United States v. Conston, Inc. (In Re Conston, Inc.)United States v. Conston, Inc. (In Re Conston, Inc.)
OPINION
When one travels the roads leading to the intersection of the Internal Revenue and Bankruptcy Codes, one may expect some curves. The present matter fives up to expectations! This bankruptcy appeal poses the question of whether an Internal Revenue Service claim for corporate income taxes, accorded seventh priority in a Chapter 11 reorganization case and contained in a confirmed reorganization plan, may reacquire a priority position when the debtor defaults on the Reorganization Plan and thereafter files a second Chapter 11. Pared to its core, this question implicates the meaning of “discharge” in the context of serial or sequential Chapter 11 cases and asks whether discharge causes a corporate income tax claim to lose its metaphysical nature as a tax claim when a reorganization plan is confirmed. The bankruptcy court held that the IRS tax claims became a non-priority general unsecured claims after confirmation of the debtor’s plan in the initial Chapter 11 proceedings. For the reasons that follow, the Court holds that the IRS claims may qualify for priority treatment in a serial Chapter 11 proceeding, provided the claims meet the statutory requirements for priority set out in the Bankruptcy Code as measured in relation to the debtor’s second Chapter 11 petition.
I. Proceedings Below
On June 20, 1990, Conston Corporation and its subsidiaries (collectively “Conston”) filed their first petition for reorganization under Chapter 11 of the Bankruptcy Code in the Eastern District of Pennsylvania. Docket Item (“D.I.”) 1, Exhibit (“Exh.”) B at ¶2, Exh. C at ¶ 2. The Internal Revenue Service (“IRS”) filed claims against the debtor’s estate for unpaid corporate income taxes accruing during periods prior to the debtor’s bankruptcy petition. These unsecured claims received seventh priority for payment by the estate pursuant to 11 U.S.C. § 507(a)(7),
1
and
Conston began to operate under the reorganization plan and made several payments to the IRS. Id., Exh. B at ¶ 4, Exh. C at ¶ 4. The reorganization plan did not solve Con-ston’s financial woes, however, and, on February 26, 1992, less than one year from the confirmation of the reorganization plan, Con-ston filed a new Chapter 11 petition in the bankruptcy court for the District of Delaware. D.I. 4 at 2. The present appeal stems from this second Chapter 11 petition.
In the second Chapter 11 proceeding, the IRS filed claims for unpaid portions of corporate income taxes included in the confirmed reorganization plan of the initial Chapter 11. D.I. 1, Exh. A. The IRS again asserted priority for these taxes under 11 U.S.C. § 507(a)(7).
3
Conston agreed that it had an outstanding obligation to the IRS, but asserted that because the original tax claims were discharged in the first reorganization plan, Conston’s obligations to the IRS stemming from the reorganization plan should be allowed in the present Chapter 11 only as general unsecured claims. D.I. 1, Exh. B. Relying on
In re Benjamin Coal Co.,
II. Stepping Back to View the Big Picture
Before turning to the specific issue presented in this appeal, it is beneficial to briefly survey the “big picture” under the Bankruptcy Code. Broadly speaking, when Congress enacted the Bankruptcy Code in 1978, it envisioned three remedies for a debtor who defaults on a non-fraudulent confirmed Chapter 11 reorganization plan: i) plan modification, including possible modification from a reorganizing to a liquidating plan, 11 U.S.C. § 1127(b) (permitting modification prior to substantial consummation of the confirmed plan); ii) conversion to Chapter 7, 11 U.S.C. §§ 1112(b)(7)-(8) (permitting conversion following default or failure to substantially consummate the reorganization plan); and iii) dismissal of the Chapter 11,
id.
(permitting dismissal following default or failure to substantially consummate the confirmed plan). Over time, debtors began to utilize a fourth option never envisioned by Congress but also not prohibited under the Code enacted by Congress — a second or serial Chapter 11 petition for relief, such as Conston has pursued in this case.
Cf. Fruehauf Corp. v. Jartran, Inc. (In re Jartran, Inc.),
Within the pre-serial Chapter 11 universe of modification, conversion, and dismissal, the courts developed legal constructs to describe the practical implications of the discharge and confirmation concepts found in the Code. The general concept of discharge flows from § 1141, which provides “[e]xcept as otherwise provided in this subsection, in the plan, or in the order confirming the plan, the confirmation of a plan ... discharges the debtor from any debt that arose before the date of such confirmation.” 11 U.S.C. § 1141(d)(1)(A). The purpose of this section is to give the debtor a fresh start — “a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting [sic] debt.”
Local Loan Co. v. Hunt,
To put teeth into § 1141(d), the Code states that discharge voids any existing judgments against the debtor and “operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived.” 11 U.S.C. §§ 524(a)(1) — (2); see also S.Rep. No. 989, 95th Cong., 2d Sess. 80 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5866 (stating that discharge acts “as a total prohibition on debt collection actions”). 5 The § 524(a) discharge injunction operates into perpetuity to ensure the post-confirmation debtor receives the fresh start envisioned in § 1141(d)(1), and, “[i]n effect, the discharge extinguishes the debt.” Id. (emphasis added). The sanctuary of the discharge injunction is limited only as “provided in this subsection, in the plan, or in the order confirming the plan.” 11 U.S.C. § 1141(d)(1).
In the pre-serial Chapter 11 universe of plan modification, conversion, or dismissal of a defaulting Chapter 11 plan, the courts borrowed the adjective “extinguished” to create a judicial gloss describing how discharge impairs a creditor’s post-confirmation ability to enforce its pre-confirmation claim. When a court states that discharge “extinguishes” a debt, the judicial gloss implies, quite accurately, that the creditor can enforce only those pre-confirmation claims found in the confirmed plan and that the creditor can enforce those claims only in the manner and
In a separate line of cases, the courts, including the Third Circuit Court of Appeals, have recognized that “discharged” debts continue to exist despite their unenforceability against the debtor on the basis of 11 U.S.C. § 524(e), which states “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”
See, e.g., First Fidelity Bank v. McAteer,
III. Conston’s Position
In the face of this well-settled understanding, Conston seeks to extend and redefine the meaning of discharge in a manner far removed from that contemplated by Congress and in derogation of Congress’s explicit statutory directives. The essence of Con-ston’s position is that confirmation of the
Conston finds support in
In re Benjamin Coal Co.,
The bankruptcy court, the district court, and the Third Circuit Court of Appeals all disagreed with the shareholder and held that administrative expenses incurred in a Chapter 11 reorganization do not automatically retain administrative expense priority in a subsequent conversion to Chapter 7. The court of appeals held that, post-confirmation, the creditor had only “former administrative claims” and no longer held the right to preferential treatment that the creditor had held before confirmation. Id. at 827. In other words, the court held the shareholder “simply no longer had an ‘administrative claim’ ” and stated:
[O]nce the reorganization plan is approved by the bankruptcy court, each claimant gets a ‘new’ claim, based upon whatever treatment is accorded to it in the plan itself. Thereafter, each claimant’s remedies for any future nonpayment of claims acknowledged in the plan are limited to the usual remedies for the type of claim granted by the plan’s provisions.
Id. According to Conston, Benjamin Coal stands for the proposition that, post-confirmation, the IRS holds former tax claims with no relationship whatsoever to the claims’ original nature as corporate income taxes and that these IRS claims consequently cannot qualify as taxes for priority treatment under § 507(a)(7).
Conston draws further support from dicta found in
Benjamin Coal.
In the concluding portion of its opinion, the
Benjamin Coal
court questioned a Seventh Circuit Court of Appeals holding on the issue identical to that presently before this Court. In the
Matter of Official Comm, of Unsecured Creditors of White Farm Equip. Co.,
the court of appeals held that a trust fund tax claim contained in a confirmed Chapter 11 plan could acquire priority status in a subsequent Chapter 11 if the claim could independently qualify for priority status in the second bankruptcy proceeding.
The Court does not read
Benjamin Coal
as broadly as Conston and the bankruptcy court below. First, although the court of appeals did use broad language in criticizing the Seventh Circuit’s
White Farm
decision, this language amounts to no more than dicta, albeit strong dicta. Chief Justice Marshall established long ago that “[i]t is a maxim not to be disregarded, that general expressions, in every opinion, are to be taken in connection with the case in which those expressions are used. If they go beyond the ease, they may be respected, but ought not to control the judgment in a subsequent suit when the very point is presented for decision.”
Cohens v. Virginia,
Second, the
Benjamin Coal
court quite simply never discussed whether a claim’s intrinsic pre-petition attributes survive discharge, and the court never stated the ‘new’ claims granted in the reorganization plan may never acquire priority status in a subsequent Title 11 proceeding. What the court of appeals unequivocally
did
hold was that the bankruptcy created characteristic of priority does not, of its own accord, survive confirmation of the plan and automatically resurrect itself in a future
Title 11
proceeding.
In re Benjamin Coal Co.,
Third,
Benjamin Coal
neither endorsed the judicial gloss of discharge that would ‘extinguish’ all vestiges of the original claim nor displaced the bedrock principle that discharge only enjoins enforcement while leaving the underlying debt in place. Furthermore, because “characteristic[s] fitting in certain contexts may be unsuitable in others,”
NationsBank of N.C., N.A. v. Variable Annuity Life Ins. Co.,
— U.S. -, -,
IV. Analysis
The Court concludes that, at least in the case of corporate income taxes, some attributes of the underlying tax claim must
A. Assessment of Tax Claims
Broadly speaking, the Internal Revenue Code authorizes the Secretary of the Treasury to make an assessment of all federal taxes not paid in a timely manner. 26 U.S.C. § 6201(a). An assessment is “essentially a bookkeeping notation ... made when the Secretary ... establishes an account against the taxpayer on the tax rolls,”
Laing v. United States,
Not unexpectedly, it is common for corporations to file a Chapter 11 reorganization petition while delinquent in the payment of as yet unassessed corporate income taxes. When the debtor files a petition for relief, the automatic stay provisions of the Bankruptcy Code restrain the IRS from assessing or collecting delinquent taxes. 11 U.S.C. § 362(a)(6). The automatic stay does not indefinitely forestall assessment of delinquent taxes, however; 11 U.S.C. § 505(c) permits assessment of a tax, “notwithstanding section 362 of this title,” once the bankruptcy court has made a determination of tax liability. Congress also coordinated the automatic stay with the procedural aspects of the assessment in the Bankruptcy Tax Act of 1980.
See
S.Rep. No. 1035, 96th Cong., 2d Sess. 48 (1980),
reprinted in
1980 U.S.C.C.A.N. 7017, 7061;
see generally id.
at 46-53,
reprinted
at 7059-66. The IRS may immediately assess any deficiency on “the debtor” as soon as “liability for such tax has become res judicata pursuant to a determination in a case under title 11 of the United States Code,” 26 U.S.C. § 6871(b)(2);
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in other words, Congress authorized the IRS to assess a tax as soon as the tax has become fixed by a final judgment by an appropriate court in the bankruptcy process.
See also
S.Rep. No. 1035 at 49,
reprinted in
1980 U.S.C.C.A.N. at 7062 (“[Because] no purpose would be served by requiring issuance of a deficiency notice prior to assessment...., the bill permits immediate assessment of a corporate debtor’s tax liabilities once the bankruptcy court has made a determination which is res judicata.”);
id.
at 50,
reprinted
at 7063 (“if the bankruptcy court has made a determination of the debtor’s tax liability which (under the doctrine of res judicata) precludes the debtor from relitigating the
Just as the Internal Revenue Code contemplates assessment activity during the post-confirmation period, the Code contemplates that the IRS may undertake tax collection activities during the post-confirmation period. The Code provides that the Secretary may collect an assessed tax “by levy or by a proceeding in court” within the applicable limitations period. 26 U.S.C. § 6502(a)(1). A bankruptcy petition will suspend this limitations period, however, “for the period during which the Secretary is prohibited by reason of such case ... from collecting” and for 6 months thereafter. 26 U.S.C. § 6503(h)(2). As with assessment, the fair import of these sections is that the monies collected by the IRS for claims granted in the confirmed plan are tax monies.
Several other factors point to the same conclusion. First, the legislative history of the Bankruptcy Tax Act of 1980 indicates that Congress intended “the provisions of the Code relating to collection of assessed taxes apply” after assessment in a bankruptcy case. S.Rep. No. 1035 at 50,
reprinted in
1980 U.S.C.C.A.N. at 7063. Second, neither the Internal Revenue nor the Bankruptcy Codes limit the application of § 6503(h)(2) to any class of debtor entity or to any class of priority tax claims. Third, when Congress amended § 6503(h) in the Bankruptcy Tax Act of 1980, it did not add any restrictions on § 6503(h)’s applicability to Chapter 11 cases. Finally, while at least one court has held that § 6503(h) applies only to Chapter 7 and individual Chapter 11 cases,
see In re Flanigan’s Enter., Inc.,
Placed against the backdrop of the post-confirmation assessment and collection activities permitted by statute, the difficulties with Conston’s position emerge. For example, under Conston’s theory, the IRS could not assess the ‘new’ claim pursuant to 26 U.S.C. § 6871 because discharge “extinguishes” the original tax claim and eviscerates the very identification of the IRS claim as a claim arising from taxes. In fact, the IRS could never assess a discharged priority tax, regardless of whether a second Chapter 11 occurs or not, because the IRS claim would no longer exist as a tax claim. Likewise, the IRS would have no authority to collect its post-discharge claim because the statutory prerequisite to collection, the assessment, could not take place. Indeed, it is not at all inconceivable that a discharged debtor would attempt to defend against an IRS action for unpaid discharged priority taxes by asserting the maxim “taxation is a game which must be played strictly in accordance with the rules,”
Philadelphia & Reading v. United States,
Nothing in this analysis derogates from the discharge and confirmation provisions of § 1141(d)(1). Permitting the IRS to assess a claim that is
res judicata,
even after confirmation, does not expand the debts and claims against the debtor. Further, the discharge injunction does not act as a blanket prohibition on collection activities; § 1141(d)(1) discharges the debtor “[ejxcept as otherwise provided in this subsection, in the plan, or in the order confirming the plan.” As such, if the plan provides for payment of debts, statutorily required actions to create collection authority in the IRS, such as assessment, may be treated as falling within the § 1141(d)(1) caveat to the scope of discharge.
Accord Norris Grain Co. v. United States (In re Norris Grain Co.),
What discharge means is that the IRS no longer retains its full panoply of collection powers;- the plan defines to the exclusion of all else the permissible modes of collecting the debt. But defining the mode of payment and collection does not mean that the ‘new’ claim loses the character of the underlying debt. The key is to distinguish between permissible modes of post-confirmation collection and the statutory prerequisites to collection, i.e., what does the IRS have to do to have the power to collect? While the confirmed plan may give the IRS the right to collect, the Internal Revenue Code requires an assessment prior to authority attaching in the IRS to collect.
The fact that post-confirmation collection and assessment is possible demonstrates beyond question the existence of tax characteristics in the IRS claims at issue in this appeal. Therefore, the Court holds the claims’ tax characteristics may be used to determine how to treat the claims under § 507(a)(7). That is not to say that a tax debt automatically arises to priority status in a second Chapter 11 simply because it held that status in the first Chapter 11; at most, the tax claim may rise to priority status.
B. Legislative Intent
The evident legislative purpose that gave rise to tax priorities in the first instance further verifies the conclusion mandated by the statutory structure. There is no indication in the legislative history that Congress ever contemplated the advent of serial Chapter 11 eases or the effect of § 524 on the debtor’s obligations in a second Chapter 11
[wjhen a statute is adopted from one jurisdiction into the jurisprudence of another, it will be construed so as to harmonize it with its new environment in preference to a rigid adherence to the interpretation given it in its original home; especially is this true when the construction given it in its original home would render it inconsistent with the system into which it has been adopted.
Berkeley v. West Indies Enter., Inc.,
Independent examination of the evident legislative purpose must begin with the recognition that Congress provided priority payment status for the claims of certain unsecured creditors because “special circumstances or special need” warranted a departure from the fundamental bankruptcy policy of pro rata distribution of assets to unsecured creditors. H.Rep. No. 595, 95th Cong., 2d Sess. 186 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6147. The Senate Judiciary Committee Report provided some broad insight into why taxes received special treatment in the Bankruptcy Code. After noting the “collection of taxes ... has presented one of the most difficult problems for the committee,” the committee articulated the principle that “the goals of rehabilitating debtors and giving equal treatment to private voluntary creditors must be balanced with the interests of governmental tax authorities who, if unpaid taxes exist, are also creditors in the proceeding.” See S.Rep. No. 989, 95th Cong., 2d Sess. 13-14 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5799-5800. The Senate Committee Report goes on with respect to taxes:
Since tax authorities are creditors of practically every taxpayer, another important element is that tax collection rules for bankruptcy eases have a direct impact on the integrity of the Federal, State and local tax systems. These tax systems, generally based on voluntary assessment, works [sic] to the extent that the majority of taxpayers think they are fair. This presumption of fairness is an asset which should be protected and not jeopardized by permitting taxpayers to use bankruptcy as a means of improperly avoiding their tax debts. To the extent that debtors in a bankruptcy are freed from paying their tax liabilities, the burden of making up the revenues thus lost must be shifted to other taxpayers.
A three-way tension thus exists among (1) general creditors, who should not have the funds available for payment of debts exhausted by an excessive accumulation of taxes for past years; (2) the debtor, whose “fresh start” should likewise not be burdened with such an accumulation; and (3) the tax collector, who should not lose taxes which he has not had reasonable time to collect or which the law has restrained him from collecting.
Id. at 14, reprinted at 5800. In adjusting the tension between a Chapter 11 debtor, the debtor’s creditors, and taxing authorities, Congress intended and ultimately provided taxes a seventh priority coupled with a mechanism for relegating to general creditor status statutorily defined “stale” taxes. See 11 U.S.C. § 507(a)(7). Keeping in mind that Congress did not anticipate serial Chapter 11 eases, this statement of Congressional intent concerning treatment of tax claims cannot be seriously controverted.
The issue then becomes whether this evident legislative purpose in treating tax claims should be frustrated by the unfore
Y. Conclusion
The advent of serial Chapter 11 cases has forced litigants and the courts to confront a host of interpretive issues fraught with the danger of unwittingly expanding accepted precepts in contravention of Congress’s overall bankruptcy scheme, not to mention expanding those precepts in a manner unforeseen by those who first articulated them in a universe devoid of the potential for serial Chapter 11 filings.
In this case, Conston’s position that the judicial gloss of discharge ‘extinguishes’ the original IRS corporate income tax claim creates a raft of conceptual and practical problems. The conceptual problems arise from the fact that the gloss would cause the IRS’s priority corporate income tax claims to cease to exist as tax claims at the time of confirmation, thereby preventing the IRS from making the assessment requisite to cloaking the IRS with statutory collection authority. In fact, the gloss would prohibit all assessment activities after confirmation, whether a subsequent Chapter 11 ensues or not, and would even prohibit the assessments made in the period intervening between the two Chapter 11 proceedings in this case. These conceptual problems highlight the inherent contradiction between Conston’s proposed extension of the judicial gloss and the plain language of the Internal Revenue and Bankruptcy Codes. Additionally, these conceptual problems arise whether the IRS’s post-discharge claim is a ‘new’ claim or a continuation of the pre-confirmation claim, albeit with limitations on the manner of enforcement.
The practical problems arise from the fact that Conston’s position would allow the Chapter 11 debtor to choose whether to abide by the evident Congressional purpose embodied in the priorities of 11 U.S.C. § 507(a)(7). Granting the taxpayer the ability to convert a claim within the sphere of 11 U.S.C. § 1129(a)(9)(C) into a general unsecured claim by filing a second Chapter 11 petition would have to be considered remarkable. Without some indication that Congress intended this result, I hold that priority corporate income tax claims contained in a confirmed reorganization plan must embody the characteristics that may entitle them to priority treatment if a second Chapter 11 petition is filed.
Finally, once it is established that the corporate income tax claims contained in the confirmed plan have tax characteristics, it is clear that the claims may, but do not necessarily, qualify for continued priority status in a second Chapter 11. Generally, § 507(a)(7) looks for certain characteristics of tax claims,
An order will issue remanding this matter to the bankruptcy court for entry of judgment consistent with this Opinion, including fixing the amount of priority indebtedness.
Notes
. 11 U.S.C. §§ 507(a)(7)(A)(i) & (ii) provide:
The following expenses and claims have priority in the following order:.... Seventh, allowed unsecured claims of governmental units, only to the extent that such claims are for ... a tax on or measured by income or gross receipts—
(i) for a taxable year ending on or before the date of the filing of the petition for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition;
(ii) assessed within 240 days, plus any time plus 30 days during which an offer in compromise with respect to such tax that was made within 240 days after such assessment was pending, before the date of the filing of the petition....
. 11 U.S.C. § 1129(a)(9)(C) provides:
The court shall confirm a plan only if ... the plan provides that ... with respect to a claim of a kind specified in section 507(a)(7) of this title, the holder of such claim will receive on account of such claim deferred cash payments, over a period not exceeding six years after the date of assessment of such claim, of a value, as of the effective date of the plan, equal to the allowed amount of such claim.
. The tax claims related to the 1986, 1987, 1988, and 1990 tax periods. The IRS had assessed the 1986, 1987, and 1990 tax period claims in the time between Conston's two Chapter 11 proceedings; the second Chapter 11 petition and the concomitant automatic stay have prevented the IRS from assessing the 1988 tax period claim. Id.; D.I. 4 at 2. No information appears in the record concerning the 1989 tax period.
. The parties before the Court have not contested the propriety of this fourth post-default option for a debtor, and the Court will assume, without deciding, that the Code permits Conston’s second Chapter 11 petition. The Court does note that although Congress did not expressly enumerate serial Chapter 11 filings as a viable post-default option, the courts have generally permitted them.
See, e.g., Elmwood Dev. Co. v. General Elec. Pension Trust (Matter of Elmwood Dev. Co.),
. The reorganization plan in Conston’s first Chapter 11 case provided that confirmation had an arguably broader effect:
Except for the obligations of the Debtors under this Plan, confirmation shall discharge all existing claims or interests of any nature whatsoever against or in the Debtors, or any of them, or against or in any of their assets or other property pursuant to § 1141 of the Bankruptcy Code. Except as provided in this Plan, all creditors or holders of interests shall be precluded from asserting against any of the Debtors, their assets or other properties, any other or further claims or interests based upon any act, omission, transaction or other activity of any kind, nature or description that occurred prior to the confirmation date.
D.I. 5 at 4-5.
.
Conston also
cites
American Bank and Trust Co. v. United States (In re Barton Indus., Inc.),
. One additional issue bordering on the metaphysical requires mention — are priority corporate income tax claims contained in a confirmed plan the same claims that existed preconfirmation, albeit with the limitations on enforcement that accompany confirmation and discharge, as suggested by the plain language of § 1141 and the cases interpreting § 524,
see supra
text at 772-73,
see also Matter of Ribs-R-Us, Inc.,
. Title 26 U.S.C. § 6216(1) states that subchapter B of chapter 70 of Title 26 [26 U.S.C. §§ 6871-72] details assessment procedures for receivership proceedings.
Accord Cohen v. Gross,
. This view of assessment is consistent with Congress's most recent pronouncement on the automatic stay in the Bankruptcy Reform Act of 1994. In an amendment that permits assessment despite the automatic stay, the Act states that "any tax lien that would otherwise attach to property of the estate by reason of such assessment
shall not take effect
unless such tax is a debt of the debtor that will not be discharged in the case.” Bankruptcy Reform Act of 1994, Pub.L. No. 103-394, § 116, 108 Stat. 4106, 4119 (1994) (amending 11 U.S.C. § 362(b)(9)) (emphasis added).
Contra United States v. W.F. Monroe Cigar, Co. (In re W.F. Monroe Cigar, Co.),