The U.S. Supreme Court has provided clarification on the interplay between federal bankruptcy law and state law, specifically in United States v. Miller, concerning a trustee’s ability to leverage state fraudulent transfer laws within a federal bankruptcy framework. The ruling denied the trustee’s attempt to reclaim funds based on Utah’s fraudulent transfer statute, with the notable exception of Justice Neil Gorsuch’s dissent.
In this case, a company’s shareholders misappropriated $145,000 in 2014 to settle their personal federal tax liabilities, but the U.S. government maintained its sovereign immunity, shielding itself from liability. Under Section 106 of the Bankruptcy Code, there is a limited waiver of sovereign immunity for trustee actions, aiming to align the government’s standing with other creditors. However, the funds were transferred more than two years before the bankruptcy filing, which precluded action under the federal fraudulent transfer statute.
Utah’s statute permits actions up to four years before, but the trustee must show an existing creditor who could challenge the transfer under state law. The trustee pointed to a former employee unable to collect a judgment due to the depletion of company funds. Yet, Utah law lacks provision for direct suits against the government, affirming the IRS’s stance of sovereign immunity even in bankruptcy court.
The Court held that a trustee could not extend the Bankruptcy Code’s waiver of sovereign immunity to state causes of action against the government. As such, the ruling confirmed that the government is not creating fewer remedies through bankruptcy proceedings where no state law basis for a claim exists.
Despite the inability of the trustee to sue the IRS under these conditions, the decision does not leave the trustee without options. The trustee can still pursue recovery directly from the company’s shareholders responsible for the misappropriation, although this may involve dealing with potentially less solvent parties.