Breaking News

Argument recap: Justices balance tax and bankruptcy policy

The Justices considered a classic puzzle in statutory construction this week when they heard arguments in Hall v. United States.  The case presents two diametrically opposed perspectives, each of which is based on the internal coherence of their own dedicated titles of the United States Code: petitioners Lynwood and Brenda Hall rest on the primacy of Title 11 (the Bankruptcy Code), while the Solicitor General asserts the primacy of Title 26 (the Internal Revenue Code).

The fact situation is so simple that it is surprising there can be any doubt about the result.  The Halls own a farm in Arizona, which is in financial distress.  Like most farmers who file for bankruptcy relief, they filed a petition under Chapter 12, a special chapter for the reorganization of family farms.  While in bankruptcy, they were fortunate enough to find a purchaser for their farm who was willing to pay more than the outstanding debt against it.  The sale went forward, but the proceeds have not yet been distributed to the Halls’ creditors because the Internal Revenue has interposed a claim to a large share of the proceeds as a tax on the capital gains from the sale of the farm.  The basic question is whether the Bankruptcy Code discharges the Halls’ obligation to pay taxes when the debtors sell their farm during bankruptcy.

The case turns entirely on a provision in Chapter 12 that lowers the priority for certain taxes.  Generally, a debtor in Chapter 12 can confirm a plan only if the plan provides for the full payment of “all claims entitled to priority.”  Section 1222(a) (recently added to the Code) exempts from the full-payment requirement any “claim owed to a governmental unit that arises as the results of the sale * * * of [a] farm.”

Arguing on behalf of the Halls, Susan Freeman went straight to the heart of the matter, arguing that bankruptcy estates incur taxes whenever they generate income and that those taxes always have been treated as administrative expenses.  The Justices seemed most disposed to this as a practical matter, but expressed repeated concerns about whether the statute fairly could be read to reach that result.  Justice Sotomayor, for example sought (and received) confirmation that taxes owed by bankruptcy estates in fact are paid in the ordinary course as administrative expenses.  At the same time, Justice Kennedy suggested that her reading might “make sense, but unfortunately, even if Senator Grassley and the others wanted it, they didn’t do it right technically.”  Justice Scalia pressed Freeman particularly hard, apparently finding it impossible to reconcile the Tax Code provisions (on which the government relies) with Freeman’s reading of the Bankruptcy Code.  At bottom, her answer was that this is the way bankruptcies have operated since the Court’s decision in Nicholas v. United States almost fifty years ago.

Assistant to the Solicitor General Pratik Shah appeared for the government.  Predictably enough, Justice Ginsburg stopped him moments into his argument to focus on its weak link, asking him how to reconcile his reading with Senator Grassley’s plainly contrary intent.  Unpersuaded by his suggestion that the statute made sense if it applied only to pre-petition sales of farms, the Chief Justice remarked that such sales would be rare and that this seemed to make Shah’s reading “at least counterintuitive.”  Justice Alito thought it made the provision “of very, very little practical value.”  Finally, when pressed repeatedly by the Chief Justice and Justice Kagan, Shah retreated to the position that Senator Grassley had simply failed to draft language adequate to accomplish his intended result.  As he put it, “I can’t speak to what Congress wanted to do.  If in fact they wanted to that, then they did it the wrong way.”

Shah did seem to get the Justices’ attention when he argued that a ruling for the Halls would adversely affect debtors by increasing the government’s priority in all Chapter 13 cases, but even then Chief Justice Roberts characterized that problem as “small potatoes compared to the sale of a farm and a boat [in Chapter 12], right?”

The government’s strongest point with the Court surely is the fear that rejection of the government’s argument would upset the structure of tax payments in bankruptcy generally.  The government can present an apparently coherent picture of how taxes are supposed to be treated, and it is very difficult for the Justices to be sure that rejection of that vision won’t have serious adverse consequences.  But in the end, the Justices have to be pretty worried about those consequences to read a statute as completely failing to accomplish what all parties agree it was intended to do.  I’m betting the Justices won’t go that way.

Recommended Citation: Ronald Mann, Argument recap: Justices balance tax and bankruptcy policy, SCOTUSblog (Nov. 30, 2011, 2:32 PM),