Court Holds that Trustee May Avoid Transfers Occurring up to 10 Years Prior to Petition Date by Stepping into Shoes of IRS Pursuant to 11 U.S.C. § 544(b)

Bankruptcy trustees often find that by the time a case has commenced, potential fraudulent transfers are already so far in the past that they are beyond the reach of the two-year look-back period under § 548 of the Bankruptcy Code. When that happens, a trustee can turn to Bankruptcy Code § 544(b), which allows him or her to stand in the shoes of “a creditor holding an unsecured claim” and assert whatever rights that creditor may possess under “applicable law” to avoid fraudulent transfers made by the debtor. The look-back period provided in the “applicable law” is what then governs the trustee’s avoidance action under § 544(b).

The “applicable law” to which § 544(b) refers can be any law applicable to an unsecured creditor of the debtor but is very often taken to mean the applicable state fraudulent transfer statute, which would generally provide an unsecured creditor standing to seek to avoid fraudulent transfers made by the debtor. Applying state fraudulent transfer law can be advantageous for trustees as the look-back period is typically four years, rather than the two-year period provided by § 548.

Background

In Mukamal v. Kipnis, a recent case in the U.S. Bankruptcy Court for the Southern District of Florida,[1] a chapter 7 trustee was faced with a debtor who had made potentially fraudulent transfers eight and a half years prior to the start of the bankruptcy case. The applicable state fraudulent transfer statute – Florida’s – had a look-back period of four years. If he was to have any hope of avoiding the transfers, the trustee would need to find another “applicable law” under which at least one of the debtor’s unsecured creditors could reach back at least eight and a half years.

Fortunately for the trustee, the debtor had one special creditor that fit the bill. This creditor had the ability to invoke its own unique “applicable law” to avoid transfers above and beyond the state fraudulent transfer statute. This creditor was the Internal Revenue Service.

The Federal Tax Code provides the IRS with a 10-year look-back period applicable to its avoidance of fraudulent transfers made by taxpayers.[2] The Tax Code does not contain its own avoidance statute. Rather, it simply supplants the applicable state statute’s look-back period with a special 10-year period for the exclusive benefit of the IRS so that when the IRS sues a transferee under the state statute, it may reach back 10 years regardless of the state statute’s look-back period.

The trustee in Kipnis reasoned that if he were to step into the IRS’s shoes for purposes of § 544(b), he would be able to wield the IRS’s extended avoidance powers on behalf of the debtor’s estate and reach back up to 10 years. With this theory in mind, the trustee filed two adversary complaints seeking to avoid the transfers pursuant to the IRS’s Tax Code-based avoidance powers, alleging that he had inherited these powers upon the commencement of the bankruptcy case by operation of § 544(b). The debtor’s wife — who was the defendant in both adversary proceedings — responded by filing motions to dismiss in which she argued that the relevant look-back period was the four years provided by the Florida fraudulent transfer statute, not the 10-year period given the IRS in the Tax Code. The trustee responded that “because the IRS is an unsecured creditor in this case, he can step into its shoes under § 544(b) and not be bound by state statutes of limitations.”[3]

Bankruptcy Court’s Analysis

For purposes of deciding the motions to dismiss, the bankruptcy court assumed that the transfers would be avoidable under Florida’s fraudulent transfer statute if they fell within the look-back period, and the defendant conceded that the IRS, which held an unsecured priority claim of approximately $25,000, was “a creditor with an allowable unsecured claim within the meaning of § 544(b).”[4] The court’s decision would turn on “whether the Florida statute of limitations [i.e., the look-back period in the state statute] is inapplicable because the Trustee is purporting to step into the shoes of the IRS, which is not subject to state statutes of limitations.”[5]

Hinting at what its “plain language”-based holding would be, the court began its analysis by summarizing the trustee’s argument:

The Trustee’s argument is very simple. The IRS is a creditor holding an unsecured claim allowable under § 502 and, on the filing date of this bankruptcy case, the IRS could have timely filed a complaint to avoid the [transfers in question] under applicable Florida fraudulent transfer law. Therefore, the Trustee, pursuant to § 544(b), can now step into the shoes of the IRS to avoid these transfers.[6]

The court then noted that several other courts have ruled that a trustee can step into the IRS’ shoes for purposes of § 544(b) and invoke the Tax Code’s 10-year look-back period for fraudulent transfer avoidance.[7] On the other hand, the court continued, “Only one court has reached the opposite conclusion.” [8] The court criticized this lone case rejecting the trustee’s position, In re Vaughan Co.,[9] stating that the court in that case overlooked the plain language of § 544(b) and based its decision instead on perceived policy concerns and a belief about Congress’s intent in enacting § 544.

On the other hand, the court praised the line of cases supporting the trustee’s position, focusing in particular on Ebner v. Kaiser. The court stated:

In interpreting § 544(b), the Kaiser court first looked at the plain meaning of the statute as required by the Supreme Court. The Kaiser court found that the clear language in the text of § 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. 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. Neither Kaiser, nor this Court, finds the plain meaning interpretation of § 544(b) to be absurd.[10]

The court stated that it “agrees with Kaiser and with the majority of decisions that the language in § 544(b) is clear and allows the Trustee in this case to step into the shoes of the IRS to take advantage of the ten-year collection period in 26 U.S.C. § 6502.”[11]

Although the court held that the plain language of the statute overrides concerns based on policy or legislative intent, the court concluded its analysis by addressing the policy concern that apparently drove, at least in part, the Vaughan decision:

Vaughan expressed concern that allowing use of § 544(b) to avoid state statutes of limitations will “eviscerate” the current practice and create a ten-year look-back period in most cases. Kaiser disagreed with this “slippery slope argument” and found it to be a “logical fallacy” because section 544(b) has read the same since its enactment in 1978 and the cases that address this issue are “few and far” between.[12]

The court certainly agreed that this policy concern has no place in the interpretation of the plain language of § 544(b). However, the court disagreed with Kaiser’s downplay of the potential significance of the holding. On the contrary, the court noted that “the IRS is a creditor in a significant percentage of cases,” and that consequently “widespread use of § 544(b) to avoid state statutes of limitations may occur and this would be a major change in existing practice.”[13] The court speculated that the reason why this practice has not yet become commonplace “may simply be because bankruptcy trustees have not generally realized that this longer reach-back weapon is in their arsenal.”[14]

The court closed its opinion by stating that concerns over the wisdom of allowing a trustee a 10-year look-back to avoid fraudulent transfers “may be justified.” However, the court again stressed that the plain language of a statute trumps policy concerns, and that a court may not “ignore basic and important rules of statutory construction,” even when the plain-language reading of a statute might cause significant ripples in current practice.

Significance

The Kipnis decision is the latest in a small-but-growing line of cases holding that a trustee may invoke the IRS’s 10-year look-back period for avoiding fraudulent transfers in any case in which the IRS is an unsecured creditor. Considering that the period provided by most state statutes is only four years, and that the period provided by § 548 of the Bankruptcy Code is only two, this certainly would be a powerful new “reach back weapon,” as the court described it, for trustees. And if this practice were to become widespread, the court may well end up being correct in its prediction that “this would be a major change in existing practice.”

Trustees should certainly keep this potential new “reach back weapon” in mind in any case in which the IRS is an unsecured creditor.