barred from asserting claims that it is entitled to collect under Bruning and Eby on the ground that it had failed to provide notice during the arrangement proceeding of its intention to seek satisfaction of the debts, we would, in effect, impose on the IRS a duty to apprise debtors of applicable judicial decisions. This we decline to do. Instead, we conclude that the debtors in this case misconstrued the law in assuming that consummation of the arrangement would satisfy all tax claims against them, including interest and penalties, and that that circumstance does not absolve them of liability for the debts which they incurred. 28 The debtors also contend that the IRS is estopped from asserting claims for post-petition interest because it left blank the line on the proof of claim form marked Dollar amount per day at which interest will accrue after date of this statement. Post-petition interest is not an allowable claim against a bankrupt's estate, however. 12 For this reason, the inclusion of an entry for this sum on a proof of claim form would not be required. The absence of an entry for post-petition interest of the proof of claim form filed in this case should not have caused the debtors' counsel to conclude that the IRS had waived a right which it could not properly have asserted on that form-namely, the right to enforce the personal liability of the debtors. 29 In submitting the proof of claim form, the IRS neither waived its right to assert claims for pre-petition penalties and post-petition interest nor induced the debtors' mistaken assumption that they would not be held liable for debts of this character. We construe the form as it should have been understood by the debtors' counsel, rather than in terms of the debtors' possible confusion over its meaning. The reasoning of the Court of Appeals for the Second Circuit in In re Jaylaw, 621 F.2d 524, 529 (2d Cir. 1980), is in accord with this approach. There Judge Friendly stated: 30 (P)roofs of claim in bankruptcy are not intended for him who runs; they are submitted for examination by lawyers skilled in bankruptcy law, who should be familiar with decisions of the Supreme Court and, in this circuit, of this court. To them the statement in the proof of claim would not have been misleading. 31 While any hardship that may be imposed on the plaintiffs is regrettable, it would not be appropriate to penalize the IRS for the failure of plaintiffs to recognize that they were personally liable for pre-petition penalties and post-petition interest. 13 Concluding as we do that the debtors' assumption that claims for these items would not be asserted against them after completion of the plan constituted a misunderstanding that was not induced by the IRS, and that their reliance on the assumption was therefore unjustified, we hold that the district court erred in affirming the bankruptcy court's application of the doctrine of equitable estoppel to the claims of the IRS for pre-petition penalties and post-petition interest.