High Court Hears Ag Law Arguments

December 2, 2011 | Roger McEowen

The U.S. Supreme Court has two cases presently before it that involve various aspects of agricultural law and taxation.  One case will be argued on December 7 and involves the issue of what the appropriate test is for determining whether a river is navigable.  If a river is navigable, then the state owns the riverbed.  But when is navigability to be determined - now or at the time the particular state entered the Union?  The case involves a wholesale generator of electricity that challenged a trial court determination that the State of Montana owned the riverbeds of three rivers and was, therefore, entitled to damages for the generator's use of the riverbeds from 2000 through 2007 at hydroelectric power stations.  The appellate court affirmed on the basis that the rivers were navigable when Montana became a state in 1889 and provided a channel for commerce at that time.  The U.S. Supreme Court will determine if navigability is to be determined at the time of statehood or at the present time.  PPL Montana, LLC v. State, 355 Mont. 402, 229 P.3d 421 (2010), cert. granted, 180 L. Ed. 2d 843 (U.S. 2011).
The other case involves taxation in a Chapter 12 (farm) bankruptcy.  The specific question before the Court is whether capital gain taxes that are triggered on the sale of farmland during a Chapter 12 bankruptcy are payable as an administrative expense under the bankruptcy reorganization plan.  If they are, then a provision enacted in the bankruptcy overhaul legislation of 2005 makes those taxes a non-priority claim.  That means they would get paid just like any other general unsecured claim gets paid under the debtor's reorganization plan - with some of the taxes being discharged in bankruptcy.  If they aren't, then they are a priority claim that must be paid in full before the debtor can pay the unsecured creditors in accordance with the reorganization plan.  Key to the Court's decision will be whether the Court believes that I.R.C. Sec. 1399 means that tax incurred on sale of farmland during a Chapter 12 case is not an administrative expense of the bankruptcy estate that is payable under the debtor's reorganization plan.  Importantly, a Chapter 12 filing does not create a separate taxable entity from the debtor.  Thus, the IRS argues that Sec. 1399 applies with the result that the tax remains the debtor's responsibility.  The U.S. Circuit Court of Appeals for the Ninth Circuit referenced our article in support of its holding that the plain meaning of the Bankruptcy Code provision at issue (11 U.S.C. Sec. 1222(a)(2)(A)) did not apply to taxes arising post-petition because there is no separate taxable entity in a Chapter 12. 
The bankruptcy case was argued before the Court on Nov. 30.  At oral argument it was pointed out by the debtors' counsel (who had never represented a farmer before and never argued a case before the U.S. Supreme Court) that the intent of the Congress was to provide for non-priority treatment irrespective of when the property was sold - either before or after the bankruptcy petition was filed.  That position is consistent with pre-Bankruptcy Code practice (at least before enactment of 11 U.S.C. Sec. 1222(a)(2)(A) in 2005) where a debtor's tax obligations that were incurred while a bankrupcty case was in process were treated as adminstrative expenses by the IRS.  Granted, the language of the 2005 provision changing the priority status of "governmental claims" is botched, but the real question is whether the Court will hold to a strict interpretation of the provision's actual language when it flies in the face of what the Congress (Senator Grassley (R-IA) in particular) intended.  At oral argument, Justice Kennedy stated that the debtors' policy-based argument made some sense, but if that is the result that Senator Grassley wanted, "they didn't do it right technically."  Justice Scalia was also unconvinced by the argument of the debtors' novice counsel when he pointed out that it was impossible to reconcile the Tax Code provisions (particularly I.R.C. Sec. 1399) with the Bankruptcy Code provision.  Other Justices, including the Chief Justice, noted that both sides were in agreement as to the intent of the non-priority provision (that it apply to pre and post-petiition taxes), and appeared troubled that the government's interpretation of the provision would render the provision (as Justice Alito put it) "of very, very little practical value."  We'll see how this one comes out.  United States v. Hall, 617 F.3d 1161 (9th Cir. 2010), cert. granted, No. 10-875 U.S. Sup. Ct. Jun. 13, 2010).