[00:00:18] Speaker 03:
Good morning, everyone, and welcome.

[00:00:20] Speaker 03:
Judge Graber, Judge DeAlba, and I would like to welcome you to Phoenix.

[00:00:24] Speaker 03:
And we're really happy to be sitting in this ceremonial courtroom for our last day of Ninth Circuit proceedings in Phoenix.

[00:00:31] Speaker 03:
We have two cases that are being submitted today without oral argument.

[00:00:34] Speaker 03:
Those are Palomino Espinosa v. Garland.

[00:00:38] Speaker 03:
That case is submitted.

[00:00:39] Speaker 03:
And Barry v. Air Force Central Welfare Fund is also submitted.

[00:00:44] Speaker 03:
And we're going to hear four cases this morning.

[00:00:46] Speaker 03:
We'll take them up.

[00:00:47] Speaker 03:
in the order that they have been calendared.

[00:00:50] Speaker 03:
Two of the appeals have been consolidated for oral argument purposes.

[00:00:55] Speaker 03:
First, we'll hear argument in United States v. Warfield and United States v. McKenzie.

[00:01:00] Speaker 03:
Each side will have 15 minutes.

[00:01:02] Speaker 03:
Mr. Johnshoy, okay, you may begin when you're ready.

[00:01:05] Speaker 03:
And if you'd like to reserve time for rebuttal, I just ask that you keep track of your own time.

[00:01:10] Speaker 00:
Thank you.

[00:01:11] Speaker 00:
May it please the court, my name is Matthew Johnshoy and I represent the United States.

[00:01:15] Speaker 00:
and I'd like to reserve two minutes of my time for rebuttal.

[00:01:18] Speaker 00:
In both of the appeals being heard today, this court must interpret Section 724A of the Bankruptcy Code, which is a penalty lien avoidance provision, and decide how to allocate the proceeds of a lien after penalty avoidance.

[00:01:30] Speaker 00:
The government argues for an approach that pays the principal portion of a secured debt first, which in the case of a tax lien means a tax-first approach.

[00:01:37] Speaker 00:
That means the unavoidable tax portion of a tax lien must be fully paid before the avoidable penalty portion of the same lien

[00:01:45] Speaker 00:
receives any proceeds.

[00:01:47] Speaker 00:
The lower courts in both cases adopted a pro rata approach.

[00:01:50] Speaker 00:
They found the text of Section 724A did not answer the question of how to allocate proceeds, and then concluded that the bankruptcy courts were free to decide how to allocate.

[00:01:58] Speaker 00:
But their analysis and the way they interpreted the code was flawed, and in any event, the method of allocating proceeds should not be a matter of discretion to be decided case by case.

[00:02:09] Speaker 00:
So before turning to the main allocation question, I'd like to first address some disputes that have arisen as to what the main issue on appeal really is.

[00:02:17] Speaker 00:
The government believes that this court is now reviewing partial lien avoidance.

[00:02:20] Speaker 00:
That is the avoidance of just the penalty portions of the liens only.

[00:02:25] Speaker 00:
In both the Freeman and the Leite bankruptcies, the trustees in those cases sought only partial avoidance, and the trustees were only granted partial avoidance by the bankruptcy courts.

[00:02:34] Speaker 00:
But the district court opinion in Freeman erroneously suggests in its legal reasoning that the entire tax liens were avoided.

[00:02:42] Speaker 00:
But that's not the case.

[00:02:43] Speaker 00:
That was not the relief sought nor the relief granted.

[00:02:46] Speaker 00:
And the bankruptcy court's final order is fairly clear on this point.

[00:02:48] Speaker 00:
The bankruptcy court's order says that avoidance was only to the extent of the penalties and the interest on penalties.

[00:02:54] Speaker 00:
And then it goes on to describe the tax portions of the tax liens as being the, quote, unavoidable portion and as, quote, not avoidable.

[00:03:02] Speaker 00:
This error is sort of further demonstrated in the district court's own opinion in its background section where it refers to the tax liens as non-avoidable.

[00:03:11] Speaker 00:
And I think it's further demonstrated in the district court's final holding.

[00:03:14] Speaker 00:
It affirms the bankruptcy court's ruling.

[00:03:16] Speaker 00:
It affirms partial avoidance while nevertheless endorsing entire lien avoidance.

[00:03:22] Speaker 00:
There was just no actual support for the district court's position regarding entire lien avoidance.

[00:03:27] Speaker 00:
It wasn't supported by the authorities it relied upon, including the bankruptcy court opinion it was reviewing.

[00:03:34] Speaker 00:
So we'd hope that the court's opinion in Freeman will clarify that only the penalty portions of liens can be avoided.

[00:03:42] Speaker 00:
My friend in the answering brief acknowledges that the district court in Freeman says that an entire tax lien was avoided.

[00:03:48] Speaker 00:
But he argues for the first time that entire lean avoidance is correct.

[00:03:52] Speaker 00:
That's simply not the case.

[00:03:55] Speaker 00:
Entire lean avoidance is not consistent with the code.

[00:03:58] Speaker 00:
It was not the relief sought and it was not the relief granted, nor was it the relief granted in the Leite case.

[00:04:04] Speaker 00:
In the answering brief, my friend also argues that entire versus partial lean avoidance wouldn't make a difference.

[00:04:10] Speaker 00:
But that's not the case either.

[00:04:12] Speaker 00:
It makes a big difference.

[00:04:13] Speaker 00:
If a creditor's lien is avoided in its entirety, then the creditor would no longer be a secured creditor.

[00:04:20] Speaker 00:
If you're no longer a secured creditor, you're no longer entitled to a payment with regard to that lien at all.

[00:04:25] Speaker 00:
So you still have to have an unavoidable lien to be a secured creditor and get paid.

[00:04:31] Speaker 00:
So we would ask the court to correct this error or at least not follow the district court's misstatements.

[00:04:37] Speaker 00:
The same issue has now also sort of come up in the Lighty case, in the trustee's brief on appeal in Lighty,

[00:04:43] Speaker 00:
The trustees suggest that the Leidy courts held that the entire tax lien at issue there was avoided, but that's also not the case.

[00:04:49] Speaker 00:
The Leidy courts only partially avoided the tax liens to the extent of the penalties, and so that's, the relief granted in Leidy was simply partial avoidance.

[00:05:00] Speaker 03:
This may seem like a small issue, but it's in fact very- One of the arguments that I think the trustee makes in the briefs is that the IRS could have assessed the taxes and penalties in separate liens.

[00:05:15] Speaker 03:
So is that possible?

[00:05:20] Speaker 00:
No, Your Honor.

[00:05:21] Speaker 00:
And I think that it gets into a tricky question.

[00:05:24] Speaker 00:
It's possible to separately assess taxes and penalties.

[00:05:28] Speaker 00:
But it's not possible to separately create a lien.

[00:05:31] Speaker 00:
That is, when you assess the tax only, that tax lien also covers the unassessed penalties.

[00:05:37] Speaker 03:
Well, I understand that here, when you assess the lien, it's covering both unpaid taxes and penalties that are associated with those unpaid taxes.

[00:05:45] Speaker 03:
What I'm asking is, you know, the IRS knows what that is, is it possible to then split those things and file a separate lien for the tax portion and a separate lien for the penalty portion?

[00:05:56] Speaker 00:
And again, the answer is no, Your Honor, and it's slightly tricky.

[00:06:00] Speaker 00:
If you assess only the tax, you create a tax lien that covers the tax and the penalties.

[00:06:05] Speaker 00:
That's the way 6321 reads, that it covers all of the additions to tax and the assessable penalties as well.

[00:06:11] Speaker 00:
So if you only assess the tax, you get a lien that covers interest, it covers all of the related amounts as well.

[00:06:16] Speaker 00:
You can, however, separately assess the penalty and create an assessment for just the penalty that will create a lien for the penalty.

[00:06:23] Speaker 00:
But that does not mean that the assessment for the tax did not already create a lien that covered the penalty.

[00:06:29] Speaker 00:
The two aren't the same.

[00:06:32] Speaker 00:
So whenever you assess the tax, you create a lien that will also cover penalty.

[00:06:36] Speaker 00:
And the penalty accrues later.

[00:06:37] Speaker 00:
It accrues over time, just like interest does, right?

[00:06:40] Speaker 00:
It's basically similar to a mortgage or, you know, more conventional liens that cover all of the additions that are to come later.

[00:06:48] Speaker 00:
So it's true that you can separately assess a penalty, but it's not true

[00:06:52] Speaker 00:
that the lien would not also cover the penalty.

[00:06:55] Speaker 00:
So this entire versus partial lien avoidance, it's actually an important issue.

[00:07:00] Speaker 00:
It's important to ensure that tax liens are not fully avoided, entirely avoided, that the tax portions are still payable, and that future cases are clear on that point.

[00:07:09] Speaker 00:
So this court should find that the common question in these cases is really the threshold question of what to do with the allocation between the unavoidable tax portion and the avoided penalty portion of the same lien.

[00:07:21] Speaker 02:
Council, does it matter if there is, let's say, enough money to cover not quite everything, but not – so, for example, I'm just going to throw out a number.

[00:07:32] Speaker 02:
Let's say your tax lien portion is $75,000 and your penalty portion is $20,000 and the sale of the property brings you, I don't know, $80,000.

[00:07:43] Speaker 02:
Does that matter versus you just not having enough to cover the entire tax portion or the entire penalty portion?

[00:07:51] Speaker 00:
I think it matters in the sense that it determines how much might go to penalties.

[00:07:56] Speaker 00:
That is, first you should pay off the principal portion of the secured debt, the $75,000 in tax, and then in your hypo, there's $5,000 left over to go to the secondary penalty.

[00:08:06] Speaker 00:
But if you grew the amount of proceeds, you'd of course have more left over to go to the secondary amount.

[00:08:11] Speaker 00:
So I think the amount of the proceeds matter only in so much as whether it exceeds the amount that should go first to the tax or first to the principal portion of a debt.

[00:08:20] Speaker 02:
But regardless of the amount, it's the IRS's position that it all should go to taxes first.

[00:08:26] Speaker 02:
And if there's anything left over, then we can, you know, let the penalty avoidance come in if that's what the trustee chooses to do.

[00:08:35] Speaker 00:
Yes.

[00:08:37] Speaker 00:
The trustee may choose to avoid the penalties sort of as a matter of course, but not yet know how much proceeds will result.

[00:08:45] Speaker 00:
You know, that often happens, right?

[00:08:47] Speaker 00:
You think the house is going to sell for more and then it doesn't.

[00:08:50] Speaker 00:
but the first proceeds should go to the principal debt, which in the case of tax liens is the tax debt.

[00:08:56] Speaker 00:
And we think that goes back to how do you interpret the code.

[00:09:00] Speaker 00:
It's certainly true that the text of the modern code does not explicitly answer the question of how to allocate, but we don't think that means there's no statutory answer.

[00:09:08] Speaker 03:
When interpreting- Why shouldn't we look at 724B for the proper allocation method?

[00:09:17] Speaker 00:
Well, I think 724B is relevant to understanding 724A.

[00:09:21] Speaker 00:
But do you mean look to 724B to allocate for only 724A?

[00:09:25] Speaker 03:
Yeah, for the unavoidable tax portion.

[00:09:29] Speaker 00:
Well, I think 724B does apply to the unavoidable tax portion, which is partly why I think 724A is only speaking to penalties.

[00:09:36] Speaker 00:
That is, 724A allows the avoidance of penalties.

[00:09:40] Speaker 03:
When that's done, if that's not sufficient, if there's... Curse me if I'm wrong, but I thought that the IRS sort of made the argument that 724B is the appropriate method to allocate the unavoidable tax portions or unavoidable portions of the lien below, but then abandoned this argument on appeal.

[00:10:01] Speaker 03:
Are you still arguing that 724B is the appropriate method to allocate the unavoidable portion of the lien?

[00:10:07] Speaker 00:
I think I understand the question now, Your Honor.

[00:10:09] Speaker 00:
Below, we were making a different argument.

[00:10:11] Speaker 00:
We were arguing that wherever there's a tax lien, there will be an unavoidable portion of a penalty lien, and therefore that is the provision that controls.

[00:10:19] Speaker 00:
We're not making that argument anymore.

[00:10:21] Speaker 00:
But when you're answering a 724A question, it's still important to realize there's still 724B.

[00:10:27] Speaker 00:
So 724A sort of gives away the penalty, if anything,

[00:10:31] Speaker 00:
If there are proceeds to go to the penalty, then that can go to the estate.

[00:10:34] Speaker 00:
But that should be informed by 724B, which also is a lien-displacing provision that says, look, if there's not enough after everything else is done, then we'll share the tax lien too.

[00:10:45] Speaker 00:
So when you're interpreting 724A, I think you still have to interpret it in light of 724B.

[00:10:52] Speaker 00:
And in this case, if this court holds a tax-first approach, that is not the end of the story.

[00:10:57] Speaker 00:
Under a tax-first approach, you figure out how to allocate the proceeds.

[00:11:00] Speaker 00:
but then it's still possible the trustee will come back for 724B.

[00:11:05] Speaker 00:
And when you're reading 724B, it's important to keep in mind 724E as well.

[00:11:09] Speaker 00:
That says when B will apply.

[00:11:11] Speaker 00:
It says basically once all of the other assets of the estate are exhausted, if you still need more funds to pay these selected groups that are called out in 724B, then you can displace the tax liens and take the principal part of the tax debt to pay these select creditors.

[00:11:28] Speaker 00:
Below, we were making a slightly different argument, Your Honor, that we're no longer pursuing an appeal, which is that 724B controls in every case.

[00:11:34] Speaker 00:
And you simply go to 724B to show who will get the proceeds of this property.

[00:11:40] Speaker 00:
We're not making that argument.

[00:11:41] Speaker 03:
So the difference between what you argued below and what you're arguing now is that there needs to be a divi- the lien is divisible between the voidable and unavoidable portions.

[00:11:50] Speaker 03:
You go to A, for purposes of taking out the penalty, but all the proceeds, and in this case,

[00:11:55] Speaker 03:
That means all of the proceeds go to pay off the tax portion.

[00:11:58] Speaker 03:
And if there's any remaining portion from the sale of the property that can satisfy the lien, including the penalty portion, then you use subsection B to allocate the balance.

[00:12:11] Speaker 00:
I think that's right, Your Honor.

[00:12:15] Speaker 00:
I would say, the thing is, after you've taken the penalty portion of the lien, you won't necessarily know whether there'll be any of the classes of creditors left

[00:12:25] Speaker 00:
unpaid, that 724B, you know, allows this lien avoidance provision for.

[00:12:30] Speaker 00:
And it's just, you know, it's important to note that it doesn't allow it for all creditors.

[00:12:34] Speaker 00:
Certain administrative expense creditors, certain priority creditors, it's a subset.

[00:12:39] Speaker 00:
But if penalty avoidance isn't enough, and if all of the other assets of the estate are already exhausted, that's not enough, then you can displace tax liens.

[00:12:47] Speaker 04:
But I think the fact that there's this tax, there's this second provision that says, hey, you can get some of the tax too in these events suggests they're not giving away the tax in A. If anything, they're only giving away the tax in B. I had a question based on what you just said about, and this may be just off base because this is not my area of expertise, but you talked about what it sounded like subordinating the tax lien.

[00:13:16] Speaker 04:
And if that's true, what effect does subsection E of 724 have, which talks about what has to happen before subordinating a tax lien?

[00:13:26] Speaker 00:
Yes, Your Honor, you have to read B and E together.

[00:13:31] Speaker 00:
So E says B essentially doesn't kick in until these conditions are met.

[00:13:35] Speaker 00:
And these conditions are you've exhausted the other assets, you've tried your best to get administrative expense through these other mechanisms.

[00:13:43] Speaker 00:
That wasn't sufficient.

[00:13:45] Speaker 04:
So in a sense, 724E is the more specific that governs the more general.

[00:13:52] Speaker 04:
of 724B, it sounds like.

[00:13:54] Speaker 00:
E is actually a provision that was added later to clarify B. So B and E work together.

[00:13:59] Speaker 00:
And I think E just makes it clear that you shouldn't turn to B, you shouldn't be taking the tax principle, displacing tax liens, until you've exhausted all other efforts.

[00:14:09] Speaker 00:
Got it.

[00:14:10] Speaker 00:
To make an analogy, I think 724A is more like the government has given up the dessert, but not the main course, right?

[00:14:18] Speaker 00:
The penalties are secondary.

[00:14:20] Speaker 00:
They arise secondarily.

[00:14:21] Speaker 00:
That's not the main purpose of the liens.

[00:14:23] Speaker 00:
And so they've given up the penalties and said, OK, we won't get penalties.

[00:14:26] Speaker 00:
And no one else will either until everyone else is paid in full.

[00:14:31] Speaker 00:
But in doing that, they're not intending to share the tax.

[00:14:33] Speaker 00:
They're not intending to share the principal portion of the secured debt.

[00:14:38] Speaker 00:
I'll reserve the remainder of my time for rebuttal.

[00:14:41] Speaker 03:
Okay.

[00:14:41] Speaker 03:
Thank you.

[00:14:49] Speaker 01:
Morning.

[00:14:49] Speaker 01:
If it please the Court, my name is Terry Dake.

[00:14:50] Speaker 01:
I represent the bankruptcy trustees, in this case Robert McKenzie and Lawrence Warfield.

[00:14:56] Speaker 01:
I want to start with a couple of the Court's questions.

[00:14:59] Speaker 01:
I disagree with government counsel about the answer to the lien question.

[00:15:04] Speaker 01:
In that regard, what I mean is it's tax 101 that when you don't pay your tax, a statutory lien arises under 26 USC 6321.

[00:15:15] Speaker 01:
So I agree with counsel that the lien itself arises.

[00:15:19] Speaker 01:
cause the lien to arise at a different point in time, but you can cause the lien to be perfected at a different point in time.

[00:15:28] Speaker 01:
The IRS does not have to record one lien that covers the taxes, the penalty, and the interest, any more than Chase Bank has to record a lien that covers all of its debts at once.

[00:15:38] Speaker 01:
Chase can record a lien that

[00:15:40] Speaker 01:
secures a $30,000 debt, another $50,000 debt, and a $70,000 debt.

[00:15:44] Speaker 01:
IRS could do the same thing, but what you see in the recorded tax liens, and this is where the practice part of this comes into play, is the IRS records a single lien that secures all of those items, and would a trustee or any… Well, and it does that, I think, for a reason, which is they would

[00:16:00] Speaker 03:
need to over time continue to file because penalties for the longer time period that goes by that somebody doesn't pay their taxes and the penalties increase, over time they would have to be filing multiple liens to, as I think what you're saying, to perfect the lien on the increased penalties.

[00:16:19] Speaker 03:
So, for example, in the Warfield case, the IRS held 11 years' worth of tax liens.

[00:16:24] Speaker 03:
And if it was required to file each of these liens as individual tax lien and penalty liens, I think it would have had to file 22 separate liens.

[00:16:33] Speaker 03:
Is that right?

[00:16:34] Speaker 01:
Yes and no.

[00:16:36] Speaker 01:
They could record one lien that covers all of just the taxes.

[00:16:41] Speaker 01:
They don't have to include the penalties and interest in that lien, but if you look at their lien filing, it has separate categories for each of the items that it's securing.

[00:16:50] Speaker 01:
It doesn't have to do that.

[00:16:52] Speaker 01:
It chooses to do that.

[00:16:54] Speaker 01:
So that's where I disagree with counsel.

[00:16:55] Speaker 01:
The lien can be perfected.

[00:16:56] Speaker 03:
Do you disagree that the IRS would have to continue to file liens over time and that

[00:17:04] Speaker 03:
that that would need to occur sort of on a regular basis and obviously also increase the number of liens that would have to be filed?

[00:17:10] Speaker 01:
No, I don't, Your Honor.

[00:17:11] Speaker 01:
It's no different than when you record a lien for a mortgage.

[00:17:14] Speaker 01:
A mortgage has accruing interest.

[00:17:15] Speaker 01:
You don't have to re-record that lien every six months because the interest on the debt changes.

[00:17:20] Speaker 01:
The underlying debt accrues.

[00:17:23] Speaker 01:
There's notice of, that's what the purpose of the filing is, is to give notice of the debt

[00:17:27] Speaker 01:
to other creditors.

[00:17:29] Speaker 01:
And the notice that the IRS is giving says, we're taking a lien for the taxes, the penalty, and the interest.

[00:17:35] Speaker 01:
The IRS could choose not to take a lien for the penalties in its initial filing.

[00:17:40] Speaker 01:
It could make that decision, but it doesn't.

[00:17:43] Speaker 01:
It records all of them.

[00:17:44] Speaker 01:
So that's where I disagree with counsel.

[00:17:46] Speaker 01:
It doesn't have to do that, and it could solve this problem on its own, but it chooses not to.

[00:17:53] Speaker 01:
There was also a question about whether or not 724B controls this.

[00:17:58] Speaker 01:
The problem is, even if you take the position that the lien is only partially avoided, it doesn't solve the problem.

[00:18:07] Speaker 01:
If the lien is avoided only to the extent of the penalties under 724A, let's say that that's $10,000, and the taxes

[00:18:15] Speaker 01:
aren't avoided under that portion of the lien, and that's $50,000.

[00:18:18] Speaker 01:
Well, when the property is sold, we still have the same problem.

[00:18:23] Speaker 01:
Let's say the property is sold for $40,000.

[00:18:25] Speaker 01:
The trustee's got part of that under 724A.

[00:18:28] Speaker 01:
The government's got part of it under 724B.

[00:18:33] Speaker 01:
How do you allocate that?

[00:18:35] Speaker 01:
It doesn't solve the problem.

[00:18:37] Speaker 04:
Well, let me ask you this.

[00:18:40] Speaker 04:
I will repeat my admonition that this is not my area of expertise.

[00:18:46] Speaker 04:
But it seems to me that we have a pretty clear message both from the code itself and from the Supreme Court that in Chapter 7, there's sort of an absolute that the priorities that the creditors

[00:19:06] Speaker 04:
must be paid in the order of their priority, the secured creditors first and government first.

[00:19:12] Speaker 04:
The tax lien is in a sort of special category.

[00:19:17] Speaker 04:
So your method, the pro rata method that you were successful in obtaining, seems to me to violate that by allowing even unsecured creditors to have a portion

[00:19:34] Speaker 04:
before the secured creditors are paid everything they're owed.

[00:19:39] Speaker 04:
As I say, this is just sort of like gestalt, but what's wrong with my thinking?

[00:19:45] Speaker 01:
First, Your Honor, in your defense, I watched a seminar that Judge Lanza participated in recently on bankruptcy appeals.

[00:19:53] Speaker 01:
He said the most difficult appeals he gets are bankruptcy appeals because the bankruptcy code is so complicated and so intertwined and he gets so little of it that he has to go and educate himself on this as if it was an exam question every time.

[00:20:07] Speaker 01:
So I can understand the difficulty this court has because you just don't see a lot of bankruptcy and it is so intertwined and complicated.

[00:20:15] Speaker 01:
The simple answer to your question is this, Congress made that decision to take that money and reallocate it.

[00:20:22] Speaker 03:
But what is the statutory justification for reducing the value of the unavoidable portion of the tax lien?

[00:20:30] Speaker 03:
That's the part that troubles me, which is there is no, I can't find the statutory justification for the pro rata method because it actually reduces the amount of the tax portion that is very clearly

[00:20:45] Speaker 03:
unavoidable, and that would be paid to the government.

[00:20:48] Speaker 01:
Well, and that's the problem, Your Honor.

[00:20:50] Speaker 01:
Congress didn't anticipate this issue and didn't address it.

[00:20:55] Speaker 01:
But what we have is a situation where you have two holders of one lien now, because admittedly, and the government doesn't dispute it, the trustee can avoid the penalty portion.

[00:21:07] Speaker 01:
And the government retains the entitlement to the tax payment.

[00:21:12] Speaker 01:
But at the end of the day, there's only one lien.

[00:21:15] Speaker 01:
That's all that was ever recorded here.

[00:21:16] Speaker 01:
That's what we're talking about is one lien.

[00:21:18] Speaker 01:
It's no different than Chase's mortgage.

[00:21:20] Speaker 03:
Well, this isn't a problem in the cases where the sale of the property yields enough proceeds to deal with the scenario that you just articulated.

[00:21:30] Speaker 03:
And I understand the policy principle and the language that

[00:21:34] Speaker 03:
The purpose is to allow the trustee to avoid the penalty portion so that it can stand in the shoes of the leanholders and essentially get a higher priority than the junior leanholders.

[00:21:45] Speaker 03:
I understand that.

[00:21:47] Speaker 03:
And that works when there are enough proceeds.

[00:21:49] Speaker 03:
But in a case where there aren't enough proceeds, we shouldn't just be displacing congressional intent to ensure that the government gets 100 percent.

[00:21:59] Speaker 03:
of the unavoidable tax lien, right?

[00:22:01] Speaker 01:
I don't think we're displacing government intent because the government is the one, Congress is the one who said that the penalties get paid to the estate.

[00:22:10] Speaker 01:
How do you explain Section 724E?

[00:22:12] Speaker 01:
Well, 724E is easy.

[00:22:15] Speaker 01:
724 says, let's assume that we have a situation where there's no penalties associated with the tax lien.

[00:22:23] Speaker 01:
And there's just a tax lien, property gets sold,

[00:22:27] Speaker 01:
The government's entitled to $50,000 from the sale of the property.

[00:22:30] Speaker 01:
What the trustee can do under 724B is come to the court and say, all right, Judge, I've got some creditors I need to pay.

[00:22:38] Speaker 01:
I've got wage claimants.

[00:22:40] Speaker 01:
And I've also got some administrative expenses.

[00:22:42] Speaker 01:
And both of those qualify for payment under 724B.

[00:22:44] Speaker 01:
Those are the only two things that qualify for payment.

[00:22:48] Speaker 01:
And what the bankruptcy judge says is, well, then let's walk through the rest of Section 724.

[00:22:52] Speaker 01:
Mr. Trustee, do you have any other money in this case?

[00:22:56] Speaker 01:
Most times the trustee is going to say, no, there are no other funds in this case.

[00:23:00] Speaker 01:
That's when that money is going to get reallocated.

[00:23:03] Speaker 01:
That's when the Congress said, take the tax money that should otherwise go to the IRS and pay those two categories of creditors.

[00:23:12] Speaker 01:
It says, pay the administrative expenses and pay the wage claimants.

[00:23:16] Speaker 01:
Now, if there is other money in the case, then the judge is going to say, I'm sorry, Mr. Trustee, you can't take the government's money until you've exhausted that other money.

[00:23:24] Speaker 04:
So, 724E just fits in to 724B and tells you when you... If I understand you correctly, and I may not, but I want to clarify this.

[00:23:33] Speaker 04:
So, that works only if you consider 724E not to cover the penalty portion.

[00:23:44] Speaker 04:
Am I right?

[00:23:45] Speaker 04:
Is that your argument?

[00:23:48] Speaker 01:
Well, 724E would not apply to an avoided penalty.

[00:23:54] Speaker 04:
Okay, so I did understand you.

[00:23:56] Speaker 01:
Yeah, so if the trustee gets money from an avoided penalty.

[00:23:59] Speaker 04:
If we disagree with that, then you lose, right?

[00:24:03] Speaker 04:
If we disagree with that.

[00:24:05] Speaker 04:
If it applies to the avoided tax lien penalty, the penalty, then

[00:24:15] Speaker 04:
you would have to pay the government first.

[00:24:19] Speaker 01:
Well, yeah.

[00:24:20] Speaker 01:
If what you're saying is 724E applies to 724A, then we're going to have to go back to the bankruptcy court and do the same analysis I just talked about.

[00:24:28] Speaker 01:
Is there any other money in the case first?

[00:24:29] Speaker 04:
Well, that's where I was thinking that 724E is more specific than 724A, which is the generic provision.

[00:24:39] Speaker 04:
So it just seems to me that if 724E applies to the

[00:24:44] Speaker 04:
penalty portion, then it supplants any other general rules that at least make sense to me.

[00:24:56] Speaker 04:
I don't know what I'm missing.

[00:24:59] Speaker 01:
Well, that's a different argument than anyone has ever made before, that somehow 724E then trumps the trustees' avoidance rights under 724A.

[00:25:09] Speaker 01:
The government has never made that argument, and I frankly have never considered that before.

[00:25:13] Speaker 03:
What would be the implications of that analysis in a case where there were sufficient proceeds?

[00:25:23] Speaker 03:
Because if we want to retain the policy of having the trustee stand in the shoes of the lean holder to be able to take higher priority than junior lean holders, is that disturbed in any way by interpreting E as the more specific provision that trumps

[00:25:44] Speaker 03:
A, I think as Judge Graber is suggesting.

[00:25:47] Speaker 03:
I want to understand what the implication of that is in a case where we have enough proceeds to distribute beyond just the government.

[00:25:57] Speaker 01:
Well, and make sure I understand your hypothetical.

[00:26:00] Speaker 01:
Let's say we sell a piece of property for $100,000, tax lien is $75,000, covers both the penalties and the interest.

[00:26:07] Speaker 01:
And I think what the court is suggesting is

[00:26:10] Speaker 01:
even though the trustee, and let's assume the penalty is $25,000.

[00:26:13] Speaker 01:
I think what the court is suggesting is before the estate gets to keep that $25,000 and pay the other unsecured creditors, we have to go through the rest of 724 and get to E and say, well, is there any other money to pay the unsecured creditors?

[00:26:30] Speaker 01:
I think that's what the court's question is.

[00:26:32] Speaker 01:
And if that's the question, yes, it changes the analysis, but doesn't change the result in 99% of all the cases, because like in this case, there is no other money.

[00:26:44] Speaker 01:
And 724B limits the distribution to only two categories of creditors, administrative claimants, Chapter 7 administrative claimants, by the way, not Chapter 11, and wage claimants.

[00:26:57] Speaker 01:
Those are the only two people who can participate in 724B money.

[00:27:02] Speaker 01:
So now if you're going to apply 724E to 724A, you're taking money that Congress said, okay, send it to the unsecured creditors, now it can't go to the unsecured creditors at all.

[00:27:12] Speaker 01:
So applying 724E to 724A totally disrupts the statutory scheme because now you've just wiped 724A off the map.

[00:27:24] Speaker 01:
I think I've exceeded my time and I don't really have anything else.

[00:27:28] Speaker 03:
Two and a half minutes left, but you don't have to use all your time if you have anything else to say.

[00:27:32] Speaker 01:
The only other thing I wanted to address was 726 because I think that probably leads to some confusion here.

[00:27:39] Speaker 01:
726 doesn't come into play until there's money to distribute to creditors.

[00:27:45] Speaker 01:
Let's take a hypothetical.

[00:27:47] Speaker 01:
Let's assume you get a piece of property with a $100,000 lien on it, gets sold for $150,000.

[00:27:53] Speaker 01:
We know that what happens to the $150,000 is you've got to pay that first lien.

[00:27:59] Speaker 01:
Where does it say that in the bankruptcy code?

[00:28:01] Speaker 01:
It doesn't.

[00:28:02] Speaker 01:
But we all know that that's the answer.

[00:28:04] Speaker 01:
First mortgage gets paid first, rest of the money then gets distributed.

[00:28:08] Speaker 01:
How does that money get distributed?

[00:28:09] Speaker 01:
It goes down to the bankruptcy estate and gets distributed under 726.

[00:28:14] Speaker 01:
But you've got to start with the liens.

[00:28:16] Speaker 01:
Now let's assume that that $100,000 lien is a tax penalty lien and there's a junior $50,000 lien.

[00:28:22] Speaker 01:
What the government is trying to tell you is that if that property is sold,

[00:28:27] Speaker 01:
That $100,000 lien drops down and doesn't get paid at all because it's subordinated under 726.

[00:28:33] Speaker 01:
It doesn't work that way.

[00:28:36] Speaker 01:
This is a lien on a piece of property.

[00:28:37] Speaker 01:
If the trustee doesn't avoid that lien, it gets paid to the lien holder.

[00:28:41] Speaker 01:
The lien holder isn't somehow subordinated because that's not a distribution under 726.

[00:28:45] Speaker 01:
That's just a payment of a lien.

[00:28:48] Speaker 01:
But what the government says is if the trustee avoids that lien, now it's subordinated under 726 and the estate gets nothing.

[00:28:56] Speaker 01:
It doesn't make any sense.

[00:28:57] Speaker 01:
You can't plug 726 into this analysis.

[00:29:00] Speaker 01:
726 comes into play when the estate is distributed.

[00:29:04] Speaker 01:
At the end of the case, when the trustee looks at the money that he has, he goes through Section 726, he's already paid the secured debt, and this is where 725 comes into play.

[00:29:14] Speaker 01:
You know, I've done bankruptcy work for the better part of 40 years.

[00:29:17] Speaker 01:
This is the first time anybody's even brought up 725.

[00:29:19] Speaker 01:
I had to look at it the first time they cited it.

[00:29:21] Speaker 01:
It's like, what is 725?

[00:29:23] Speaker 01:
It says if you've got property that's subject to a lien, you've got to pay the lien holder.

[00:29:28] Speaker 01:
We all know that.

[00:29:29] Speaker 01:
And so the trustee doesn't pay secured creditors under 726.

[00:29:32] Speaker 01:
It never happens.

[00:29:34] Speaker 01:
If you look at a trustee's distribution under 726, there's never a payment to a secured creditor.

[00:29:38] Speaker 01:
What the trustee pays are the unsecured creditors.

[00:29:41] Speaker 01:
And if there's a penalty claim in there,

[00:29:43] Speaker 01:
drop to the bottom and doesn't get any money, but it doesn't have anything to do with tax lien avoidance.

[00:29:49] Speaker 03:
Thank you, Mr. Dake.

[00:29:53] Speaker 03:
Mr. John Choi, I think you have about a minute and a half for a vote.

[00:29:57] Speaker 00:
Thank you, Your Honor.

[00:29:58] Speaker 00:
Just a couple of points.

[00:30:00] Speaker 00:
First, just returning to this, I think that when you're interpreting the code and when you're interpreting 724A, there's a presumption that precode practice still applies.

[00:30:09] Speaker 00:
The pre-code practice ensured that the tax portion of the tax lien was paid in full and there's nothing to suggest that that should not still occur.

[00:30:17] Speaker 00:
As to the nature of a tax lien, just going back to 6321 and its language, when an assessment is made, right, if any person liable to pay any tax neglects or refuses to pay the same after demand,

[00:30:29] Speaker 00:
The amount, that's the amount of the tax, including any interest, additional amount, additional tax or assessable penalty together with any cost that may accrue in addition to or to shall be a lien.

[00:30:39] Speaker 00:
Most of these accruing categories won't exist or may not exist when you assess the tax.

[00:30:43] Speaker 00:
That's why I say the tax lien includes the other things.

[00:30:46] Speaker 00:
Those are things to come in the future, particularly interest and accruing penalties.

[00:30:50] Speaker 00:
So the nature of a lien is just different, of a tax lien is just different than other things.

[00:30:55] Speaker 00:
It doesn't need to be recorded to be perfected.

[00:30:58] Speaker 00:
It comes into being.

[00:30:59] Speaker 00:
It's perfected in co-eight as soon as the assessment is made and the lien arises.

[00:31:05] Speaker 00:
The difference is 6323 provides statutory exceptions that allow some people to jump in front of that lien if the lien has not been recorded.

[00:31:13] Speaker 00:
But it's perfected and it exists before that.

[00:31:15] Speaker 00:
And an assessment only for tax will cover penalties as well.

[00:31:20] Speaker 00:
The other thing I wanted to point out to the court is that,

[00:31:25] Speaker 00:
With regard to this E question, I think 724E does not apply to 724A by its own terms.

[00:31:33] Speaker 00:
724E says, before subordinating a tax lien, well the subordination of tax liens only occurs in 724B and not in 724A.

[00:31:42] Speaker 00:
But this is one of the reasons why you should not interpret 724A to allow for pro rata allocation.

[00:31:47] Speaker 00:
You should not reduce the tax under pro rata allocation before

[00:31:51] Speaker 00:
later subordinating the tax lien.

[00:31:54] Speaker 00:
If they're going to share the tax, Congress chose to share it in 724B, not in 724A.

[00:31:58] Speaker 03:
So is the order of events then, in your view, the entire tax portion gets paid to the IRS, then if there's anything remaining and it would satisfy the penalty provision, then we go to A, and then back to B for distribution of anything beyond that?

[00:32:20] Speaker 00:
Yes, and you go back to be in the event that all of the other assets are insufficient.

[00:32:26] Speaker 00:
And that's the answer under precode practice, and that should still be the answer today.

[00:32:31] Speaker 00:
Thank you.

[00:32:31] Speaker 03:
Thank you.

[00:32:32] Speaker 03:
This case is now submitted.

[00:32:34] Speaker 03:
These cases, the two cases are submitted.