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In re Burden

argued: July 31, 1990.

IN RE BURDEN, WILFRED, H., A/K/A BURDEN, WILFRED, H., JR., T/A BURDEN'S JANITORIAL SERVICE & SUPPLY COMPANY
v.
THE UNITED STATES OF AMERICA, APPELLANT



On Appeal from the United States District Court for the Eastern District of Pennsylvania; (D.C. Civil Action No. 89-06550).

Higginbotham, Jr., Chief Judge, Scirica and Alito, Circuit Judges.

Author: Higginbotham

Opinion OF THE COURT

HIGGINBOTHAM, JR., Chief Judge

This is a Chapter 13 bankruptcy case. The Internal Revenue Service ("IRS") appeals from the judgment of the District Court for the Eastern District of Pennsylvania, which affirmed the Bankruptcy Court's ruling that a claim for nonpecuniary loss tax penalties may be subordinated to the claims of other general unsecured creditors, absent a showing of misconduct by the government. 109 Bankr. 107 (1989).*fn1

Because the district court automatically subordinated the tax penalties without weighing the equities of the various claims, we will reverse and remand.

I.

Wilfred H. Burden, debtor and appellee, was assessed federal income and employment taxes, related penalties, and interest for various tax periods from 1980 to 1985. When the debtor failed to pad all of the amounts assessed against him, the IRS filed four separate notices of tax lien.*fn2

On June 30, 1987, the debtor filed for protection under Chapter 13 of the Bankruptcy Code. In response, on July 28, 1987, the IRS timely filed a proof of claim in the amount of $57,930.17, of which $51,903.32 was subsequently secured. Of the secured amount $10,655.64 was assessed for penalties and $18,862.68 for interest. The remaining unsecured portion of the claim includes $1,384.67 in penalties and $3,510.19 in taxes. The issue before us on appeal concerns the penalty portion (secured and unsecured) of the total liabilities, which amounts to $12,040.31.*fn3

On March 30, 1989, the debtor filed a timely objection to the IRS' proof of claim. The parties were able to resolve all of the issues in contention raised by the debtor's objection except one, namely, that in its proof of claim, the IRS failed to subordinate the pre-petition penalties (totalling $12,040.31) to the claims of other general unsecured creditors. The parties did agree that only $52,000 in assets were available to compensate the secured creditors, some having interests prior to those of the IRS.

In response to the debtor's objection, on August 1, 1989, the bankruptcy court entered an order that modified the IRS' proof of claim. Pursuant to § 510(c) of the Bankruptcy Code, the court subordinated the pre-petition penalties portion to the claims of other general non-subordinated unsecured claims. The IRS filed a timely appeal to the bankruptcy court's order. The district court affirmed the bankruptcy court's final order.

The IRS filed a timely appeal before this court contending that 1) equitable subordination does not permit the automatic subordination of nonpecuniary loss tax penalties; 2) § 510(c) on its face precludes class subordination; 3) the invocation of equitable subordination requires a showing of inequitable conduct; 4) § 510(c) requires a notice and fair hearing for all claims; and 5) the automatic subordination of nonpecuniary loss tax penalties would diminish the purpose and effect of such IRS penalties.

Our review of the district court's order affirming the bankruptcy court's order is plenary. See Universal Minerals, Inc. v. C.A. Hughes & ...


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