Bankruptcy Court Permits Chapter 7 Trustee to Utilize IRS’ Look-Back Period in Seeking to Avoid Fraudulent Transfers

Kramer Levin Naftalis & Frankel LLP
Contact

Kramer Levin Naftalis & Frankel LLP

Bottom Line

In its recent decision in Mitchell v. Zagaroli, Adv. Pro. No. 20-05000, 2020 WL 6495156 (Bankr. W.D.N.C. Nov. 3, 2020), the Bankruptcy Court for the Western District of North Carolina held that the Chapter 7 trustee could step into the shoes of the IRS and utilize the IRS’ longer look-back period to avoid fraudulent transfers.

What Happened?

Individual Peter Zagaroli filed for Chapter 7 bankruptcy relief in a North Carolina bankruptcy court in 2018. The IRS filed a proof of claim for approximately $4,200. In 2020, the Chapter 7 trustee filed an adversary proceeding to avoid certain transfers of real property to the defendants, the parents of the debtor. The trustee alleged that in 2010 and again in 2011, the debtor transferred multiple parcels of land to the defendants for no consideration while he was insolvent.

The defendants filed a motion to dismiss, asserting the trustee could not avoid the transfers of real property. By way of background, Section 544(b)(1) of the Bankruptcy Code allows a trustee to avoid “any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable” by a creditor under applicable law. The statute of limitations under the North Carolina Uniform Voidable Transactions Act (NCUVTA) is four years, but the IRS is exempt from the NCUVTA’s statute of limitations. Under the Internal Revenue Code (the IRC), there is a 10-year look-back period to avoid transfers. Thus, the issues before the court were (i) whether 11 U.S.C. § 544(b) allows the trustee to step into the shoes of the IRS and utilize the NCUVTA to avoid the pre-petition transfers to the debtors and (ii) whether the trustee could utilize the longer look-back period under the IRC.

Among other arguments, the defendants argued that the trustee did not have the power to bring avoidance actions grounded in tax evasion claims that are only available to the United States outside of bankruptcy and that the trustee could not take advantage of the longer look-back period. The court concluded that the majority view is that the plain language of Section 544(b)(1) allows the trustee to step into the shoes of the IRS. The court refused to look past the plain language of the statute, concluding that when the statutory language is clear, the court must simply “apply the plain language.”

Citing an Idaho bankruptcy court decision, the court stated that to find in favor of the defendants would leave both the trustee and the IRS without the right to avoid the transfers. If the defendants’ view prevailed, the IRS could not pursue its right to recover the transfers in bankruptcy, and the trustee would be too late under the NCUVTA to pursue the transfers. Accordingly, the court found that the trustee could step into the shoes of the IRS and invoke applicable law that the IRS could use outside of bankruptcy to avoid the transfers. Since the IRS could have used both the NCUVTA and the IRC outside of bankruptcy, the trustee was permitted to utilize the longer look-back period.

Why This Case Is Interesting

The Bankruptcy Code permits a trustee to avoid certain pre-petition fraudulent or preferential transfers under state law, which typically have a four-to-six-year statute of limitations. Courts are split on whether a trustee may utilize the IRS’ extended look-back period of 10 years. With this decision, the Bankruptcy Court for the Western District of North Carolina sided with what it characterized as the majority view in holding that a trustee can use the extended IRS period. Bankruptcy trustees should be cognizant that they may be able to take advantage of the IRS’ longer look-back period to reach transfers that they otherwise could not reach under typical state law.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Kramer Levin Naftalis & Frankel LLP | Attorney Advertising

Written by:

Kramer Levin Naftalis & Frankel LLP
Contact
more
less

Kramer Levin Naftalis & Frankel LLP on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.