United States v. Energy Resources Company, Inc.

PETITIONER:United States
RESPONDENT:Energy Resources Company, Inc.
LOCATION:San Jose, California

DOCKET NO.: 89-255
DECIDED BY: Rehnquist Court (1988-1990)
LOWER COURT: United States Court of Appeals for the First Circuit

CITATION: 495 US 545 (1990)
ARGUED: Mar 19, 1990
DECIDED: May 29, 1990

ADVOCATES:
Alan I. Horowitz – on behalf of the Petitioner
Guy B. Moss – on behalf of the Respondent

Facts of the case

Question

Audio Transcription for Oral Argument – March 19, 1990 in United States v. Energy Resources Company, Inc.

William H. Rehnquist:

We’ll hear first this morning in Number 89-255, United States against Energy Resources Co.–

Mr. Horowitz.

Alan I. Horowitz:

Thank you, Mr. Chief Justice, and may it please the Court:

This case involves two different bankruptcy court disputes that were consolidated on appeal in the First Circuit.

They present a single issue: whether the bankruptcy courts erred in ordering the IRS to apply the periodic payments of priority taxes that are required under a Chapter 11 reorganization plan, applying those payments first to satisfy the debtor corporation’s trust fund tax liability.

That is, the withholding tax liability for which the corporation’s responsible officers are separately and personally liable.

This order prevents the IRS from applying any of these periodic payments to the corporation’s other, nontrust fund tax liabilities, for which there is no other source of collection, until the trust fund liability is completely satisfied.

In the absence of this court order, the IRS would apply the periodic payments in the reverse manner, in accordance with its usual practice.

As the court of appeals frankly acknowledged–

Byron R. White:

Is there some basis in law for the IRS allocation?

They say they have the right to allocate it… they permit the taxpayer to do it with voluntary payments.

Alan I. Horowitz:

–That’s… the IRS has a policy of permitting the taxpayers to designate–

Byron R. White:

Well, is there some basis in law for that?

Alan I. Horowitz:

–There is no, there is no legal provision that directs the IRS how to allocate, either voluntary or involuntary or any other kind of payment.

So this policy pretty much comes out of common sense.

It is pretty much the same way–

Antonin Scalia:

The IRS is just big hearted on voluntary payments?

I find that hard to believe.

You really think that you’re–

Alan I. Horowitz:

–It’s not a question of being–

Antonin Scalia:

–that you’re complying with some common law rule?

Alan I. Horowitz:

–It’s not a question of being big hearted, I don’t think, Justice Scalia.

In a normal commercial setting, when a debtor makes a payment to a creditor and attaches a condition to it, the creditor normally is forced to accept that condition, because if he doesn’t do that the debtor can pull back the payment and say look, if you’re not going to accept that condition, then I am not going to pay you.

Now, the IRS is not quite in the same position, because it has administrative remedies.

It can assess the tax and go out and levy on it.

But the IRS prefers not to do that.

It prefers to get voluntary payments.

It saves a lot of costs of collection and what not.

So the IRS has a matter of policy of encouraging taxpayers to pay voluntarily, rather than requiring the IRS to go to court or to seize onerous designations of voluntary payments.

Antonin Scalia:

It seems to me there are other penalties for forcing the IRS to go to court.

Antonin Scalia:

They really have to give them that free gift in order to induce them not to go to court?

Alan I. Horowitz:

I don’t think–

Antonin Scalia:

It seems to me that you’re doing this for voluntary payments simply because that’s what the law is.

That is how voluntary payments are.

If I give you money for X, you either accept it for X or you give it back to me.

That’s the law in every other… in private transactions.

Why wouldn’t it be so with regard to the IRS?

If they want to use it for something else they say I’m sorry, we can’t accept the limitation, but if you don’t accept the limitation you don’t accept the payment.

Alan I. Horowitz:

–Your Honor, that’s–

Byron R. White:

You consider these to be involuntary payments?

Alan I. Horowitz:

–Well, in this case these are involuntary payments.

Justice Scalia asked me about voluntary payments, I think.

I am just answering that.

That is true, the taxpayer can then withdraw the payment, and the IRS would then have to go to court to get it.

So the situation is similar.

The IRS has a little more power.

It doesn’t have to go to court, excuse me.

It can also take administrative action and prefers not to do that.

So, as a practical common sense way of administering the tax laws in the same practical common sense way that private debtors and creditors deal with it, the IRS accepts these designations.

It seems like a perfectly reasonable thing to do, whether it is required to do so by law, by something that is implicit in the Code, maybe it is, maybe it isn’t.

But it has never really been an issue.

Byron R. White:

Well, is it your claim in this case that the district court was, that the bankruptcy court was bound to respect the IRS policy with respect to involuntary payments?

Alan I. Horowitz:

Our position here is that the bankruptcy court had nothing to do with how the IRS was going to allocate payments.

There is a payment… the IRS is owed a certain amount of taxes.

Under the Bankruptcy Code these taxes are of equal priority.

No reason for the bankruptcy court to distinguish between the nontrust fund and the trust fund taxes.

Byron R. White:

But do you think there is some legal… some legal basis that you argue that the bankruptcy court was wrong, namely that it should have… it should have preserved your right to get at this… at the officers?

Alan I. Horowitz:

Well, we are… we do argue, which I plan to explain in more detail a little bit later, that there are a lot of policies that are embodied both in the Internal Revenue Code and the Bankruptcy Code that… with which there is at least some tension with what the bankruptcy court did here.

There is no… there is obviously no specific provision in the Bankruptcy Code that either permits or forbids the bankruptcy court from doing this.

Otherwise this case probably wouldn’t be here.

Alan I. Horowitz:

This is–

Antonin Scalia:

The reason it is important to me, why the IRS is… does this with respect to voluntary payments, is I have no idea what the difference is between voluntary and involuntary, or where one looks for that distinction, except you invite us to look to what the IRS has done in the past.

And you seem to assert that we should be bound… it is voluntary where the IRS says it is voluntary, and it is involuntary where the IRS says it is involuntary.

What else do you tie that distinction to, unless it is the will of the IRS?

Alan I. Horowitz:

–I think the IRS’ own policy is just tied to the will of the IRS.

Now, you are suggesting that there is some… some law or something that requires the IRS–

Antonin Scalia:

It’s called the common law, it was called.

Alan I. Horowitz:

–Well, I don’t think there is any common law rule that requires the IRS to do this, or that the common law binds the IRS.

And so now the bankruptcy court held… I’m sorry, the court of appeals held that there was something that prevented the IRS from applying its policy in this case, namely the bankruptcy court’s own authority to deal with these payments.

And that is where the issue is–

Antonin Scalia:

But you choose to call this involuntary.

And you want us to accept it because you choose to call it involuntary.

Alan I. Horowitz:

–Well, I think to the extent that some of the bankruptcy courts in this area have fought over what the IRS’ policy is, I think you are right.

That’s the wrong place to fight the battle.

The IRS’ policy is that this is involuntary, and as far as–

William H. Rehnquist:

All the lower courts upheld that conclusion, didn’t they, that–

Alan I. Horowitz:

–All the courts of appeals have.

There are some bankruptcy courts–

William H. Rehnquist:

–That these were involuntary payments.

Alan I. Horowitz:

–Yes, that is correct.

William H. Rehnquist:

Then the question we granted certiorari on is whether the authority of the bankruptcy court to allocate tax payments under these circumstances.

Alan I. Horowitz:

Well, that’s true.

Just to finish the point, it’s a very sterile inquiry as to whether this is the IRS’ policy or not.

I mean, we think clearly it is, but if it isn’t, if the court somehow takes the view that the IRS is misapplying its own policy and doesn’t know what it means by the distinction that it has drawn, then I imagine the IRS will probably clarify that.

And I think the real issue here is whether there is some law, either the common law, and we think there is nothing that has been suggested as any common law bar to it, or whether there is something in the bankruptcy court’s power that prevents the IRS from applying these payments which it receives, becomes its money on its books, in a way that will preserve its security and its ability to collect.

Sandra Day O’Connor:

Mr. Horowitz, did the bankruptcy court have the power to approve these plans over the objections of the IRS?

Alan I. Horowitz:

The bankruptcy court is required under Section 1129… Section 1129 sets forth a lot of requirements for confirmation of a plan, and the bankruptcy court can only confirm a plan if it meets those requirements.

Whether or not the IRS objects, it would object on a ground that one of those provisions of 1129 was not satisfied.

So, the bankruptcy court can overrule the IRS’ objections if it concludes that the plan satisfies the legal requirements.

Sandra Day O’Connor:

Does the IRS have an express policy in its manual to the effect that it will comply with orders of the bankruptcy court?

Alan I. Horowitz:

Absolutely.

We will comply with the order of the bankruptcy court, but we reserve the right to appeal it, which is what we have done here.

So if we lose this case in the Supreme Court we will abide by the designation.

Byron R. White:

One of these plans actually provided for the prior allocation of these payments to the ordinary tax liability.

Alan I. Horowitz:

To the trust fund tax liability.

Byron R. White:

Yes.

Alan I. Horowitz:

Yes.

Well, what happened in the Energy Resources case was that the… one of the requirements of Section 1129 is that all of the priority taxes, which includes both components here, have to be paid in full over, within a six-year period.

So, when the first payment was made in that case, the debtor sent a letter saying we would like these payments to be applied first to the non… excuse me, to the trust fund taxes.

And the IRS wrote back and said well, we’re not going to do that unless you get a court order.

Byron R. White:

Yes.

Alan I. Horowitz:

And then they went and got a court order, which is where–

Byron R. White:

In the other case now, the other case… what about the other case?

Alan I. Horowitz:

–The other case, as I recall, they just went and got a court order first.

Byron R. White:

Well, there was a… I think there was a provision in the plan, wasn’t there, to pay–

Alan I. Horowitz:

Well, there may have been a provision in the plan to which the IRS objected, and claimed that the bankruptcy court does not have the authority to require us how to… remember, what the bankruptcy court has done here is… there is no question that the money is being paid to the IRS.

The question then is how the, once it becomes the IRS’ money, how the IRS is going to deal with it on its books, which liability is it going to say has been satisfied.

Antonin Scalia:

–You mean the question is whether it becomes the IRS’ money, until the IRS agrees to accept it in the manner in which is it offered.

Alan I. Horowitz:

Well, that I think is the difference between what everyone agrees is a voluntary payment and what we have here, because under Section 1129 there is no plan, unless the IRS… these payments are made to the IRS.

The debtor has no discretion not to make the payments if the IRS says we are not going to designate them the way you want, then it’s just too bad for the debtor.

He has no choice.

xxx.

Anthony M. Kennedy:

If we were to rule against you in this case, would the IRS in future reorganizations have the capacity to object to a plan and block a reorganization on the grounds that it objected to the allocation?

Alan I. Horowitz:

If you hold that the bankruptcy court has the power to–

Anthony M. Kennedy:

Right.

Alan I. Horowitz:

–No, I don’t think so.

We can only object on the grounds–

Anthony M. Kennedy:

In other words, as a creditor it could not object to the approval of the plan?

Alan I. Horowitz:

–That is right.

The IRS, as long as the requirements for payment of taxes that are specified in the statute are satisfied, if the plan complies with that, then the IRS can’t object.

Alan I. Horowitz:

And if there are, as in this case we contend, if there is no other provision in the plan that somehow is violative of law.

But we… the IRS does not have the authority to just veto the plan because it doesn’t like it.

Byron R. White:

I am surprised that you say that the trust fund taxes and the other taxes are of the same quality, or they–

Alan I. Horowitz:

Same priority.

Byron R. White:

–Same priority, is that what you say?

Alan I. Horowitz:

Same priority.

Byron R. White:

But the trust fund taxes belong to somebody.

Alan I. Horowitz:

Well, they once belonged to somebody.

They once belonged to us.

Byron R. White:

Yes.

Alan I. Horowitz:

There was a trust fund, and there are a lot of rights that the IRS has in that trust fund as long as it exists.

In fact, as long as the trust fund can be identified prior to bankruptcy, those funds don’t go into the estate at all.

Byron R. White:

That’s right.

Alan I. Horowitz:

But what’s happened here is that the trust funds have completely been dissipated by the officers.

There is no way of identifying any trust funds in the estate.

And so at this point all you have are tax liabilities.

There is no longer any fund to which the IRS can make a claim of its own money.

There are just tax liabilities.

And Congress has given the same priority to both of these kinds of tax liabilities.

Byron R. White:

Well, the court of appeals ruled that the equitable power of the bankruptcy court included the power to prefer the restoration or the payment of these trust fund taxes first.

Alan I. Horowitz:

That is what the court of appeal held, incorrectly in my view.

John Paul Stevens:

Were these monies generated after the petition was filed or before the petition was filed?

Alan I. Horowitz:

The payments that are being made–

John Paul Stevens:

Not the payments, the money that is being used to make the payments.

Was there a cash surplus?

Alan I. Horowitz:

–I would guess that it was generated after the petition was filed.

John Paul Stevens:

Because if it was generated before, then it would have had to go to the IRS.

Alan I. Horowitz:

I think the IRS had a claim, yes, that it was not to be put in the bankruptcy estate at all, but–

John Paul Stevens:

And it would have belonged definitely in the trust fund–

Alan I. Horowitz:

–Right.

John Paul Stevens:

–under your theory in this other case.

Alan I. Horowitz:

Yes.

And if that happened, of course, then the plan would only be paying out the nontrust fund taxes and we would be getting paid those taxes at the very beginning, instead of being pushed off effectively to the very back end of the plan, which is what is happening here.

As the court of appeals said at page 3(a) of its opinion, the only thing that turns on this dispute is who bears the risk that the reorganization will not be fully successful.

That is, that all the payments contemplated in the plan will not be made.

Is it the IRS and the taxpaying public, or is it the responsible officers of the corporation?

The designation provision that the court imposed here works to the advantage of these officers at the expense of the government.

William H. Rehnquist:

You said the designation provision which the court imposed.

You mean the bankruptcy court?

Alan I. Horowitz:

Yes, I mean the bankruptcy court.

William H. Rehnquist:

And how would you describe it?

Alan I. Horowitz:

The bankruptcy court ordered the IRS to apply the payments that it receives first to all of the trust fund liability of the corporation.

And only after the trust fund liability has been completely satisfied, which in turn completely eliminates the separate liability of the officers, because the IRS only collects those liabilities once, only then can the IRS go and apply any of the payments to the nontrust fund liabilities.

William H. Rehnquist:

But these payments are being made out of the bankruptcy estate, right?

Alan I. Horowitz:

That is correct.

William H. Rehnquist:

And need the authority of the bankruptcy court to make them.

Alan I. Horowitz:

Well, the… what the bankruptcy court does is it confirms the plan of reorganization.

And then the debtor continues to operate the company within the parameters of the plan.

The plan requires that certain payments be made on a schedule to the IRS.

So each time a payment is made I don’t think the debtor has to go to the court for approval.

It has already been set up by the plan, and in fact required by the plan.

William H. Rehnquist:

You just follow the plan.

Alan I. Horowitz:

You follow the plan, right.

Byron R. White:

There is no regulation, formal regulation relating to this controversy, is there?

Alan I. Horowitz:

As far as how the IRS allocates payments?

Byron R. White:

Yes.

Alan I. Horowitz:

No, there are various revenue procedures about how the IRS allocates this money first.

Now, the only purpose of the designation is to give an advantage to the responsible officers of the corporation.

The idea is so that the partial payments that have been made, if the plan ends up failing and all the payments are not made, will be used so as to minimize those officers’ personal liability under Section 6672.

It makes no difference to the debtor, and no direct difference to the other creditors, how these payments are designated.

Alan I. Horowitz:

The other party that cares about it is the IRS, because what the designation does is it thwarts the government’s goal of ensuring collection… of maximizing the collection of all of its taxes.

William H. Rehnquist:

The plan is silent on this point, I take it, as to how the IRS is to apply the payments?

Alan I. Horowitz:

No.

There is a provision in the plan that the IRS has to apply it to the trust fund taxes.

That is what the government is objecting to, the bankruptcy court’s power to include such a provision in the plan.

William H. Rehnquist:

In both cases, then, there is a provision… the plan specifies how the payments are to be made?

Alan I. Horowitz:

I believe so.

Well, I’m sorry, what do you mean by how, how the payments would be applied–

William H. Rehnquist:

Well, how the payments will be applied by the IRS.

Alan I. Horowitz:

–There is a court order, I think it’s incorporated in the plan in at least one case–

Antonin Scalia:

I think it is in one and not in the other.

That’s my–

–They just went to court for the order, but–

–Well, what… what if the debtor here, if they simply, without any approval of the bankruptcy court other than the plan, it simply made this payment and said I want it applied to the trust fund liabilities?

Alan I. Horowitz:

–Well, at what stage do… you mean before he went into bankruptcy?

Antonin Scalia:

No, no.

Right now.

At the point he made this payment.

Alan I. Horowitz:

Well, I don’t know.

If it’s before the confirmation of the plan, then he is not subject to a court order requiring him to make that payment.

He is also, I am not sure he would be paying the taxes at that point until a plan had been confirmed, because the other creditors would be negotiating about it.

So I am not sure how that would come up.

I think the IRS… if it was… if they weren’t already in Chapter 11, I think the IRS’ view would be that it would, the IRS would have the power to allocate those payments.

And if you want to do that as a voluntary payment at that stage, then the IRS would probably say well just wait until the plan is confirmed.

But once they… when the debtor goes into Chapter 11 there is an automatic stay that goes into effect invoking the protection of the bankruptcy court holding off all the creditors, holding them at bay with the powers of the court.

But at the same time they have to give up certain rights.

And one of the rights they are giving up is… they are required to abide by a plan that requires full payment of all these priority taxes.

There is no discretion left to the debtor at that point as far as paying the taxes.

Antonin Scalia:

Is it before the bankruptcy either.

Did they have the discretion to pay or not to pay their taxes before they went bankrupt?

Alan I. Horowitz:

They were… they were under a legal obligation to pay, but they weren’t subject to a court order.

And the IRS has taken the view, as I said before, to encourage people to pay without having to go to court or to seize their assets.

We are going to allow them to designate at that point.

John Paul Stevens:

And in fact they had a duty, I suppose, to pay the trust fund obligation first.

If they didn’t have enough money to pay both the general obligation and the trust fund obligation, their duty would have been to pay the trust fund obligation first–

Alan I. Horowitz:

That is correct.

John Paul Stevens:

–the day before bankruptcy.

Alan I. Horowitz:

That is correct.

There never should have been a trust fund liability–

John Paul Stevens:

And that of course is just for the benefit of the officers of the corporation in a sense.

Alan I. Horowitz:

–That would benefit, well–

John Paul Stevens:

It’s the same, the same mix of allocation of risks as you have the day after the bankruptcy.

Alan I. Horowitz:

–Well, but the difference is, if… you are suggesting that there is no trust fund liability in the bankruptcy at all–

Byron R. White:

No, no, no.

I am saying… I am suggesting there is… if there is money there, that the duty is to discharge that obligation first, because it isn’t really a… it’s somebody else’s money, it’s the employees’ taxes that have to be paid.

Alan I. Horowitz:

–Well, if there is money there then it’s not part of the bankruptcy, and it is being paid before the bankruptcy, whether you want to say it’s technically or really, but it is being paid outside the bankruptcy.

So then at that point when you get into the bankruptcy the government is going to get the nontrust fund tax payments in short order.

So–

John Paul Stevens:

But you say the equities, or the priorities should suddenly change the day the bankruptcy petition is filed.

Alan I. Horowitz:

–It’s not a question of the priorities changing.

I mean, it’s just… at that point it’s just money that is being paid.

As I said, it’s just the satisfaction of a tax liability.

There is no longer a fund that belongs to the government.

And what is happening here is that the money is being applied for the specific purpose of getting the responsible officers off the hook.

John Paul Stevens:

Well, and for discharging a tax obligation of all the former employees, too.

Alan I. Horowitz:

Yes, but in a sense the tax obligation is being paid… is being guaranteed, shall I say, by the government, not by the responsible officers any more.

Anthony M. Kennedy:

But it is a policy of the government, is it not, to accelerate payments of the trust fund?

Your whole… you whole argument here is that this is a vital obligation that ought to be discharged, and that’s… whether or not there are any trust monies left, the policy still remains, and the bankruptcy court’s order accords with that policy.

Alan I. Horowitz:

I don’t think there is a policy, when you have two tax liabilities, that one has to be paid ahead of the other, because dollars are dollars to the IRS.

What there is a policy is that officers of the corporation are not supposed to borrow without permission the government’s money in order to run the corporation.

Alan I. Horowitz:

In order to enforce that policy there is a special provision of the Code, Section 6672, that is supposed to act as a very strong deterrent to having officers do that.

And it imposes a personal liability on them.

Now, hopefully–

Anthony M. Kennedy:

Yes, but the reason for that is so that the trust fund obligation is paid.

Alan I. Horowitz:

–Is paid on time, yes.

So that–

John Paul Stevens:

And is paid before a general corporate tax, if that is also due and owing.

If you have two to pay, you’ve got to pay the trust fund first.

That’s the whole purpose of this, isn’t it?

Alan I. Horowitz:

–Well, that is true, but again that is because… that’s not the corporation making a payment out of its own funds to the government.

That’s the corporation holding the government’s money in trust, and it’s supposed to turn it over to the government.

Antonin Scalia:

Whatever the reason, it gets the officers off the hook.

The corporation first has to satisfy–

Alan I. Horowitz:

If the officers turn over, if they turn over the trust fund to the government they are not on the hook in the first place.

But what has happened here is that the officers have ignored their statutory duty.

They have taken the money, spent it on the corporate liabilities, there is nothing left, the whole thing has been thrown into bankruptcy.

And now the government, having had all this money stolen from it basically, at least wants to be able to allocate the payments so as to protect the public fisc in a way to maximize the government’s ability to collect taxes.

Sandra Day O’Connor:

–Mr. Horowitz, do you think the government will be more likely to collect all its taxes if, by insisting on this policy, it has the effect of forcing the debtor into a Chapter 7 liquidation instead of Chapter 11?

Alan I. Horowitz:

The government’s policy does not force debtors into Chapter 7 liquidation.

Sandra Day O’Connor:

Well, it could.

I mean, the argument of the other side, of course, is that the ability of the bankrupt estate to be reorganized and carry on as an ongoing business may turn in part on the agreement of how these taxes are to be allocated.

And if that is the case, and if the government declines to go along with that and thereby causes the reorganization to fail, is the government going to be more likely to collect all its taxes?

Alan I. Horowitz:

Well, I disagree with the premise of your question, Justice O’Connor.

The government is never going to be forced… the government’s designation is never going to force the debtor into liquidation.

It has nothing to do with the debtor.

It is no difference to the debtor how the IRS applies these payments.

It is no difference to the other creditors.

The only thing that the court of appeals seized on here was the notion that the responsible officers would try to negotiate their personal liability away by threatening to do various things to the debtor, maybe to force it into liquidation, if the IRS doesn’t… if they are not able to get what is basically a personal accommodation from the IRS in discharging their liability.

Now that is not the IRS’ fault.

That is the responsible officers fault.

Alan I. Horowitz:

And I would say a few things about that.

One, we really think it is very inappropriate for the bankruptcy court to kind of become an accomplice in this scheme where the responsible officers take the government’s money and then threaten the vitality of the reorganization in order to get out from under their liability.

Secondly, the idea of Chapter 11 is that there, is to give the corporation a chance to keep going as a going concern.

And there is no indication at all anywhere in the Code and the legislative history that Congress thought it was necessary to bribe the officers, to somehow entice the officers into cooperating with this endeavor.

They are the officers of the corporation; they are trying to keep their corporation going.

Byron R. White:

Mr. Horowitz, before bank ruptcy, the trust fund was dissipated before bankruptcy, I take it.

Alan I. Horowitz:

Either before bankruptcy or before anyone could get at it after the bankruptcy.

Byron R. White:

And so the officers… it seems to me the officers’ obligation matured right then.

They should have paid and they didn’t.

Alan I. Horowitz:

They should have paid even before that, probably.

Byron R. White:

Yes.

All right, well, why shouldn’t the, why shouldn’t you be able to just sue them now, outside the bankruptcy?

Alan I. Horowitz:

Well, we can sue them now, but–

Byron R. White:

And why shouldn’t the… is there a trustee in this case, or these cases?

Alan I. Horowitz:

–There is a trustee in at least one of the cases there is a trustee.

Byron R. White:

I would think the debtor could collect from the officers the trust fund that was dissipated, or at least they owe somebody, the officers, they dissipated the trust fund, they should owe somebody right now.

Alan I. Horowitz:

Well, I don’t know if the debtor has an action against the officers or not, but the problem with the IRS going after the officers directly is that the officers can string out the litigation for quite a while by posting a bond, litigating it, et cetera, et cetera.

It will take a while for the government to collect from the officers.

During this time in which they are trying to collect from the officers, the payments out of the organization plan will be being applied to the corporation’s liability under provision of the plan and reducing the officers separate liability.

So it is not necessarily a useful remedy for the IRS to go after the officers.

Second of all, it is completely counterproductive to what the court of appeals thought it was doing, if the IRS is going to run out… is going to be induced by this to run out and go after the officers immediately, that is not going to help the reorganization at all–

Anthony M. Kennedy:

Suppose you had a reorganization and the officers said we are willing to make this company run, but we want to make sure that our trust fund obligation is discharged first by the corporation.

Could the IRS say well, in looking at all the circumstances we agree?

Alan I. Horowitz:

–The IRS could agree, yes.

This case is about whether the IRS can be forced to agree.

I say no.

I would like to reserve–

Antonin Scalia:

Mr. Horowitz, before you stop, what do you say… you started to talk about Chapter 11.

You say there is no provision in there that lets the court do this.

What do you do with Section 1123(b)(5), which says that the plan may include any other appropriate provision not inconsistent with the applicable provisions of this title?

Alan I. Horowitz:

–Well, it’s our position that–

Antonin Scalia:

So the issue is just whether this is appropriate?

Alan I. Horowitz:

–That is right.

Whether it is appropriate, and whether it is inconsistent with other provisions of this title.

Antonin Scalia:

Of this title.

Alan I. Horowitz:

Yes, of this title.

Antonin Scalia:

You assert it’s inconsistent with the–

Alan I. Horowitz:

Well, there is also… well, we think it is at least somewhat inconsistent with the general idea in Chapter 11, which is specifically embodied, I think, in Section 1123(a)(4), which is that the court is not to distinguish among claims that have the same priorities.

So we do think there are some inconsistencies with this title and with, of course, the main provision that requires the IRS to be paid all its priority taxes.

I would like to reserve the remainder of my time.

William H. Rehnquist:

–Very well, Mr. Horowitz.

Mr. Moss.

Guy B. Moss:

Mr. Chief Justice, and may it please the Court:

Where we seem to disagree is whether the payments made under a confirmed plan are voluntary, and the consequences if they are not.

I think if there is one word that is going to become the key to the decision here it will be control.

It is not a perfect word, but it is a good word for this case.

We suggest that the tax payments under a plan are voluntary because the debtor taxpayer controls the use of the funds.

And we say if that is not the conclusion that this Court chooses to reach, then control must be in the bankruptcy court, and as a result the court has the power to designate the allocation of the taxes paid.

Let me start with a test that occupied the bulk of Mr. Horowitz’s time, and suggest an example that we can discuss.

A simple $100,000 tax debt existing on the eve of bankruptcy.

Of that, $60,000 constitute so-called trust fund taxes and $40,000 anything else: income, excise, matching FICA, what have you.

Now, take the day before the bankruptcy filing.

The taxpayer is in hopeless financial trouble, is insolvent.

The IRS may have sent out notices, demands, revenue agents, is all over the company.

The risk upon default is levy, seizure.

And the corporation, a day or two before the bankruptcy sends a check, let’s make it a certified teller’s check, to the IRS and pays the $60,000 in trust fund taxes, thereby helping the responsible officers.

No issue here.

IRS says that is fine.

And whether or not anyone is blameworthy, whether or not the IRS position is impaired and it is stuck with the nontrust fund taxes, that is fine.

It reflects the common law.

Guy B. Moss:

We don’t have a case.

Now let’s take the case–

John Paul Stevens:

Yes, but in that case may not the trustee claim that is a preference?

Guy B. Moss:

–The trustee may, and I realize that is a case working its way up to this Court.

John Paul Stevens:

It is here.

[Laughter]

Guy B. Moss:

Depending… and not decided yet.

I don’t think that is relevant to this issue.

It may or may not be a preference and usually will not be, because the test for a preference requires that the party receiving it do better than it would upon bankruptcy.

And because the taxes are priority, it is relatively rare that the IRS receiving a prepayment sum would be in that position.

Usually there are enough free funds to go beyond the priorities, and that is why the usual preference issue concerns payments to unsecured creditors.

Now, let’s take the situation we have.

After the plan is confirmed, and we are in that situation right now with these two cases.

The taxpayer is now rehabilitated.

The plan has been confirmed by a bankruptcy court.

The plan has been found feasible.

The flexibility that Congress gave to the debtor to stretch out tax payments over six years from date of assessment has been utilized by the debtor.

It won’t happen in every case, but it did here.

The IRS is owed an undisputed sum.

The IRS has not sent out any notices or demands, because it is now passively awaiting the payment of the taxes under the plan.

The same risk of default exists as was the case before.

And the corporation sends out the same check, although it is not likely it will be certified this time, to the Service and pays the installment that is due under the plan.

Now, I suggest there is little if any difference in that scenario from the pre-bankruptcy, except that it is better.

And yet under… it is better in the sense that the debtor is more in control of its situation.

It has made its peace with its creditors.

The plan has been confirmed, et cetera, et cetera.

But this time when the IRS gets that check in the mail somebody says wait a minute, it’s involuntary.

Send it back because our policy, our interpretation of the common law says we don’t accept them when a letter accompanies the check, as it did, allocating the payment to the trust fund section of the taxes.

So the irony is that at a time the taxpayer has wider latitude than it did before, the government has a harsher position, and this fight ensues.

Antonin Scalia:

The tax law is full of irony, Mr. Moss.

Antonin Scalia:

Why… what’s the matter with this one?

Why… the IRS says it has this policy, voluntary versus nonvoluntary and that what makes the difference is whether there has been a court proceeding and whether the payment is under court order or not.

It’s a line, it’s certainly a clear line at least.

Guy B. Moss:

I think the irony lies simply in examining the government’s response along the continuum of the common law situation, at least as we view it.

When things are at their harshest and most out of control there is no issue between the parties, and when things are calmest and most in control and a reorganization has been structured, that probably maximizes the likelihood that the entire creditor body will do better than it did before, we wind up in this controversy.

Antonin Scalia:

Suppose that the IRS is taking the position… let’s assume they are… we don’t have to treat anything the way you want and let you designate, that in fact we are the government.

And any money we get that you owe the government, we can attribute it to what we like.

Is there anything wrong in principle with beginning from that standpoint and then saying out of the goodness of our heart… or really, not for that reason, but in order to prevent litigation… we are going to adopt the rule nonetheless, even though we have the power to treat it all the way we want, we won’t treat it the way we want if you haven’t made us go to court.

That makes sense.

Guy B. Moss:

I think the best response I can offer to that is the standard phrase it’s a country of laws and not men.

The Internal Revenue Service is but one creditor.

It has an important function for the country, which is to raise revenue.

But it doesn’t act in a vacuum.

And the many, many provisions of Chapter 11 that affect the rights of creditors as they have them pre-bankruptcy suggest that, for the purpose of fostering reorganization, what a particular creditor would like to do in a context of nonbankruptcy it cannot do in a context of bankruptcy, and Congress says that it should not do.

I view this case as really an extension of that.

Look at the various sections that go to that observation.

Preferences.

Perfectly lawful payments that are made pre-bankruptcy have to be disgorged for equitable reasons.

Rejection of executory contracts, which this Court dealt with in Bildisco.

Perfectly lawful contracts that are terminated and made into pre-bankruptcy damage claims.

Limitations on the damage claims from contract rejection.

Section 502 artificially set limitations that would not exist under state or federal law that applies.

Tax claims themselves are not all priorities, even though revenue collection is certainly a policy that we all feel is extremely important.

Some taxes are nonpriority, and those nonpriority taxes would be treated the same as all the general unsecured creditors.

And in a straight bankruptcy if the assets were not sufficient, those unsecured tax claims, or, I should say those nonpriority tax claims, would not even be paid.

Penalties are subordinated under Section 726, IRS penalties.

In your Whiting Pools case, under Section 543, seized property might have to be disgorged to assist the reorganization effort.

And the very provision that gave rise to this dispute, tax claims may be paid over six years, under Section 1129(a)(9).

Now Congress, I think, put that in to facilitate cash flow problems that would face a reorganizing debtor.

But when it did so, the IRS was put at the mercy that, at some point as those six years evolved, the debtor might not survive and might not be able to make the payments.

Guy B. Moss:

In between these two periods that I mentioned, the pre-bankruptcy day before when the check is paid, and the post-bankruptcy day after when the check is paid, let’s look at what the government suggests is so important here.

Indeed, I think that one might even question how relevant any of it is, because in light of our emphasis upon control, what we think is fairly significant is that on the day that those post-confirmations are being… payments are being made, the debtor has received the benefit of Section 1141, the assets have revested in the debtor, all creditors abound by the plan, and with full control over and custody of the funds, the taxpayer makes the payments.

But it is true that the cases have focussed upon, to some measure, what takes place during the course of the Chapter 11.

So, notwithstanding my suggestion that it may or may not be terribly relevant, let’s look at the arguments.

The debtor says… I am sorry, the government says the debtor lacks options.

But as, I think, Justice Scalia pointed out, the debtor always lacks options to pay involuntary taxes.

That is, taxes are involuntary in that the law says they arise under certain circumstances.

But yet the debtor is afforded more options in a Chapter 11 than it had before, because it is given the six-year provision and it is given the hiatus period to work out of its troubles.

The government says the tax is a priority.

William H. Rehnquist:

But the debtor is somewhat different.

There is… if you consider the plan a court order, the debtor is under a court order to pay taxes every so often, is it not?

Guy B. Moss:

It is not.

The government made that argument in its brief, and it made it to suggest that there is some type of judicial activity taking place here that is of the nature of involuntariness, like the court approving a seizure or a levy or something of that.

I suggest that when we look at the applicable statute, which I think is Section 1129 of the Bankruptcy Code, the one that sets the standards for when a plan may be confirmed.

What that statute says is that the court shall confirm a plan that meets the following requirements.

Now there are, I think, 11 requirements.

Some are relatively unimportant and some are very important.

The two that probably are germane to this case are 1129(a)(9), that says the plan shall provide for full payment of priority taxes, but may do so over the course of six years with interest, and the Section, I think, 1129(a)(11), that says the plan shall be feasible, or the exact language is not likely to… the corporation is not likely to run into the immediate need of bankruptcy relief again.

There is no court order in the sense that the court says thou shalt do X, Y or Z.

The court says that the standards of 1129 have been met and the plan may be confirmed.

And then you go to Section 1141 that says that when a plan has been confirmed, all creditors are bound by it.

William H. Rehnquist:

Let’s break it down a minute, Mr. Moss.

Take, for example, the plans that were confirmed in this case.

What specifically did they say with respect to the payment of taxes to the IRS?

Guy B. Moss:

Both plans provided that the priority tax payments would be paid over a period of time with interest.

One plan–

William H. Rehnquist:

Did they say anything about–

Guy B. Moss:

–One plan may have used four years, one six years.

William H. Rehnquist:

–Did they specify dates of payment?

Guy B. Moss:

Yes.

Guy B. Moss:

You must, and indeed the government objected to the Energy Resources–

William H. Rehnquist:

Okay, but I’m not mentioning the government’s objection right now.

Now, is there any penalty or sanction that attaches to the debtor in this case if it fails to make its tax payments, other than simply having an overdue debt?

Guy B. Moss:

–The penalty that attaches is the penalty that existed before the Chapter 11.

The debtor… Section 1141, and this is backing into your question with a statutory observation–

William H. Rehnquist:

You’ve been backing in quite a bit.

Let me ask you a more specific question, if I may.

Guy B. Moss:

–Okay.

The penalty… I am prepared to answer it.

William H. Rehnquist:

Could the IRS apply to the bankruptcy court for an order requiring the debtor to pay according to the plan?

Guy B. Moss:

That depends on whether or not the bankruptcy court still has retained jurisdiction over the case.

William H. Rehnquist:

Well, what is the typical situation?

Guy B. Moss:

The answer–

William H. Rehnquist:

What is the typical situation?

Guy B. Moss:

–The typical situation, I am not sure there is one.

William H. Rehnquist:

Well, what was the situation in these cases?

Guy B. Moss:

The area of retained jurisdiction is an area that counsel will often focus upon carefully.

Sometimes a creditors committee will negotiate.

The creditors committee is not a committee that worries about the Service, but it will sometimes negotiate for retained jurisdiction to watch over the plan, and sometimes will not.

So in some cases the bankruptcy court loses jurisdiction over the case before these tax payments are completed, and in other cases, depending upon whether the provision is in the plan, the court will keep it.

William H. Rehnquist:

Now, in those cases where the court has retained jurisdiction, could the IRS go to the court and say there is a payment due here that was not made, you tell the debtor to make it?

Guy B. Moss:

I believe that that is possible for it to do.

William H. Rehnquist:

That would be at least a different situation than the pre-bankruptcy.

Guy B. Moss:

Well, it may and may not, because I think more typically what the Service would do is invoke its levy and seizure procedures.

William H. Rehnquist:

Well, but supposing the Service chooses to do it this way.

That would be different from pre-bankruptcy, would it not?

Guy B. Moss:

But in pre-bankruptcy I see no reason that a, the Internal Revenue Service could not go to a court of competent jurisdiction and ask for the same type of order.

William H. Rehnquist:

To order a taxpayer to pay?

What sort of a suit would that be?

Guy B. Moss:

Because money is owed.

Guy B. Moss:

It would be a collection suit.

The IRS is unlikely to do it because its powers are vast, and I think we all know that.

So that rather than go to the court like a typical plaintiff, it has the ability more than any other creditor in this country to take unitary action and seize assets after, I believe, assessments are made.

It could do that pre-bankruptcy, it could do that post-confirmation.

The only time it can’t do it is when the debtor is under court control, and that is during the Chapter 11 period, prior to confirmation of the plan.

The government also cites that because a claim was filed there is some significance that transfers this from a controlled payment to an uncontrolled payment.

As Mr. Horowitz argued common sense, I might also.

Firstly, in a Chapter 11, under Section 1111(a), a proof of claim need not even be filed if there is no dispute over the debt.

A debtor is obligated to file schedules.

They are done under oath, and they state what the indebtedness is to each creditor it has.

If the Service looked at those schedules and agreed, its failure to file a proof of claim would not cause it any harm.

The claim is deemed proved, allowed, and must be dealt with under the plan.

All the proof of claim is is one piece of paper that has a signature and an amount of money on it.

It may be important when it is due, but the fact of the matter is it isn’t much.

And in the–

Byron R. White:

That’s if it isn’t scheduled.

Guy B. Moss:

–It’s quite important to the creditor, without question, but I don’t think that this one piece of paper should be the touchstone between the court determining that this is a controlled or voluntary payment within the meaning of the common law–

Byron R. White:

Could you… could you tell me, Mr. Moss, did the bankruptcy court indicate any reason for agreeing with the request to allocate these payments first to the trust fund taxes?

Guy B. Moss:

–Yes, in both–

Byron R. White:

And maybe another question is why did the debtor request it this way?

Guy B. Moss:

–Well, as to the first question, I believe that the decisions in both cases and the record do suggest that the court took into account reasons for doing this.

Byron R. White:

What are they?

Guy B. Moss:

In the case of Newport, this was a plan funded by a third party.

An entity not before the court ended up with 85 percent of the stock.

And there were a variety of tradeoffs that were entered into at the time that the plan was structured.

The responsible officers had a wide variety of claims, unsecured and secured, and as part of this array of tradeoffs, they were put into a separate class.

They waived the secured claim.

They reduced, I believe, the unsecured claim.

And they, I believe, bargained for this tax designation provision as part of it.

They also–

Byron R. White:

Because that provision would reduce their… would reduce their exposure.

Guy B. Moss:

–Yes.

Yes.

There is no question that such a provision reduces the exposure of the responsible officers to the extent that the corporate tax payments over time are not made.

Byron R. White:

And so those are… that’s really the reason in both of these cases that the debtor wants to have the tax payments applied in this way.

Guy B. Moss:

Well, the debtor recognized, and it is worth noting that counsel for the debtor, by the way, is not counsel for the responsible officers, or you would never be appointed to that position at the start of the Chapter 11.

Byron R. White:

Yes.

Guy B. Moss:

Chapter 11 is an endless process of negotiation, and there are reasons, as Justice O’Connor pointed out, one, why these tradeoffs are requested.

One which she noted was that you need an inducement, and it makes sense to have that inducement to the people controlling the corporation not to tank the company.

So that in a Chapter 7 the priority taxes will be paid off the top first.

And interestingly enough, they run a risk by not doing so and by moving forward with a reorganization plan.

Byron R. White:

But I take it it’s really immaterial to the debtor, I suppose, how these payments are–

Guy B. Moss:

No, it’s… the government took the position that it is immaterial to creditors, and your question, which I would like to answer with that observation, says is it immaterial to the debtor.

You have an almost endless variety of things that can occur in a Chapter 11.

It doesn’t follow.

For example, the responsible officers quite often will own the company at the commencement of the case.

Not always, because sometimes they are not the equity holders and sometimes they are fired.

And certainly, as equity holders, they often will strive to own the company at the end of the case.

Now, in doing so, that means that in those types of cases when it is reorganized they are still running it, and they own it.

And it would certainly be an odd kettle of fish to find that, after doing that and possibly making financial contributions to the plan, the Service is then pursuing them on the trust fund taxes and possibly levying upon their stock, which is their basis for owning the company.

Byron R. White:

–Well, after all, these taxes were deducted from peoples’ paychecks, weren’t they?

Guy B. Moss:

Yes.

Byron R. White:

And they were used before bankruptcy in a way that they shouldn’t have been used for.

Guy B. Moss:

That is correct, but in one sense that question asks if–

Byron R. White:

I would think… I would think other creditors would have, would want to go after the officers rather than share the income of the company with… with the government.

Guy B. Moss:

–There is no basis for going after the officers.

The primary party obligated to the tax creditor is the corporation.

And when the unsecured creditors negotiate with the debtor and look at everything going on to try to formulate the best possible result here, they take into account that the debtor must pay these taxes.

The responsible officer is simply liable to the government under a penalty assessment–

Byron R. White:

Well, then if the government could have sued the… the Chapter 11 proceeding doesn’t interfere with the government’s right to sue the–

Guy B. Moss:

–Not at all.

Byron R. White:

–the officers immediately.

Guy B. Moss:

Not at all, and that is precisely why, in the balancing of policies that we have argued in the brief, the tax policy, however quite important, we suggest is either not materially impaired, or at least is taken into account in other ways.

William H. Rehnquist:

Do you say there is no liability from the officers to the debtor for their having misappropriated the trust funds?

Guy B. Moss:

That’s correct.

I am not aware of any liability for that purpose.

Usually the trust fund payments simply never existed.

That is not to take away the blame, and we are not here to praise any creditor, or any debtor rather, who does not pay his creditor.

The reality is–

Harry A. Blackmun:

Have you given us–

Guy B. Moss:

–the taxes simply… net payroll was made.

Harry A. Blackmun:

–Mr. Moss, have you given us a specific reason why the officers should be taken off the hook?

Guy B. Moss:

I am not asking that they be taken off the hook.

The Section 6672 liability remains.

Both parties have cited, I think, the same cases in the brief.

Ours, if I recall, was Huckabee Auto saying that 6672 is an independent source of collection for the government, and that it is inappropriate, indeed impermissible, for the bankruptcy court to enjoin the Internal Revenue Service from pursuing those responsible officers.

The government could have pursued them pre-bankruptcy, during bankruptcy and after bankruptcy, as part of the policy, the federal policy toward tax collection.

What’s taking place here, I suggest, is a balancing of interests.

This Court recognized that–

Harry A. Blackmun:

Are you saying they are not taken off the hook?

Guy B. Moss:

–That is correct.

Harry A. Blackmun:

Their liability is eliminated to the extent the trust funds are used.

Guy B. Moss:

Well, it’s… I’m sorry, it’s a question of my being careful how I interpret your question.

At any given moment, to the extent the trust fund taxes are due, they are not taken off the hook.

But what is at issue in this case is whether they benefit from a payment that is allocated to the trust fund portion.

So, in my hypothetical, if the $60,000 of trust fund taxes out of $100,000 were to be paid over five years, say, then they would benefit as those payments ensue.

But they would also be subject to IRS attack also as those payments ensue, because it would probably take two to three years for those trust fund taxes to be paid in full.

Antonin Scalia:

What would happen if the IRS sued them immediately and got all the money from them?

What would happen with the money that was supposed to be paid to the government under the plan?

Wouldn’t that money go to them?

Antonin Scalia:

Wouldn’t they have a cause of action to be reimbursed by the corporation, or not?

Or we don’t know?

Guy B. Moss:

What… no, I… that has been an interesting debate in a number of law firms.

My view of what probably should happen is that from the corporate standpoint the taxes should be viewed as still due.

The government should receive those tax payments, which then gives them in effect a double payment.

They are not looking for a double payment, but that is the result.

And then, upon the existence of a double payment, the responsible officer can sue for a refund, thereby keeping the government paid in full and ultimately leaving the responsible officer in the position of a kind of surety, with the debtor primarily paying and the responsible officer secondarily liable.

Byron R. White:

That gets it out of the officers, and I would think the other creditors would want to have the plan revised, because it would enhance their ability to be paid in full if the government gets their taxes, their trust fund taxes out of the officers.

Guy B. Moss:

The creditors might want that, but it doesn’t mean that they… that they can have it.

Interestingly enough, those same creditors are often the ones who benefit by what the corporation did with the money–

Byron R. White:

Well can’t the creditors usually profit from the fact that a debtor has a surety, has a guarantor?

Guy B. Moss:

–No, not usually.

The guarantor is secondarily liable, and the debtor is forced to meet its primary responsibility.

In fact, while it is not the case here, for reasons that are set forth in the Code, in an unsecured, nontax situation, the guarantor, if he paid, would be subrogated to the position of the creditor, and the indebtedness would not go away.

William H. Rehnquist:

Thank you, Mr. Moss.

Guy B. Moss:

Thank you.

William H. Rehnquist:

Mr. Horowitz, you have two minutes remaining.

Alan I. Horowitz:

Thank you, Mr. Chief Justice.

I would like to make a couple points.

First of all, we completely disagree with the notion that the debtor is not under a court order to make these payments under the plan.

If he doesn’t pay, then the government can move to dismiss the plan for not… the Chapter 11 proceeding for non-compliance.

That is under Section 1112(b)(8) of the Code.

And if for some reason the court no longer has retained jurisdiction over the case, the case can be reopened in the event of noncompliance under Section 350 of the Code.

Antonin Scalia:

Well, excuse me, if you move to dismiss it for noncompliance, then you are back in the situation you were in pre-plan, I assume, right?

Alan I. Horowitz:

That is right.

Antonin Scalia:

You have the same legal remedies under the statute that you had.

Alan I. Horowitz:

Well, we would levy on them, and it would be an involuntary payment and we would apply it where we wanted.

Antonin Scalia:

It’s not a very useful court order.

You’re saying the penalty for not obeying the court order is the court order is eliminated.

Alan I. Horowitz:

And the protections against creditors are eliminated, which is the reason why the… don’t forget Chapter 11 is a proceeding that is invoked by the debtor to protect themselves against creditors, not one that the IRS commences in order to collect.

Alan I. Horowitz:

Second, as far as the question of whether this kind of order is appropriate, I would also like to point to Section 523 of the Code, which specifically does not allow a responsible officer to be discharged for a 6672 liability in his personal bankruptcy.

This designation provision here is nothing more than an attempt to use the corporation bankruptcy to discharge his 6672 liability.

As far as the ability of the IRS to go directly against the officers–

John Paul Stevens:

Well, that’s not quite right.

It’s not a discharge in the bankruptcy sense.

The liability is paid.

Alan I. Horowitz:

–I understand it’s not a discharge in the bankruptcy sense.

John Paul Stevens:

And it won’t be discharged if it’s not paid.

And normally when something is discharged in bankruptcy the debt is extinguished even though it is not paid.

Alan I. Horowitz:

Well, if all the taxes are paid, we have no complaint.

But the idea is to manipulate the corporate bankruptcy proceeding in such a way–

John Paul Stevens:

Then there is no need for a discharge.

The discharge term doesn’t even arise if they are paid.

Alan I. Horowitz:

–I just direct the Court’s attention to the footnote on page 3 of our reply brief, the petition stage, which discusses the practical problems with going against the officers first.

John Paul Stevens:

Let me ask… may I ask you one hypothetical?

Supposing the court order directed management to pay $100,000 in taxes for six years to get rid of all of these obligations, and gave management discretion as to which ones to apply to the trust fund obligations and which not.

Voluntary or involuntary?

Alan I. Horowitz:

Well, if you’re talking about the IRS’ policy, we would not permit that designation.

We would view that as under the involuntary.

William H. Rehnquist:

Thank you, Mr. Horowitz.

The case is submitted.