Supreme Court Hands IRS Win Over Bankruptcy Trustee Clawback (3)

The IRS triumphed over a liquidating trustee at the US Supreme Court after a long-fought battle over payments that a transportation company made before it filed for bankruptcy.

The 8-1 ruling in United States v. Miller determined the Internal Revenue Service’s sovereign immunity outweighs US Bankruptcy Code and state law provisions governing how far back in time a trustee can reach to recover fraudulent transfers. The justices held that a bankruptcy trustee can’t void a debtor’s tax payment to the IRS when no creditor could’ve obtained the same relief under state fraudulent transfer laws outside of bankruptcy.

The ruling means bankruptcy trustees or companies are prohibited from using fraudulent transfer laws that allows recovery efforts going back up to four years in most US states.

“The court’s precedents require construing sovereign-immunity waivers narrowly, with any ambiguities resolved in favor of the sovereign,” the Wednesday ruling said.

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

“Waivers of sovereign immunity are jurisdictional provisions that empower courts to hear claims against the government but do not themselves typically create any new substantive rights against the government,” Justice Ketanji Brown Jackson wrote for the majority.

While Section 106(a) of the bankruptcy code waives sovereign immunity for the government in certain instances, it doesn’t change the “actual creditor” requirement under Section 544(b), Jackson added.

Under the liquidating trustee’s analysis, Section 106(a) would “transform” the statute from a “jurisdiction-creating provision into a liability-creating provision,” she said.

Justice Neil M. Gorsuch noted in dissent that it’s undisputed that under Utah law a transfer can be voided if an insolvent debtor made it without “reasonably equivalent value in exchange.”

Allowing a trustee to claw back funds from the government as permitted under bankruptcy and state law doesn’t “‘modify the elements’ of any claim or ‘create any substantive claim for relief’ that did not ‘otherwise exist,’” he wrote.

Read More: IRS Climbing a Steep Hill in Bankruptcy Trustee Clawback Dispute

Ripple Effects

The effect of the ruling will likely ripple down to other bankruptcy cases involving payments to government entities. Bankruptcy law 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 fraudulent in another court.

Now, with the high court’s decision, that lookback period can’t be extended two more years by applying a second bankruptcy provision that would’ve allowed the piggybacking of a state’s fraudulent transfer law.

“This case is big in small ways,” Jack Williams, a law professor at Georgia State University, said.

Single asset debtors, like small real estate owners or consultants, could use another provision, Section 550, under the bankruptcy code that would allow them to claw back transfers in a different way, Williams added.

A trustee for single asset debtors could use the “actual creditor” provision and state law to sue individuals who made the fraudulent transfer, he said.

After obtaining a judgment, the trustee could “go after subsequent transferees and make the argument that the liability is founded,” Williams added. This means, if successful, the trustee would be able to claw back funds from the government outside the two-year lookback period that the high court closed off under the “actual creditor” route.

Under Section 550, sovereign immunity is waived, and a disgorgement of funds or property is permitted, Williams said.

Piggybacking

The government appealed to the Supreme Court to reverse lower court rulings that allowed a Chapter 7 trustee to recover a $145,000 transfer made to the IRS three years before transportation company All Resort Group Inc. filed for bankruptcy. The transfer is more than 10 years old now.

The US Bankruptcy Court for the District of Utah in 2020 found that the transfer to the IRS was fraudulent under state law, which a federal district court affirmed on appeal. The 2014 payment was made to cover “personal tax debts” for two former All Resort Group directors.

The trustee brought the claim on behalf of a former employee who accused the company of discrimination. The former employee, a creditor in the bankruptcy, had yet to be paid by All Resort Group after winning a discrimination suit.

The IRS argued to the US Court of Appeals for the Tenth Circuit, and later the Supreme Court, that the former employee, as the “actual creditor,” couldn’t claw back the company’s tax payments because sovereign immunity would prevent that action outside of bankruptcy.

The bankruptcy provision allowing the piggybacking of a state fraudulent transfer law couldn’t have been intended to waive the government’s sovereign immunity, the IRS argued.

It’s undisputed that outside of bankruptcy, the government would’ve been able to invoke its sovereign immunity against a lawsuit seeking to use a state’s fraudulent transfer law to recover a federal tax payment, the high court said.

Federal appeals courts were split 3-1 over whether bankruptcy trustees should be permitted, under state law, to claw back funds paid to the government beyond the two-year standard under the bankruptcy code. The Fourth, Ninth, and Tenth circuits had all rejected the Seventh Circuit’s approach, which said a bankruptcy trustee couldn’t recover the money outside the typical two-year window.

Williams & Connolly LLP represents the trustee.

The case is United States v. Miller, U.S., 23-824, 3/26/25.