Opinion
No. 898-40514-JFQ.
September 15, 1992
Opinion
Internal Revenue Code section 6321 grants a lien in favor of the United States in a taxpayer's real or personal property for principal, penalties, and costs to account for delinquent taxes. 26 U.S.C. § 6321 (1986). In this case, the Internal Revenue Service has a secured lien amounting to $44,054.81. Of this total, $1,697.72 constitutes principal plus a $20.00 lien fee; $25,652.25 represents prepetition penalties, and $16,684.84 is prepetition interest. The issue presented is whether the interest and penalty portion of the I.R.S. claim should be treated as a secured claim.
I conclude that the I.R.S. claim should be fully allowed as a secured claim. Decisions which have disallowed payment of penalties and certain interest claims as priority claims are distinguishable from the present case. These decisions are generally premised on the language of 507(a)(7)(G) which allows priority treatment of unsecured tax claims to the extent necessary to compenstate for actual pecuniary loss. In re Patco Photo Corp., 82 B.R. 192 (Bankr.E.D.N.Y. 1988); In re Healis, 49 B.R. 939 (Bankr.N.D.Penn. 1985). Courts disallow priority status to amounts found to be punitive rather than compensatory. Healis, 49 B.R. 939. However, section 507(a)(7)(G) is inapplicable here since the I.R.S. claim is secured by a lien on the Debtor's property. The question is not whether an unsecured tax claim should be afforded priority over general unsecured claims. It is, rather, whether the lien securing the tax claim should be avoided.
I see no grounds to avoid this lien. While the Code explicitly provides for automatic subordination of penalty claims in a chapter 7, there is no such provision applicable to chapter 11 proceedings. 11 U.S.C. § 726(a)(4) (1978). In a chapter 7, secured and unsecured claims for penalties or fines which do not compensate for actual pecuniary loss are paid after the unsecured creditors received their distribution. Id. The absence of such a provision suggests to me that Congress intended to afford different treatment to penalty claims in a chapter 11. Rather than enacting an automatic subordination provision for penalty claims in chapter 11 cases, Congress limited subordination of claims to principles of equitable subordination. 11 U.S.C. § 510(c)(1) (1978).
Section 510(c) permits a court to subordinate certain claims if equity demands that result. However, the legislative history of that section indicates that Congress did not intend to permit equitable subordination of tax claims. In fact, the original bill specifically excluded tax claims from this provision. The language excepting tax claims was deleted as unnecessary "since (as pointed out in Congressional Statements) the House amendment authorizes subordination of claims only under principles of equitable subordination, and thus incorporates principles of existing case law, a tax claim would rarely be subordinated under this provision of the bill." (124 Cong. Rec. H11113 (daily ed. Sept. 28, 1978); S17430 (daily ed. Oct. 6, 1978); remarks of Rep. Edwards and Sen. DeConcini).
I see two reasons why the principles of equitable subordination should not be applied to this case. First, equitable remedies such as subordination under section 510(c)(1) are warranted only when parties are guilty of misconduct which causes injury to the creditors or confers an unfair advantage on the claimant. See Matter of Multiponics, 622 F.2d 709, 713 (5th Cir. 1980); Matter of Mobile Steel Co., 563 F.2d 692, 700 (5th Cir. 1977). Absent such behavior by the Internal Revenue Service, its penalty claim should be allowed. Second, equitable subordination of claims must not be inconsistent with the Bankruptcy Act. Multiponics, 622 F.2d at 713; Mobile Steel, 563 F.2d at 700. In light of the express wording of section 726(a)(4) mandating subordination of penalty claims in a chapter 7 and the absence of such language relating to chapter 11 proceedings, I conclude that without inequitable conduct by the claimant it would be inconsistent with the Bankruptcy Code to subordinate the I.R.S.'s claim for penalties.
The few courts that have subordinated tax penalty claims are distinguishable from the present case. See, e.g., Schultz Broadway Inn v. United States, 912 F.2d 230, 234 (8th Cir. 1990); Matter of Virtual Network Services Corp., 902 F.2d 1246, 1250 (7th Cir. 1990); In re Mako, 135 B.R. 902, 904 (E.D. Okla. 1991). These decisions all involved liquidating chapter 11 cases. Here, the debtor's business is operating as a going concern. The Schultz court distinguished a liquidation proceeding from a chapter 11 reorganization and indicated that subordination of penalty claims would be inappropriate in a chapter 11 reorganization. Id. at 233. The court reasoned that "in chapter 11 proceedings, Congress expected that many debtors would continue their operations under a reorganization plan and ultimately return to a viable and profitable enconomic state. In such cases, the debtor, quite rightly, should bear the burden of its full punitive obligations" Id. at 233. Concerns about reduced payment to unsecured creditors which would result if penalties were allowed as a priority claim in a liquidation proceeding are less present in a reorganization scenario. Id. at 233-4. Since this case involves a chapter 11 reorganization, I need not decide how I would conclude in a liquidation proceeding.
Only one court has used section 510(c)(1) to subordinate a prepetition tax penalty secured by a lien in a chapter 11 reorganization proceeding.In re Manchester Lakes Associates, 117 B.R. 221, 225 (Bankr. E.D Va. 1990). In Manchester Lakes, the court disallowed the lien securing the penalty portion of the county's tax claim and subordinated the claim to claims of unsecured creditors. Id. The court reasoned that one policy of Code is to protect general unsecured creditors and to avoid penalizing them for the debtor's wrongdoing. Id. In arriving at their conclusion, the court discussed the legislative history of section 724(a) of the Code which permits the chapter 7 trustee to avoid a lien that secures a fine or penalty to the extent the amount secured exceeds actual pecuniary loss. S. Rep. No. 989, 95th Cong., 2d Sess. 96, reprinted in 1978 U.S. Code Cong. Admin. News 5787, 5882. By making the line voidable rather than void, the Code protects creditors by preventing debtors from filing under chapter 7 to void a lien and later converting the case to a chapter 11, leaving creditors without recourse to revive the penalty lien "which should be valid in a reorganization." Id. Despite the Manchester court's recognition of the distinction between a chapter 11 and a chapter 7, the court relied on the policy considerations present in a chapter 7 case and its equitable power under section 510(c)(1). I choose not to read the Code as conferring such broad powers on the court. I believe we are constrained in section 510(a)(1) by basic principles of equity which require some wrongful conduct by a party before the court may intervene.
Finally, section 560(b) is inapplicable in this case. Section 506(b) deals with allowance of postpetition interest to an oversecured creditor.
The interest secured by the I.R.S. lien in this case is prepetition interest.
For the reasons stated herein, I hold that the United States' claim of $44,054.81 which includes prepetition interest and penalties is allowed as a fully secured claim.