Of The
UNITED STATES BANKRUPTCY CODE

Presented To The

Prepared By

THE HONORABLE RAY VALDES
SEMINOLE COUNTY TAX COLLECTOR
PRESIDENT, FLORIDA TAX COLLECTORS ASSOCIATION
CHAIRMAN, LEGISLATIVE COMMITTEE, NACTFO
1101 East First Street * Sanford, FL 32771

Phone: (407) 665-7601 Fax: (407) 665-7603

August, 1998

On Behalf Of

NATIONAL ASSOCIATION OF COUNTY TREASURERS
AND FINANCE OFFICERS

Based heavily on an analysis written in 1995 by Karen Cordry, Bankruptcy Counsel for NAAG.

NATIONAL ASSOCIATION OF COUNTY TREASURERS AND FINANCE OFFICERS

BANKRUPTCY SUMMARY
POINTS OF INFORMATION
AUGUST, 1998

• Counties, cities, schools and special districts rely heavily on real and personal property taxes as the largest single source of local government annual revenue. The property tax is universally recognized as providing necessary funding for local government services.

• The United States Constitution requires that state government and its political subdivisions have the power to finance their legitimate functions free from federal interference. This includes the responsibility to raise necessary revenues, unhindered by federal restrictions, to finance critical basic public services. When anticipated revenue is lost by a federal bankruptcy ruling, every dollar of tax not collected from a debtor (taxpayer) must be paid by all other taxpayers. This can cause severe hardship to the local governments in forecasting and funding required responsibilities for schools, police protection, fire fighters, hospital care, and roads.

• The ability of counties, cities, schools and special districts to collect properly assessed and levied real property taxes is being restrained by some federal District Courts in their interpretation of the federal Bankruptcy Code.

• Ad valorem taxes already assessed, levied and attached before the filing of a bankruptcy petition must retain their liens and status as secured claims under the Bankruptcy Code.

• The current Code provides for expansive powers of the bankruptcy courts over local taxes, such as the power to determine the valuation, benefit, amount and status of tax liens. Ad valorem taxes should not be considered a normal "debt", but rather an "obligation" shared by all citizens to fund a needed government service.

• A debtor should not be able to discharge or avoid pre-petition taxes by filing for bankruptcy. Any exception should be reviewed with great care to determine whether the benefit to the debtor outweighs the cost to society as a whole.

• Conflict among federal court rulings currently result in the bankruptcy laws being applied differently in various parts of the country. Attorneys will continue to spread the decisions favorable to their debtor clients into other jurisdictions. It appears attorneys are using certain aspects of the bankruptcy proceedings as a positive financial tool in some business plans.

United States Bankruptcy Legislation Reform Issues
Supported By
The National Association of County Treasurers and Finance Officers
August 3, 1998

I. BASIC CONCEPT ISSUES

Governments in the United States of America exist, function, and are funded through the voluntary consent of the governed. They survive because the vast majority of the populace willingly obey the laws and pay their taxes without the need for direct action by the government. That cooperation depends on the belief of the citizenry that their neighbors will also be expected to obey those same requirements. If there are easy ways to avoid the payment of legitimate taxes, voluntary compliance begins to break down. Others see no reason why they should obey the law if their neighbors do not. Thus, whatever benefits are provided to the relatively small number of persons who receive a bankruptcy discharge, they must be balanced against the possibility of harm to society as a whole if debtors are seen as people who use bankruptcy as a legal loophole to beat the system.

Under the Federal Bankruptcy Code, what should the proper procedure and policy be for the treatment of taxes?

Some bankruptcy claims involve voluntary creditors who have some ability to decide how and when they wish to extend credit to the debtor and to obtain protection for themselves if they do. If they obtain a voluntary lien from the debtor, that security will be given substantial protection by the law. Other claims, such as taxes owing to governmental units, are held by involuntary creditors. This should give added equity to a claim held by a party who had no ability to avoid being embroiled with the debtor.

Local governments serve unique functions - public education, police powers, taxing powers, mandated requirements, regulatory processes -- not duplicated in the private sector. They cannot restrict their activities to only a particular portion of their territories or to a desirable segment of the population. Just as the rain falls on the just and the unjust, so too are police and fire protection given to both timely and delinquent taxpayers. Potholes outside a tax protester's house will still be filled, and his children may still attend public school, despite his failures to pay the taxes he owes. All of these services are provided from taxes, and a citizen that accepts the privileges and benefits of citizenship must accept the reciprocal duties and obligations. A system that makes it too easy to avoid taxes risks losing not only the monies owed by the debtor, but also by those who imitate that initial violator. In light of the unique responsibilities owed by a government to its citizens, the bankruptcy system must not undermine the duty that citizens owe to their government and each other.2

Further, one must recognize that individual bankruptcies -- which comprise the vast majority of all cases -- almost never provide substantial sums to creditors; rather, they are merely a way of officially closing the books on bad debts. This is occurring at a time when "the federal government expects states, counties, and municipalities to pay for more varied services. However the bankruptcy code, as it currently exists, hinders local governments from collecting the money to pay for these services."

"Some federal courts seem to take the position that local government tax liens are not real property interests and claims, but 'just' the government's money. In fact, the public and other taxpayers are the ones who are burdened by these ill-founded conclusions and decisions."

Thus, one must balance carefully the limited value to society of giving a "fresh start" to some, against the damage that can be done to our overall social system if citizens are led to believe they can easily escape their tax obligations by filing bankruptcies.

In business bankruptcies, the theory is that reorganization will provide a stronger and more viable entity that will be able to produce a greater economic return for creditors than would a liquidation of the enterprise. The reality is that 90% of cases that start in Chapter 11 never achieve a viable reorganization. The prompt payment of taxes should be considered as an early "litmus test" when determining the feasibility of a Chapter 11 planned reorganization. "Payment of taxes on a timely basis is not an expectation that will overly burden and/or prejudice a debtor seriously contemplating reorganization."

It is the position of taxing authorities that revision of the Bankruptcy Code should adopt, as a first principle, that taxes that become due and owing during the case must be paid in a timely fashion in the ordinary course of the debtor's activities. Taxes should not be treated worse than other expenses that are incurred by a debtor during its case, and they should not be sacrificed to generalized goals of achieving a "fresh start" or a successful reorganization. When the debtor emerges from bankruptcy, it will again be required to pay its taxes in full. If it cannot successfully master those problems while it is under the protective wing of the bankruptcy court, how can it hope to do so when it returns to the harsh world of normal economic life? An equally important principle is that, in general, the debtor should not be able to discharge or avoid pre-petition taxes by filing for bankruptcy.

CURRENT STATUS OF BANKRUPTCY REFORM LEGISLATION -
CONGRESS HR 333 AND S 420

Most members of Congress agree that there is a need to pass bankruptcy reform legislation. They know that the number of bankruptcies filed has skyrocketed to an all-time high in the past year, creating a loss in the economy of approximately $40 billion annually. U.S. House Judiciary Committee Chairman, James Sensenbrenner (R-WIS) has worked diligently to recently offer what he outlines as a "global compromise package", from the House to the Senate. The intent is to resolve the Joint House/Senate Conference Committee remaining differences between HR 333 and S 420, including the two most controversial of homestead exemption value and relief of debts arising from abortion clinic violence.

As Representative Sensenbrenner said in early March, 2002, "we have argued and debated the fine points of bankruptcy long enough. This is an issue that is good for the economy. The time has come for Congress to get on with the business of passing bankruptcy reform."

At the same March 2002 meeting, Senate Majority Leader Tom Daschle (D-SD) stated he hopes to see a "strong bankruptcy bill come out of conference committee and move on to the President's desk within the next four weeks". Senate Judiciary Chairman Patrick Leahy (D-VT) reported that he "welcomes what the House has sent us, since it reflects some agreements among House and Senate staff members in recent months."

On March 13, 2002, Senate conferees were poised to send a comprehensive counteroffer on bankruptcy reform legislation issues to the House, as aides on both sides continue to seek a consensus on the lesser issues before the members of the House and Senate convene again as a "Joint Conference Committee".

After seven years, we remain close, but still without an acceptable U.S. Bankruptcy Code reform package to be adopted by the Congress, that would be acceptable to the President in the White House. Stay tuned.

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