U.S. v. Noland

• Decision Date: 13 May 1996
• Docket Number: 95323
• Parties: UNITED STATES v. NOLAND, TRUSTEE FOR DEBTOR FIRST TRUCK LINES, INC.
• Court: U.S. Supreme Court

517 U.S. 535

116 S.Ct. 1524

134 L.Ed.2d 748

UNITED STATES

v NOLAND, TRUSTEE FOR DEBTOR FIRST TRUCK LINES, INC.

Certiorari to the United States Court of Appeals for the Sixth Circuit.

No. 95-323.

Supreme Court of the United States

Argued March 25, 1996

Decided May 13, 1996

Syllabus ^*

The Internal Revenue Service filed claims in the Bankruptcy Court for taxes, interest, and penalties that accrued after debtor First Truck Lines, Inc., sought relief under Chapter 11 of the Bankruptcy Code but before the case was converted to a Chapter 7 bankruptcy. The court found that all of the IRS's claims were entitled to first priority as administrative expenses under 11 U. S. C. Section(s) 503(b)(1)(C) and 507(a)(1), but held that the penalty claim was subject to ``equitable subordination'' under Section(s) 510(c), which the court interpreted as giving it authority not only to deal with inequitable Government conduct, but also to adjust a statutory priority of a category of claims. The court's decision to subordinate the penalty claim to the claims of the general unsecured creditors was affirmed by the District Court and the Sixth Circuit, which concluded that postpetition, nonpecuniary loss tax penalty claims are susceptible to subordination by their very nature.

Held: A bankruptcy court may not equitably subordinate claims on a categorical basis in derogation of Congress's priorities scheme. The language of Section(s) 510(c), principles of statutory construction, and legislative history clearly indicate Congress's intent in its 1978 revision of the Code to use the existing judge-made doctrine of equitable subordination as the starting point for deciding when subordination is appropriate. By adopting "principles of equitable subordination," Section(s) 510(c) allows a bankruptcy court to reorder a tax penalty when justified by particular facts. It is also clear that Congress meant to give courts some leeway to develop the doctrine. However, a reading of the statute that would give courts leeway broad enough to allow subordination at odds with the congressional ordering of priorities by category is improbable in the extreme. The statute would then empower a court to modify the priority provision's operation at the same level at which Congress operated when it made its characteristically general judgment to establish the hierarchy of claims in the first place, thus delegating legislative revision, not authorizing equitable exception. Nonetheless, just such a legislative type of decision underlies the reordering of priorities here. The Sixth Circuit's decision runs directly counter to Congress's policy judgment that a postpetition tax penalty should receive the priority of an administrative expense. Since the Sixth Circuit's rationale was inappropriately categorical in nature, this Court need not decide whether a bankruptcy court must always find creditor misconduct before a claim may be equitably subordinated. Pp. 3-9. 48 F. 3d 210, reversed and remanded.

Souter, J., delivered the opinion for a unanimous Court.

Justice Souter delivered the opinion of the Court.

The issue in this case is the scope of a bankruptcy court's power of equitable subordination under 11 U. S. C. Section(s) 510(c). Here, in the absence of any finding of inequitable conduct on the part of the Government, the Bankruptcy Court subordinated the Government's claim for a postpetition, noncompensatory tax penalty, which would normally receive first priority in bankruptcy as an "administrative expense," Section(s) 503(b)(1)(C), 507(a)(1). We hold that the bankruptcy court may not equitably subordinate claims on a categorical basis in derogation of Congress's scheme of priorities.

In April 1986, First Truck Lines, Inc., voluntarily filed for relief under Chapter 11 of the Bankruptcy Code, and in the subsequent operation of its business as a debtor-in-possession incurred, but failed to discharge, tax liabilities to the Internal Revenue Service. First Truck moved to convert the case to a Chapter 7 liquidation in June 1988, and in August 1988 the Bankruptcy Court granted that motion and appointed respondent Thomas R. Noland as trustee. The liquidation of the estate's assets raised insufficient funds to pay all of the creditors.

After the conversion, the IRS filed claims for taxes, interest, and penalties that accrued after the Chapter 11 filing but before the Chapter 7 conversion, and although the parties agreed that the claims for taxes and interest were entitled to priority as administrative expenses, Section(s) 503(b), 507(a)(1), and 726(a)(1), ¹ they disagreed about the priority to be given tax penalties. The Bankruptcy Court determined that the penalties (like the taxes and interest) were administrative expenses under Section(s) 503(b) but held them to be subject to equitable subordination under Section(s) 510(c). ² In so doing, the Court read that section to provide authority not only to deal with inequitable conduct on the Government's part, but also to adjust a statutory priority of a category of claims. The Bankruptcy Court accordingly weighed the relative equities that seemed to flow from what it described as "the Code's preference for compensating actual loss claims," and subordinated the tax penalty claim to those of the general unsecured creditors. In re First Truck Lines, Inc., 141 B. R. 621, 629 (SD Ohio 1992). The District Court affirmed. Internal Revenue Service v. Noland, 190 B. R. 827 (SD Ohio 1993).

After reviewing the legislative history of the 1978 revision to the Bankruptcy Code and several recent appeals cases on equitable subordination of tax penalties, the Sixth Circuit affirmed, as well. In re First Truck Lines, Inc., 48 F. 3d 210 (1995). The Sixth Circuit stated that it did

"not see the fairness or the justice in permitting the Commissioner's claim for tax penalties, which are not being assessed because of pecuniary losses to the Internal Revenue Service, to enjoy an equal or higher priority with claims based on the extension of value to the debtor, whether secured or not. Further, assessing tax penalties against the estate of a debtor no longer in existence serves no punitive purpose. Because of the nature of postpetition, nonpecuniary loss tax penalty claims in a Chapter 7 case, we believe such claims are susceptible to subordination. To hold otherwise would be to allow creditors who have supported the business during its attempt to reorganize to be penalized once that effort has failed and there is not enough to go around." Id., at 218.

See also Burden v. United States, 917 F. 2d 115, 120 (CA3 1990); Schultz Broadway Inn v. United States, 912 F. 2d 230, 234 (CA8 1990); In re Virtual Network Services Corp., 902 F. 2d 1246, 1250 (CA7 1990). We granted certiorari to determine the appropriate scope of the power under the Bankruptcy Code to subordinate a tax penalty, 516 U. S. ___ (1995), and we now reverse.

The judge-made doctrine of equitable subordination predates Congress's revision of the Code in 1978. Relying in part on our earlier cases, see, e.g., Comstock v. Group of Institutional Investors, 335 U. S. 211 (1948); Pepper v. Litton, 308 U. S. 295 (1939); Taylor v. Standard Gas & Elec. Co., 306 U. S. 307 (1939), the Fifth Circuit, in its influential opinion in In re Mobile Steel Co., 563 F. 2d 692, 700 (CA5 1977), observed that the application of the doctrine was generally triggered by a showing that the creditor had engaged in "some type of inequitable conduct." Mobile Steel discussed two further conditions relating to the application of the doctrine: that the misconduct have "resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant," and that the subordination "not be inconsistent with the provisions of the Bankruptcy Act." Ibid. This last requirement has been read as a "reminder to the bankruptcy court that although it is a court of equity, it is not free to adjust the legally valid claim of an innocent party who asserts the claim in good faith merely because the court perceives that the result is inequitable." DeNatale & Abram, The Doctrine of Equitable Subordination as Applied to Nonmanagement Creditors, 40 Bus. Law. 417, 428 (1985). The district courts and courts of appeals have generally followed the Mobile Steel formulation, In re Baker & Getty Financial Services, Inc., 974 F. 2d 712, 717 (CA6 1992).

Although Congress included no explicit criteria for equitable subordination when it enacted Section(s) 510(c)(1), the reference in indicates congressional intent at least to start with existing doctrine. This conclusion is confirmed both by principles of statutory construction, see Midlantic Nat. Bank v. New Jersey Dept. of Environmental Protection, 474 U. S. 494, 501 (1986) ("The normal rule of statutory construction is that if Congress intends for legislation to change the interpretation of a judicially created concept, it makes that intent specific. The Court has followed this rule with particular care in construing the scope of bankruptcy codifications") (citation omitted), and by statements in the legislative history that Congress "intended that the term `principles of equitable subordination' follow existing case law and leave to the courts development of this principle," 124 Cong. Rec. 32398 (1978) (Rep. Edwards); see also id., at 33998 (Sen. DeConcini). In keeping with pre-1978 doctrine, many Courts of Appeals have continued to require inequitable conduct before allowing the equitable subordination of most claims, see, e.g., In re Fabricators, Inc., 926 F. 2d 1458, 1464 (CA5 1991); In re Bellanca Aircraft Corp., 850 F. 2d 1275, 1282-1283 (CA8 1988), although several have done away with the requirement when the claim in question was a tax penalty. See, e.g., Burden, supra, at 120; Schultz, supra, at 234; In re Virtual Network, supra, at 1250.

penalty, since the Code's requirement that a Chapter 7 trustee must distribute assets "in the order specified in . ....