336 F.2d 96 (3rd Cir. 1964), 14645, In re Connecticut Motor Lines, Inc.

Docket Nº14645.
Citation336 F.2d 96
Party NameIn the Matter of CONNECTICUT MOTOR LINES, INC., Bankrupt. John H. McKeever, Trustee, Appellant.
Case DateAugust 12, 1964
CourtUnited States Courts of Appeals, Court of Appeals for the Third Circuit

Page 96

336 F.2d 96 (3rd Cir. 1964)

In the Matter of CONNECTICUT MOTOR LINES, INC., Bankrupt.

John H. McKeever, Trustee, Appellant.

No. 14645.

United States Court of Appeals, Third Circuit.

Aug. 12, 1964

Argued March 5, 1964.

As Amended Nov. 5 and Dec. 15, 1964.

Rehearing Denied Nov. 9, 1964.

Page 97

E. G. Scoblionko, Allentown, Pa., for appellant.

Karl Schmeidler, Atty., Dept. of Justice, Washington, D.C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, I. Henry Kutz, Attys., Dept. of Justice, Washington, D.C., Drew J. T. O'Keefe, U.S. Atty., Sidney Salkin, Asst. U.S. Atty., on the brief), for appellee.

Before McLAUGHLIN and FORMAN, Circuit Judges, and LEAHY, District judge.

FORMAN, Circuit Judge.

This is an appeal by John H. McKeever, Trustee in Bankruptcy for Connecticut Motor Lines, Inc., from an order by the United States District Court for the Eastern District of Pennsylvania reversing an order of the Referee in bankruptcy.

On May 28, 1958, Connecticut Motor Lines, Inc. was adjudicated a bankrupt in the United States District Court pursuant to its voluntary petition filed that day. Among the claims filed by creditors of the Bankrupt were those for unpaid wages and vacation pay earned within the immediate three months period prior to bankruptcy, and in some instances for wages and vacation pay earned within an earlier period. Those with claims for wages and vacation pay earned within the three months immediately preceding the bankruptcy rightfully asked for, and were allowed, a priority distribution under Section 64, sub. a(2) of the Bankruptcy Act. 1 Claimants with a wage accrual which preceded the three months' period qualified for dividends as general creditors of the Bankrupt.

The Referee's order provided for a distribution of $20,154.81 to be made to wage claimants entitled to Section 64, sub. a(2) second priority status. After isolating other priority matters, a balance of $145,313.42 was available for distribution of dividends to general creditors, including the pre-three month wage claimants. The Referee's order neither made provision for deductions of employees' contributions for income withholding and social security taxes 2 from the sums distributed to priority and non-priority wage claimants, nor for payment of the employer's social security excise. 3 Accordingly, the United States filed a petition for review with the District Court, that court reversing the Referee and holding the Trustee liable for all the above-mentioned taxes as a first priority administrative expense. 4

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Though novel for this court, the issue presented on appeal is a recurring one, viz., what status in the order of creditors' priorities is to be given a Government claim for income withholding and social security taxes arising from wages accrued prior to bankruptcy, but paid during bankruptcy as a second priority matter, or as a dividend to general creditors?

I

It is well settled that taxes arising from transactions completed in all respects prior to bankruptcy are to be treated as fourth priority items. 5 The problem faced here, however, is a hybrid-- there has been an accrual of wages prior to bankruptcy, but their payment was held in abeyance until the second priority and general creditor distributions under the Bankruptcy Act. Though the Government's right to income withholding and social security taxes is fixed in the struggle among pre-bankruptcy creditors, the provisions of the Bankruptcy Act are clear neither as to what constitutes a pre-bankruptcy tax claim subject to fourth priority status as distinguished from a post-bankruptcy tax claim, nor what the Government's rights are once a post-bankruptcy tax claim is established. In its relationship to an estate as a taxpayer, the Government 'finds itself tacitly referred to the wisdom of the courts.' 6

The first enunciation on the subject appeared in the leading case of United States v. Fogarty 7 and subsequent cases, 8 all relied upon by the Government but questioned by the Trustee. In upholding the Government's claim for taxes based on wages earned prior to bankruptcy, but distributed in bankruptcy, facts of the type before us on this appeal, the United States Court of Appeals for the Eighth Circuit, in Fogarty, concluded that as the Internal Revenue

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Code made the wage payment a prerequisite to the attachment of the tax, and as that wage payment was accomplished after the filing of the bankruptcy petition, the Government's tax claim was a post-bankruptcy claim. The Eighth Circuit then held that such tax claims were not fourth priority items, but as post-bankruptcy expenses were first priority costs and expenses of administering the bankrupt's estate. 9

In determining whether to accept as persuasive precedent the ruling in United States v. Fogarty, an analysis of the foundation of this leading decision can be revealing. The ultimate result in Fogarty rests on a number of cases which lend little support to that holding, and if anything, detract from the reasoning of the Eighth Circuit. 10 In all the cases cited, the trustee or bankrupt was taxed on activities involved in further developing the bankrupt's assets or in seeking to maintain such assets for the maximum benefit of creditors. Post-bankruptcy taxation such as this has long been viewed by the courts as part of classic administration expenses. It is of import then that one of the leading treatises, in noting the thrust of the Fogarty ruling, mistakenly cited the case for the classic proposition that 'any such taxes as accrue during continuance of business by a receiver or trustee are considered part of the expense of administration.' 11 Such a misconception of Fogarty could have arisen because courts construing activities aimed at developing or preserving

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the bankrupt's assets as a basis for a first priority tax claim have implied that any activity, short of a purpose on the part of the bankrupt, trustee, or receiver to develop or maintain assets for the maximum benefit of creditors, would not be a basis for a tax claim entitled to first priority status.

This court, in upholding New Jersey's claim for franchise taxes accruing during a bankruptcy reorganization, stated:

'* * * the order appointing the trustees specifically referred to the 'franchises' of the corporation and required the trustees to protect and conserve this asset as well as other assets transferred to them. * * *

'* * * (The franchise tax) thereby became one of the expenses of administration incurred by the trustee.' 12

United States v. Fogarty has, in reality, stood on procedent which has recognized a cleavage between allowing as first priority matters, taxes arising from post-bankruptcy activities geared towards development or preservation of the bankrupt's assets, but disallowing as an expense of administration, taxes attaching to post-bankruptcy activities incidental to the development or preservation of the bankrupt's assets. This is the measure both by which Fogarty becomes of little value to this court and makes necessary an independent analysis of the rationale of the Fogarty rule.

II

Most post-bankruptcy taxes have been placed into the category of costs and expenses of administration, and as such, these taxes have been entitled to first priority status. This position is the natural consequence of the broad principle that 'the cost of protecting a fund in court is everywhere recognized as a dominant charge on that fund.' 13 Section 64, sub. a(1) of the Bankruptcy Act also recognizes that costs associated with the distribution of the fund are expenses of administration.

'* * * If the tax (on wages accruing prior to bankruptcy but allotted in bankruptcy) were on the distribution of the wage claim, the tax could be a valid expense of administration since distribution is a part of administration; but the tax in question is not a tax on distribution but a tax on wages paid.' 14

Thus, as the tax on such wages as is before us neither has a relationship to the cost of protecting or developing the bankrupt's assets, nor can be reasonably considered a tax on the mere distribution of the wages, Section 64, sub. a(1) of the Bankruptcy Act is distorted by attempting to create a fiction as was done in United States v. Fogarty.

The Government's argument amounts to a bland assertion that all post-bankruptcy expenses, including taxes, are by definition first priority costs and expenses of administration. 15 There has been an unwillingness to recognize that Section 64, sub. a(1) does have built-in limitations. A few courts, however, have been aware of this problem and the considerations to be weighed in classifying an expense as a Section 64, sub. a(1) first priority matter.

In re Mt. Washington S.S. Co., Inc. 16 involved the levy of a use tax on an uncompleted sailing vessel four days

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after the filing of the bankruptcy petition. The bankrupt's assets were insufficient to reach fourth priority creditors. The city, therefore, argued that as the tax accrued after the filing of the bankruptcy petition, a post-bankruptcy expense entitled to first priority status arose. The federal district court held that because the trustee neither operated the boat nor was ever apparently authorized to operate the boat, the tax assessed could not be considered a current expense of administration. 17

In Denton & Anderson Co. v. Induction Heating Corp., 18 a creditor-agent of the bankrupt secured orders for the bankrupt's goods prior to filing of the bankruptcy petition. The bankrupt accepted the orders, but had not filled them prior to the filing. After the filing, the bankrupt was allowed to remain in possession and operate his business, at which time the orders were filled and the creditor-agent's commissions arose upon the bankrupt's being paid for the orders. The creditor claimed that because his commissions were post-bankruptcy expenses, they...

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28 practice notes
  • 370 F.2d 624 (3rd Cir. 1967), 15507, In re I.J. Knight Realty Corp.
    • United States
    • Federal Cases United States Courts of Appeals Court of Appeals for the Third Circuit
    • January 6, 1967
    ...of administration' within the meaning of Section 64 sub. a (1) as amended in 1962. In the Matter of Connecticut Motor Lines, Inc., 3 Cir., 336 F.2d 96 (1964). We there said at pages 101-102: 'Our view of the boundaries of Section 64, sub. a(1) of the Bankruptcy Act is reinforced by the late......
  • 242 B.R. 574 (Bkrtcy.E.D.Pa. 1999), 96, In re Main, Inc.
    • United States
    • Federal Cases United States Bankruptcy Courts Third Circuit
    • December 7, 1999
    ...202, reh. den., 246 F.2d 70 (C.A.9), cert. denied, 355 U.S. 857, 78 S.Ct. 86, 2 L.Ed.2d 64 (1957); In re Connecticut Motor Lines, Inc., 336 F.2d 96 (C.A.3 1964). To the same effect is In re Daigle, 111 F.Supp. 109, 111 (D.Me.1953). 419 U.S. at 48, 95 S.Ct. 247. See also In re Armadillo Corp......
  • 385 F.Supp. 327 (D.Md. 1974), M-13856, In re Jonker Corp.
    • United States
    • Federal Cases United States District Courts 4th Circuit District of Maryland
    • November 7, 1974
    ...of a proof of claim by the government is statutorily required even in priority matters. In the matter of Connecticut Motor Lines, Inc.,336 F.2d 96 (3d Cir. In Connecticut Motor Lines, supra, the government did not make a timely proof of claim for taxes and thus was not entitled to fourth pr......
  • 175 B.R. 769 (S.D.Fla. 1994), 93-10734-BKC, In re William Schneider, Inc.
    • United States
    • Federal Cases United States District Courts 11th Circuit Southern District of Florida
    • December 1, 1994
    ...omitted), aff'd. on other grounds, 126 B.R. 47 (N.D.Ohio 1991) (federal employment taxes); see, In re Connecticut Motor Lines, Inc., 336 F.2d 96 (3rd Cir.1964) (precode case dealing with federal taxes arising from wages); see also, Otte v. United States, 419 U.S. 43, 95 S.Ct. 247, 42 L.Ed.2......
  • Request a trial to view additional results
28 cases
  • 370 F.2d 624 (3rd Cir. 1967), 15507, In re I.J. Knight Realty Corp.
    • United States
    • Federal Cases United States Courts of Appeals Court of Appeals for the Third Circuit
    • January 6, 1967
    ...of administration' within the meaning of Section 64 sub. a (1) as amended in 1962. In the Matter of Connecticut Motor Lines, Inc., 3 Cir., 336 F.2d 96 (1964). We there said at pages 101-102: 'Our view of the boundaries of Section 64, sub. a(1) of the Bankruptcy Act is reinforced by the late......
  • 242 B.R. 574 (Bkrtcy.E.D.Pa. 1999), 96, In re Main, Inc.
    • United States
    • Federal Cases United States Bankruptcy Courts Third Circuit
    • December 7, 1999
    ...202, reh. den., 246 F.2d 70 (C.A.9), cert. denied, 355 U.S. 857, 78 S.Ct. 86, 2 L.Ed.2d 64 (1957); In re Connecticut Motor Lines, Inc., 336 F.2d 96 (C.A.3 1964). To the same effect is In re Daigle, 111 F.Supp. 109, 111 (D.Me.1953). 419 U.S. at 48, 95 S.Ct. 247. See also In re Armadillo Corp......
  • 385 F.Supp. 327 (D.Md. 1974), M-13856, In re Jonker Corp.
    • United States
    • Federal Cases United States District Courts 4th Circuit District of Maryland
    • November 7, 1974
    ...of a proof of claim by the government is statutorily required even in priority matters. In the matter of Connecticut Motor Lines, Inc.,336 F.2d 96 (3d Cir. In Connecticut Motor Lines, supra, the government did not make a timely proof of claim for taxes and thus was not entitled to fourth pr......
  • 175 B.R. 769 (S.D.Fla. 1994), 93-10734-BKC, In re William Schneider, Inc.
    • United States
    • Federal Cases United States District Courts 11th Circuit Southern District of Florida
    • December 1, 1994
    ...omitted), aff'd. on other grounds, 126 B.R. 47 (N.D.Ohio 1991) (federal employment taxes); see, In re Connecticut Motor Lines, Inc., 336 F.2d 96 (3rd Cir.1964) (precode case dealing with federal taxes arising from wages); see also, Otte v. United States, 419 U.S. 43, 95 S.Ct. 247, 42 L.Ed.2......
  • Request a trial to view additional results