Petition for Writ of Certiorari — United States v. Energy Resources Co.

Supreme Court brief1990

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UA ae? oe

YOSEPH F. SPANIOL, JR,

CLERK

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~ ale wa" 24

‘ No. .

In the Supreme Court of the Gnited States

OcTOBER TERM, 1989

Y ’

x UNITED STATES OF AMERICA, PETITIONER :

ENERGY RESOURCES Co., INC.

UNITED STATES OF AMERICA, PETITIONER

Vv.

NEWPORT OFFSHORE, LTD.

| PETITION FOR WRITS OF CERTIORARI

i” TO THE UNITED STATES COURT OF APPEALS

) FOR THE FIRST CIRCUIT

KENNETH W. STARR

Solicitor General

SHIRLEY D. PETERSON

Assistant Attorney General

LAWRENCE G. WALLACE

Deputy Solicitor General <

ALAN I. HOROWITZ

Assistant to the Solicitor General

GARY D. GRAY <3

LINDA E,. MOSAKOWSK!I :

Attorneys

¥ Department of Justice

Washington, D.C. 20530 :

E (202) 633-2217

QUESTION PRESENTED

Whether a bankruptcy court may require the Internal

Revenue Service to apply tax payments made by a cor-

porate debtor pursuant to its Chapter 11 plan of

reorganization first to the trust fund portion of the cor-

poration’s tax liability, thereby relieving the corporation’s

responsible persons of their separate liability for those

taxes.

(1)

eT ee Se eS eae | eee ee ee ee ———

TABLE OF CONTENTS

nS er

EE I a ee

TABLE OF AUTHORITIES

Cases:

Amos v. Commissioner, gE Se

Avildsen Tools & Machines, Inc., In re, 40 Bankr. 253

(N.D. Ill. 1984), aff'd, 794 F.2d 1248 (7th Cir. 1986) ... 14, to

B & P Enterprises, Inc., In re, 67 Bankr. 179 (Bankr.

EE PE

Bird vy. Carl’s Grocery Co. (In re NWFX, Inc.), 864 F.2d

ke). o bialsiene sb see

DuCharmes & Co. v. Michigan, 852 F.2d 194 (6th Cir.

ee ei, ook eke ey a dbeesadesee se

Frank Meador Buick, Inc., In re, No. 88-349-R (W.D.

Va. Mar. 16, 1989), rev’g 85 Bankr. 392 (Bankr. W.D.

Va. 1988), appeal pending, No. 89-2954 (4th Cir.) .....

Frost, In re, 47 Bankr. 961 (D. Kan. 1985) .............

Hineline vy. Household Fin. Corp., 72 Bankr. 642 (N.D.

EEE ES re

Hubler Rentals, In re, 79-2 U.S. Tax Cas. (CCH) € 9621

ee ob ste evceccécecec esses

Intermarket, Inc., In re, 93 Bankr. 70(D. Md. 1988) .....

(III)

Cases — Continued: Page

Jehan-Das, Inc., In re, 91 Bankr. 542 (Bankr. W.D. Mo.

1988), aff'd, No. 89-3030-CV-S-2 (W.D. Mo. May 8,

1989), appeal pending, No. 89-1859 (8th Cir.) ........ 14-15

Lifescape, Inc., In re, 54 Bankr. 526 (Bankr. D. Colo.

Nahe Renee te TG Peete reer sy Perr ee ETE Ee 15

McCom Communications, Inc.>-In re, 76 Bankr. 180

I ED 6 code dnc nicecens toes dene Rhanpese 14

Mister Marvins, Inc., In re, 48 Bankr. 279 (E.D. Mich.

DE cietocedégsnesecebesss ctes Ceeeeuneeneseg ss 14

Muntwyler vy. United States, 703 F.2d 1030 (7th Cir.

SD iad. Se egachicnedveneseeedeerures keteoeaes 16

O’Dell v. United States, 326 F.2d 451 (10th Cir. 1964) .... 16

Obie Elie Wrecking Co., In re, 35 Bankr. 114 (Bankr.

kang ihé OR Rbaeeaseces 15

Official Committee of Equity Security Holders v. Mabey,

832 F.2d 299 (4th Cir. 1987) ..... 2... 6 ee eee 19

Professional Technical Services, Inc., In re, 94 Bankr.

Lick cane cicdadebcarveccccece 14

Puget Sound Plywood, Inc., In re, 89-1 U.S. Tax. Cas.

(CCH) 4 9240 (Bankr. W.D. Wash. 1989) ............ 14

R.L. Inge Development Corp., In re, 78 Bankr. 793

CE Ns ND Bb a CV USs cee cede wei cecdecss 15

Ribs-R-Us, Inc., In re, 828 F.2d 199 (3d Cir. 1987) ...... 8, 9,

12, 13, 16

Shoup’s Food Service, Inc., In re, 96 Bankr. 767 (Bankr.

oso cael bi duasdeeehO¥stavebeccts 14

Slodov v. United States, 436 U.S. 238 (1978) ........... 17

Tam Speciality Co., In re, 85-2 U.S. Tax Cas. (CCH)

¢ 9758 (Bankr. N.D. Cal. 1985) .................0.. 15

Timbers of Inwood Forest Assocs., Ltd., In re, 808 F.2d

363 (Sth Cir. 1987), aff'd, 108 S. Ct. 626 (1988) ....... 21

Tom LeDuc Enterprises, Inc., In re, 47 Bankr. 900

SS Pn 6 cekeo ghd cri c owe FUs eiceded bows 15

Technical Knockout Graphics, Inc., In re, 833 F.2d 797

SE etic actnoutiyededews sibebeeeews os 13

United States v. A & B Heating & Air Conditioning,

Inc., 823 F.2d 462 (11th Cir. 1987), vacated, 108 S. Ct.

1724 (1988), on remand, 861 F.2d 1538 (lIth Cir.

Re ec ot og Ce aera Ss. oe bAR OE MEDE SARS Os 14

United States v. Sotelo, 436 U.S. 268 (1978)... 0.00.6... 17

Cases — Continued: Page

United States v. Sutton, 786 F.2d 1305 (Sth Cir. 1986)... . 19

USLIFE Title Insurance Co. v. Harbison, 784 F.2d 1238

I ig cet ol os a eR 4

Vermont Fiberglass, Inc., In re, 88 Bankr. 41 (D. Vt.

hel | iat lag cl ede * Sei leael ak nage sil WA ae lly Cane 14

Vincent-McCall Co., In re, 68-2 U.S. Tax Cas. (CCH)

cee enea ve, 14

Statutes:

pg RE ee 18

Bankruptcy Code, 11 U.S.C. 101 ef seq.:

|i °° at RP ee Satie dobnch conan. 9, 18

Re 2, 19

11 U.S.C. 507 (1982 & Supp. V 1987) .............. 2

11 U.S.C. 507(a) (1982 & Supp. V 1987) ........... 2, 19

Sh ES ES 4

11 U.S.C. 507(a)(7) (Supp. V 1987) ............... 2,4

11 U.S.C. 507(ay(7(C) (Supp. V 1987) ............ 3, 20

11 U.S.C. 523(a)(1) (1982 & Supp. V 1987) ......... 20

RE Rr 8 SS Re passim

11 U.S.C. 1129 (1982 & Supp. V 1987) ............. 3, 10

11 U.S.C. 1129(ay(9)(C) (Supp. V 1987) ........... 3,4

Internal Revenue Code, (26 U.S.C.):

UE Cae RU SELLS doe oek Clerk <a bo deb Chew dednan 17

PC NW a ee 4

PT > Fo. 6.dess abWehe ad caeccasalldeokabnaell 4

TT sic 4's o.ac-aoaeemas a ete 4, 11, 13, 16, 17, 18, 20, 21

ERE. err eget enna, EO a) 4

Miscellaneous:

H.R. Rep. No. 595, 95th Cong., Ist Sess. Sa: 18

Rev. Rul. 58-239, 1958-1C.B.94..................... 15

Rev. Rul. 73-305, 1973-2C.B.43..................... l>

Rev. Rul. 79-284, 1979-2C.B. 83 ..................... 15

S. Rep. No. 989, 95th Cong., 2d Sess. (1978) ........... 18, 19

= ee MOOT mee

In the Supreme Court of the Gnited States

OCTOBER TERM, 1989

No.

UNITED STATES OF AMERICA, PETITIONER

ENERGY RESOURCES Co., INC.

UNITED STATES OF AMERICA, PETITIONER

NEWPORT OFFSHORE, LTD.

PETITION FOR WRITS OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

The Solicitor General, on behalf of the United States of

America,' petitions for writs of certiorari to review the

judgments of the United States Court of Appeals for the

First Circuit in these cases.

OPINIONS BELOW

The opinion of the court of appeals (App., infra,

la-23a) is reported at 871 F.2d 223. In the Energy

Resources case the opinion of the district court (App.,

' The Internal Revenue Service was erroneously named as the

governmental party in the Energy Resources litigation. Accordingly,

we have substituted the United States as the proper party in the cap-

tion of Energy Resources.

(1)

infra, 24a-26a) is unreported; the opinion of the bankrupt-

cy court (App., infra, 31a-41a) is reported at 59 Bankr.

702. In the Newport Offshore case, the oral opinion of the

district court (App., infra, 27a-30a) is unreported; the

opinion of the bankruptcy court (App., infra, 42a-50a) is

reported at 75 Bankr. 919.

JURISDICTION

The judgments of the court of appeals (App., infra,

5la-52a) were entered on March 31, 1989. On June 19,

1989, Justice Brennan extended the time to petition for

writs of certiorari to and including August 8, 1989. The

jurisdiction of this Court is invoked under 28 U.S.C.

1254(1).

STATUTES INVOLVED

Section 105 of the Bankruptcy Code, 11 U.S.C. 105

(Supp. V 1987), provides in pertinent part:

Power of court

(a) The court may issue any order, process, or

judgment that is necessary or appropriate to carry out

the provisions of this title.

* * ™ ~ *

Section 507 of the Bankruptcy Code, 11 U.S.C. 507

(Supp. V 1987), provides in pertinent part:

Priorities

(a) The following expenses and claims have

priority in the following order:

* % » ~ ~

(7) Seventh, allowed unsecured claims of

governmental units, only to the extent that such

claims are for —

~ * x * x

and for which the debtor is liable in whatever

capacity;

* * - * a

Section 1129 of the Bankruptcy Code, 11 U.S.C. 1129

(Supp. V 1987), provides in pertinent part:

Confirmation of plan

(a) The court shall confirm a plan only if all of

the following requirements are met:

* * * * ba

(9) Except to the extent that the holder of a par-

ticular claim has agreed to a different treatment of

such claim, the plan provides that —

* - * ” *

section 507(a)(7) of this title, the holder of such claim

will receive on account of such claim deferred cash

payments, Over a period not exceeding six years after

the date of assessment of such claim, of a value, as of

the effective date of the plan, equal to the allowed

amount of such claim.

« x * * -

STATEMENT

These two cases were consolidated for purposes of argu-

ment and decision in the court of appeals. Both cases in-

volve corporations that are in reorganization under

Chapter 11 of the Bankruptcy Code (11 U.S.C. 1101 ef

seq.) and that owe the government both trust fund and

non-trust fund taxes. Trust fund taxes are those taxes

withheld from the wages of employees and held by the em-

ployer in trust for the government under Section 7501 of

the Internal Revenue Code (26 U.S.C.).? If the persons

responsible to collect, account for, and pay over trust fund

taxes to the government willfully fail to do so, they each

become personally liable under 26 U.S.C. 6672 for a

penalty in the full amount of the unpaid trust fund taxes.

Since the government collects the amount of the unpaid

trust fund taxes only once (see USLIFE Title Insurance

Co. v. Harbison, 784 F.2d 1238, 1243 (Sth Cir. 1986)), the

Section 6672 liability of each “responsible person” is

reduced to the extent that the trust fund taxes are paid by

the corporation.

1. In January 1983, respondent Energy Resources

Company and its affiliates filed petitions for reorganiza-

tion under Chapter 11 of the Bankruptcy Code (11 U.S.C.

1101 ef seqg.). At that time, respondent owed about $1

million in taxes, most of which were trust fund taxes.

App., infra, Sa. Under Chapter 11 as in effect at that time,

these taxes were entitled to a “sixth priority” (11 U.S.C.

$07(a)(6)).? Chapter 11 requires as a condition of confir-

mation that a reorganization plan provide for the payment

of all priority tax liabilities over a period not to exceed six

years (11 U.S.C. 1129(a)(9(C)).

2? Sections 3102 and 3402 of the Internal Revenue Code (26 U.S.C.)

require employers to deduct from wages certain amounts for the

employees’ income taxes and for the employees’ portion of social

security taxes. These amounts are to be “held * * * im trust” for the

United States and later paid over to the government by the employer

(26 U.S.C. 7501). Other corporate tax liabilities that are not withheld

from employees’ wages, such as corporate income tax and the

employer's share of social security taxes, are referred to as “non-trust

fund” taxes.

> Due to a 1984 amendment that added a new category of priority

claims, priority federal tax claims are now seventh priority claims. See

11 U.S.C. 507(aX7) (Supp. IV 1986).

a. The bankruptcy court confirmed Energy Resources’

third amended plan of reorganization. That plan provided

that most of the debtor’s assets would be transferred to the

ERCO Liquidation Trust, and thereafter liquidated under

the supervision of a liquidation trustee for payment to

creditors of the estate. The plan provided for the payment

of pre-petition tax claims, with interest, from the liquida-

tion trust in four annual installments beginning on the an-

niversary of the confirmation date, October 1, 1984. The

trustee could prepay the taxes at any time. App., infra, Sa,

32a.

On November 6, 1985, the trustee made a payment of

the pre-petition federal tax claims totalling $281,517. The

trustee designated “that this payment be applied to the

trust fund portion of the taxes, first for the period ended

June 30, 1982 with the excess, if any, applied to the trust

fund portion of the taxes for the period ended September

30, 1982.” App., infra, 33a. The Internal Revenue Service

(IRS) refused to accept the trustee’s designation, maintain-

ing that it had the right to apply the payment to the cor-

porate debtor’s oustanding tax liability as it chose. The

IRS informed the trustee by letter that, “{ujnless such

direction of payment is given in a court order, the United

States reserves the right to apply such payment{,] which is

a distribution of a bankruptcy proceeding[,] to its max-

imum benefit.” /bid.

The trustee thereupon moved the bankruptcy court for

an order directing the IRS to apply payments under the

plan according to the trustee’s designation. In his motion,

the trustee argued that he was entitled to designate tax

payments under the plan because the payments were

“voluntary.” He also contended that the designation of

payments was necessary for the benefit of the bankruptcy

estate. He stated that the designation enabled him to im-

plement a settlement agreement entered into with Richard

Rosen, a former officer of the debtor, in which Rosen im-

mediately released $14,000 to the trust, assertedly in ex-

change for the trustee’s agreement “to cooperate in

designating tax payments which would forestall personal

liability assessed by the IRS against the former officers

from affecting them.” The trustee also asserted that the

designation would not harm the IRS because the plan pro-

vided, ultimately, for payment of the tax claims in full.

The IRS opposed the trustee’s motion on the ground that

the payment of priority taxes under a Chapter 11 plan is

involuntary and therefore the IRS is permitted to apply the

payment as it chooses. App., infra, 33a-34a.

b. The bankruptcy court granted the motion and

ordered the IRS to follow the trustee’s designation (App.,

infra, 31a-4la). The court stated the general rule that a

taxpayer who makes a “voluntary” tax payment is entitled

to designate the manner in which it is to be applied,

whereas that authority rests with the IRS if the payment is

“involuntary” (id. at 34a). Relying on several other

bankruptcy court decisions, the court held that “the mere

filing of a claim in a Chapter 11 proceeding and the confir-

mation of a p’- .. of reorga.. “ation do not constitute suffi-

cient judic «1 action to render p. ‘ment made pursuant to a

Chapte 11 plan involuntary” (. »p infa, 36a), and

there’ ore the trustee was entitled to. \gnate how the tax

payr ent should be applied (id. at 36a-4 a). The court also

stat d that its conclusion was buttress 1 by the govern-

met ’s failure to object to confirmatior of the plan, even

thor zh the plan was silent on the quest »n of designation

or th* manner in which the tax paym nts should be ap-

plied, Yecause it was “foreseeable” th « the trustee would

seek su. a designation (/d. at 40a 1a).

c. On. weal, the district co” . affirmed (App., infra,

24a-26a). The. ~* ©tet* ° _. che bankruptcy court’s role

in confirming a plan under Chapter 11 does not make a

tax payment thereunder involuntary because the

Bankruptcy Code affords debtors considerable flexibility

in Chapter 11. Thus, in the district court’s view, the

bankruptcy “court here didn’t compel the action; rather, it

approved a payment which a debtor wished to make”

(App., infra, 26a).

2. a. In the Newport Offshore case, respondent

Newport Offshore filed a petition for reorganization

under Chapter 11 on November 13, 1985, and continued

operating as a debtor-in-possession. The trustee proposed

a plan of reorganization under which a third party, Allied

Marine Associates, agreed to pay all of respondent’s pre-

petition tax liability and various other debts, and to invest

additional money in the corporation; in return, it would

receive 85% of the shares of the new, reorganized

Newport Offshore. The proposed plan provided for full

payment of pre-petition priority tax claims over a period

of about six years. It further provided that these payments

would be applied to extinguish all “trust fund” tax debts

“prior to the commencement of payment of the non-trust

fund portion” of the taxes (App., infra, 5a). The govern-

ment objected to the designation provision on the same

grounds that it raised in Energy Resources.

b. The bankruptcy court overruled the government’s

objection (App., infra, 42a-50a). The court declined to

adopt respondent’s contention that tax payments under a

Chapter |! plan always may be designated by the debtor

because there is no “enforced collection measure” that

makes them involuntary (see id. at 45a-46a). Instead, the

court concluded that whether a Chapter 11 debtor may

designate its tax payments should be decided on a case-by-

case basis according to the “totality of the facts and cir-

cumstances” (/d. at 47a).* The court expressed the concern

* The court listed several factors that it regarded as relevant to this

analysis, including: (1) the history of the debtor; (2) whether the

a S

that, if payments of priority taxes in Chapter 11 cases were

always held to be involuntary, it “would remove the ini-

tiative of [the debtor’s] former principals to seek outside

investors, who voluntarily inject needed cash into the

estate, and would, as a consequence, either inhibit or

eliminate altogether the likelihood of a viable Chapter |!

plan” (id. at 48a). The court concluded that the existence

of third-party financing constituted “special circum-

stances” that justified including the trustee’s requested

designation provision in the plan (ibid.).

c. Ruling from the bench, the district court reversed

and ordered the bankruptcy court to delete the designation

provision from the reorganization plan (App., infra,

27a-30a). Relying on the Third Circuit's decision in Jn re

Ribs-R-Us, Inc., 828 F.2d 199 (1987), the court concluded

that advancing the policy of reorganization did not require

permitting the designation provision at issue, which would

undermine the policy of collecting taxes (App., infra,

29a). The court concluded that Congress “did not ever in-

tend that a principal stockholder of a corporation in

reorganization would have the ability to negotiate in the

Bankruptcy Court an exculpatory provision with respect

to the trust fund taxes” (id. at 29a-30a).

3. On consolidated appeals, the court of appeals at-

firmed in the Energy Resources case and reversed in the

Newport Offshore case (App., infra, la-23a). The court

stated that whether payments made pursuant to a Chapter

11 reorganization plan should be characterized as “volun-

tary” or “involuntary” depends upon the degree of control

IRS had taken any pre-bankruptcy collection measures, (3) the nature

of the Chapter 11 plan; (4) the extent of administrative or court ac-

tion; and (5) the “existence of exceptional or special circumstances

warranting [the] allocation provided by the plan.” App., infra, 47a

n.7.

the bankruptcy court has over the payments at issue, and it

found that a Chapter 11 proceeding exhibits some charac-

teristics that are “voluntary” and others that are “involun-

tary.” Recognizing the deference due the IRS’s interpreta-

tion on this matter, the court declared that it accepted the

view that payments made pursuant to a Chapter 11 plan

are “involuntary.” Jd. at 7a-12a. The court determined,

however, that this conclusion was not dispositive because

it “only means * * * that the /RS’s own rules and regula-

lions do not compel it to accept the taxpayers’ determina-

tions as to how it must apply payments here at issue” (id.

at 12a). The court then proceeded to hold that the

bankruptcy courts were empowered to require the IRS to

apply the tax payments first to the trust fund tax liability.

The court acknowledged that this holding was inconsistent

with the Third Circuit's decision in Jn re Ribs-R-Us, Inc.,

supra, which had been followed by two other circuits

(App., infra, 4a).

The court of appeals viewed the governing question as

(App., infra, 12a-13a): “Does a bankruptcy court possess

the legal power to order the IRS to apply a payment in a

way that runs counter to IRS’s own internal policies?” The

court listed several factors it considered significant in con-

cluding that bankruptcy courts do have the power to over-

ride the IRS’s traditional authority to apply involuntary

tax payments as it chooses.

First and foremost, the court stated that “Congress has

granted bankruptey courts broad equitable powers”

(App., infra, 13a). In particular, the court pointed to the

bankruptcy court's power to “ ‘issue any order, process, or

Judgment that is necessary or appropriate to carry out the

provisions’ of the Bankruptcy Code” (ibid., quoting 11

U.S.C. 105 (emphasis by the court)). As an example of

when “an order allocating Chapter 11 tax payments to

‘trust fund’ liabilities first would seem ‘appropriate,’ ” the

court posited the situation where the responsible officers

offer to help rehabilitate the debtor by advancing funds,

but “only if the court would assure them that the

reorganized corporation would pay its ‘trust fund’ tax

debts first” (App., infra, 13a-14a). In that situation, the

court reasoned, the bankruptcy court could determine that

the diminished chances that the government would collect

its entire tax debt would be outweighed by the increased

chances that the debtor would pay something to its general

creditors (id. at 14a).

In the court’s view, the other factors that it listed but-

tressed this conclusion regarding the bankruptcy court’s

power. The court stated that the bankruptcy courts have

long had the legal power to tell creditors how to apply

payments against the debtor’s several debts (App., infra,

14a-15a) and that nothing in the Bankrutpcy Code limits

the bankruptcy court’s designation power when the

creditor is the IRS (id. at 1Sa-16a). The court reasoned

that “it makes administrative sense for the bankruptcy

court to have the power to determine, in some cases, the

debt allocation of Chapter 11 tax payments” because it is

equipped to consider the effect of that determination on

the debtor’s prospects for rehabilitation and already has

the power to structure the timing of tax payments within

the six-year constraint of 11 U.S.C. 1129 (App., infra,

16a).

The court further noted that the IRS’s policy of

allocating payments first to non-trust fund taxes, while

clearly calculated to maximize the collection of delinquent

taxes, was not embodied in any statute (App., infra,

16a-17a). Finally, the court stated that it could “find no

policy embodied in any specific statute, tax or otherwise,

that either directly, or by manifesting a congressional in-

tent, circumscribes a bankruptcy court’s general powers in

the respect at issue here” (id. at 17a). In particular, the

———eeEooorrr

——E

court stated that the strong congressional policy of ensur-

ing the collection of trust fund taxes embodied in 26

U.S.C. 6672 would not be undermined by its decision

because the designation provided for the collection of trust

fund taxes first, albeit at the expense of non-trust fund

taxes that would go unpaid if the reorganization failed,

while the IRS’s allocation postponed the collection of trust

fund taxes (App., infra, 17a-20a).

Accordingly, the court of appeals concluded that the

bankruptcy courts have the legal power to order the

allocation of involuntary tax payments in Chapter 11 pro-

ceedings. The court held that the allocation question

should be determined by the bankruptcy court on a case-

by-case basis, subject to review under the clearly er-

roneous standard. App., infra, 2la. And the court

specified the following as the appropriate inquiry (/bid.):

“upon consideration of the reorganization plan as a whole,

in so far as the particular structure or allocation of

payments increases the risk that the IRS may not collect

the total tax debt, is that risk nonetheless justified by an

olfsetting increased likelihood of rehabilitation, i.e., in-

creased likelihood of payment to creditors who might

otherwise lose their money?” The court concluded that it

was unnecessary to remand the cases, holding that the

bankruptcy courts’ opinions indicated that they both

would have upheld the requested designations under the

standard promulgated by the court of appeals (id. at

21a-23a).

REASONS FOR GRANTING THE PETITION

The court of appeals has erroneously decided an im-

portant and frequently recurring question of federal law,

in direct confict with the decisions of other courts of ap-

peals. The court has held that bankruptcy courts have dis-

cretion to allow a corporate debtor in Chapter 11 pro-

ceedings to designate priority federal tax payments under

its reorganization plan for application first to trust fund

tax liability. The effect of this decision is to sanction the

use .of Chapter 11 by officers of the corporate debtor to

reduce or eliminate their potential personal liability for

delinquent trust fund taxes and thereby undermine the

separate source of collection of those taxes and the deter-

rent to their misuse that has been established by Congress.

As a result, tax payments under Chapter 11 plans would,

as a practical matter, first redound to the benefit of the

corporate officers, not the government. If the plan were

not successfully completed, the government would still be

left with an uncollectible non-trust fund tax claim, while

the corporate officers would have been relieved of their

trust fund liability to the extent payments have been made.

In light of the frequency with which this issue recurs, it is

essential that the conflict in the circuits be resolved and

that a uniform rule be established to guide the conduct of

Chapter 11 proceedings.

1. The court of appeals acknowledged (App., infra,

4a) that the decision below directly conflicts with the Third

Circuit’s decision in Jn re Ribs-R-Us, Inc., 828 F.2d 199

(1987). It similarly conflicts with the Sixth Circuit’s deci-

sion in DuCharmes & Co. v. Michigan, 852 F.2d 194

(1988). In each of those cases, as here, the government ob-

jected to a proposed Chapter 11 plan that provided that

payments of priority taxes were to be applied first to the

trust fund portion of the outstanding tax liability. Both

courts of appeals determined that tax payments made pur-

suant to a Chapter 11 plan are not voluntary and therefore

may be allocated as the IRS determines. /n re Ribs-R-Us,

Inc., 828 F.2d at 201-203; DuCharmes & Co. v. Michigan,

852 F.2d at 196. Pointing to the debtor’s failure to produce

evidence “that suggests that Congress intended by the

Bankruptcy Code to curtail the IRS’s longstanding ability

to use 26 U.S.C. § 6672 to provide a collateral source for

collection of trust fund taxes,” the Third Circuit held that

“no provision of the Bankruptcy Code allows either the

debtor or the bankruptcy court to direct application of

payments and thereby preclude recourse by the United

States against responsible parties” (Jn re Ribs-R-Us, Inc.,

828 F.2d at 203-204 & n.4). The court concluded that per-

mitting the debtor to designate the portion of its tax liabili-

ty to which payments should be allocated would be “in

derogation of Congress’ strong policy, reflected in section

6672, to protect the government’s tax revenues by insuring

an additional source from which trust fund taxes can be

collected” (id. at 204). The Third Circuit also criticized the

approach of permitting designation on a case-by-case

basis, which was approved by the court of appeals below;

it explained that “[a] uniform federal rule is preferable so

that debtors, creditors, and the Internal Revenue Service

will be able to know in advance whether the debtor can

make such a designation and guide their decisions accord-

ingly” (id. at 202).

The decision below is also inconsistent with the Ninth

Circuit’s decision in a slightly different context in /n re

Technical Knockout Graphics, Inc., 833 F.2d 797 (1987).

In that case, a debtor filed a petition for relief under

Chapter 11 and then, before the confirmation of its

reorganization plan, filed a motion asking that it be per-

mitted to make payments to the IRS designated for ap-

plication to its trust fund tax liability. Rejecting the IRS’s

objection, the bankruptcy court ordered the IRS to apply

any such payments according to the debtor’s requested

designation. The court of appeals reversed, finding that

those payments would be “involuntary” and that the

bankruptcy court’s equitable powers do not permit it to

enforce such a designation. The court explained that, once

a debtor invokes the assistance of the bankruptcy court to

keep its creditors at bay by filing a Chapter 11 petition, it

can no longer claim that its tax payments are voluntary,

and it “is not free to abuse this system by designating its

payments in a way that benefits only its responsible per-

sons, and possibly harms other creditors, including the

IRS, without the scrutiny of the court or other creditors”

(833 F.2d at 803).°

In addition to these court of appeals decisions, the ques-

tion presented here has been addressed with varying results

by numerous lower courts.® Thus, there exists an acknowl-

’ The result reached by the court below is consistent with that

reached by the Eleventh Circuit in United States v. A & B Heating &

Air Conditioning, Inc., 823 F.2d 462 (1987), vacated, 108 S. Ct. 1724

(1988), on remand, 861 F.2d 1538 (1988). On the government’s peti-

tion for a writ of certiorari, that decision, which upheld the bankrupt-

cy court’s discretion to order the IRS to comply with the debtor’s

designation, was vacated by this Court in light of the debtor’s declara-

tion that it was no longer interested in enforcement of the designation

provision. The reorganization plan ultimately w=, amended to remove

that provision.

* The following cases have held payment of priority taxes in

bankruptcy to be subject to application as the IRS determines on the

ground that the payments are involuntary: /n re Frank Meador Buick,

Inc., No. 88-349-R (W.D. Va. Mar. 16, 1989), rev’g 85 Bankr. 392

(Bankr. W.D. Va. 1988), appeal pending, No. 89-2954 (4th Cir.); /n re

Intermarket, Inc., 93 Bankr. 70 (D.Md. 1988); Jn re Professional

* Technical Services, Inc., 94 Bankr. 578 (E.D. Mo. 1988); In re Ver-

mont Fiberglass, Inc., 88 Bankr. 41 (D. Vt. 1988); Jn re McCom Com-

munications, Inc., 76 Bankr. 180 (N.D. Ala. 1987); /n re Mister Mar-

vins, Inc., 48 Bankr. 279 (E.D. Mich. 1984); Jn re Frost, 47 Bankr.

961 (D. Kan. 1985); /n re Avildsen Tools & Machines, Inc., 40 Bankr.

253 (N.D. Ill. 1984), aff'd on other grounds, 794 F.2d 1248 (7th Cir.

1986); Jn re Vincent-McCall Co., 68-2 U.S. Tax Cas. (CCH) € 9591

(E.D. Wis. 1986); Jn re Puget Sound Plywood, Inc., 89-1 U.S. Tax

Cas. (CCH) 4 9240 (Bankr. W.D. Wash. 1989); /n re Shoup’s Food

Service, Inc., 96 Bankr. 767 (Bankr. W.D. Mich. 1988); Jn re

edged conflict in the circuits and considerable disarray in

the lower courts on an important and frequently recurring

issue. It is therefore necessary for this Court to resolve the

conflict and provide a uniform rule to guide the lower

courts in dealing with attempts by Chapter 11 corporate

debtors to protect their officers’ personal funds by

designating priority tax payments for application first to

trust fund tax liability.

2. a. The court of appeals erred in holding that the

bankruptcy court has the power to direct the IRS to

allocate a corporate debtor’s involuntary tax payments

first to the debtor’s trust fund tax liability, so as to

eliminate the corporate officers’ personal liability for

those taxes. The IRS’s longstanding policy has been to per-

mit taxpayers to designate the application of tax payments

that are voluntarily made. See Rev. Rul. 79-284, 1979-2

C.B. 83, modifying Rev. Rul. 73-305, 1973-2 C.B. 43,

superseding Rev. Rul. 58-239, 1958-1 C.B. 94. The IRS’s

policy, however, does not permit the taxpayer to designate

involuntary payments which traditionally have been

viewed as including payments received as a result of a levy

or legal proceeding in which the government is seeking to

Jehan-Das, Inc., 91 Bankr. 542 (Bankr. W.D. Mo. 1988), aff'd, No.

89-3030-CV-S-2 (W.D. Mo. May 8, 1989), appeal pending, No.

89-1859 (8th Cir.); Jn re R.L. Inge Development Corp., 78 Bankr. 793

(Bankr. E.D. Va. 1987); In re Tam Specialty Co., 85-2 U.S. Tax Cas.

(CCH) ¢ 9758 (Bankr. N.D. Cal. 1985); Jn re Obie Elie Wrecking Co.,

35 Bankr. 114 (Bankr. N.D. Ohio 1983); Jn re Hubler Rentals, 79-2

U.S. Tax Cas. (CCH) € 9621 (E.D. Pa. 1979). The following decisions

have held such payments to be voluntary and thus subject to designa-

tion by the debtor or the bankruptcy court: /n re Lifescape, Inc., 54

Bankr. 526 (Bankr. D. Colo. 1985); /n re Tom LeDuc Enterprises,

Inc., 47 Bankr. 900 (W.D. Mo. 1984). The following cases have held,

like the court of appeals below, that allocation of payments is within

the discretion of the bankruptcy court: Hineline v. Household Fin.

Corp., 72 Bankr. 642 (N.D. Ohio 1987); /n re B & P Enterprises, Inc.,

67 Bankr. 179 (Bankr. W.D. Tenn. 1986).

collect its delinquent taxes. See Amos v. Commissioner, 47

T.C. 65, 69 (1966). This policy, which has generally been

approved by the courts, encourages taxpayers to make

voluntary payments. See, e.g., Muntwyler v. United

States, 703 F.2d 1030, 1032 (7th Cir. 1983); O'Dell v.

United States, 326 F.2d 451, 456 (10th Cir. 1964); Amos v.

Commissioner, 47 T.C. at 69-70. In particular, when a

corporation is in financial distress, this policy encourages

responsible persons to resist the temptation to borrow

money from the government’s trust fund, /.e., to pay

business expenses with taxes that have becn withheld from

employees’ wages. Instead, the officers are motivated to

turn those withheld taxes over to the government in a time-

ly fashion so that they can avoid the prospect of personal

liability under 26 U.S.C. 6672. Such voiuntary compliance

with the trust fund structure avoids the expenditure of

government resources on collection by means of adminis-

trative levy or judicial proceedings. See, e.g., In re Ribs-R-

Us, Inc., 828 F.2d at 201-202; In re Avildsen Tools &

Machines, Inc., 794 F.2d 1248, 1251 (7th Cir. 1986).

The court of appeals disregarded this established

framework by permitting a corporate debtor, with the ap-

proval of the bankruptcy court, to designate the applica-

tion of tax payments that the court acknowledged were in-

voluntary. This decision severely undermines the salutary

policy goals that are advanced by the established differen-

tial treatment of voluntary and involuntary payments. The

incentive for the debtor to make its tax payments volun-

tarily prior to bankruptcy is removed; despite its decision

to default on its taxes and instead to pay them only as re-

quired by statute as a condition of confirmation of its

reorganization plan, the debtor retains the power to

designate its payments as if it had paid the taxes voluntari-

ly. Specifically, the ability later to make the particular

designation approved here significantly reduces the likeli-

hood that a failing corporation will pay over to the

government the taxes that it has withheld from its

employees. Knowing that there will be the opportunity in

Chapter 11 proceedings to designate payments first for

trust fund taxes substantially weakens the disincentive for

corporate officers to use the trust fund in a last-ditch ef-

fort to alleviate a corporation’s pre-bankruptcy financial

difficulties. The specter of Section 6672 liability would be

removed as a deterrent to the conversion of trust funds if

the responsible persons believe that they can ultimately

escape liability under cover of Chapter 11 if the corpora-

tion’s financial difficulties prove insurmountable.

The decision below a!so undermines the congressional

policies favoring collection of trust fund taxes and of

federal tax liabilities in general in bankruptcy proceedings.

Congress viewed the conversion by employers of monies

held in the trust fund as a particularly severe type of tax

delinquency. Taxes that are withheld by an employer from

its employee’s wages are credited by the government to

that employee’s account as paid, whether or not the

withheld funds are actually paid over to the government

by the employer. Accordingly, the loss from the

employer’s failure to turn over those trust fund taxes is

suffered directly by the Treasury. See 26 U.S.C. 31(a);

Slodov v. United States, 436 U.S. 238, 243 (1978). To pre-

vent such losses, Congress enacted Section 6672 to impose

personal liability in the amount of delinquent withholding

taxes directly upon the persons responsible for not turning

them over to the government. This provision establishes

not Only an alternative means of collection but also a

strong disincentive to corporate officers to draw upon

withheld taxes to alleviate a corporation’s financial dif-

ficulties. See Slodov v. United States, 436 U.S. at 243;

United States v. Sotelo, 436 U.S. 268, 277 n.10 (1978).

The decision below, however, allows responsible per-

sons to use the corporate Chapter |! proceedings as a

shield to protect themselves from Section 6672. The

designation sought here benefits the responsible persons of

the corporation (by reducing their Section 6672 liability)

while providing, at most, only a speculative benefit to the

corporation. At the same time, it compromises the protec-

tion afforded the public fisc by Section 6672. Corporate

tax payments that would otherwise be applied to reduce

the corporation's other tax liabilities for which there is no

alternative means of collection will instead be applied first

to reduce the potential exposure of the corporate officers

for the delinquent trust fund liabilities. Thus, in the event

the delinquent taxes are only partially paid under the

reorganization plan, the Treasury will suffer a loss.

b. The bankruptcy court lacks authority to direct the

IRS to allocate payments first to the outstanding trust

fund liability. Clearly, there is no provision expressly con-

ferring this authority, and the court of appeals erred in

reading such authority into 1! U.S.C. 105, which em-

powers bankruptcy courts to “issue any order, process, or

judgment that is necessary or appropriate to carry out the

provisions of this title.” That general provision speaks to

the procedural powers of the court; the legislative history

explains that it is designed to extend the power of the All

Writs Act (28 U.S.C. 1651) to bankruptcy courts, as well

as to cover any other powers traditionally exercised by

bankruptcy courts under the old Bankruptcy Act. See

H.R. Rep. No. 595, 95th Cong., Ist Sess. 316-317 (1977);

S. Rep. No. 989, 95th Cong., 2d Sess. 29 (1978). Thus, the

courts have recognized that the purpose of Section 105 is

to allow the bankruptcy court to issue equitable orders

such as injunctions and stays and to punish contempt in

cases where such orders are consistent with the Bankrupt-

cy Code; its purpose is not to give the bankruptcy court

leeway to create new substantive rights for debtors. See,

e.g., Bird v. Carl’s Grocery Co. (In re NWFX, Inc.), 864

F.2d $93, 595 (8th Cir. 1989); Official Committee of Equi-

ty Security Holders v. Mabey, 832 F.2d 299, 302 (4th Cir.

1987); United States v. Sutton, 786 F.2d 1305, 1307-1308

(Sth Cir. 1986).

The designation orders approved by the court of appeals

here plainly fall outside the scope of this authority. The

bankruptcy court does not have “a roving commission (t%

do equity” (United States v. Sutton, 786 F.2d at 1308) or

to issue any order that conceivably could aid the

rehabilitation of the debtor. Rather, it is bound to imple-

ment the substantive rules established in the Bankruptcy

Code and to observe other requirements of law. The

designation order here does not help to “carry out the pro-

visions” of the Bankruptcy Code (11 U.S.C. 105); indeed,

it runs counter to the Code provisions that seek to secure

the payment of delinquent taxes. The Bankruptcy Code es-

tablishes a priority system for the payment of outstanding

debts in which the taxes owed by respondents are accorded

a high priority (see 11 U.S.C. 507(a) (1982 & Supp. V

1987)); thus, it is not appropriate for the bankruptcy court

to upset settled rules in order to enhance the prospects of

unsecured creditors at the acknowledged expense of the

IRS's ability to collect its priority taxes (see App., infra,

21a).

In enacting the Bankruptcy Code, Congress weighed the

government's right to collect its taxes against the com-

peting interests of the general creditors in collecting their

debts and the debtor's desire to obtain a “fresh start.” See

e.g., S. Rep. No. 989, supra, at 13-14. There is no sugges-

tion, however, that Congress intended to confer upon the

bankruptcy court power to designate tax payments, to the

detroment of the IRS’s ability to collect taxes, in order to

entice responsible persons to release claims against the

—_- -——— — =| _ aii i i i i i gi Cl

debtor or to cooperate in obtaining financing. It is un-

doubtedly true that the success of a reorganization may be

jeopardized if the debtor’s officers are, for whatever

reason, unwilling to cooperate fully in the reorganization.

But that does not give the bankruptcy court carte blanche

to enter orders designed to secure such cooperation by

assisting the officers at the expense of another party to the

bankruptcy. As the district court stated in Newport O//-

shore (App., infra, 29a-30a), Congress did not “intend

that a principal stockholder of a corporation in reor-

ganization would have the ability to negotiate in

Bankruptcy Court an exculpatory provision with respect

to the trust fund taxes.”’ The general principle regarding

the allocation of involuntary tax payments should be fully

applicable here, and a corporate debtor in Chapter |!

should not be permitted to insist on application of its

payments first to trust fund taxes in order to eliminate its

officers’ Section 6672 liability.

3. Resolution of the question presented here is of great

importance to the administration of the tax laws. The issue

of the validity of a corporate designation in a Chapter 11

plan is one that frequently recurs because most corporate

bankruptcies involve withholding tax liability, and the

lower courts are in considerable disarray on the issue.

Thus, resolution of the conflict will eliminate disparate

’ Indeed, those responsible persons would not be able to obtain that

relief in their own personal bankruptcy proceedings. Section 6672

liabilities would be entitled to priority of payment in those pro-

ceedings and, to the extent not satisfied therein, they would not be

dischargeable, but would remain an enforceable debt after bankrupt.

cy. See 11 U.S.C. S07(aX7VKC), S2MaX1) (1982 & Supp. V 1987). It is

inappropriate for the bankruptcy court to permit the same officers to

use the threat of noncooperation in the corporate debtor's reorganiza-

tion to achieve personal relief that they could not obtain in their own

bankruptcy proceedings.

results among taxpayers depending upon the jurisdiction

in which they file their Chapter 11 petition. Moreover, the

issue has significant fiscal impact upon the government.

When a Chapter 11 reorganization fails after a few pay-

ments are made, as many of them do,* the effect of the

designation is to reduce the total amount of the outstand-

ing tax liability that may be collected by the government

because of the reduction in the responsible persons’ Sec-

tion 6672 liability.’ Allowing such a designation thus shifts

the risk of failure of the plan from the responsible of-

ficers, whose improper conduct created the delinquency in

the first place, to the government. And, as we have ex-

plained (pp. 16-17, supra), it would also tend to increase

arrearages in trust fund payments by reducing the officers’

incentive to make voluntary payments prior to bankrupt-

cy. At all events, resolution by this Court of the conflict in

the courts of appeals is required if there is to be even-

handed administration of the tax and bankruptcy laws.

* The Administrative Office of the United States Courts has

estimated that 90% of Chapter 11 reorganizations fail. See /n re

Timbers of Inwood Forest Assocs., Lid., 808 F.2d 363, 382 (Sth Cir.

1987) (Jones, J., dissenting), aff'd, 108 S. Ct. 626 (1988). Indeed, if

there were not a considerable likelihood that the plan would fail, the

designation issue would be of no concern to the responsible officers

since the plan must provide for the payment of all trust fund taxes by

the corporate debtor within six years.

* The Collection Division of the IRS estimates that up to $34

millon per \ car in tax revenue could be lost if designations are permit-

ted routinely.

The petition for writs of certiorari should be granted.

Respectfully submitted.

KENNETH W. STARR

Solicitor General

SHira ey D. PETERSON

Assisiant Attorney General

LAWRENCE G. WALLACE

Deputy Solicitor General

ALAN |. Horowitz

Assistant to the Solicitor General

Gary D. Gray

LInDA E. MOSAKOWSKI

Attorneys

AUGUST 1989

APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

No. 87-1896

IN Re ENercy Resources Co., INC., DEBTOR

INTERNAL REVENUE SERVICE, PLAINTIFF, APPELLANT

ENerRGY Resources, Co... INC., DEFENDANT, APPELLEE

APPEAL FROM THE UNITED DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

{Hon. John J. McNaught, U.S. District Judge}

No. 88-1175

IN Re Newport OrrsHore, LTD, DEBTOR

UNITED STATES OF AMERICA, PLAINTIFF, APPELLEE

Newport OFFSHORE, LTD... DEFENDANT, APPELLANT

APPEAL FROM THE UNITED DISTRICT COURT

FOR THE DISTRICT OF RHODE ISLAND

{Hon. Francis J. Boyle, U.S. District Judge

(la)

March'31, 1989

Before: Bownes and Breyer, Circuit Judges, and Caffrey,*

Senior District Judge

Breyer, Circuit Judge. The Internal Revenue Code re-

quires employers to withhold from their employees’

paychecks money representing employees’ personal in-

come taxes, unemployment insurance and social security

taxes that those employees owe or will owe the govern-

ment. 26 U.S.C. §§ 3102(a), 3402(a) (1982). Because

federal law requires employers to hold these funds in

“trust for the United States,” 26 U.S.C. § 7501(a) (1982),

these taxes are commonly referred to as “trust fund” taxes.

Slodov v. United States, 436 U.S. 238, 242-43 (1978).

And, should employers fail to pay them, the government

can collect an equivalent sum directly from the officers or

employees of the employer who are responsible for their

collection and payment. 26 U.S.C. § 6672 (1982). These

individuals are commonly referred to as “responsible” in-

dividuals. Slodov, 436 U.S. at 244 0.5. An employer, of

course, may also fail to pay the government its ordinary

corporate income tax or other “non-trust fund” taxes (/.¢.,

taxes owed directly by the corporation and not withheld or

collected from third parties).

These two cases involve corporations in Chapter !1

bankruptcy reorganizations. Each corporation owes the

government both trust fund and ordinary (non-trust fund)

taxes. In each instance, the reorganization plan says that

the corporation must satisfy its total tax debt to the

* Of the District of Massachusetts, sitting by designation

government by making partial payments each year for sev-

eral years. In each instance, the bankruptcy judge

specified that, as the reorganized corporation paid off its

tax debts, the government should treat the payments as

satisfying the corporation’s trust fund tax debts first; only

after it received enough money to satisfy all trust fund

debts may the government apply the money received to the

corporation’s non-trust fund tax debts. This order of pay-

ment helps the “responsible” ‘ndividuals associated with

the corporation, for it diminishes the likelihood that they

will end up having personally to pay the “trust fund” tax

debts that the corporation owes. That fact also means that

the government may find it harder to collect the entire tax

debt (trust fund and non-trust fund). If, for example, the

reorganized corporation were to run out of money a few

years from now and “trust fund” debts were still owed, the

government might collect them from “responsible” in-

dividuals. But, if all “trust fund” debts have been paid,

and if the only debts are for, say, ordinary corporate in-

come taxes, the government will be out of luck, for there

are no personal guarantors of payment of a corporation’s

ordinary tax liabilities.

The IRS has appealed these two bankruptcy court deci-

sions. It wants to apply the debtors’ payments to the or-

dinary, non-trust fund, tax debts first. It argues that it is

entitled to do so because payments pursuant to a Chapter

11 reorganization plan are “involuntary” payments; and

under a longstanding IRS policy, backed by case-law

authority, the IRS may designate the allocation of “in-

voluntary” payments among a firm’s various tax debts as

the IRS sees fit. The IRS adds that to allocate Chapter 11

taX payments to “trust fund” tax debts will frustrate the

congressional policy underlying Section 6672 of the Inter-

nal Revenue Code, 26 U.S.C. § 6672 (1982), which holds

“responsible” individuals personally liable for a corpora-

tion’s “trust fund” tax debts. In Energy Resources, the

district court rejected these arguments and affirmed the

bankruptcy court’s allocation of payments to “trust fund”

debts first; in Newport Offshore the district court accepted

these arguments and reversed the bankruptcy court’s order

for payment of “trust fund” tax debts first.

The basic legal question that these two cases raise on ap-

peal is whether the bankruptcy court has the legal authori-

ty to order the government to apply the tax payments

made by the reorganized corporation to the corporation

“trust fund” debts first. We conclude that the bankruptcy

court does possess that legal power, regardless of whether

the payments are characterized as “voluntary” or “involun-

tary.” Our result is consistent with that of the Eleventh

Circuit in Jn re A & B Heating & Air Conditioning, Inc.,

823 F.2d 462 (11th Cir. 1987), vacated and remanded for

consideration of mootness, __. U.S. ____, 108 S. Ct.

1724 (1988). Our result is not consistent with that reached

by the Third Circuit, in Jn re Ribs-R-Us, Inc., 828 F.2d

199 (3d Cir. 1987) (tax payments made pursuant to a

Chapter 11 reorganization are per se “involuntary” and

“no provision of the Bankruptcy Code allows either the

debtor or the bankruptcy court to direct” the allocation of

such payments). Two other circuits have followed the

Third Circuit. Jn re DuCharmes & Co., 852 F.2d 194 (6th

Cir. 1988) (per curiam); Jn re Technical Knockout

Graphics, Inc., 833 F.2d 797 (9th Cir. 1987).

I. Background

The first case before us concerns a Chapter 11 debtor

called Newport Offshore, Inc. Newport Offshore failed to

pay the government employee social security and unem-

ployment withholding taxes (“trust fund” taxes) in 1985; it

owes the government some ordinary, non-trust fund,

OO a

taxes as well. On November 13, 1985, Newport Offshore

filed a petition for reorganization under Chapter 11 of the

Bankruptcy Act, 11 U.S.C. §§ 101-1330 (1982). In June

1986, the bankruptcy court appointed a trustee to run

Newport Offshore’s business. See 11 U.S.C. § 1104 (1982

& Supp. IV 1986). Subsequently, Allied Marine Asso-

ciates, a Rhode Island partnership, agreed to pay all

Newport Offshore’s prepetition tax liability, to pay

various other debts, and to invest additional money in the

corporation; in return, it would receive 85 percent of the

shares of the new, reorganized Newport Offshore. The

reorganization plan provided that the reorganized

Newport Offshore would pay its tax debts (totalling about

$300,000) over a period of about six years and that the

money would be applied to extinguish all “trust fund” tax

debts “prior to the commencement of payment of the non-

trust fund portion” of the tax debts owed. The IRS

objected to the plan’s tax debt payment designation provi-

sion. The bankruptcy judge, after hearing IRS’s objec-

tions, approved the plan. The IRS appealed to the district

court, which reversed, following the Third Circuit in Ribs-

R-Us, supra. The debtor now appeals that decision here.

The second case involves a debtor called Energy

Resources Co., Inc. In January 1983, the debtor peti-

tioned for reorganization under Chapter 11. In September

1984 the Bankruptcy court confirmed a reorganization

plan under which all of Energy Resources’ assets, except

those of its Environmental Division, would be placed in a

special trust (called the ERCO Liquidation Trust) to pay

debts owed, including about $1,000,000 in federal taxes,

most of which were trust fund taxes. The ERCO Liquida-

tion Trust was to pay the tax debt over a period of about

five years. The plan also provided that reorganized Energy

Resources, Inc. would, upon merging with an independent

company, continue to operate under the name Enseco,

Inc. In November 1985 the trustee of ERCO Liquidation

Trust sent checks to the IRS for about $280,000, which

represented the scheduled payment and $78,000 in addi-

tional payments. The trustee asked the IRS to apply the

money to Energy Resources’ “trust fund” tax debt. The

IRS refused to accept the trustee’s designation. The trustee

then asked the bankruptcy court to order the IRS to apply

the money to the “trust fund” tax liabilities. After hearing

argument, the bankruptcy court held that tax payments

made pursuant to a Chapter 11 reorganization are “volun-

tary” payments, and it “ordered” the IRS “to apply tax

payments under the Plan as designated by the Trustee.”

The IRS appealed this order to the District Court, which

affirmed the bankruptcy court. The IRS now appeals that

decision.

Il. The Law

In our view, these cases require us to answer (‘wo legal

questions. The first legal question concerns the scope of

IRS policy. It is whether a payment made pursuant to a

Chapter 11 reorganization plan is “voluntary” or “involun-

tary,” as IRS rules and regulations use these terms. Our

answer to that question is similar to that of the Third Cir-

cuit. We believe that the law permits the IRS to call tax

payments within a Chapter 11 reorganization “involun-

tary,” for purposes of applying its own regulations. We

reach a result that differs from the Third Circuit, however,

because we believe we must ask a second question: Does

the law permit a bankruptcy court to order the IRS to

allocate an “involuntarily” made payment to a debtor’s

“trust fund” tax liability first? We conclude that the law

does authorize a bankruptcy court to order the IRS to

allocate such “involuntary” payments to a taxpayer’s “trust

fund” liability first, provided that the court reasonably

concludes that this allocation will likely increase the

reorganization plan’s chances for success. We shall

analyze each of these two legal questions in turn.

A. The “IRS Rule” Question: “Voluntary” or “Involuntary”?

IRS policy has long permitted a taxpayer who “voluntari-

/y” submits a payment to the IRS to designate the tax liabili-

ty (/.e., “trust fund” or non-trust fund tax debts) to which

the payment will apply. See Rev. Rul. 79-284, 1979-2 C.B.

83, modifying Rev. Rul. 73-305, 1973-2 C.B. 43, super-

seding Rev. Rul. 58-239, 1958-1 C.B. 94 (“partial payments

of . . . taxfes] are to be applied as the taxpayer designates

. . Where the taxpayer provides specific written instruction

for the application of a voluntary partial payments”);

Slodov, 436 U.S. at 252 n.15. In re Technical Knockout

Graphics, Inc., 833 F.2d at 801; In re Ribs-R-Us, Inc., 828

F.2d at 201; In re A & B Heating & Air Conditioning, 823

F.2d at 436; Muntwyler v. United States, 703 F.2d 1030,

1032 (7th Cir. 1983); O’Dell v. United States, 326 F.2d 451,

456 (10th Cir. 1964); see also Wood v. United States, 808

F.2d 411, 416 (Sth Cir. 1987). However, where the taxpayer

“involuntarily” makes the payment, the IRS has granted the

taxpayer no such freedom to designate the allocation; the

IRS will decide to apply the payment; and it will almost

always decide to apply the payments to a non-trust fund tax

debt first. See IRS Policy Statement P-5-60, reprinted in |

Administration, Internal Revenue Manual (CCH) 1305-15;

Slodov, 436 U.S. at 252 n.15; In re Technical Knockout

Graphics, Inc., 833 F.2d at 801; In re Ribs-R-Us, Inc., 828

F.2d at 201; In re A & B Heating & Air Conditioning, 823

F.2d at 436; Muntwyler, 703 F.2d at 1032.

These payment designation rules, says the IRS, are con-

sistent with “the common law” policy,

generally recognized between creditors and debtors,

that the debtor may indicate which debt he intends to

pay when he voluntarily submits a payment to his

creditor, but may not dictate the application of funds

that the creditor collects from him.

In re Energy Resources Co., Inc., Brief for Appellants

{IRS], at 18 n.11. See O’Dell v. United States, 326 F.2d

451, 456 (10th Cir. 1964); see also Hewitt v. United States,

377 F.2d 921, 925 (Sth Cir. 1966). The IRS adds that the

Tax Court defined the “voluntary”/“involuntary” distinc-

tion authoritatively in Amos v. Commissioner, 47 T.C. 65

(1966), where it said,

[aJn involuntary payment of Federal taxes means any

payment received by agents of the United States as a

result of distraint or levy or from a legal proceeding in

which the Government is seeking to collect its delin-

quent taxes or file a claim therefor.

Amos, 47 T.C. at 69. But see also Muntwyler, 703 F.2d at

1033 (“The distinction between a voluntary and involun-

tary payment in Amos and all the other cases is not made

on the basis of the presence of administrative action alone,

but rather the presence of court action or administrative

action resulting in an actual seizure of property or money,

as in a levy.” (emphasis in the original).

The IRS argues that payments made by compromise

pursuant to a Chapter 11 reorganization plan fall within

the (rearranged) literal words of Amos (“payment received

as a result of a legal proceeding in which the government ts

seeking to file a claim for its delinquent taxes”); it sees a

payment made pursuant to a Chapter | 1 plan as a payment

made pursuant to a court order; and it distinguishes Munt-

wyler on the ground that the trustee there did not act pur-

suant to a court order, or a bankruptcy proceeding, thus

taking the case outside the scope of Amos’s words “legal

proceeding.”

In essence, the IRS sees the words “voluntary” and “in-

voluntary” as defining polar opposite points on a spec-

trum. At the “voluntary” end, one finds the taxpayer who

discharges a debt before the IRS brings a legal proceeding

against him. At the “involuntary” end, one finds the tax-

payer whose property the court has seized and transmitted

to the IRS. The IRS believes that the court’s control of the

taxpayer's assets in a Chapter 11 proceeding, along with

the court’s power to confirm the plan, bring this case close

enough to the “involuntary” end of the spectrum to war-

ramt the finding that all payments made pursuant to a

Chapter 11 reorganization plan are “involuntary.”

The debtor corporations, Energy Resources Co. and

Newport Offshore, Ltd., counter that Muntwyler’s phrase

“resulting in an actual seizure” applies to court action as

well as to administrative action, and that the “limited role

of the court in confirming [a reorganization] plan

demonstrate[s] that the action of a Chapter 11 court falls

far short of the coercive power of a levy, execution or

judicial sale.” Jn re Energy Resources, Brief for Appellee,

at 12. Therefore, they conclude, tax payments made sub-

ject to a Chapter 11 reorganization plan are not “involun-

tary” tax payments.

The bankruptcy courts have split over the question of

whether tax payments made pursuant to Chapter 11

reorganizations are “voluntary” or “involuntary.” See

cases collected in /n re A & B Heating & Air Conditioning,

823 F.2d at 463 n.2. As we pointed out above, at p. 6,

supra, the circuit courts have also divided on the question.

In re Ribs-R-U's, Inc., supra, the Third Circuit concluded

that such payments are “most realistically classified as in-

voluntary tor purposes of the debtor’s ability to designate

to which taxes the payments should be allocated.” Rib-R-

Us, 828 F.2d at 203. The Ninth and Sixth Circuit have fol-

lowed the Third Circun’s Ribs-R-U's reasoning. See In re

10a

Technical Knockout Graphics, Inc., supra; In re

DuCharmes & Co., supra. The Eleventh Circuit, however,

in In re A & B Heating & Air Conditioning, supra, held

that payments made pursuant to a Chapter | 1 reorganiza-

tion plan, at least sometimes, are “voluntary.”

In our view, the labeling questivn is a difficult one

because a Chapter 11 proceeding has some characteristics

that make one consider a related tax payment “involun-

tary,” but it also has other characteristics that make a

“voluntary” label seem more natural. The Third Circuit, in

Ribs-R-Us, 828 F.2d at 202-03, has pointed to those

features of a Chapter 11 proceeding that make the pay-

ment seem “involuntary:” (1) Once a debtor files for

reorganization under Chapter 11 all its assets vest in the

bankruptcy estate, 11 U.S.C. § 541 (1982 & Supp. IV

1986). (2) The debtor-in-possession (or other trustee) is no

longer free to spend the debtor’s money; rather, he must

act as a “fiduciary” for the benefit of the creditor, 1!

U.S.C. § 1107 (1982 & Supp. IV 1986); see Wolf v. Wein-

stein, 372 U.S. 633, 649-50 (1963), and, he must act in ac-

cordance with orders the bankruptcy court may issue, |!

U.S.C. §§ 105(a); 1141(a), 1142(b) (1982 & Supp. IV

1986). (3) The bankruptcy court will determine the effect

of the debtor’s tax liability, 11 U.S.C. § 505 (1982 & Supp.

IV 1986). (4) The debtor must produce a plan that will see

that all tax claims (those enjoying what is now called a

“seventh priority,” 11 U.S.C. § 507(a\(7) (Supp. IV 1986))

are paid in full “over a period not exceeding six years after

the date of assessment of such claimfs],” 11 U.S.C.

§ 112%aK9KC) (Supp. IV 1986). (5) A bankruptcy court

order confirming a plan is an order requiring the debtor

(or trustee) to carry out the plan, 11 U.S.C. § 1142 (Supp.

IV 1986), including, of course, its payment schedule. (6) If

the debtor fails to produce, or comply, with such a plan,

the bankruptcy court may convert the proceeding, against

a eee

the debtor’s wishes, into a Chapter 7 liquidation, 11

U.S.C. 1112(b) (1982 & Supp. IV 1986), which invariably

will involve a bankruptcy court order requiring the debtor

(or the trustee), to pay assets to the government to satisfy

tax liabilities.

On the other hand, a Chapter | 1 proceeding also has im-

portant features that favor application of a “voluntary”

label. They include the following: (1) The debtor may

choose “voluntarily” to enter a Chapter 11 reorganization

proceeding (2) The Chapter 11 proceeding offers the tax-

payer protection from creditors, including the IRS; the

debtor need not pay its tax debts for six years, 11 U.S.C.

§ 112% aK9KC), and, as a practical matter, given that six

year leeway, it may take the IRS longer to get its money

from such a taxpayer than from delinquent taxpayers who

are not in bankruptcy, against whom the IRS can demand

immediate payment and pursue such legal action as a ob-

taining a levy on the debtor's property. (3) Chapter 11

gives the debtor many “options” for structuring payment

and considerable “latitude” as to “how and when the IRS

will be paid.” Jn re Lifescape, Inc., 54 B.R. 526, 528

(Bankr. D.Colo. 1985). (4) Here, third parties (Allied

Marines in Newport and Enseco in In re Energy

Resources) provided the money (or much of the money)

used to pay the IRS; no law nor any court order required

these third parties to provide their money. Moreover, the

bankruptcy judge in Newport wrote that this feature of

these cases is not unusual. He said “in the real world of

business reorganizations, most successful Chapter 11

plans depend, in part, at least, on the infusion of funds

provided by outside investors.” (5) If a debtor fails to pro-

duce an acceptable Chapter 11 plan, the bankruptcy court

need not convert the proceeding into a Chapter 7 liquida-

tion; the court may decide simply to dismiss the pro-

ceeding, 1! U.S.C. § 1112(b), leaving the debtor back

\2a

where he started; (6) Under historic bankruptcy practice, a

debtor can propose which of a creditor’s several debts a

particular payment shall satisfy. See National Bank of the

Commonwealth v. Mechanics’ National Bank, 94 U.S.

437, 439 (1876) (“The rule settled by this court as to the ap-

plication of payment is, that the debtor or party paying the

money may, if he chooses to do so, direct its appropria-

tion.”) And, this practice is important considering the IRS

suggestion that its “voluntary”/involuntary” rule basically

mimics ordinary debtor/creditor law. See p. 11, supra.

Given the strength of both sets of competing considera-

tions, we are not surprised to find a split in the circuits.

We recognize, however, that when we evaluate these con-

siderations, we must pay particular attention to an inter-

pretation that a government agency offers of its own rules

and regulations. Ford Motor Credit Co. v. Milhollin, 444

U.S. $55, 565-66 (1980); Bowles v. Seminole Rock & Sand

Co., 325 U.S. 410, 413-14 (1945); LaFlower v. United

States, 849 F.2d 8, 12 (ist Cir. 1988); United States v.

Franchi-Forlando, 838 F.2d 585, 588 (ist Cir. 1988).

Despite the strength of the arguments favoring a deter-

mination that these payments are voluntary, we Cannot say

that the IRS’s view is clearly unreasonable. We therefore

accept its view that payments made pursuant to a Chapter

11 plan are “involuntary” for purposes of its own rules.

That conclusion only means, however, that the /RS’s own

rules and regulations do not compel it to accept the tax-

payers’ determinations as to how it must apply payments

here at issue. See Arizona Grocery Co. v. Atchison,

Topeka & Santa Fe Railway Co., 284 U.S. 370, 389-90

(1932) (an agency must follow its own rules).

B. The Bankruptcy Court's Power to Allocate Tax Payments

A central legal question remains: Does a bankruptcy

court possess the legal power to order the IRS to apply a

l3a

payment in a way that runs counter to IRS’s own internal

policies? That is to say, may a bankruptcy court order the

IRS to apply an “involuntary” payment made by a Chapter

11 debtor to “trust fund” tax liabilities first, and only later

apply payments to ordinary, non-trust fund tax liabilities?

Compare In re A & B Heating & Air Conditioning, 823

F.2d at 464 (noting tension between Internal Revenue

Code’s aim io “maximize the public fisc” and the

Bankruptcy Code’s “preference toward reorganization

rather than liquidation”). We conclude that the answer to

this question is “yes,” for several reasons.

First, Congress has granted bankruptcy courts broad

equitable powers, including those powers “expressly or by

necessary implication conferred by Congress.” Johnson v.

First National Bank of Montevideo, 719 F.2d 270, 273

(8th Cir. 1983), cert. denied, 104 S. Ct. 1015 (1984); see

also Pepper v. Litton, 308 U.S. 295, 304-05 (“The

bankruptcy courts have exercised these equitable powers

in passing on a wide variety of problems arising out of the

administration of bankrupt estates.”); Jn re Leasing Con-~

sultants, Inc., 592 F.2d 103, 107 (2d Cir. 1978) (bankrupt-

cy court sits in equity); 11 U.S.C. § 1129(b)(1) (court must

ensure that reorganization plan is “fair and equitable”).

And historically, bankruptcy courts have been called upon

to use their powers to promote the “twofold” (and often

conflicting) purpose of the Bankruptcy Code: ensure fair

payment to creditors and provide the bankrupt firm with

an Opportunity to make a “fresh start.” Burlington v.

Crouse, 228 U.S. 459 (1913). The bankruptcy court may

“issue any order, process, or judgment that is necessary or

appropriate to carry Out the provisions” of the Bankruptcy

Code. 11 U.S.C. § 105 (emphasis added). At least on some

occasions, an order allocating Chapter 11 tax payments to

“trust fund” liabilities first would seem “appropriate.”

Suppose, for example, that certain third parties that in-

cluded “responsible” individuals were willing to advance

l4a

enough money to rehabilitate the corporation only if the

court would assure them that the reorganized corporation

would pay its “trust fund” tax debts first. That assurance

would diminish the likelihood that the third partics would

have to pay the debts personally; without it they might

prefer immediate liquidation, which could mean total pay-

ment of all tax debt, and “a guarantee{] that no tax penal-

ty will be assessed against them personally. Note,

Bankruptcy Court Jurisdiction and the Power to Enjoin

the IRS, 70 Minn. L. Rev. 1279, 1299-1300 (1986). Of

course, to give the “responsible” persons this assurance,

and then allow the reorganized corporation to stretch out

its tax payments over six years, might diminish the chances

that the reorganizing firm will pay its entire tax debt, for

no one can be absolutely certain that the reorganized cor-

poration will still have money four or five years into the

future. But, by giving this assurance, and thereby keeping

the firm alive, the bankruptcy court would also increase

the chances that the debtor will pay something to its

general unsecured creditors. As the Eleventh Circuit

pointed out, “[f]requently, the efforts put forth by these

officers during the reorganization is the corporation's only

hope for future viability.” In re Heating & Air Condition-

ing, 823 F.2d at 465.

Second, bankruptcy courts have long had the legal

power to tell creditors against which of a debtor's several

debts they are to apply a particular payment; see National

Bank of the Commonwealth, 94 U.S. at 439; see also 60

Am. Jur. 2d [Payment] § 103 (1987) (“A court applies in-

voluntary payments according to principles of equity and

justice, according to intrinsic justice or the equity of the

case, according to rights and priorities concerned, or

ratably to all debts, and in such a way as will best maintain

and protect the rights of all the parties.”) (citations Omit-

ted). There is case law authority holding that courts may

order the IRS to ignore its own “allocation” rules. See

Commercial Crédit Corporation v. Schwartz, 130 F.

Supp. 524, 530-31 (E.D. Ark. 1955) (federal district court

exercised its equitable powers to set aside IRS allocation of

involuntary payment because _llocation was unfair to

other creditors); cf. Amos v. Commissioner, 47 T.C. 65,

70 n.S (1966) (“We expressly refrain from deciding

whether the same right of application governs where the

rights of other creditors may be adversely affected.”).

And, to the extent that courts have held to the contrary,

they have simply assumed that the IRS’s internal “volun-

tary”/“involuntary” categorization determined the matter

without considering whether a bankruptcy court held the

legal power to allocate tax payments over the IRS’s objec-

tion. See cases cited at p. 11, supra.

Third, nothing in the bankruptcy statute limits, in any

relevant way, the bankruptcy court’s power to allocate

when the creditor is the IRS. To the contrary, Congress

specifically granted the bankruptcy court the power to

restucture tax debts, along with other debts, insisting, only

by way of compromise, that a Chapter 11 plan must en-

sure that the debtor will pay all tax debts within six years

(from the date of assessment.) We must read the absence

of such restrictions in light of Congress’ specific regulation

of the compromise nature of Chapter 11's tax debt policy.

The Senate wrote:

In a broad sense, the goals of rehabilitating debtors

and giving equal treatment to private voluntary

creditors must be balanced with the interests of

governmental tax authorities who, if unpaid taxes

exist, are also creditors in the proceeding.

A three-way tension thus exists among (1) general

creditors, who should not have the funds available for

payment of debts exhausted by an excessive accumu-

16a

lation of taxes for past years; (2) the debtor, whose

“fresh start” should likewise not be burdened with

such an accumulation; and (3) the tax collector, who

should not lose taxes which he has not had reasonable

time to collect or which the law has restrained him

from collecting.

S. Rep. No. 989, 95th Cong., 2d Sess. 13-14, reprinted in

1978 U.S. Code Cong. & Admin. News 5787, 5799-800.

We cannot assume that Congress automatically preferred

the resolution of all such tension (illustrated by the issue

before us) in favor of the IRS.

Fourth, it makes administrative sense for the bank-

ruptcy court to have the power to determine, in some

cases, the debt allocation of Chapter 11 tax payments. It is

unlikely that the IRS, charged with the duty to collect

taxes rather than to worry about firms in bankruptcy,

could easily balance on a case-by-case basis the increased

“tax collection” risk against the increased likelihood of

“rehabilitation.” But, it is very likely that the bankruptcy

court could and would do so; indeed, it is just this kind of

work that it ordinarily performs. Of course, the statute re-

quires the bankruptcy court to assure itself that reoganiza-

tion will succeed, 11 U.S.C. § 1129%(a)(11) (1982), and that

therefore, the IRS, in all likelihood, will collect the fotal

tax debt owed; and that court has no more than a six year

leeway within which to structure payments. I! U.S.C.

§ 112%anK9MC). But, acting within that leeway, it would

seem to make administrative sense to permit the court to

structure not only times and amounts of payment, but also

the particular tax debt to which each payment shall be

allocated.

Fifth, the IRS's policy of allocating payments first to a

corporate debtor's non-trust fund tax liability is not a

statutory policy. That policy, created by internal rule, is

designed to preserve the liability of the “responsible” in-

17a

dividuals. It thereby increases the likelihood that the IRS

will ultimately collect the entire tax debt (“trust fund” and

non-trust fund) owed by the corporation. This objection is

understandable, even commendable, for an agency whose

mission is to collect taxes. See Rev. Rul. 79-284, 1979-2

C.B. 83, modifying Rev. Rul. 73-305, 1973-2 C.B. 43,

superseding Rev. Rul. 58-239, 1958-1 C.B. 94 (“[T]}he In-

ternal Revenue Service will allocate partial payments of

withheld employment taxes . . . in a manner serving [the

IRS'] best interests.”) (emphasis added). But, we can find

no statute that attaches so overriding an importance to this

tax objective as to circumscribe a court’s statutorily

granted powers to ‘he contrary. As a general matter, the

IRS cannot, in any obvious way, circumscribe, by using an

internal rule, a court’s statutory powers. See Dixon v.

United States, 381 U.S. 68, 74 (1965).

Sixth, we can find no policy embodied in any specific

tatute, tax or otherwise, that either directly, or by

manifesting a congressionai intent, circumscribes a bank-

ruptcy court’s general powers in the respect at issue here.

The IRS argues strongly that requiring the IRS to allocate

tax payments in Chapter 11 proceedings to “trust fund”

debts first would frustrate the congressional intent of 11

U.S.C. § 6672 —the statute that permits the IRS to collect

unpaid “trust fund” taxes directly from the personal assets

of “responsible” individuals. But, we do not see how that

is SO.

We agree with the IRS that Section 6672 reflects a

strong congressional policy to collect “trust fund” tax

liabilities. Such a policy reflects the fact that if a corpora-

tion is unable to pay its “trust fund” taxes, the United

States Treasury suffers the loss because the employees

from whose wages the taxes are withheld are still credited

with those amounts as if they had in fact been paid to the

government. United States v. Huckabee Auto Co., 783

18a

F.2d 1546, 1548 (11th Cir. 1986); Jn re Avildsen Tools &

Machine, Inc., 794 F.2d 1248, 1251 n.6 (7th Cir. 1986).

But, we do not agree that such a policy helps the IRS in its

argument. Indeed, the IRS’s argument seems to stand the

policy of Section 6672 on its head: The IRS’s Chapter 11

allocation policy and interpretation of Section 6672 does

not assure that “trust fund” taxes are promptly turned over

to the government. Rather, it ensures that “trust fund”

money is paid over /ast, only after all non-trust fund taxes

have been paid.

The IRS seeks to use the personal liability of “responsi-

ble” persons, not to help collect “trust fund” tax debts, but

to collect total tax debts. And, in order to help maximize

that total collection, it is willing, by not crediting the “trust

fund” debt first, to run a greater risk of nor collecting the

‘trust fund” debt at all, as would be the case if the

reorganized corporation ran out of money while paying

the non-trust fund tax debt and there were no personal

assets of “responsible” persons. In this way, the IRS's

allocation policy gives ordinary, non-trust fund tax debts a

special status; it places the payment of “trust fund” tax

debts at risk; and it effectively forces the “responsible”

persons to be liable for the /ast tax dollars due from the

debtor, a liability which Congress did not say

“responsible” persons ought to have. Section 6672 does

refer to “responsible” person liability as a “penalty” but

this characterization “does not alter their essential

character as taxes.” United States v. Sotelo, 436 U.S. 268,

275 (1978); Huckabee Auto Co., 783 F.2d at 1548

(“Although denoted a penalty in the statute, the liability

imposed by section 6672 is not penal in nature, but is

‘simply a means of ensuring that the tax is paid.’ ”)

(quoting Botta v. Scanlon, 314 F.2d 392, 393 (2d Cir.

1963)) (citation omitted). And, the IRS collects the

amount of the unpaid trust fund taxes only once, from the

19a

“responsible” individuals, the corporate debtor, or some

combination thereof. Sotelo, 436 U.S. at 279 n.12:

USLIFE Title Ins. Co. v. Harbison, 784 F.2d 1238, 1243 &

n.7 (Sth Cir. 1986) (citing IRS Policy Statement P-5-60,

supra). Indeed, the IRS itself has said that it would try to

collect trust fund taxes from responsible individuals

“‘only when all other means of securing the delinquent

taxes have been exhausted.’ ” Sotelo, 436 U.S. at 279-280

(quoting Opinion B-137762 (May 3, 1977), reprinted in

CCH 1977 Stand. Fed. Tax Rep. ¢ 6614, at 71,438 (state-

ment of Comptroller General of United States)).

A simple example will help illustrate our problem with

the IRS argument. Assume, for example, that a debtor

owes the IRS $1 million in “trust fund” tax liabilities and

$5 million in ordinary, non-irust fund tax liabilities.

Assume further that the Chapter 11 reorganization plan

schedules payments of $1 million per year for six years.

Although the bankruptcy court will not approve such a

schedule unless it is convinced that the debtor will pay the

entire $6 million over the six years, we can understand the

IRS’s fear that risk of noncollection for later payments is

greater than for earlier payments. We cannot, however,

understand the IRS’s argument that a bankruptcy court’s

insistence that the IRS apply the first $1 million payment

to “trust fund” debts inhibits its collection of such debts.

Such an allocation does indeed tend to prevent the IRS

from pursuing “responsible” individuals for the money

after Year One (or if the IRS has pursued them, they can

obtain a refund, 26 U.S.C. § 6511(a) (1982)); but that is

only because the “trust fund” debts have been paid. \f the

IRS were anxious simply to check off the tax liabilities in

its “trust fund” books, it would as we have said, try to get

this money in Year One, not Year Six (by which time the

risk increases that both debtor corporation and “responsi-

ble” individuals will lack the assets to pay.)

20a

In fact, because money is fungible, the effect of the

bankruptcy court’s ruling is to diminish the IRS's ability

(by looking to “guarantors” of the “trust fund” $1 million)

to obtain the whole six million. But, that ruling releases

the guarantor only to the extent that the IRS actually

receives $1 million, the full “trust fund” liability; and as to

the remaining $5 million, the IRS is no worse off than had

the entire debt been an ordinary tax debt without a “trust

fund” component. And, so long as there is a “trust fund”

tax debt outstanding, nothing, including our opinion to-

day, legally restrains the IRS from attempting to collect

“trust fund” taxes from “responsible” individuals. See /n

re LaSalle Rolling Mills, 832 F.2d 390 (7th Cir. 1987)

(Anti-injunction Act prohibits courts from restraining IRS

from collecting “trust fund” taxes from individuals under

§ 6672); A to Z Welding & Manufacturing, Co. v. United

States, 803 F.2d 932 (8th Cir. 1984) (same); Huckabee

Auto Co., supra.

As we have said, we can find no policy in any statute

suggesting that Congress felt that bankruptcy courts must

maximize the likelihood that the IRS will receive its entire

tax debt, irrespective of all other goals, particularly the

Bankruptcy Code’s preference for rehabilitation over li-

quidation. We note that a bill introduced in the House of

Representatives would give the IRS the very statutory

power it seeks here. See H. R. 3984, 100th Cong., 2d Sess.

§ 201 (1988) (proposing that Section 505 of title 11 of the

United States Code be amended to include that

. “[p]ayments of taxes under this title to a governmental

unit may be applied by the governmental unit in a manner

that preserves alternative sources of collection, if any”).

But, Congress has not enacted that bill into law.

Thus, in weighing the competing aims of the Bank-

ruptcy Code and Internal Revenue Code, we reach the

same result as the Eleventh Circuit in /n re A & B Heating

2la

& Air Conditioning, supra. We hold that “ ‘the allocation

question in a Chapter 11 case under the Ban

should be left to judicial discretion to be decided ig

by-case basis.’ Jd. at 465 (quoting Jn re B & P Enter-

prises, Inc., 67 B.R. 179, 183 (Bankr. W.D.Tenn. 1986)).

Specifically, the bankruptcy court should make the

following inquiry: upon consideration of the reorganiza-

tion plan as a whole, in so far as the particular structure or

allocation of payments increases the risk that the IRS may

not collect the total tax debt, is that risk nonetheless

justified by an offsetting increased likelihood of

rehabilitation, i.e., increased likelihood of payment to

creditors who might otherwise lose their money? And, the

standard for judging the lawfulness of any such bankrupt-

cy court action should be similar to that applied to other

bankruptcy court tax-related actions. See e.g., Darman v.

Metropolitan Alarm Corp., 528 F.2d 908 (ist Cir. 1976)

(findings of fact by bankruptcy judge entitled to stand

unless “clearly erroneous”). In applying this test, of

course, the bankruptcy court must recognize the obvious

importance of satisfying tax liabilities, but where this test

is Satisfied, we are convinced that the bankruptcy court

has the legal power to order the allocation.

IV. The Result

We have also considered whether or not we we must re-

mand these cases to the bankruptcy court for reconsidera-

tion in light of the appropriate standard. We should do so

if these courts ordered the “trust fund” debt paid first

simply because they thought the IRS rules so required

i.e., if they did so simply because they thought these

payments were “voluntary,” and if they might have exer-

cised their legal authority differently had they realized that

their allocation orders ran contrary to IRS policy. Having

22a

examined the opinions of the bankruptcy courts and the

records in these cases, we conclude that no remand is

necessary.

The bankruptcy judges in both cases clearly understood

the IRS’s opposition to their “trust fund” allocation

orders. The bankruptcy judge in Newport Offshore con-

sidered that he had the legal “flexibility” to allocate

payments to “trust fund” tax debt when bankruptcy

related circumstances so required. He wrote that he con-

sidered the “totality of the circumstances,” he noted the

special circumstances that a “third party, Allied Marine

Associates,” provided funding for the plan, and he re-

jected as without “factual or practical support” the IRS

claim that the allocation would do no more than benefit a

particular individual who was a “responsible” person.

Moreover, given the presence of the third party, the record

offers adequate support for the reasonableness of a deter-

mination that the allocation order is both fair and will help

to rehabilitate the company. Under these circumstances,

we do not believe that remanding could serve any purpose.

The bankruptcy court opinion in /n re Energy Resources

indicates less clearly that the court would reach the same

conclusion had it been aware of our eventual conclusion

about the law. The court seemed to base its result upon its

“voluntary” versus “involuntary” analysis. Nonetheless,

that court held a special hearing about whether it should

order the IRS to accept the taxpayer’s payment designa-

tion, it heard argument about the trustee’s claim that the

designation would not significanily hurt the IRS, and that

it was “necessary” for the trustee to maximize the extent to

which the IRS payments would “benefit the estate.” In ad-

dition, the bankruptcy judge found that “the Plan in the

instant case and the tax payments at issue were made

possible, at least in part, by the infusion of capital” from a

third party. And, in issuing the order it specifically rested

23a

its decision upon the “entire record of the case and the

arguments of counsel.” The record makes us reasonably

certain that the court would not have reached a different

result had it been fully aware that it was ordering the IRS

to accept a designation contrary to IRS rules. And, the

— provides adequate support for the court’s conclu-

For these reasons, we conclude that the orders of the

oonkruptcy judges in both cases are lawful. Therefore, the

— of the district court in Jn re Newport Offshore

td. is

Reversed.

The judgment of the district court in Jn re Energy

Resources Co. is

Affirmed.

24a

APPENDIY B

UNITED STATES DISTRICT COURT

DISTRICT OF MASSACHUSETTS

Civil Action No. 86-1533Mc

In RE ENercy Resources Co., INC., DEBTOR

UNITED STATES OF AMERICA, APPELLANT

Enercy Resources, Co., INC., APPELLEE

August 5, 1987

Memorandum and Order

Mc Nauour, D.J.

The issue presented by this appeal was whether the

bankruptcy court erred in holding that the payments of tax

pursuant to a Chapter 11 Plan were voluntary, and

therefore, their application could be directed by the

Trustee. Muntwyler v. United States, 703 F.2d 1030, 1032

(7th Cir., 1983). If payments are “involuntary”, the

Trustee may not direct the application of the payments.

On April 7, 1986 the Bankruptcy Court entered an

Order allowing the motion of the Liquidation Trustee, and

ordering the Internal Revenue Service to apply tax

payments under a confirmed Plan, as designated by the

Trustee. The terms of the Plan approved by the Bankrupt-

cy Court provide that the taxing authorities are to be paid

in full with interest in four equal payments commencing

one year after the confirmation date of the Plan. During

the year 1985, the Trustee tendered one check in the

—

25a

amount of $203,516.54, and another in the amount of

$78,000, the Trustee designating to the IRS that these

payments be applied first to the trust fund portions of

taxes due from the debtor. The IRS refused to accept the

checks under the terms of the designation, without a court

order. The Bankruptcy Judge, as recited hereinbefore,

granted a motion for such an order, and this appeal

followed.

The basic principle, as enunciated in Muntwyler, supra,

is that if a taxpayer's payment is “voluntary”, the taxpayer

may designate its allocation among tax, penalty and in-

terest. If it is “involuntary”, the taxpayer, here the

Trustee, may not designate. Bankruptcy Judge James

Gabriel held that the payments were voluntary, by reason

of broad discretion given to debtors under § 1129 of the

Bankruptcy Code. 11 U.S.C. § 112%a)(9\(C). | agree with

the conclusion of the Bankruptcy Judge that Section 1129

payments are voluntary, 2ad that this ruling is consistent

with the policies underlying Chapter 11.

The United States contends on this appeal that, since

“court action” is involved in a Chapter 11 proceeding, Sec-

tion 1129 payments are therefore “involuntary”.

The argument of the Trustee (to the effect that the

payments are voluntary) is perhaps best summed up in /n

re Lifescape, Inc., 54 B.R. 526 (Bankr. D. Colo. 1985) in

the following language: “The mere filing of a claim in a

Chapter |! proceeding is clearly not the type of court ac-

tion envisioned in Amos and Muntwyler since it does not

approach the ‘actual seizure of money or property as in a

levy’... . The fact that payments are made pursuant to a

plan which must comply with the requirements of the

Bankruptcy Code does not rise to a level of court action

equivalent to a levy, judicial order, execution or judicial

sale.”

26a

The reason behind the statement of the principle is the

recognition by courts that Section 1129 allows “far greater

flexibility” than was available under the Bankruptcy Ac}.

Along with the Trustee and the Judge in Bankruptcy, |

see a distinction between the court’s role in confirming a

plan under Section 1129 and other court action, rising to

the level of a seizure. It seems to me that the position of

the appellant fails to recognize that the action of the

Bankruptcy Court in this voluntary Chapter 1!

reorganization is limited action: the approval of a plan

Section 1129. The court here didn’t compel action; rather,

it approved a payment which a debtor wished to make.

Judge Gabriel's reliance upon decisions as In re

A&B Heating and Air Conditioning Inc., 53 B.R. 54

(Bankr.M.D. Fla 1985), aff'd May 7, 1986) and In re

Lifescape, Inc., $4 B.R.526 (Bankr. D. Colo. 1985) is well

The Order of the Bankruptcy Court is affirmed. The In-

ternal Revenue Service is directed to apply the tax

payments in accordance with the designation of the tax-

payer.

/s/ JOHN Mc NAUGHT

John J. Naught

United States District Judge

27a

APPENDIX C

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF RHODE ISLAND

Docket Number CA 87-0433

UNITED STATES OF AMERICA

vs.

NewPport OFrsHore, LTp.

Providence, Rhode Island

December 9, 1987

TRANSCRIPT OF PROCEEDINGS IN ABOVE-

CAPTIONED CASE BEFORE CHIEF JUDGE FRAN-

CIS J. BOYLE.

[35] THE COURT: This is an appeal from the confirma-

tion of a plan by the Bankruptcy Judge in this district in

the matter of in re Newport Offshore LCD debtor Bank-

ruptcy Number 885723. The Bankruptcy Judge’s opinion

appears at 75 Bankruptcy Reporter 919 and was filed on

July 14 of 1987. The plan in part provides how the tax

payments, federal tax payments, should be [36] applied.

Specifically the plan provides that payments be credited

first to the trust fund portion of the oldest taxes. Second,

to the interest on such trust fund portion of such taxes,

and, third, to the oldest nontrust fund portion of the re-

maining tax Obligations and the interests thereon.

The Interest Revenue Service objects to the application

of the tax payments as proposed and argues that it be per-

mitted to apply the tax payments first to the nontrust fund

taxes in accordance with IRS policy. The significance of

this is that under the provisions of 26 United States Code

Section 6672 any person required to collect, truthfully

28a

per nephron eein dierrrt

to personal liability if the taxes are not giving

eects teadaniinaaiandaires Gun aig

to its bow. That is, it may collect the taxes from the cor-

poration or it may collect the taxes from the person in-

volved in the corporation who has the ability to direct the

payment and application of the corporation's income and

assets.

The fact of the matter is that with respect to [trust] fund

taxes, particularly withholding taxes and social security

taxes which are withheld by the employer and not paid

over to the government, the guvernmceat is [37] required to

credit the employee with the payment of those taxes in

spite of the fact that the government does not receive those

taxes. The theory of Section 6672 is that the assets of the

corporation have been misapplied by the persons who had

control over them * .<.ms of not carrying out the trust

which is impose «ith respect to those type of taxes. 7

There is a thorough and complete split in the Circuits

with respect to whether or not under these circumstances

of this plan payments to the Internal Revenue Service are

voluntary or involuntary. That split is dependent on the

application of a definition of what is voluntary and what is

not voluntary contained, which is contained in the Amos

case. Amos versus The Commissioner, a Tax Court deci-

sion in 1966 which says that an involuntary payment of

federal taxes means any payment received by agents of the

United States as the result of the restraint or levy or from a

legal proceeding in which the government is seeking to col-

lect its delinquent taxes or file a claim therefor. Amos was

obviously not a bankruptcy case, it's a case cited in the Tax

Court. And the definition perfectly serves the purposes for

which it was given. It has, however, been applied by |

think the Eleventh Circuit as ®eng the only definition, and

in this instance by the Baekreptcy [38] Judge as being the

29a

only definition of what is involuntary. The definition does

not take into consideration the nature of the bankruptcy

proceeding, whether a voluntary petition or not. The

Bankruptcy Covr te’ _s control of the debtor’s assets and

which there?‘ .« ac ministers those assets for the benefit of

all of the credit ors, including Internal Revenue Service.

That Internal Revenue Service is not in the position at that

point in time to engage in any kind of restraint or levy or

bring a legal proceeding, except file a claim in the

bankruptcy proceeding and to seek relief in the Bankrupt-

cy Court. So that it seems to me adopting the definition of

Amos is to create a strawman argument here that under

which the government, the Internal Revenue Service can-

not possibly succeed, that by defining “involuntary” in the

way that it is done it excludes bankruptcy proceedings. |

don’t think that’s what Internal Revenue Service's policy

means or how it intends to apply it. Nor do I think the

Congress had that result in mind.

I'm satisfied that the better reasoning, the more com-

plete reasoning, the more sensible reasoning is that found

in the Third Circuit's more recent opinion in the matter of

Ribs Are Us Incorporated in which the United States was

an appellant, an opinion filed by [39] a panel of the Third

Circuit on 9, 1987, subsequent to the

Bankruptcy J 's opinion. That opinion | would incor-

porate in full in mine. It seems to me that it adequately

argues the various points of view that have arisen with

respect to this question and I believe comes down on the

better side of the argument that the Congress would see to

it that both of these policies work together, the policy of

reorganization and the policy of collecting taxes and

avoiding what is not just a loss of taxes but a double-

whammy to the government in terms of these trust fund

taxes, that Congress, if asked the question, would say “we

did not ever intend that a principal stockholder of a cor-

30a

poration in reorganization would have the ability to

negotiate in the Bankruptcy Court an exculpatory provi-

sion with respect to the trust fund taxes, that both of these

policies can coexist and should be applied coextensively.”

Under these circumstances, therefore, I'm going to sustain

the appeal from the Bankruptcy Court and remand the

matter to the Bankruptcy Court to delete the allocation

provisions in the reorganization plan and for such other

proceedings as may be required. The trustee may have an

exception. I'm going to ask the government to prepare a

form of order.

(Proceedings concluded)

‘?™

a a

3la

APPENDIX D

UNITED STATES BANKRUPTCY COURT

DISTRICT OF MASSACHUSETTS

Chapter 11

Nos. 83-00060-JG

83-00128-JG

83-00129-JG

83-00130-JG

83-00131-JG

IN RE:

ENERGY Resources, Co., INC.,

ENERGY OPERATORS, INC.,

OILFIELD INNOVATIONS, INC.,

OILFIELD Resources Co., INc. (TEXAs),

OILFIELD Resources Co., INc. (DELAWARE)

DEBTORS

MEMORANDUM

This matter is before the Court on the motion of

William A. Browner, Liquidation Trustee (the “Trustee”)

of the Erco Liquidation Trust (the “Trust”) established

under the Debtor’s Third Amended Plan of Reorganiza-

tion (the “Plan”). The Trustee seeks an order directing the

Internal Revenue Service (“IRS”) to apply payments under

the Plan as designated by him. The IRS opposes the

Trustee’s motion. Both parties have briefed their respec-

tive positions. The factors are undisputed.

32a

FACTS

On January 17, 1983 and January 31, 1983, the debtors,

Energy Resources Co., Inc. and its affiliates, commenced

proceedings under Chapter 11 of the Bankruptcy Code. By

order dated September 5, 1984, this Court confirmed the

debtors’ Plan pursuant to which the Trust was established.

The purpose of the Trust, as the IRS notes in its brief, is to

liquidate all remaining assets of the debtors for the benefit

of their creditors. |

Pursuant to Article 5 of the Plan, claims of taxing

authorities, including the IRS, are to be paid in full either

upon such terms as the debtors and the taxing authorities

may agree or in accordance with section 1129(a(9"C )ot

the Code in four equal annual payments commencing one

year after the Confirmation Date (as defined in the Plan

and ultimately determined to be October 1, 1984).' The

annual payments include a repayment of principal

together with interest at the statutory rate established by

the Secretary of the Treasury pursuant to 26 U.S.C.

§ 6621. In addition to the annual payments, the Plan pro-

vides that the Trustee has the right to prepay tax claims at

anytime.

' The Court's order of September 5, 1984 indicates that:

By agreement of the Debtors, Article 5 of the Plan shall be

deemed modified to provide that all Finally Allowed tan claims

covered thereby shall be paid over a period of four years trom the

Confirmation Date, as defined in the Plan, and not trom the

Consummation Date, and that, in any event, the Debtors and

thereafter the Trustees, as defined in the Plan, shall use their best

effort consistent with the payment of priority claims and ad-

ministrative expenses and consistent with their duties, including

their expenses under the Erco Liquidation Trust Agreement, to

prepay all Finally Allowed tax claims, in whole or in part, prior to

the four anniversary dates described in Article $ of the Plan.

33a

On November 6, 1985, the Trustee made payments to

the IRS in accordance with the Plan in the amounts of

$203,516.54, representing the Plan payment then due, and

$78,000, representing a partial prepayment of the out-

standing claim. In so doing, the Trustee designated “that

this payment be applied to the trust fund portion of taxes,

first for the period ended June 30, 1982 with the excess, if

any, applied to the trust fund portion of the taxes for the

period ended September 30, 1982.”

The IRS refused to acknowledge the Trustee’s designa-

tion of the payment. In a letter dated November 7, 1985,

its Bankruptcy Advisor advised the Trustee that “[{uJnless

such direction of payment is given in a court order, the

United States reserves the right to apply such payment

which is a distribution of a bankruptcy proceeding to its

maximum benefit.” As a result of the refusal of the IRS to

honor his designation, the Trustee moved for an order

directing the IRS to apply Plan payments as designated by

the Trustee. In his motion, the Trustee argued inter alia:

1) that the ability of the Trustee to direct payments is

necessary for the Trustee to maximize the benefit to

the estate from such payments;

2) that the IRS will not be harmed by the designation,

since the Plan provides for the payment in full of the

IRS’ claim, plus interest;

* The court in Muntwyler v. United States, 703 F.2d 1030 (7th Cir.

1983) described trust fund taxes as follows:

The Internal Resenue Code directs employers to deduct and

withhold a tax upon wages paid. 26 U.S.C. § 3401(a). The

withheld taxes are deemed to be held in a special fund im trust for

the United States, id. §7501(a), and accordingly every person re-

quired to collect and pay over such a tax (including an officer of

the corporation .. . , id. § 6671(b)) is personally liable for the

full amount of the tax not paid, id. § 6672.

Id. at W032.

34a

3) that by directing payments, the Trustee is able to

implement a settlement agreement with Richard

Rosen, a former officer, whereby $14,000 was im-

mediately released to the Trust and the Trustee =

to cooperate in designating tax payments whic

would forestall personal liability assessed by the IRS

against the former officers from affecting them and

their ability to cooperate with the Trustee; and

4) that payments made under a plan of reorganiza-

tion pursuant to 11 U.S.C. § 1129(a)(9(C) are volun-

tary and, therefore, entitled to be designated.

In its response to the Trustee’s motion, the IRS focused on

the Trustee’s final argument, asserting that payments

made to the United States pursuant to a Chapter 11 plan

are “involuntary” and the manner of their application is in

the sole discretion of the United States. The question then

presented for the Court is whether, in fact, tax payments

made pursuant to a confirmed Chapter 11 plan of

reorganization are voluntary or involuntary.

DISCUSSION

The starting point for any discussion is the general rule

that a taxpayer who makes a “voluntary” tax payment to

the IRS may designate, at the time of payment, the man-

ner of allocation of such payment among tax, penalty and

interest, Muntwyler v. United States, 703 F.2d 1030 (7th

Cir. 1983); O’Dell v. United States, 326 F.2d 451 (10th Cir.

1964), whereas a taxpayer who makes an “involuntary”

payment may not designate the manner of its allocation,

the IRS being free to apply such payment to maximize the

amount of assessed tax that may be collected, United

States v. DeBeradinis, 395 F Supp. 944 (D. Conn. 1975),

aff'd, 538 F.2nd 315 (2d Cir. 1976); United States v.

Augspurger, 508 F.Supp. 327 (W.D.N.Y. 1981).

3Sa

Courts have adopted the United States Tax Court’s

definition of an involuntary payment set forth in Amos vy.

Commissioner, 47 T.C. 65 (1966). It provides:

An involuntary payment of federal taxes means any

payment received by agents of the United States as a

result of a distraint or levy from a legal proceeding in

which the Government is seeking to collect its delin-

quent taxes or file a clain§ therefor.

Id. at 69. For example, the United States Court of Appeals

for the Seventh Circuit stated:

The distinction between a voluntary and involuntary

payment in Amos and all the other cases is not made

on the basis of the presence of administrative action

alone, but rather the presence of court action or ad-

ministrative action resulting in an actual seizure of

property Or money as in a levy. No authorities sup-

port the proposition that a payment is involuntary

whenever an agency takes even the slightest action to

collect taxes, such as filing a claim or, as appears to

be a logical extention of the Government's position,

telephoning or writing the taxpayer to inform him of

taxes due.

Muntwyler, 703 F.2d at 1033." >

* In Muntwvier, a corporation which was delinquent in paying its

federal withholding taxes entered into a common law assignment to a

trustee for the benefit of creditors. The IRS filed a claim with the

trustee. When the trustee sent monies to the IRS, imstructing that

payments be applied to the trust fund portion of the corporate tax

lability so that the 100% penalty assessment against the responsible

officer would be partially satisfied, the IRS refused to follow his in-

structions. The responsible officer then filed suit seeking a refund

from the IRS. The district court ruled that trustee's payment to the

IRS was voluntary

aaa

36a

Although courts are in agreement as to the definition of

“involuntary” payment, partly because of dictum in

Muntwyer,* they diverge from there, leading to conflicting

precedent as to whether payments to the IRS pursuant to a

bankruptcy proceeding are involuntary. Cf. In re

Lifescape, Inc., 54 B.R. 526, 527 (Bankr. D. Colo. 1985).

However, recent decisions are in agreement that the mere

filing of a claim in a Chapter 11 proceeding and the con-

firmation of a plan of reorganization do not constitute

sufficient judicial action to render payment made pur-

suant to a Chapter |! plan involuntary. Jn re Lifescape,

Inc., 54 B.R. 526 (Bankr. D. Colo. 1985); in re A&B

. Heating & Air Conditioning, Inc., 53 B.R. 54 (Bankr.

M.D. Fla. 1985); Jn re Franklin Press, Inc., 52 B.R. 151

(Bankr. D. Fla. 1985); accord In re Hartley Plumbing

Company, Inc., 32 B.R. 8 (Bankr. M.D. Ala. 1983); cf

Hineline v. Household Finance Corp., No. 85-0100

(Bankr. N.D. Ohio Jan. 27, 1986).

The courts in the /n re Lifescape, Inc. and In re A&B

Heating & Air Conditioning, Inc. cases, both of which in-

volved Chapter 11 debtors seeking to allocate payments to

the IRS so that the trust fund portion of the IRS’ claim

would be credited first until paid in full, stressed the op-

tions a debtor has under section 1129 of the Code and the

nature of the court's involvement. In a rationale specifi-

* For example, the court in footnote two indicated:

The Government might have been correct in ws claim if the cor-

poration had been in bankruptcy, which & was not. An assign-

ment for the benefit of creditors is an act of bankruptcy and

presumably any creditor, including the Government, could have

proceeded to file an involuntary petition for bankruptcy based

thereon. . . . We do not equate the assignment for the benefu of

creditors with a formal bankruptcy, proceeding.

703 F.2d at 1034 n. 2.

cally adopted by the court in Jn re Lifescape, Inc., the

court in In re A&B Heating & Air Conditioning Co., Inc.

Stated:

Court involvement in the context of a Chapter 11

reorganization case is not the type which results i

seizure of property or money as in a levy. Unlike

taxpayer faced with a government instituted collec-

joys great latitude in how and if a plan is proposed

and thus how and when the IRS will be paid. § 1129

requires only that a plan provide for payment of pre-

petition taxes Over a period not io exceed 6 years from

the date of assessment in order that it may be con-

firmed. The debtor propounding a plan has a number

of options with respect to treatment of a claim by the

IRS and « is the freedom afforded by these options

which dictates the conclusion that payments to the

IRS pursuant to a confirmed Chapter 11 plan of

$3 B.R. at 57 (emphasis supplied).

Likewise, the court in Jn re Franklin Press, inc. found

that payment made pursuant to a Chapter |! plan was

voluntary. In that case, the reorganization was funded by

the infusion of outside capital provided or guaranteed by 3

third party. The court held that this established volun-

tarimess since the third party was not subject to the

court’s control, in contrast to a debtor in liquidation

without real options. Significantly, the Plan in the instant

case and the tax payments at issue were made possible, at

least in part, by the infusion of capital from Enseco, Inc.’

* See Supulation Regarding Management. Plan Funding and Asset

Purchase filed March 26, 1984, Modification of Supulanon Regarding

Management, Plan Funding and Asset Purchase filed April 13, 1984,

ee ——— a = OE

38a

Since the facts of the cases just discussed are similar to

the ones in the instant case, the Court finds their reasoning

persuasive. Furthermore, the three cases primarily relied

upon by the IRS are distinguishable from the instant case

and the cases just discussed. For example, Jn re Frost, 47

B.R. 961 (D. Kan. 1985), unlike the instant case, did not

involve section 1129. In that case, the district court, citing

Muntwyler, reversed the bankruptcy court, which had

held that payments made under a Chapter 13 plan are

voluntary, because the IRS had filed a claim and because

the plan had to comply with the Bankruptcy Code. The

district court’s reliance on the proposition that Muntwyler

makes it clear that it is the involvement of the court and

not the type of bankruptcy which makes payments by a

oten involuntary is open to serious question, see In re

Lifescape Inc., $4 B.R. at $29. Therefore, this Court will

not follow its lead, particularly in view of the fact that sec-

tion 1129 was not involved.

Likewise, in In re Avildsen Tools and Machines, Inc.,

40 B.R. 253 (D.C.N.D. I. 1984), section 1129 was not in.

volved. In that case, both judicial orders and a judicial

sale concerned the district court. Furthermore, the bank-

ruptcy court’s orders, approving and confirming the sale

of the debtor's assets and authorizing the debtor to pay its

liabilities from the proceeds, were issued pursuant to the

Bankruptcy Act which required more court involvement in

case administration than under the Code.

Finally, Jn re Mister Marvins, Inc., 48 B.R. 279 (E.D.

Mich. 1984), is distinguishable because it involved a hi-

quidation of the debtor's assets pursuant to a court order

which authorized the settlement of a claim. As the court in

—$—————$_

_ a

this Court's Order, dated April 13, 1984, Approving and \llow ing

Debtor's Motion for Approval of Supulation with Enso, Inc , and

the Debtor's Third Amended Plan of Reorganisation

39a

In re A&B Heating & Air Conditioning, Inc. observed,

“the [cjourt in the Mister Marvins case was clearly more

active than is a court whose only concern is to determine if

the proposed plan of reorganization meets tHe standards

set forth in § 1129.” 53 B.R. at 56.

The Court, therefore, concludes that the Trustee’s pay-

ment to the IRS, pursuant to Article 5 of the debtors’ con-

firmed Plan, as modified by the Court's order of

September 5, 1984, was voluntary and that the Trustee had

every right to direct the IRS to allocate the payments to the

trust fund portion of taxes owed. The Court is persuaded

not only by the recent cases unequivocally holding that

payments made pursuant to section 1129 are voluntary but

by common sense as well.

Historically, bankruptcy has been a statutory vehicle for

aid to those in financial need. Congress, through the

Bankruptcy Code, has provided bankrupts with extensive

protection from their creditors and a reasonable oppor-

tunity to rehabilitate not only for their benefit but for that

of the public as well.

Although the IRS’ argument that it has the statutory

responsibility to collect all taxes from all taxpayers who

may be liable for their payment is persuasive and indeed

laudable (9 in most contexts, this Court believes that

Congress has tempered that objective in the bankruptcy

context, albeit in a limited fashion. The Court cannot

agree with the IRS’ contention that an act is involuntary

simply because it Occurs in a bankruptcy proceeding. Such

an assertion flies in the face of Congressional concern for

the rehabilitation of bankrupts, the dictionary definition

of voluntary® and the consistent usage of the word

* The word voluntary » defined in Webster's New Collegiate Dic

thomary a5 “lo proceeding from the will or from one’s own chowe or

consent 2 unconstramed by interference velt determining

—_— Se ai ig

involuntary by practitioners and scholars to distinguish

cases commenced pursuant to 11 U.S.C. § 303 from other

cases.

Furthermore, the Court is mindful that the IRS had the

opportunity to voice its concern with respect to the alloca-

tion issue at the time of the confirmation hearing but did

not do so.’ Although the Plan does not state specifically

that all payments to the IRS will be credited first to the

trust fund portion of the IRS claim until it is paid in full,

the likelihood that the Trustee would seek such a designa-

tion was foreseeable. Indeed, both the Plan and Erco Li-

quidation Trust Agreement repeatedly emphasize the

Trustee’s broad powers to act for the benefit of creditors."

The Court is inclined, therefore, to view the Plan and the

Trustee’s authorized actions pursuant to it, including the

designation of tax payments, as binding. As the court

observed in Jn re St. Louis Freight Lines, Inc., 45 B.R. 546

(Bankr. E.D. Mich. 1984), with respect to its jurisdiction

to interpret the terms of a confirmed plan ana the distribu-

tion of post-petition, pre-confirmation taxes:

Section 1141(a) of the Code provides that confirma-

tion binds the debtor, creditors and other parties in

interest to the terms of the plan, even if a party has

not accepted the plan. Case law has established the

binding contractural nature of the plan. This rule has

recently been used to bind the IRS and other taxing

’ The IRS filed an objection to the debtors’ Plan on August |, 1984

on the grounds that (he payment schedule would extend beyond the si.

years from the earliest day of assessment. It withdrew ity objection 11

open court on the date of confirmation, September 9, 1984

* For example, Article $.1(h) of the Trust Agreement gives the,

Trustee the power to “amend this agreement in any manner whatever.

provided that no such amendment shall permit the Trustce to engage

in any activity prohibited hereunder and provided no such amendmen

shall limut the Righ'. oi Beneficiaries ~

4la

authorities to the terms of the debtor’s confirmed

plan. It is equally well established that an order con-

firming a plan is an appealable order that has res

judicata effect on all issues that could have been

raised regarding the claim. \n other words, a party in

interest . . . is bound by the plan when confirmed,

even if the plan ultimately provides it with less than

that to which it is otherwise legally entitled.

Id. at S$51-52 (footnote omitted, citations omitted, em-

phasis supplied).

In view of the foregoing, the entire record of the case,

and arguments of counsel whether or not mentioned

herein, the Trustee’s motion is allowed and the IRS is

hereby ordered to apply tax payments under the Plan as

designated by the Trustee.

By the Court,

‘s/ James N. Gaprie

James N. Gabriel

Bankruptcy Judge

Dated at Boston in said District, this 7th day of April,

1986

42a

APPENDIX E

UNITED STATES BANKRUPTCY COURT

FOR THE DISi RICT OF RHODE ISLAND

BK No. 8500723

IN RE.

Newport OFrsHore, LTD., DEBTOR

DECISION AND ORDER OVERRULING THE OBJECTION

BY THE INTERNAL REVENUE SERVICE TO ARTICLE Itt

OF THE TRUSTEE’S PLAN OF REORGANIZATION

Before: Arthur N. Votolato, Jr., United States

Bankrupicy Judge

Heard on the objection of the United States, on behalf

of the Internal Revenue Service (IRS), to that portion of

the Chapter 11 trustee’s plan of reorganization which seeks

to designate the manner in which IRS should apply plan

payments to prepetition tax liabilities. '

Article IL of the plan proposes to pay all Class Four

claims, those of all the taxing authorities,’ through “pay:

ment .. . of deferred cash payments over a period not in

excess of six years after the date of assessment of such

claim” pursuant to 11 U.S.C. § 112% aX9KC). Interest on

those claims will be paid according to the rate set forth in

' The order confirming the plan was signed on April 3, 1987, but

this issue was reserved pending a ruling on the objection by IRS

2 Class Four clawms consist of taxes owed to IRS, the State of Rhode

Island, the Rhode Island Department of Employment Security, and

the City of Newport

26 U.S.C. § 6621. In addition, and in dispute, is that part

of the plan which designates how the tax payments should

be applied. Specifically, the plan provides that payments

be credited first to the “ ‘trust fund"’ portion of the . . .

oldest taxes,” second to the “interest on such trust fund

portion of such taxes,” and third, to “the oldest non-trust

fund portion of the remaining tax obligations and the in-

terest thereon.” See Trustee's Plan of Reorganization, Ar-

ticle IIL at 7-8. IRS objects to the application of the tax

payments as proposed,‘ and argues that it be permitted to

apply the tax payments first to the non-trust fund taxes, in

accordance with established IRS policy. See Muntwyler v.

United States, 703 F.2d 1030, 1032 (7th Cir. 1983).

IRS and the trustee agree that if the tax payments are

“voluntary,” the debtor may designate how the payments

should be applied. See Muntwyler v. United States, supra,

at 1032. Conversely, if the payment is involuntary, the

debtor does not have the power to direct application of the

payments.

If it had its druthers, IRS would apply payments first to

the non-trust fund taxes due, see IRS Memorandum in

Support of the Objection to the Trustee’s Plan at §, essen-

tially the opposite of how the trustee would direct the ap-

plication of payments. Not surprisingly, the purpose of

this IRS policy is to preserve the personal liability, created

by 26 U.S.C. § 6672, of “[a}ny person required to collect,

' Trust fur * taxes are those required to be withheld pursuant to 26

U.S.C. § 7501 and which “shall be held to be a special fund in trust for

the United States.” They include the tax collected from employee

wages, and the employee share of FICA tax. Mokomh » Unwed

States, 622 F.2d 937, 938 (7th Cir, 1980).

* The other taxing authorities which did not object to the manner in

which the plan directs payments to be apphed to Class Four clawns are

bound by the order Confirming the plan to apply them as directed 11

USC. § li4hta

44a

truthfully account for, and pay over any tax imposed by

this title.” If IRS were unable to collect the full amount of |

trust taxes from the debtor, it then could proceed against

the “responsible person,” as defined by 26 U.S.C.

§ 6671(b), for the unpaid portion of those taxes. There is

no personal liability for unpaid non-trust fund taxes. See

In re Mister Marvins, Inc., 48 B.R. 279, 280 (E.D. Mich.

1984). While IRS policy is to apply involuntary payments

first to non-trust fund obligations, “there is no tax code

provision regarding this subject.” Jn re Technical

Knockout Graphics, Inc., 68 B.R. 463, 465 (Sth Cir.

B.A.P. 1986).

The most frequently cited definition of an involuntary

payment, Muntwyler v. United States, supra, at 1032, is

that of the Tax Court in Amos v. Commissioner, 47 T.C.

65, 69 (1966):

An involuntary payment of Federal taxes means any

payment received by agents of the United States as a

result of distraint or levy or from a legal proceeding in

which the Government is seeking to collect its delin-

quent taxes or file a claim therefor.

However, in applying that definition the Seventh Circun

has stated that .

[t}he distinction between a voluntary and involuntary

payment in 4mos and all the other cases ts not made

on the basis of the presence of administrative action

alone, but rather the presence of court action or ad-

ministrative action resulting in an actual sefcure of

property or money, as in a levy. No authorities sup-

port the proposition that a payment is involuntary

whenever an agency takes even the shghtest action to

collect taxes, such as filing a claim.

703 F.2d at 1033 (emphasis in the original).

4Sa

In Muntwyler, which involved a non-judicial assign-

ment for the benefit of creditors. the Seventh Circuit held

that “merely filing a etawm for back taxes” absent some

form of “enforced collection measures” did not render the

payment involuntary. /d. at 1033. IRS contends that the

filing of a bankruptcy petition is sufficient “court action”

under Muntwyler to render “any payment [of taxes] in a

bankruptcy proceeding . . . per se involuntary.” See IRS

Memorandum at 15. Apparently, IRS draws this conclu-

sion from note 2 of Muntwyler, 703 F.2d at 1034, where

the court stated that “(t}he Government might have been

correct in its claim if the corporation had been in

bankruptcy, which it is not.” However, the note continues

“[ajn assignment for the benefit of creditors is an act of

bankruptcy [under the 1898 Act] and presumably, any

creditor, including the Government, could have proceeded

to file an involuntary petition for bankruptcy based

thereon.” At best, it is unclear whether the Seventh Circuit

meant that the requisite “court action” referred to filing a

proof of claim, or to the filing of an involuntary

bankruptcy petition, followed by a proof of claim. The

difference between the two forms of “court action” is

significant, and for our purposes is in fact dispositive.

The trustee disagrees with the per se test advanced by

IRS, and reads Muntwyler in a different light. “In the in-

stamt matter, the IRS has merely filed a proof of claim.

There has been no court action with respect to the iRS’

claim, let alone ‘court action [or administrative action]*

resulting in an actual seizure of money or property as in a

levy’ ” (citing Muntwyler, supra, at 1033). See Trustee’s

Memorandum at 7. The trustee construes the phrase

“resulting in an actual seizure” to apply to court action as

* The trustee’s memorandum omitted the bracketed portion of the

quotation.

46a

well as administrative action.* In any event, the trustee

argues that some type of “ ‘enforced collection measure,’ ”

Muntwyler, supra, at 1033, beyond the filing of a proof of

claim, is necessary to qualify as “involuntary,” payments

made under a Chapter 11 plan of reorganization.

Several courts have already faced the issue of determir -

ing voluntary versus involuatary payments, within the

context of a bankruptcy case. The trustee’s position that

payments to IRS pursuant to a Chapter |! plan are volun-

tary is supported by the following: Jn re Technical

Knockout Graphics, Inc., supra; In re Energy Resources

Co., Inc., 59 B.R. 702 (Bankr. D. Mass. 1986); In re

Lifescape, Inc., 54 B.R. 526 (Bankr. D. Colo. 1985); Jn re

A & B Heating & Air Conditioning, Inc., 53 B.R. 54

(Bankr. M.D. Fla. 1985); Jn re Franklin Press, Inc., 52

B.R. 151 (Bankr. S.D. Fla. 1985). On the other side of the

coin, although none have phrased their conclusions as

strongly as a per se rule, the following courts support the

IRS position that payments of tax claims in bankruptcy

are involuntary: /n re Mister Marvins, Inc., supra; In re

Frost, 47 B.R. 961 (D. Kan. 1985); Matter of Avildsen

Tools & Machine, Inc., 40 B.R. 253 (N.D. Ill. 1984); aff'd

794 F.2d 1248 (7th Cir. 1986); In re Vincent-McCall Co.,

68-2 USTC (CCH) ¢ 9591 (E.D. Wisc. 1968) (Act case,

referee’s opinion). In affirming the district court in

Avildsen Tools, however, the Seventh Circuit stated “[wJe

do not have to decide whether a payment for delinquent

pre-bankruptcy petition taxes made to the government is

voluntary or involuntary” since the debtor had breached

that the qualifier “resulting in an actual seizure,” applies only to “ad-

ministrative action,” and that any “court action” within the bankrupt.

cy case, even if it involves only the filing of a proof of claim, renders

the payment involuntary.

47a

its agreement as to how the tax payments would be ap-

plied. 794 F.2d at 1252. Since the debtor breached its

agreement with IRS, the government was no longer bound

as to how the payments would be applied. /d. at 1254. It

appears, therefore, that no Court of Appeals has squarely

decided the issue of whether payments under a plan pur-

suant to § 1129 are voluntary or involuntary

In re B & P Enterprises, Inc., 67 B.R. 179 (Bankr. W.D.

Tenn. 1986) reaches a more flexible conclusion about mid-

way between the positions taken by the parties. There, the

bankruptcy court rejected both the IRS per se rule, and

any ruling wherein the trustee or debtor-in-possession

could unilaterally direct the allocation of payments under

a confirmed plan to the trust fund portion of the IRS

claim. /d. at 183. Instead, the court held that such ques-

tions should be decided on a case-by-case basis, and set

out what it considered were the relevant factors in the

analysis.’ /d. at 184.

We feel that the Court’s approach in Jn re B & P Enter-

prises, Inc., supra, is more workable than either of the

rigid approaches advocated by the parties. Taking full ad-

vantage of our new found flexibility, and considering the

“totality of the facts and circumstances,” id. at 184, of this

case, we conclude that the trustee should be allowed to

direct the application of payments to IRS as set forth in

the plan. Except for filing a proof of claim, the only in-

volvement of IRS in any court action in this case has been

’ The factors include: (1) the history of the debtor; (2) whether IRS

has taken any pre-bankruptcy collection or “enforced collection

measures” against the debtor or the appropriate responsible person;

(3) the nature of the Chapter 11 plan (¢.g., reorganization or liquida-

tion); (4) the presence, nature and extent of administrative and/or

court action, (S) existence of exceptional or special circumstances war-

ranting allocation provided by the plan. /n re B & P Enterprises,

supra, at 184

; OO Es SS SSS ”Clrt(<t = EE ———————— Dhl

48a

to press the objection to confirmation. IRS has not (nor

had it previously) taken any “enforced collection

measures.” The plan calls for reorganization as a going

concern, rather than liquidation of assets and conversion

to Chapter 7. Most importantly, however, the funding for

this plan comes from a third party, Allied Marine

Associates. Other courts have held that third-party fund-

ing alone is sufficient to render payments to IRS volun-

tary. See In re Energy Resources Co., Inc., supra; In re

Franklin Press, Inc., supra. \n the real world of business

reorganization, most successful Chapter 11 plans depend,

in part, at least, on the infusion of funds provided by out-

side investors. The inflexible application of the per se rule

advanced by IRS would remove the initiative of former

principals to seek outside investors, who voluntarily inject

needed cash into the estate, and would, as a consequence,

either inhibit or eliminate altogether the likelihood of a

viable Chapter 11 plan. If the purpose of Chapter 11 is to

rehabilitate rather than liquidate debtors, the Court’s role

in this process is greatly enhanced by allowing the judge to

review each case on its own merits and to confirm those

which meet the requirements of § 1129. Using thai ap-

proach in this case, we conclude that the third party

payments constitute sufficient “special circumstances,” /n

re B & P Enterprises, Inc., supra, at 184, to allow the

trustee to allocate such payments first, to the trust fund

portions of the debtor's tax liabilities and, thereatter, to

the non-trust fund amounts.

IRS expends considerable argument on two points

which deserve comment. IRS argues that allowing the

allocation of payments to trust fund taxes unfairly

benefits the “responsible person” as defined by the Inter-

nal Revenue Code, and shifts the risk of non-payment of

the tax liability to the government. In this case, however,

IRS fails to identify the responsible person to whom it

49a

ascribes such remarkable influence over the plan proposed

by the trustee.* That person, who we surmise (since IRS

has not told us) might be the “responsible person,” a mid-

level financial employee, is neither a principal of the

debtor nor a major stockholder, and does not directly

benerit from the plan (except perhaps for payment of a

Priority wage claim, along with all other employees). The

contention that the sole purpose of this part of the plan is

to benefit Kevin Walsh, the controller, is a theoretical

argument with no factual or practical supprt. IRS also

argues that the plan could likely fail as soon as the trust

fund tax liabilities are paid, and the responsible person

relieved of any potential assessment under 26 U.S.C.

$ 6672. As we view it, a plan likely to fail in the manner

IRS describes would not be confirmable under 11 U.S.C.

§ 112%a)(11) (“[cjonfirmation of the plan is not likely to

be followed by the liquidation, or need of further financial

reorganization of the debtor . . . unless such liquidation

or reorganization is proposed in the plan”). We have

already found that the trustee’s plan complies with the re-

quirements of §1129, that rehabilitation is likely, and that

failure (either prior or subsequent to payment of trust

fund taxes) is not the expected route for this debtor.

Therefore, for the foregoing reasons, Article III of the

trustee's plan of reorganization regarding the treatment of

Class Four tax claims is confirmed, and IRS is ordered to

apply the payments as designated in the plan.

5 ' .

IRS does not argue that the trustee is the “responsible person”

seeking to avoid personal liability under the plan

$0a

Dated at Providence, Rhode Island this I4th day of

July, 1987.

/s/ ArTHUR N. Voro.aTo, Jr.

Arthur N. Votolatos, Jr.

Bankruptcy Judge

Sla

APPENDIX FE

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

No. 87-1896

IN RE. ENeaoy Resources Co., INC, DEBTOR

INTERNAL REVENUE SERVICE, PLAINTIFF, APPELLANT

vy.

ENERGY Resources, Co., INC. DEFENDANT, APPELLEE

Entered March 31, 1989

JUDGMENT

This cause came on to be heard on appeal from the

United States District Court for the District of Massachu-

setts, and was argued by counsel.

Upon consideration whereof, It is now here ordered, ad-

wdged and decreed as follows: The judgment of the

district court is affirmed.

By the Court:

Ss’ Frances P. Scigat ano |

Francis P. Scighlano

Clerk

52a

APPENDIX G

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

No. 88-1175

IN RE: NEWPORT OFFSHORE, LTD., DEBTOR

UNITED STATES OF AMERICA, PLAINTIFF, APPELLEE

NEWPORT OFFSHORE, LTD., DEFENDANT, APPELLANT

Entered March 31, 1989

JUDGMENT

This cause came on to be heard on appeal from the

United States District Court for the District of Rhode

Island, and was argued by counsel.

Upon consideration whereof, It is now here ordered, ad-

judged and decreed as follows: The judgment of the

district court is reversed.

By the Court:

/s/ FRANCIS P. SCIGLLANO

Francis P. Scigllano

Clerk

US GOVERNMENT PRINTING OFFICE 1989— 241 699/00 544

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