A Trustee in IRS Clothing

By Abigail Henderson

In addition to explicitly creating certain procedures and means of protection for debtors and creditors in bankruptcy, Bankruptcy Code provisions define the Trustee’s role and the extent of the Trustee’s powers in bankruptcy proceedings. The effect of the Code is twofold: it both equips the Trustee with the powers necessary to perform the Trustee’s role and, at least historically, has allowed North Carolina creditors and transferees to find some assurance that after four years, they are no longer exposed to the risk of an avoidance action. Recently, however, courts have increasingly adopted case law that expands the Trustee’s reach and undermines the four-year safe harbor for transferees.

Section 544(b) of the Bankruptcy Code provides the Trustee the authority to avoid any transfers to unsecured creditors by the debtor which are voidable under “applicable law by a creditor holding an unsecured claim.” Traditionally, this has meant that in cases in North Carolina the Trustees could avail themselves of the statute of limitations provided for in North Carolina’s Uniform Voidable Transactions Act—four years from when the transfer was made or, in certain circumstances, a year after the transfer was or reasonably should have been discovered.

However, as of late, Trustees across the country have begun to use section 544(b) to assume the benefits not just of the state law on voidable transfers, but also the those afforded to the IRS under both the Federal Debt Collections Procedures Act (“FDCPA”) and the Internal Revenue Code (“IRC”) in cases where the IRS has an unsecured claim against the estate. This adds several more means of recovery to Trustees, including but not limited to the ten-year look-back period for voiding transactions under the IRC or, as most recently applied in South Carolina, by avoiding transfer by disclaimer.

In In re Gaither, 595 B.R. 201 (Bankr. D.S.C., 2018), the court in South Carolina considered this issue for the first time. After the Debtors’ son died in an aviation accident, the couple was named as their deceased son’s personal representatives in the probate court. The couple subsequently filed a lawsuit against the aviation company based on the damages caused by their son’s death, and on May 6, 2015, the state court in South Carolina approved a settlement in favor of the Plaintiff Debtors. On the day the settlement was approved, the Debtors disclaimed their right to the settlement proceeds so that the funds transferred to their three surviving children.

Nearly three years later, in March of 2018, the Debtors filed a Chapter 7 petition. The IRS filed a proof of claim for $787,239.85, of which $455,216.33 was unsecured. The Trustee filed an adversary proceeding under section 544(b) alleging that the IRS was an unsecured creditor of the estate, and because federal law provides that a disclaimer does not defeat a federal tax lien, the Trustee, via the IRS, had the authority to avoid the transfer of the disclaimed settlement proceeds to the Debtors’ surviving children. Over the strenuous objection of the surviving children, the court found that because the IRS could avail itself of the tools of recovery provided in both the FDCPA and the IRC, the Trustee could do the same. As the court explained, this decision, though a matter of first impression for the Court in South Carolina, was consistent with decisions of courts in various jurisdictions. See, e.g., In re CVAH, 570 B.R. 816, 823 (Bankr. D. Idaho, 2017) (“[T]he operation of [section] 544(b)(1) in tandem with the FDCPA is clear: because [the] IRS, as a federal creditor, could sue the defendants under the FDCPA to avoid the target transfers, Trustee may also do so.”); Gordon v. Harrison (In re Alpha Protective Servs., Inc.), 531 B.R. 889, 906 (Bankr. M.D. Ga. 2015) (“[T]he FDCPA is ‘applicable law’ for the purposes of [section] 544.”); In re Tronox, 503 B.R. 239, 273 (Bankr. S.D.N.Y. 2013) (holding that the FDCPA is applicable law under section 544(b)); see also In re Kaiser, 525 B.R. 697, 711(Bankr. N.D. Ill., 2014) (holding that a trustee may step into the shoes of any unsecured creditor, including the IRS, and utilize a longer look-back period); In re Kipnis, 555 B.R. 877, 883 (Bankr. S.D. Fla., 2016) (same).

While North Carolina bankruptcy courts have not yet addressed this issue, at least one court has indicated that it is aware that they may soon be called upon to make this determination. See In re Yahweh Ctr., Inc., No. 16-04306-5-JNC, 2019 WL 1325032, at *4 (Bankr. E.D.N.C. Mar. 22, 2019) (acknowledging that the Trustee’s argument, that it should be allowed to assume the federal limitation periods granted to the IRS, as something that may need to be addressed following the resolution of other preliminary issues). Therein lies a caution to transferees in cases where the IRS holds an unsecured claim.

Abigail Henderson is an associate a Grier Wright Martinez, P.A. in Charlotte. Abbie’s practice focuses on debtor/creditor workouts and business workouts as well as general corporate law. Abbie also represents bankruptcy trustees and debtors in possession in bankruptcy court.