United States v. Noland

PETITIONER: United States
LOCATION: Eastern District Court of Michigan

DOCKET NO.: 95-323
DECIDED BY: Rehnquist Court (1986-2005)
LOWER COURT: United States Court of Appeals for the Sixth Circuit

CITATION: 517 US 535 (1996)
ARGUED: Mar 25, 1996
DECIDED: May 13, 1996

Kent L. Jones - Argued the cause for the petitioner
Raymond J. Pikna - Argued the cause for the respondent

Facts of the case

The IRS filed claims in Bankruptcy Court for taxes, interest, and penalties that accrued when Thomas R. Noland, the trustee of the in-debt First Truck Lines, Inc., sought relief under federal Bankruptcy Code. The Bankruptcy Court held that the claims for taxes and interest were the first priority in the case. Consequently, the court subordinated the penalties, to be adjudicated following the taxes and interest, because the penalties were not financial losses for the IRS. The Court of Appeals affirmed the decision.


May a bankruptcy court subordinate government attempts to collect tax penalties?

Media for United States v. Noland

Audio Transcription for Oral Argument - March 25, 1996 in United States v. Noland

William H. Rehnquist:

We'll hear argument first this morning in Number 95-323, United States v. Thomas R. Noland.

Mr. Jones.

Kent L. Jones:

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

This case involves the detailed statutory priorities that Congress has enacted to govern the payment of claims in bankruptcy cases.

Section 503(b)(1)(C) of the Bankruptcy Code provides that postpetition tax penalty claims are to be treated as administrative expenses of the debtor's estate with a first priority in payment.

The statute codifies this Court's 1966 decision in Nicholas v. United States, which reached precisely the same conclusion under prior law.

In this case, however, the court of appeals stated that it did not see the fairness or the justice of the first priority for postpetition tax penalty claims.

The court stated that it would be more fair and more just for general commercial creditors to be paid in advance of tax petition claims and therefore reverse the statutory priorities, changing the priority for postpetition tax penalty claims from first to last.

The court stated that its restructuring of the statutory priorities was justified by the principles of equitable subordination that Congress codified in 1978 as section 510(c) of the Bankruptcy Code, but the principles of equitable subordination do not confer such a broad power of statutory nullification on bankruptcy courts.

The principles of equitable subordination were designed to provide a remedy for the individual misconduct of a creditor in acquiring or pursuing his claim.

As this Court stated in the Comstock case, the doctrine deprives the wrongdoer of the fruits of his wrong.

Prior to the enactment of the Bankruptcy Code, the courts have consistently held that in the absence of creditor misconduct, courts were not permitted under the principles of equitable subordination to simply disregard a statutory priority that they disagreed with.

They were not permitted to say, as the court said in this case, that the statutory priority is a mistake and will not be enforced.

The court of appeals recognized in this case that under the traditional judge made principles of equitable subordination, that doctrine served the limited function of providing a guarantee against creditor misconduct, but the court reasoned that when Congress codified these principles in 1978, Congress somehow radically altered the scope of the doctrine, and that it is now appropriate for the court to disregard a statutory priority when the court concludes that it is just to do so.

Sandra Day O'Connor:

Mr. Jones, do you agree that a tax penalty claim in theory could be subordinated if there were some sufficient reason for finding fault with the Government... misconduct?

Kent L. Jones:

I agree that the principles of equitable subordination can apply to all claims.

Our understanding of those principles and the understanding that this Court stated in the Comstock case and that all other courts had stated prior to the enactment of the Bankruptcy Code was that what those principles did was to prevent a creditor from acquiring or pursuing a claim based upon misconduct.

The legislative history of the Bankruptcy Code states, but we think it is obvious, that these principles of equitable subordination would rarely apply to a tax claim, but if--

Sandra Day O'Connor:

Yes, but I took your position basically to be that in a particular case, no equitable subordination absent a showing of inequitable conduct.

Kent L. Jones:

--That is correct.

That is what the doctrine is designed--

Sandra Day O'Connor:

And in theory the Government could engage in such conduct.

Kent L. Jones:

--In theory, it could.

Again, I think it would be rare that we could think of a situation where that would happen, and the Senate report on this bill made that very point, but certainly, if the United States acquired a claim through misconduct, it would be subject to equitable subordination.

David H. Souter:

Of course, those of us who look to legislative history have got one problem from your standpoint, and that is, it may be that the person who made the statement about the intent was wrong in describing what courts had been doing, but the intent still seems to be there, and what is the tie breaker?

Do we look to the person's mistake, or to the person's intent in making the statement?

Kent L. Jones:

Well, let me... that is... the court of appeals relied on what you're referring to, which is a fragment of a single sentence of the floor statements of the sponsors of the bill, but let's consider that statement in its context.

The sponsors made several points.

First, they pointed out that the principles of equitable subordination that were being codified were those expressed in existing case law, and certainly that represents an intent to incorporate, not to significantly alter the preexisting doctrine.

Second, the sponsors stated that under existing case law, the principles of equitable subordination served as a remedy for creditor misconduct much in the same way that this court had said in the Comstock case.