Two Supreme Court Decisions Turn on Statutory Language

In two bankruptcy appeals decided this summer, the Supreme Court faithfully followed congressional intent in one case, while finding that the language used by Congress did not quite do the job in the other.    In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065, 182 L.Ed.2d 967 (2012), the Court put In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010) to rest, holding that a chapter 11 plan which provided for sale of the debtors assets while denying lenders the right to credit bid could not be approved as providing the lender the “indubitable equivalent” of its collateral.     However, in Hall v. United States, 132 S.Ct. 1882, 182 L.Ed.2d 840 (2012), the Court held that a tax provision intended to benefit family farmers who sell their farm during a chapter 12 proceeding was ineffective in the particular case because chapter 12 cases do not create a separate taxable estate.    The two decisions point out the imprecision present in the English language.

Not So Rad for Debtors

In the RadLAX case, the Supreme Court had to consider whether one of three confirmation cram-down options could contradict another.   The debtor proposed to sell its property pursuant to a plan of reorganization, but did not want to allow the secured creditor to credit bid.    The bankruptcy court and the Seventh Circuit said no.   However, the Third Circuit had previously said yes.  The debtor and the Third Circuit said that it was possible to use the phrase “indubitable equivalent” to get in through the back door what would otherwise not be possible under the provision dealing with sales free and clear of liens.  Justice Scalia and seven of his brethren were not impressed.   (Justice Kennedy did not participate so the decision was a unanimous 8-0).

Under 11 U.S.C. Sec. 1129 (b)(1), a debtor seeking to overcome the dissenting class of claims must propose a plan that is “fair and equitable” and which does not discriminate “unfairly.”   The statute goes on to state that the requirement that a plan be “fair and equitable” “includes” certain requirements.   There may be more requirements to “fair and equitable” but Congress did not tell us what they are.    However, at a minimum, they include a checklist of items applicable to classes of secured claims, unsecured claims and interests.  

For secured claims, the checklist says that treatment must include one of the following options:

(       a. The creditor must retain its lien and receive payment of the present value of its secured claim;

(      b. The debtor may sell the property free and clear of liens subject to the creditor’s right to credit bid; or

(    c. The debtor must provide the creditor with the realization of the “indubitable equivalent” of its secured claim.

While the first two options are fairly specific, “indubitable equivalent” is neither a defined term nor one whose meaning is readily apparent with the use of a dictionary.   The term does have a very learned history, since it originated from Learned Hand’s opinion in In re Murel Holding Corp, 75 F.2d 941 (2nd Cir. 1935). 

However, Justice Scalia did not find it necessary to wade into the thicket of what constituted the “indubitable equivalent” of a secured claim.    Instead, he invoked a canon of statutory interpretation.   

We find the debtor’s of §1129(b)(2)(A)—under which clause (iii) permits precisely what clause (ii) proscribes—to be hyperliteral and contrary to common sense.  A well established canon of statutory interpretation succinctly captures the problem:  “[I]t is a common place of statutory construction that the specific governs the general.”  (citation omitted).
132 S.Ct. at 2070-71.

Eric Brunstad, who successfully argued the case before the Supreme Court, described the case as “unsatisfying” in a keynote address to the National Conference of Bankruptcy Judges.  He compared canons of statutory interpretation to aphorisms, such as look before you leap and strike while the iron is hot—whoever chooses the canon to apply determines the outcome.

While the opinion goes on for some nineteen pages, these two sentences capture its essence.   cases, it simply was not necessary here.   Whatever else “indubitable equivalent” means, it does not mean that courts can make an end run around the more specific provisions of section 1129(b)(2)(A)(i) and (ii).

By the way, my preferred definition of “indubitable equivalent” is a treatment which causes the judge to don a monocle and remark “indubitably” in an upper-class British accent.

A Taxing Result

In Hall v. United States, the chapter 12 debtors were not able to save the farm or escape paying capital gains tax on its sale—despite Congressional efforts to the contrary.  The debtors filed chapter 12 and sold the family farm.   They sought to classify $29,000 in post-petition capital gains liability as a dischargeable pre-petition debt.   While this might seem audacious, the debtors were simply trying to take advantage of 2005 legislation meant to protect family farmers from crushing tax bills.   Under 11 U.S.C. Sec. 1222(a)(2)(A), a chapter 12 plan must pay priority claims under section 507 in full unless the claim:

arises as a result of a sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation in which case the claim shall be treated as an unsecured claim that is not entitled to priority under section 507 . . . .
If Congress had simply stated that tax claims arising from sale of a farming asset shall be treated as unsecured claims, the Halls would have been protected.   However, because the exemption was included within a general section on priority claims, the provision interacted with other provisions to deny the debtors relief.    

      The provision classifying taxes from sale of farm assets as unsecured claims is included in an exception to the rule that a chapter 12 plan must pay priority claims under section 507 in full.
Section 507 has two tax provisions within it. Section 507(a)(8) grants priority status to prepetition tax claims.   Section 507(a)(2) incorporates section 503(b) which refers to “any tax . . . incurred by the estate.” 
 a. Under 26 U.S.C. Sec. 1398 and 1399, filing chapter 12 does not create a separate taxable estate. 
 b. As a result, post-petition taxes in a chapter 12 case are incurred by the debtor, not the bankruptcy estate.  
c. Because post-petition taxes in a chapter 12 case are incurred by the debtor and not the estate, they do not qualify as priority claims under section 507. 
 d. Because they do not qualify as priority claims under section 507, they do not get the benefit of the exception to treatment of priority claims in chapter 12. 
This is undoubtedly a result contrary to Congressional intent.   Sen. Charles Grassley, who authored the legislation, is known to be an ardent advocate for family farmers.   However, under the Supreme Court’s decision, capital gains arising from sale of a family farm prior to bankruptcy would be dischargeable as general, unsecured claims, while claims arising from a sale during the bankruptcy would be a non-dischargeable post-petition debt.    

Furthermore, the proceeds from sale of the farm would be property of the estate which would be required to be used to pay creditors, even though the debtor could not use that same estate property to pay the taxes.   Even if the IRS wanted to allow the taxes to be paid through the plan, there is not a statutory mechanism for doing so.   While section 1305(a), allows a post-petition creditor in a chapter 13 proceeding to file a claim, there is no similar provision in chapter 12.

This is unfortunately a case where the statutory language used was not robust enough to do the job.   If Congress wants to fix the problem, they could do so by replacing section 1222(a)(2)(A) with the following language:

A claim owing to a governmental unit arising from a sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation, regardless of whether such sale, transfer, exchange or other disposition occurs prior to the petition date or during the pendency of the bankruptcy case, shall be includable in the plan and shall be treated as an unsecured claim that is not entitled to priority under section 507, but the debt shall be treated in such manner only if the debtor receives a discharge.