In an 8-1 opinion issued today, the United States Supreme Court determined that sovereign immunity protects the Internal Revenue Service from avoidance claims asserted by a bankruptcy trustee under applicable state law.
In United States v. Miller, the trustee of failed Utah-based transportation business sought to recover $145,000 that the company’s two shareholders had misappropriated to pay their personal taxes to the IRS three years before the bankruptcy filing.
The trustee filed an avoidance suit against the United States under Section 544(b) of the Bankruptcy Code, which allows a trustee to avoid any transfer of a debtor’s interest that is voidable under applicable law by a creditor holding an unsecured claim. Utah’s fraudulent transfers statute was the applicable state law and allowed for a look back period beyond the two-year period under Section 548 of the Bankruptcy Code.
The US Bankruptcy Court for the District of Utah in 2020 found that the transfer to the IRS was fraudulent under Utah. The District Court and Tenth Circuit affirmed on appeal.
As they did below, the government argued that the trustee’s claim was invalid because sovereign immunity would prevent any creditor from voiding the transfer under Utah law such that the trustee, standing the creditor’s shows, could not rely on applicable state avoidance law under Section 544(b).
The Bankruptcy Court had rejected that assertion, ruling that §106(a) of the Bankruptcy Code, which waives the government’s sovereign immunity with respect to certain provisions, also applied to the Utah cause of action created under Section 544(b).
The Supreme Court reversed, finding that Section 106(a)’s sovereign-immunity waiver applies only to the federal claim itself, i.e. Chapter 5 avoidance claims, and not to state-law claims made applicable by Section 544(b).
In short, while Section 106(a) has been construed to waive sovereign immunity for claims created by the Bankruptcy Code, it does not extend to the underlying state law causes of action made available under Section 544.
The decision clarifies the limits of sovereign immunity waivers under the Bankruptcy Code and reinforces the principle that such waivers must be explicitly stated and narrowly construed.
The decision resolves a split among the circuits as to whether sovereign immunity protects the IRS from claims asserted by a trustee based on state avoidance law. The Fourth, Ninth, and Tenth Circuit Courts had all rejected the Seventh Circuit’s approach, which said a bankruptcy trustee couldn’t recover the money outside the typical two-year window.