Nicholas v. United States (384 U.S. 678)/Opinion of the Court

The question presented in this case is whether a superseding trustee in bankruptcy is liable for interest and penalties on federal taxes incurred by a debtor in possession during an arrangement proceeding under Chapter XI of the Bankruptcy Act. The facts are not in dispute.

On August 6, 1958, Beachcomber Motel, Inc., a Florida corporation operating a motel in Miami Beach, filed an original petition for an arrangement with its unsecured creditors under Chapter XI. Bankruptcy Act § 322, 11 U.S.C. § 722 (1964 ed.). During the pendency of the arrangement proceeding, the corporation was permitted to operate its business as a debtor in possession under the authority of the bankruptcy court. In the course of its business operations, the corporation withheld federal income taxes and social security taxes from the wages paid to its employees and collected federal excise taxes on the receipts from its cabaret. Subsequently, the corporation was dispossessed of its property and the motel premises were closed.

Unable to proceed with a plan of arrangement with its creditors, the corporation filed a petition in bankruptcy on September 17, 1958, and was adjudged a bankrupt on the same date. Bankruptcy Act § 376(2), 11 U.S.C. § 776(2) (1964 ed.). On September 19, 1958, a trustee in bankruptcy, the petitioner in this case, was appointed. On October 31, 1958, the federal income taxes withheld, as well as the social security taxes and the cabaret taxes, were due to be paid. On January 31, 1959, the payroll tax imposed on employers by the Federal Unemployment Tax Act was due. The trustee in bankruptcy neither paid these taxes nor filed any of the returns required with respect to them. On April 11, 1963, the United States submitted an administrative expense statement in the bankruptcy proceeding, claiming as administrative expenses the principal of the taxes due, penalties assessed for the trustee's failure to file the returns for the taxes, and interest that had accumulated and would continue to accumulate on the taxes and penalties until they were paid.

The referee in bankruptcy allowed the Government's claim for the principal of the taxes but disallowed the claims for penalties and interest. The referee's order was affirmed in all respects by the District Court. The Court of Appeals for the Fifth Circuit reversed the judgment of the District Court and allowed the claims for penalties and interest on the taxes. 5 Cir., 346 F.2d 32. Shortly after that decision, the Court of Appeals for the Eighth Circuit reached the opposite result with respect to a similar claim by the Government for interest on taxes incurred during a Chapter XI proceeding, and we granted certiorari to resolve this conflict. 382 U.S. 971, 86 S.Ct. 541, 15 L.Ed.2d 464.

It is a well-settled principle of American bankruptcy law that in cases of ordinary bankruptcy, the accumulation of interest on claims against a bankrupt estate is suspended as of the date the petition in bankruptcy is filed. Sexton v. Dreyfus, 219 U.S. 339, 31 S.Ct. 256, 55 L.Ed. 244. That rule, grounded in historical considerations of equity and administrative convenience, was specifically made applicable to the accumulation of interest on claims for taxes by the decision of this Court in City of New York v. Saper, 336 U.S. 328, 69 S.Ct. 554, 93 L.Ed. 710.

The debts in Sexton, like the taxes in Saper, were incurred during the regular business operations of the taxpayer, prior to the invocation of any procedures under the Bankruptcy Act, whereas the taxes in the present case were incurred after a petition invoking Chapter XI of the Act had been filed. On the basis of that distinction, the Government contends that the taxes here in question were entitled to bear interest throughout the bankruptcy period. We draw no such conclusion from that distinction.

We believe that the decisions of this Court in Sexton and Saper, reflect the broad equitable principle that creditors should not be disadvantaged vis-a -vis one another by legal delays attributable solely to the time-consuming procedures inherent in the administration of the bankruptcy laws. In the context of interest-bearing debts, the equitable principle enunciated in Sexton and Saper rests at bottom on an awareness of the inequity that would result if, through the continuing accumulation of interest in the course of subsequent bankruptcy proceedings, obligations bearing relatively high rates of interest were permitted to absorb the assets of a bankrupt estate whose funds were already inadequate to pay the principal of the debts owed by the estate.

To be sure, the amount of interest that accumulates on a debt incurred during a Chapter XI arrangement depends upon the duration of a proceeding that takes place under the direction and authority of the bankruptcy court. Bankruptcy Act §§ 342, 343, 11 U.S.C. §§ 742, 743 (1964 ed.). But interest claimed on such a debt does not arise through a 'delay' of the law in any meaningful sense. The underlying obligation of the debtor in possession is incurred as part of a judicial process of rehabilitation of the debtor that the procedures of Chapter XI are designed to facilitate. Interest on a current Chapter XI obligation is therefore different in kind from interest claimed during the arrangement period on a debt incurred before the Chapter XI petition was filed. From the vantage point of pre-arrangement creditors, the panorama of a Chapter XI proceeding is intimately bound up with the intrusion of the bankruptcy law into the previously untrammelled relationship between a debtor and his creditors. For these creditors, the filing of the Chapter XI petition may legitimately be regarded as introducing the very sort of legal delay that bankruptcy courts, in denying claims for interest, have traditionally characterized as inequitable. On the other hand, from the vantage point of the creditor whose credit relationship arose during the Chapter XI proceeding itself, it is the subsequent filing of a petition in bankruptcy that marks the intervention of meaningful legal delays. The equitable rationale underlying our decisions in Sexton and Saper is therefore fully applicable to cases in which a Chapter XI proceeding is superseded by a liquidating bankruptcy.

The principle that our past decisions thus establish is that the accumulation of interest on a debt must be suspended once an enterprise enters a period of bankruptcy administration beyond that in which the underlying interest-bearing obligation was incurred. In Saper, there were two relevant periods to be considered-the pre-petition period, before the petition in bankruptcy was filed, and the post-petition period, during the bankruptcy liquidation. The Court there upheld the accumulation of interest throughout the pre-petition period on taxes incurred during that period; it rejected only the claim for post-petition interest on the pre-petition taxes. By contrast, the circumstances of the present case commend a division into three periods-the pre-arrangement period, the arrangement period, and the liquidating bankruptcy period. A tax incurred within any one of these three periods would we think, be entitled to bear interest against the bankrupt estate until, but not beyond, the close of the period in which it was incurred. Thus, in a case concerning taxes incurred during the first period-that is, before the filing of a petition for a Chapter XI arrangement-the Court has summarily affirmed a judgment holding that the accumulation of interest must be suspended as of the date the Chapter XI petition was filed. Where, as in the present case, the taxes have been incurred in the Chapter XI proceeding itself, application of the principle enunciated in Sexton and Saper permits interest to accrue throughout the arrangement proceeding; the principle requires only that the accumulation of interest be suspended once a petition in bankruptcy is filed.

The allowance of interest on Chapter XI debts until the filing of a petition in bankruptcy promotes the availability of capital to a debtor in possession and enhances the likelihood of achieving the goal of the proceeding, the ultimate rehabilitation of the debtor. Disallowance of interest on Chapter XI debts might seriously hinder the availability of such funds and might in many cases foreclose the prospect of the debtor's recovery. No such significant detriment to the viability of a Chapter XI proceeding is imposed by the suspension of interest once the proceeding enters the liquidating bankruptcy period, since potential creditors can readily adjust their interest rates to accommodate their prognosis of the particular debtor's chances of rehabilitation.

The division of the proceedings in the present case into three separate periods defining the permissible accumulation of interest is supported by the threefold hierachy of priorities for tax claims under the Bankruptcy Act. Taxes incurred in the pre-arrangement period must be content with a fourth priority under § 64a(4) of the Bankruptcy Act. On the other hand, taxes incurred during the arrangement period are expenses of the Chapter XI proceedings and are therefore technically a part of the first priority under § 64a(1). The final sentence of that section, however, subordinates arrangement expenses within that priority to the expenses of the superseding bankruptcy administration. Tax claims incurred during Chapter XI proceedings are therefore in fact junior to claims for expenses incurred in subsequent bankruptcy proceedings. The suspension of interest on taxes incurred during the arrangement period as of the date a bankruptcy petition is filed thus corresponds to the suspension of interest on pre-arrangement taxes when a Chapter XI petition is filed. Moreover, the suspension of interest extricates the superseding trustee from a serious dilemma he would otherwise face, whether to pay subordinated Chapter XI tax claims prematurely in order to forestall the accrual of interest, or to increase the burden on the bankrupt estate by allowing the interest to accumulate.

Aside from its basis in the equitable principle that creditors of a bankrupt estate should not be disadvantaged solely by means of the law's delay, the confinement of the accrual of interest on Chapter XI obligations to the arrangement proceeding itself is also grounded in significant considerations of administrative convenience. As the Court recognized in Vanston Bondholders Protective Committee v. Green, 329 U.S. 156, 164, 67 S.Ct. 237, 240, 91 L.Ed. 162 'Accrual of simple interest on unsecured claims in bankruptcy was prohibited in order that the administrative inconvenience of continuous recomputation of interest causing recomputation of claims could be avoided.' Thus, by accepting as a cutoff the date of filing of the petition in bankruptcy, the trustee avoids the potentially laborious procedure of recalculating the pro rata share to which each Chapter XI creditor is entitled whenever a distribution in the supervening bankruptcy is carried out.

The application of the principle of our past decisions to the facts of the present case is straightforward. Since the taxes in question were incurred during the Chapter XI arrangement proceeding itself, the United States was entitled to interest on those taxes for the duration of that period. The actual arrangement proceeding in this case, however, terminated before the taxes became payable, and, therefore, no interest on the taxes accumulated before the petition in bankruptcy was filed by the debtor in possession. The entire amount of interest sought by the United States represents interest claimed for the liquidating bankruptcy period. Since we hold that the accumulation of interest on debts incurred during Chapter XI proceedings is suspending on the date the petition in the superseding bankruptcy is filed, it is clear that the United States is not entitled to the interest that it seeks on the taxes in this case.

The result here is in no way inconsistent with the provisions of 28 U.S.C. § 960, which states that persons conducting a business under the authority of a federal court shall be taxed as if they were conducting a private business. As an officer of the bankruptcy court, the debtor in possession was fully subject to taxes and interest incurred during his operation of the business in the Chapter XI arrangement. Nothing in the general language of 28 U.S.C. § 960, however, necessarily subjects the trustee in the superseding bankruptcy proceeding to an obligation to pay additional interest on those prior taxes once a petition in bankruptcy has been filed. United States v. Kalishman, 346 F.2d 514; cf. City of New York v. Saper, 336 U.S. 328, 69 S.Ct. 554, 93 L.Ed. 710; United States v. General Engineering & Mfg. Co., 188 F.2d 80 (C.A.8th Cir.), aff'd, 342 U.S. 912, 72 S.Ct. 364, 96 L.Ed. 686. In the absence of explicit congressional direction, the considerations of equity and administrative convenience established by our decisions under the Bankruptcy Act clearly support this interpretation of the scope of this provision of the Judicial Code.

We find no merit in the Government's alternative suggestion that the interest on two of the taxes here in question-those withheld from the wages of employees and those collected from the patrons of the cabaret-constitutes a trust fund over which the United States has an absolute priority under § 7501(a) of the Internal Revenue Code. We need not here determine whether, with regard to the principal of those taxes, the general language of § 7501(a) overrides the strong policy of § 64a(1) of the Bankruptcy Act, which establishes a sharply defined priority that places all expenses of administration on a parity, including claims for taxes. Cf. Guarantee Title and Trust Co. v. Title Guaranty & Surety Co., 224 U.S. 152, 32 S.Ct. 457, 56 L.Ed. 706; Davis v. Pringle, 268 U.S. 315, 45 S.Ct. 549, 69 L.Ed. 974; Missouri v. Ross, 299 U.S. 72, 57 S.Ct. 60, 81 L.Ed. 46. The second sentence of § 7501(a) specifically provides that interest on such a trust fund is collectible in the same manner as the taxes from which the fund arose. Since we have already determined that no interest on any of the taxes here in question accrues beyond the period of the arrangement proceeding, no interest could accumulate on a trust fund composed of the withholding and cabaret taxes.

We therefore reverse the judgment of the Court of Appeals with regard to the liability of the trustee for the interest on the taxes.

The validity of the claim by the United States against the trustee for penalties for failure to file the returns for the taxes in question presents a completely different issue. The result here is governed squarely by the rationale of our decision in Boteler v. Ingels, 308 U.S. 57, 60 S.Ct. 29, 84 L.Ed. 78 in which we sustained a penalty against a trustee in bankruptcy who failed to pay state automobile license taxes incurred while he was operating the business of the bankrupt estate for the purpose of liquidation. We held in Boteler that Congress, under the predecessor of 28 U.S.C. § 960, had 'with vigor and clarity declared that a trustee and other court appointees who operate businesses must do so subject to State taxes 'the same as if such business(es) were conducted by an individual or corporation." 308 U.S., at 61, 60 S.Ct. at 32. As we stated in Boteler, if the trustee were exempt from the penalty, a 'State would thus be accorded the theoretical privilege of taxing businesses operated by trustees in bankruptcy on an equal footing with all other businesses, but would be denied the traditional and almost universal method of enforcing prompt payment.' Id., at 61, 60 S.Ct. at 32.

The same considerations are equally applicable to the present case. It is conceded that the trustee, in his status as representative of the bankrupt estate and successor in interest to the debtor in possession, is liable for the principal of the taxes incurred by the debtor in possession, to the extent of the priority enjoyed by the taxes under § 64a(1) of the Bankruptcy Act. Once that liability is established, there can be no question that, under § 6011(a) of the Internal Revenue Code, the trustee was under an obligation to file returns for these taxes, even though the taxes themselves were incurred by the debtor in possession during the pendency of the arrangement proceeding. It therefore follows under Boteler that, in the circumstances of the present case, where a Chapter XI arrangement has been superseded by a liquidating bankruptcy under the Bankruptcy Act, the United States is entitled to exact the penalties here in question as a legitimate means to enforce the prompt filing of the tax returns. Although the rule in Boteler may be open to some question as applied to the facts of that case, no such difficulty is presented here. In Boteler, the trustee was penalized for his failure actually to pay the license fees within the time period prescribed by the State, even though it could not have been clear at that date that the assets of the bankrupt estate would be sufficient to pay all of the expenses of administration that were entitled to share equally with the taxes under the first priority of § 64a(1) of the Bankruptcy Act in any distribution of assets from the estate. In the present case, on the other hand, the penalties were imposed solely because of the trustee's failure to file timely returns for the taxes incurred during the Chapter XI arrangement period.

No legitimate interest would be served by permitting the trustee to escape the unburdensome responsibility of merely filing the returns and thereby notifying the United States of the taxes that are due. We therefore affirm the judgment of the Court of Appeals with regard to the liability of the trustee for the penalties in question.

For the reasons stated, the judgment of the Court of Appeals for the Fifth Circuit is affirmed in part and reversed in part, and the case is remanded to the Court of Appeals for further proceedings consistent with this opinion.

It is so ordered.

Affirmed in part and reversed in part, and case remanded.