Bankruptcy trustee cannot avoid transfer of funds to IRS

In an 8—1 decision, the Supreme Court held that the waiver of sovereign immunity under Bankruptcy Code Section 106(a) for suits to avoid (i.e., set aside) certain transfers under Bankruptcy Code Section 544(b) applies only with respect to the federal cause of action created by Section 544(b) and does not apply to state–law claims that underlie the federal cause of action. Thus, a bankruptcy trustee could not sue the IRS to avoid a fraudulent transfer of funds by two of the owners of an insolvent company (which later filed for bankruptcy) to the IRS to pay their personal tax expenses.

Background

A Utah–based transportation business called All Resort Group fell into insolvency in 2013. As the company struggled financially, two of its shareholders began misappropriating company funds and transferred roughly $145,000 to the IRS in 2014 to pay their personal income tax obligations. The company received nothing in return for paying off these shareholders’ debts. Three years later, the company filed for bankruptcy.

David Miller, the trustee of All Resort’s bankruptcy estate, filed suit against the IRS under Bankruptcy Code Section 544(b), seeking to avoid the tax payments. Section 544(b)(1) allows a trustee to “avoid any transfer of an interest of the debtor … that is voidable under applicable law by a creditor holding an unsecured claim,” or, in other words, to avoid a transfer that would be voidable outside bankruptcy proceedings. Technically, the “applicable law” can be any state or federal law outside the Bankruptcy Code, but bankruptcy trustees typically use state statutes to supply the “applicable law” in suits to avoid a transfer under Section 544(b).

The state statutes that trustees most often use are known as “fraudulent transfer” laws. As the source of the necessary applicable law for his Section 544(b) claim, Miller invoked Utah’s fraudulent–transfer statute (Utah Code §25–6–6 et seq. (2014)), which allows a creditor to void a debtor’s transfer of assets if the debtor was insolvent at the time of the transfer and received less than equal value in return.

In bankruptcy court, the parties cross–moved for summary judgment. The government did not contest Miller’s allegation that All Resort Group was insolvent when it made the 2014 tax payments or that it received nothing in exchange for making them. Instead, the government argued that Miller’s claim was invalid because he could not satisfy Section 544(b)’s actual–creditor requirement. Under this requirement, to bring suit under Section 544(b), the bankruptcy trustee must be able to identify the creditor that could have set aside the transaction in question. Specifically, the government claimed that Miller could not identify any creditor capable of prevailing in a fraudulent–transfer suit against the IRS under Utah law because, outside bankruptcy, any such suit would be barred by sovereign immunity.

The bankruptcy court rejected the government’s argument and granted Miller’s motion for summary judgment, based on Bankruptcy Code Section 106(a), which provides that “sovereign immunity is abrogated as to a governmental unit to the extent set forth in this section with respect to” any of 59 Bankruptcy Code provisions listed in Section 106(a)(1), which include Section 544. The bankruptcy court concluded that Section 106(a) waived the IRS’s sovereign immunity not only with respect to Miller’s Section 544(b) claim but also “as to the underlying state law cause of action” nested within the Section 544(b) claim. Accordingly, the court held that “sovereign immunity does not preclude [Miller] from satisfying the actual creditor requirement.”

The district court adopted the bankruptcy court’s decision, and the Tenth Circuit affirmed, concluding that Section 106(a) expressed Congress’s intent to abolish the government’s sovereign immunity in a Section 544(b)(1) proceeding to avoid a transfer, regardless of the context in which the defense arises (Miller, 71 F.4th 1247 (2023)).

Because of a split in the appellate circuits on the issue of whether Section 106(a) abrogates sovereign immunity with respect to a state–law claim that supplies the applicable law for a trustee’s Section 544(b) claim, the Supreme Court agreed to hear the case.

The Supreme Court’s decision

The Supreme Court, reversing the Tenth Circuit’s decision, held that Section 106(a)’s sovereign–immunity waiver applies only to the Section 544(b) claim itself and not to state–law claims nested within that federal claim. Section 106(a), the Court found, is properly understood as a jurisdictional provision that empowers courts to hear Section 544(b) claims against the government to the extent such claims are otherwise available under state law and does not alter the substantive meaning of Section 544(b)’s applicable–law clause.

The Court found that its determination on the issue turned on the interplay between Sections 106(a) and 544(b). Waiving sovereign immunity for the applicable law that was the basis of a Section 544(b) claim, the Court reasoned, would transform Section 106(a) from a jurisdiction–creating provision into a liability–creating one. Citing FDIC v. Meyer, 510 U.S. 471, 475 (1994), the Court stated that sovereign immunity is jurisdictional in nature and works to prevent courts from hearing suits against the United States without Congress’s express consent. Thus, the Court found that a waiver of sovereign immunity is simply a prerequisite for jurisdiction and does not create any new substantive rights or alter any preexisting ones. According to the Court, Miller’s attempt to leverage Section 106(a)’s waiver of immunity (i.e., the statute’s grant of jurisdiction) into an affirmative expansion of the trustee’s avoidance powers under Section 544(b) conflicted with the Court’s traditional understanding of sovereign–immunity waivers.

In the Court’s view, Section 106(a)’s text, context, and structure and Section 544’s text and structure made it clear that Section 106(a) does not operate to modify Section 544(b)’s substantive requirements. Construing Section 106(a) to modify the elements of a Section 544(b) claim, the Court posited, would give the trustee a substantive claim for relief against the government that does not otherwise exist under Section 544(b) or Utah law. This would be in direct conflict with Section 106(a)(5), which states that Section 106(a) does not “create any substantive claim for relief or cause of action not otherwise existing” under some other source of law. Furthermore, the Court found that eliminating the actual–creditor requirement would “upend decades of practice and precedent” recognizing that Section 544(b) “merely empowers a trustee to step into the shoes of a creditor, subject to the same limitations and defenses that would apply to that creditor outside bankruptcy.”

Finally, the Court found that even if the language and logic of Sections 544 and 106(a) allowed for Miller’s broad reading of the sovereign–immunity waiver, the Court’s precedents would still foreclose that reading. As the Court had held previously (e.g., FAA v. Cooper, 566 U.S. 284 (2012)), courts are required to construe sovereign–immunity waivers narrowly, with any ambiguities resolved in favor of the sovereign.

Miller’s arguments

Miller had argued in the Court that the phrase “with respect to” in Section 106(a)(1) showed Congress’s intent to end sovereign immunity for “all subjects that concern or regard” the listed provisions, including the meaning of “applicable law” in Section 544(b). On this point, Miller relied on dictionary definitions and cases that adopted broad readings of phrases similar to “with respect to.” The Court found that the cases Miller cited as authorities did not support his argument, as they all examined those terms in very different statutory contexts, and Miller’s textual argument was contrary to the fundamental canon of statutory construction that the words of a statute must be read in their context and with a view to their place in the overall statutory scheme. The Court explained that this canon carries particular force when construing phrases that govern conceptual relationships such as “with respect to,” whose meanings inherently depend on their surrounding context. Thus, the Court rejected this argument, finding that “context cuts decidedly against the broad reading [Miller] advances.”

Miller also asserted Section 106(a)’s enactment history showed that Congress purposefully expanded the scope of its immunity waiver in 1994 by adding the list of 59 specific provisions, including Section 544, to the statute. However, the Court found that this change in the statute did nothing to change the original understanding (as expressed in S. Rep’t No. 95–989, 95th Cong., 2d Sess. (1978), at 29, and H.R. Rep’t No. 95–595, 95th Cong., 1st Sess. (1977), at 317) that Section 106 provides a limited waiver of sovereign immunity in bankruptcy cases, designed to “achieve approximately the same result that would prevail outside of bankruptcy.” Furthermore, the Court noted that under its precedent (Department of Agriculture Rural Development Rural Housing Service v. Kirtz, 601 U.S. 42, 49 (2024)), legislative history cannot supply a waiver where the language of the statute does not clearly do so.

Another argument Miller raised was that the Supreme Court’s interpretation would render Section 106(a)’s waiver meaningless with respect to Section 544, as this interpretation would simply grant federal courts jurisdiction over a set of inherently unwinnable claims. The Court found this was not true, noting that Section 106(a) might enable a trustee to prevail against the government in a claim under Section 544(a), which, unlike Section 544(b), does not have an actual–creditor requirement. Separately, Internal Revenue Code Sec. 6323 provides that tax liens may be invalidated in certain circumstances, so a trustee could thus avoid a transfer of certain IRS tax liens. The Court also pointed to the fact that Bankruptcy Code Section 106(a) also grants federal courts jurisdiction to hear Section 544(b) claims against state governments that have consented to being sued under their fraudulent–transfer statutes.

Miller further argued that because Section 106(a)(1) refers to Section 544 as a whole (rather than by subsection), the waiver must be construed to give substantive effect to all of Section 544’s subsections. The Supreme Court, observing that many of the other 58 Bankruptcy Code provisions listed “as a whole” in Section 106(a)(1) include subsections that plainly do not implicate sovereign immunity at all, stated, “The sheer number of provisions on the list with subsections that cannot plausibly be the subject of an immunity waiver rebuts [Miller’s] strained reading of [Section] 106(a).”

Finally, Miller argued the Supreme Court’s recent holding in Kirtz was evidence that Congress sometimes waives sovereign immunity while simultaneously establishing a new substantive right against the government. The Court, however, found that Kirtz involved a statute that bears little resemblance in text, structure, or operation to Section 106(a). Nothing in Kirtz, according to the Court, suggested that courts should presume, in the absence of explicit statutory language, that Congress has waived the government’s sovereign immunity for a state cause of action that does not explicitly authorize suits against the government.

Reflections

A lone dissent by Justice Neil Gorsuch in the case argued that the majority confused the doctrine of sovereign immunity with the requirement that a plaintiff state a cause of action. According to Gorsuch, Miller met all the requirements of Utah Code §25–6–6 et seq. (2014), and there was no dispute that Miller’s claim was a good fraudulent–transfer claim. Thus, under the applicable law in Miller’s case, the transfers to the IRS were voidable, and the bankruptcy trustee could use Section 544(b)(1) to set them aside.

Gorsuch concluded that this remained true even though the bankruptcy trustee was required to sue the United States to void the relevant transfers, because Section 106(a)(1) bars the government from raising a sovereign–immunity defense in the trustee’s action. Therefore, he agreed with the Fourth, Ninth, and Tenth circuits that bankruptcy trustees may avoid fraudulent transfers to the United States under Section 544(b).

Miller, No. 23-824 (U.S. 3/26/2025)

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.