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#2160 signed 2-12-96



In re:



NO. 93-41090-7







ADV. NO. 94-7094


This proceeding is before the Court on a motion to reconsider filed by the Board of County Commissioners of Johnson County, Kansas (Johnson County). Johnson County is represented by Assistant County Counselor Roger L. Tarbutton. The trustee appears as his own counsel in this proceeding. The Court has reviewed the relevant pleadings and is now ready to rule.

Johnson County asks the Court to reconsider four facets of the Memorandum of Decision it issued on August 21, 1995. The County argues: (1) 11 U.S.C.A. §724(b) does not apply in this case because the debtor's general unsecured creditors will not benefit from its application; (2) its tax liens should be paid first from the proceeds of the sale of the debtor's real property because a foreclosure judgment had been entered prepetition and, under state law, the taxes would have been paid first from the proceeds of a foreclosure sale; (3) the County's claim for the debtor's 1993 real property taxes qualifies as an administrative expense under 11 U.S.C.A. §503(b)(1)(B)(i); and (4) the County's claim for the 1994 real property taxes qualifies as an administrative expense of the chapter 7 portion of the bankruptcy case and not the chapter 11 portion. After thoroughly reviewing these matters, the Court concludes it must reject all of Johnson County's arguments.

Johnson County first argues that §724(b) was adopted solely to benefit general unsecured creditors and may not be applied in this case because no such benefit will be realized. The argument is based on a quotation from Oakland County Treasurer v. Allard (In re Kerton Industries), 151 B.R. 101, 103 (E.D.Mich. 1991), discussing "general creditors," which the County takes to refer to general unsecured creditors. However, the County apparently overlooked the significance of a case citation and parenthetical remark which it replaced with an ellipsis in its brief. The omitted material reads: "See, e.g., In re K.C. Machine and Tool Co., 816 F.2d 238, 247 (6th Cir. 1987) ('Here, because of §724(b), administering (selling) the property promises a large benefit by increasing the funds available for distribution to administrative creditors.' (Emphasis supplied).)." 151 B.R. at 103. This material indicates that the court was not saying that §724(b) could be applied only when some of the proceeds of property encumbered by a tax lien would be paid to general unsecured creditors. Instead, the court was saying that the estate had to receive some benefit other than simply paying the costs of selling the property and that obtaining money to pay administrative expenses was a sufficient benefit.

While there may be insufficient money in the case before this Court to pay anything to the general unsecured creditors, the estate will still benefit from the application of §724(b) because more money will be available to pay the priority claims against the estate. The faulty logic of Johnson County's theory is made even more clear by considering a hypothetical bankruptcy estate which has no property other than that subject to an unavoidable tax lien. As the Court indicated in its prior ruling, §724(b) provides that such property is to be distributed: (1) first to any holder of a nonavoidable lien that is senior to the tax lien; (2) second to any holders of claims specified in §507(a)(1) through (7) to the extent of the allowed amount of the tax claim that is secured by the lien; (3) third to the holder of the tax lien to the extent that the allowed amount of its claim that is secured by the lien exceeds any amount distributed to claims under clause (2); (4) fourth to the holder of an allowed claim secured by a lien that is junior to the tax lien; (5) fifth to the holder of the tax lien to the extent its secured claim was not paid under clause (3); and (6) sixth to the bankruptcy estate. To get any money to the general unsecured creditors, the property subject to the tax lien would have to be sufficient to pay the first five items in full and leave something in addition to distribute to the estate. In that situation, the first five items would have been paid in full even if §724(b) did not exist. Thus, Johnson County's theory is that the provision can apply only when its application would be meaningless. Since there are priority claims in this case in addition to those arising from the sale of the property subject to the County's liens and from the trustee's dispute with the County, §724(b) applies to subordinate the County's liens to the priority claims covered by subsection (2) of that provision.

Johnson County next argues that the foreclosure judgment entered before the debtor filed for bankruptcy somehow increased the significance of its tax liens on the debtor's real property so that the property should not be considered to be property of the estate or at least that equitable considerations shoud preclude applying §724(b) to the liens. Of course, the County's liens already had first priority against the property before the judgment was entered, and were entitled to be paid first if the property were sold. According to the Kansas Court of Appeals, Kansas law provides that no title passes upon entry of a foreclosure judgment; instead, equitable title passes when a foreclosure sale is confirmed, and legal title passes only at the expiration of any redemption period. In re Application of SBA for Ad Valorem Tax Exemption, 14 Kan.App.2d 600, 604-05 (1990).(1) Consequently, following the foreclosure judgment, the debtor still had both equitable and legal title to the real property, and the property passed into the bankruptcy estate upon the filing of the debtor's chapter 11 petition. See Jim Walter Homes v. Spears (In re Thompson), 894 F.2d 1227, 1228-31 (10th Cir. 1990) (under similar state law and §1322(b), even after a foreclosure judgment, debtors retain the right to cure a mortgage default at least until the foreclosure sale; obviously, the property became property of the estate despite the foreclosure judgment). Once the property became property of the estate and the case was converted to chapter 7, §724(b) became applicable to determine the distribution of the proceeds of the property, overriding the distribution scheme that would apply under Kansas law. Johnson County's equitable arguments are simply complaints that it was unfair for Congress to pass §724(b). The Court, of course, has no authority to substitute its view of fairness and equity for the clearly expressed view of Congress.

Johnson County's third argument is that its claim for the debtor's 1993 real property taxes qualifies as an administrative expense under §503(b)(1)(B)(i), and consequently, a first priority under §507(a)(1), rather than an eighth priority under §507(a)(8), as the Court declared in its decision. Section 503 provides in pertinent part:

(b) After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including--

(1) . . .

(B) any tax--

(i) incurred by the estate, except a tax of a kind specified in section 507(a)(8) of this title.

Such expenses are given the first priority under §507(a). Section 507(a) gives an eighth priority for:

(8) Eighth, allowed unsecured claims of governmental units, only to the extent that such claims are for--

. . .

(B) a property tax assessed before the commencement of the case and last payable without penalty after one year before the date of the filing of the petition.

Section 502(i) also has some bearing on tax claims. It provides:

A claim that does not arise until after the commencement of the case for a tax entitled to priority under section 507(a)(8) of this title shall be determined, and shall be allowed under subsection (a), (b), or (c) of this section, or disallowed under subsection (d) or (e) of this section, the same as if such claim had arisen before the date of the filing of the petition.

Congress' intent in drafting these provisions is somewhat less than clear. Among other things, the use of three different words--"incurred," "assessed," and "arise"--to refer to the time when the tax liability comes into existence creates the possibility of conflicting interpretations. One treatise has remarked:

Depending on the characterization of when a tax is "incurred" and "assessed," it is possible that under a strict reading of the Code, a tax could be incurred before bankruptcy, and thus be ineligible for first priority treatment, but not be assessed until after bankruptcy, and thus be disqualified as a[n eighth] priority. Some courts have nevertheless allowed the taxing authority a[n eighth] priority.

2 Norton Bankruptcy Law & Practice 2d, §42.38 at 42-188 to -189 (1994). Besides the difficulties caused by those words, the exception clause in §503(b)(1)(B)(i) seems literally to say administrative expenses do not include any tax of the kind covered by §507(a)(8), In re Westholt Manufacturing, 20 B.R. 368, 370-71 (Bankr.D.Kan. 1982); the word "kind" seems to refer broadly to an income or gross receipts tax, property tax, withholding tax, and so forth, without regard to the other, largely temporal, requirements of §507(a)(8). The exception has usually been interpreted, though, simply to exclude prepetition liabilities from administrative expense treatment. See 3 Collier on Bankruptcy, ¶503.04[1][b] at 503-35 to -36 (15th ed. 1994). Separating prepetition and postpetition liabilities, of course, remains a difficult problem.

The common legal definitions of "assess," "incur," and "arise" demonstrate the flexible meanings they can have. The leading legal dictionary explains that "assess" means:

To ascertain; fix the value of. To fix the amount of the damages or the value of the thing to be ascertained. To impose a pecuniary payment upon persons or property. To ascertain, adjust, and settle the respective shares to be contributed by several persons toward an object beneficial to them all, in proportion to the benefit received. To tax.

In connection with taxation of property, means to make a valuation and appraisal of property, usually in connection with listing of property liable to taxation, and implies the exercise of discretion on the part of officials charged with duty of assessing, including the listing or inventory of property involved, determination of extent of physical property, and placing of a value thereon. To adjust or fix the proportion of a tax which each person, of several liable to it, has to pay; to apportion a tax among several; to distribute taxation in a proportion founded on the proportion of burden and benefit. To calculate the rate and amount of taxes. To levy a charge on the owner of property for improvements thereto, such as for sewers or sidewalks.

Black's Law Dictionary (5th ed. 1979), p. 106. This definition shows that "assess" can refer to nearly any step in the process of imposing a property tax, determining its amount, and requiring its payment. The same source explains "incur" means:

To have liabilities cast upon one by act or operation of law, as distinguished from contract, where the party acts affirmatively. To become liable or subject to.

Id. at 691. This definition also does not clearly refer to any particular point in the process by which a tax is imposed, beyond perhaps suggesting it occurs at the earliest time when it becomes certain that some tax will be owed. The most general meaning provided for "arise" is similar:

To spring up, originate, to come into being or notice; to become operative, sensible, visible, or audible; to present itself.

Again, this definition suggests an earlier rather than a later time in the taxing process. Still, all three words seem broad enough to cover nearly any step in that process.

Having carefully reviewed §§502(i), 503(b)(1)(B)(i), and 507(a)(8)(B), the Court is convinced that Congress intended for all property taxes coming due postpetition to qualify for either the first or eighth priority. This purpose is best served by construing "incurred" in §503 to mean the same thing as "assessed" in §507(a)(8)(B). Under the Bankruptcy Code, "debt" means "liability on a claim" and "claim" means "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured." §101(12) & (5)(A). Under these definitions, a claim for a property tax must be considered to be "incurred" under §503 or "assessed" under §507(a)(8)(B) as soon as the debtor (or the debtor's property, if the tax is collectible only from the property) is necessarily liable to pay it. Section 502(i) then serves the purpose of making sure a tax that constitutes a claim prepetition can qualify for priority under §507(a)(8) even if it might not be allowable until sometime postpetition, for example, because the amount of the tax is not fixed prepetition. When the debtor became necessarily liable to pay the tax is answered in this case by Kansas real property tax law.

There was a time in Kansas when an owner could exempt property from real estate taxes by transferring it to an exempt entity even after the listing and valuation of property for taxation had begun. Trinity Evangelical Lutheran Church v. Wyandotte County Comm'rs, 118 Kan. 742 (1925). However, since that time, the legislature has provided in K.S.A. 79-1804 that when property is transferred to an exempt entity after January 1 but before November 1 (when a lien attaches for that year's real property tax), a tax is owed for the portion of the year when the property was still owned by the non-exempt entity. Thus, as long as a non-exempt entity owns real property in Kansas after January 1, the property will necessarily be subject to at least some tax for that year. A claim for the tax therefore comes into existence on January 1 each year, and the only question thereafter is how much tax will be owed, not whether any will be owed. In addition, since the nonexempt owner cannot free the property from any of the tax for the full year except by transferring it to an exempt entity, the Court believes the claim that comes into existence on January 1 must be considered to be one for the full year's tax. For these reasons, the Court concludes the tax is "assessed" in the sense of "imposed" on January 1 each year. Since the debtor filed its bankruptcy case after January 1, 1993, its 1993 real property taxes are covered by §507(a)(8)(B).

That conclusion also resolves Johnson County's fourth argument. Since "incurred" in §503(b)(1)(B)(i) and "assessed" in §507(a)(8)(B) must be construed to mean the same thing, the 1994 taxes were incurred on January 1 of that year, before the bankruptcy case was converted to chapter 7. Consequently, they are administrative expenses of the chapter 11 portion of the case.

The Court's Memorandum of Decision is hereby amended to specify that the 1994 real property taxes are chapter 11 administrative expenses. Except for this clarification, the Court concludes that Johnson County's motion to reconsider must be denied.


Dated at Topeka, Kansas, this _____ day of February, 1996.




1. The Court notes that its prior decision mistakenly indicated this opinion began on page 879 of the reporter. As indicated above, it actually begins on page 600.


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