courts. Therefore, it may reasonably be concluded that any claim which arises from any governmental activity of the United States, regardless of the form which that activity takes, will be entitled to priority of payment under the provisions of the priority statute. Since the priority statute is limited in its application to claims held by the United States against an insolvent debtor, the second problem of construing the Act 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.11 Within the limitations of this rule, the United States will be given priority as creditor whenever there is a voluntary assignment for the benefit of creditors of all, or substantially all, of the debtor's property, or whenever there is a legal insolvency such as a liquidating receivership under state laws 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.42 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 the debtor should reach an informal agreement with his creditors to postpone his debts or to rearrange his affairs, even to the extent of effecting liquidation, without resorting to the classical 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 affirma 41 "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). 42 See Holman, op. cit. pp. 264-265. The "act of bankruptcy," to which the priority statute refers is clearly not limited to the statutory definitions in Section 3 of the Bankruptcy Act. (30 Stat. 546, 11 U. S. Code 21, since at the time of the passage of the priority statute there was no Federal bankruptcy law in existence. 43 Footnote 36 and text, supra. 430 Stat. 563, 11 U. S. Code 104(a). This is true in the following cases: agricultural compositions and extensions under Chapter VIII of the Act (30 Stat. 544, 11 U. S. Code 203(1)); railroad reorganizations (id. 205(b)); Chapter XI arrangements (Id. 737(2)); Chapter XII real property arrangements (Id. 855); and Chapter XIII wage earner's plans (Id. 1059(6)). tion by the courts of the need for a liberal interpretation of the statute to effect its public purpose.43 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 the 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 provides generally for the types of debts which are to have priority and be paid in full before dividends are paid to creditors: (1) administration expenses, (2) wages up to $600 per claimant, earned within three months of the institution of the bankruptcy proceeding, (3) special costs incurred by a creditor in setting aside the bankrupt's discharge, (4) state and federal 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 aspect of this section is that it establishes certain exceptions to the first priority accorded to the United States by the priority statute. But while it creates higher degrees of priority for the purposes of the Bankruptcy Act, the preference granted to the United States by the priority statute remains untouched within the framework of Section 64 (a) (5). The application of the priority statute, therefore, is determined in each bankruptcy situation by whether Section 64 is applicable. In several such situations, there are provisions in the Bankruptcy Act to the effect that the order of priority established by Section 64 is to be followed.45 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 that bankruptcy be proceeded with...." Although the point is disputable, 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. According to this line of reasoning, 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.46 As a result, 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 (30 Stat. 562, 11 U. S. Code 102). Another problem presented by the priority statute concerns its operation with relation to liens asserted by other claimants. The priority of the United States extends only to the property of the debtor at the time of his insolvency, which excludes property of which he had effectively divested himself prior to that time, or of which he had been effectively divested by operation of law through a specific and perfected lien. The courts have experienced much difficulty, however, in determining what constitutes a specific and perfected lien by way of limiting the operation of the priority statute. It is clear that inchoate liens, which do not effect divestment of the debtor's property 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.47 And in an early case, the Supreme Court held that the United States was entitled to priority of payment over an earlier judgment creditor, on the ground that the language of the priority statute is broad and it covers all debts due to an individual whatever their dignity.48 On the other hand, the same court has stated that the priority statute does not create a lien in favor of the United States, and accordingly, a bona fide transfer 48 See 6 Collier on Bankruptcy (14th Ed.) Sec. 9.13 at pp. 28452848. 47 See Illinois v. Campbell, 329 U.S. 362, )73-375 (1946). 48 Thelusson v. Smith, 2 Wheat. 396 (1817). This principle is not free from doubt, however. See United States v. Fisher, 2 Cranch 358, 390 (1805). Conrad v. Atlantic Insurance Co., 1 Pet. 386 (1828), (mortgage); Prince v. Bartlett, 8 Cranch 431 (1814), (attachment). 1 See United States v. Texas, 314 U.S. 480, 484-486 (1941). 52 United States v. Waddill Co., 323 U.S. 353 (1945). 53 Id. pp. 356-357. of property in the ordinary course of business will not thereby be overreached.49 On the theory that the operation of the priority statute is limited by the divestment of the debtor's property, the courts have held that a mortgage or an attachment might postpone the Government's priority.50 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 a preference can attach. In a jurisdiction which adopts the lien theory of mortgages, therefore, a different result might well be reached; indeed, in a recent case the Supreme Court took occasion to question the "current vitality" of the exception in favor of mortgages.51 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 asserted liens of the landlord and the municipality were not sufficiently specific and perfected on the date of the debtor's voluntary assignment to affect the Government's priority in spite of a determination by the Virginia courts to the contrary.52 After examining the action taken by the lien claimants, the Court stated that "it is a matter of federal law as to whether a lien created by state statute is sufficiently specific and perfected to raise questions as to the applicability of the priority given the claims of the United States by an act of Congress.... A state court's characterization of a lien as specific and perfected, however conclusive as a matter of state law, cannot operate by itself to impair or supersede a long-standing Congressional declaration of priority."53 Finally, describing these liens as a warning of more perfect liens to come, the Court suggested that possibly an actual distraint, accompanied by transfer of title or possession, might serve to perfect the claimed liens. The Supreme Court seems generally to have looked with suspicion upon lienholders who have neglected to assert their rights until the debtor has become insolvent, whereas it has viewed more favorably those who, before insolvency, have taken affirmative action to protect their interests. In the present state of the law, it would appear that little less than complete divestment of a debtor's interest in property, prior to the crucial time at which priority attaches, would be effective to defeat a priority claim of the United States. The Department of the Navy has no authority to settle or compromise indebtedness to the Government except where specifically authorized by statute. During the war, such authority existed by virtue of the First War Powers Act and the Contract Settlement Act of 1944,54 but being temporary, such authority does not exist at this time in the Navy.55 Consequently, in effecting the collection of debts due the Government it is necessary that administrative remedies to secure payment be first exhausted. When such steps are insufficient, complete statements covering the indebtedness are submitted to the General Accounting Office or the Department of Justice, depending upon the facts involved and remedy sought. As a practical matter, nearly all cases involving representation of the interests of the Navy in the courts are submitted to the Department of Justice. However, Congress has by statute, at times, authorized the heads of different departments and establishments to adjust and settle particular classes of claims and demands against the United States, such as the Dent Act, 40 Stat. 1272. Also, it properly may be, and in many instances is, provided in contracts under certain circumstances, such as upon termination, that a designated official is authorized to determine particular facts, such determination to be final and conclusive-in which event General Accounting Office cannot go behind the findings in the absence of fraud or bad faith (20 Comp. Gen. 573, 579). As will be developed in the next chapter, it is possible, in the absence of statute or specific contract provision, for the contracting officer and the contractor to agree by supplemental agreement upon the amount to be paid as a termination settlement (18 Comp. Gen. 826, 828). 54 55 Stat. 839; 50 U. S. Code App. 601 and 58 Stat. 649; 41 U. S. Code 101, respectively. 55 The General Accounting Office is authorized by Sec. 305 of the Act of 1921 (42 Stat. 24, U. S. Code 71) to settle and adjust all accounts in which the Government of the United States is concerned. Executive Order 6166, June 10, 1933, vests in the Department of Justice the function of compromising claims of the United States referred to it. (7 Comp, Gen. 193, 194 (1927)). SUMMARY Article I, Section 9, of the Constitution provides for legislative control of the purse. In accordance with this provision, the Navy is entirely dependent on appropriations made by Congress for its support and development. To insure continuous control, Congress makes such appropriations for the Navy on certain conditions which affect both the period of availability and the use thereof. The great majority of naval appropriations are annual in nature, which means that they must be obligated within the fiscal year for which they were made, after which time they expire. If an obligation is incurred by naval contracting officers within this period, the funds thus obligated remain available for expenditure for two additional fiscal years, whereupon they lapse and revert to the Treasury. Whenever a contractor fails to complete his performance until after the appropriation in question has lapsed because of circumstances beyond his control, he must resort to the certified claims procedure or take his case directly to the Court of Claims to secure payment for his post lapse performance. It seems probable, however, that a contract is invalid insofar as it contemplates post lapse performance at the time of its execution. In the event of undue hardship and in the absence of any contract right, a contractor may in certain instances gain relief by means of a private relieving bill. Congress has also imposed certain conditions on the obligation and use of appropriations, which conditions have been interpreted in the decisions rendered by the Comptroller General. An obligation, to be valid, must meet certain tests of legality. Thus, a valid obligation must be for an authorized purpose, it must be for the bona fide needs of the current fiscal year, and it must be certain, definite, and specific in its terms. When an appropriation expires, there are limitations on the Navy's authority to add more funds from that appropriation by amending the contract. If the contract is entire, as distinguished from severable, old funds may be added to those already obligated even though the appropriation has expired, provided that the additional funds are used not to increase the scope of the original contract but merely to effect changes in the specifications of the product in question. Naval appropriations may be obligated by project orders placed with other Government Departments or within the Navy Department itself, as well as by contracts with private contractors. Since a project order closely parallels a contract with a private contractor, it is subject to the same general conditions and limitations that are prescribed for such contracts if it is to constitute a valid obligation of appropriated funds. However, because of the increased opportunity for evasion of fiscal limitations, Congress has provided certain additional conditions to insure proper control over the use of project orders. Before a project order may be placed there must be an administrative determination that it is in the interest of the Government to do so. To prevent the use of the project order as a device for continuing the availability of otherwise unobligated funds, it is the general rule developed by the Comptroller General that the order must serve a need of the current fiscal year, that it must be definite and certain, and that the work required under an order must be commenced immediately. Finally, with certain exceptions, a project order may not be placed with another Department, or with a subordinate activity of the Navy, unless the requisitioned agency is substantially in a position to supply or equipped to render the materials or services in question. The transfer of functions from one department to another by means of a project order is not permissible. But when the work has been reduced to a specific project description, the Economy Act of 1932 permits the requisitioning agency to reimburse the performing agency for the total cost of the work done under the project order, including the cost of personal services and administrative or overhead expenses. As a result, the project order has become an instrument for obtaining intragovernmental services while maintaining the appropriation integrity of the agenies concerned. In this way, Congress is assured that one department will not augment its appropriations at the expense of other departments by the use of project orders, contrary to the legislative scheme. There are several methods of financing Navy contractors provided for by statute and executive order. Guaranteed loans were used during the recent war to facilitate wartime expansion of defense plants, but since August, 1945, the Navy has not entered into any new agreements of this sort. The only direct lending procedure now in use by the Navy is the making of advance payments. This procedure is implemented by the regulations published under the Armed Services Procurement Act of 1947. Subject to the general supervision of the Fiscal Director of the Navy, each contracting bureau or office of the Navy is authorized to make progress payments under certain circumstances. Finally, private financing is encouraged under the Assignment of Claims Act of 1940, subject to regulations prescribed by the Navy. Whenever the United States becomes a creditor of an insolvent debtor, whether as a result of financing or otherwise, its position is governed by a statute that has the effect of giving it an absolute priority with respect to all the property in the hands of that debtor at the time when the insolvency occurred. The application of this statute to bankruptcy matters depends, in each case, on the applicability of Section 64 of the Bankruptcy Act. Except where expressly authorized by statute and in certain cases involving termination settlements, the Navy has no authority to settle or compromise indebtedness to the Government. Consequently, after the Navy has exhausted its administrative remedies to secure payment of its debts, it must refer the case either to the General Accounting Office if the remedy sought involves administrative set-off or the assertion of priorities in bankruptcy, or to the Department of Justice if the claim is to be prosecuted in the courts. CHAPTER 5 TERMINATION OF CONTRACTS* DEVELOPMENT OF THE CONTRACT THE CORLISS STEAM ENGINE COMPANY CASE Thereafter, Corliss made an alternative proposition to the Navy Department, in writing, offering to settle all claims on the basis of either (1) retaining all of the machinery then in process, receiving in addition the sum of $150,000 or (2) delivering all of the machinery in its then incomplete condition to the Charleston Navy Yard for $259,068.40, payable on delivery there. The latter offer, after a complete and thorough investigation was decided * Prepared by Robert S. Moss, formerly a member of the Office of the General Counsel, Department of the Navy, now a practicing lawyer in the city of Washington, D. C. 1 Act of February 24, 1870 (16 Stat. 68); Act of March 3, 1871 (16 Stat. 531); Act of May 23, 1872 (17 Stat. 154). 2 Act of July 15, 1870 (16 Stat. 325). 3 Ibid. 410 Ct. Cl. 494 (1874). Ibid., at page 501. to be the fairest offer and was accepted by the Navy Department. A certificate of indebtedness was issued, as there were then no appropriations available to pay that sum. The Comptroller of the Treasury refused to approve the certificate for congressional appropriation of funds, contending, inter alia, that the settlement was not fair and reasonable, and that the Contracting Officer of the Navy Department had no authority to enter into it. Thereafter, the Congress, on the recommendation of the Comptroller, adopted legislation designed to prevent the use of annual appropriations for shipbuilding to pay the agreed amount,1 and directed a re-examination of the claim by law officers and engineers of the Navy "who shall deduct from the contract price with said steam-engine company whatever sum it would have cost said company to have completed their said contract."2 Pursuant to the Act of July 15, 1870,3 a determination was made by Navy Department engineers that the sum due to the Corliss Steam Engine Company should be $140,978.40 rather than the agreed sum of $259,068.40. Thereupon, the Corliss Steam Engine Company brought action in the Court of Claims of the United States on the certificate of indebtedness in the sum of $259,068.40. The Court of Claims fully approved the settlement made between the Department and Corliss Steam Engine Company, finding that there was no fraud, misrepresentation or other wrong, but that, on the contrary, all the facts were known to both parties.5 The matter, however, did not stop there, as the government appealed that decision to the Supreme Court of the United States. The Supreme Court was little impressed with the arguments advanced on behlf of the Comptroller. In affirming the decision, it was held: 1 |