Supreme Court to consider IRS request for pre-bankruptcy tax payments

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The court will begin its December session on Monday. (Katie Barlow)

When someone makes a payment to a creditor shortly before filing for bankruptcy, the Bankruptcy Code requires the creditor to return the money. However, it is less clear whether the same obligations apply to the Internal Revenue Service. On Monday, the justices will consider whether the IRS is protected by sovereign immunity from having to return funds from bankrupt debtors facing private creditors.

Case, United States / Miller, Includes Section 544(b) of the Bankruptcy Code; This section allows the bankruptcy trustee to “avoid”—that is, to void and reverse—“any transfer that would be deemed void under applicable law” by a creditor who retains a valid claim against the debtor.” This provision generally occurs shortly before the debtor enters bankruptcy. It is implemented to allow the trustee to undo transfers that the trustee has made, often referred to as “fraudulent transfers”.

The debtor in this case, All Resort Group, Inc., made a payment to the IRS to pay income taxes owed by its owners about three years before filing for bankruptcy. Because the company received no value in exchange for these tax payments (where it paid off debts owed by the owners) and because the company was insolvent at the time, they are the type of payment covered by Utah’s Uniform Fraudulent Transfers Act. Under this law, the company would generally be able to recover payments either from the IRS (the person to whom the money was paid) or from the owners (who benefited from the payments). Regardless, the same will be true in most, if not all, of the states in the country, as most states have a uniform version of state law that allows the recovery of such payments.

When the company filed for bankruptcy, David Miller, the company’s trustee in bankruptcy, filed a lawsuit seeking to recover payments from the IRS. The biggest problem is that the payment was made to the IRS rather than to a private creditor. Because the IRS has sovereign immunity, creditors cannot sue the IRS under the Utah Uniform Fraudulent Transfers Act. Accordingly, the IRS argues to the judges that there is no actual creditor who can sue the IRS under Utah law. From the IRS perspective, the absence of a true creditor means that it is protected from liability under Section 544(b).

Miller points to Section 106 of the Bankruptcy Code, which includes an express waiver of government sovereign immunity in the Bankruptcy Code: “Notwithstanding the assertion of sovereign immunity, sovereign immunity is waived with respect to a unit of government… Bankruptcy, including Chapter 544 Law.” To be clear, Section 106(a)(3) states that relief a bankruptcy court may issue against the government includes “an order directing the recovery of money,” and Section 101 defines “governmental entity” as not only “the United States” but also “ It defines the United States to include “the United States” itself, but also “any department, agency, or instrumentality of the United States.”

The government’s argument is a completely literal reading of Section 544(b): Because Section 106 of the Bankruptcy Code would not apply in a state court proceeding under the Utah Fraudulent Conveyancing Act, there is essentially no creditor who can successfully sue the IRS. in accordance with this law.

Miller has two strong arguments against this provision. The first is that it overrides the express reference to Article 544 in Article 106. It may seem a bit much to say that Congress did not specifically address this problem when writing a law specifically mentioning Section 544.

Moreover, the history of the provision suggests that this is even less likely. Inside Hoffman v. Connecticut Department of Revenue MaintenanceIn the case, the court ruled that Section 106 of the original Bankruptcy Code was not specific enough to waive state immunity. Congress responded immediately by amending the Bankruptcy Code to include the very specific provision I quoted above. I doubt the justices will want to send this back to Congress a second time.

Miller’s second argument (which I found quite interesting when reading the text) points out that the law does not require the transfer to be recoverable from the government, but only to be “avoidable” by a bona fide creditor. Here, under Utah law (and typical fraudulent assignment law), creditors will have the right to recover the amount of the challenged transfer not only from the person to whom the transfer was made (IRS), but also from those persons for whose benefit it was made. The transfer was made (owners of the company). Because these owners do not have sovereign immunity, they would be defendants in an action under state law and should therefore invalidate the transfer under Section 544(b).

We’ll have to see how the debate progresses – and I’m rarely this biased in advance – but I don’t expect an easy day for the government. Miller.