Tenth Circuit Holds that Sovereign Immunity Does Not Limit Section 544 Claim

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Section 544(b)(1) of the Bankruptcy Code enables a trustee to step into the shoes of a creditor and avoid a transfer “of an interest of the debtor in property” that an unsecured creditor could avoid under applicable state law. See 11 U.S.C. § 544(b)(1). Thus, for example, if outside of bankruptcy a creditor could avoid a transaction entered by a debtor as a fraudulent transfer, in bankruptcy, the trustee acquires the power to avoid such a transaction.

This principle raises special questions in the context of government entities. Outside of bankruptcy, sovereign immunity bars many suits against the government, including suits seeking to avoid a fraudulent transfer. It might thus seem that the federal government is also immune from an action under section 544(b)(1), because an unsecured creditor could not avoid a transfer to the government under applicable state law. But there is another wrinkle: section 106(a)(1) of the Code abrogates sovereign immunity for any “governmental unit” as to an extensive list of Code sections, including section 544. So is a fraudulent transfer claim under section 544 against the government barred because a creditor’s suit under applicable state law would be barred by sovereign immunity? Or is it permitted, given the express sovereign immunity waiver as to section 544 suits in section 106? There is a split among the U.S. courts of appeals on this question. The latest entry in this disagreement comes from the Tenth Circuit, which recently held, in Miller v. United States, No. 21-4135 (10th Cir. Jun. 27, 2023), that such claims may be brought against the government.

The decision arose out of a converted chapter 7 bankruptcy filed in 2017. In 2014, the debtor paid the personal tax debts of two of its principals, totaling $145,138.78. The chapter 7 trustee (the “Trustee”) sued the United States (the “Government”) to avoid these transfers under section 544(b), arguing that they were fraudulent transfers under Utah’s Uniform Fraudulent Transfer Act. The Government did not contest that the transfers qualified as fraudulent transfers under Utah law. However, the Government argued that, outside of bankruptcy, a creditor could not avoid the transfers because sovereign immunity would bar the suit. Thus, the Government argued, the action could not be brought under section 544(b)(1) either. The Trustee, in turn, did not contest that sovereign immunity would bar a creditor suit outside of bankruptcy, but argued that a section 544(b)(1) claim could nonetheless be brought based on the sovereign immunity waiver in section 106(a)(1). The bankruptcy court ruled for the Trustee, relying on section 106, and the district court affirmed. The Government appealed.

The Tenth Circuit ruled for the Trustee. The court’s decision focused on the text of section 106(a)(1). Section 106(a)(1) provides that sovereign immunity is “abrogated” “with respect to” the enumerated sections, including section 544. Characterizing “with respect to” as synonymous with “respecting,” the Tenth Circuit relied on Lamar, Archer & Cofrin, LLP v. Appling, 138 S. Ct. 1752, 1760 (2018), which broadly interpreted “respecting” to mean that a provision “covers not only its subject but also matters relating to that subject.” Given this broad meaning, the Tenth Circuit reasoned that section 106(a)(1) abolished the Government’s sovereign immunity defense to the Utah state law claim insofar as brought under section 544(b)(1). The Tenth Circuit also invoked section 106(a)(2), which provides that a court “may hear and determine any issue arising with respect to the application of such sections to governmental units.” This provision, the Tenth Circuit explained, showed that Congress presumed that a court would have subject-matter jurisdiction over a section 544 claim involving a governmental unit. But sovereign immunity deprives a court of subject-matter jurisdiction, so Congress must have intended that sovereign immunity would not apply.

The Tenth Circuit acknowledged that the Seventh Circuit had come to a different conclusion in In re Equipment Acquisition Resources, Inc., 742 F.3d 743 (7th Cir. 2014). The court was critical of the Seventh Circuit’s ruling, saying that it failed to meaningfully address the textual scope of section 106(a)(1). Instead, the Tenth Circuit embraced the approach of the Ninth Circuit in In re DBSI, Inc., 869 F.3d 1004 (9th Cir. 2017), which similarly held that section 106(a)(1) operated to permit a section 544(b)(1) suit even where sovereign immunity would bar the underlying state-law claim outside of bankruptcy. The Tenth Circuit noted two additional arguments made by the Ninth Circuit: that Congress had enacted section 106(a)(1)’s sovereign immunity waiver with knowledge that section 544(b)(1) incorporated state law, and that the Government’s reading would make section 106(a)(1)’s waiver of sovereign immunity largely meaningless as to section 544(b)(1) because it would only allow a section 544(b)(1) claim against the Government where there was a separate waiver of sovereign immunity as to the underlying state-law claim.

The Tenth Circuit proceeded to briefly address and reject the Government’s argument that the Internal Revenue Code impliedly preempted the Trustee’s cause of action. The Tenth Circuit held that if Congress had intended section 544 to give way to federal tax interests, it could have expressly excluded federal tax collection from section 544. As such, the Tenth Circuit affirmed the district court.

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.

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