In an 8-1 decision written by Justice Ketanji Brown Jackson, the Supreme Court resolved a split of circuits by holding that Section 106(a) does not permit a bankruptcy trustee to sue the federal government for receipt of a fraudulent transfer under state law and Section 544(b)(1), because no actual creditor could sue the government outside of bankruptcy.

In her 19-page opinion for the Court on March 26, Justice Jackson saw the “actual creditor” requirement in Section 544(b)(1) as bringing sovereign immunity back into play as a defense for the Internal Revenue Service, even though Section 106(a) waives sovereign immunity for suits under Section 544.

The Fraudulent Transfer to the IRS

The case arose from an often-occurring fraudulent transfer to the Internal Revenue Service: A corporation paid $145,000 in federal income taxes owed by one of its owners. The corporation ended up in bankruptcy three years later. Because the transfer did not occur within two years of filing, the chapter 7 trustee could not sue under Section 548(a)(1)(B).

The 7 trustee therefore 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).

Responding, 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. The subsection provides that “sovereign immunity is abrogated as to a governmental unit to the extent set forth in” 59 sections of the Bankruptcy Code, including Section 544.

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 $145,000. Miller v. United States (In re All Resort Group Inc.), 617 B.R. 375 (Bankr. D. Utah 2020). 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’s affirmance, click here. The IRS appealed to the circuit.

Tenth Circuit Affirms

The Tenth Circuit affirmed in U.S. v. Miller, 71 F.4th 1247 (10th Cir. June 27, 2023). Focusing on the language in Section 106(a), the Denver-based appeals court noted that Congress “abrogated” immunity “with respect to” Section 544. The circuit court cited Supreme Court authority for the proposition that “with respect to” has a “broadening effect.” To read ABI’s report, click here.

The Tenth Circuit’s opinion deepened an already existing circuit split. The Ninth and Fourth Circuits had already held that the waiver of immunity in Section 106(a) allows claims against the government under state law for recovery of fraudulent transfers. 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.

The Seventh Circuit held to the contrary in 2014 in In re Equip. Acquisition Res. Inc., 742 F.3d 743 (7th Cir. 2014). The Seventh Circuit reasoned that Section 106(a) did not modify the actual creditor requirement in Section 544(b). As it turns out, Justice Jackson followed the Seventh Circuit’s approach.

To resolve the circuit split, the Court granted the government’s petition for certiorari. The appeal was argued on December 2, 2024. To read ABI’s report on oral argument, click here.

Section 106 Is Only Jurisdictional

Justice Jackson began her analysis of the merits by citing the Collier treatise for the idea that a trustee is “powerless” in the absence of an actual creditor who could have sued. “This ‘actual creditor’ requirement serves as an important check on the trustee’s §544(b) powers,” she said.

Justice Jackson saw the “dispute [as] turn[ing] on the interplay between §106(a) and §544(b) of the Bankruptcy Code.” Referring to Section 548(a), she conceded that “§106(a) waives the Government’s sovereign immunity with respect to the federal cause of action created by §544(b).”

Justice Jackson began her analysis from the proposition that waivers of sovereign immunity are jurisdictional “but do not themselves typically create any new substantive rights against the Government.”

On the topic of substantive rights, Justice Jackson said that Section 106 is “merely jurisdictional.” She quoted Section 106(a)(5), which says, “Nothing in this section shall create any substantive claim for relief or cause of action not otherwise existing under this title, the Federal Rules of Bankruptcy Procedure, or nonbankruptcy law.” The trustee’s theory, she said, “would thus transform that statute from a jurisdiction-creating provision into a liability-creating provision.”

The ‘Text’ and ‘Structure’

Having decided that Section 106 does not create substantive rights, Judge Jackson turned to the “text and structure of §106 and §544[, which] make clear that §106(a)’s waiver of sovereign immunity does not operate to modify §544(b)’s substantive requirements.”

If Section 106(a) were to modify the elements of a claim under Section 544(b), Justice Jackson said it “would necessarily give the trustee a substantive claim for relief against the Government that does not ‘otherwise exis[t]’ under §544(b) or Utah law.”

Justice Jackson noted that the actual creditor requirement is “unique” to Section 544(b) and “reflects a deliberate congressional choice to tie the trustee’s rights under subsection (b) to the rights of an actual creditor under ‘applicable law.’” She observed that “Section 544(b) was expressly ‘derived’ from §70e of the Bankruptcy Act of 1898, which had long been understood to give trustees the same rights as creditors under state law.”

Given the “long-settled understanding of the trustee’s §544(b) powers,” Justice Jackson said it “would be so anomalous to treat §106(a) as expanding the trustee’s rights beyond those of an actual creditor.”

“Even if the language and logic of §544 and §106(a)” broadened the sovereign immunity waiver, Justice Jackson said “that our precedents would still foreclose that reading,” because “Congress must use unmistakable language to abrogate sovereign immunity.” Financial Oversight and Management Bd. for P. R. v. Centro De Periodismo Investigativo, Inc., 598 U.S. 339, 342 (2023).”

‘Close, but No Cigar’

Justice Jackson said that the trustee had a “slightly” better argument in saying that a narrow “reading of §106(a) would blunt the impact of Congress’s decision to include §544 on the list of provisions subject to §106(a)’s immunity waiver.” She paraphrased the trustee as contending that “the Government’s reading of §106(a) effectively robs the immunity waiver of any meaningful purpose with respect to §544; it simply grants federal courts jurisdiction over a set of inherently unwinnable claims.”

Justice Jackson was “not persuaded.” Even if Section 106(a) would let the trustee win “under §544(b), [the trustee] might still prevail against the Government under §544’s other subprovision — subsection (a).” She noted that “subsection (a), unlike subsection (b), does not contain an actual-creditor requirement.”

In addition, Justice Jackson said that Section 106(a) has an “independent function” by “grant[ing] federal courts jurisdiction to hear §544(b) claims brought against state governments” in states that have waived sovereign immunity “under their own fraudulent-transfer statutes.”

Justice Jackson ended her opinion by reversing the Tenth Circuit and holding:

Section 106(a) of the Bankruptcy Code abrogates sovereign immunity for the federal cause of action created by §544(b). It does not take the additional step of abrogating sovereign immunity for whatever state-law claim supplies the “applicable law” for a trustee’s §544(b) claim.

The Dissent

Justice Neil M. Gorsuch wrote a three-page dissent.

Apart from the question of sovereign immunity, Justice Gorsuch began from the concession that a fraudulent transfer claim existed under Utah law. He continued:

Thus, under “applicable law,” the relevant transfers are “voidable,” and the bankruptcy trustee can use §544(b)(1) to set them aside. That remains true even though the trustee must sue the United States to void the relevant transfers, because §106(a)(1) bars the government from raising a sovereign-immunity defense in the trustee’s action.

Justice Gorsuch asked whether “the federal government [could] defeat the claim by raising the affirmative defense of sovereign immunity?” He answered his own question by saying, “With respect to a private creditor pursuing relief in state court, the answer is yes. With respect to a trustee pursuing relief in a federal bankruptcy proceeding, the answer — thanks to §106(a)(1) — is no.”

Justice Gorsuch “respectfully” dissented, saying he would “agree with the majority of circuits to have considered the question that bankruptcy trustees may avoid fraudulent transfers to the United States under §544(b).”