Bankruptcy Trustees Borrow Longer Look-Back Provisions Meant for Governmental Creditors

It’s widely known that avoidance actions to claw back fraudulent transfers can be filed after the typical four-year limitations period has expired under most states’ versions of the Uniform Fraudulent Transfers Act (or the new Uniform Voidable Transactions Act) by invoking the “discovery rule” in those statutes. Under the discovery rule, the limitations period may be tolled where the transfer was made with the debtor’s intent to defraud creditors and the transfer (or in many states, its wrongful character) was not reasonably discoverable 12 months before the bankruptcy petition was filed. But what can the trustee do when both the four-year and the 12-months-from-discovery periods have expired pre-petition?

Trustees have found some success in arguing for a much longer limitations period when the federal government is a creditor in the case, as is often the case with the Internal Revenue Service. And courts increasingly are concluding that the trustee can borrow the extended limitation periods provided by federal statutes to a governmental creditor, since § 544(b)(1) of the Bankruptcy Code gives the trustee (and chapter 11 debtor-in-possession) the avoidance powers of an existing unsecured creditor.

Living on Borrowed Time

One example of “borrowed” law is the Federal Debt Collection Procedures Act (FDCPA), which provides that the U.S. government may claw back fraudulent transfers for as long as six years, or two years after discovery of the transfer.[1] Courts are divided on how this aligns with § 544(b)(1). Some have held that a bankruptcy trustee cannot borrow the six-year statute available to governmental creditors under § 3306 to reach fraudulent transfers more than four years old, because the statute is meant only to enforce a public right and is not “applicable law” for unsecured creditors within the meaning of § 544(b)(1), and because § 3003(c) of the same act provides that no portion of the law shall effect a modification of the Bankruptcy Code.[2] Another court has held that a trustee may borrow § 3306 for fraudulent transfer actions, but not for the purpose of extending the one-year state-law reach-back period for insider preferences.[3] And in an unpublished opinion, an Eleventh Circuit panel held that § 3306 was written solely for the benefit of the government and could not be used by a bankruptcy trustee to extend the limitations period.[4]

On the other hand, Judge Alan Gropper, in entering a multibillion-dollar judgment in favor of the chapter 11 debtor-in-possession in Tronox Inc. v. Kerr-McGee Corp.,[5] held that the FDCPA is applicable law under Bankruptcy Code § 544(b) and provides the bankruptcy trustee a “six-or-two”-year limitations period instead of the “four-or-one”-year period provided under the UFTA.[6] It should be noted that in Tronox the IRS intervened as a party in the avoidance action to share with the debtor-in-possession its standing to avoid transfers.[7] Several other bankruptcy judges have ruled the same way in adversary proceedings where the IRS had not intervened.[8]

While the IRS sometimes invokes § 3304 and that statute’s specific avoidance powers to attack fraudulent transfers discovered during the preceding two years and insider preferences, it also asserts a 10-year period of its own.[9] Section 6901(a) of the Internal Revenue Code provides that the IRS can pursue the “collection” of taxes from a taxpayer’s transferee where the transferee is liable for the taxes at law or in equity, the same as it can pursue collection from the taxpayer.[10] And IRC § 6502((a)(1) provides that collections can proceed to levy judicial proceedings so long as collection is begun within 10 years after assessment. On this basis, trustees now argue that the IRS is an existing creditor for whom “applicable law” provides the power to avoid fraudulent transfers for 10 years.

Courts have long agreed that § 6901(a)(1) “provides only a procedural remedy against an alleged transferee; substantive state law controls whether a transferee is liable for a transferor’s tax liabilities.”[11] So, state fraudulent transfer statutes govern. However, federal governmental creditors asserting public rights are not bound by state statutes of limitation.[12] The time for the federal government to bring a clawback action under state fraudulent transfer principles is governed only by federal statutes.[13]

In the past decade, at least nine bankruptcy judges have ruled that the trustee may commence an avoidance action so long as the IRS’s time to pursue an avoidance action remains open, and that the time remains open so long as the IRS has pursued collection within 10 years after the tax is assessed. These cases hold that the government’s 10-year entitlement to sue (whether based on Section 6502(a)(1) of the Internal Revenue Code or 28 U.S.C. §§ 2415-2416) is applicable nonbankruptcy law under § 544(b) that the trustee may apply to the trustee’s own avoidance actions.[14]

At least one court has ruled against the trustee on the issue of borrowing §§ 6901(a) and 6502(a), holding that the 10-year IRS limitations period is a public right that cannot be “applicable law” under § 544(b). In Wagner v. Ultima Homes Inc.,[15] Judge Robert Jacobvitz reasoned that the IRS would have been bound by the state law four-year statute of limitations period had it been acting for private interests, and that to give the trustee (in the private interest of creditors) the benefit of a public right that runs only to the sovereign cannot have been the intention of Congress in enacting § 544(b). The Supreme Court once noted that “[t]he true reason [for leaving the federal government unbound by state statutes of limitations] is to be found in the great public policy of preserving the public rights, revenues, and property from injury and loss, by the negligence of public officers.”[16]

Conclusions

Transferees, particularly those who had no knowledge of the transferor’s insolvency or of any fraudulent intent on the part of the transferor, may have taken comfort for many years in the belief that monies or assets received from another were theirs to keep and spend, only to learn that a trustee is planning to recover the asset by borrowing the IRS limitations period. And sometimes trustees have sought even more than the IRS was owed, citing the principles of Moore v. Bay[17] and its progeny that a transfer avoidable by one creditor is avoidable by the bankruptcy trustee for the benefit of all creditors regardless of amount.[18] The extended applications of Moore v. Bay (a § 544(a)-type proceeding) to fraudulent transfer cases has been criticized,[19] but it is nonetheless “entrenched” in bankruptcy jurisprudence.[20]

The issue of trustees borrowing longer limitations periods from governmental creditors promises to be a subject of dispute among the courts for the foreseeable future. Transferees beware!