Washington, Employment Security Department v. Hovan, Inc. (In re Hovan, Inc.)

We must decide whether certain state tax obligations are punitive or compensatory for the purpose of determining the priority of bankruptcy claims.

I

The State of Washington appeals the district court’s affirmance of a bankruptcy court’s order, which determined that Washington’s penalty assessments for state tax obligations were general unsecured claims in the Chapter 11 bankruptcy of debtor Hovan, Inc. Washington contends that the assessments deserve priority status because they are compensatory rather than punitive.

Hovan filed a petition for relief under Chapter 11 of the Bankruptcy Code on August 6, 1993. On behalf of the Washington Departments of Employment Security, Labor & Industries, and Revenue, Washington filed priority claims against Hovan for unpaid taxes including unpaid principal balances, prepetition interest, and penalties. The penalties, which total $5,382.14, are based on percentages that increase with each of the first three months of delinquency. 1 In addition to the percentage-based penalties, the relevant statutes also provide for interest on delinquent payments. Wash. Rev.Code §§ 50.24.040, 51.48.210, 82.32.050.

Hovan’s reorganization plan, which was…