UNPUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

STATE OF NORTH CAROLINA, on
relation of James E. Long,
Commissioner of Insurance, as
Liquidator of the Northwestern
Security Life Insurance Company,
Plaintiff-Appellant,

v.
                                                                    No. 97-2108
UNITED STATES OF AMERICA,
Defendant-Appellee.

NATIONAL CONFERENCE OF INSURANCE
GUARANTY FUNDS; NATIONAL
ORGANIZATION OF LIFE AND HEALTH
INSURANCE GUARANTY ASSOCIATIONS,
Amici Curiae.

Appeal from the United States District Court
for the Eastern District of North Carolina, at Raleigh.
James C. Fox, District Judge.
(CA-96-921-5-F)

Argued: January 28, 1998

Decided: April 16, 1998

Before LUTTIG and MICHAEL, Circuit Judges, and
GOODWIN, United States District Judge for the
Southern District of West Virginia, sitting by designation.

_________________________________________________________________

Affirmed by unpublished opinion. Judge Goodwin wrote the opinion,
in which Judge Luttig and Judge Michael joined.

_________________________________________________________________
COUNSEL

ARGUED: V. Lane Wharton, Jr., BODE, CALL & STROUPE,
L.L.P., Raleigh, North Carolina, for Appellant. Robert Martin Rolfe,
HUNTON & WILLIAMS, Richmond, Virginia, for Amici Curiae.
Paula Keyser Speck, Tax Division, UNITED STATES DEPART-
MENT OF JUSTICE, Washington, D.C., for Appellee. ON BRIEF:
Anthony D. Taibi, BODE, CALL & STROPE, L.L.P., Raleigh, North
Carolina, for Appellant. Thomas W. Jenkins, Rowe W. Snider, Ron-
ald M. Lepinskas, LORD, BISSELL & BROOK, Chicago, Illinois,
for Amici Curiae. Loretta C. Agrett, Assistant Attorney General,
Janice McKenzie Cole, United States Attorney, David I. Pincus, Tax
Division, UNITED STATES DEPARTMENT OF JUSTICE, Wash-
ington, D.C., for Appellee.

_________________________________________________________________

Unpublished opinions are not binding precedent in this circuit. See
Local Rule 36(c).

_________________________________________________________________

OPINION

GOODWIN, District Judge:

Northwestern Security Life Insurance Company (Northwestern)
was a North Carolina corporation specializing in life, health, and acci-
dent insurance. Northwestern failed in the late eighties after being
looted by its holding company, resulting in a loss of over $10 million.
J.A. at 55. On November 2, 1989, the Wake County Superior Court
ordered Northwestern placed in rehabilitation and appointed the
appellant, North Carolina Insurance Commissioner James E. Long,
receiver of the company. J.A. at 28. Rehabilitation efforts proved
unsuccessful, and on May 8, 1990, the Superior Court ordered North-
western placed in liquidation and instructed Commissioner Long to
marshal and liquidate Northwestern's remaining assets. J.A. at 56, 61.

As liquidator, Commissioner Long distributed the remaining assets
according to the state priority statute in effect at the time, N.C. GEN.

                     2
STAT. § 58-30-220, and the federal priority statute, 31 U.S.C. § 3713.
The federal priority statute required Commissioner Long to accord
first priority to claims of the United States. Therefore, Commissioner
Long paid federal income taxes of $159,253,1 which accrued during
liquidation, before paying any other claims. J.A. at 12-15. Commis-
sioner Long also paid real estate taxes, state license taxes and fees,
state premium taxes, state franchise taxes, and social security taxes
during the liquidation period, presumably as first-priority costs of
administration under the state priority statute. J.A. at 31, 40-41. After
payment of administrative costs, Northwestern's remaining assets
covered only partial payments to third-priority claims of policyhold-
ers and guaranty associations.2 J.A. at 8, 45. No funds remained to
pay fourth-priority unearned premium claims and fifth-priority claims
of general creditors.

In 1993, the Supreme Court decided United States Department of
the Treasury v. Fabe, which held that under the McCarran-Ferguson
Act, 15 U.S.C. § 1012, state insurance insolvency statutes are not pre-
empted by the federal priority statute to the extent that the state stat-
utes afford a higher priority to policyholder claims and claims for
administrative expenses than to claims of the United States. 508 U.S.
491, 493 (1993). In response to Fabe, the Commissioner filed
amended tax returns for 1990 and 1991. He argued that Fabe allowed
him to pay first-priority administrative expenses and third-priority
policyholder claims before federal claims, and because there would be
no assets left after paying these two classes of claims, that he was
entitled to a refund of the $159,253 paid in federal income taxes in
1990 and 1991. J.A. at 16-17.

On November 3, 1994, the Internal Revenue Service informed the
Commissioner that it would not allow his refund claim on the grounds
that the federal income taxes that accrued during liquidation were
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1 Specifically, Commissioner Long paid an alternative minimum tax of
$112,377 and an environmental tax of $4343 in 1990, and an alternative
minimum tax of $42,165 and an environmental tax of $368 in 1991.
2 The North Carolina priority statute accorded certain employee wage
claims second-priority status, but because no such claims were made dur-
ing liquidation, the Commissioner proceeded directly to third-priority
claims.

                     3
entitled to first-priority status as administrative expenses under North
Carolina General Statute § 58-30-220(1). J.A. at 19-20. On November
6, 1996, the Commissioner filed suit in district court, claiming that he
was entitled to the refund. J.A. at 5-11. The court granted summary
judgment for the United States, holding that the federal taxes at issue
qualified as administrative expenses entitled to first-priority status
under the North Carolina statute. J.A. at 90. We review the district
court's grant of summary judgment de novo.

When an insurance company enters liquidation, state statutes often
create a priority scheme for payment of claims from the company's
assets. Until recently, such state statutes were preempted by the fed-
eral priority statute, which provides that "[a] claim of the United
States Government shall be paid first when a person indebted to the
Government is insolvent and . . . an act of bankruptcy is committed."
31 U.S.C. § 3713(a)(1)(A)(iii). However, in 1993, the Supreme Court
saved these state priority statutes from federal preemption to the
extent that they protect policyholders. Fabe, 508 U.S. at 493. The
Court based its decision on the McCarran-Ferguson Act, which
exempts from federal preemption state laws enacted"for the purpose
of regulating the business of insurance." 15 U.S.C. § 1012(b). The
Supreme Court reasoned that the provisions in Ohio's priority statute
which protected policyholder interests were enacted"for the purpose
of regulating the business of insurance." Fabe, 508 U.S. at 504 (citing
15 U.S.C. § 1012(b)). Although other provisions in Ohio's priority
statute were preempted by federal law, the Court concluded that the
provisions which protected policyholders were not. Id. at 508-09.
Specifically, the Court held that, "Ohio may effectively afford prior-
ity, over claims of the United States, to the insurance claims of poli-
cyholders and to the costs and expenses of administering the
liquidation." Id. at 493.

Thus, after Fabe, the former North Carolina priority statute, § 58-
30-220,3 and the federal priority statute interact as follows: Former
_________________________________________________________________
3 The North Carolina General Assembly repealed and replaced this stat-
ute in 1993. However, it still controls the disposition of this case because
under North Carolina General Statute § 58-30-105(c), the relative rights
of Northwestern's creditors are governed by the law in effect on the date
Northwestern was placed in liquidation.

                    4
North Carolina General Statute § 58-30-220 distributes claims in the
following order:

          (1) claims for cost of administration and conservation of
          assets of the insurer;

          (2) compensation actually owing to employees . . .;

          (3) claims or portions of claims for benefits under policies
          . . .;

          (4) claims for unearned premiums;

          (5) claims of general creditors.

Although the federal priority statute accords first-priority status to
federal claims, it only preempts subsections (2), (4), and (5) above.
This is because Fabe saves from preemption claims for administrative
expenses and policyholder claims. Thus, under Fabe, the Commis-
sioner was obligated to pay costs of administration and conservation
of assets first, policyholder claims second, and federal claims third.
Northwestern's available assets, however, were sufficient only to
cover administrative expenses and a portion of the policyholder
claims. After paying these claims, the Commissioner would not have
had any assets left to pay federal claims. Under this view, the Com-
missioner contends that he is entitled to a refund of federal income
taxes paid in 1990 and 1991.

The United States argues, however, that the federal taxes are them-
selves costs of administration, qualifying for first-priority status under
subsection (1) of § 58-30-220. As noted above, subsection (1) of § 58-
30-220 withstands federal preemption. Thus, the question of whether
federal taxes are costs of administration under§ 58-30-220(1) must be
resolved under North Carolina state law.

The Commissioner relies heavily on National Surety Corp. v.
Sharpe, 72 S.E.2d 109 (N.C. 1952), to show that federal taxes do not
qualify as administrative expenses under North Carolina law. In that
case, the North Carolina Supreme Court addressed the relative rights

                     5
of claimants against an insolvent manufacturing company in receiver-
ship proceedings. After creating a complicated priority scheme for
payment of various purchase money chattel mortgages and judgment
creditor liens, the National Surety Corp. court distributed the remain-
ing assets according to a priority scheme that placed administrative
expenses and federal taxes in separate categories. Id. at 126. How-
ever, any support that National Surety Corp. lends to the Commis-
sioner's argument vanishes after referring to the later decided case of
King v. Premo & King, Inc., in which the North Carolina Supreme
Court explicitly held that federal taxes which accrue postreceivership
are costs of administration. 129 S.E.2d 493, 500 (N.C. 1963).

North Carolina statutory law also supports the conclusion that costs
of administration include postliquidation federal taxes. For example,
North Carolina General Statute § 58-30-120(4) authorizes the Com-
missioner "to defray from the funds or assets of the insurer all
expenses of taking possession of, conserving, conducting, liquidating,
disposing of, or otherwise dealing with the business and property of
the insurer." The last clause, in particular, sweeps various expenses
into the realm of administrative costs. In "dealing with the business
and property" of Northwestern, the Commissioner was legally obli-
gated to pay taxes as they accrued. Under the North Carolina statute,
these payments could properly be characterized as administrative
costs.

North Carolina is hardly alone in reaching this determination. It is
a generally accepted proposition that taxes which accrue postreceiver-
ship or postliquidation are administrative costs. For example, the
Bankruptcy Code includes taxes in its itemization of allowed adminis-
trative expenses. 11 U.S.C. § 503(b)(1)(B). In addition, this Court has
previously held that postpetition taxes incurred by a bankrupt debtor's
estate constitute a cost of administration. United States v. Friendship
College, Inc., 737 F.2d 430, 431-32 (4th Cir. 1984). And the Third
Circuit has noted, "[p]ost-bankruptcy taxation . . . has long been
viewed by the courts as part of classic administration expenses." In
re Connecticut Motor Lines, Inc., 336 F.2d 96, 99 (3d Cir. 1964).

The Commissioner attempts to distinguish the taxes in this case
from other taxes paid as administrative expenses by claiming that the
alternative minimum tax and the environmental tax were neither nec-

                    6
essary nor beneficial to the estate. The Commissioner urges too nar-
row a view. As the Supreme Court ruled in Reading Co. v. Brown,
damages arising from postreceivership negligence constitute adminis-
trative expenses because they are "costs ordinarily incident to opera-
tion of a business." 391 U.S. 471, 483 (1968). Certainly, paying tort
damages did not benefit the estate in Reading Co. in an obvious sense.
Similarly, in this case, paying federal taxes does not benefit the estate
in an obvious sense, because it results in fewer assets for distribution.
But paying legal obligations is necessary and beneficial in the sense
that it allows the receiver or the liquidator to conduct the ongoing
business of selling assets and distributing claims in an orderly man-
ner. The legal obligations that arise as a result of this ongoing busi-
ness are properly considered administrative expenses.

In the end, it comes down to a question of timing, that is, when the
taxes accrued. Taxes that accrued before Northwestern was placed in
liquidation cannot be considered administrative expenses because
those taxes accrued before there was an estate to administer. See State
ex rel. Long v. Interstate Cas. Ins. Co., 464 S.E.2d 73, 78 (N.C. Ct.
App. 1995). Taxes that accrued after liquidation are administrative
expenses.

The Commissioner concedes that these taxes accrued in 1990 and
1991 (postliquidation), but nonetheless argues that they should not be
classified as administrative expenses because they were based on
"phantom income." (Appellants' Br. at 15-16). According to the Com-
missioner, this phantom income was generated by premium payments
received by Northwestern before liquidation and subsequently stolen.
Because the taxes were based on money Northwestern had, and lost,
before liquidation, the Commissioner argues that the taxes should not
be considered administrative expenses incident to the liquidation.

We find this argument unpersuasive. Insurance companies like
Northwestern are taxed under the Internal Revenue Code, 26 U.S.C.
§ 832(b)(4). Under this provision, insurers benefit from a tax scheme
that defers recognition of income. That is, premiums may be paid up-
front, but for tax purposes, the earned income from the premium is
spread over the life of the policy. It is immaterial whether an insurer
actually has the premium income on hand when the IRS attributes that
income to the insurer. Income taxed in years subsequent to the year

                    7
when the premium is actually paid is not "phantom income." It is real
income. Because the federal income taxes at issue accrued in 1990
and 1991, after the Superior Court entered the liquidation order, those
taxes should be considered administrative expenses entitled to first-
priority status under former North Carolina General Statute § 58-30-
220. For these reasons, the Court affirms the district court's grant of
summary judgment for the United States.

AFFIRMED

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