UNITED STATES v. ENERGY RESOURCES CO.

(COMMISSION TRACK NUMBER 321)

Present Law

Under section 1129(a)(9)(C) of the Bankruptcy Code, a plan of reorganization may provide for the payment of certain priority tax claims over a six-year period commencing on the date of assessment of such claim, provided that the payments have a value, as of the effective date of the plan, equal to the allowed amount of such tax claim. Governmental authorities may have more than one tax claim in any given case. It is not clear from the statute whether each tax claim is payable over a six-year period, and if not, how payments made during the six-year period are applied in the case of any single taxing authority, among several tax claims dealt with under the plan.

It is a general principle of commercial law that when a debtor owes two or more debts, he may designate a partial payment as satisfying either (fn. 112). The Internal Revenue Service has generally adopted this view with respect to multiple tax claims. Thus, the Service permits a debtor outside of bankruptcy to apply any payment to the principal amount of a tax claim, or to interest or penalties, as the debtor sees fit (fn. 113). However, the Service and other taxing authorities have taken the position that if a payment is "involuntary," e.g., where the government levies against property to satisfy a tax claim, the government, and not the taxpayer, applies the payment as it sees fit (fn. 114). The most significant consequence of the application of a payment today is that the government will apply partial payments to those tax liabilities that are nondischargeable in bankruptcy or which are not "trust fund taxes" as to which the government may pursue individuals for collection of the taxes if the primary taxpayer does not pay.

Taxing authorities historically took the position that all tax payments made in a chapter 11 plan are involuntary, so that payments under section 1129(a)(9)(C) would be applied to the trust fund portion of any liability only after all other tax debts were satisfied. Prior to the decision by the United States Supreme Court, the lower courts were divided, some holding that payments made pursuant to a chapter 11 plan were involuntary (fn. 115) and therefore could not be allocated by the debtor to the trust fund portion of its tax liabilities, while other courts permitted the debtor to make such an allocation (fn. 116). In United States v. Energy Resources Co., (fn. 117) the Supreme Court rejected an analysis based on whether the payments were deemed to be "voluntary" or "involuntary." Instead the Court held that the bankruptcy court may approve an allocation of payments to trust fund liabilities pursuant to a plan if it finds that such an allocation is necessary for the success of the reorganization. Thus, the bankruptcy court is to make a judgment in each case, based upon all of the facts and circumstances of the case.

Proposals Before the Commission

Commission Track Number 321. The Government Working Group proposes that the Bankruptcy Code be amended to overrule the decision in Energy Resources and "allow taxing authorities to allocate payments made in the course of bankruptcy in a manner that preserves alternative sources of collection." Government Working Group Proposal No. 3. See also Justice Proposal, p. 102; IRS Proposal, p. 45; Santa Fe Discussion Issues, p. 19, Item IIIA.

Task Force Position

The Task Force opposes these proposals. The Supreme Court's decision in United States v. Energy Resources Co. should continue to govern, and the Bankruptcy Court's authority to enjoin collection from third parties should be made clear.

Reasons for Position

Although many of the proposals now before the Commission provoke debate giving rise to a spectrum of views within both the government and the private bar, this Commission proposal is one of the few that sharply divides the government and the private sector. Without exception, government spokesmen urge the legislative overruling of the Energy Resources decision. Government representatives believe that under Energy Resources chapter 11 debtors will in bad faith propose plans that will apply partial payments to satisfy trust fund taxes, leaving the government with the risk of default on the non-trust fund portion, which cannot be satisfied until a later date. On the other hand, private practitioners almost unanimously view this proposal as either unwise, mean-spirited or striking at the heart of the chapter 11 process. It will therefore not surprise anyone that this Task Force opposes repeal. The Commission is well aware of the recitation of thc policy reasons in favor of retaining the Energy Resources rule. The Energy Resources decision already represents a balancing of views. It does not favor either the government or the debtor, but instead leaves the determination to the discretion of the bankruptcy court on a case by case basis. To confirm the plan, the bankruptcy judge must make a finding based on evidence that the plan is feasible. The taxing authority may be heard on that issue. If the plan is feasible, then the government will ultimately collect 100 percent of its priority taxes. Allocation of early payments to trust fund taxes may encourage insiders to invest further capital or key employees to continue to work for the debtor. In such case, there seems little reason to visit upon individuals the personal pain and anxiety that a six-year payout will generate, to say nothing of the very real possibility that the taxing authorities will attempt to pursue them for collection of the trust fund portion of the taxes even if there is no reason to believe that they will not ultimately be paid by the debtor. The price seems too high to pay in human terms.

It should be noted that the Congress has squarely faced this issue twice before. In 1988, legislation was introduced in the House but failed to pass. On November 3, 1989, the Senate passed the Federal Debt Collection Practices Act. Section 201 of the bill would have permitted a governmental unit to apply tax payments "in a manner that preserves alternative sources of collection, if any." There were no Senate hearings and no opportunity for public comment. There is no evidence that the Senate in enacting this provision had any idea of what it was voting on. "Because the Senate had acted on the legislation without formal hearings, the House Judiciary Committee decided to pursue the important issues raised by the proposal with a hearing in which a broad range of witnesses would testify on issues involving enforcement activity, the state of debtor/creditor laws with respect to both impediment to government collection and protection to the debtor and other non-governmental creditors, and the implications of a new Federal debt collection law for bankruptcy law and tax law" (fn. 118).

The House Committee on the Judiciary held hearings, and for the first time, these hearings elicited testimony in response to section 201. The majority and minority staff of the Judiciary Committee actively followed the argument, and members questioned witnesses during the hearing. The result was that the Energy Resources repealer was removed from the House version of the bill. More important, it was not adopted in the final version of the Act. Faced clearly with the arguments on both sides of this issue, the Congress affirmatively chose not to adopt repeal. The same agencies that sought adoption of this unwise provision in 1988 and 1990 are back in the hope of enlisting the support of the Commission.

The position of the taxing authorities before the Commission is not without irony. These authorities admit that on the day before bankruptcy the responsible officers having personal liability can write a corporate check to the taxing authority in satisfaction of the trust fund liabilities and the trustee cannot recover such a payment as a preference (fn. 119). In fact, state taxing authorities openly encourage retail debtors to remit to them all sales tax collections up to the date of a bankruptcy filing notwithstanding that tax returns are not yet due, for the express purpose of relieving the responsible officers of personal liability and the expense and agony of resisting collection. Many retail debtors, being well advised, in fact make these payments prior to filing and spare themselves and their responsible officers this litigation. Others, unaware, create unwanted pain for their officers. Yet, these very same taxing authorities would not permit the debtor to make these payments at the front end of a plan of reorganization if the Congress adopts the government's proposals. The practical result will be that these officers will be made personally liable for taxes for which no statute provides personal responsibility. As a result, they would now be held hostage for trust fund taxes until every other penny of tax liability will be paid. These proposals contravene the goals of the Bankruptcy Code and should be rejected.

Consideration of the issues raised by Energy Resources necessarily involves the jurisdiction of the Bankruptcy Court to enjoin collection of trust fund taxes from responsible officers while deferred payments are made by the debtor under section 1129(a)(9)(C). For this purpose, we temporarily put aside the general question of bankruptcy court jurisdiction to determine the liability of non-debtors (fn. 120). The Task Force hopes to have a proposal on this question for the Commission in the near future, but we have found it to be a "more than meets the eye" problem. Our narrow focus here is on balancing the preservation of the government's alternative sources of collection against the responsible officer's legitimate expectation that the debtor will satisfy the obligation.

When employment taxes required to be withheld are not collected and paid over, Internal Revenue Code Section 6672 imposes a "100% penalty" on individuals responsible for remitting these taxes to the Treasury. Similar rules apply to federal, state and local sales and excise taxes. These amounts are not property of the estate and should be collectible by the taxing authority under applicable tracing principles. Otherwise, they are collectible in accordance with priority and deferred payment rules.

Outside of Chapter 11, failure by the employer to pay gives the taxing authority immediate collection remedies against individuals determined to be responsible, and this is proper. But although a literal reading of Internal Revenue Code Section 6672 might impose liability on the responsible person in addition to the employer, or upon more than one individual for the same amount, the IRS concedes that Internal Revenue Code Section 6672 is merely a device to collect a tax once. Payment by the employer will relieve the responsible officer of liability.

If the Service is permitted to pursue the individuals during the time the debtor avails itself of the privilege of deferring payments under section 1129, an injustice will result. The individual's payment will, as a practical matter, relieve the debtor of the obligation it undertook in the plan of reorganization. It is not an answer that the responsible officer can then pursue the debtor. Assuming, although it is not clear, that the responsible officer is subrogated to the taxing authority's claim, he does not appear to be subrogated to the taxing authority's priority (fn. 121). The other unsecured creditors will have received a windfall.

Accordingly, the Bankruptcy Code and the Internal Revenue Code should be amended to provide that in chapter 11 there should be an automatic stay upon filing a petition and a permanent injunction upon confirmation of a plan, against collection of trust fund taxes from a debtor's employees. The taxing authority should be entitled to a lifting of the stay or the injunction upon a showing that collection of the tax from the debtor is in jeopardy. Neither the stay nor the injunction would preclude filing a lien against the responsible officers once their liability has been determined. In this way, the taxing authority's interests would be protected.

Other Institutional Positions

The Association of the Bar of the City of New York opposes repeal of Energy Resources. A focus group of the American College of Bankruptcy takes the same position. The National Bankruptcy Conference would allow the debtor to allocate payments.

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fn. 112: See National Bank v. Mechanics Nat'l Bank, 94 U.S. 437 (1876).

fn. 113: See e.g., Rev. Rul. 79-284, 1979-2 C.B. 83.

fn. 114: Amos v. Comm., 47 T.C. 65 (1966).

fn. 115: In re Matter of Ribs-R-Us, 828 F.2d 199 (3d Cir. 1987); In re DuCharmes & Co., 852 F.2d 194 (6th Cir. 1988); In re Technical Knockout Graphics, 833 F.2d 797 (9th Cir. 1987).

fn. 116: In re Energy Resources Co., Inc. 871 F.2d 223 (1st Cir. 1989), aff'd, 495 U.S. 545 (1990); In re A&B Heating and Air Conditioning, 823 F.2d 462 (11th Cir. 1987), vacated, 486 U.S. 1002 (1988), on remand 861 F.2d 1538 (11th Cir. 1988), further opinion, 878 F.2d 1311 (11th Cir. 1989).

fn. 117: 495 U.S. 545 (1990).

fn. 118: H. Rep. No. 101-736, 101st Cong., 2d Sess. 26 (1990).

fn. 119: Begier v. United States, 496 U.S. 53 (1990).

fn. 120: See e.g., In re Quattrone Accountants, Inc. 895 F.2d 921 (3d Cir. 1990) and In re Wolverine Radio Co., 930 F.2d 1132 (6th Cir. 1991).

fn. 121: Bankruptcy Code Section 507(d).

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Last updated June 1, 1997