Fraudulent Transfer Law and Sovereign Immunity: An Actual Abuse of Federalism?

After All Resort Group filed for bankruptcy, David Miller, its appointed trustee, sought to claw back tax payments the company had made on behalf of two of its principals to the IRS by arguing the payments constituted fraudulent transfers. Unlike a typical clawback action, however, the trustee brought this proceeding under Section 544(b), rather than the more common fraudulent transfer provision, Section 548, because § 544(b) permits the trustee to rely on state fraudulent transfer law—which has longer statutes of limitations than the federal fraudulent transfer provision. The Government challenged this action, arguing that recovery from the IRS was barred by sovereign immunity. The United States Bankruptcy Court for the District of Utah rejected this view, finding that the plain text of § 106(a)(1) of the Bankruptcy Code, which waives sovereign immunity for fifty-nine sections of the Code, including 544, unequivocally abrogates sovereign immunity as to the underlying Utah state law cause of action. On appeal, the Tenth Circuit affirmed, holding that the language of § 106(a), which abrogates sovereign immunity "with respect to" Section 544, was intended to be broad enough to encompass applicable state law. The Court should reverse, as an actual creditor who sought to avoid the transfer in question would be prohibited from doing so outside of bankruptcy. To affirm the Appellate Court's holding would allow a trustee in bankruptcy to exploit a favorable state law—here, a longer statute of limitations—thereby circumventing federal law. In doing so, the Court risks undermining the nation's delicate system of structural federalism.