The High Court overturned the 10th Circuit’s ruling that the IRS is not entitled to maintain bankruptcy companies’ payments that could be contaminated by fraud.
The U.S. Supreme Court ruled on March 26 that state and federal laws did not allow bankruptcy trustees to regain payments to the IRS that could be fraudulent.
The bankruptcy trustee is appointed by the court to manage the debtor’s property in the bankruptcy proceedings. The trustee monitors the debtor’s financial position, collects assets, and distributes money to the creditors.
Creditors are usually required to rebate to the trustee’s payments made by the debtor during the preparation stage for bankruptcy filing. If the debtor makes a payment to avoid the creditor’s payment, the court can declare the transaction as a fraudulent transfer.
In this case, justice was asked to consider whether payments would need to be refunded if the IRS was the recipient of such payments.
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Such filings allow the debtor to reorganize his or her business and maintain his or her business.
In 2014, when the company was already in bankruptcy, it took the extraordinary step of paying the IRS $145,138 to meet the individual tax liabilities of the two principals.
The Utah federal bankruptcy court has turned the Chapter 11 case into a Chapter 7 procedure. In this process, the trustee sold the debtor’s assets to cover the debt. The debtor is permitted to maintain certain property where the law exempts liquidation.
Bankruptcy Councillor David Miller launched what he called hostile suits against the United States in the bankruptcy case to void payments to the IRS.
Section 544(b) of the U.S. Bankruptcy Code allows “under applicable law by creditors to challenge any voluntary transfer…any transfer…” with a valid claim.
Miller argued that bankrupt properties are entitled to collect payments to the IRS despite tax agencies enjoying immunity from sovereignty as part of the federal government. Sovereign immunity is a legal doctrine that prevents the government from being sued in its own court unless it agrees that it may be sued.
The Bankruptcy Court has determined that the fiduciary’s claim under the fraudulent transfer clause of the Bankruptcy Code was too late, as taxes were paid more than two years before the company’s bankruptcy petition was filed.
However, the Bankruptcy Court agreed with the trustee that under Utah’s law, the state’s law allows four years of payment to cancel fraudulent payments, which could result in IRS payments being void.
The Bankruptcy Court awarded the trustee a ruling against the United States in March 2020 for $145,138. The federal government appealed, and Utah’s U.S. District Court upheld the ruling in September 2021.
The federal government again appealed, and the US Court of Appeals for the 10th Circuit was upheld in June 2023.
But the government argued that the IRS should hold assets that others need to return, Bratt said.
“As a result, the trustee will get this money back and prevent it from paying it to the bus drivers and vendors who have given all the resorts more value than the IRS,” the lawyer said.
The Supreme Court ruled in its new ruling that the IRS’ sovereignty immunity will take precedence over both bankruptcy and state law provisions, allowing the trustee to curb fraudulent transfers.
Many opinions say that Jackson speaks of the facts of the case, writing that bankruptcy law allows bankruptcy trustees to “avoid” the transfer of some of the debtor’s assets and retrieve them to benefit the bankruptcy property.
Section 544(b) allows the trustee to use evasive capabilities for transfers that may be void outside of bankruptcy proceedings. “The trustees generally rely on state law to supply “appropriate law” when sue under (section) 544(b) to avoid the transfer of the debtor’s assets,” she wrote.
While federal sovereign immunity generally prevents sue under Utah law, Section 106(a) of the Bankruptcy Act waives the “” immunity with regard to Section 544(b) which allows proceedings against the government to proceed.
Justice wrote that the Supreme Court was asked to decide whether Section 106(a) would only abolish the sovereign immunity in relation to the cause of action made by “section) 544(b), or whether to abolish the claims repealing the claims relating to the state law on which it is based.
Repeal is an act that officially invalidates any law or legal provision. The cause of your actions is a set of facts that provide a legal basis for sue someone.
The Supreme Court held that Section 106(a) had the effect of abolishing the sovereign immunity for the cause of Section 544(b), but that “the state’s claim does not take the additional steps to abolish the sovereign immunity that supplies “applicable law” to the claim of (section) 544(b) of the trustee.”
“It reflects a very unusual understanding of sovereign immunity to change the elements of Interpretation (Section) 106(a) (Section) 544(b),” Jackson added.
The Supreme Court overturned the 10th Circuit decision.
