WASHINGTON (CN) — The Supreme Court plugged a bankruptcy loophole Wednesday and blocked a trustee from recovering tax payments for employees who worked without full pay at a Utah-based transportation company as it was failing.
In an 8-1 opinion, the high court ruled that the Internal Revenue Service’s sovereign immunity outweighs Bankruptcy Code and state law provisions that govern how far back in time a trustee can recover fraudulent transfers.
The decision bars bankruptcy trustees or companies from using the transfer law to recover funds going back up to four years in most states.
The Supreme Court took up the case to address whether a bankruptcy court could use Utah’s fraudulent transfer law to extend the statue of limitations for a trustee to recover a payment from a company, before its bankruptcy, to the IRS.
Justice Ketanji Brown Jackson, a Joe Biden appointee, wrote the court’s majority opinion.
“Waivers of sovereign immunity are jurisdictional provisions that empower courts to hear claims against the government but do not themselves typically create any new substantive rights against the government,” Jackson said.
Under the court’s ruling, trustees seeking relief in bankruptcy courts will only be able to claw back a property transfer or payment made in the two years leading up to a bankruptcy.
That so-called “lookback” period thus cannot be extended another two years by applying a second bankruptcy provision that would’ve allowed the piggybacking of a state’s fraudulent transfer law.
Justice Neil Gorsuch, a Donald Trump appointee, was the sole dissenter, noting that is is undisputed that under Utah law a transfer can be voided if an insolvent debtor made it without “reasonably equivalent value in exchange.”
Allowing trustees to claw back funds from the government as normally permitted under bankruptcy and state law does not “‘modify the elements’ of any claim or ‘create any substantive claim for relief’ that did not ‘otherwise exist,’” Gorsuch wrote.
Richard Bizzaro and Gordon Cummins withdrew hundreds of thousands of dollars from All Resort Group as the company fell into insolvency in December 2013. Amid mounting debts and a $55,000 employment-discrimination suit, the men — who were shareholders and directors at the company — withdrew over $2.2 million from All Resort Group.
In June 2014, Bizzaro and Cummins made fraudulent transfers of $145,138 in company funds to pay their personal federal income tax debts.
A trustee was appointed in 2017 during All Resort’s bankruptcy and subsequent liquidation. The Chapter 11 proceedings lasted five months, during which about 300 of the company’s employees continued to work without full pay.
The workers filed post-petition claims for wages, which were pushed to the top of the priority list during bankruptcy proceedings.
The trustee tried to recover Bizzaro’s and Cummins’ fraudulent tax transfers to settle the employees’ accounts. Outside of bankruptcy cases, the federal government can use sovereign immunity or tax field preemption to avoid facing similar suits, but the trustee tried to take advantage of the lone scenario where those options were unavailable.
A bankruptcy court sided with the trustee, and the Tenth Circuit affirmed.
The IRS then appealed to the Supreme Court, challenging the appellate court’s holding that allowed the trustee to recover the $145,138, as it occurred three years before All Resort Group filed for bankruptcy.
The agency argued that the attempt by the former employee, as the “actual creditor,” to claw back the company’s tax payments went against sovereign immunity, which would prevent that action outside of bankruptcy.
The IRS said it seemed unlikely that the bankruptcy provision, which allows the piggybacking of a state fraudulent transfer law, could have been intended to waive the government’s sovereign immunity.
There had been a 3-1 spilt among the appeals courts, with the Fourth, Ninth and 10th Circuit courts all rejecting the Seventh Circuit’s approach, which barred a bankruptcy trustee from recovering money outside the typical two-year window.
The justices remanded the case for further proceedings.