High Court to Hear Bankruptcy Case Over IRS Sovereign Immunity

The US Supreme Court agreed to hear the government’s case challenging a bankruptcy trustee’s clawback of a payment to the Internal Revenue Service that the trustee said was a fraudulent transfer.

The US Solicitor General argued that the US Court of Appeals for the Tenth Circuit incorrectly interpreted the US Bankruptcy Code when it affirmed a ruling finding a Chapter 7 liquidating trustee could recover a $145,000 payment to the IRS for “personal tax debts.” The government said the agency is protected by sovereign immunity against the clawback of that payment, which was made by transportation company All Resort Group Inc. to cover the personal tax debts of two of its principals.

But bankruptcy law waives the sovereign immunity of the IRS in this case, the lower court ruled last year.

The government contends that while the bankruptcy code permits certain authority to a liquidating trustee, Utah law is controlling, according to its January petition to the high court. State law wouldn’t permit a creditor to recover the tax payment outside of bankruptcy court due to the IRS’s sovereign immunity—meaning the trustee can’t do so in bankruptcy court, the government said.

The bankruptcy code allows a trustee to claw back a property transfer, or payment, made in the two years leading up to a bankruptcy if it would be deemed a fraudulent transfer in another court.

The US Bankruptcy Court for the District of Utah in 2020 found that the transfer to the IRS was fraudulent under state law. Although bankruptcy law only allows the clawback of such transfers that occurred in the two-year period before a bankruptcy, Utah law allows four years, according to court papers. The bankruptcy court’s ruling was affirmed on appeal.

The Tenth Circuit rejected the IRS’s argument that it’s protected against the recovery of federal tax payments due to its sovereign immunity. But the government argued that its position aligns with a decade-old US Court of Appeals for the Seventh Circuit ruling.

The Tenth Circuit ruled that the bankruptcy code was contextually connected with Utah law and “Congress thus ‘clearly’ intended ‘to abolish the Government’s sovereign immunity in an avoidance proceeding arising under § 544(b)(1), regardless of the context in which the defense arises.’”

The Fourth, Ninth, and Tenth Circuit Courts all rejected the Seventh Circuit’s approach and the high court should, too, the liquidating trustee said in a May response.

All Resort filed for bankruptcy in 2017, listing liabilities between $10 million and $50 million.

Williams & Connolly LLP and Strong & Hanni represent the liquidating trustee.

The case is US v. Miller, U.S., No. 23-824, conference 6/24/24.