Pearlstein v. U.S. Small Business Admin.

• Decision Date: 14 October 1983
• Docket Number: No. 82-1789,82-1789
• Citation: 719 F.2d 1169
• Parties: , 9 Collier Bankr.Cas.2d 1134, 11 Bankr.Ct.Dec. 544, Bankr. L. Rep. P 69,433, 37 UCC Rep.Serv. 533 Paul D. PEARLSTEIN, Trustee for Sardis, Inc. v. U.S. SMALL BUSINESS ADMINISTRATION. Appeal of DISTRICT OF COLUMBIA GOVERNMENT.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1169

719 F.2d 1169

231 U.S.App.D.C. 250, 9 Collier Bankr.Cas.2d 1134,

11 Bankr.Ct.Dec. 544, Bankr. L. Rep. P 69,433,

37 UCC Rep.Serv. 533

Paul D. PEARLSTEIN, Trustee for Sardis, Inc. v. U.S. SMALL BUSINESS ADMINISTRATION Appeal of DISTRICT OF COLUMBIA GOVERNMENT.

No. 82-1789.

United States Court of Appeals District of Columbia Circuit.

Argued March 21, 1983.

Decided Oct. 14, 1983.

Richard B. Nettler, Asst. Corp. Counsel, Washington, D.C., with whom Judith W. Rogers, Corp. Counsel, Washington, D.C., and Charles L. Reischel, Deputy Corp. Counsel, Washington, D.C., were on the brief, for appellant. Richard L. Aguglia, Asst. Corp. Counsel, Washington, D.C., also entered an appearance for appellant.

A. Patricia Frohman, Asst. U.S. Atty., Washington, D.C., with whom Stanley S. Harris, U.S. Atty., Royce C. Lamberth and R. Craig Lawrence, Asst. U.S. Attys., Washington, D.C., were on the brief, for appellee.

Before WALD and SCALIA, Circuit Judges, and FRIEDMAN, ^* Circuit Judge, United States Court of Appeals for the Federal Circuit.

Opinion for the Court filed by Circuit Judge FRIEDMAN.

FRIEDMAN, Circuit Judge:

This is an appeal from an order of the United States District Court for the District of Columbia, 27 B.R. 153, giving a perfected lien held by the Small Business Administration (SBA) priority in bankruptcy over a later-perfected lien for unpaid sales taxes of the District of Columbia (District). We reverse.

I.

The facts are simple and uncontested. In December 1980, Sardis, Inc., filed a petition in the United States Bankruptcy Court for the District of Columbia for an arrangement under chapter 11 of the Bankruptcy Code. On May 4, 1981, the proceeding was converted to a chapter 7 liquidation. On September 4, 1981, pursuant to an order of the bankruptcy court, the Trustee in Bankruptcy, Paul D. Pearlstein, sold certain assets of the Sardis estate for $70,000.

At the time of the sale, the assets were subject to two liens. The National Savings & Trust Company (the bank) had a security interest in Sardis' assets covering a loan to Sardis. The SBA had guaranteed the loan by the bank pursuant to 15 U.S.C. Sec. 636 (Supp. V 1981) and 13 C.F.R. Sec. 122 (1982). On January 26, 1979, after Sardis had defaulted on the loan, the bank perfected its security interest by recording it with the District of Columbia Recorder of Deeds.

Following Sardis' default, the SBA paid the bank the portion of the loan it had guaranteed. On May 15, 1981, the bank assigned its claim and perfected security interest to SBA. As of May 12, 1981, the SBA's claim against the Sardis estate, secured by the transferred lien, was approximately $630,000.

The second lien against the Sardis assets was held by the District for unpaid sales taxes of approximately $81,000. The District had perfected that lien on December 8, 1980, almost two years after the bank had perfected its lien, by recording with the Recorder of Deeds.

Since the proceeds of the sale of the Sardis assets were insufficient to satisfy both liens, the trustee in bankruptcy filed a complaint in the bankruptcy court to determine their relative priority. He requested authorization to distribute the proceeds to the SBA.

The bankruptcy court, 17 B.R. 660, awarded the District tax lien priority over the SBA lien. It held that under the pertinent provision of the Bankruptcy Act (section 724(b), discussed below), the question of priority should be determined "outside of the Bankruptcy Code ... pursuant to District of Columbia law." The court then ruled that a District statute, 47 D.C.Code Sec. 2012 (1981), made "the District of Columbia's claim for sales taxes preferred over all other liens or security interests." Finally, the court held that although the District tax lien was "superior to the lien of the SBA," it was "clearly subordinate to the first five priorities of section 507(a) of the Bankruptcy Code." The court therefore directed the trustee to retain the sale proceeds until "the issue of priority of claims is resolved," at which time the proceeds will be distributed first pursuant to section 507(a), and then any surplus will go to the District.

The district court reversed. It held that under section 724(b), "the concept of 'first in time, first in right' applies with full force when a perfected security interest is faced with a statutory tax lien," and that since the SBA lien had been perfected prior to the District tax lien, the SBA lien was entitled to priority in the distribution of the proceeds of the sale of Sardis' assets. The court ruled that "[t]he D.C. law relied on [by the bankruptcy court] is not applicable to the underlying bankruptcy proceeding ... [and] was not enacted to affect federal proceedings."

II.

The relevant statutory provision in this case, section 724(b)(1) of the Bankruptcy Code, 11 U.S.C. Sec. 724(b)(1) (Supp. V 1981), provides:

(b) Property in which the estate has an interest and that is subject to a lien that is not avoidable under this title and that secures an allowed claim for taxes, or proceeds of such property, shall be distributed--

(1) first, to any holder of an allowed claim secured by a lien on such property that is not avoidable under this title and that is senior to such tax lien;

....

The district court held that the term "senior" in subsection (1) "should have its ordinary meaning of first in time," and that "[t]he concept of first in time, first in right applies with full force when a perfected security interest is faced with a statutory tax lien." The court cited a House Committee Report and Collier on Bankruptcy, which it treated as establishing that the scheme for distribution Congress set out in section 724(b)(1) subordinates tax liens to liens that are senior to the tax lien under the first in time principle. See H.R.Rep. No. 595, 95th Cong., 1st Sess. (1977), reprinted in U.S.Code Cong. & Ad.News 5787, at 5963 (1978). See also Collier, Bankruptcy p 723.03 (15th ed. 1980). Applying this principle to the two competing liens in the case, the court thus determined that "[t]he claim of the Small Business Administration under the senior perfected security interest shall be given priority over the junior D.C. tax lien."

A more detailed analysis of the legislative history of that provision and its predecessors, however, shows that in section 724(b)(1) Congress did not establish a federal system of priorities between tax and nontax liens. That history establishes that Congress intended, in bankruptcy proceedings, for the relative priority of tax and nontax liens to be determined according to the law that governs the priority of these competing interests outside of bankruptcy.

A. The starting point in the analysis is the Bankruptcy Act of 1898, ch. 541, 30 Stat. 544 (1898), which codified and changed the scattered bankruptcy statutes then existing.

A basic premise of that Act, incorporated in section 70(a), was that, upon the institution of bankruptcy proceedings, the trustee in bankruptcy acquired the interest of the debtor in the property of the estate, subject to all valid liens against the property. See 30 Stat. 565 ("The trustee of the estate of a bankrupt, upon his appointment and qualification ... shall in turn be vested by operation of law with the title of the bankrupt ...."). See also Zartman v. First National Bank, 216 U.S. 134, 138, 30 S.Ct. 368, 369, 54 L.Ed. 418 (1910) ("[T]he trustee takes the property of the bankrupt, not as an innocent purchaser, but as the debtor had it at the time of the petition, subject to all valid claims, liens and equities."); W.F. Pigg & Son v. United States, 81 F.2d 334, 335-36 (10th Cir.1936) and cases cited therein. See also Collier,Bankruptcy p 67.20, at 208.1 (14th ed. 1978).

Section 67(d) of that Act explicitly recognized as valid against the trustee liens that were not expressly invalidated by other provisions in the Act. 30 Stat. 564. "Section 67d of the Act of 1898 was intended to be a saving clause for the protection of holders of valid liens not affirmatively invalidated by the Act." Collier, Bankruptcy p 67.20, at 209 (14th ed.).

Neither section 67 nor any other provisions of the Act established priorities between competing liens that were valid in bankruptcy. Although section 64 of the Act, 30 Stat. 563, created priorities between unsecured claims, those priorities did not include or apply to liens valid against the estate. See City of Richmond v. Bird, 249 U.S. 174, 39 S.Ct. 186, 63 L.Ed. 543 (1919). In fact, liens valid in bankruptcy were required to be satisfied prior to distributions to priority claimants under section 64. See, e.g., Miners Sav. Bank of Pittston, PA. v. Joyce, 97 F.2d 973, 976 (3d Cir.1938).

Since the Bankruptcy Act of 1898 did not itself establish priorities between competing liens, the federal courts looked to nonbankruptcy law to determine priority among these secured claims. See, e.g., Lerner Stores Corp. v. Electric Maid Bake Shops, 24 F.2d 780, 782 (5th Cir.1928); Preetorius v. Anderson, 236 F. 723, 724 (5th Cir.1916); In re Byrne, 97 F. 762, 765 (S.D.Iowa 1899). The rationale of those decisions was both the failure of the Act to provide for priorities between liens valid in bankruptcy, and the basic theory of the Act, reflected in the sections discussed above, that the trustee took the property of the estate subject to existing valid liens. See Martin v. Orgain, 174 F. 772, 779 (5th Cir.1909), cert. denied, 216 U.S. 619, 30 S.Ct. 574, 54 L.Ed. 640 (1909); In re Yoke Vitrified Brick Co., 180 F. 235, 238 (D.Kan.1910).

B. Although the Chandler Act of 1938 (ch. 575, 52 Stat. 840 (1938)) substantially revised the 1898 Bankruptcy Act, it did not alter this rule of lien priorities.

The Chandler Act retained the basic treatment of liens under the 1898 Act. Section 70(a) of the Chandler Act, 52 Stat. 879-80, with some changes not relevant here, kept intact the principle of section 70(a) of the 1898 Act, which vested the trustee with the...