In 2014, the U.S. Court of Appeals for the Seventh Circuit confronted, for the first time, the issue of whether a bankruptcy trustee can claw back assets that a bankrupt debtor fraudulently transferred to the federal government. Generally, government entities are immune to suit due to sovereign immunity, but the Bankruptcy Code abrogates federal sovereign immunity as to a number of Code provisions. One such provision is Section 544(b), often referred to as the source of the bankruptcy trustee's "strong-arm" powers. The strong-arm powers allow trustees to avoid transfers that would be fraudulent and voidable under state law. However, these powers are subject to the limitation that there must actually be some creditor of the debtor who has standing outside of bankruptcy to invoke state law and avoid the transfer at issue.
The Seventh Circuit held that because any state law creditor would be barred by sovereign immunity from recovering assets from the IRS outside of bankruptcy court, the trustee is also barred inside bankruptcy court, in spite of the Bankruptcy Code's explicit abrogation of sovereign immunity. This counterintuitive holding parts ways with every other court to have considered this issue. The Seventh Circuit reasoned that it was simply relying on the plain meaning of the relevant Code provisions, but so did prior courts—and they nonetheless reached an opposite result. This article argues that the Seventh Circuit's plain meaning approach creates ambiguity and renders the Code partly meaningless. Why would Congress abrogate sovereign immunity as to a section of the Code, knowing that the abrogation would have no effect? The Seventh Circuit's approach also fails to give credence to Congress' intent and the purpose of the Code provisions when viewed holistically. The Seventh Circuit's decision should therefore be overruled, and not followed by other circuits.
Paul T. Geske,
Seventh Circuit Holds That Bankruptcy Trustee's "Strong-Arm" Powers Not Strong Enough for the IRS,
Seventh Circuit Rev.
Available at: https://scholarship.kentlaw.iit.edu/seventhcircuitreview/vol10/iss1/2
Additional FilesSeventhCircuitHoldsBankruptcyTrusteesStrongArm.mp3 (9535 kB)