IRS Climbing a Steep Hill in Bankruptcy Trustee Clawback Dispute

The IRS has a bumpy road ahead in a US Supreme Court case against a bankruptcy trustee after multiple justices appeared skeptical of its argument that it should be able to keep payments that a transportation company made before filing for bankruptcy.

The case, United States v. Miller, tasks the high court with determining whether the agency’s sovereign immunity affords it special bankruptcy law privileges. The case also pits state laws against bankruptcy trustees’ authority to claw back funds that a company paid more than two years before a bankruptcy that aren’t already waived by federal law.

During oral arguments Dec. 2, justices across ideological lines questioned the government’s position involving payments that transportation company All Resort Group Inc. made to cover two directors’ personal tax debts three years before it filed for bankruptcy. The company’s liquidating trustee argued that because All Resort Group was insolvent at the time the payments were made, the IRS—like any other creditor—must pay them back to the estate.

Reversing lower court rulings that favored the trustee could “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 Brett M. Kavanaugh said during the arguments.

An insolvent company must receive equal value for a transaction to avoid it being flagged as a fraudulent transfer, said former Nevada bankruptcy judge Bruce A. Markell, now a professor of bankruptcy law at Northwestern Pritzker School of Law.

“Paying someone else’s debt, where’s your reasonably equivalent value?” Markell said.

Piggybacking

Liquidating trustees typically have power, if a bankruptcy judge approves, to undo fraudulent transfers made two years before a bankruptcy to generate recoveries for junior creditors. This lookback period can be usually extended two more years by applying a second bankruptcy provision that allows the piggybacking of a state’s fraudulent transfer law.

A Chapter 7 liquidating trustee for All Resort Group, which filed for bankruptcy in 2017, claims that was the case when the business paid the IRS $145,000 in 2014.

After losing its case in lower courts, the IRS argued to the Supreme Court that the bankruptcy provision didn’t waive the agency’s sovereign immunity. The agency added that the clawback action falls outside of bankruptcy law’s clear two-year lookback period and the trustee shouldn’t be allowed to use the fraudulent transfer law in Utah, where All Resort Group is based, to open the window an additional two years.

If the Supreme Court reverses the lower court’s ruling, the IRS would enjoy preferential treatment, bankruptcy academics and practitioners said. That would be a blow to trustees’ and bankrupt companies’ rights under the law. The ability to recover debts is one of the most important powers granted to bankrupt companies and trustees, said Diane Lourdes Dick, a professor at the University of Iowa College of Law.

“This decision has the potential to reshape how we think about the avoidance powers, as well as how we think about the IRS as a creditor,” Dick said. “Is the government as a tax collector the same as every other creditor, or is it exceptional?”

Several high court justices expressed confusion as to why the trustee shouldn’t be able to use Utah’s law. Most questions came from Justices Elena Kagan and Amy Coney Barrett, while Kavanaugh and Justice Ketanji Brown Jackson also pushed back on the government’s stance.

Avoidance Powers

The government’s stance is that Utah law wouldn’t permit a traditional creditor to recover a payment outside of bankruptcy court due to the IRS’s sovereign immunity—meaning the trustee can’t do so in bankruptcy court.

Reversing the lower court’s decision would “give the government preference, but only for those transactions that occurred more than two and less than four years before the filing,” because of the piggyback provision at issue in this case, Markell said.

If an insolvent company paid its owner’s personal loan obligations to a bank rather than a director’s personal tax debts to the IRS, it would clearly be a fraudulent transfer, said Steve Pezanosky, a bankruptcy partner at Haynes Boone.

If the IRS prevails, “it’s going to get different treatment than a nongovernment creditor would get in a situation like this,” Pezanosky said.

Intention Versus Plain Language

The sovereign immunity at issue is a mix of common law and bankruptcy law, Markell said.

The government claims no creditor would be able to bring the claim outside of bankruptcy, so the bankruptcy provision shouldn’t be applied.

“Any creditor’s attempt to avoid these federal taxes under state law would obviously be barred by sovereign immunity and other obstacles,” Yaira Dubin, assistant to the solicitor general, said during the arguments.

The “actual creditor” requirement plagued Jackson, who wondered why Congress would allow a trustee the two-year lookback but then, in the government’s eyes, close them off from further recovery though the piggyback provision. The two-year period already provided under bankruptcy law is “a big deal,” but the limitation of a traditional creditor in the piggyback provision is what the government is leaning on, Jackson said.

The IRS’s argument was “peculiar,” Kagan said.

The government contends that allowing the case to stand as is would result in a mere a slap on the wrist for the directors, whose personal debts were paid with the company funds.

State fraudulent transfer laws were modeled after, the bankruptcy provision that allows the avoidance of fraudulent transfers, Markell noted.

The IRS’s stance is “a nice armchair argument, but it’s not a winning argument,” Markell said.

Williams & Connolly LLP represent the trustee.

The case is United States v. Miller, U.S., 23-824, oral arguments 12/2/24.