The right of priority of payment of debts due to the government is a prerogative of the crown well known to the common law. It is founded not so much upon any personal advantage to the sovereign as upon motives of public policy, in order to secure an adequate revenue to sustain the public burdens, and discharge the public debts. The claim of the United States, however, does not stand upon any sovereign prerogative, but is exclusively founded upon the actual provisions of their own statutes. The same policy which governed in the case of the royal prerogative may be clearly traced in these statutes, and as that policy has mainly a reference to the public good, there is no reason for giving to them a strict and narrow interpretation. Like all other statutes of this nature, they ought to receive a fair and reasonable interpretation, according to the just import of their terms.205

The liberal construction of the priority statute just noted is intended to serve its purpose of protecting the public revenue. This point is illustrated by a case involving a claim brought by the NLRB against a bankrupt based on a back pay order issued as a result of certain unfair labor practices of the bankrupt. Since the claim was asserted by the United States for the benefit of private parties, the victims of the unfair labor practices, it bore no relation to the function of protecting the public revenue and therefore it was held to be outside the scope of the priority rule.206

32. Construction. The priority given to the United States by the priority statute is absolute, not conditional; once it attaches it is final and conclusive and not subject to defeasance.207 Furthermore, the only exception to the priority accorded to the claims of the United States by this statute are those created by express statutory language or the plainest inconsistency.208 And in any case, a person who contests the "absolute" priority of the United States under this statute must sustain the burden of proving an exception in his case.209

33. Application of the priority statute to debts of the United States. A question that often arises in cases involving the priority statute concerns the phrases "indebted to the United States" and "the debts due to the United States," and particularly the meaning of the term "United States." There has been some controversy, for example, over the application of the priority statute to claims that originate in the operations of government corporations and other quasi-independent government instrumentalities. If the government corporation is a distinct legal entity separate from that of the United States, the priority statute has been held to be inapplicable. Conversely, if the instrumentality has no distinct legal entity, and

210

205 United States v. State Bank of North Carolina, 31 U.S.C. (6 Pet.) 29, 35 (1832). 200 Nathanson v. NLRB, 344 U.S. 25 (1952).

207 Massachusetts v. United States, 333 U.S. 611 (1948).

208 United States v. Emory, 314 U.S. 423 (1941).

200 Beaston v. Farmer's Bank, 37 U.S. (12 Pet.) 102, 134 (1838).

210 United States Shipping Board Emergency Fleet Corporation v. Wood, 258 U.S. 549 (1922).

the claim which it asserts represents a debt of the United States, the instrumentality will be accorded the statutory priority of the United States.211 Since the United States must act through agencies and instrumentalities of one sort or another in carrying out the functions of government, the better view would seem to be that the form which the Government takes is immaterial,212 and the only test should be whether the Government has suffered pecuniary loss. Under this view, when funds of a government corporation or instrumentality are government funds and the losses government losses, the pecuniary loss test is satisfied and the priority statute should be applied. This construction is in accord with the purpose of the priority statute described in paragraph 31 above. Under the guaranteed loan program in effect during World War II, the Government's priority was even extended to the exposure of private banks by means of the exercise by the Government of its option to purchase the loan whenever bankruptcy or insolvency of the borrower threatened. The take-over agreement, of course, provided for a pro rata distribution of collections. While never contested in an appellate court, the principle was frequently approved by allowance of such claims in federal district courts.

34. Insolvency of the debtor. Since the priority statute is limited in its application to claims held by the United States against an insolvent debtor, another problem presented by the statute concerns the meaning of the word "insolvent." By a rather artificial construction the Supreme Court has limited the meaning of this word to the examples stated in the latter part of the statute.213 Within the limitations of this rule, the United States will be given priority as creditor whenever the debtor is divested of his property by a voluntary assignment for the benefit of creditors, whenever there is a legal insolvency such as a liquidating receivership under state law or an equity receivership in a federal court, and finally whenever the debtor commits an act of bankruptcy, whether or not it results in a petition, adjudication, or liquidation.214 The result of this narrow construction has been to remove from the scope of the priority statute a number of situations in which a debtor is plainly insolvent in the common acceptance of the word. For example, if a debtor should

211 United States Department of Agriculture v. Remund, 330 U.S. 539 (1947). In this case the claim was asserted by and in the name of the Farm Credit Administration. 212 See Inland Waterways Corp. v. Young, 309 U.S. 517, 523, 524 (1940). 213 "Insolvency . . . must be manifested in one of the modes pointed out in the latter part of the statute which defines or explains the meaning of insolvency referred to in the earlier part." United States v. Oklahoma, 261 U.S. 253, 260 (1923). See also Bramwell v. United States Fidelity Co., 269 U.S. 483, 488 (1926).

214 See Holman, op. cit. supra n. 204, at 264-265. The "act of bankruptcy," to which the priority statute refers, is clearly not limited to the statutory definitions of bank ruptcy in section 3 of the Bankruptcy Act (30 Stat. 546 (1898) 11 U.S.C. § 21 (1958)), since at the time of the passage of the priority statute there was no federal bankruptcy law in existence.

enter into an informal agreement with his creditors to postpone his debts or rearrange his affairs, even to the extent of effecting liquidation, without resorting to the normal legal procedures of assignment, receivership or bankruptcy, the priority statute might thereby be circumvented. The strict construction of the word "insolvent," as used in the priority statute, therefore, is a surprising departure from the repeated affirmation by the courts of the need for a liberal interpretation of the statute to effect its public purpose.215

35. The priority statute and the Bankruptcy Act. One of the situations in which the claims of creditors against a debtor become matured and have to be asserted for participation in the distribution of a debtor's assets is the voluntary or involuntary resort by the latter to the provisions of the Bankruptcy Act. Section 64 (a) of the act 218 provides generally for the types of debts which are to have priority and be paid in full before dividends are paid to general unsecured creditors: (1) administration expenses, (2) wages up to $600 per claimant, earned within three months before the commencement of the bankruptcy proceedings, (3) special costs incurred by a creditor in setting aside the bankrupt's discharge, (4) federal, state, and local taxes owed by the bankrupt, and (5) "debts owing to any person, including the United States, who by the laws of the United States is entitled to priority. . . ." The most important aspects of this section is that it places certain classes of claims ahead of the general priority accorded to the United States by the priority statute.217 However, section 64(a) (5) preserves the priority over general unsecured creditors granted the United States by the priority

statute.

36. Specific proceedings under the Bankruptcy Act. The application of the priority statute, therefore, is determined in each type of bankruptcy proceeding by whether section 64 is applicable. In several types of bankruptcy proceedings there are provisions in the Bankruptcy Act to the effect that the order of priority established by section 64 is to be followed.218 In such cases the claims of the United States will continue to be granted priority, but only after the specified prior claims have been satisfied. In corporate reorganizations under Chapter X of the act, however, a different result is obtained. Section 102 expressly provides that section 64 "shall not apply in such proceedings unless an order shall be entered directing

215 See the discussion in par. 31 supra.

216 30 Stat. 563 (1898), 11 U.S.C. § 104 (a) (Supp. I, 1959). For a discussion of the procedures for handling Navy claims against bankrupt contractors, see pars. 45-50 infra.

217 See United States v. Emory, 314 U.S. 423, 428 (1941).

318 This is true in the following types of bankruptcy proceedings: agricultural compositions and extensions under Chapter VIII of the act (11 U.S.C. § 203 (1) (1958)), railroad reorganizations (Id. at § 205(b) (1958)), Chapter XI arrangements (Id. at §§ 702 and 737(2) (1958)), Chapter XII real property arrangements (Id. at §§ 802 and 855 (1958)), and Chapter XIII wage earner's plans (Id. at § 1059 (6) (1958)).

that bankruptcy be proceeded with. . . ." Although the point has been disputed, nevertheless there is good authority for the proposition that the deliberate exclusion of section 64 in Chapter X proceedings, together with the failure similarly to exclude the priority statute, must be given full significance, and that, since section 64 merely provides an exception to the normal operation of the priority statute, its express exclusion in Chapter X proceedings serves only to restore and render fully applicable the provisions of the priority statute.219 If this is so, a claim of the United States in such a proceeding is entitled to priority of payment under the priority statute, subject only to the exception in favor of administration costs and expenses which are paid out of the bankrupt's estate, as distinguished from debts incurred by the bankrupt himself.220

37. The priority statute and liens of other claimants. Another problem presented by the priority statute concerns its operation with relation to liens asserted by other claimants against the debtor of the United States. 221 The priority of the United States extends only to the property of the debtor at the time of his insolvency, which would, of course, exclude specific property of which he has been divested prior to that time by a bona fide conveyance to third persons, by a mortgage to secure a debt, or by levy of execution.222 Also, it would probably exclude property of which the debtor has been effectively divested by operation of law through a specific and perfected lien, although this question has never been decided.223

38. Conveyances, mortgages and attachments. The Supreme Court has held that the priority statute does not create a lien in favor of the United States; accordingly, a bona fide transfer of property by a debtor to third persons in the ordinary course of business while he is still solvent will not thereby be overreached.224 On the theory that the operation of the priority statute is limited by the divestment of the debtor's property, the Supreme Court has also held that a mortgage or an attachment prior to insolvency might postpone the Government's priority.225 The decision in the mortgage case was based on the view that a mortgage has the effect of a conveyance, divesting the debtor of his title and leaving nothing but an equity to which the preference of the United States could attach. In a jurisdiction which adopts the lien theory of mortgages, there

210 This point is fully discussed in 6 COLLIER, BankruptCY ¶ 9.13 at 2845-2848 (14th ed. 1956).

220 30 Stat. 562 (1898), 11 U.S.C. § 102 (1958).

For a comprehensive and critical discussion of the cases dealing with this aspect of the priority statute, see Kennedy, The Relative Priority of the Federal Government: The Pernicious Career of the Inchoate and General Lien, 63 YALE L.J., 805 (1954). 222 See Thelusson v. Smith, 15 U.S. (2 Wheat.) 396, 425 (1817).

233 See Illinois v. Campbell, 329 U.S. 362, 370 (1946).

224 United States v. Fisher, 6 U.S. (2 Cranch) 358 (1805).

225 Conard v. Atlantic Insurance Co., 26 U.S. (1 Pet.) 386 (1828) (mortgage); Prince

v. Bartlett, 12 U.S. (8 Cranch) 431 (1814) (attachment).

fore, a different result might well be reached. Indeed, in a case decided in 1941, the Supreme Court in passing questioned the "current vitality" of the rule in favor of mortgages.224

39. Inchoate liens. It is clear that inchoate liens, which do not effect divestment of specific property of the debtor until they are perfected by appropriate legal action, stand behind a claim of the United States asserted in proceedings where the priority statute is applicable. For example, in an early case the Supreme Court held that the United States was entitled to priority of payment over a judgment creditor on the ground that the judgment gave him merely a general lien on the debtor's property which, whatever its dignity, must yield to the preference of the United States created by the broad language of the priority statute.227 Presumably the result would have been different had execution of the judgment proceeded far enough to take the property out of the possession of the debtor. Again, in a case involving a lien for state unemployment compensation which attached to all the personal property of a debtor devoted to or used in his business, including after-acquired property, the Supreme Court ruled that the lien was not so specific and perfected as to overcome the statutory priority of the United States, even though notice of lien had been filed and recorded and a receiver appointed, and under applicable state law nothing further remained to be done to perfect the lien.228 The Court went on to say that "The long-established rule requires that the lien must be definite, and not merely ascertainable in the future by taking further steps, in at least three respects as of the crucial time. These are: (1) the identity of the lienor . . . (2) the amount of the lien . . . and (3) the property to which it attached." 229 Although the first two conditions were satisfied in this case, the Court reasoned that the lien was not perfected since it did not attach to specific property of the debtor but rather to personal property devoted to or used in his business, including after-acquired property, a shifting and inconstant category. As the Court noted, the lien of the state was merely a caveat of a more perfect lien to come.

40. Characterization of liens a matter of Federal law. In a case that involved the priority of the United States over a landlord's lien and a municipal tax lien, both of which were created by Virginia law, the Supreme Court held that the liens asserted by the land

220 See United States v. Texas, 314 U.S. 480, 484-486 (1941); Kennedy, op. cit. supra n. 221.

227 Thelusson v. Smith, 15 U.S. (2 Wheat.) 396 (1817). In a later discussion of this decision the Supreme Court noted that the judgment creditor had not perfected his title by execution and levy on the debtor's property so as to take the case beyond the reach of the priority statute. Conard v. Atlantic Insurance Co., 26 U.S. (1 Pet.) 386, 444 (1828).

228 Illinois v. Campbell, 329 U.S. 362 (1946).

Id. at 375.