Supreme Court to review IRS claim on pre-bankruptcy taxes
CASE PREVIEW
When a person makes a payment to their creditor just before filing for bankruptcy the Bankruptcy Code demands that the creditor return the money. The question is whether the IRS is protected by sovereign immunity from the requirement to return funds from insolvent debtors that private creditors face. On Monday, the justices will consider whether the IRS is protected by sovereign immuinity from the requirement to return funds from insolvent debtors that private creditors face.
The case, United States v. Miller, involves Section 544(b) of the Bankruptcy Code, which allows the bankruptcy trustee to “avoid” – that is, invalidate and recover – “any transfer … that is voidable under applicable law by a creditor holding” a valid claim against the debtor.” The provision usually applies to allow the trustee to recover transfers, often called “fraudulent conveyances,” that a debtor makes shortly before bankruptcy.
The debtor in this case, All Resort Group, Inc., made a payment to the IRS to pay off income taxes owed by its owners about three years before it filed for bankruptcy. The company received no benefit in exchange for the tax payments, which paid off debts owed to its owners. Because the company was insolvent when it made the payment, the Utah Uniform Fraudulent Transfers Act covered the payment. The company would have been able recover the payments from either the IRS (to whom they were paid) or the owners (who benefited from them). For what it’s worth, the same thing would be true in most if not all states in the country, as most states have a version of a uniform state law allowing recovery of such payments.
When the company filed for bankruptcy, the trustee in the company’s bankruptcy proceeding, David Miller, filed an action seeking to recover the payments from the IRS. The IRS was paid, not a private creditor. This is the biggest problem. The IRS has sovereign immunity and creditors cannot sue it for violating the Utah Uniform Fraudulent Transfers Act. The IRS believes that the lack of a creditor protects it from liability under Section 544(b). From the IRS’s perspective, the lack of an actual creditor means that it is protected from liability under Section 544(b).
Miller points to Section 106 of the Bankruptcy Code, which includes an explicit waiver of the government’s sovereign immunity in the Bankruptcy Code: “Notwithstanding an assertion of sovereign immunity, sovereign immunity is abrogated as to a governmental unit … with respect to” several sections of the Bankruptcy Code, including Section 544.” To be clear, Section 106(a)(3) specifies that the relief a bankruptcy court can grant against the government includes a “judgment awarding a money recovery,” and Section 101 defines “governmental unit” to include not only the “United States” itself, but also “any “department, agency, or instrumentality of the United States.”
The government’s argument is a purely literalist reading of Section 544(b): Because Section 106 of the Bankruptcy Code would not apply in a state court proceeding under the Utah Fraudulent Conveyance Act, there in fact is no creditor that could have sued the IRS successfully under that statute.
Miller has two powerful arguments against that provision. The first is that this provision invalidates the explicit mention of Section 544 in section 106. To say that Congress hasn’t specifically solved this problem when it wrote a statute that specifically mentions Section 544 might seem like a bit much.
Moreover, the history of the provision makes that seem even less likely. In Hoffman v. Connecticut Department of Income Maintenance the court ruled that the version of Section 106 of the original Bankruptcy Code wasn’t specific enough to waive sovereign immunity. Congress amended the Bankruptcy Code immediately to include the eminently precise provision that I have quoted above. I rather doubt the justices will want to send this back to Congress a second time.
Miller’s second argument – which I find pretty compelling as a reading of the text – points out that the statute only requires that the transfer be “avoidable” by an actual creditor, not that it be recoverable from the government. Under Utah law (and the typical fraudulent conveyance laws), creditors could recover the amount of a challenged transfer from both the IRS and the owners of the company. These owners would not have had sovereign immunity and would therefore have been liable in a lawsuit under state law. This would have made the transfer voidable.
