Amicus Curiae Brief — California Franchise Tax Board v. MacFarlane, 117 S. Ct. 1243 (1997) (No. 96-235)

Supreme Court, U.S

2 F I E D

4

No. 96-235 DEC 30 1996

In the Supreme Court of the Binited states —

OCTOBER TERM, 1996

CALIFORNIA FRANCHISE TAX BOARD, PETITIONER

v.

STEPHEN B. MACFARLANE

N PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE NINTH

CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE

WALTER DELLINGER

Acting Solicitor General

LORETTA C. ARGRETT

Assistant Attorney General

GARY D. GRAY

BRIDGET M. ROWAN

Attorneys

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

at

QUESTION PRESENTED

Whether the government has the burden of proving

that a taxpayer is not entitled to a deduction when an

income tax claim is litigated in a bankruptcy case.

(I)

TABLE OF CONTENTS

Page

IIE IIE ci cilscshadtidinhAcunbthncniabwhentisanseesenentaencscceteenecs 1

Statutory provisions and rules involved ...................0006 =

REE ELS SETS SS Te ae oe a 2

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TABLE OF AUTHORITIES

Cases:

BFP v. Resolution Trust Corp., 511 U.S. 531

TARE ae ENR ORES WY 2 ele ee 10

Bacchus, In re, 718 F.2d 736 (5th Cir. 1983) ............. 13

Betson v. Commissioner, 802 F.2d 365 (9th Cir.

SESS EIT TRESS SRE SE "SSC re a 9

Bonner Mall Partnership, In re, 2 F.3d 899

(9th Cir. 1993), cert. dismissed, 513 U.S. 18 (1994) .. 13

Briglevich, In re, 847 F.2d 759 (11th Cir. 1988) .........

Brown, In re, 82 F.3d 801 (8th Cir. 1996) ................. 7

Bull v. United States, 295 U.S. 247 (19385) .............. 9, 11

Burnett v. Houston, 283 U.S. 223 (1981) ................. 9

Butner v. United States, 440 U.S. 48 (1979) ........... 10-11

Caravansary, Inc., In re, 821 F.2d 1413 (9th Cir.

aN neha ih I nea nila hialintehlad creetiantaavennneees 13

Cobb v. United States, 135 B.R. 640 (Bankr. D. Neb.

a emannen 7

Delaney v. Commissioner, No. 95-2066 (ist Cir.

I a sabisinbiebosoanace 8

Dominguez, In re, 51 F.3d 1502 (9th Cir. 1995) ......... 13

Federated Department Stores, Inc., In re, 135 B.R.

950 (Bankr. S.D. Ohio 1992), aff’d, 171 B.R. 603

I a sbienebenenbons 7

Fullmer, In re, 962 F.2d 1463 (10th Cir. 1992) .......... 7

(IIT)

IV

Cases—Continued: Page

Goldblatt Bros., In re, 758 F.2d 1248 (7th Cir.

BOGE saicscscicntstacsstioeenininnniaias sesdbenneatansbbestaiias 13

Gran, In re, 964 F.2d 822 (8th Cir. 1992) .................. 7

Helvering v. Taylor, 293 U.S. 507 (1935) ............0006 8

IRS v. Levy (In re Landbank Equity Corp.),

OTS F.2d 265 (4th Cir. 1908). ...ccisccsscrcssccsccscscsescsees 7, 9-10

Krumpotich v. Franchise Tax Bd., 31 Cal. Rptr.2d

BOE LITE) ccccnsscrncrersdesscedaeatedinscddscsueceuinca instante 9

Placid Oil Co., In re, 988 F.2d 554 (5th Cir. 1993) ..... 7

Premo, In re, 116 B.R. 515 (Bankr. E.D. Mich.

BIIID - icréssanprsencobscciavsichéieenndanasnemaibendaiitamhaminassittins 7

Resyn Corp. v. United States, 851 F.2d 660

Ce SR RD ince cancctcehitnatiedhddacccipeatiasnneedetiahsdatanesics 7

Rockwell v. United States, 512 F.2d 882 (9th Cir.),

cert. denied, 423 U.S. 1015 (1975) ............cceecesecseeees 9

TCL Investors, In re, 775 F.2d 1516 (11th Cir.

ERED dconesccntstatnnescahaercuihactcaentmasanbddgaittadinhineniceens 13

Tripplett, In re, 115 B.R. 955 (Bankr. N.D. Ill.

SIIIID . scuiccinccniciceicannctiaglnk ince ciiebalaanbeAbissadpraleninsediatenaian 7

Unioil, In re, 962 F.2d 988 (10th Cir. 1992) ............... 11

United States v. Coleman American Cos.,

26 B.R. 825 (Bankr. D. Kan. 1983) .............ccccsccsseeees 7

United States v. Terrell, 75 B.R. 291 (N.D. Ala.),

aff’d without opinion, 835 F.2d 1439 (11th Cir.

ROT) wecincssssenhschisnapnshhinenereuiticnnbbegnbienphisetninabessinsbens 7-8

Welch v. Helvering, 290 U.S. 111 (1933) ..............000 8

Wilhelm, In re, 173 B.R. 398 (Bankr. E.D. Wis.

FED ccicerscisscschvesdasscovicavishtnacskbasgaataiesetdbibetnaisieseseves 7

Statutes and rules:

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

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Statutes and rules—Continued:

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“Gr De ” Geers

SD. TN iss cc

Fed. R. Bankr. P.:

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INE I Kaivudicesnccnciininadlonsccnasalincedenbes

Miscellaneous:

9 J. Wigmore, Evidence (J. Chadbourn rev. 1981)

21 C. Wright & K. Graham, Federal Practice and

PVOGOUTG (UOTE) sciasevsssnaysvesstievsvesenncs

PPP PPP PPE S ES

SCHR RHEE TERETE eee

10

In the Supreme Court of the Anited States

OCTOBER TERM, 1996

No. 96-235

CALIFORNIA FRANCHISE TAX BOARD, PETITIONER

Vv.

STEPHEN B. MACFARLANE

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE NINTH

CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE

This brief is submitted in response to the Court’s

order inviting the Solicitor General to express the

views of the United States.

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. 1-11)

is reported at 83 F.3d 1041. The opinion of the district

court (Pet. App. 13-34) and the opinion of the bank-

ruptcy court (Pet. App. 35-42) are unreported.

STATUTORY PROVISIONS AND RULES INVOLVED

In addition to the provisions of the Bankruptcy

Code, the Federal Rules of Bankruptcy Procedure

and the Internal Revenue Code that are set forth at

Pet. App. 44-52, the following statutory provisions are

involved in this case:

(1)

2

1. 28 U.S.C. 158 provides, in relevant part:

(a) The district courts of the United States

shall have jurisdiction to hear appeals

(1) from final judgments, orders, and

decrees;

and, with leave of the court, from interlocutory

orders and decrees, of bankruptcy judges entered

in cases and proceedings referred to the bank-

ruptcy judges under section 157 of this title.

* * *

(d) The courts of appeals shall have jurisdic-

tion of appeals from all final decisions, judgments,

orders and decrees entered under subsections (a)

and (b) of this section.

2. 28 U.S.C. 1291 provides, in relevant part:

The courts of appeals (other than the

United States Court of Appeals for the Federal

Circuit) shall have jurisdiction of appeals from all

final decisions of the district courts of the United

States, * * * except where a direct review may

be had in the Supreme Court.

STATEMENT

The United States adopts the Statement contained

in the Petition with the following additions:

1. a. After the debtor filed his objection to the

state tax claim, a hearing was held by the bankruptcy

court on March 15, 1993. At that hearing, the bank-

ruptcy court announced its conclusion that (i) the

3

proof of claim filed by the state agency “is prima facie

valid under the Bankruptcy Rules” but (ii) that the

debtor had filed “competent evidence” that would

support a conclusion that no tax was owed and (iii)

that “the prima facie validity” of the tax claim there-

fore “has been rebutted” (App., infra, 2a-3a). The

court then held that the ultimate burden of “proving

by a preponderance of the evidence the factual basis

for [the tax] claim” rests on the state agency rather

- than on the debtor (id. at 3a).

Having determined that the burden of proof on the

tax claim rests ultimately on the state agency, the

court concluded that (App., infra, 3a)

there ought to be a window of time in which the

[state agency] is allowed to conduct subsequent

discovery as it believes it needs to support its

claim. And then we’ll have an evidentiary hearing

and determine what the allowed amount of the

claim should be.

The court set “a status conference” for the case for

July 12, 1998 (id. at 5a).

b. Before the date of the status conference, the

debtor filed a motion for summary judgment on his

objection to the state tax claim (Pet. App. 15-16).

That motion, which was accompanied with documen-

tary evidence and deposition testimony, contained a

statement of the uncontroverted facts that the debtor

claimed entitled him to summary judgment (App.,

infra, 17a). The motion was opposed by the state

agency, which relied on the same materials submitted

by the debtor (Pet. App. 15-16).

At the status conference held on July 12, 1993, the

court announced that “[t]he uncontroverted facts in

this record” (App., infra, 8a) support the conclusion

4

that no tax is owed. The court stated that if there had

been “controverting facts” it might have reached a

different conclusion but that “the uncontroverted

evidence at this point in time” required judgment to

be entered in the debtor’s favor on his objection to the

state tax claim (ibid.). In explaining its ruling at the

July 12 hearing, the court stated (id. at 17a):

I went through the list of the assertedly uncon-

troverted facts set out in exhibit 1 to the notice of

this motion filed by the debtor and found that I

could agree with each of those based upon the

statements I’ve already made * * *.

Having thus ruled on the “motion filed by the debtor,”

the court directed the debtor’s counsel to “prepare a

proposed formal order” (ibid.).

The formal order thereafter entered by the bank-

ruptcy court states (Pet. App. 41):

The California Franchise Tax Board has had an

adequate opportunity for discovery. The only evi-

dence has been offered by the Debtor. * * * The

evidence offered by the Debtor is not controverted

by the California Franchise Tax Board. Accord-

ingly the Court concludes that there is no issue of

material fact raised by the evidence before the

Court which is in reasonable dispute.

Expressing the view that the uncontroverted facts re-

quire the conclusion that no tax was owed, the court

entered judgment in the debtor’s favor on the state

tax claim (ibid.).

2. On appeal, the district court agreed with the

bankruptcy court that the state agency has the

ultimate burden of proof on state tax claims in bank-

ruptcy cases (Pet. App. 23). The district court fur-

5

ther stated that, on the record before it, the “findings

of fact” recited in the bankruptcy court’s order were

not clearly erroneous (id. at 25.30). The district

court concluded, however, that the state agency pre-

sented evidence that “creates a genuine issue of tri-

able fact” on these material facts and that summary

judgment was therefore inappropriate (id. at 31). The

court explained (id. at 32):

Although the [state agency] has the ultimate

burden of proof to establish to what extent the

funds advanced * * * were for the purpose of a

tax shelter, the Board has pointed to sufficient

evidence in the record to create a triable issue

that some of the funds were not loans and were

used to generate a tax loss.

“Viewing all inferences that can be drawn from the

excerpts of the record * * * ina light most favorable

to the [state agency],” the district court held that

material issues of fact were in genuine dispute (id. at

34) and therefore “reverse[d] the bankruptcy court’s

grant of summary judgment” (idid.).

3. Both the debtor and the State appealed. The

court of appeals noted that there is “a jurisdictional

concern that the district court’s reversal of the bank-

ruptcy court’s judgment is not a final order because

further proceedings in bankruptcy court are con-

templated” (Pet. App. 6). Taking what it described as

“a pragmatic approach,” the court held that it would

assume jurisdiction in this case even though the

district court’s order “remands for further pro-

ceedings in the bankruptcy court” (id. at 6-7).

Reaching the merits, the court of appeals agreed

with the analysis and conclusions of the bankruptcy

court and directed that judgment be entered in the

6

debtor’s favor (Pet. App. 7-11). In so ruling, the court

expressed uncertainty as to whether the case had

been decided below after an evidentiary hearing or on

summary judgment. The court of appeals suggested

that an evidentiary hearing may have occurred be-

cause the findings of fact recited in the order of the

bankruptcy court appear to have “resolved factual dis-

putes” (id. at 10). The court stated that, on the record

before it, the findings recited in the bankruptcy court

order “are not clearly erroneous” (ibid.). The court

further held that, “even if summary judgment stan-

dards are applied [in this case], we agree with debtor

that the bankruptcy court’s decision should be af-

firmed” because no “genuine issues of material fact”

exist (id. at 11). The court of appeals therefore re-

versed the judgment of the district court and re-

manded for entry of judgment in favor of the debtor

(ibid.).

DISCUSSION

The holding of the court of appeals that the taxing

authority has the burden of proof on tax claims in

bankruptcy cases is in direct conflict with decisions

of other circuits. This case does not provide a suit-

able vehicle for resolving the conflict on this impor-

tant and recurring question, however, for the court of

appeals lacked jurisdiction over the appeal from the

district court order that denied summary judgment in

this case. In bankruptcy litigation, as in other civil

litigation, an order denying a motion for summary

judgment on the ground that material issues of fact

remain in genuine dispute is not a “final” order from

which an appeal may be taken.

Because the court of appeals lacked jurisdiction,

the judgment should be vacated and the case remanded

7

to the bankruptcy court for further proceedings pur-

suant to the order of the district court. Petitioner,

however, has not suggested’ that the absence of juris-

diction in the court of appeals is a basis for this

Court’s review of the decision below. And, the ques-

tion that is framed in the petition—the proper alloca-

tion of the burden of proof on tax claims in bankruptcy

cases—is not appropriate for review on this petition

because the court of appeals had no jurisdiction to

consider it.

1. The court of appeals correctly noted that its

holding that the taxing authority has the burden in

bankruptcy cases of proving the correctness of a tax

determination is consistent with the decisions of

three other courts of appeals (Pet. App. 8, citing Jn re

Placid Oil Co., 988 F.2d 554, 557 (5th Cir. 1993); Jn re

Gran, 964 F.2d 822, 827-828 (8th Cir. 1992); In re

Fullmer, 962 F.2d 1463, 1466 (10th Cir. 1992) (dictum);

see also Jn re Brown, 82 F.3d 801, 805 (8th Cir. 1996)

(dictum)) but conflicts with the decisions of two other

circuits (Pet. App. 8, citing Resyn Corp. v. United

States, 851 F.2d 660, 663 (8d Cir. 1988); IRS v. Levy

(In re Landbank Equity Corp.), 973 F.2d 265, 268-272

(4th Cir. 1992))." This direct conflict among the cir-

1 The decisions of the lower courts reflect the division

among the circuits. Compare, e.g., Jn re Wilhelm, 173 B.R. 398

(Bankr. E.D. Wis. 1994); In re Federated Department Stores,

Inc., 135 B.R. 950, 957-958 (Bankr. S.D. Ohio 1992), aff'd, 171

B.R. 603, 607 (S.D. Ohio 1994); In re Premo, 116 B.R. 515

(Bankr. E.D. Mich. 1990); United States v. Coleman Ameri-

can Cos., 26 B.R. 825 (Bankr. D. Kan. 1983) (tax authorities,

like other creditors, must bear burden of proof to establish

their claims), with, e.g., Cobb v. United States, 135 B.R. 640,

641 (Bankr. D. Neb. 1992); In re Tripplett, 115 B.R. 955, 964 n.

11 (Bankr. N.D. Ill. 1990); United States v. Terrell, 75 B.R. 291

8

cuits concerns a recurring issue of substantial impor-

tance to the administration of the tax laws.

a. In litigation involving federal tax liabilities, the

taxpayer bears the ultimate burden of. persuasion.”

More than sixty years ago, this Court stated in

Helvering v. Taylor, 293 U.S. 507, 515 (1935), that

“{uJnquestionably the burden of proof is on the

taxpayer to show that the commissioner’s determina-

tion is invalid.” See also Welch v. Helvering, 290 U.S.

111, 115 (1933). As the First Circuit has recently

explained, “[t]he rationale for this rule is more deeply

rooted than the conventional regimen that places the

burden of proof on the moving party.” Delaney v.

Commissioner, No. 95-2066 (Nov. 1, 1996), slip op. 6:

The Supreme Court has held that the Com-

missioner’s “ruling has the support of a presump-

tion of correctness, and the petitioner has the

burden of proving it to be wrong.” Welch v.

Helvering, 290 U.S. 111, 115 (1933); see also

United States v. Janis, 428 U.S. 483, 439 (1976);

Estate of Todisco v. Commissioner, 757 F.2d 1, 6

(Ist Cir. 1985) (the basic rule in all tax cases

places the burden of proof with the taxpayer).

* * * [TJjn a tax deficiency suit “the burdens of

going forward and of ultimate persuasion are

(N.D. Ala.), aff’d without opinion, 835 F.2d 1439 (11th Cir.

1987) (burden of proof is governed by _ applicable

nonbankruptcy law and, in tax cases, burden lies with tax-

payer).

2 The party who bears the burden of proof in litigation

bears the ultimate burden of persuasion or the risk of non-

persuasion. 9 J. Wigmore, Evidence § 2485 (J. Chadbourn rev.

1981). Although the burden of production may shift during the

course of a lawsuit, the burden of proof is fixed as a matter of

law and never shifts. Jd. § 2489.

9

always on the taxpayer and never shift to the

Commissioner.” [United States v. Rexach, 482

F.2d 10, 16-17 (1st Cir.), cert. denied, 414 U.S. 1039

(1973).]

The present case involves a claim for additional

state income taxes arising from the disallowance of

asserted bad debt deductions. In cases involving fed-

eral taxes, it is well established that the taxpayer

always bears the burden of proof in establishing a

claim of entitlement to a deduction. See, e.g., Bull v.

United States, 295 U.S. 247, 260 (1935); Burnet v.

Houston, 283 U.S. 228, 227-228 (1931).2 This same

allocation of the burden of proof to the taxpayer

applies under the state law applicable to the state tax

involved in this case (Pet. App. 7, citing Krumpotich

v. Franchise Tax Bd., 31 Cal. Rptr.2d 896, 899 (1994))

and, evidently, under the laws of all other States (Am.

State of Arizona, et al., Br. 5 n.2).

b. The court of appeals erred in this case in con-

cluding that this burden of proof should be shifted

from the taxpayer to the government simply because

the tax issue arises in the bankruptcy context. As

this Court noted in Bull v. United States, 295 U.S. at

260, the usual procedure for recovery of debts is

“reversed” in the field of taxation in that “the burden |

of proof, normally on the claimant, is shifted to the

taxpayer.” This allocation of the burden of proof in

tax cases is governed by substantive law, not by any

rule of bankruptcy procedure. Jn re Landbank Equity

3 In federal tax cases litigated outside of the bankruptcy

context, the Ninth Circuit has routinely adhered to that rule.

See, e.g., Betson v. Commissioner, 802 F.2d 365, 367 (1986);

Rockwell v. United States, 512 F.2d 882, 885-886, cert. denied,

423 U.S. 1015 (1975).

ae

10

Corp., 973 F.2d at 269-271. See 21 C. Wright & K.

Graham, Federal Practice and Procedure § 5122

(1977).

The court of appeals acknowledged that “(t]he bank-

ruptcy code is silent on the allocation of the ultimate

burden of proof in this case” (Pet. App. 9). Because

there is no “clear and manifest” (BFP v. Resolution

Trust Corp., 511 U.S. 531, 544 (1994)) indication in the

Bankruptcy Code of any intent to displace substantive

state and federal law in the enforcement of tax claims,

allocation of the burden of proof to the taxpayer under

the applicable provisions of substantive law should not

have been discarded by the courts below.

The court of appeals sought to justify its decision

in this case as an effort to “balance the equities

‘between the Board and the other creditors of Deb-

tor’s estate’” (Pet. App. 9). But the court’s concerns

about “equities” between claimants does not justify a

refusal to enforce substantive state and federal tax

law. Here, as in Butner v. United States, 440 U.S. 48,

4 Neither 11 U.S.C. 502 of the Bankruptcy Code, which gov-

erns the allowance of claims generally, nor 11 U.S.C. 505,

which authorizes the bankruptcy courts to adjudicate tax

disputes, contains any provision regarding allocation of the

burden of proof. Compare 11 U.S.C. 362(g) (assigning burden

of proof in challenges to automatic stay); 11 U.S.C. 363(0) (in

hearing on use of property, assigning burden on adequate pro-

tection to trustee); 11 U.S.C. 364(d)(2) (in hearing on obtaining

credit, assigning trustee burden on adequate protection issue);

11 U.S.C. 547(g) (assigning burden with respect to avoidability

of certain allegedly preferential transfers); 11 U.S.C. 1129(d)

(assigning to government burden of proving claim of tax avoid-

ance as principal purpose of plan). See also Fed. R. Bankr. P.

4003(c) (party objecting to exemption bears burden); Fed. R.

Bankr. P. 4005 (burden assigned to party objecting to dis-

charge).

11

56 (1979), “undefined considerations of equity provide

no basis for adoption of a uniform federal rule” in

bankruptcy that departs from generally applicable

rules of substantive law. Furthermore, as Amici

_ State of Arizona, et al., explain (Am. Br. 9-10), the

burden of proof has been assigned to the debtor in

non-tax disputes in bankruptcy cases when applicable

nonbankruptcy law assigns that burden to the party

in the debtor’s position. See, e.g., In re Unioil, Inc.,

962 F.2d 988, 994 (10th Cir. 1992) (debtor had burden of

proving accord and satisfaction as mandated by appli-

cable state law). It is thus not a special dispensation

to taxing authorities in bankruptcy cases to apply the

rules allocating the burden of proof that are estab-

lished under substantive, nonbankruptcy law. In-

stead, it is a distinctive discrimination against the

taxing authority to refuse to apply the allocation

rules established under applicable nonbankruptcy law.

ec. The proper allocation of the burden of proof on

tax claims in bankruptcy cases is an issue of sub-

stantial recurring importance in the administration

of the tax laws. The Internal Revenue Service files

more than 100,000 proofs of claim in bankruptcy cases

each year seeking to recover several billion dollars of

taxes. If the Service were required to bear the

burden of proof on tax claims in bankruptcy cases, it

would potentially be necessary for the government to

engage in substantial discovery and case preparation

in vast numbers of cases to meet pro forma objections

that the government must “prove up its case.” Such a

requirement can not be reconciled with this Court’s

holding in Bull v. United States, 295 U.S. at 260, that

“the usual procedure for the recovery of debts is

reversed in the field of taxation” and that “the burden

12

of proof, normally on the claimant, is shifted to the

taxpayer.”.

A rule that allowed taxpayers in bankruptcy to

avoid the burden of proof would encourage abusive use

of the bankruptcy courts. It would make bankruptcy a

favorable arena in which to defend questionable deduc-

tions and would materially impede the effective en-

forcement of the revenue laws.

2. In its present posture, this case is not a suitable

vehicle for resolving the important and recurring

question of the proper allocation of the burden of proof

on tax claims in bankruptcy cases. Although the pro-

ceedings that occurred in the bankruptcy court are

not clearly reflected in the orders of the courts below,

it appears from examination of the record that (i) the

debtor moved for summary judgment on his objection

to the state tax claim, (ii) the bankruptcy court

granted summary judment to the debtor based upon

the “uncontroverted facts set out in * * * this

motion” (App., infra, 17a), and (iii) the form of order

prepared by debtor’s counsel, and entered by the

court, contained both a recitation of “findings” and

a statement by the bankruptcy court that “[t]he

evidence offered by the Debtor is not controverted”

and “that there is no issue of material fact” for the

court to resolve (Pet. App. 41). On appeal from that

order, the district court reversed the grant of sum-

mary judgment by the bankruptcy court because

there was “sufficient evidence in the record to create

a triable issue” on the tax claim (id. at 32) and mate-

rial issues of fact thus remained in genuine dispute

(id. at 34).

The posture of the case at the conclusion of these

proceedings in the district court was thus simply that

a motion for summary judgment had been denied. A

13

district court order that denies a motion for summary

judgment on the ground that material issues of fact

remain in controversy is not a “final” order from

which an appeal may be taken under 28 U.S.C. 158(d)

or 28 U.S.C. 1291. See, e.g., In re Caravansary, Inc.,

821 F.2d 1413, 1414 (9th Cir. 1987); In re TCL In-

vestors, 775 F.2d 1516, 1519 (11th Cir. 1985); In re

Goldblatt Bros., 758 F.2d 1248, 1250-1251 (7th Cir.

1985); In re Bacchus, 718 F.2d 736, 737 (5th Cir. 1983).°

5 The court of appeals cited several decisions from its

circuit that embody what the court described as a “pragmatic

approach” to the finality question (Pet. App. 6). Those cases,

however, are inapposite. For example, in In re Dominguez, 51

F.3d 1502 (9th Cir. 1995), the court stated that, “[a]lthough we

ordinarily lack jurisdiction when the lower appellate decision

remands for further factual findings related to a central issue

raised on appeal, we may assert jurisdiction if the appellate

‘issue is legal in nature and its resolution either 1) could dispose

of the case or proceeding and obviate the need for factfinding;

or 2) would materially aid the bankruptcy court in reaching its

disposition on remand.’” Jd. at 1506-1507, quoting In re

Bonner Mall Partnership, 2 F.3d 899, 904 (9th Cir. 1993), cert.

dismissed, 513 U.S. 18 (1994). The issue decided in the courts

below in the present case, however, was whether material

issues of fact were in genuine controversy—which was a

factual, not legal, issue. There was no legal dispute about

whether the issues of fact, if in genuine controversy, would be

material. Thus, even under the Ninth Circuit’s “pragmatic”

approach, the court of appeals lacked jurisdiction because “the

lower appellate decision remands for further factual findings

related to a central issue raised on appeal” (ibid.). See In re

Caravansary, Inc., 821 F.2d at 1414.

Moreover, the Ninth Circuit’s overall attempt to craft a

special, “pragmatic” approach to the question of finality in

bankruptcy cases has been a highly dubious enterprise. The

decisions cited by the court of appeals in this case (Pet. App. 6-

7) suggest an effort to apply criteria similar to those governing

interlocutory appeals under 28 U.S.C. 1292(b). But, while the

— ee ee ee

14

The court of appeals therefore lacked jurisdiction

over the appeal in this case.

Because the court of appeals lacked jurisdiction,

the issue of the proper allocation of the burden of

proof should not have been reached on appeal. Instead,

the appeal should have been dismissed. Because the

appeal should have been dismissed, this case does not

present an appropriate opportunity for this Court to

review the decision below on the merits. In particu-

lar, the question presented in the petition for a writ of

certiorari cannot properly be addressed in this case at

this time.

The relief that would be appropriate in this context

would be an order vacating the judgment of the court

of appeals for lack of jurisdiction and remanding the

case to the bankruptcy court for further proceedings.

Although petitioner has not requested such relief, it

would, in our view, be useful (see note 5, supra).

latter category of appeals are clearly optional and discretionary

in nature, a party is placed at a substantial risk of losing its

right to appeal under the Ninth Circuit’s “pragmatic” ap-

proach if it forgoes taking an immediate appeal from a seem-

ingly interlocutory order in bankruptcy that may meet the

Ninth Circuit’s flexible standard of finality. Hence, the erosion

of a reliable finality criterion tends to spawn appeals from

interlocutory orders—as in the present case.

15 y

CONCLUSION

The petition for a writ of certiorari should be

denied or, if granted, the judgment of the court of

appeals should be vacated for lack of jurisdiction and

the case remanded for further proceedings. If the

case is set for briefing and argument, the parties

should be asked to address, in addition to the question

presented in the petition, whether the court of appeals

lacked jurisdiction in this case.

Respectfully submitted.

WALTER DELLINGER

Acting Solicitor General

LORETTA C. ARGRETT

Assistant Attorney General

GARY D. GRAY

BRIDGET M. ROWAN

Attorneys

DECEMBER 1996

APPENDIX A

[167]

UNITED STATES BANKRUPTCY COURT

SOUTHERN DISTRICT OF CALIFORNIA

U.S. Courthouse

940 Front Street

San Diego, California 92189

Department No. 4

IN THE MATTER OF: STEPHEN MACFARLANE,

DEBTOR

HEARING RE: OBJECTION TO CLAIM

March 15, 1993

REPORTER’S TRANSCRIPT OF PROCEEDINGS

Hon. PETER W. BowlE, Judge

Federal Court Reporting

By: Kathleen Cheyne

940 Front Street

San Francisco, California 92189

(619) 726-8053

(la)

a ea ee

[169]

The Clerk: 90 11875, Stephen Macfarlan, objec-

tion to claim.

The Court: Appearances.

Mr. Martin: Good afternoon, your Honor. Elmer

Martin appearing for the debtor.

Mr. Sgherzi: Good afternoon, your Honor. An-

thony Sgherzi, Deputy Attorney General, appearing

on behalf of the State Board of Equalization.

The Court: Mr. Sgherzi. Would you like a pre-

liminary assessment?

Mr. Sgherzi: That would be helpful.

The Court: All right. I’ve reviewed the volum[e]s

of moving and opposing papers, and where I come out

is as follows on the threshold issues. It appears to me

as follows: first off the franchise tax board has filed a

proof of claim. Their proof of claim is prima facie

valid under the bankruptcy rules and therefore is

treated that way. The debtor has filed an objection to

claim. The debtor has provided competent evidence

tending to challenge that there was in fact a debt that

existed in 1988 and 1989. Further the debtor has pro-

vided competent evidence to establish that the debt

was worthless in 1988 and 1989.

3a

What that means then as far as this court is con-

cerned is that the presumption of validity, the prima

facie validity, of F.T.B.’s claim has been rebutted.

Now we get to [170] the issue that always divides the

taxing authorities and debtors; and that is who has

the burden at this juncture.

Do we have the non-bankruptcy burden or do we

have the bankruptcy burden. It is this court’s view

after having reviewed a number of cases over the last

several years in which this issue has been tested that

in fact in the bankruptcy arena the taxing authority

having submitted a proof of claim is a claimant or

creditor claimant like other creditor claimants and

therefore has the burden once the prima facie validity

has been rebutted, proving by a preponderance of

evidence the factual basis for its claim.

Now, having concluded that and because the burden

issue is a threshold issue that needs to be resolved,

it’s my view that there ought to be a window of time in

which the franchise tax board is allowed to conduct

subsequent discovery as it believes it needs to sup-

port its claim. And then we'll have an evidentiary

hearing and determine what the allowed amount of the

claim should be.

All right. Who wants to be heard first? Mr.

Martin, you want to be heard? It’s your objection to

claim. You agree with everything except giving him a

window of time to conduct discovery.

Mr. Martin: Well, I don’t—Actually I don’t disagree

with anything your honor said. I don’t know of

anything that they’re going to find that we haven’t

put in the papers we’ve already put forward, but we’re

4a

willing to make time available to them, if that’s the

court’s wish.

The Court: Mr. Sgherzi.

[171]

Mr. Sgherzi: Your Honor, based on the court’s pre-

liminary assessment, I would appreciate at least the

opportunity to see if we can somehow persuade the

court that there’s merit in the points and authorities

that we filed in terms of not only the burden but

actually the underlying evidence to sustain that.

The Court: Well, I’ve made my threshold rulings.

So at this point in time the burden is yours to prove

it. What window of time do you think will be reason-

able for you? Do you think we can take 30 days to

review it and we hold a status conference in 30 days or

something?

Mr. Sgherzi: If we are going to do discovery, natu-

rally we'll probably do depositions or requests for

production of certain documents and so on. I would

like rather than have to come back here and continue

to expend time, I would say 90 days should be a rea-

sonable amount of time in which we can either con-

clude that we have something or we don’t.

The Court: All right. With respect to the burden

issue, I understand the arguments on both sides and

have faced it before, particularly with the I.R.S., and

this is where I come out siding with the primo line of

cases, if you will.

Mr. Martin, Can you live with that window?

Mr. Martin: Yes, your honor.

5a

The Court: Al! right. Why don’t we set a status

conference for roughly 90 days, and that should not

preclude either of you from doing what you feel you

need to do in a shorter period of time.

Mr. Sgherzi: Sure.

[172]

The Court: Because everybody has an interest in

trying to get this resolved.

The Clerk: July 12th at 2:00 o’clock.

The Court: You want to go all the way to July?

That’s about 120 days.

The Clerk: June 14th at 2:00 o’clock.

Mr. Martin: Your Honor, I’m going to be out of

state on June 14th in a program at Notre Dame on

how to try trials in bankruptcy cases so I won’t be

available on June 14th.

The Clerk: June the 21st at 2:00 o’clock.

Mr. Martin: June 21st I’m serving as a pro team

judge in superior court.

The Court: Maybe we ought to go back to July the

12th.

Mr. Martin: What day of the week does that fall on?

The Clerk: Monday.

The Court: July the 12th, 2:00 p.m.

Mr. Martin: That’s fine with me.

The Court: Okay.

Mr. Sgherzi: Thank you.

Mr. Martin: Thank you.

6a

[173]

State of California)

County of San Diego)

I, Kathleen Cheyne, a shorthand reporter, do here-

by certify that the foregoing hearing was taken

before me at the time and place herein named; that

said hearing was reported by me in shorthand and

then transcribed through computer-aided transcrip-

tion, and the foregoing transcript contains a true

record of the said hearing.

I do further certify that I am a disinterested person

and am in no way interested in the outcome of this

action.

In witness whereof, I have hereunto set my hand on

the 21st day of July, 1993, at San Diego, California.

/s/ KATHLEEN CHEYNE

KATHLEEN CHEYNE

7a

APPENDIX B

[69]

UNITED STATES BANKRUPTCY COURT

SOUTHERN DISTRICT OF CALIFORNIA

U.S. Courthouse

940 Front Street

San Diego, California 92189

Department No. 4

IN THE MATTER OF: STEPHEN MACFARLANE,

DEBTOR

HEARING RE: OBJECTION TO CLAIM AND MOTION

FOR SUMMARY DETERMINATION DENYING

CALIFORNIA FRANCHISE TAX

BOARD CLAIM

July 12, 1993

REPORTER’S TRANSCRIPT OF PROCEEDINGS

Hon. PETER W. BowlE, Judge

Federal Court Reporting

By: Kathleen Cheyne

940 Front Street

San Diego, California 92189

(619) 726-8053

8a

* * Ke K

(71]

* * *

The Clerk: 90 11375, Stephen Macfarlane, objec-

tion to claim and motion for summary determinatioii

denying California franchise tax board claim.

The Court: Appearances.

Mr. Martin: Good afternoon, your Honor. Elmer

Martin appearing for the debtor.

Mr. Sgherzi: Good afternoon, your Honor. Anthony

Sgherzi, Deputy Attorney General, appearing on

behalf of the Franchise Tax Board.

The Court: Mr. Martin. That’s the smallest piece

of paper you’ve gotten in this case, isn’t it?

Mr. Martin: And there’s nothing on it, too.

Well, does your honor have a tentative?

The Court: Ido.

Mr. Martin: Could we hear it?

The Court: My view of this proceeding is as fol-

lows: that while if I had facts to support it, I might

have some question about what went on here as being

embezzlement by Mr. Cheng and thus qualifying as a

loss rather than a debt.

The uncontroverted facts in this record as estab-

lished particularly by Ms. Szuetenback in both her

declaration and her transcript of her deposition

establish that [72] these were loans.

Now, whether if I had controverting facts, I might

conclude that if I saw more evidence. I can’t say. But

the uncontroverted evidence at this point in time is

that they were loans.

9a

Now, in as much as they were loans and in as much

as we then come upon the question of whether at some

point in time they became worthless, is really the

controlling question. Because to the extent they

were loans, they were an obligation to pay, and that

would therefore qualify them as debts, which if they

became bad, meaning they became worthless, would

entitle the debtor to the deductions that the debtor

has claimed.

The amounts have not been challenged. Ms.

Szuetenback in her deposition testifies both as to the

amounts and as to the evidence of the loans, the

additional checks that were—that were other than

the ones discussed with Mr. Macfarlane in his deposi-

tion. And if you add those up, there’s been no facts

established to controvert the facts asserted by the

debtor with respect to the dollar amounts claimed in

either the ‘88 or ‘89 tax returns. So the issue then

becomes, when did it become worthless.

The state has argued that how can Mr. Macfarlane

say it became worthless in ‘88 when he didn’t even

know that it became worthless. But we have Mr.

Cheng who instructs Ms. Szuetenback to take it as a

bad debt loss because he has an [73] inability to pay,

that she’s got personal knowledge, as does Ms. J oyce,

that Mr. Cheng does not have the ability to pay at that

point in time.

Under all the circumstances and accepting that

whether or not a debt becomes worthless when a debt

becomes worthless, is a question of fact. The uncon-

troverted facts established that it became worthless

in ‘88 as to ‘88 and by the end of ‘89 as to ‘89.

And the next question is, well, but if Mr. Macfar-

lane didn’t owe that, how can he claim that that was in

fact worthless. But we have the fact that Mr. Cheng

10a

acknowledges it by directing its inclusion in the ‘88

and ‘89 tax returns, but we also have Mr. Cheng

having Mr. Macfarlane’s power of attorney and the

ability to recognize that in the very office where

you’re preparing Mr. Macfarlane’s tax return. So

somebody on behalf of Mr. Macfarlane was authorized

to and apparently did recognize that in fact the

obligations to Mr. Cheng in ‘88 and again in ‘89 had

become worthless.

Now, the state has suggested that Mr. Macfarlane

could have had no expectation of repayment in ‘89,

having signed the ‘88 tax return because he knew at

least at that point in time that there was no way that

Mr. Cheng could repay him. Well, one, that fact is not

at all clear. Secondly, the date on which the ‘88 tax

return was signed was in October of ‘89. Third, is

that the premise of the state appears to be that the

[74] debt had to be a good debt at the start of the year

and termed worthless sometime during the year.

In point of fact, we could make a loan to somebody,

as banks often do, even at a time when the banks are

administratively or accountantwise insolvent, make

loans or advances by way of credit card accounts to

people who are themselves insolvent and still do it

notwithstanding their circumstances. The fact that

you could say that I knew that he could not pay back

last year’s obligations, one does not establish that he

couldn’t pay back the next year’s obligations on new

loans made in 1989, but, secondly, there is at least the

value advance in the loan amounts which establishes

value and at least momentarily inability to repay

within that window of time.

So however unreasonable one might say Mr.

Macfarlane’s expectations were and recognizing that

Mr. Macfarlane had a real difficulty distinguishing

lla

between what’s a loan and an investment, neverthe-

less under all the circumstances, it’s the court’s

ruling under a tentative basis, and I’ll hear from Mr.

Sgherzi on it, that the debtor’s motion ought to be

granted.

Mr. Martin: Thank you, your Honor.

Mr. Sgherzi: I guess by now the court’s pretty

familiar, after reading all of these papers, the state’s

position. I think there are a lot things that are clear.

I think—but there are also very many things that are

not clear.

(75)

First of all, I think you have to take a look at what

the debt is. First of all, we don’t have a situation

where there was one particular circumstance in

which the debtor gave Cheng or any of the associates

money. The facts clearly indicate that the debtor pro-

vided Cheng and the associates with an all-inclusive

power of attorney. Which meant they could have

taken the money out at any time; they could have done

whatever in fact they wanted to do with it.

Under those circumstances, I don’t see how anyone

else can indicate that there was an intent on the part

of the debtor to make a loan. It just does not add up.

Cheng had an all-inclusive power of attorney, and the

fact that—

The Court: Well, let me interrupt you for a

minute.

Mr. Sgherzi: Sure.

The Court: Because one of the documents on

which I rely to establish that is the letter from Mr.

Cheng to Mr. Macfarlane in January of ‘87 which

Says, you know, we've talked about a loan to me.

We've talked about your investing in this information

system, which was not Cheng at the time. It was the

12a

other one. Altear (phonetic spelling) I think it was

called. But at this point in time we went to treat it as

a personal loan and deal with it this way. And as the

process of Altear solidifies, then we'll talk about

investing. And that’s a threshold document which

suggests, here is where money is going, [76] this is

what Macfarlane understands he’s doing and what he

thinks he’s getting into.

Mr. Sgherzi: Well, I understand that. That proba-

bly is in effect to one particular transaction. But my

understanding of the way this whole thing went down

is that there were multiple transactions over a period

of time. I think the evidence shows, and if the court

takes look at page seven.

The Court: Of?

Mr. Sgherzi: Of my last—

The Court: Page seven of which document?

Mr. Sgherzi: Responsive creditor franchise tax

board’s objection to a complaint in the July 2nd

document.

It basically indicates that he gave an all-inclusive

power of attorney; he had signatory power over all the

checking accounts.

Now, when someone says on a particular occasion

that money is being used for purposes of a loan, I don’t

think you can assume that that money is being used

for purposes of a loan with respect to every trans-

action which takes place during 1988 and 1989. My

reading of the evidence certainly doesn’t bear that out

at all.

The Court: But then when we add to the January,

‘87 letter all the copies of checks, the subsequent

notes in ‘87; there was a note in February of ‘87; there

was a note in September; there was a note in Decem-

ber; there was the undated [77] million dollar note;

18a

there were multiple copies of checks that have on the

memo line “loan.”

Mr. Sgherzi: Well, I understand what the court is

saying, but to me that’s not perfectly clear. Because,

for example, on page 11 of the same document I refer-

red to earlier, Macfarlane tells Cheng, “I need a tax

shelter.” The only purpose of a tax shelter that I’m

aware of is to generate a loss. If you're going to

generate a loss, I don’t see how there would be any

reasonable expectation of repaying it. It’s just totally

inconsistent.

This is testimony that came from the debtor’s own

mouth. It’s nothing I said. His counsel was present.

He had the opportunity to rehabilitate if there’s a

problem. This came from his deposition. How can you

have a reasonable expectation of repayment on one

hand and enter into a tax shelter, which the court is

well aware of. The only purpose would be—

The Court: If you show me that any of that

money went into the wind power systems, which is

what that particular tax shelter was according to Mr.

Macfarlane, which was not in ‘87 and not in ‘88 and not

in 89, then we might talk about what’s being ex-

cluded. But this was part of the problem and this is

part of the threshold issue which, of course, the state

doesn’t like my March ruling on, and I understand

that. I mean, I recognize that there is a split in

authority, but I ruled in March and my position re-

mains the same; and that is that the [78] claim filed by

the state was prima facie valid. It was rebutted by the

debtor. The state therefore has the burden of going

forward, notwithstanding that it is a taxing author-

ity, the state in non-bankruptcy circumstances would

able to require the debtor, the taxpayer, to carry the

burden of proof.

l4a

Mr. Sgherzi: Right. I understand completely what —

the court is saying, but I think you can see why the

problem is the way it is. When you put that type ofa

burden on the state, it’s almost impossible to enable it

to do its job. It should make no difference whether it’s

in tax court or in bankruptcy court. I think the

substantive law requires that the debtor prove his

case, entitlement to a bad debt deduction, entitlement

to anything else.

The Court: Well, I disagree with you in several

particulars. One, I think there are probably—I mean,

I don’t know, but based upon the record I’ve seen, it

seems to me that if there’s evidence out there that in

fact this was an embezzlement by Cheng, there was

discovery that the state could have undertaken to

establish the fact that it was embezzlement rather

than a series of loans.

Secondly, that there were documents or amounts

that don’t add up and that show that at least some

portions of the transactions are not accountable for as

loans by any documentation, by any testimony and the

like. None of that was done in the intervening

months.

[79]

Mr. Sgherzi: I understand. I thought the record

was clear. I spoke to my client. My client believed

the record was clear that there was substantial doubt

in terms of the alleged bad debt deductions during

1988 and 1989. But I understand if we’re just talking

about a particular event or two or three particular

~ events that took place in 1988 and 1989, then I think

we’re dealing with something else. But when some-

one has an all-inclusive power of attorney and enables

them to get money out whenever they want and to

place it in this account and place it in that account,

15a

that puts a real serious burden on trying to determine

what exactly happened.

I believe that’s why the law is the way it is outside

of the bankruptcy context, which requires them to

prove—

The Court: Well, that’s right. Outside the bank-

ruptcy context, that’s how the burden would be. But

there was nothing to prohibit your office from, for

instance, going and taking Ms. Szuetenback’s deposi-

tion and saying, all right now let’s take this transac-

tion and let’s add up the sum totals, and what do you

have that supports your contention that this was a

loan or wasn’t a loan and go through and establish

what facts you contend are either, one, genuine issues

of material fact that precludes this entry of judgment

on this objection to claim, or two, establish that in

fact it was an embezzlement, or that it wasn’t a loan;

it was something [80] else. Those opportunities were

there.

Mr. Sgherzi: I understand that, but I just review

the evidence somewhat differently. I think that there

is still quite a bit of doubt in terms of what happened.

I understand the court indicates it’s my burden, but

again I believe that—

The Court: Therein lies the crux of the problem.

Mr. Sgherzi: Exactly. I think really that’s the

major problem right there to be honest with you.

The Court: Thank you. Mr. Martin.

Mr. Martin: Well, your Honor has displayed a

very extensive familiarity with the record, so I won’t

belabor the point except to say that I think there is

undue emphasis placed on the concept of embez-

zlement here.

The Court: Well, I’m not finding embezzlement.

16a

Mr. Martin: I understand that, your Honor, but

I’ve explained and I thought I explained adequately

that these takings were authorized pursuant to the

power of attorney. There was a breach of fiduciary

relationship, which is a civil problem. And I pointed

out how under other cases—

The Court: Well, under traditional embezzlement

law, the embezzler comes into possession of the prop-

erty lawfully and then converts it.

Mr. Martin: Well, in any event, on the issue of

evidence of transactions, I think your Honor is very

familiar with it. Attached to the original objection at

pages 248 [81] through 259 were copies of checks

signed by Macfarland designated as loans to Cheng.

At pages 329 through 350 are copies of notes. The

first one February, 1987, $250,000 signed by Cheng to

Macfarlane. July 19, 1988, $600,000. There’s another

one page 331, one million dollars. There’s another one

which the record shows was prepared by Cheng’s

lawyer September 25th, 1987. It’s a comprehensive

note for $250,00. It was the context of this note that

the documents referred to by the court were prepared

evidencing an ongoing relationship, creditor/lender/

borrower relationship, between Cheng and Macfar-

lane. And then there’s the agreement which appears

at page 333 dated July 31st, 1988, which again goes

into a line of credit of up to $1,250,000.

I think there is no question that the record estab-

lishes that there was intended to be a debtor/creditor

relationship, that the money was intended to be loaned

to Mr. Cheng. I think the record also shows that it

was misapplied by him, but that’s not really relevant

once the threshold issue of a debtor/creditor relation-

ship has been shown.

17a

The Court: I think that’s right. And I went

through the list of the assertedly uncontroverted

facts set out in Exhibit 1 to the notice of this motion

filed by the debtor and found that I could agree with

each of those based upon the statements I’ve already

made with respect to my tentative. And the same is

true with respect to the conclusions of law, [82]

including the burden issue. So every state has its

remedy with respect to that.

Mr. Martin, will you prepare a proposed formal

order and lodge it.

Mr. Martin: Thank you, your Honor.

Mr. Sgherzi: Thank you.

[83]

18a

State of California)

County of San Diego)

I, Kathleen Cheyne, a shorthand reporter, do

hereby certify that the foregoing hearing was taken

before me at the time and place herein named; that

said hearing was reported by me in shorthand and

then transcribed through computer-aided transcrip-

tion, and the foregoing transcript contains a true

record of the said hearing.

I do further certify that I am a disinterested person

and am in no way interested in the outcome of this

action.

In witness whereof, I have hereunto set my hand on

the 21st day of July, 1998, at San Diego, California.

/s/ KATHLEEN CHEYNE

KATHLEEN CHEYNE