Any creditor that has experienced more than a few customers or borrowers filing for bankruptcy is aware that there is a risk of being sued by a trustee to avoid transfers that the creditor received prior to the bankruptcy filing. Bankruptcy Code Section 547 empowers a trustee to recover a transfer made in the 90 day period before the bankruptcy filing (or one year period if the creditor is an “insider”) that enabled the creditor to receive more than it would have received in a Chapter 7 liquidation as a “preferential transfer.” Bankruptcy Code Section 548 empowers a trustee to avoid a transfer made in the two year period before the bankruptcy filing as a “fraudulent transfer” if the debtor made it with actual intent to hinder, delay, or defraud a creditor or if the debtor was insolvent and received less than reasonably equivalent value in return. What is less common knowledge, however, is that a trustee may sue to recover transfers made by a debtor more than two years before a bankruptcy filing.
Such suits are made possible by Bankruptcy Code Section 544. That section provides, in part, that “the trustee may avoid any transfer of an interest of the debtor in property…that is avoidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title.” As most commonly applied, this section enables a trustee to take advantage of the statute of limitations applicable to suits to avoid fraudulent transfers under state law if that is longer than two years and there is a creditor with an allowed unsecured claim in the bankruptcy who could have sued to avoid the applicable transfer, even if the creditor would not have sued because its claim is too small to justify the litigation expense.
State statutes of limitations generally are longer than two years. Under both the Uniform Fraudulent Transfer Act (the “UFTA”), which has been adopted by a majority of states, and the newer Uniform Voidable Transactions Act which is gradually being adopted to replace the UFTA, the statute of limitations is generally four years. However, as a November 3, 2020 decision of the United States Bankruptcy Court for Western District of North Carolina demonstrates, creditors may be at risk of having to disgorge transfers that they received as much as a decade before the bankruptcy filing.
In In re: Zagaroli, the Debtor transferred real property to his parents for no consideration in December of 2010 and June of 2011. He did not file for bankruptcy until May 21, 2018, almost seven years after the last of the transfers. The trustee sued the Debtor’s parents on January 20, 2020 to recover the 2010 and 2011 transfers under applicable non-bankruptcy law.
The Debtor’s parents filed a motion to dismiss the trustee’s complaint on the grounds that the statute of limitations for avoiding fraudulent transfers under North Carolina law is four years and the transfers at issue had occurred well more than four years before the trustee sued. The trustee responded that the suit was timely because the Internal Revenue Service (“IRS”) had a $4,261.27 allowed unsecured claim against the Debtor and, under 26 U.S.C. § 6502, the statute of limitations for actions by the IRS is ten years.
The court sided with the trustee. Since the IRS had an allowed unsecured claim and could avoid transfers up to ten years after they occurred, the court said that the plain, unambiguous language of Bankruptcy Code Section 544 gave the trustee the right to avoid transfers that were avoidable by the IRS. The court bolstered its decision by noting that, in the Fourth Circuit, once a bankruptcy case is filed, the trustee has the exclusive right to sue to avoid fraudulent transfers. Consequently, if the trustee could not sue to avoid transfers avoidable by the IRS, the bankruptcy filing would prevent anyone from suing to recover transfers that would have been avoidable by the IRS had the bankruptcy not been filed.
The Zagaroli decision raises an intriguing question that the court did not need to discuss at length because of the ten year statute of limitations afforded the IRS by 26 U.S.C. § 6502. The court noted that the North Carolina Uniform Voidable Transactions Act (“NCVTA”) “has a statute of limitations of four years.” That is true as to transfers made by debtors for less than reasonably equivalent value while insolvent. However, as to transfers made with actual intent to hinder, delay, or defraud a creditor, the statute of limitations under the NCVTA is “not later than four years after the transfer was made or the obligation was incurred or, if later, not later than one year after the transfer or obligation was or could reasonably have been discovered by the claimant.” This same language is in the UFTA and the majority of courts that have interpreted it have held that the one year period starts to run, not just when the “transfer” was or reasonably could have been discovered, but when the “fraudulent nature” of the transfer was or reasonably could have been discovered. If the trustee can sue to avoid a transfer that occurred ten years ago because the IRS has an allowed unsecured claim, can the trustee also sue to avoid a transfer that occurred ten years ago if there is a creditor with an allowed unsecured claim who, due to location, limited resources, or other reasons, could not have reasonably discovered the fraudulent nature of the transfer more than a year before the trustee sues?
Creditors often breathe a sigh of relief when 90 days have passed since they last received a transfer from a financially distressed customer or borrower without a bankruptcy case being filed. As Zagaroli demonstrates, such sighs of relief may be premature.
