Stepping into the Shoes of the IRS to Pursue Otherwise Time-Barred Avoidance Actions Under Fraudulent Transfer Statutes

Don't Mess with the IRS

Section 6502(a)(1) of the Internal Revenue Code provides the IRS with authority to collect taxes for 10 years after the date of tax assessment. So, while the IRS may be owed money prior to the date of assessment for a given tax year, this provision gives the IRS that certain time frame to pursue collection after assessment. In turn, Section 6901(a) of the Internal Revenue Code enables the IRS to pursue avoidance actions against transferees of the taxpayer's property, subject to the same limitations applicable to collection from the taxpayer; that is, subject to the same 10-year post-assessment recovery period. However, in order to establish transferee liability, the IRS must rely substantively on applicable state law, since Section 6901 of the IRC only provides a procedural remedy.

This means the IRS has to show that a transfer was actively or constructively fraudulent like any other creditor. Still, the IRS is not limited by state statutes of limitation to pursue these recovery actions. U.S. v. Summerlin, 310 U.S. 414, 416 (1940) (Summerlin) (holding it is well settled that the United States is not bound by state statutes of limitation whether the United States brings suit in federal court or in state court). The Summerlin rule applies to fraudulent transfer actions brought by an unsecured government creditor. Bresson v. Comm'r, 213 F.3d 1173, 1177-79 (9th Cir. 2000).

IRS As Triggering Creditor: A Vignette

In the recent bankruptcy proceeding of Mukamal v. Kipnis (In re Kipnis), Adv. Pro. Nos. 16-1044-RAM & 16-1045-RAM, 2016 WL 4543772 (Bankr. S.D.Fla. Aug, 31, 2016) pending in the Bankruptcy Court for the Southern District of Florida (in which the undersigned authors represent the trustee), the Chapter 7 trustee filed adversary proceedings against the Debtor and his wife to recover several transfers from the year 2005 (a bank account and a luxury condominium, respectively), which the trustee alleged the Debtor orchestrated at a time he was disputing a significant tax liability with the IRS in an effort to evade creditors. For example, the Kipnis trustee pursued recovery of a luxury condominium that the Debtor allegedly transferred to his wife by quitclaim deed in 2005 pursuant to a then-recent premarital settlement agreement. That agreement acknowledged the Debtor's contingent IRS obligations among his liabilities, based on an IRS examination report determining approximately $1 million in prior tax debt deficiencies. In 2013, after litigation and appeals in tax court, the IRS issued its tax assessment, and the Debtor filed his bankruptcy petition in 2014.

The IRS clearly was a creditor holding an unsecured claim at the time of the transfers, and actually filed a proof of claim in the bankruptcy case. The issue was whether Bankruptcy Code Section 544(b) allows the trustee to step into the shoes of the IRS and utilize the 10-year post-assessment collection window enjoyed by the IRS. The trustee argued in the affirmative, relying on a plain-meaning reading of the statute and a majority line of cases finding same.

The defendants disagreed in their motions to dismiss, based on a sole minority case position, asserting that the trustee's complaint was untimely (and limited by the state law fraudulent transfer look-back period) because Section 6502 applied only when the government was acting in its sovereign capacity, such as when the IRS seeks to collect taxes, and that the trustee's action was private in nature. The court agreed with the trustee and the majority line position, and found under Section 544(b) that the trustee may use the IRS recovery period to pursue avoidable transfers beyond the state law statutes of limitation. It should be noted, however, that the Kipnis defendants have filed a motion for reconsideration, which remains pending as of press time.

Survey of Case Law

While there is a split of authority as to whether a bankruptcy trustee can utilize the IRS 10-year collection window to avoid a transfer in bankruptcy for the benefit of bankruptcy estate, only a handful of courts have had occasion to confront this issue, with all but one concluding the trustee may use the IRS's 10-year recovery period as a triggering creditor under Section 544(b) of the Bankruptcy Code.

Among the cases, now including Kipnis, concluding that Section 544(b) enables trustees to step into the shoes of the IRS and take advantage of the longer limitations period are: Ebner v. Kaiser (In re Kaiser), 525 B.R. 697,710 (Bankr. N.D. Ill. 2014) (Kaiser); Finkel v. Polichuk (In re Polichuk), No. 10–0031-ELF, 2010 WL 4878789, at *3 (Bankr. E.D. Pa. Nov. 23, 2010); Alberts v. HCA Inc. (In re Greater Southeast Cmty. Hosp. Corp. I), 365 B.R. 293, 299–306 (Bankr. D.D.C. 2006); Shearer v. Tepsic (In re Emergency Monitoring Technologies, Inc.), 347 B.R. 17, 19 (Bankr. W.D. Pa. 2006); Osherow v. Porras (In re Porras), 312 B.R. 81, 97 (Bankr. W.D. Tex. 2004).

Only one court has reached the opposite conclusion, in Wagner v. Ultima Holmes, Inc. (In re Vaughan Co.), 498 B.R. 297 (Bankr. D.N.M. 2013) (Vaughan). The Vaughan court held that IRS immunity from state statutes of limitation is a public right that cannot be invoked by a bankruptcy trustee under Section 544(b). The court noted that, in defending public rights or serving the public interest, the federal government is not bound by state law statutes of limitation. The Vaughan court also looked beyond the clear language of Section 544(b) to Congressional intent for support that Congress did not intend to vest these sovereign powers in a bankruptcy trustee. Additionally, the court expressed concern that because the IRS holds a claim in most cases, allowing bankruptcy trustees to use Section 544(b) to override state law statutes of limitations would result in an unintended and “dramatic change in the law.” As explained in cases such as Kipnis and Kaiser, the majority line of cases start (and end) with the statute's plain meaning and the text of Section 544(b). The Kaiser court found that the clear language in the text of Section 544(b) imposed no limitation on the meaning of “applicable law” or on the type of unsecured creditor a trustee can choose as a triggering creditor. 525 B.R. at 711. Under the plain meaning analysis, if the language is clear, then policy concerns and legislative intent may not be considered, unless the result from applying the plain meaning would be absurd, in which now a majority line of cases have approved the use of the IRS as a triggering creditor for purposes of Section 544(b).

Policy Considerations

As noted in Kipnis, the court in Vaughan expressed concern that allowing use of Section 544(b) to avoid state statutes of limitation would dramatically alter the current practice and create a 10-year look-back period in most cases. 498 B.R. at 306. The court in Kaiser downplayed the potential effect of its ruling because section 544(b) has read the same since its enactment in 1978 and there are only a few cases that address this issue. 525 B.R. at 712. However, the Kipnis court acknowledged its ruling would have a meaningful impact noting that the IRS is a creditor in a meaningful portion of bankruptcy cases. 2016 WL 4543772 at *5.

The dearth of published decisions on the issue may simply be because bankruptcy trustees have not generally realized that this longer reach-back weapon is at their disposal. Id. Ultimately, the Kipnis court concluded that widespread use of Section 544(b) to avoid state statutes of limitation may occur and this would be a key change in bankruptcy practice, but the court (like the majority line of cases) could not ignore basic and important rules of statutory construction. Id.

The private action versus public function debate is interesting on its face, which the majority line of cases, including Kaiser and Kipnis, reconcile by noting that Section 544(b) is a derivative statute. Id.; 525 B.R. at 713. That is, since the trustee is stepping into the shoes of a creditor that has sovereign immunity, the focus is not on whether the trustee is performing a public or private function, but rather, whether the IRS — the creditor from whom the trustee is deriving his or her rights — would have been performing that public function if the IRS had pursued the avoidance actions under “applicable law.” Id.; Id. As stated in another majority line case, Greater Southeast Cmty. Hosp. Corp. I, an unsecured creditor's ability to trump the applicable state statute of limitations might derive from its sovereign immunity, but the estate representative's ability to override that same limitation derives from Section 544(b). Id.; 365 B.R. at 304.

Comparative Statutory Interpretation

Another example of a federal statute and its interplay with Section 544(b) of the Bankruptcy Code is the Federal Debt Collection Procedures Act (FDCPA). In the FDCPA context, there is case law going both ways, permitting or prohibiting a trustee's use of a triggering creditor under Section 544(b). Compare In re Mirant Corp., 675 F.3d 530 (5th Cir. 2012) (prohibiting the trustee's proposed Section 544(b) use of the FDCPA provisions) with In re Tronox Incorporated, 503 B.R. 239 (Bankr. S.D.N.Y. 2013) and In re Alpha Protective Services, Inc., 531 B.R. 889 (Bankr. M.D.Ga. 2015) (permitting the trustee's propose use of the FDCPA provisions under Section 544(b) of the Bankruptcy Code).

Generally, cases like Mirant focus on the language of the FDCPA (675 F.3d at 535), while cases like Tronox and Alpha Protective Services look toward the language and derivative standing purpose of Section 544(b). See 503 B.R. at 274; 531 B.R. at 906. However, even in cases like Mirant, which do not permit the trustee to step into the shoes of the government's avoidance powers under the FDCPA as they determined the FDCPA is NOT “applicable law” under Section 544(b), a key distinction reveals itself between the FDCPA and the Internal Revenue Code (IRC), which distinguishes the result for Section 544(b) purposes.

As noted in Mirant, the FDCPA in 28 U.S.C. § 3003(c) — unlike the IRC — specifically addresses how it interacts with the Bankruptcy Code (Title 11). The FDCPA states that “[t]his chapter shall not be construed to supersede or modify the operation of (1) title 11.” 675 F.3d at 535. Such a clear, concise statement of the interplay between itself and the Bankruptcy Code is NOT found anywhere in the IRC, in which the Mirant court found that treating the FDCPA as “applicable law” under Section 544(b) would impermissibly modify or impair the enforcement scheme of the Bankruptcy Code. Id.

However, faced with an argument in its case that such FDCPA language could be read to work within the Bankruptcy Code's enforcement scheme, the Mirant court looked to the FDCPA's legislative history to support its interpretation. Id. As referenced by the court in Mirant, an author of the FDCPA (Committee Chairman Brooks) stated at a Congressional hearing that Section 3003(c) of the FDCPA was carefully worded to make clear that it would have absolutely no effect of the Bankuptcy Code, such that even provisions of the Bankruptcy Code making reference to nonbankruptcy law are to be read as if the FDCPA did not exist. Id.

Since the IRC does not include any such contrary language essentially prohibiting its use as other “applicable law” for purposes of Section 544(b)'s derivative standing like that found in the FDCPA [and even the FDCPA issue is currently the subject of a divergent line of case law as discussed above], the majority line of cases that permit trustees to use the IRS's extended recovery period under Section 544(b) based on the plain meaning of the statute appears rather straightforward.

Practice Pointers for Trustees, Debtors and Creditors

Another point practitioners should consider on this issue is that, upon the existence of a “triggering creditor” under Section 544(b), the measure and distribution of recovery is not limited by the creditor's right. That is, the trustee will not be limited to recovery of the transfer solely to satisfy the IRS claim, but only would be limited by the larger claims pool in the bankruptcy estate. Debtors considering the landscape of their financial distress prior to entering bankruptcy should consider carefully the cost benefit of resolving their tax liabilities, as same could have a meaningful effect on exposure in a bankruptcy estate.

While the nondischargeability of certain tax debt used to be a main concern for some debtors dealing with the IRS, now the ability for the trustee to bootstrap the IRS's extended recovery period to bypass state statutes of limitation for avoidance actions should be among the additional planning considerations for debtors and their counsel. As a final practice point, creditors considering the filing of an involuntary bankruptcy petition as a debt-recovery tool may now have yet another mechanism to improve their distribution in bankruptcy that they otherwise would not receive outside of bankruptcy, and likely will be included in their cost-benefit analysis.

***** Corali Lopez-Castro and David A. Samole are partners at Kozyak Tropin & Throckmorton in Miami. They handle local and national corporate bankruptcy litigation matters. Reach them at [email protected] and [email protected], respectively.