SCOTUS Weighs Bankruptcy Trustee’s Ability to Claw Back Tax Payments

This Monday, the U.S. Supreme Court considered whether federal tax payments made on behalf of a now-bankrupt company’s owners can be reclaimed and distributed to creditors. (United States v. Miller, No. 23-824)

The December 2 oral arguments hinged on the proper reading of a Bankruptcy Code waiver of sovereign immunity with respect to an underlying state cause of action.

Background.

The case arose after debtor All Resorts Group, Inc., filed for bankruptcy in 2017. Less than three years earlier, All Resorts Group made payments of over $145,000 to the IRS for the personal tax debts of two of its principals. After David Miller was appointed trustee in the bankruptcy action, he sought to “avoid” or claw back these payments as fraudulent transfers.

Given applicable statutes of limitations, Miller sought to use §544(b) of the U.S. Bankruptcy Code to avoid the transactions. That section allows a trustee to step into the shoes of an actual creditor with an unsecured claim and invoke applicable state law — in this case, Utah law — to avoid a transfer. But the government contends sovereign immunity bars Miller’s action. An actual creditor could not avoid the payments, so Congress wouldn’t have intended to allow a trustee acting on their behalf to do so, argues the government.

10th Circuit decision.

The case came to the Supreme Court from the 10th U.S. Circuit Court of Appeals, which sided with Miller. (Miller, (CA10, 06/27/23) 131 AFTR 2d ¶2023-2196). The circuit court had upheld the decisions of the U.S. Bankruptcy Court for the District of Utah and the U.S. District Court for the District of Utah.

However, the 10th Circuit did note a circuit split in its opinion. Like the lower courts in Miller’s case, the Fourth and Ninth Circuits have held that §106(a) of the Bankruptcy Code “unequivocally abrogates sovereign immunity as to the underlying state law cause of action,” it said. But the 7th Circuit found that “transfers against a ‘governmental entity'” can be set aside “absent a second waiver of sovereign immunity by way of Congress or a state legislature,” noted the 10th Circuit.

And there are policy reasons for the 7th Circuit’s holding, said the 10th Circuit. Waiving federal sovereign immunity where a state cause of action is invoked could allow states to “render[ ] federal tax revenue… more vulnerable to unexpected recovery actions.”

Supreme Court considers the case.

The government argued in its Supreme Court brief that §544(b) is “unique” because it is “predicated on law external to the Bankruptcy Code.” And during Monday’s oral arguments, the Department of Justice’s Yaira Dubin drilled down on that interplay of state and federal law in a §544(b) claim.

Dubin contended that §544(b) only comes into play once a trustee has “indentif[ied] a creditor with the right to avoid the transfer under state law.” But in Miller’s case, an All Resorts Group creditor would be barred by sovereign immunity from avoiding the federal tax payments via a state law claim, said Dubin.

Justice Ketanji Brown Jackson brought up another policy concern during oral arguments — that allowing a trustee to void transactions beyond the generally applicable two-year statute of limitations is “a big deal” and will “caus[e] a lot of disruption in the market.” She posited that §544(b) may grant a trustee this power “only to the extent that an actual creditor could have affected the same kind of disruption in the market by bringing this kind of action on his own.”

Dubin agreed with the assessment, noting that “many states have adopted longer lookback periods or longer limitations periods, four years or even six years.” She argued that a trustee can take advantage of these longer limitations periods only “if an actual creditor could have done so outside of bankruptcy because that transfer was vulnerable.” However, a trustee “can’t do so where no actual creditor already had that right,” she added.

Miller’s brief, however, emphasizes the wide scope of Bankruptcy Code §106(a)’s sovereign immunity waiver. During oral arguments, Miller’s attorney Lisa Blatt, of Williams & Connolly, contended that “Congress waived [sovereign] immunity knowing that [§]544 has always required trustees to step into creditors’ shoes under state law.” According to Blatt, “Congress clearly expected trustees to sue governments by relying on state law.”

Blatt noted that after 1989 and 1992 Supreme Court findings against a trustee, Congress actually amended §106(a) to clarify when sovereign immunity was waived. The 1994 Bankruptcy Reform Act (P.L. 103-394), updated §106(a) to list out 59 sections of the Bankruptcy Code for which sovereign immunity is abrogated, including §544, Blatt explained.

Blatt contends that a ruling against Miller would mean “asking Congress to go back again” and “add a second waiver, and all the provisions to which the state law is incorporated.” And this ask, Blatt said, would be despite Congress already having overruled two Supreme Court decisions against trustees with the 1994 act. And additional action by Congress might not be enough, according to Blatt, because “in the government’s view, the state sovereign immunity will always creep in.”

Justice Neil Gorsuch noted that the government called for stepping into the shoes of the creditor and looking at the identity of the transferee to determine if sovereign immunity is applicable. He characterized Miller’s position, instead, as starting by “ask[ing] whether the transfer is voidable by the creditor.”

But Justice Amy Coney Barrett, despite recognizing that the statute doesn’t mention a transferee, seemed skeptical. “[I]sn’t the suit you’re asserting somewhat hypothetical rather than actual?” she asked. “And how can you know what [the state law] defenses would be if you weren’t considering who the transferee was?” she added.

Blatt, however, countered that here, “you’re just looking at the elements, whether the transfer is voidable.” Recovery — “how you go and get the money” — is a distinct issue, she said.