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Bankruptcy Dispute Resolution Litigation

Trustee Allowed to Reach Back 10 Years to Avoid a Fraudulent Transfer

Recently, a Florida bankruptcy court permitted a Chapter 7 trustee to reach back 10 years to unwind a fraudulent transfer, a period of time well beyond the two years that practitioners generally expect.

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Nullum tempus occurrit regi means “no time runs against the King.” It spells no good fortune when a bankruptcy court references such a phrase.

Recently, in the case of In re Donald Jerome Kipnis (Mukamal v. Citibank), (Bankr. S.D. Fla. Aug. 31, 2016, No. 1:16-ap-01044-RAM), a Florida bankruptcy court permitted a Chapter 7 trustee (Trustee) to reach back 10 years to unwind a fraudulent transfer, a period of time well beyond the two years that practitioners generally expect. To put it in today’s perspective and look back just over 10 years to 2006, that would be when Barry Bonds hit his 715th home run, the Bankruptcy Abuse Prevention and Consumer Protection Act was one year old, and President Obama was still a United States Senator.

Factual Background

Prior to filing bankruptcy, the Internal Revenue Service (IRS) audited the debtor and concluded that he owed back taxes. Id. at 3. Several years later, in 2014, the debtor filed for bankruptcy and the IRS filed a $1.9 million proof of claim, part of which was unsecured. Id. at 4. The Trustee then commenced an adversary proceeding to unwind the prepetition fraudulent transfer of assets that occurred in 2005 (nine years prepetition) when the debtor was aware that the IRS was auditing him and when he began to transfer his assets to the defendant. Id. at 4.

The target defendant in the fraudulent transfer action filed a motion to dismiss the action, arguing that the Trustee’s complaint was time-barred under Florida’s four-year statute of limitation. See Florida Statute § 726.110(1)-(2). The Trustee replied that he was authorized to step into the shoes of the IRS, an unsecured creditor as of the petition date, and since the IRS is permitted 10 years to collect a tax under 28 U.S.C. § 6502(a)(1), then so can the Trustee. Kipnis at 5. The bankruptcy court agreed and denied the defendant’s motion to dismiss. Id. at 6.

The bankruptcy court clarified that 11 U.S.C. § 544(b) of the Bankruptcy Code permits a Chapter 7 trustee to avoid any transfer that is voidable by a creditor holding an allowable unsecured claim. Id. at 7. The bankruptcy court, invoking the late Justice Scalia’s strict textual approach, reasoned that since there are no nouns or adjectives preceding the word “creditor” in the statute, the bankruptcy court would not read any such limitation into the text of who this hypothetical creditor could be. Id. at 15. As such, the bankruptcy court allowed the Trustee to step into the shoes of the IRS and take advantage of the extended limitation in the tax code in order to unwind the alleged fraudulent transfer. Id.

Other Jurisdictions

Anticipating gasps from the bankruptcy bar, the bankruptcy court said that the scarcity of decisions holding similar views is due to other Chapter 7 trustees not realizing that they have this 10-year reach-back opportunity in their war chests. Id. at 10.

The majority of courts agree that Chapter 7 trustees may step into the shoes of the IRS, a federal government entity that is immune to state court statute of limitations. Ebner v. Kaiser (In re Kaiser), 525 B.R. 697, 710 (Bankr. N.D. Ill. 2014). In Kaiser, the Chapter 7 trustee filed a complaint against several defendants for fraudulent transfers that occurred more than four years prior to the petition date. Id. The Chapter 7 trustee alleged in that complaint that since the IRS was a creditor, he could assert its rights and go back further than the four-year limitation. Id. at 698. The court there held that the Chapter 7 trustee may step into the shoes of the IRS in avoiding these fraudulent transfers, including the extended statute of limitations. Id.

This is where the phrase “no time runs against the King” derives from — insinuating that the King (our democratically elected government) is not bound by a state’s statute of limitation. See also United States v. Summerlin, 310 U.S. 414, (1940) (where the Supreme Court held that when the United States becomes entitled to a claim, acting in its governmental capacity and asserts its claim in that right, it cannot be deemed to have abdicated its governmental authority so as to become subject to a state statute putting a time limit upon enforcement.).

Other courts holding similarly include:

The Opposing Position

Alternatively, only one court has found that a trustee cannot invoke this extended limitation period. In Wagner v. Ultima Holmes, Inc. (In re Vaughban Co.), 498 B.R. 297 (Bankr. D.N.M. 2013), the court ruled against the trustee because the IRS’s immunity from a state statute of limitation is intended as a public right, since the government is defending the public’s rights and serving the public’s interest as opposed to a trustee who has a private interest. In Vaughan, the debtor paid over $500,000 to a contractor to have the latter build his home, but the debtor received nothing in return. Id. at 331. The debtor filed bankruptcy four years later and the IRS filed a claim. Id. The Chapter 11 trustee in that case relied upon 11 U.S.C. § 544(b) to reach back 10 years to unwind the fraudulent transfer. Id. The court expressed its concern that since the IRS is a creditor in nearly all of these cases, permitting the Chapter 11 trustee to use 11 U.S.C. § 544(b) to circumvent the state’s statute of limitations would lead to a dramatic change in the law. Id. at 306.

Practice Tips

In the Kipnis case, the debtor conceded that the IRS held an allowable unsecured claim, which permitted the Trustee to step in the IRS’s shoes as discussed above. For debtors, to defend against a trustee in a similar situation, a successful objection to the IRS’s unsecured claim under 11 U.S.C. § 502(b) should be filed; or, prior to filing bankruptcy enter into a stipulation with the IRS to convert its unsecured claim to a secured one. If one employs either of these tactics, the IRS will have no unsecured claim and the trustee will be precluded from stepping in its shoes.

For creditors and trustees, assuming the IRS is not a creditor, it is worthwhile to determine if any other governmental agency holds an unsecured claim that the trustee can step into the shoes of (i.e., a claim held by the United States Department of Health and Human Services (HHS) in a case where the debtor is a hospital, or a claim held by the Department of Education in a case where the debtor is a for-profit institution). By employing this litigation tactic, the Chapter 7 trustee may reach back much further than what is permitted under a state’s statute of limitation.

Conclusion

It stands to reason that trustees will begin to request and analyze financial statements dating back further than two to four years prior to the petition date to determine if any causes of action arise that are worthy of unwinding. Also, it will not be uncommon for trustees to request more governmental agencies to file a claim, even for $1.00, that the government entity may otherwise believe to be futile, in order for the trustees to garner their standing to bring a cause of action under 11 U.S.C. § 544(b). During a period when bankruptcy work has been relatively slow, this new avenue for asset recovery may just be what practitioners have been waiting for.

***** Aram Ordubegian is a partner and Sevan Gorginian is an associate in the Los Angeles office of Arent Fox LLP. They may be reached at aram.ordubegian@arentfox.com and sevan.gorginian@arentfox.com, respectively.

The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.

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