United States v. Randall

PETITIONER:United States
RESPONDENT:Randall
LOCATION:Duke Power Company’s Dan River Stream Station

DOCKET NO.: 125
DECIDED BY: Burger Court (1970-1971)
LOWER COURT: United States Court of Appeals for the Seventh Circuit

CITATION: 401 US 513 (1971)
ARGUED: Feb 22, 1971
DECIDED: Mar 24, 1971

Facts of the case

Question

Audio Transcription for Oral Argument – February 22, 1971 in United States v. Randall

Warren E. Burger:

We’ll hear arguments next in United States against Randall, number 125.

Richard B. Stone:

Mr. Chief Justice and may it please the Court.

This case which is here on a writ of certiorari to the United States Court of Appeals for the Seventh Circuit raises a fundamental question as to the legal status of taxes which an employer withholds from the wages of his employees and specifically the case raises the proper treatment of those withheld funds in the event that the employer becomes bankrupt or in is to a Bankruptcy Procedure.

The facts of the case are relatively simple.

Halo Metal Products, Inc. filed a petition for an arrangement under Chapter 11 of the Bankruptcy Act and that is the provision which allows operation of the business to try to stow up the Bankruptcy.

It was allowed by the referee of the Bankruptcy Court to remain in possession of the business and to carry on the business’ operation subject to the referee supervision during the Chapter XI arrangement.

As is the custom in such an arrangement, the referee entered in elaborate order requiring the debtor in possession to file periodic reports and to maintain full records of its operations during the arrangement period.

And in addition, the referee ordered the debtor to open up three bank accounts.

First of these accounts was to receive all revenues, received by the business during the operation in the arrangement period.

And the second account was to receive periodically from the funds deposited in the first revenues account the amount necessary to pay all employee wages and disbursements from this payroll account were to be made at proper intervals with the approval of the referee.

The referee ordered that simultaneously with meeting the debtor in possession’s payroll obligations that the debtor deposit into a third special account the amount of tax and social security deductions that the debtor was required to withhold from his employee’s wages and withdrawals from this third account were to be allowed only for payment of withheld taxes and welfare benefits as those payments became due to United States Government.

The debtor failed almost entirely to comply with the referee’s orders with the orders of the Bankruptcy Court with respect to this withheld taxes.

Although the income in social security taxes were withheld from the employee wages, the withheld funds were not placed in the special account nor would they pay over the United States at the proper time as required by the arrangement court.

During the arrangement, the United Stats filed the proof of claim for payment of a thousand and seventy-five dollars that is $1,075 of FICA in income taxes withheld from employees salaries on the ground that this amount was a special trust for the United States benefit under Section 7501 (a) of the Internal Revenue Code of 1954 and about the Section, I shall elaborate shortly.

Subsequently, about three months after the filing of the original arrangement petition, Halo was adjudicated a bankrupt.

In a month later on December 22, 1967, the United States filed the petition in the Bankruptcy Proceeding asking that the withheld taxes at which it claim as the Trust Fund under Section 7501 be paid over to the United States just as any Trust Fund would be paid over prior to payment of the cost and expenses of administration of the Bankruptcy Proceeding and the referee denied the Government’s petition, the District Court and the COurt of Appeals upheld the referee’s denial of the petition and it is that which we are here on the writ of certiorari to contest now.

Both of these courts held essentially that Halo’s obligation to pay over to the Government the taxes withheld from employee wages was merely an administrative expense of the bankrupt estate and was thereby subject to the scale of priorities established by Section 64 of the Bankruptcy Act with which I am sure this Court is quite familiar.

And I think it would be helpful to view the issue presented here which is whether the Government is entitled to recognition of a trust fund for the amount of taxes withheld from the salaries of the bankrupt’s employees during the arrangement period.

As breaking down essentially into two parts, two questions.

The first question is and this is as really the question is construed by the Court of Appeals whether the trust fund concept is simply inapplicable altogether as both courts below seemed to have felt in a Bankruptcy Proceeding.

And the second question which neither court reached but which I believe was the focus of the bankruptcy referee’s decision is whether assuming that the trust does not disappear merely by virtue of the withholding employer’s bankruptcy.

Whether the trust is nonetheless defeated or enjoinment of the trust is defeated by virtue of the Government’s inability to trace the race of the trust and I will address myself to both of these questions.

Potter Stewart:

Does the Government in this case really is not a matter of priorities at all?

Richard B. Stone:

That’s right Mr. Justice Stewart, it’s not.

Potter Stewart:

And by contrast, the way the Court looks at it, that’s all it was?

Richard B. Stone:

That’s right.

Potter Stewart:

And priorities.

Richard B. Stone:

That’s exactly right and prior to several years ago, I believe in 1965 when the Third Circuit decided the Connecticut Motor Lines case, every court that had looked into this and all the commentators as I shall shortly view the question as not one of priorities but simply the recognition of a trust and not a matter of relative priorities.

I think it’s —

Potter Stewart:

I think the question becomes to the trust to be —

Richard B. Stone:

Yes, is it —

Potter Stewart:

It is here because they raise —

Richard B. Stone:

Exactly, exactly that is precisely what I think is important to show and what we are really alarmed about in this decision is the fact that the Court of Appeals viewed these trust assets as debts and viewed this case as a matter of priorities between conflicting administrative expenses.

Now, —

Harry A. Blackmun:

Mr. Stone, on your theory the bankrupt estate is really enjoying the windfall if it prevails here is it not?

Richard B. Stone:

That’s right Mr. Justice Blackmun though it is hard to trace as I intend to discuss at length that is hard to trace precisely what happen to the funds one likely illogical assumption is that this trust fund has simply been added to the amount of assets available to the collection of the bankrupt’s creditors and therefore collection from those assets would be windfall to those creditors.

Harry A. Blackmun:

But the trust fund you’re talking about is in every case of this kind is a fund that arises from the bankrupt’s asset themselves, from the bankrupt’s own assets.

Richard B. Stone:

That’s right.

Harry A. Blackmun:

It’s just something that he paid wages but he wrote checks to his employees for an amount left than they’re — what they were —

Richard B. Stone:

That’s right.

Harry A. Blackmun:

— paid and so he just kept the rest.

Richard B. Stone:

That’s right and so —

Harry A. Blackmun:

And so there’s never been a transfer creation of the trust fund?

Richard B. Stone:

No, though it was ordered by the referee and it was ordered by the referee that the trustee make a transfer at the time he paid the wages.

Harry A. Blackmun:

He never did.

Richard B. Stone:

In fact, he never did.

Harry A. Blackmun:

He never did.

Richard B. Stone:

And one of the points which I plan to address myself to is whether the enjoyment of the trust ought to be defeated by the fact that the trustee never did make these deposits and so that all that we’re really talking about is whether a trust ought to be imposed on general assets of the bankrupt estate.

That is the question in this case as we view it.

But that is not the question as Court of Appeals viewed it and I think it is very important to see exactly how the Court of Appeals did identify this question and to make sure that what I consider the gross misconception on the Court of Appeals opinion be corrected.

Warren E. Burger:

But on your theory, this statute along with the order of the court impresses a constructive trust on the total receipts of the bankrupt and regards him as having done what he had been ordered to do, is that —

Richard B. Stone:

That’s exactly right.

It’s exactly right Mr. Chief Justice that is our theory.

And that is the theory of Professor Scott and that is the theory of all the courts which have directed themselves to this aspect of the case and the theory which these courts have gone on and ever since we’ve gotten into this, I might as well anticipate what I expected to be a later stage of the argument.

The theory that these courts have gone upon is that yes, in a situation where the raise of a trust cannot be traced where you are simply talking about general assets, it is you run a risks in either imposing the trust or disregarding the trust you run a risks that loss in the — that the actual proceeds have been lost in the accounting procedure, there is no record to say where the assets went and so that either the trustee, either the beneficiary of the trust or the general creditors may have suffered in some way.

Now, this seems to me the most likely assumption is that the estate has been fattened by the failure to pay over these funds at the designated time.

And though we want to protect the creditors with respect to the general assets, the estate has been the view of all the courts that have considered this.

That because of the fact that the referee, the debtor in possession is himself an officer of the bankruptcy court and because the debtor in possession is the person who buy his negligence failed to segregate these funds and failed to setup the trust for the benefit of the Government that we ought not to make the beneficiary of a trust suffer because of the negligence of an officer of the Bankruptcy Court.

We ought to give that a beneficiary the right to rely on the fact that an officer of the Bankruptcy Court is going to do what the Bankruptcy Court tells him to particularly when the Bankruptcy Court states in the order that it shall supervise all these operations on a weekly or monthly basis.

So that all have — all who have considered this question have felt that the equitable considerations which militate in favor of recognizing this right to rely on the Bankruptcy Court doing what it says its going to do should eliminate the requirement of tracing the raise of the trust.

Richard B. Stone:

But I want also to make clear is that this is not the ground.

This issue which I consider to be the crucial issue of the case is not the issue that the courts below went upon.

The courts below in my opinion fundamentally misconstrued the whole nature of withheld taxes and the interrelation of the bankruptcy Act with this trust fund.

Warren E. Burger:

Mr. Stone, let me test your argument with the hypothetical case.

Richard B. Stone:

Yes.

Warren E. Burger:

If I may.

Suppose the money had been indeed put in the segregated account and had build up to many thousands of dollars over a period of time and if the weekly check had been made and money was always there, then the officer of the company having control of the account suddenly withdrew it all of the segregated account, the tax — the trust account that you’re arguing about.

Withdrew all of it out in currents — got it in currency and flew to Argentina.

Then would you say that you could impress any trust — constructive trust on the other assets of the company?

Richard B. Stone:

That is a very different case from the one we’re facing Mr. Chief Justice, for it.

Warren E. Burger:

Oh!

Yes, I realize.

Richard B. Stone:

But — and I think that I’m not sure what the answer to that question is perhaps not but I don’t think that controls the instant case for the following reason.

Warren E. Burger:

No, what I’m driving at is, I was trying to setup a hypothesis where you could identify —

Richard B. Stone:

If you can identify the raise of this trust —

Warren E. Burger:

You can trace it all the way to — you can trace it all the way to Argentina now.

Richard B. Stone:

If you can identify the raise of this trust, I at the moment find no argument against the proposition that the general assets of the creditors of this company ought then to be subject of the Government’s tax claim.

I would not want to go on record is committing the Government to that position.

But it seems to me that if you can trace the raise of the trust then the Government ought to be required to go after trace of a raise and the person has clearly responsible for the ways of the raise of that trust.

William J. Brennan, Jr.:

Incidentally Mr. Stone, I gather the employees get credit for the amount–

Richard B. Stone:

That’s right.

William J. Brennan, Jr.:

— on the books indicated as withheld from the —

Richard B. Stone:

That’s right Mr. Justice Brennan, their liability with respect to those withheld funds is discharge that the time wages are paid and taxes withheld from those wages which we think identifies —

William J. Brennan, Jr.:

Without payment over by the employer.

Richard B. Stone:

That’s right there and similarly if any refund is owed.

If the employer although withholds it is the employee who has the —

William J. Brennan, Jr.:

Well, the point is that nothing in the way of the trust involved here for the employees.

Richard B. Stone:

No, it’s a trust for the Government.

William J. Brennan, Jr.:

Only for Uncle Sam.

Richard B. Stone:

Only for the Government.

Richard B. Stone:

Now, that trust is set forth in Section 7501 of the Internal Revenue Code which is quoted on page 26 of our brief to which I refer the Court and that provision states as follows.

“Whenever any person is required to collect or withhold any Internal Revenue Tax from any other person and to pay over such tax of the United States, the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States.”

Now, I take it that neither respondent nor the courts below would dispute it by virtue of Section 7501 an employer who withholds income and social security taxes from his employee’s salaries is the trustee of a trust at least up until the point that the employer becomes insolvent.

Now, let us consider the case of the employees — of the employer’s insolvency and look briefly at Section 64 of the Bankruptcy Act which is set forth in relevant part of page 23 of our brief.

That Section entitled “Debts which have Priority” establishes those debts of the bankrupt which have priority over general unsecured creditors in the Bankruptcy Proceeding and that Section reads as follows, “The debts to have priority, in advance of the payment of dividends to creditors, and to be paid in full out of bankrupt estates, and the order of payment, shall be (1) the costs and expenses of administration including the actual and necessary costs and expenses of preserving the estate subsequent to filing the petition.”

And then follows a general enumeration of expenses considered to be administrative expenses of the bankrupt estate followed by four other categories of debts which have priority.

And I note in that regard just for the sake of clarity that the fourth category of Debts with Priority includes “taxes which became legally due knowing by the Bankrupt to the United States or to any State or any subdivision thereof” and this priority for tax debts includes essentially tax debts which are incurred by the employer prior to the institution of bankruptcy proceedings and it is not disputed that tax debts incurred by the bankrupt during the bankruptcy proceeding are administrative expenses of the bankrupt estate in sharing the first priority but that would not in our view include these taxes for the reason I am about to state.

Harry A. Blackmun:

Mr. Stone, we’re really in a situation here of tension between the two statutes, aren’t we?

Richard B. Stone:

My precise point Mr. Justice Blackmun is that we are not in the state of tension between these two statutes for the reason that though the Court of Appeals certainly felt we were for the reason that Section 64 of the Bankruptcy Act has nothing to do with trust funds.

Harry A. Blackmun:

Well, this —

Richard B. Stone:

It deals with administrative expenses of the bankrupt estate and unless you can at some point identify withheld taxes as tax debts of the employers, there is no tension because Section 64 has no bearing on those amount.

Harry A. Blackmun:

This has to be your position.

I think you have no alternative.

The question I wanted to ask however is there anything in the chronology of the two statutes which is that is of help here, which is the older of the two?

Richard B. Stone:

Section 64, The Bankruptcy Act is the older of the two.

Harry A. Blackmun:

So that the other one which is I recall came in about 1934 is the newer one?

Richard B. Stone:

Right.

Harry A. Blackmun:

Does this lend you any support at all?

Richard B. Stone:

Well, it lends — I think it does lend us some support.

Of course, there have been — it lends us some support but the trust was still congressionally enacted even though Section 64 is already on the book and the trust is not, the trust provision Section 7501 does not refer in any way to a limitation arising from bankruptcy.

Harry A. Blackmun:

Do you know what prompted at its birth (Inaudible)?

Richard B. Stone:

The institution of the trust fund?

Harry A. Blackmun:

Yes.

Richard B. Stone:

Provision?

Yes, as far as we can tell, there is the Senate Report and the House Report of both are unlimited in terms of explaining the purpose but as far as we can tell, the trust impose in Section 7501 was designed to forestall the possibility that courts would limit the Government to mere debt collection procedures and would not allow either trust collection or tax collection extraordinary procedures against those withheld funds.

Harry A. Blackmun:

Am I correct that this statute come in to being before withholding was established?

Richard B. Stone:

Withholding of income tax was after.

Yes, it came between before the withholding of income tax and before the withholding of FICA but there was already on the Board’s withholding a various excise taxes and it was this particular taxes which the original predecessor Section 7501 was designed to take care of.

Warren E. Burger:

Well then your view isn’t the Trust Section imperative to the integrity of the Social Security Act structure?

Richard B. Stone:

It is imperative to the structure of the Social Security Act and to the withholding of income taxes.

Richard B. Stone:

Yes it is, Mr. Chief Justice.

Our view is that the entire legislative scheme which we discuss at length at pages 7 to 10 of our brief, the entire legislative scheme behind withholding of all taxes shows that the Government serves merely as a collection agent with respect to these taxes that these are tax debts of the employee to the Government and not of the employer to the Government.

And therefore, that these are neither taxes nor debts of the bankrupt to the Government and therefore don’t come under the provisions of the Bankruptcy Act which establish priorities for the debts and expenses of the bankrupt estate.

Essentially, if employees paid $100 in wages, he receives $85 and he is considered to have discharged the $15 a tax liability, and the employer at that point merely holds as the Tenth Circuit recently said holds as a collection agent for the Government.

He holds it for a brief period of time and is required to pay it over and it’s my submission to this Court that regardless of how strong a policy Section 64, The Bankruptcy Act embodies this to the equal priority of administrative expenses does nothing in that provision which converts trust funds into administrative expenses or which deals in any way with the bankrupt’s obligation to handle the funds which it is receive in the capacity of collection agent and neither of the Court’s below nor the respondent trustee has attempted to answer this what I considered to be a crucial threshold question of what interplay it all to Section 64 have on this funds.

You think the Nicholas case bears on your problem here?

Richard B. Stone:

Yes, I think that it certainly needs to be discussed.

Of course, this Court reserved in Nicholas the question before us here.

Nicholas involved the question where the interest on withheld taxes accrues past the period of bankruptcy or whether it stops with the institution of bankruptcy proceedings or the actual institution of bankruptcy.

And the court in Nicholas held that interest did not accrue, it held on the broad general principle that interests during a bankruptcy proceeding ought not to accrue it all because it eats away it creditors, assets, and creditors ought not be disadvantaged merely because of delays attributable to the long length of the Bankruptcy Proceeding.

Byron R. White:

Does the Government have a lien for this access?

Richard B. Stone:

A lien?

Not a special lien Mr. Justice White, it does not file a special [Voice Overlap] trust rather than —

Byron R. White:

The Government doesn’t have the same lien for these withheld taxes as it would for the income taxes of the employer himself owed?

Richard B. Stone:

That is a question that hasn’t been tested.

It hasn’t — it can go in I suppose, this hasn’t been tested but I suppose it go in under —

Byron R. White:

Well, let’s assume the Government has a protected lien for income taxes and the employer goes bankrupt.

What’s the relative position of the Government vis-à-vis of taxes and where it’s got a lien for income taxes, how do they stand as against administrative expenses?

Richard B. Stone:

I don’t know the answer to that question Mr. Justice White except that I believe that if the lien is perfected that they stand ahead of all and secured obligations including administrative expenses but I’m not sure about the answer to that.

I want to point out that the Court in the Nicholas case cited the sentence of Section 7501 and I think it is important since no doubt the Nicholas case will — does have to be examined to determine the outcome of this case.

The second sentence of Section 7501 after the trust is declared says as follows, the withheld taxes shall be “assessed, collected, and paid” in the same manner and subject to the same provisions and limitation including penalties as are applicable with respect to the taxes from such fund arose.

Now we think that as we’ve discussed in our brief that the legislative history of that statute makes it clear that it was not designed really though it says limitations, it was not designed to limit remedies but to expand Government revenues but even the quoted language taken at its face value is I think of anything favorable to our position in this case because the phrase “taxes from which such fund arose” clearly refers to the income and social security taxes owed by the employees and withheld by the employer.

And these taxes on the employees would not subject to any collection limitation by virtue of the employer’s bankruptcy.

Now they would be subject in any bankruptcy proceeding to a limitation on the accrual of interests during the bankruptcy proceeding but they would not be subject to a limitation by virtue of the employer’s bankruptcy and there and I think lies the essential distinction even given the fact that the Court relied on the second sentence of Section 7501 in the Nicholas case.

That is the essential distinction between Nicholas and this case.

William J. Brennan, Jr.:

Mr. Stone, I gather that generally, employer not a bankrupt, an employer doesn’t have to or does he keep withheld taxes in the separate fund?

He may use them, can he in the business ordinarily?

Richard B. Stone:

That is also an (Inaudible), Mr. Justice Brennan.

William J. Brennan, Jr.:

Well, —

Richard B. Stone:

I think that that —

William J. Brennan, Jr.:

If he absconds with it.

Richard B. Stone:

He has —

William J. Brennan, Jr.:

Is he prosecuted as embezzlement?

Richard B. Stone:

He could be.

William J. Brennan, Jr.:

Oh really?

Richard B. Stone:

He could be.

William J. Brennan, Jr.:

On the federal law?

Richard B. Stone:

I would think he could be.

It is embezzlement because he is required —

William J. Brennan, Jr.:

But is he prosecuted as an embezzlement?

Richard B. Stone:

I don’t know of any cases that have raised that.

William J. Brennan, Jr.:

What do they prosecute him that under?

This must happen doesn’t it that an employer absconds with the money?

Richard B. Stone:

Mr. Justice Brennan, I will have to say that the Government has not attested at all the whole range of permissible activity that an employer can conduct with respect to these withheld funds.

They are due so quickly.

In the ordinary case, they’re paid over so quickly because they are due —

William J. Brennan, Jr.:

Yes, but what if they’re not and it has to be a prosecution because he absconds with it.

Under what do you prosecute?

Some special provision of the income tax law?

Richard B. Stone:

I don’t know of any special provision that would cover that.

William J. Brennan, Jr.:

So then it would have to be as an embezzlement?

Richard B. Stone:

I would think that the embezzling remedy would be available but I suppose the willful, a criminal prosecution for willful avoidance of a tax payment under the normal criminal provision of the revenue code.

For these reasons, I believe first that this Court are too definitely make it clear that this are withheld funds are expenses are not expenses and eats of the employer to the Government but are held in trust by the Government and that the mere fact of bankruptcy does not defeat the trust set forth in Section 7501 and that in addition, the trust in this case ought to be recognize even though the raise is not specifically traceable and for the reason set forth in our brief in which I have collaborated on.

I would like to save whatever remaining time I have for rebuttal.

Warren E. Burger:

Mr. Gillogly.

In order to avoid interrupting you, Mr. Gillogly, let me put a hypothetical question to that may help further something on my mind.

Kevin J. Gillogly:

Yes, sir.

Warren E. Burger:

Suppose I would assume that a large employer like General Motors or others of that category probably have it any given day millions of dollars in the segregated account.

Now hypothetically, assume the impossible which is that Congress acted very swiftly with simply abolished the whole statutory scheme.

Whose property would that account to the fund?

Warren E. Burger:

Who would be the owners of that fund?

Kevin J. Gillogly:

I would say under the existing law it would be the United States Government.

Warren E. Burger:

And would they be the legal owner only or the equitable?

Kevin J. Gillogly:

Well, I would say the legal owner under the trust theory.

Warren E. Burger:

Yes.

Kevin J. Gillogly:

The legal title of course is in the holder of funds and the equitable title would be in the United States Government.

Warren E. Burger:

Well, don’t you think the equitable title would vest in the employees if the Act had been repealed?

The employees had made this contributions —

Kevin J. Gillogly:

Oh!

If the Act had been repealed.

Warren E. Burger:

That’s right.

The Act is repealed.

Kevin J. Gillogly:

I’m sorry.

If the Act had been appealed, I think then that the equitable title would be in the employees.

Warren E. Burger:

Employees.

In other words, had have (Inaudible) an accounting procedure to unscramble this very large omelet and give to each employee what he had according to the records of the employer contributed to that fund.

Kevin J. Gillogly:

Yes, sir.

That would just be unpaid wages then, wouldn’t it?

Kevin J. Gillogly:

I — if the law were repealed?

Yes.

Subject to the limitations with regard to priorities of unpaid wages have under the Bankruptcy Act.

It certainly don’t take over administrative expenses.

Kevin J. Gillogly:

But we’re now talking about a Bankruptcy Proceedings.

I understood Mr. Chief Justice to be talking about in any given situation exclusive of bankruptcy.

Warren E. Burger:

I was thinking at one step at a time.

I have just taken the first stage and then you can pursue it with Justice White’s illustration and see where you’d come out and see whether that has any bearing on this case?

Kevin J. Gillogly:

Well, I would say that once the case is in the Bankruptcy Court either by a chapter proceedings or by an adjudication, then the entire Bankruptcy Act prevails and then the systems of priorities are set forth by Section 64.

Warren E. Burger:

Well then.

Kevin J. Gillogly:

If this law were rescinded or if it were repealed, or if the courts were to strike it down and there were no bankruptcy then I think there’ll be no question as to where it would go.

The equitable title would be in the employees.

Warren E. Burger:

Let me pursue with the hypothetical a little bit beyond that.

Take a Trust Company Bank that has a large trustee fund and the bank becomes insolvent and goes through these processes, are they accounts of the Trust Department or the Trust Company segregated accounts?

Would they ever find there way into a Bankruptcy Proceeding of the corporate trustee?

Kevin J. Gillogly:

I think by the nature of the Bankruptcy Act, I believe that the Trust Company is specifically excluded by the Act.

Warren E. Burger:

This is all hypothetical.

Kevin J. Gillogly:

All hypothetical, assuming —

Warren E. Burger:

All hypothetical.

Kevin J. Gillogly:

That it went, so I understand you fully that it — the Trust Company became insolvent or bankrupt.

Warren E. Burger:

Right.

Kevin J. Gillogly:

I don’t think there’s any question at all that the Bankruptcy Act would prevail assuming that it did go and come in the Bankruptcy Act either voluntarily or involuntarily.

Warren E. Burger:

You mean the general creditors could reach into the segregated accounts of the beneficiaries of the trust?

You don’t mean that?

Kevin J. Gillogly:

I would say in so far as I understand trust companies, they hold some of them in trust pools where they commingle funds. (Voice Overlap) I think they get a different problem there.

Warren E. Burger:

This is not a trust pool.

Kevin J. Gillogly:

Or the individual.

Well then again, I think you have an entirely different situation here.

Warren E. Burger:

The equitable owner in the Trust Company hypothetical is the beneficiary of the trust, isn’t it?

Kevin J. Gillogly:

Yes sir, that’s correct.

Warren E. Burger:

Well, I’m taking you off enough — track.

Kevin J. Gillogly:

Yes.

The Government seems to be relying rather heavily upon the trust fund theory and the theory of trust and trust ex mal officio and question why the Seventh Circuit Court did not address itself to this.

And I think it’s very obvious that the reason why the Seventh Circuit Court did not address itself to this particular argument of the Government, is that it wasn’t necessary for it to do so because the court there interpreted Section 64 (a) to the same as the Connecticut General case did and the same as the Green case is that number one, they were not in conflict with one another that Section 7501 (a) and 64 (a) (1) could be read separately and by the second sentence in 7501 (a), it provided that the trust have the same limitations on it as the taxes from which the fund arose and then went on to say that the taxes arose from and by virtue with the Bankruptcy Act and therefore the Bankruptcy Act would prevail and there goes Section 64 (a).

But further, if these were not the case, that the strong policy of 64 (a) of the Bankruptcy Act would prevail over the general provisions and the general policy of Section 7501.

I would like to review rather briefly the history of these cases starting out with the Guaranty Title Company case, an opinion in 1912 where the Section 3466 of the Internal Revenue Code provided for a priority as opposed to 7501 which provides for trust fund.

There the Supreme Court held that it was a beneficent policy that 64 (a) should prevail especially in that case that pertain to wage earners.

This was reaffirmed by this Court in Davis versus Pringle in 1925.

Now, this line of cases goes undisturbed up until the time of U.S. versus Nicholas or Nicholas versus U.S. which was decided in this Court in 1964.

The problem arises with the line of cases under the City of New York versus Rassner and then the Rassner case.

The first case in 1942 in which this trust fund was found to apply.

The Rassner case provided or the Rassner case said that it was a general provision of the Bankruptcy Act in Section 64 (a) as opposed to the specific provisions of the trust.

Kevin J. Gillogly:

And the Rassner case went on to say that if it could be shown that the policy or if the provisions of 64 (a) were other than general then the result would be different.

And this Court has shown in Nicholas versus United States in express language said that it is a strong policy that prevails in 64 (a).

That being the case than the perhaps fall from underneath the Rassner case and all of the cases that follow it fall like dominoes.

This is the theory of the trustee.

This has been the position of the trustee from its very — the very inception of this case.

In the Nicholas case, the Court went so far as to say that the taxes that were incurred during the Chapter XI, and this is precisely what we’re talking about here, come within the first priorities of Section 64, the Bankruptcy Act.

That is the cost of administration.

The history of the administrative and cost of administration provisions of the Bankruptcy Act have constantly worked towards allowance across of administration and the way from tax collecting.

When you trace the history in the Bankruptcy Act is enacted in 1800 and 1841, 1867 and 1898.

All gave top priority to taxes.

It wasn’t until 1926 that the priorities were changed, the cost of administration was advanced and that the taxes were reduced to a sixth priority.

Then under the Chandler Act of 1938, the system of priorities was retained and further the tax collector was further restricted but being required to file this claim within the limitation set on all other claimants.

And again in 1952, the Act was again amended to give further priority to cost of administration by providing that cost of administration in a superseding bankruptcy takes priority over the cost of administration in the superseded chapter proceedings, further strengthening the position of cost of administration.

And lastly in 1966, the most recent amendment which changed the priorities further or limited further the claim for taxes by holding that the taxes could only be claimed for a three-year period prior to the filing of the bankruptcy.

So we see historically, this picture of the reducing of the tax claim in advancing the cost of administration.

And I think as the court below in the very scholarly opinion by Mr. Justice Hastings points out and refers to the congressional or rather the Senate Reports and the House Conference Reports as it apply to the cost of administration.

And the need to preserve this cost of administration because let’s take just what could happen very easily in this case.

We are only — the Government is only seeking to impress the trust on those taxes that were collected by the debtor in possession.

But if you were to read Section 7501 that says any person who collects taxes that would also mean the bankrupt prior to filing.

Further and following the Rassner line of cases, if you have every state and every municipality enacting trust fund legislation, there’s nothing left to administer in these cases or were still, you have a trustee who is going to wait and to see if anyone is going to assert his trust rights and the estate is going to go unadministered during this period of time.

And as the House Reports and the House Conference Report and the Senate Report, I believe it was in the 82nd Congress emphasized the necessity to protect the trustee in order to have orderly administration of the estate.

If you don’t protect the trustee, if you don’t give him the first priority, then you are not going to have orderly administration of estate just the normal routine that’s employed by the trustee.

First of all, he ceases the property in order to protect it and so doing here immediately in first liabilities.

He’s got to post the bond as required by Court.

He’s got to assume rent liabilities for use in occupancy.

He’s got to employ inventory clerks.

He has got to employ appraiser by rule of court.

These are all obligations that he himself must pay.

Byron R. White:

Could I ask you a question about ordinary taxes the Government — that a bankrupt owes a Government — a bankrupt company owes a Government.

Let’s assume the Government has perfected a lien on the prior to bankruptcy on the assets of the individual or the company.

Byron R. White:

What is the status of that lien in bankruptcy with respect to administration expense?

Kevin J. Gillogly:

If the lien has been perfected the same as any lien under the Uniform Commercial Code.

If it has been perfected, it is a valid and subsisting lien.

And that property is excluded from the bankrupt estate.

But that’s by separate statute though, sir.

Byron R. White:

Well, so is this?

Kevin J. Gillogly:

Yes, sir.

Byron R. White:

So as this.

It’s excluded in the bankrupt estate and yet the trustee takes position of it at the outset.

Kevin J. Gillogly:

Usually does has some accommodation, sir.

Byron R. White:

Well, know, it it’s still — it’s still the bankrupt’s property just subject to the lien that’s all it is.

It’s just a protective lien.

The Government has to take possession of it.

Now the trustee takes position of the properties as the bankrupt’s property just subject to the lien.

Now, does the lien holder have to share administrative expenses?

Kevin J. Gillogly:

No, sir.

Byron R. White:

Not even if there is any other funds?

Kevin J. Gillogly:

No sir, there is no provision in the Bankruptcy Act, Mr. Justice White.

The usually an accommodation is worked up.

Byron R. White:

Well —

Kevin J. Gillogly:

But if the —

Byron R. White:

Let me ask you the question that I asked Mr. Stone.

Is this — under 7501, it says that these amounts owing the withholding taxes shall be assessed, collected, and paid in the same manner and such the same provisions limitations, as other as applicable with respect to taxes from which said fund arose?

Now, does that mean that the Government did not want to lien if it wants some priority over other creditors if it wants the position of the lien holder, must it perfect its lien and what else could that language mean?

I mean it may be a trust fund but it says it’s collectible in the same manner as other taxes?

Kevin J. Gillogly:

Well I — you’re speaking now of the second sentence of 7501 (a).

Well, I feel that after the interpretation put on that language in the Connecticut Motor Lines case and the Green case and also in this case in the court below is that the trust has a limitations placed upon it by that as a taxes from which the fund arose and that is the Bankruptcy Act and therefore the Bankruptcy Act would apply.

Now, I think in the hypothesis that you gave me is it pertains to something entirely different Mr. Justice White.

Byron R. White:

Why?

Why would it?

Kevin J. Gillogly:

Because it is again a separate statutory procedure.

Byron R. White:

Well, yes but the Government didn’t take the position.

It didn’t take the normal steps to perfect its tax claim here in order to give it priority over administration expenses.

There’s no claim that the Government has perfected any lien in these cases.

Kevin J. Gillogly:

No, there is none sir.

They did not protect or perfect the lien.

Well, as a practical matter Mr. Justice White, if that were the case, the trustee wouldn’t take possession of the property and there be no estate to administer.

He would file a “no assets” report and that would be the end of the case.

Byron R. White:

If that’s all the assets.

Kevin J. Gillogly:

If that’s all the assets there were, certainly.

And that happens in any number of cases not only in tax liens, but on Uniform Commercial Code liens.

This is very common place.

(Voice Overlap) But there you have it, you have it set forth with clarity in the law and if they have protected their position, then there is nothing to administer for the title —

Byron R. White:

Would you say that if a trustee is appointed before a company that has been adjudicated and he finds that the only sizeable assets the company has, is made up of withholding taxes and haven’t been paid over to the Government.

He won’t treat that as a no asset case?

Kevin J. Gillogly:

He would treat that, sir.

I —

Byron R. White:

Why?

Kevin J. Gillogly:

No —

Byron R. White:

Under your position?

Kevin J. Gillogly:

No, because if I understand you Mr. Justice White, you’re talking about funds that have been segregated.

That there any withholding tax account —

Byron R. White:

I’ll just say.

I’ll just say that you find some bank accounts and you find that the total amount owed for withholding taxes exceed the money in the bank.

There hasn’t been any segregation or anything.

The only assets are bank accounts but the obligation here withholding taxes exceeds the amount in the bank.

Now, would you make that a no asset case or not?

Kevin J. Gillogly:

No, I would not because the Government has not perfected its lien rights in that instance.

And it becomes the general funds of the estate.

Byron R. White:

Yes.

Kevin J. Gillogly:

Then if you get back again to 7401 and 64 (a), where does the priorities lie?

William J. Brennan, Jr.:

Now, let me – you said that —

Kevin J. Gillogly:

Yes, Mr. Justice Brennan?

William J. Brennan, Jr.:

I understand where the Government has perfected the lien you say that’s treated exactly as you would on the other lien case (Inaudible)?

Kevin J. Gillogly:

Yes, sir.

William J. Brennan, Jr.:

But suppose it has not perfected the lien, take Mr. Justice White’s hypothetical except that money in the bank is earmarked on the account title as withholding taxes belonging to United States, what then is this?

Kevin J. Gillogly:

Well, I think you have a different situation.

As a matter of fact —

William J. Brennan, Jr.:

Well, with this — would you say that is a no asset case?

Kevin J. Gillogly:

That’s exactly what we did sir in this case.

What we did — let me change that.

That’s exactly the way the trustee treated funds that were on deposit in the bank account that was created and set up in this case for deposit of tax moneys.

There was an account that was set up here.

And I refer you to abstract 39 which show in the petition that when the president of the corporation was questioned about the assets, he said that a bank account had been set up and this was — this was set forth in the petition paragraph 1 in abstract 44. Paragraph 1 of the referee’s orders makes an order with reference to that bank account.

William J. Brennan, Jr.:

But what we’re dealing with here I gather are with taxes withheld after the petition had replied.

Kevin J. Gillogly:

That’s precisely what I’m talking about.

William J. Brennan, Jr.:

I know the taxes withheld have not been deposited in any bank account —

Kevin J. Gillogly:

I’m afraid I —

William J. Brennan, Jr.:

I mean had not been segregated.

They have not been segregated in an account as had the — with the taxes withheld before in filing of the petition?

Kevin J. Gillogly:

They were filed during the Chapter XI proceedings by the debtor in possession.

William J. Brennan, Jr.:

Now, what did they do with money when he withheld it?

What did he do?

Kevin J. Gillogly:

He deposited them in a special account in the State Bank of Elk Grove Village in Elk Grove, Illinois.

Those moneys may still be there for all I know.

We exercise no jurisdiction over them.

William J. Brennan, Jr.:

Then what are talking about then?

Kevin J. Gillogly:

We’re talking about separate funds that were — when the debtor went into possession, an order was entered ordering him to open up three accounts.

He did open up an account in the Elk Grove Bank for the purpose of withholding taxes and FICA he did make some deposits in there.

William J. Brennan, Jr.:

He did make some.

Kevin J. Gillogly:

He made some deposits.

William J. Brennan, Jr.:

But not enough.

Kevin J. Gillogly:

But not enough.

That’s right.

We haven’t touched these funds.

We had — we don’t claim that.

William J. Brennan, Jr.:

So to the extent that they created a separate fund you make no claim —

Kevin J. Gillogly:

I make no claim.

William J. Brennan, Jr.:

— and that but the Government makes a claim with respect to the total he should have deposited.

Kevin J. Gillogly:

That’s right.

And they want to impress the trust on property, on capital assets of the corporation that existed long before the Chapter XI proceedings and in no way traceable and there’s no question of commingling.

There is no question of trust ex mal officio as it provide — as it pertains to the capital funds.

Byron R. White:

(Voice Overlap) round numbers taxes withheld by debtor-in-possession total amount.

Kevin J. Gillogly:

I would say roughly maybe $200 to $300.

Byron R. White:

How much was deposited in the trust fund?

Kevin J. Gillogly:

Oh!

Excuse me, the total amount that was withheld I’m sorry was $10,075.52, the amount that was deposited that was maybe $200 to $300.

Byron R. White:

So he found $700 that he didn’t deposit, is that what we’re trying to —

Kevin J. Gillogly:

No, the Government wants the entire sum.

Well, and did you say the $200 or $300 on deposit —

Kevin J. Gillogly:

Actually that would be it and would be whatever is in that account.

Warren E. Burger:

Who would you say has benefited by the money which should have lawfully been put in to the segregated accounts but which was not put in according to both the statute and the directions?

Kevin J. Gillogly:

I would say the wage earners at least to the extent that credit is given to them for the moneys that should have been deposited.

I can’t see in no way at all that the estate has been enhanced.

Warren E. Burger:

Doesn’t the Government stand in the shoes — since the Government has had to take on the responsibility of discharging the employees for that obligation?

Doesn’t the Government stand on the shoes of those employees?

Shouldn’t they preferably?

Kevin J. Gillogly:

You mean as subrogees, I don’t know any statutory provision.

I know of no case law.

Warren E. Burger:

As a matter of equitable — established equitable principles relating to trusts?

Kevin J. Gillogly:

Well except that that is — I would say under ordinary circumstances, I would have to buy your argument.

However, I feel that what we’re here before this Court to interpret is the effect of 7501 and that’s in the relationship with 64 (a) (1).

And I’m just asking the Court to follow the precedent that’s here before have been sent is that it is a strong policy of 64 (a) that must prevail over 7501 if there is a conflict.

In other words, this 7501 (a) applies up until the moment that the bankrupt — any proceeding on bankruptcy is filed.

Then the Bankruptcy Act takes over completely.

I don’t think you can have the bankruptcy applied just piecemeal and have collateral legislation that is going to interfere with the administration of the estates which is what 7501 does because you’re in real serious problems when it comes to the administration of estates.

If you’re going to ask a trustee whose worth is sought to come in and to expend money, his own money and incur personal liabilities and not know whether or not there is a trust that is going to be exerted by the United States Government and I suggest later on if the Court is to reverse the courts below.

All the municipalities that would pass that legislation and all the states that would pass that legislation you would have no orderly administration of the estate until the Congress of the United States would untangle it.

Now, I would say that there would be irreparable damage done to the system during that hiatus.

Excuse me.

Kevin J. Gillogly:

Yes, sir?

If the Government loses this case, your right its claims still administration expense, isn’t it?

Kevin J. Gillogly:

Oh!

No, sir.

What is it?

Kevin J. Gillogly:

They are claiming over and above —

No, no.

What do you think the — what priority does the Government’s claim at?

Kevin J. Gillogly:

They enjoy a fourth priority under Section 64 (a) (1).

Excuse me, no.

I’m sorry.

They enjoy a first priority.

They enjoy —

Administrative expense?

Kevin J. Gillogly:

Administrative expense after — the administrative expense of the proceeding bankrupt.

So they have — because these are taxes accruing during the operation of the business?

Kevin J. Gillogly:

Yes, sir.

That would the cost of administration.

And so it’s an administrative expense?

Kevin J. Gillogly:

Yes, sir.

And if they don’t have — that postpone to their usual position with respect to taxes?

Kevin J. Gillogly:

That’s right.

They do enjoy that first priority with the subject to the one condition that I stated.

That is only two — about $700 of it, $200 or $300 like 100%?

Kevin J. Gillogly:

Yes sir, but I think the principle is much larger than that what could be done to the entire system.

Warren E. Burger:

Mr. Stone, you have four minutes remaining.

Richard B. Stone:

Yes, I’ll just take a minute Mr. Chief Justice.

I want to clarify one point.

I have been informed by my co-counsel that as to the Government’s lien on these taxes if it is on real property, it comes ahead of administrative expenses.

If it’s on personal property reduced to possession, it comes ahead.

But if it is on personal property not reduced to possession, it comes behind for preferred expenses.

However, in a lien in the Chapter XI proceeding cannot be perfected against the trustee in any circumstances.

The Government is —

William J. Brennan, Jr.:

He doesn’t need it, has he?

Richard B. Stone:

Has a trust.

It doesn’t need it because it has trust fund anyway.

William J. Brennan, Jr.:

Or you can say that he doesn’t need it because of his estate?

Richard B. Stone:

That I suppose is an undesirable but albeit an alternative.

William J. Brennan, Jr.:

How about this (Inaudible)?

Richard B. Stone:

Oh!

Mr. Justice Brennan, there is some reference.

There is a report filed after the institution of liquid — of the applicable liquidation have occurred which refers to a special account in a bank of special tax account but the referee specifically found and I guess this is the facts for the purposes of this case that no such moneys have in fact been entered and it’s unclear from the little record we have about this $200 to $300 that it was in fact a special Government account.

And I would say that for purposes of this case, we have to assume that that we’re going simply at the general funds of this estate in imposing the trust with respect to those funds.

I want to say in conclusion only that, I think that respondent’s argument in this case merely affirms my prior statement that neither the courts below nor the respondent have dealt with the issue of what is the nature of these debts.

Are they tax debts of the employer owed to the Government or does the employer hold them merely as collecting agent for debts of the employee.

I don’t see on the theory of that either the court below or respondent has gone on how they would recognize this trust fund even if the amounts — the proper amounts have been segregated.

It seems to me that under their theory which precludes operation of 7501 trust when a Bankruptcy Proceedings starts, the trustee would not have been authorized to pay over segregated funds even if he had segregated them because they simply would he no trust in the time of bankruptcy and that is a totally unacceptable holding form our point of view.

Byron R. White:

What do you say about subject liable in so far as it says that taxes withheld by the employers will be collected by the same procedures?

Richard B. Stone:

We have dealt with that in length in our brief Mr. Justice White.

Briefly, to reiterate, we say that first of all that the legislative history shows that the real purpose of that second sentence was to make sure that it would be clear that the tax remedies were available altogether to the Government.

Richard B. Stone:

There was a fear on Congress’ part that absent that ordinary tax remedies would not be available precisely because this was not a tax debt of the bankrupt and the Congress wanted all available procedural remedies, trust, tax, and debt to be —

Byron R. White:

Accumulated?

Richard B. Stone:

Right.

But even if it is viewed as restrictive and I suppose it must be said that the Nicholas Court and I believe the Court went perhaps further than ahead to as an alternative ground, the Nicholas court invoked this sentence to the proposition that interests couldn’t be supported during this time to the extent that it is limiting.

I believe this case is distinguishable because even though interests would have been precluded on any debt — tax debt including the employee’s tax debts and a Bankruptcy Proceeding, the employee’s tax debts would at no time have been subjected to collecting limitation of being placed in the bankrupt employer’s estate and his funds available to general creditors.

Thank you.

Warren E. Burger:

Thank you Mr. Stone.

Thank you Mr. Gillogly.

The case is submitted.