Brief for the United States — United States v. Key

Supinions below. . ...-....~=----.-----.----------.-.2. .

Ricans code cbaduviinntabétevekwihladleeban te

E Questions presented ---......-------------------------

UND. dio Kctiakdn nk odes dcndemubasvude thus

Geatement... . -..------------------------- +52 ek ee

Argument:

Introduction and Summary------_---.-----.------

I. The United States is entitled to absolute priority

of payment under Section 3466 of the Revised

Piva. onc in tin nndcucidéskaeeeeetbete

II. The history of Chapter X generally, and Sec-

tion 199 in particular, shows not only that the

absolute federal priority is unimpaired but also

that the United States has independent rights

not satisfied in the decision below___._-------

A, Tat SRR sb bkn dans Css idea

B. The absolute priority that the United States

had in equity receiverships under Section

3466 is preserved in Chapter X reorgani-

zations of insolvent corporations--- -----

C. Even if Section 199 superseded Section

3466, its provision for ‘“‘payment” of the

government’s tax claims in itself embodies

a priority which was not satisfied by the

reorganization plan approved in this case_

III. The “fair and equitable’’ rule of Sections 216 and

: 221 requires that a tax claim of the United

A. The meaning of the fair and equitable rule_-

B. The fair and equitable rule is not satisfied by

the reorganization plan approved in this

371-862—69——1

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DOE ao vnicctetcckccssnedessecssccbudeestnbsnky 41

CITATIONS

Cases: a?

Beaston v. Farmers’ Bank, 12 Pet. 102__-------..._- 10

Bramwell v. U.S. Fidelity Co., 269 U.S. 483_..-.___- 10

Case v. Los Angeles Lumber Co., 308 U.S. 106, rehearing

—_ Oe eae 32, 33, 35, 37

Central States Electric Corp. v. Austrian, 183 F. 2d 879,

certiorari denied, 340 U.S. 917_....._-_-..-_____. 25, 34

Cherry Valley Homes, Inc., In re, 255 F. 2d 706, cer-

tiorari denied sub nom. Du Bois v. United States, 358

Acids ha supnkindddtahe ib scehnnanoadie ts 13

Commonwealth of Kentucky, Dept. of Rev. v. United

I SE Eh ict cewacenécneinssnaecests 9

Consolidated Rock Co. v. Du Bois, 312 U:S. 510_____- 8,

29, 33, 35, 36, 37

Curran v. State of Arkansas, 15 How. 304_-__-_---._- 31

Group of Investors v. Milwaukee R. Co., 318 U.S. 523.- 34,

36, 37

Illinois v. Campbell, 329 U.S. 362._..-------------- 9, 15

Illinois v. United States, 328 U.S. 8....-.-.-------- 11

Kyser v. MacAdam, 117 F. 2d 232...._------------ 34

Lowden v. N.W. National Bank, 298 U.S. 160__._.-- 13, 25

Marine Properties v. Trust Co., 317 U.S. 78_--_----- 34, 36

Massachusetts v. United States, 333 U.S. 611__.------ 9, 11

Mumma v. The Potomac Co., 8 Pet. 281__.....-..--- 31

New York v. Maclay, 288 U.S. 290. -....----------- 8, 15

Northern Pacific Ry. v. Boyd,.228 U.S. 482_____.-.-. 31

Portland Electric Power Co., Petition of, 162 F. 2d 618,

cerfiorari denied sub nom. Watson v. Portland Electric

pg OS eee ee ree 34, 37

Price v. United States, 269 U.S. 492.__.__..___----- 10, 15

Protective Committee v. Anderson, 390 U.S. 414.___-.-- 37, 38

Railroad Co. v. Howard, 7 Wall. 392.._...-..------ 31

Reconstruction Finance Corp. v: Flynn, 175 F. 2d 761,

certiorari denied, 338 U.S. 819.............------ 13

Sta

Cases—Continued

St. Louis Union Trust Co. v. Champion Shoe Mach. Co., Page

I Be i al a ed Eke Ladiesonas 34

620 Church St. Corp., In re, 299 U.S. 24...-.-------- 36

Spitzer v. Stichman, 278 F. 2d 402_.....-.---------- 34, 37

Spokane County v. United States, 279 U.S. 80_.------ 11,15

Standard Gas & Electric Co. v. Deep Rock Oil Corp.,

117 F. 2d 615, certiorari denied, 313 U.S. 564__-__- 37

United States v. Anderson, 334 F. 2d 111, certiorari

dented, 370 OS. O70..<..,...-.........-..-.... 13, 25

United States v. Butterworth Corp., 269 U.S. 504....-- 15

United States v. Edens, 189 F. 2d 876, affirmed per

SU EE I Biv dicate weetwenacsaccweonns 27

United States v. Emory, 314 U.S. 423.......---.---- 11, 15

United States v. Fisher, 2 Cranch 358_-_.._.._..---- 10

United States v. Gilbert Associates, 345 U.S. 361--_---- 9,15

United States v. Marzen, 307 U.S. 200_...-.-------- 12

United States v. Oklahoma, 261 U.S. 253...----.---- 9

United States v. State Bank of North Carolina, 6 Pet.29. 9,10

United States v. Texas, 314 U.S. 480___..__..-._---- 9

United States v. Waddill Co., 323 U.S. 353_..--_---- 9

Utilities Power & Light Corp., In re, 29 F. Supp. 763 - - - 34

Statutes:

Act of July 31, 1789, c. 5, 1 Stat. 29, Sec. 21______-_- 9

Act of August 4, 1790, c. 35, 1 Stat. 145, Sec. 45_____- 9

Act of May 2, 1792, c. 27, 1 Stat. 259, Sec. 18__.___- 9

Act of March 3, 1797, c. 20, 1 Stat. 512, Sec. 5..__-- 9

Act of March 2, 1799, c. 22, 1 Stat. 627, Sec. 65... _- 9

Act of March 3, 1933, c. 204, 47 Stat. 1467, Sec. 1... 15

Act of June 7, 1934, c. 424, 48 Stat. 911, Sec. 1.____- 16

Act of August 29, 1935, c. 809, 49 Stat. 965_._.__._- 17

Act of June 26, 1936, c. 833, 49 Stat. 1969. .__.....- 18

Act of June 22, 1938, c. 575, 52 Stat. 840.__...___-- 20

Act of July 28, 1939, c. 393, 53 Stat. 1134_.....----- 20

Bankruptcy Act, c. 541, 30 Stat. 544:

2 Ae CR cana ncdckaneens dcnnesein 11

TG, OE GED Tt On on dns k danncedenccuee 12

SU Alga Seoketcndcdtunientbodsbatane 15, 16, 17, 18, 20

Pies ktnneedudnwekinwns 16, 17, 18, 20, 22, 23, 32

ek: BI OE WRG CRs oivnincncenmnncnadenne 12, 41

Statutes—Continued

Bankruptcy Act, o. 541, 30 Stat. 544—Continued Pan

Sec. 107 (11 U.S.C. 607)... 2----------22- ee

Sec. 115 (11 U.S.C. 515)...-.------- beh ak, 49

Sas. 207 (10 TR Goes os sce ee eka 30, 34, 42

Seo. 260 (11 UBS OG eat Se 4,

5, 7, 11, 12, 14, 22, 24, 25, 26, 28, 36, 49

Sec. 216 (11 U.S.C. 616)_-\ --------- 4, 5, 8, 29, 30, 43

Sec. 221 (11 U.S.C. 621)_....---- 4, 5, 8, 29, 30, 36, 44

Revised Statutes Section 3466 (31 U.S.C. 191)_____- 4,5,

7, 8, 10, 11, 12, 13, 14, 20, 25, 26, 28, 36, 41

13 Te i ik cn eee 9

SD Tak: Vaaes © OO, SOs VE cc nsiei iene ee Secu. 9

Miscellaneous:

Blair, The Priority of The United States in Equity Re-

ceiverships, 39 Harvard L. Rev. 1 (1925)---..----- 15

Collier, Bankruptcy, Vol. 6A (14th ed. 1969):

LE seen 4h) MRA TS AYRE yo Pe eee Slay eee 26

Bem. LL BBaiik e Sen daca todd ‘_ 34, 35, 36. 37

70 Gone: Be: SG0G-OGIS i wee ec. 18

Criticisms and Suggestions Relating to H.R. 14359

and S. 5551, Amending the Bankruptcy Act (1933) - 16

Finletter, The Law of Bankruptcy Reorganization |

cen e cwnncansusensenchtesknbhnechenncdas 15, 26

H. Conference Rep. No. 1320, 76th Cong., Ist Sess... 20

H.R. 0048, 75th Cong:; 3d Sem. ......... 2... 22

H.R. 6439, 75th Cong., Ist Sess. -...-------------- 21

H.R. 10382, 74th Cong., 2d Sess. -.-.-_--------- oe |

H.R. 12889, 74th Cong., 2d Sess. _-.....----------- 21

H. Rep. No. 1897, 72d Cong., 2d Sess. -__________-- 15

H. Rep. No. 194, 73d Cong., Ist Sess. ----...------ 16

H. Rep. No. 1366, 74th Cong., Ist Sess. --....__---- 18

H. Rep. No. 2926, 74th Cong., 2d Sess. ____._------ 20

H. Rep. No. 1409, 75th Cong., ist Sess.............. 24

House Hearings Before the Committee on the Judiciary

on the Revision of the Bankruptcy Act, 75th Cong.,

is na Gacee be kenehnwns Gusaees Westie tbaae 22, 23

88-Gn. AG. 20 CONN). 22) oo 282. 16

$4 Op. AG. 108 (1008).........-.-2-.2-025.222..- 16

Remington, Bankruptcy (1961 Rev.), Vol. 11, Sec.

Slice cckeceG ch eee ee eeebe Rite conte eeeee ane 34

ae fiscellaneous—Continued

41 S. Rep. No. 1215, 72d Cong., 2d Sess. ___._-__-___-

42 S. Rep. No. 482, 73d Cong., 2d Sess. -.._-.________-

42 S. Rep. No. 953, 74th Cong., Ist Sess. _. _________-

4, S. Rep. No. 1386, 74th Cong., Ist Sess. __._.______-

42 S. Rep. No. 1985, 74th Cong., 2d Sess. __._________-

43 S. Rep. No. 1916, 75th Cong., 3d Sess. _...._______-

44 S. Rep. No. 489, 76th Cong., 1st Sess. _____.___-__-

5, Senate Hearings before the Committee on Interstate

4l Commerce on Railroad Reorganization Act of 1939,

: I es BO ic crea canes askansnee

Senate Hearings before the Subcommittee of the Com-

mittee on the Judiciary on the Revision of the Na-

tional Bankruptcy Act, 75th Cong., 2d Sess. ..__.-

Page

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16

18

18

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gn the Supreme Court of the Hnited Stutes

OctToBER TERM, 1969

No. 402

UNITED STATES OF AMERICA, PETITIONER

v.

SHELDON A. KEy, TRUSTEE

ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF

APPEALS FOR THE SEVENTH CIRCUIT

BRIEF FOR THE UNITED STATES

OPINIONS BELOW

The order of the district court confirming the plan

of reorganization (R. 58-63)’ is not officially reported.

The opinion of the court of appeals (R. 74-80) is re-

ported at 407 F’. 2d. 635.

JURISDICTION

The judgment of the court of appeals was entered

on February 27, 1969 (R. 81). On May 20, 1969, Mr.

Justice Marshall extended the time for filing a peti-

tion for a writ of certiorari to and including July 27,

1969. The petition for a writ of certiorari was filed on

July 28, 1969 (July 27, 1969, being a Sunday), and

1“R.” references are to the separately bound record appendix.

(1)

2

was granted on October 20, 1969. The jurisdiction of

this Court is conferred by 28 U.S.C. 1254 (1).

, @UmerIeNS PRESENTED

“. Whether the Secretary of the Treasury’ 8

jection of a debtor’s proposed plan of wile

corporate reorganization under Chapter X of the

Bankruptey Act entitles the United States to have

its unpaid tax claims first satisfied under Section

3466 of the Revised Statutes.

2. If the United States is not entitled to priority

of payment, whether it must accept payment later in

time than junior creditors and without provision for

interest during the period of delay.

STATUTES INVOLVED

The pertinent provisions of Revised Statutes, See-

tion 3466, and of Sections 102, 107, 115, 197, 199, 216,

and 221 of the Bankruptcy Act, as amended, are set

forth in the Appendix, infra, pp. 41-44.

STATEMENT

On May 3, 1954, Hancock Trucking, Inc. (the

debtor), filed a voluntary petition for corporate re-

organization under Chapter X of the Bankruptcy

Act, as amended, in which it alleged that it was u-

able to meet its debts as they became due and re-

quested the appointment of a trustee to operate its

business and manage its property (R. 74). The United

States filed proofs of claim for unpaid withholding

of federal income, employment and excise taxes in

the amount of $377,648.79 (R. 5-8, 21-22, 74).

An initial reorganization plan was confirmed by the

district court in 1957 but, for reasons not relevant

here, it was never consummated.’ Subsequently, with

district. court approval, the debtor agreed with

Hennis Freight Lines, Inc. that Hennis would pur-

chase its major asset, its Interstate Commerce Com-

mission operating rights for truck freight services.

The agreement provided that Hennis would pay not

more than $935,000 for the rights—$300,000 within

90 days of the Commission’s approval of the sale and

the balance in 78 monthly installments. The Commis-

sion approved the sale, with modifications, in March,

1965 (R. 9-11, 12-20, 23-28, 40-43, 75).

On June 23, 1967, the trustee filed an amended

plan of reorganization, the terms of which reflected

this underlying sale. The $300,000 down payment was

to be exhausted by paying 100 percent of certain

wage and local and state claims, 20 percent of the

claims of the unsecured creditors, and 10 percent of

the United States’ tax claims and other state and

local tax claims. The remainder of the amount due

to the United States and to state and local tax

authorities was to be paid in 78 monthly install-

ments, secured by an assignment of the note and

chattel mortgage Hennis had executed on its pur-

*Under this plan, the United States and certain states were

to be paid 25 percent of their tax claims in cash upon con-

firmation, and the balance in four quarterly installments, with

six percent interest on the unpaid balance. The plan also pro-

vided an acceleration clause in favor of the United States in

the event of default. The United States had indicated that it

would accept this plan.

4

chase of the debtor’s operating rights. No interest

was to be paid in connection with the installment

payments, and the plan did not contemplate the

continued existence of the debtor (R. 43-45, 64-70,

74-75).

The Secretary of the Treasury filed a timely notice

that he rejected the amended plan (R. 51, 75), but,

following a hearing, the district court nonetheless

confirmed it (R. 58-63, 75). Upon appeal by the

United States from the order of confirmation (R. 71),

the court of appeals affirmed (R. 74-80).

ARGUMENT

INTRODUCTION AND SUMMARY

The present case involves the meaning and inter-

action in a reorganization under Chapter X of the

Bankruptcy Act of three sets of statutory provisions:

(1) Section 3466 of the Revised Statutes,

31 U.S.C. 191, which provides in straight-

forward terms that “[w]henever any person

indebted to the United States is insolvent * * *

the debts due to the United States shall be

first satisfied’”’;

(2) Section 199 of the Bankruptcy Aet,

11 U.S.C. 599, which provides as to federal tax

claims against both solvent and insolvent cor-

porations in reorganization, that “no plan

which does not provide for the payment

thereof shall be confirmed by the judge except

upon the acceptance of a lesser amount by the

Secretary of the Treasury * * *’’;

(3) Sections 216 and 221 of the Aet,

11 U.S.C. 616, 621, which require that a plan

of reorganization must ‘“‘equitably and fairly”

i= mg

5

protect the value of claims made by ‘‘any class

of creditors which is affected. by and does not

accept the plan,’’ without specific reference

to the United States, and that the “judge

shall confirm a plan if satisfied that—(1) the

provisions of * * * section 199 * * * have

been complied with; and (2) the plan is fair and

equitable * * *.”’

The questions of meaning which arise in this case

include the following: What is required by the man-

date of Section 3466 that debts due the United States

be “first satisfied’? What constitutes ‘‘payment’’ of

tax claims under Section 199 and what is ‘‘a lesser

amount’’? What, under Sections 216 and 221, consti-

tutes “‘fair and equitable’’ protection of the claims of

a class of creditors?

The principal question of interaction among the

statutory provisions involves the relationship between

Section 199 and Section 3466—whether the ‘‘pay-

ment’? requirement can be met only if the govern-

ment’s tax claims are ‘‘first satisfied,’’ and, if not;

whether in Chapter X proceedings provision for

“nayment”’ is enough. In addition, there is a question

of the relationship between Section 199 and Sections

216 and 221—whether a provision for ‘‘payment’”’

under Section 199 is, ipso facto, ‘‘fair and equitable’’

to the United States under the latter sections.

The plan which the courts below approved as ‘‘pay-

ment” of the government’s claim, and therefore “fair

and equitable,’ provides for an initial payment—on

the government’s total claim of $375,400—of approxi-

mately $37,500 and 78 equal monthly installments of

6

approximately $4,330. The Revenue Service informs

us that the present value of the right to receive

monthly payments in that amount for 78 months,

figuring six percent interest compounded semi-

annually, is approximately $280,000; thus the total

package of initial payment and installments, under

this hypothesis, would be worth approximately

$317,000. On the other hand, if the United States is

entitled to be paid first, allowing $90,000 for adminis-

trative expenses and $14,500 for the few claims which

may have priority,’ it would receive $271,000 at once,‘

and thirteen monthly installments of approximately

$8,140. The value of this package is insignificantly

less than the government’s total claim of $375,400.

We submit that the scheme of payment approved

below fails to satisfy the rights of the United States

under each of the three applicable statutes.

We seek to show, first, that the long established

general requirement of Section 3466, that debts of an

insolvent debtor to the United States must be “first

satisfied”, entitles the United States to absolute prior-

ity of payment of its claims in a Chapter X reorga-

nization. Such priority covers tax debts as well as

other debts, and on the facts of this case it is indis-

putable that the debtor is insolvent; thus, the provi-

*It appears from respondent’s brief below that there are

approximately $14,500 of claims ranked as Class I, entitled to

priority over the government’s claim, which is the sole claim

ranked as Class II. Ct. App. Br. p. 34, n. 9; cf. App. 64.

‘The insolvent’s estate has $75,000 available for immediate

payment in addition to the $300,000 down payment from

Hennis Freight Lines. (Resp. Opp. 6.)

a ee ee,

aj ao apes fS Ss ee @d =e -

ome It cm rs 2

=

ee

7

sion applies by its plain language. Nor is there any

inconsistency with Section 199 that would justify the

conclusion below that Section 3466 has been displaced

in Chapter X reorganization cases. Indeed, Chapter X

reorganizations are the direct statutory descendants

of equity receivership proceedings, to which the ap-

plieability of Section 3466 is firmly established. An

extensive review of the legislative background of Sec-

tion 199—-which applies in terms to reorganizations

of solvent as well as insolvent debtors—reveals that

the Congress was aware of the government’s absolute

priority in insolvency cases and had no purpose to

rescind it; rather, the section was viewed as carrying

forward the established practice under equity re-

ceiverships, which recognized that priority.

Section 199 speaks of “payment”’ as contrasted with

“acceptance of a lesser amount.’’ This contrast, illu-

mined by the economic realities of the present case,

evidently implies that the government is entitled to

the maximum payment which can be made to it in view

of the funds available to pay its claim. As shown

above, here it received, in return for its claim, a

bundle of rights worth less than $320,000; but the

available funds could, and therefore should, have

been allocated in a manner which would have given

the United States value almost equivalent to the

amount of its claim. In addition, the installment pay-

ment feature required the United States to bear what-

ever risks might arise relative to consummation of the

plan, further reducing the present value of the gov-

ernment’s award. It is thus clear that the government

8

has improperly been given “a lesser amount,” rather

than “payment” of its claim.

Finally, the reference in Sections 216 and 221 to

“fair and equitable’’ treatment of creditors draws on

a settled body of law under which senior creditors

must be fully satisfied before junior creditors are

paid, and any plan under which juniors receive some-

thing of value at the expense of senior creditors

“eomes within judicial denunciation.” Consolidated

Rock Co. v. Du Bois, 312 U.S. 510, 529. Since the

present plan provides junior creditors with immedi-

ate, partial payment of their claims at the cost of

requiring the government to accept delayed and there-

fore discounted payment of its claims and to bear the

risk that the installment purchase contract will fail,

it is not fair and equitable within the statutory con-

templation.

I

THE UNITED STATES IS ENTITLED TO ABSOLUTE PRIORITY

OF PAYMENT UNDER SECTION 3466 OF THE REVISED

STATUTES

Since virtually the beginning of the Republic, See-

tion 3466 and its predecessors have guaranteed an

unqualified priority of payment for all “debts due to

the United States” by an insolvent debtor.’ This

5 We are not concerned with the relative priority of the gov-

ernment’s claims under Section 3466 vis-a-vis prior, specific and

perfected liens upon the debtor’s property at the time of in-

solvency, where there had been a transfer of the debtor’s prop-

erty and the debtor had no estate to which the government's

priority could attach. Cf. New York y. Maclay, 288 U.S. 2,

an

9

policy had its roots in established English .practices

under which the Crown: enjoyed an absolute priority

over all other creditors of an insolvent debtor. This

deference, attributed to royal prerogative, was based

on the necessity of preserving government revenue.°

In the United States, the sovereign priority was car-

ried forward by explicit statutes. United States v.

State Bank of North Carolina, 6 Pet. 29; United

States v. Oklahoma, 261 U.S. 253. Although initially

the priority was only for debts due on bond and for

customs duties, see Act of July 31, 1789, c. 5, 1 Stat.

29, Section 21, by 1799 all debts due the United States

out of the estate of an insolvent debtor were entitled

to such priority of payment, under a statute whose

language has since remained substantially unchanged.

See, e.g., Act of March 3, 1797, ¢. 20, 1 Stat. 512,

Section 5, as amended by the Act of March 2, 1799,

¢. 22, 1 Stat. 627, Section 65.’

294; United States v. Texas, 314 U.S. 480, 484-485; United

States v. Waddill Co., 323 U.S. 353, 355-356; Jllinois v. Camp-

bell, 329 U.S. 362, 370-372; Massachusetts v. United States, 333

US. 611, 634, n. 38; United States v. Gilbert Associates, 345

US. 361, 365-366; Commonwealth of Kentucky, Dept. of Rev.

v. United States, 383 F. 2d 13, 15 (C.A. 6). There does not

appear to be any claimant in the Chapter X proceedings in the

present case with prior specific liens upon the debtor’s property.

* See 33 Hen. VIII, c, 39, § 74; 13 Eliz.jc4. .

*See also Act of August 4, 1790, c. 35, 1 Stat. 145, Sec. 45;

Act of May 2, 1792, c. 27, 1 Stat. 259, Sec. 18; Act of March 3, 1797,

¢. 20, 1 Stat. 512, Sec. 5; Act of March 2, 1799, c. 22, 1 Stat. 627,

Sec. 65.

10

This statutory priority is now established by

Revised Statutes Section 3466, which provides as

follows:

Whenever any person indebted to the United

States is insolvent, or whenever the estate of

any deceased debtor, in the hands of the execu-

tors. or administrators, is insufficient to pay

all the debts due from the deceased, the debts

due to the United States shall be first satisfied;

and the priority hereby established shall extend

as well to cases in which a debtor, not having

sufficient property to pay all his debts, makes

a voluntary assignment thereof, or in which the

estate and effects of an absconding, concealed,

or absent debtor are attached by process of

law, as to cases in which an act of bankruptcy

is committed.

The statutory purpose is to advance the same

public policy which governed the English royal pre-

rogative, t.e., to secure an adequate revenue to sustain

the public burdens and discharge the public debts.

United States v. Fisher, 2 Cranch 358, 391-392;

United States v. State Bank of North Carolina,

6 Pet. 29, 35. The terms of the statute are to be

liberally construed to effectuate this public purpose.

Beaston v. Farmers’ Bank, 12 Pet. 102, 135; Bram-

well v. U.S. Fidelity Co., 269 U.S. 483, 487; Price v.

United States, 269 U.S. 492, 499-501.

It is settled that a tax debt to the United States—

such as is in question here—is covered by the broad

language of Section 3466. Price v. United States,

supra, at 499; Spokane County v. United States, 279

11

U.S. 80, 92-93; Illinois v. United States, 328 U.S. 8,

9; Iinots v. Campbell, 329 U.S. 362, 366-367 ; Massa-

chusetts v. United States, 333 U.S. 611, 625-626. Nor

js there any dispute that the debtor in this case is

insolvent within the meaning of the statute. On sev-

eral occasions, the debtor has admitted its insolvency,

and the district court has se adjudged. The trustee

was appointed following a voluntary petition by the

debtor consenting to a reorganization and confessing

insolvency. Likewise, the debtor’s financial situation

is such that upon the discontinuance of its business

and the sale of its assets, the proceeds of sale will

be insufficient to pay all its debts (R. 12, 23-24, 62).

Thus, there have been both a voluntary assignment

and an act of bankruptcy to bring this debtor within

the seope of Section 3466.° See United States v.

Emory, 314 U.S. 423.

In these circumstances, there is on the face of

things no reason why Section 3466 would not apply so

as to give the United States an absolute priority for

the payment of this debtor’s taxes. The court of ap-

peals, however, believed that Section 3466 was dis-

placed here by Section 199 of the Bankruptey Act,

which governs government tax claims in Chapter X

reorganizations to the extent of establishing the prin-

ciple that no reorganization plan may be confirmed

®Under Section 3a of the Bankruptcy Act, as amended (11

US.C. 21(a)), the fifth act of bankruptcy consists of a person

having—

“* * * (5) while insolvent or unable to pay his debts as

they mature, procured, permitted, or suffered voluntarily or

involuntarily the appointment of a receiver or trustee to take

charge of his property; * * *.”

371-862—69- —3

12

unless; it provides for “the payment” of such claims

(or unless the Secretary of the Treasury consents to

less than full payment), The court of appeals re.

garded Section 199 as a more specific and later enact-

ment superseding “the more general and conflicting

direction of § 3466’’ (R. 79).

But there is no inconsistency. or anomaly in apply-

ing both sections in a Chapter X reorganization, Sec-

tion 199 applies to both solvent and insolvent cor-

porations, and provides simply that the United States

cannot be compelled to accept less than full payment

of its taxes. If, as here, the Secretary of the Treasury

insists upon payment, the wholly separate question of

priority for that payment then arises. Section 199

does not purport to answer the priority question;

in the ease of an insolvent corporation like the debtor

here, the general provision of Section 3466 :does an-

swer it, stating that the United States is entitled to

payment first if it insists upon it. Thus, far from

being inconsistent, the two statutes dovetail perfectly

in the situation presented by this case.’ And, as we

shall show in Part IT of the Argument, the legislative

history of Section 199 shows no congressional intent

to displace the general priority statute; indeed, Chap-

ter X reorganizations are the direct statutory de-

*Thus, Chapter X differs from liquidation bankruptcy, as to

which the Bankruptcy Act prescribes in Section 64, 11 U.S.C.

104, a complete system of priorities that does plainly supersede

Section 3466. See United States v. Marxen, 307 U.S. 200. There

is no comparable general provision in Chapter X, and Section

102 of the Bankruptcy Act expressly makes Section 64 inap-

plicable to Chapter X reorganizations.

a

13

gendents of equity receivership proceedings, in which

the applicability of Section 3466-was clearly estab-

lished. See Lowden v. N.W. National Bank, 298 U.S.

160, 163.

Other courts of appeals have applied the unequiv-

ocal language of Section 3466 to give the United

States first access to insolvents’ assets in Chapter X

reorganizations. United States v. Anderson, 334 F, 2d

111 (C.A. 5), certiorari denied, 379 U.S. 879; In re

Cherry Valley Homes, Inc. 255 F. 2d 706 (C.A. 3),

certiorari denied sub nom. Du Bois v. United States,

358 U.S. 864, Reconstruction Finance Corp. v. Flynn,

175 F. 2d 761 (C.A. 2), certiorari denied, 338 U.S. 819.

To be sure, these cases involved non-tax debts owed

to the government. But there is nothing in the simple

language of Section 3466 that would provide any basis

for distinguishing between tax debts and other kinds

of debt.

Indeed, in United States v. Anderson, supra, the

Fifth Circuit reasoned from the assumption that the

government would have Chapter X priority in tax

debt cases to its conclusion on the only disputed point,

whether it also had priority as to non-tax debts. The

government’s. claims in the Chapter X proceedings in

Anderson included tax as well as non-tax debts; the

district court accorded the tax debts priority and

denied it only as to the non-tax debts. 334 F. 2d at

113, n. 2. Then it was argued in the court of appeals

that this differentiation was proper, because Section

199 specifically provided for tax debt priority in

Chapter X proceedings, but there was no similar

statement regarding other government debts. The

-

Fifth Circuit refused to draw that inference in light

of the long history of undifferentiated government

priority under Section 3466 of the Revised Statutes

and the distinct functions of Section 199 in cases not

involving insolvency. Jd. at 116-117.”

II

THE HISTORY OF CHAPTER X GENERALLY, AND SECTION

199 IN PARTICULAR, SHOWS NOT ONLY THAT THE ABS0-

LUTE FEDERAL PRIORITY IS UNIMPAIRED BUT ALSO THAT

THE UNITED STATES HAS INDEPENDENT RIGHTS Not

SATISFIED IN THE DECISION BELOW

A. THE HISTORY

Until the enactment of the first federal corporate

reorganization provisions in 1933 anda 1934, the prin-

cipal method of reorganizing insolvent corporations

was the federal equity receivership. This was a judge-

made procedure developed in the nineteenth century

to protect railroads from dismemberment by their

creditors. Unlike ordinary bankruptcy, this procedure

was designed to rehabilitate a debtor in financial

straits and to preserve its business as a going con-

cern. Briefly, the court created a receivership to pre-

vent the corporation’s creditors from enforcing their

claims against the property of the debtor; a judicial

sale was held of that property to the creditors, free

10 Tt would be anomalous if the government were entitled to

a priority in payment of the full amount of its nontax claims

but denied this priority for its tax claims, nothwithstanding

that Congress has given the government greater protection for

its tax and customs claims than for its other claims.

a nl

= .

of the old debts; and the property was conveyed by

the creditors to a new company formed for the pur-

pose of carrying on the enterprise. The court’s juris-

diction was founded on the existence of a limited

fund which was less than the claims against it, thus

necessitating the intervention of the court to assure

an equitable distribution among the creditors. See,

Finletter, Zhe Law of Bankruptcy Reorganization,

pp. 1-17 (1939).

A long line of cases established that Section 3466

of the Revised Statutes gave the United States—as

its literal language suggested—an absolute priority

for payment of debts due it from an insolvent corpo-

ration in equity receivership. E.g., Price v. United

States, 269 U.S. 492, 502-503; United States v.

Butterworth Corp., 269 U.S. 504, 513; Spokane

County v. United States, 279 U.S. 80; New York v.

Maclay, 288 U.S. 290; United States v. Emory, 314

U.S. 423, 433; Illinois v. Campbell, 329 U.S. 362,

366-367 ; United States v. Gilbert Associates, 345 U.S.

361, 365. See also, Blair, The Priority of the United

States in Equity Receiverships, 39 Harvard L. Rev. 1

(1925).

The first corporate reorganization statute was the

Act of March 3, 1933, ¢. 204, 47 Stat. 1467, Section 1,

which added Section 77 to the Bankruptey Act to

regulate railroad reorganizations. It brought railroads

under the jurisdiction of the bankruptcy court, but

with a procedure radically different from that of a

liquidating bankruptcy and more closely resembling

equity receivership. See H. Rep. No. 1897, 72d Cong.,

16

2d Sess., pp. 5, 8 (S.L.A. 18-19) “; S. Rep. No. 1215,

72d Cong., 2d Sess. (S.L.A. 20-38). Insofar as ig

relevant here, Section 77(e)(1), as enacted in 1933,

provided :

If the United States of America is directly

a creditor or stockholder, the Secretary of the

Treasury is hereby authorized to accept or

reject a plan in respect of the interests or

claims of the United States.

This provision was not intended to affect the priority

of the government’s claims. It resulted, instead, from

two prior rulings of the Attorney General that the

Secretary of the Treasury lacked authority to com-

promise claims of indebtedness owed to the govern-

ment by the railroads. 33 Op. A. G. 423 (1923)

(S.L.A. 1-6) ; 34 Op. A. G. 108 (1924) (S.L.A. 7-13).

The Secretary requested Congress to give him such

authority, and Section 77(e)(1) did so. See Criticisms

and Suggestions Relating to H.R. 14359 and S. 5551,

Amending the Bankruptey Act (1933), pp. 19-20

(S.L.A. 16-17).

The Act of June 7, 1934, c. 424, 48 Stat. 911, See-

tion 1, added Section 77B to the Bankruptey Act in

order to extend these reorganization procedures to

private corporations generally. It too adopted the

general concepts of equity receivership. See H. Rep.

No. 194, 73d Cong., Ist Sess. (S.L.A. 39-51) ; 8. Rep.

No. 482, 73d Cong., 2d Sess. (S.L.A. 52-66). Section

—_—_ oe - s+, *, &«. =e -—-— SS

1 &S.L.A.” references are to a separately bound Supplemental

Legislative Appendix, copies of which are being lodged with the

Clerk and served upon counsel for the respondent. It includes

legislative materials not readily available elsewhere.

17

T7B(e)(1), like Section 77(e)(1), authorized the

Secretary of the Treasury to accept or reject a plan.

In 1935, the Secretary of the Treasury called the

attention of Congress to the fact that lower federal!

courts were interpreting Section 77B(e)(1) to defeat

the government's priority, placing it in the status of a

general creditor with regard to its claims for taxes; as

a result, the government ran a risk of losing millions

of dollars of tax revenues. In order to remedy this

situation, Congress amended Section 77B(e)(1) by

the Act of August 29, 1935, c. 809, 49 Stat. 965,

966, which introduced the predecessor of Section 199, as

follows:

If the United States of America is a creditor

or stockholder, the interests or claims thereof

shall he deemed to be affected by the plan, and

the Secretary of the Treasury is hereby au-

thorized to accept or reject a plan in respect

of the interests or claims of the United States.

If, in any reorganization proceeding under this

section, the United States is a creditor on claims

for taxes or custom duties (whether or not the

United States has any other interest in, or claim

against, the debtor, as creditor or stockholder),

no plan which does not provide for the pay-

ment thereof shall be confirmed by the judge

except upon the acceptance of a lesser amount

by the Secretary of the Treasury certified to

the court: Provided, That if the Secretary of

the Treasury shall fail to accept or reject a

plan for more than ninety days after receipt

of written notice so to do from the court to

which the plan has been proposed, accompanied

by a certified copy of the plan, his consent shall

be conclusively presumed.

18

See S. Rep. No. 953, 74th Cong., Ist Sess. (S.L.A,

67); H. Rep. No. 1366, 74th Cong., Ist Sess. (S.L.A,

68-70) ; S. Rep. No. 1386, 74th Cong., Ist Sess. (S.L.A.

71-74).”

A similar amendment was made to Section 77(e),

relating to railroad reorganizations, by the Act of June

26, 1936, c. 833, 49 Stat. 1969. In pertinent part, §.

Rep. No. 1985, 74th Cong., 2d Sess., pp. 2-3 (S.L.A.

76-77), stated as follows with respect to that amend-

ment:

Since the beginning of our Federal Govern-

ment, Congress has consistently maintained a

policy of preferring claims of the United States

in insolvency and bankruptcy proceedings over

those of general creditors. Section 3466 of the

Revised Statutes (U.S.C., title 31, see. 191) re-

quires that debts due the United States shall

22 When the bill was before the Senate, Senator Burke, the floor

manager, explained it as follows (79 Cong. Rec. 14101) :

«“* * * [Under] section 77B of the Bankruptcy Act, the Sec-

retary of the Treasury is authorized to accept or reject cor-

poration reorganization plans in which the United States is

interested. It was assumed when that act was passed that the

United States Government would have preferential treatment

in its claims for taxes, customs duties, and so forth, but the

courts have held otherwise. So, at the request of the Treasury

Department, identical bills were introduced in the House and

Senate to make that point clear.”

As for the operation of the provision, Senator Gerry asked

(ibid.): “And that prevents a reorganization until the taxes

have been paid?” Senator Burke responded (/d., pp. 14101-

14102) :

“Yes; or until the Secretary of the Treasury has agreed, on

behalf of the Government, to accept a percentage, or to waive

the claim altogether. The reorganization may not be put

through, if the United States has a claim for taxes or customs

duties, without the consent of the Secretary of the Treasury.”

ee ee

—

19

be satisfied first, where a debtor’s or dece-

dent’s estate is insolvent. Ii recognition of the

policy of that provision, anq of the underlying

necessity for protecting the revenues of the

Government against the ¢yntingencies of in-

solveney, the Supreme Court has given it a lib-

eral construction, and heg that the word

“debts” includes unpaid taxps (Price vy. United

States, 269 U.S. 492 (1926)) This policy is fur-

ther manifested in the provigions of all of the

bankruptcy acts enacted by Congress (City of

Waco v. Bryan, 127 Fee 49 (C.C.A. 5th,

1904) ). ** #

*

- * * ’

It will be noted that S. 394) is mueh more

flexible and much less dragj. than either sec-

tion 3466 of the Revised Stitutes, or section 64

of the Bankruptcy Act. The ¢ormer gives a first

claim upon the assets of theinsolvent’s estate to

debts due the United Stat. phe latter gives

both to tax claims and to her debts due the

United States (which are ontitied to priority

under section 3466) a defini, place among those

debts which are preferred vey the claims of

general creditors. 8. 3841, on the other hand,

like the amendment to secti,,, T7B, gives to the

President, or the officer dei mated by him, an

opportunity to accede to aN, proposition which

protects the revenue, and which, at the same

time, is not so burdensome upon the debtor as

to impair its ability to rege... sound financial

status. The bill entitles theg overnment to pre-

ferred treatment only a5 t0.J,ims for taxes and

customs duties. Such treatt, ont is not accorded

other debts due the Unitec States, in spite of

371-862—69-——_4

a eae

20

the fact that Congress’ continued policy would

so warrant.

See also, H. Rep. No. 2926, 74th Cong., 2d Sess., pp.

4-6 (S.L.A. 78-80).”

The legislative history of the Chandler Act, which

is the basis of the present Bankruptcy Act, shows

clearly that Congress was fully aware of the extent

to which the priority of payment of the government’s

tax claims were protected under Section 3466 and was

specifically concerned to provide protection to the gov-

ernment not only as to insolvent debtors, but more

generally as to all debtors involved in Chapter X

reorganizations.”

The first draft bill was prepared in 1932 (S.L.A.

87-93). It included a provision, Section 76, dealing

#84 similar provision was included in Chapter XV, Section

722 of the Bankruptcy Act, as amended, as added by the Act

of July 28, 1939, c. 393, 53 Stat. 1134, relating to the volun-

tary adjustment of railroad obligations. See Senate Hearings

before the Committee on Interstate Commerce on Railroad Re-

organization Act of 1939, 76th Cong., Ist Sess., pp. 78-80 (1939)

(S.L.A. 82-84); S. Rep. No. 489, 76th Cong., Ist Sess., p. 6

(S.L.A. 85); H. Conference Rep. No. 1320, 76th Cong., Ist

Sess., p. 8 (S.L.A. 86).

%* Extensive hearings were held by Congress through the

1930’s to consider a general revision of the Bankruptcy Act.

These ultimately resulted in the Act of June 22, 1938, c. 575,

52 Stat. 840, the so-called Chandler Act. At the same time Con-

gress was also concerned with the plight of many classes of

debtors caused by the depression. As a result, various provisions

for the relief of debtors were included in the draft proposals

for a general revision of the Bankruptcy Act and, concurrently,

a number of bills were separately introduced to provide immedi-

ate relief for special classes of debtors. Sections 77 and 77B

resulted from such bills.

21

with corporate reorganizations, but did not refer

specifically to the payment of federal taxes. The next

five drafts were prepared by the National Bankruptcy

Conference. The first three of these, all prepared in

1933, provided for corporate reorganizations in a pro-

posed Section 78. The first draft (S.L.A. 94-96) made

no reference to payment of federal taxes; but the sec-

ond (S.L.A. 97-99) and third drafts (S.L.A. 100-

102) each would have authorized the Secretary of the

Treasury to represent the United States and to ac-

cept or reject a proposed plan, as in the initial version

of Section 77B(e)(1). The fourth (S.L.A. 103-109)

and fifth Bankruptcy Conference drafts (S.L.A. 110-

114), prepared in 1935 and 1936, respectively, dealt

with corporate reorganizations in a proposed Section

12 as part of a package of various debtor relief pro-

visions, but omitted the provision authorizing the Sec-

retary to accept or reject plans. The fifth draft was

introduced into the House by Representative Chandler

as H.R. 10382, 74th Cong., 2d Sess. (S.L.A. 110-114).

Later in that session, the same Congress considered

H.R. 12889 (S.L.A. 115-121). The proposed Section

12(II)d(5) of this bill, also drafted by the National

Bankruptcy Conference, spelled out in detail the au-

thority of the Secretary to represent the United

States, but omitted any requirement that taxes must

be paid in full, since the Conference opposed continua-

tion of these rights to the government. Congress, how-

ever, disagreed, and Section 12(II)h(5) of H.R. 6439,.

75th Cong., Ist Sess. (S.L.A. 122-123), introduced ap-

proximately one year later, contained a provision for

22

payment of tax claims almost identical with the

present Section 199 and similar to Section 77B(e) (1)

as it had been amended by the 1935 Act (see p. 17,

supra). The final bill, H.R. 8046, 75th Cong., 3d Sess.

(S.L.A. 127-128), was introduced in 1937 and enacted in

1938; it transferred the corporate reorgattization pro-

visions from Section 12 to a separate Chapter and in-

chtded Seetion 199 in its present form.

During the hearings on the various bills very little

opposition was expressed to the reinstatement of the

Government’s right either to a priority of payment or

to fall payment of taxes. One member of the National

Bankruptey Conference who had helped draft the

legislation stated his opposition to the inclusion of

such a provision as follows (House Hearings Before

the Committee on the Judiciary on the Revision of the

Bankruptcy Act, 75th Cong., Ist Sess., p. 298 (1987))

(S.L.A. 124-126):

This bill puts it in the power of the Govern-

ment to veto any plan, if it is a creditor. I think

that Mr. Teitelbaum will mention that point,

but the point is just this, that if the Govern-

ment is a creditor, it seems to me that it should

not be able te say ‘‘No’’, and block a whole

plan—it ought to say ‘‘No’’, and have its no

counted with the other yeas and noes, and if

two-thirds vote ‘‘Yes’’, the Government should

be bound.

The Assistant General Counsel of the Treasury re-

futed the allegations that retention of the govern-

ment’s existing priority under Section 77B(e) (1)

23

would hamstring reorganizations, as follows (House

Hearings, supra, pp. 350-351) (S.L.A. 125):

Now that provision, I believe, has worked

very well in practice. I am informed that there

is not a single case in which a reorganizing

debtor has been forced into liquidation because

of inability to arrive at a fair and proper set-

tlement of the governmental tax claim with the

officials of the Treasury Department. If the

plan of reorganization failed, it has been for

some other reason. The Treasury Department

has proceeded upon this principle: It has rec-

ognized the objective of Congress in the enact-

ment of 77B to enable enterprises which are in

trouble to get back onto their feet. On the other

hand, the Department has felt that it was not

the intention of Congress in enacting that legis-

lation that private pocketbooks should be en-

riched at the expense of the Treasury of the

United States.

Finally, it was clear to all that the proposed Sec-

tion 199 would carry forward the practice under

equity receiverships and Section 77B. Thus, a member

of the National Bankruptcy Conference stated (Sen-

ate Hearings before a Subcommittee of the Commit-

tee on the Judiciary on the Revision of the National

Bankruptey Act, 75th Cong., 2d Sess., p. 77 (1938)

(S.L.A. 130)):

Section 64 of the general bankruptcy act, for

example, provides for a fixed priority in the

payment of claims. This section deals solely

with unsecured claims, only unsecured claims

being affected by bankruptcy. To apply it in

“ .

corporate reorganizations—where secured ag

well as unsecured claims are dealt with—would

cause great confusion. To make it clear that

section 64 does not apply, we propose this

amendment which expressly provides that 64

shall not be applicable to chapter X. The prior-

ities under chapter X would therefore be those

used in equity receiverships. That is the present

practice under 77B, which expressly provides

that section 64 shall not be applicable. When we

adopt the same provision here we merely adopt

the practice which is already in existence under

section 77B.

And Congress made the history and purpose manifest

in explaining the form of Section 199 in the final bill,

stating (H. Rep. No. 1409, 75th Cong., Ist Sess., p.

5d) (S.L.A. 132)):

Section 199 of chapter X contains in virtually

identical form, the provision in section 77B of

the act authorizing the Secretary of the Treas-

ury—where the United States of America is a

creditor or stockholder of the debtor—to ac-

cept or reject a plan in respect of the claims or

rights of the United States. * * *

See also S. Rep. No. 1916, 75th Cong., 3d Sess., p. 32

(S.L.A. 133).

B. THE ABSOLUTE PRIORITY THAT THE UNITED STATES HAD IN

EQUITY RECEIVERSHIPS UNDER SECTION 3466 IS PRESERVED IN

CHAPTER X REORGANIZATIONS OF INSOLVENT CORPORATIONS

The legislative history of the enactment of Chapter

X, and particularly of Section 199, emphasizes two

points—(1) that corporate reorganizations were not

derived from the precedents of liquidating bank-

ruptey, but had their origins in equity receiverships

25

and similar debtor relief proceedings,” and (2) that

when it enacted Section 199 Congress did not intend

to eliminate the priority as to all debts of insolvents

which the United States had in equity receiverships

under Section 3466. Section 199 was necessary be-

cause, tnter alia, the existing priorities established by

Section 3466 aided the government only if the corpo-

ration undergoing reorganization was insolvent within

the meaning of that statute; it was necessary to have

general rules applicable to all Chapter X reorganiza-

tions. We have found no indication of any Congres-

sional intention that Section 199 or any other pro-

vision of Chapter X was intended to supersede the

generally applicable provisions of Section 3466, which

had—as we have shown, supra, p. 15—been universally

recognized in the equity proceedings from which

Chapter X arose. Congress was aware of the United

States’ existing priority under Section 3466, and in-

tended to supplement rather than impair it. See

United States v. Anderson, supra.

C. EVEN IF SECTION 199 SUPERSEDED SECTION 3466, ITS PROVISION

FOR “PAYMENT” OF THE GOVERNMENT'S TAX CLAIMS IN ITSELF

EMBODIES A PRIORITY WHICH WAS NOT SATISFIED BY THE RE-

ORGANIZATION PLAN APPROVED IN. THIS CASE

Even if this Court should determine that Section

199 does supersede Section 3466 in Chapter X reorga-

* This Court pointed out in Lowden v. NV. W. National Bank,

298 U.S. 160, 163:

“A proceeding to reorganize is not a bankruptcy, though an

amendment to the bankruptcy act creates and regulates the

remedy.”

See Central States Electric Corp. v. Austrian, 183 F. 2d 879,

886 (C.A. 4), certiorari denied, 340 U.S. 917. See also Part

III of the argument, infra.

26

nizations, it remains clear from the legislative history

that Congress acted in Section 199 to preserve gener.

ally, at least as to tax debts, the rights which the

United States had previously enjoyed in equity re.

ceiverships. In Collier, Bankruptcy, Vol. 6A (14th ed,

1969), Section 9.17, this is stated as follows (pp. 269-

270) : )

The second sentence of § 199 establishes a first

priority in payment for claims of the United

States for taxes or customs duties, either ge-

cured or unsecured, irrespective of whether the

United States has any other interest in or claim

against the debtor. The priority thus conferred

is superior to all other claims against the estate,

even to existing and perfected liens which might

otherwise be prior. * * *

See also, Finletter, The Law of Bankruptcy Reorga-

nization (1939), pp. 1-35, 385, 404. Indeed, the pref-

erence over secured claims provided by Section 199

exceeds the general preference given by Section 3466.

The priority given by Section 199 is embodied in the

contrast it draws between “payment”? and ‘‘accept-

ance of a lesser amount.’’ The comparison made im-

plies that the government is entitled to the maximum

payment which can be made to it in view of the funds

available to pay its claim. Any other payment would

be a “lesser amount” which the Secretary is entitled

to refuse.

In the present case, the purchase by Hennis and

other funds in the trustees’ hands made $375,000 avail-

able for immediate distribution to creditors. Only

a small proportion of that sum—respondent suggested

$105,000 below—could be claimed for administrative

ey A a

orm

27

expenses and the smal] amount of wage claims placed

in Class I, ahead of the government in priority of

claim. Thus, it would have been possible to pay the

government at least $270,000 at once, plus as many of

the monthly installments (of $8140 each) as were re-

quired to make up the balance of its $375,386.55 claim.

Instead, the government is to be paid $37,538.66 in

cash and $4,331.38 monthly for 78 months.

This is payment of a “lesser amount” in several

respects. As shown above, the rights conferred would

have substantially lower present economic value than

immediate payment, even if it were certain that the

monthly installments would be paid. Moreover, the

monthly installment plan requires the United States

to assume whatever risks may arise relative to con-

summation of the plan—for example, that the pur-

chaser will remain solvent throughout the 78 month

period and that the collateral for the installment pay-

ments, the operating rights, will retain its value. These

risks reduce the value of the government’s rights still

further and thus make it even clearer that it is being

required to accept a ‘‘lesser amount.”’

The courts below came to a different conclusion,

that the ‘‘payment’’ obligation was satisfied by any

scheme which promised to return to the government,

as a simple sum, the amount owed it. That reason-

ing depended in part on the proposition that the

United States is not allowed post-petition interest on

its claim, United States v. Edens, 189 F. 2d 876 (C.A.

4), affirmed per curiam, 342 U.S. 912, and that rec-

———

a.

ognition of any difference in value between available

modes of paying the government’s claim would amount

to the payment of such interest. While the. first prop-

osition is correct, the second is economically -un-

sound. The roughly $375,000 due to the government

cannot now be expanded by assessment of interest on

that amount, despite the considerable delay since the

insolvency proceedings began; but the government is

entitled to its full claim unless the Secretary agrees

to accept less, and there is no blinking the fact that

under the plan as approved he will be receiving less. .

Accordingly, we submit that even if the govern-

ment has no absolute right to first payment under Sece-

tion 3466, its right to full payment under Section 199

entitles it to no less payment than is available at any

stage of the proceedings. At the very least, the gov-

ernment is entitled to compensation for the reduced

present value of the payments planned to be made in

the future.

**The hypothesis that the government receives “payment”

under Section 199.so long as it receives all the moneys due to

it at some point in time, without reference to when other

creditors are paid, leads to an unacceptable result if the element

of tisk is also considered. Delaying payment to the govern-

ment relative to other creditors imposes on it an unequal risk

of loss if the transaction fails of completion after it has been

only partially consummated. Once the juniors were paid, it

would be difficult if not impossible for the government to se-

cure satisfaction from them if the risk then materializes. From

this perspective, the requirement of full payment would be dia-

phanous indeed. Congress must have recognized that such a

requirement was workable only in conjunction with a right to

priority of payment.

;

Iil

THE ‘‘FAIR AND EQUITABLE’’ RULE OF SECTIONS 216 AND

221 REQUIRES THAT A’ TAX CLAIM OF THE UNITED

STATES BE PAID BEFORE THE CLAIMS OF LOWER RANK-

ING CREDITORS

The court of appeals considered that giving the

United States priority would conflict with Sections

216(7)(d) and 221(2) of the Bankruptcy Act, which

require that a plan of reorganization under Chapter

X must, in substance, be fair, equitable and feasible.

In its construction of the fair and equitable rule, how-

ever, the court in effect eliminated the well established

distinctions between senior and junior creditors, hold-

ing the government entitled to nothing ‘more than

reasonable protection. This violated the settled prin-

ciple that the fair and equitable rule is applicable not

to the body of creditors as a whole, but on a class-

by-class basis, treating the senior claims first. Each

class of claims must be satisfied in full for the rights

surrendered, in descending order, before the next

junior class may properly be paid in the distribution.

If junior creditors receive something. of value at the

expense of the senior creditors, the plan is not fair

and equitable but ‘‘comes within judicial denuncia-

tion.”’ Consolidated Rock Co. v. Du Bois, 312 U.S.

510, 529. That in effect is the result of the plan ap-

proved below, which is therefore inconsistent even

with the rule upon which it purports to be based. _

A. THE MEANING OF THE FAIR AND EQUITABLE RULE

Although Chapter X envisages that a reorganiza-

tion plan will alter or modify the rights of creditors

. a

and stockholders, it imposes conditions on the extent

of modification and alteration possible vis-a-vis the

rights of others, in order to protect the relative stand-

ing which various classes of creditors and equity hold-

ers enjoy. Thus, Section 197, 11 U.S.C. 597, requires the

reorganization judge to classify creditors and stock-

holders “according to the nature of their respective

claims and stock,” and this requirement is understood

to call for an ordering based on the priority of claim

of the various classes to the debtor’s assets. Under

Section 216(7)(d), 11 U.S.C. 616(7) (a), if any class

of creditors affected by the plan does not accept it, the

plan must assure “adequate protection for the realiza-

tion by them of the value of their claims * * * by

such method as will * * * equitably and fairly pro-

vide such protection.” And Section 221(2) of the

Act, 11 U.S.C. 621(2), provides as a condition of con-

firmation of a plan that the court be “satisfied’’ that

“the plan is fair and equitable, and feasible.”

The repeated statement in the Act of the require-

ment that a Chapter X plan be “fair and equitable”

Since generally, if not inevitably, the United States is the

sole member of the class of creditors to which it belongs, the

provision for acceptance of the plan by a vote of two-thirds

of the amount of debt held by the class is irrelevant to it; the

provision thus amounts to a statement that if it rejects a plan,

the plan can be adopted only if it equitably and fairly protects

the government’s realization of the value of its claims. In view

of the specific mandate of Section 199 on this issue, it might

appear that the section is redundant as to the government in

tax cases such as this. Section 221 evidently is not redundant, how-

ever, since it makes separate reference to Section 199 and the fair

and equitable rule.

_ .

draws on a settled tradition of according creditors

absolute priority over stockholders in equity proceed-

ings involving a debtor’s estate. See, ¢.9., Mumma v.

The Potomac Co., 8 Pet. 281, 286-287; Curran v. State

of Arkansas, 15 How. 304, 307-308; Railroad Co. v.

Howard, 7 Wall. 392, 409-410. That principle was

regularly applied in the equity receivership proceed-

ings which were the historical source of Chapter X.

Thus, in Northern Pacific Ry. v. Boyd, 228 U.S. 482,

a general creditor who was denied participation in the

reorganized company sought recovery of the amount

of his claim against the new corporation on the ground

that by permitting the stockholders to participate in

the plan, the latter had received assets belonging to

the unsecured creditors. This Court agreed, holding

that the reorganizers were bound to recognize the

superior rights of the general creditors, and stated,

in part, as follows (228 U.S. at 504-505) :

For, if purposely or unintentionally a single

creditor was not paid, or provided for in the

reorganization, he could assert his superior

rights against the subordinate interests of the

old stockholders in the property transferred

to the new company. * * * The property was a

trust fund charged primarily with the payment

of corporate liabilities. Any device, whether by

private contract or judicial sale under consent

decree, whereby stockholders were preferred

before the creditor was invalid. * * * “* * *

Any arrangement of the parties by which the

subordinate rights and interests of the stock-

holders are attempted to be secured at the ex-

32

pense of the prior rights of either class of

creditors comes within judicial denunciation,”

The opinion then set forth what has since become

known as the absolute priority rule (at 508) :

If the value of the road justified the issuance

of stock in exchange for old shares, the credi-

tors were entitled to the benefit of that value,

whether it was present or prospective, for

dividends or only for purposes of control. In

either event it was a right of property out of

which the creditors were entitled to be paid be-

fore the stockholders could retain it for any

purpose whatever.

The absolute priority rule was carried forward to

govern corporate reorganizations under Section 77B

of the Bankruptcy Act. As this Court stated in Case

v. Los Angeles Lumber Co. 308 U.S. 106, 115-116, re-

hearing denied, 308 U.S. 637:

The words “fair and equitable” as used to

§77B(f) are words of art which prior to the

advent of §77B had acquired a fixed meaning

through judicial interpretations in the field of

equity * * * reorganizations. * * *

In equity reorganization law the term “fair

and equitable” included, inter alta, the rules of

law enunciated by this Court in the familiar

eases of Railroad Co. v. Howard, 7 Wall. 392;

Louisville Trust Co. v. Loutsville, N.A. & C. Ry.

Co., 174 U.S. 674; Northern Pacific Ry. Co. v.

Boyd, 228 U.S. 482; Kansas City Terminal Ry.

Co. v. Central Union Trust Co., 271 U.S. 4465.

These cases dealt with the precedence to be ac-

corded creditors over stockholders in reorga-

33

nization plans. In Louisville Trust Co. v. Louis-

ville, N.A. & C. Ry. Co., supra, this Court re-

affirmed the “familiar rule’ that “the stock-

holder’s interest in the property is subordinate

to the rights of creditors; first of secured and

then of unsecured creditors.” * * *

One of the arguments made in Case, as in the courts

below, was that the absolute priority rights of a dis-

senting class need not be recognized if a substantial

majority of the creditors as a whole had voted for a

plan. This Court rejected that argument in strong

terms, holding as a matter of law that the rights of

the senior ranking creditors must be observed (at

114) :

* * * [Where a plan is not fair and equit-

able as a matter of law it cannot be approved

by the court even though the percentage of the

various classes of security holders required by

§ 77B(f) for confirmation of the plan has con-

sented. It is clear from a reading of § 77B(f)

that the Congress has required both that the

required percentages of each class of security

holders approve the plan and that the plan

be found to be “fair and equitable.’’? The

former is not a substitute for the latter. The

court is not merely 2. ministerial register of the

vote of the severai classes of security holders.

All those interested in the estate are entitled to

the court’s protection. Accordingly the fact that

the vast majority of the security holders have

approved the plan is not the test of whether

the plan is a fair and equitable one. * * *

In Consolidated Rock Co. v. Du Bois, 312 U.S. 510,

this Court referred to the absolute priority rule as

follows (at 520-521) :

- NRA OLDS ATI

34

The full and absolute priority rule of North-

ern Pacific Ry. Co. v. Boyd, 228 U.S. 482, and

Case v. Los Angeles Lumber Products Co,

supra, would preclude participaition by the

equity interests in any of those assets until the

bondholders had been made whole, * * *

Subsequently, Marine Properties v. Trust Co., 317

U.S. 78, 85, 86-87, applied the absolute ‘priority rule

to Chapter X. See Group of Investors w. Milwaukee

R. Co., 318 U.S. 523, 569, 571; Central States Electric

Corp. v. Austrian, 183 F. 2d 879, 885-888 (C.A. 4),

certiorari denied, 340 U.S. 917; Petition of Portland

Electric Power Co., 162 F. 2d 618, 622 (C.A. 9),

certiorari denied sub nom. Watson v. Portland Electric

Power Co., 332 U.S. 837; Spitzer v. Stichman, 278 F. 2d

402 (C.A. 2). See also, Collier op. cit. supra, Vol. 6A,

Section 11.06; Remington, Bankruptcy (1961 Rev.),

Vol. 11, Section 4584.

Thus, the requirement of fair and equitable treat-

ment is a requirement that creditors having different

priorities be separately classified under Section 197

and given the different priority rankings to which

their claims entitle them. Kyser v, MacAdam, 117 F.

2d 232, 237 (C.A. 2); St. Louis Unior. Trust Co. v.

Champion Shoe Mach. Co., 109 F. 2d 313, 316 (C.A.

8). A plan is not fair and equitable if creditors of a

junior class receive something of value at the expense

of a senior class. In re Utilities Power & Light Corp.,

29 F. Supp. 763, 769 (N.D. IIl.).

Any arrangement by which a junior class re-

ceives values allocable to a senior class ‘‘comes

within judicial denunciation.’’ Beginning with

the topmost class of claims against the debtor,

35

each class in descending rank must. receive full

and complete compensation for the rights sur-

rendered before the next class below may prop-

erly participate. [Collier, op. cit. supra, Vol.

6A, Section 11.06, pp. 613-617; see also id. at

619.]

The court of appeals’ conclusion that a grant of

priority to the United States would conflict with the

“fair and equitable’’ provisions of Sections 216 and

221 rests on its failure to accept this settled mean-

ing. The court appears to have started from the pre-

mise that the fair and equitable rule entitled it to

balance interests of junior creditors against those of

senior creditors to achieve a suitable compromise—in

effect, protecting lower ranking creditors at the ex-

pense of those with prior rights. But this Court has

inade it abundantly clear that compromising the rights

of senior creditors to protect their juniors is the an-

tithesis of fair and equitable treatment within the stat-

utory contemplation, whether or not it might appeal

to a disembodied sense of justice.“ See Case v. Los

Angeles Lumber Co., supra, at 114; Consolidated Rock

Co. v. Du Bots, supra, at 520-521, 527, 528-529;

*s Thus it is irrelevant whether the junior unsecured creditors

have, by agreeing to the plan, given up a portion of the divid-

end they might have expected in the event of liquidation in

bankruptcy. It may be noted, however, that the hypothetical

bankruptcy distribution would not be made until all priority

claims had been satisfied—that is, in the last part of the 78

months installment payment period. Depending on prevailing

interest rates and the degree of risk that the installment pur-

chase agreement would be abandoned, & present right to 20

percent could be more valuable than a future expectancy of 27

percent or 32 percent. Indeed, it is the fact that the govern-

ment as senior creditor has been made to absorb this discount

and risk which prompts the present appellate proceedings.

36

Marine Properties v. Trust Co., 317 U.S. 78, 85-

86; In re 620 Church St. Corp., 299 U.S. 24, 27;

Group of Investors v. Milwaukee R. Co., 318 U.S. 523,

556-558, 562-563, 564-566, 569. See also, Collier op,

cit. supra, Vol. 6A, Section 11.06, pp. 613-617. When

the fair and equitable rule is given the meaning estab-

lished by this Court’s repeated decisions, there is no

conflict. Section 3466 establishes the United States as

a senior ranking creditor; Section 199 assures that a

proposed plan will provide for payment in full of the

government’s tax claim unless it consents to a redue-

tion; and Sections 216 and 221 aid in determining

whether the method of payment adopted satisfies the

government’s priority rights.

B. THE FAIR AND EQUITABLE RULE IS NOT SATISFIED BY THE RE-

ORGANIZATION PLAN APPROVED IN THIS CASE

A reorganization plan “comes within judicial de-

nunciation” under the fair and equitable rule, Con-

solidated Rock Co. v. Du Bots, supra, at 529, if it pro-

vides junior creditors with something of value at the

senior creditors’ expense. The present plan calls for

such denunciation since it provides junior creditors

with immediate, partial payment of their claims at the

cost of requiring the government to accept delayed

(and therefore discounted) payment of its claims and

to bear the risk that the installment purchase contract

will fail.

The point, again, is that a choice has been made

to favor others at the government’s expense. Thus, this

is not a case in which the government’s priority is

recognized but there is only a small amount of cash

a — =

37 =

on hand to provide a down payment; nor even one

jn which both junior and senior creditors share rat-

ably in available cash, installment, or security inter-

ests. Here, a large sum of money—$375,000—is avail-

able for immediate payment, and junior creditors have

been given preferential access to it. By requiring the

government to accept installment payments, without

interest, over a period of 78 months, the court has

allotted it substantially less value than it would re-

ceive if it shared in the down-payment funds to the

extent its priority suggests, or even equally with the

other creditors. As senior creditor, it cannot be re-

quired to forego part of its rights, the right to be paid

out of the first available funds, at least without receiv-

ing equivalent compensation in return. Consolidated

Rock Co. v. Du Bots, supra; Group of Investors v.

Milwaukee R. Co., 318 U.S. 523; Petition of Portland

Electric Power Co., 162 F. 2d 618 (C.A. 9). See also

Collier, op. cit. supra, Vol. 6A, Section 11.06, pp. 620-

621; Spitzer v. Stichman, 278 F. 2d 402, 405 (C.A.

2). See also, Protective Committee v. Anderson, 390

U.S. 414, 424. Cf. Standard Gas & Electric Co. v.

Deep Rock Oil Corp., 117 F. 2d 615, 617 (C.A. 10),

certiorari denied, 313 U.S. 564.

We recognize that compromises are ‘‘a normal part

of the process of reorganization.’’ Case v. Los Angeles

Lumber Co., supra, at 130; Protective Committee v.

Anderson, 390 U.S. 414, 424. We also recognize that

lower ranking creditors are not prevented from bar-

gaining their consent to a plan for a higher return on

their claims, and that higher ranking creditors may

accept an extended payment or a smaller amount for

their claims in order to induce a settlement and to

avoid the delays and hazards of protracted court

proceedings. On the other hand, as this Court recently

emphasized in Protective Committee v. Anderson,

supra, at 424, even in such circumstances the reorgani-

zation court has the responsibility of scrutinizing the

merits of compromises ‘‘to determine that a proposed

compromise forming part of a reorganization plan is

fair and equitable. In re Chicago Rapid Transit Co.,

196 F. 2d 484 (C.A. 7th Cir. 1952).’’ There is even

greater reason for applying the fair and equitable

rule where, as here, a priority creditor, such as the

United States, refuses to accept a compromise of its

rights, as it is permitted by statute to do.

Finally, there is the least possible basis for requir-

ing the government to assume any risk in this case,

for the debtor here is no longer operating its business.

Whether or not the business could be forced into liq-

uidation, rather than reorganized, is thus a matter

of complete indifference to the government, and there

is no justification for favoring general creditors in the

apportioning of risk and delay. Confirming this plan

as ‘‘fair and equitable’? would only suggest to pro-

ponents of future plans, where continuation might ap-

pear feasible, that the government could be subjected

to even greater discounts and risks. Such a result is

entirely inconsistent with the bankruptcy statutes and

the interpretation which they have consistently re-

ceived in this Court.

39

CONCLUSION

The judgment of the court of appeals should be re-

yersed and the case remanded for further proceedings.

Respectfully submitted.

ERWIN N. GRISWOLD,

Solicttor General.

JOHNNIE M. WALTERS,

Assistant Attorney General.

Peter L. Strauss,

Assistant to the Solicitor General.

CROMBIE J. D. GARRETT,

Kari SCHMEIDLER,

Attorneys.

DECEMBER 1969.

APPENDIX

Revised Statutes:

Sec. 3466. Whenever any person indebted to

the United States is insolvent, or whenever the

estate of any deceased debtor, in the hands of

the executors or administrators, is insufficient

to pay all the debts due from the deceased, the

debts due to the United States shall be first

satisfied; and the priority hereby established

shall extend as well to cases in which a debtor,

not having sufficient property to pay all his

debts, makes a voluntary assignment thereof,

or in which the estate and effects of an abscond-

ing, concealed, or absent debtor are attached by

process of law, as to cases in which an act of

bankruptcy is committed.

(31 U.S.C. 191.)

Bankruptey Act, ce. 541, 30 Stat. 544 [as amended

by Sec. 1, Act of June 22, 1938, c. 575, 52 Stat. 840]:

Sec. 102. The provisions of chapter I to VII,

inclusive, of this Act shall, insofar as they are

not inconsistent or in conflict with the previ-

sions of this chapter, apply in proceedings

under this chapter: Provided, however, That

section 23, subdivisions h and n of section 57,

section 64, and subdivision f of section 70, shall

not apply in such proceedings unless an order

shall be entered directing that bankruptcy be

proceeded with pursuant to the provisions of

chapters I to VII, inclusive. * * *

(11 U.S.C. 502.)

Sec. 107. Creditors or stockholders or any

class thereof shall be deemed to be ‘‘affected’’

(41)

42

by a plan only if their or its interest shall he

materially and adversely affected thereby. In

the event of controversy, the court shall after

hearing upon notice summarily determine

whether any creditor or stockholder or class is

so affected.

(11 U.S.C. 507).

Sec. 115. Upon the approval of a petition,

the court shall have and may, in addition to the

jurisdiction, powers, and duties hereinabove

and elsewhere in this chapter conferred and

imposed upon it, exercise all the powers, not

inconsistent with the provisions of this chap-

ter, which a court of the United States would

have if it had appointed a receiver in equity

of the property of the debtor on the ground of

insolvency or inability to meet its debts as they

mature.

(11 U.S.C. 515.)

Sec. 197. For the purposes of the plan and

its acceptance, the judge shall fix the division

of creditors and stockholders into classes aec-

cording to the nature of their respective claims

and stock. * * *

(11 U.S.C. 597.)

Sec. 199. If the United States is a secured

or unsecured creditor or stockholder of a debtor,

the claims or stock thereof shall be deemed to

be affected by a plan under this chapter, and

the Secretary of the Treasury is hereby au-

thorized to accept or reject a plan in respect of

the claims or stock of the United States. If,

in any proceeding under this chapter, the

United States is a secured or unsecured creditor

on claims for taxes or customs duties (whether

or not the United States has any other interest

in, or claim against the debtor, as secured or

unsecured éreditor or stockholder), no plan

which does not provide for the payment thereof

43

shall be confirmed by the judge except upon the

acceptance of a lesser amount by the Secretary

of the Treasury certified to the court: Provided,

That if the Secretary of the png A shall fail

to accept or reject a plan for more than ninety

days after receipt of written notice so to do

from the court to which the plan has been pro-

posed, accompanied by a certified copy of the

plan, his consent shall be conclusively presumed.

(11 U.S.C. 599.)

Sec. 216. A plan of reorganization under this

chapter—

(1) shall include in respect to creditors gen-

erally or some class of them, secured or unse-

cured, and may include in respect to stock-

holders generally or some class of them, provi-

sions altering or modifying their rights, either

through the issuance of new securities of any

character or otherwise;

(2) may deal with all or any part of the

property of the debtor;

(3) shall provide for the payment of all costs

and expenses of administration and other al-

lowaneces which may be approved or made by

the judge;

* * > * *

(5) shall specify what claims, if any, are to

be paid in eash in full;

~ * . ~ *

(7) shall provide for any class of creditors

which is affected by and does not accept the

plan by the two-thirds majority in amount re-

quired under this chapter, adequate protection

for the realization by them of the value of their

claims against the property dealt with by the

plan and affected by such claims, either as pro-

vided in the plan or in the order confirming the

plan, (a) by the transfer or sale, or by the

retention by the debtor, of such property sub-

_ject to such claims; or (b) by a sale of such

44

property free of such claims, at not less thar

a fair upset price, and the transfer. of such

claims to the proceeds of such sale; or (¢) by

appraisal and payment in cash of the value of

such claims; or (d) by such method as will,

under and consistent with the circumstances

of the particular case, equitably and fairly pro-

vide such protection ;

= os

(11 U.S.C. 616).

Sec. 221. The judge shall confirm a plan if

satisfied that—

(1) the provisions of article VIT, section 199,

and article X of this chapter have been com-

* *

plied with ;

(2) the plan is fair and equitable, and feas-

ible ;

o . a = *

(11 U.S.C. 621).

U.S. GOVERNMENT PRINTING OFFICE: 1968-