Business Restructuring Review

Delaware Bankruptcy Court Rejects Use of Tax Code Look-Back Period in Avoidance Action

The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to avoid fraudulent transfers is an important tool to promote 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 applicable state law by stepping into the shoes of a "triggering" or "predicate" creditor plaintiff.

Thus, 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. Moreover, a majority of courts have concluded that a trustee or DIP can expand the look-back period even more if the trustee or DIP can use section 544(b) to step into the shoes of the Internal Revenue Service ("IRS"), which is bound not by state law but by the 10-year statute of limitations for collecting taxes specified in the Internal Revenue Code ("IRC"), or other government entities subject to laws providing for longer look-back periods.

The U.S. Bankruptcy Court for the District of Delaware recently weighed in on this issue in In re J&M Sales Inc., 2022 WL 532721 (Bankr. D. Del. Feb. 22, 2022). The court denied a chapter 7 trustee's motion to amend his complaint in an avoidance action to use the IRS as a "predicate" or "triggering" creditor because the IRS had not filed a proof of claim in the bankruptcy case and the existence of a prepetition payroll tax debt, which was paid pursuant to a "first day motion," was insufficient to treat the IRS as a creditor.

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)(1). 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., In re Musselwhite, 2021 WL 4342902 (Bankr. E.D.N.C. Sept. 23, 2021); In re Webster, 629 B.R. 654 (Bankr. N.D. Ga. 2021); Mitchell v. Zagaroli (In re Zagaroli), 2020 WL 6495156 (Bankr. W.D.N.C. Nov. 3, 2020); 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.

The court in Vaughan, however, ruled to the contrary. 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." Id. at 883.

However, the Kipnis 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." Id.

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. Moreover, 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. Finally, section 1111(a) provides that, in a chapter 11 case, "[a] proof of claim or interest is deemed filed under section 501 of this title …, except a claim or interest that is scheduled 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 J.R. Deans Co., Inc., 249 B.R. 121, 131 (Bankr. D.S.C. 2000) (a chapter 7 trustee could not step into the shoes of asbestos claimants for purposes of avoidance litigation because no asbestos claimant filed a proof of claim and had an allowable claim under section 544(b)); 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).").

In the same vein, other courts have concluded that an entity qualifies as a triggering creditor under section 544(b) because it has filed a proof of claim (formal or informal), no objection was filed to the claim, or the objection was withdrawn. See, e.g., In re Davis, 2016 WL 11696269, *4 (Bankr. W.D. Tenn. June 15, 2016) ("creditors who have filed proofs of unsecured claims satisfy the requirements of section 544(b)" in order to give the chapter 7 trustee standing to pursue those claims); In re Rosenblum, 545 B.R. 846, 859-60 (Bankr. E.D. Pa. 2016) (finding that because a creditor filed an informal proof of claim in a chapter 13 case, it met the requirement for an allowable claim under 544(b)); In re All-Type Printing, 274 B.R. 316, 323 (Bankr. D. Conn. 2002) ("Because the only objection to the [applicable] Proof of Claim was withdrawn prior to trial of this [chapter 7] adversary proceeding, that Proof of Claim is deemed allowed, and is therefore 'allowable' under Code Section 502, as is required by Section 544(b)."); In re Richardson, 268 B.R. 331, 334 (Bankr. D. Conn. 2001) ("Because no objections to the qualifying claims have yet been filed [in the chapter 7 case], they are deemed allowed, and therefore are 'allowable' under Code Section 502, as required by Section 544(b).").

However, the majority approach is that the allowability of a claim for purposes of section 544(b) should be determined as of the petition date and, therefore, 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 J&M Sales, the bankruptcy court considered whether a chapter 7 trustee could step into the shoes of the IRS for purposes of section 544(b).

J&M Sales

California-based discount retailer J&M Sales Inc. and various affiliates (collectively, the "debtors") filed for chapter 11 protection on August 6, 2018, in the District of Delaware. The IRS did not file a proof of claim in the chapter 11 cases, nor did the debtors schedule a claim on behalf of the IRS. However, the debtors did owe certain payroll taxes as of the petition date, which they obtained court authority to pay under a "first day" order. 

After the bankruptcy court authorized the debtors to sell substantially all of their assets, the court converted the chapter 11 cases to chapter 7 liquidations. Beginning in July 2020, the chapter 7 trustee filed complaints against hundreds of individuals and entities seeking, among other things, to avoid and recover allegedly fraudulent transfers under Delaware law and sections 544(b) and 550 of the Bankruptcy Code. 

In his complaints, the trustee alleged that the debtors had at least one general unsecured creditor holding an allowable claim who, but for the bankruptcy filing, would have standing to bring claims to avoid and recover the fraudulent transfers. He also alleged that, in addition to those predicate creditors, various state and local government creditors (including taxing authorities) qualified as predicate creditors and were not subject to state-law statutes of limitations.

Certain transferees (collectively, the "defendants") moved to dismiss, claiming that the four-year look-back period under Delaware fraudulent transfer law expired before the trustee filed his complaint against them (the "complaint"). The bankruptcy court agreed and dismissed with prejudice as time-barred all fraudulent transfer claims stated in the complaint for transfers made prior to August 6, 2014 (four years before the petition date). In so ruling, the court rejected the trustee's argument that, because there were state and local government triggering creditors that could invoke the doctrine of nullum tempus, he could step into their shoes to avoid application of the Delaware statute of limitations. The court reasoned that, "because [Delaware fraudulent transfer law] specifically applies to government entities, nullum tempus did not apply and the claims were time barred." However, the court did not address whether federal governmental entities could act as predicate creditors because the trustee did not allege that any existed in his complaint.

The trustee then moved for leave to amend his complaint to add the IRS as a triggering creditor. The trustee acknowledged that the IRS had not filed a proof of claim and that the debtors had not scheduled any claim by the IRS. Nevertheless, the trustee relied on the first-day order authorizing the payment of prepetition payroll taxes, arguing that he could utilize that (now paid) prepetition claim to step into the shoes of the IRS and avoid the Delaware four-year statutory look-back period.

The defendants opposed the motion, arguing that, because section 544(b) expressly refers to section 502, a creditor must either file a proof of claim or be excused from doing so under section 1111(a) to have an "allowable" claim. As the IRS did not satisfy either of these conditions, they contended, the IRS could not act as a predicate creditor. 

The Bankruptcy Court's Ruling

The bankruptcy court denied the motion for leave to amend, ruling that amendment of the complaint would be futile because the IRS could not act as a triggering creditor under section 544(b). U.S. Bankruptcy Judge John T. Dorsey agreed with the defendants that a creditor must have filed a proof of claim to qualify as a predicate creditor for the purpose of avoidance litigation under section 544(b).

Examining the language of sections 544(b) and 502, Judge Dorsey wrote, "[i]t is not difficult to conclude that … Congress intended that for a trustee to pursue potential fraudulent transfers under Section 544(b) an allowable claim only includes those claims for which a proof of claim has been filed." J&M Sales, 2022 WL 532721, at *3. Significantly, he explained, section 502(b)(9) of the Bankruptcy Code prohibits a bankruptcy court from determining the validity and amount of a claim where "proof of such claim is not timely filed, except to the extent tardily filed as permitted under paragraph (1), (2), or (3) of section 726(a)." Thus, Judge Dorsey reasoned, "if no proof of claim is filed, it is not an allowable claim under Section 502." Id.

Judge Dorsey rejected the trustee's argument that requiring the filing of a proof of claim would interfere with a trustee's ability to gather and administer the bankruptcy estate for the benefit of all creditors "because of potential manipulation of the claims process by parties in interest." Id. According to Judge Dorsey, this argument is based on the misconception that only the creditor asserting a claim can file a proof of claim. Section 501(c), he explained, provides that the debtor or the trustee may file a proof of claim if a creditor fails to timely do so.

Finally, Judge Dorsey noted that he was troubled by the trustee's argument that he could rely on unpaid payroll taxes, which accrue as wages are paid, but are not due to the IRS until sometime later depending on the employer's filing status, as a basis to use the IRC's 10-year look-back period for avoidance actions. If this were permitted, he wrote, because virtually every business will have accrued but unpaid payroll taxes when it files for bankruptcy, "every business bankruptcy case would automatically have a ten-year lookback period for fraudulent transfers under Section 544(b) … [which] cannot be what Congress had in mind." Id. at *3 n.7. 


The J&M Sales court's endorsement of the minority approach on the availability of a longer look-back period in cases in which the IRS is a creditor is notable. Even so, limiting predicate creditors for purposes of avoidance litigation to those who have either filed a proof of claim or had one filed for them may not drastically undermine a bankruptcy trustee's ability to bring avoidance actions under section 544(b) with the benefit of longer look-back periods than those provided for under state fraudulent transfer laws. It does place the burden on trustees to ensure that a proof of claim has been timely filed by or on behalf of a potential triggering creditor.

It should be noted that 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 § 544(b) and the Illinois UFTA); In re G-I Holdings, Inc., 313 B.R. 612, 636 (Bankr. D.N.J. 2004) (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 § 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.

A version of this article was published in Lexis Practical Guidance. It appears here by permission.


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