The U.S. Supreme Court considered this week whether state and federal law permit a bankruptcy trustee to take back a payment made to the IRS that may have been fraudulent.
A bankruptcy trustee is appointed by a court to administer a debtor’s estate in a bankruptcy proceeding. The trustee stays apprised of the debtor’s financial condition, collects assets, and distributes money to creditors.
A creditor normally has to rebate to the trustee payments the debtor made in the run-up to the bankruptcy filing. When a debtor makes a payment to avoid paying creditors, a court can declare the transaction a fraudulent transfer.
In United States v. Miller, the justices were asked during oral argument on Dec. 2 to consider whether payments have to be rebated when the IRS is the creditor.
In 2014, when the company was already insolvent, it paid $145,138 to the IRS to satisfy the individual tax debts of two of the company’s principals.
A federal bankruptcy court in Utah converted the Chapter 11 case into a Chapter 7 proceeding, in which a trustee sells off the debtor’s assets to cover debts. The debtor is allowed to keep certain property the law exempts from liquidation.
The bankruptcy trustee, David Miller, initiated an adversary proceeding against the United States in an effort to void the payments to the IRS.
Section 544(b) of the U.S. Bankruptcy Code permits a trustee to challenge “any transfer ... that is voidable under applicable law by a creditor” who has a valid claim.
Miller argued that he was entitled to recoup the payment to the IRS even though as an agency of the federal government it is normally immune to lawsuits.
The bankruptcy court determined that because the tax payments were made more than two years before the company’s bankruptcy petition was filed, the trustee’s claim under the bankruptcy code’s fraudulent transfer clause was filed too late.
However, the bankruptcy court agreed with the trustee that under Utah law, the IRS payment could be voided because that state’s law allows four years to revoke a payment that was fraudulent.
The bankruptcy court awarded the trustee a judgment against the United States for $145,138 in March 2020.
The government appealed and the federal district court in Utah upheld the ruling in September 2021.
The government appealed again and the U.S. Court of Appeals for the 10th Circuit affirmed in June 2023.
During oral argument on Dec. 2, the trustee’s attorney, Lisa Blatt, said Congress has spelled out specifically when the IRS should receive special treatment but it did not do so in Section 544(b) of the U.S. Bankruptcy Code.
Yet the government argues the IRS should retain assets that others would be required to give back, Blatt said.
“That result would prevent the trustee from recouping this money and paying it to the bus drivers and the mechanics and the vendors who certainly gave All Resort more value than the IRS did,” the lawyer said. “The government’s position finally destroys creditor equality. Where governments are creditors, like they are here, the government gets to keep the fraudulent transfer and its share of a much smaller pie.”
Justice Elena Kagan told U.S. Justice Department attorney Yaira Dubin that it seemed “a bit peculiar” that the IRS’s governmental immunity is waived in the Bankruptcy Code but not in state law claims outside the bankruptcy process.
Dubin disagreed about the effect of the legal provision, but Kagan said, “Why would Congress have gone to this trouble of waiving sovereign immunity if the trustee was always going to lose anyway?”
Justice Brett Kavanaugh told Dubin her position would “create a playbook for fraud, that you pay your personal tax debts with corporate funds and let the IRS then, in their words, hide behind sovereign immunity that would short-change creditors.”
Justice Ketanji Brown Jackson, addressing Blatt, said, “The result of your view is that the trustee can recover money from the estate under this particular circumstance in a way that no actual creditor could because you concede that all actual creditors bringing a lawsuit against the United States for recovery for ... this fraudulent transfer would be barred by sovereign immunity.”
The Supreme Court is expected to issue its ruling on the case by June 2025.
