By: L. Alexis Whitley, Esq.
Earlier this year, the Internal Revenue Service (“IRS”) recognized a victory in United States v. Miller United States v. Miller moving forward.
Bankruptcy trustees are empowered to avoid, or invalidate, certain asset transfers that debtors have made. These avoidance powers help the trustee to recover assets and equalize the distribution of those assets among a debtor’s creditors. For example, § 544(b) of the Bankruptcy Code allows a trustee to “avoid any transfer of an interest of the debtor in property … that is voidable under applicable law by a creditor holding an unsecured claim.” Generally, the “applicable law” that a trustee relies on is state fraudulent transfer law, which typically provides creditors with a cause of action to avoid transfers the debtor made with the intent to defraud creditors. Section 544(b) requires there to be an actual creditor that could avoid the transfer under the state fraudulent transfer law, serving as a check on a trustee’s powers.
One important provision that pairs with § 544(b) is § 106(a) , which is the Bankruptcy Code’s sovereign immunity waiver. Under § 106(a)(1), a governmental unit’s sovereign immunity is abrogated with respect to avoidance actions under § 544(b). However, § 106(a)(5) provides that the sovereign immunity waiver does not create a cause of action that does not otherwise exist under bankruptcy or non-bankruptcy law.
In Miller , the avoidance power under § 544(b) and the sovereign immunity waiver of § 106(a) collided and presented a key question to the Supreme Court: can a bankruptcy trustee avoid a debtor’s transfer to the IRS? In this case, a Utah-based transportation company became insolvent in 2013 due to financial malfeasance and poor management. The following year, two shareholders misappropriated company funds to pay off personal debts, including a $145,000 tax payment to the IRS. In 2017, the company filed for bankruptcy, and the trustee sought to avoid the 2014 tax payment under § 544(b) by relying on Utah’s fraudulent transfer statute.
While the parties agreed that § 106(a) waived the IRS’s sovereign immunity with respect to the cause of action created under § 544(b), they disagreed as to whether § 106(a) also waived sovereign immunity with respect to the state law cause of action. To resolve this dispute, the Supreme Court looked at the sovereign immunity waiver as a whole, noting that it does not create a cause of action under non-bankruptcy law. The Court then reviewed § 106(a) in the context of § 544(b) and determined that § 106(a) does not alter the substantive requirements for avoiding a debtor’s transfer under § 544(b). This means that the actual creditor requirement must be met, and the trustee can only avoid a transfer by relying on state law if another creditor could have avoided the transfer. The trustee can step into the shoes of another creditor to avoid a transfer, but the trustee cannot create the shoes of another creditor to avoid a transfer.
Ultimately, because sovereign immunity would have barred any private creditor from recovering from the IRS under Utah’s state fraudulent transfer law, and because the Bankruptcy Code’s sovereign immunity waiver applies only to § 544(b) causes of action, no creditor could serve as the necessary predicate and the trustee could not avoid the $145,000 tax payment.
Although the Supreme Court has settled the issue, this decision will likely impact bankruptcy cases moving forward. As an example, identical transfers to a governmental entity could be voidable under § 548, the federal fraudulent transfer provision in the Bankruptcy Code, but not voidable under § 544(b). This is because the federal fraudulent transfer provision has a two-year lookback period, while state laws relied on for § 544(b) often have an extended lookback period. Despite this potential impact, the case has shed light on bankruptcy avoidance actions and the IRS’s sovereign immunity.
Greenspoon Marder attorneys are available to assist with tax and bankruptcy matters. Contact Nick Richards at nick.richards@gmlaw.com with questions.
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