The Supreme Court is the next stop for the U.S. government because the Ninth Circuit will not rehear Zazzali v. U.S. (In re DBSI Inc.), 869 F.3d 1004 (9th Cir. Aug. 31, 2017), where the appeals court held that the waiver of sovereign immunity under Section 106(a)(1) allows a trustee to file a derivative suit against the Internal Revenue Service for receipt of a fraudulent transfer under Section 544(b)(1).
Deciding DBSI, the Ninth Circuit created a split with Seventh Circuit, which had held in In re Equipment Acquisition Resources Inc., 742 F.3d 743 (7th Cir. 2014), that the waiver of immunity does not extend to Section 544(b)(1) suits because sovereign immunity would bar any actual creditor from suing the government.
In the Ninth Circuit case, the debtor was a Ponzi scheme. As a subchapter S corporation, the debtor had paid the IRS about $17 million for taxes owing by its shareholders. The trustee for a creditors’ trust sued the IRS to recover the payments as fraudulent transfers.
The IRS conceded it was obliged to return about $56,000 that had been paid within two years of bankruptcy, where the waiver of sovereign immunity would apply to fraudulent transfer suits by the trustee under Section 548(a)(1)(B).
The IRS resisted claims for the remainder of the $17 million, which the trustee based on Idaho’s version of the Uniform Fraudulent Transfer Act and its four-year statute of limitations. For claims beyond two years, the trustee invoked Section 544(b)(1), which requires the existence of an actual, unsecured creditor who could have sued under state law.
The district judge granted the trustee’s cross motion for summary judgment, holding that Section 106(a)(1) waived sovereign immunity for derivative fraudulent transfer claims brought under Section 544(b)(1). Creating a split with the Seventh Circuit, the Ninth Circuit affirmed in late August.
The government filed a petition for rehearing en banc, which the appeals court denied on Dec. 20. The Ninth Circuit’s order said that no circuit judge “requested a vote on whether to rehear the matter en banc.”
If the government files a petition for certiorari to the Supreme Court, the IRS will need to convince the justices that the case merits further review, even though, arguably, the circuit split is not yet fully developed. Or, the government might try to convince the high court that the Ninth Circuit precedent will result in enormous fraudulent transfer liability for the IRS.
To read ABI’s discussion of the Ninth Circuit opinion, click here.