Siding with the majority on a split of circuits, the Tenth Circuit held that the waiver of sovereign immunity in Section 106(a) permits a bankruptcy trustee to sue the government for receipt of a fraudulent transfer under Section 544(b)(1), even though an actual creditor could not have sued the government outside of bankruptcy.

The Tenth Circuit found guidance from the sovereign immunity decision handed down by the Supreme Court in June. Lac du Flambeau Band of Lake Superior Chippewa Indians v. Coughlin, 22-227, 2023 BL 204482, 2023 US Lexis 2544 (June 15, 2023). To read ABI’s report, click here.

The Fraudulent Transfer to the IRS

The case arose from a typical fraudulent transfer to the Internal Revenue Service: A corporation paid federal income taxes owed by one of its owners.

The corporation’s chapter 7 trustee invoked Section 544(b)(1) to sue the IRS for receipt of a fraudulent transfer under Utah law. The section allows a trustee to “avoid any transfer of an interest of the debtor in property . . . that is voidable under applicable law by a creditor holding an [allowable] unsecured claim.”

The government agreed there was an actual creditor and admitted the elements of a constructively fraudulent transfer. However, the government contended that sovereign immunity would have prevented an actual creditor from suing the IRS outside of bankruptcy, thus disabling the trustee from suing under Section 544(b)(1).

In response, the trustee argued that the waiver of sovereign immunity as to Section 544 contained in Section 106(a) allowed suit based on a state-law claim.

On cross motions for summary judgment, Bankruptcy Judge R. Kimball Mosier of Salt Lake City ruled in favor of the trustee and entered judgment for about $145,000. The IRS appealed to the circuit after the district court affirmed. See U.S. v. Miller, 20-00248, 2021 BL 340200 (D. Utah Sept. 08, 2021). To read ABI’s report on the district court affirmance, click here.

The Circuit Split

In his June 27 opinion, Tenth Circuit Judge Bobby R. Baldock laid out the split of circuits.

The Seventh Circuit first tackled the question in 2014 by ruling that the immunity waiver in Section 106(a) did not allow suit against the state, reasoning that Section 106(a) did not modify the actual creditor requirement in Section 544(b). In re Equip. Acquisition Res. Inc., 742 F.3d 743 (7th Cir. 2014). Judge Baldock said that the Chicago-based appeals court “never meaningfully addressed the scope of § 106(a) as reflected in its text.”

Judge Baldock interpreted the Seventh Circuit’s opinion as “effectively” erecting a “total ban” on fraudulent transfer suits against governmental units under Section 544(b)(1).

On the other side of the fence, the Ninth and Fourth Circuits both held that the waiver of immunity in Section 106(a) covers claims against the government under state law. See In re DBSI, Inc., 869 F.3d 1004 (9th Cir. 2017); and Cook v. U.S. (In re Yahweh Center Inc.), 27 F.4th 960 (4th Cir. 2022). To read ABI’s reports, click here and here.

To decide which faction had the better reasoning, Judge Baldock took counsel from Lac du Flambeau, where the Court said that the intent of Congress to waive sovereign immunity must be “unmistakably clear,” although there is no requirement for the statute to use “magic words.”

Focusing on the language in Section 106(a), Judge Baldock noted that Congress “abrogated” immunity “with respect to” Section 544. The Supreme Court, he said, held that “with respect to” has a “broadening effect.”

Like the Fourth and Ninth Circuits, which were “faithful to the text of Code § 106(a),” Judge Baldock held:

[T]he critical phrase “with respect to” in § 106(a)(1) clearly expresses Congress’s intent to abolish the Government’s sovereign immunity in an avoidance proceeding arising under § 544(b)(1), regardless of the context in which the defense arises.

Judge Baldock found support for his holding in Section 106(a)(2), which says that the court “may hear and determine any issue arising with respect to the application of” Section 544. [Emphasis in original.]

Judge Baldock made “short work” of the government’s alternative argument based on field preemption. Had Congress believed that Section 544(b) posed an obstacle to the collection of income taxes, he said that “Congress surely would have added an express preemption provision to § 544(b) exempting the Government from its operation just as it provided an exemption for a transfer of charitable contributions in subsection (b)(2).”

Contrary to the Seventh Circuit, Judge Baldock held:

Code § 106(a) waives the Government’s sovereign immunity both as to the Trustee’s proceeding under Code § 544(b)(1) and the underlying Utah state law cause of action subsection (b)(1) authorizes the Trustee to rely on to avoid the debtor’s tax transfers made on behalf of its principals in this case.