The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to avoid fraudulent transfers is an important tool promoting the bankruptcy policies of equality of distribution among creditors and maximizing the property included in the estate. One limitation on this avoidance power is the statutory "look-back" period during which an allegedly fraudulent transfer can be avoided—two years for fraudulent transfer avoidance actions under section 548 of the Bankruptcy Code and, as generally understood, three to six years if the trustee or DIP seeks to avoid a fraudulent transfer under section 544(b) and state law by stepping into the shoes of a "triggering" creditor plaintiff.
The longer look-back periods governing avoidance actions under various state laws significantly expand the universe of transactions that may be subject to fraudulent transfer avoidance. Indeed, under a ruling recently handed down by the U.S. Bankruptcy Court for the Western District of North Carolina, the look-back period in avoidance actions under section 544(b) may be much longer—10 years—in bankruptcy cases where the Internal Revenue Service ("IRS") or another governmental entity is the triggering creditor. In Mitchell v. Zagaroli (In re Zagaroli), 2020 WL 6495156 (Bankr. W.D.N.C. Nov. 3, 2020), the court, adopting the majority approach, held that a chapter 7 trustee could effectively circumvent North Carolina's four-year statute of limitations for fraudulent transfer actions by stepping into the shoes of the IRS, which is bound not by North Carolina law but by the 10-year statute of limitations for collecting taxes specified in the Internal Revenue Code ("IRC").
Derivative Avoidance Powers Under Section 544(b) of the Bankruptcy Code
Section 544(b)(1) of the Bankruptcy Code provides in relevant part as follows:
[T]he trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title or that is not allowable only under section 502(e) of this title.
11 U.S.C. § 544(b). Thus, a trustee (or DIP pursuant to section 1107(a)) may seek to avoid transfers or obligations that are "voidable under applicable law," which is generally interpreted to mean state law. See Ebner v. Kaiser (In re Kaiser), 525 B.R. 697, 709 (Bankr. N.D. Ill. 2014); Wagner v. Ultima Holmes (In re Vaughan), 498 B.R. 297, 302 (Bankr. D.N.M. 2013).
The fraudulent transfer statutes of almost every state are versions of the Uniform Fraudulent Transfer Act ("UFTA"), which was recently amended and renamed the "Uniform Voidable Transactions Act" ("UVTA"). States that have adopted the UFTA or UVTA most commonly provide that avoidance actions are time-barred unless brought within four years of the time the transfer was made or the obligation was incurred. Notably, New York adopted the UVTA effective as of December 2019, reducing its look-back period to four years, from six under longstanding prior law.
Longer Look-Back Period for Certain Governmental Entities
The federal government is generally not bound by state statutes of limitations, including those set forth in state fraudulent transfer laws. Vaughan, 498 B.R. at 304. Instead, various federal statutes or regulations specify the statute of limitations for enforcement actions. For example, the IRC provides that, with certain exceptions, an action to collect a tax must be commenced by the IRS no later than 10 years after the tax is assessed. See 26 U.S.C. § 6502(a). The rationale behind a longer federal statute of limitations is that public rights and interests that the federal government is charged with defending should not be forfeited due to public officials' negligence. Vaughan, 498 B.R. at 304.
On the basis of the plain meaning of section 544(b), nearly all of the courts that have considered the issue have concluded that a trustee or DIP bringing an avoidance action under that section may step into the shoes of the IRS (if it is a creditor in the case) to utilize the IRC's 10-year statute of limitations. See, e.g., Murphy v. ACAS, LLC (In re New Eng. Confectionary Co.), 2019 Bankr. LEXIS 2281 (Bankr. D. Mass. July 19, 2019); Viera v. Gaither (In re Gaither), 595 B.R. 201 (Bankr. D.S.C. 2018); Hillen v. City of Many Trees, LLC (In re CVAH, Inc.), 570 B.R. 816 (Bankr. D. Idaho 2017); Mukhamal v. Citibank, N.A. (In re Kipnis), 555 B.R. 877 (Bankr. S.D. Fla. 2016); Kaiser, 525 B.R. at 711–12.
Vaughan is apparently the only published decision to the contrary with respect to the IRS and the IRC. The Vaughan court reached its conclusion after considering policy and legislative intent. It noted that the IRS is not bound by state law statutes of limitations because it exercises sovereign powers and is therefore protected by the doctrine of nullum tempus occurrit regi ("no time runs against the king"). According to the court in Vaughan, Congress did not intend for section 544(b) to vest sovereign power in a bankruptcy trustee, and allowing a trustee to take advantage of the IRC's 10-year statute of limitations would be an overly broad interpretation.
In MC Asset Recovery LLC v. Commerzbank A.G. (In re Mirant Corp.), 675 F.3d 530, 535 (5th Cir. 2012), the U.S. Court of Appeals for the Fifth Circuit rejected a line of cases holding that the Federal Debt Collection Practices Act ("FDCPA") can be "applicable law" for purposes of section 544(b), thereby affording the trustee use of the FDCPA statute of limitations, because the FDCPA expressly provides that "[t]his chapter shall not be construed to supersede or modify the operation of … title 11." Id. at 535 (quoting 28 U.S.C. § 3003(c)); accord MC Asset Recovery, LLC v. Southern Co., 2008 WL 8832805 (N.D. Ga. July 7, 2008) ("[T]he FDCPA cannot be the 'applicable law' within the meaning of Section 544(b) of the Bankruptcy Code."). However, the IRC does not include comparable language.
The Vaughan minority approach has been rejected by almost all other courts. For example, in Kipnis, the court concluded that the meaning of section 544(b) is clear and does not limit the type of creditor from which a trustee can choose to derive rights. Moreover, because the court determined that its interpretation of the statute was not "absurd," the court did not deem it necessary to expand its inquiry beyond the express language of section 544(b) to consider legislative intent or policy concerns. Kipnis, 555 B.R. at 882 (citing Lamie v. United States Trustee, 540 U.S. 526, 534 (2004) ("It is well established that 'when the statute's language is plain, the sole function of the courts—at least where the disposition required by the text is not absurd—is to enforce it according to its terms.'")).
The court concluded that Vaughan's nullum tempus argument was misplaced. Because section 544(b) is a derivative statute, the Kipnis court wrote, "the focus is not on whether the trustee is performing a public or private function, but rather, the focus is on whether the IRS, the creditor from whom the trustee is deriving her rights, would have been performing that public function if the IRS had pursued the avoidance actions."
However, the court agreed with Vaughan on one point—if applied in other cases, the court's ruling could result in a 10-year look-back period in many cases. According to the Kipnis court, because the IRS is a creditor in a significant number of cases, the paucity of decisions addressing the issue can more likely be attributed to the fact that trustees and DIPs have not realized that this "weapon is in their arsenal."
Triggering Creditor Must Have an "Allowable Claim"
Avoidance under section 544(b) is permitted only if a transfer could be avoided under applicable law by a creditor holding an "allowable" unsecured claim. The term "allowable" is not defined in the Bankruptcy Code. However, section 502(a) provides that a claim for which the creditor files a proof of claim is deemed "allowed" unless a party in interest objects. Rule 3003(b) of the Federal Rules of Bankruptcy Procedure provides that, in a chapter 9 or chapter 11 case, a creditor need not file a proof of claim if the claim is listed on the debtor's schedules in the proper amount and is not designated as disputed, contingent, or unliquidated.
Thus, if an unsecured creditor has not filed a proof of claim and if, in a chapter 9 or chapter 11 case, its claim either is not scheduled in any amount or is scheduled as disputed, contingent, or unliquidated, a handful of courts have concluded that the claim is not "allowable" and the trustee or DIP may not step into the creditor's shoes to bring an avoidance action under section 544(b). See In re Republic Windows & Doors, 2011 WL 5975256, *11 (Bankr. N.D. Ill. Oct. 17, 2011) (a chapter 7 trustee could not take advantage of the IRC's 10-year statute of limitations because the IRS had not filed a proof of claim in the case); Campbell v. Wellman (In re Wellman), 1998 WL 2016787, *3 (Bankr. D.S.C. June 2, 1998) ("[A]s Robert McKittrick was the only creditor of these three [creditors] to file a proof of claim, he is the only one with an allowable claim into whose shoes the [chapter 7] Trustee may step pursuant to § 544(b).").
However, the majority approach is otherwise. Most courts have held that the allowability of a claim for purposes of section 544(b) should be determined as of the petition date and, therefore, that the failure to file a proof of claim does not disqualify a creditor from being the triggering creditor. See, e.g., In re Tabor, 2016 WL 3462100, at *2 (Bankr. S.D. Fla. June 17, 2016); Whittaker v. Groves Venture, LLC (In re Bolon), 538 B.R. 391, 408 n.8 (Bankr. S.D. Ohio 2015); Finkel v. Polichuk (In re Polichuk), 506 B.R. 405, 432 (Bankr. E.D. Pa. 2014); In re Kopp, 374 B.R. 842, 846 (Bankr. D. Kan. 2007).
In Zagaroli, the bankruptcy court considered whether a chapter 7 trustee could step into the shoes of the IRS for purposes of section 544(b).
In 2018, Peter Zagaroli ("debtor") filed a chapter 7 case in North Carolina. The IRS filed a proof of claim in the case in the unsecured amount of approximately $4,000. In 2020, the chapter 7 trustee sued the debtor's parents, seeking to avoid 2010 and 2011 transfers of real property by the debtor to his parents as fraudulent transfers under the North Carolina UVTA, which has a four-year look-back period. See N.C. Gen. Stat. § 39-23.9. The defendants moved to dismiss, arguing that the challenged transfers occurred more than four years prior to the petition date. The trustee countered that he could utilize the IRC's 10-year look-back period because the IRS was a triggering creditor.
The bankruptcy court denied the motion to dismiss.
The defendants argued that, instead of focusing on the plain language of section 544(b), the court should consider the legislative history, the purpose of the provision, related provisions of the Bankruptcy Code, and other relevant statutes, such as the IRC, which requires specific authorization to bring any action thereunder. See 26 U.S.C. § 7401. According to the defendants, limiting consideration solely to the language of section 544(b) would lead to "absurd results or conflict with other statutory provisions."
The bankruptcy court rejected those arguments. When the language of a statute is unambiguous, the court explained, "'the court's task is simple: apply the plain language'" (citation omitted). Moreover, the court wrote, "the Defendants' position would result in leaving both the Trustee and the IRS without the right to avoid offending transfers" that occurred outside the look-back period under state law. The court concluded that "the applicable law that the Trustee seeks to invoke is the [North Carolina UVTA] and the IRC, both of which the IRS could have used to seek to avoid the transfers outside of bankruptcy."
Zagaroli does not break new ground on the power of a bankruptcy trustee or DIP to bring avoidance actions under section 544(b) of the Bankruptcy Code. Nevertheless, the court's endorsement of the majority approach on the availability of a longer look-back period in cases in which the IRS is a creditor is notable. Widespread adoption of this approach could significantly augment estate avoidance action recoveries.
Furthermore, the IRS is not the only potential triggering creditor under section 544(b) with a longer look-back period. Other federal and state governmental entities may also provide that additional tool to a trustee or DIP. See, e.g., In re 160 Royal Palm, LLC, 2020 WL 4805478 (Bankr. S.D. Fla. July 1, 2020) (permitting a debtor under section 544(b) to take advantage of the Securities and Exchange Commission's six-year statute of limitations for fraudulent transfer claims under 28 U.S.C. §§ 2415(a) and 2416); Alberts v. HCA Inc. (In re Greater Southeast Cmty. Hosp. Corp. I), 365 B.R. 293, 304 (Bankr. D.D.C. 2006) (the trustee of a liquidating trust created by a chapter 11 plan could step into the shoes of the IRS as well as the U.S. Department of Health and Human Services (six-year statute of limitations for actions to collect Medicare overpayments under 28 U.S.C. § 2415) for the purpose of bringing an avoidance action under section 544(b) and the Illinois UFTA); G-I Holdings, Inc., 313 B.R. at 636 (the asbestos claimants' committee in a chapter 11 case could step into the shoes of the New Jersey Department of Environmental Protection (10-year statute of limitations for enforcement action) for purposes of section 544(b)). In addition, despite the Fifth Circuit's rejection of the FDCPA as "applicable law" for purposes of § 544(b), other courts have ruled to the contrary. See, e.g., Gaither, 595 B.R. at 214; In re Alpha Protective Servs., Inc., 531 B.R. 889, 905 (Bankr. M.D. Ga. 2015) (citing cases). Thus, understanding the approach adopted in a particular jurisdiction is paramount for this purpose.