Bankruptcy Court Permits Chapter 7 Trustee to Utilize IRS’ Look-Back Period in Seeking to Avoid Fraudulent Transfers | Kramer Levin Naftalis & Frankel LLP
In its recent decision in Mitchell v. Zagaroli, Adv. Pro. No. 20-05000, 2020 WL 6495156 (Bankr. WDNC November 3, 2020), the Bankruptcy Court for the Western District of North Carolina ruled that the Chapter 7 trustee could step into the shoes of the IRS and use the ‘IRS longer. look-back period to avoid fraudulent transfers.
Individual Peter Zagaroli filed for Chapter 7 bankruptcy relief in North Carolina bankruptcy court in 2018. The IRS filed proof of claim for approximately $ 4,200. In 2020, the Chapter 7 trustee filed adversarial proceedings to avoid certain transfers of real estate to the defendants, the parents of the debtor. The trustee alleged that in 2010 and again in 2011, the debtor transferred several plots of land to the defendants for no consideration while he was insolvent.
The defendants filed a motion to dismiss, claiming that the trustee could not avoid transfers of real estate. By way of information, Article 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 contracted by the debtor which 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 statute of limitations. Under the Internal Revenue Code (IRC), there is a 10-year look-back period to avoid transfers. Thus, the issues before the court were (i) whether 11 USC § 544 (b) allows the trustee to step into the shoes of the IRS and use the NCUVTA to avoid pre-petition transfers to debtors and (ii) whether the trustee could use the longer look-back period provided by the IRC.
Among other arguments, the defendants argued that the trustee did not have the power to bring avoidance actions based on allegations of tax evasion which are only available in the United States outside of bankruptcy and that the trustee could not take advantage of the longer period of retrospection. . 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 beyond the plain language of the law, concluding that when the language of the law is clear, the court should simply “apply the plain language”.
Citing an Idaho bankruptcy court ruling, the court said ruling in favor of the defendants would leave both the trustee and the IRS without the right to avoid transfers. If the defendants’ view prevailed, the IRS could not exercise its right to recover transfers in bankruptcy, and the trustee would be too late under the NCUVTA to pursue the transfers. As a result, the court concluded 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 transfers. Since the IRS could have used both the NCUVTA and the IRC outside of the bankruptcy, the trustee was allowed to use the longer lookback period.
Why this case is interesting
The Bankruptcy Code allows a trustee to avoid certain fraudulent or preferential pre-petition transfers under state law, which typically have a limitation period of four to six years. Courts are divided over whether a trustee can use the IRS’s 10-year extended look-back period. With the ruling, the West District of North Carolina bankruptcy court sided with what it called a majority view in ruling that a trustee can use the IRS’s extended period. Bankruptcy trustees should be aware that they may be able to take advantage of the IRS’s longer look-back period to achieve transfers that they might not otherwise be able to achieve under typical state law.