Supreme Court Urged to Back IRS in Bankruptcy Trustee Battle (1)

A government lawyer argued to the US Supreme Court that state and federal laws don’t allow a bankruptcy trustee to claw back a potentially fraudulent payment made to the Internal Revenue Service.

The arguments came Monday in a case that tasks the Supreme Court justices with answering whether a bankruptcy trustee can void a debtor’s tax payment to the IRS when no creditor could have obtained the same relief under state fraudulent-transfer laws outside of bankruptcy.

Yaira Dubin, assistant to the Solicitor General, urged the court during oral arguments in United States v. Miller to consider what Congress would have wanted and reverse lower court decisions in favor of the bankruptcy trustee for transportation company All Resort Group Inc.'s estate.

The statute in question, 544(b), has always been understood to bring liability that already exists into the bankruptcy code, Dubin said. But there’s no reason to think Congress was waiving sovereign immunity and creating new liability that never existed against the government under state fraudulent-transfer law, she argued.

“We’ve obviously been losing. We’ve lost this case in three courts,” Dubin said. “And I think the reason is that there’s some intuition that there’s something strange going on here.”

Lisa S. Blatt of Williams & Connolly LLP, representing the trustee, said Congress has said explicitly when it’s wanted to give the IRS special treatment and make exceptions for fraudulent transfers, but it did neither for the IRS under Section 544 of the bankruptcy code. The government’s position allows the IRS to keep assets that others would have to return, she 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,” Blatt said.

Justice Elena Kagan told Dubin it was “a bit peculiar” that the part of the bankruptcy code that waives sovereign immunity at the federal level in some circumstances doesn’t waive immunity for state law claims outside bankruptcy.

Dubin argued that the same provision doesn’t waive immunity for state law claims outside of bankruptcy, but Kagan said the result would be that a trustee could go to court over the issue but always lose.

“Why would Congress have gone to this trouble of waiving sovereign immunity if the trustee was always going to lose anyway?” Kagan said.

If the justices affirm the decision, bankruptcy trustees may be empowered to claw back more potentially fraudulent payments made to government entities, which could result in more funds to flowing back to junior, nongovernment creditors.

The justices in June agreed to hear the appeal. The federal government asked the high court to reverse a 2023 ruling by the US Court of Appeals for the Tenth Circuit, which found that a Chapter 7 trustee liquidating the estate of All Resort Group was allowed to claw back the company’s 2014 transfer of $145,000 to the IRS.

The government has said the Tenth Circuit was wrong when it affirmed a ruling by the US Bankruptcy Court for the District of Utah allowing the trustee to sue the IRS to claw back payment for personal tax debts on behalf of two former directors. The bankruptcy was filed in 2017, three years after the payment was made to the IRS.

The bankruptcy code only has a two-year lookback period, but Utah’s law allows the clawback of such transfers that occurred up to four years before a bankruptcy, according to court papers.

The question faced by the justices Monday was whether the bankruptcy court can use Utah’s fraudulent transfer law to extend the statute of limitations for the trustee’s ability to recover a payment from a company, before its bankruptcy, to the IRS.

The government argued in court papers that a reversal was needed to fix a breach of the federal government’s sovereign immunity rights. The federal government’s position was backed up in August by 23 state attorneys general, which argued in an amicus brief that state sovereign immunity was also in jeopardy if the case isn’t reversed.

The case is United States v. Miller, U.S., No. 23-824, oral argument 12/2/24.