Existence of Unpaid Tax Claim in Bankruptcy Opens the Door to Expanded Statute of Limitations on Fraudulent Conveyances

In bankruptcy proceedings, if the bankruptcy trustee seeks to gain access to assets that the debtor transferred prior to bankruptcy under fraudulent conveyance law, the trustee must act within the applicable state fraudulent conveyance law statute of limitations. For example, in Florida, this would mean transfers occurring more than 4 years prior to the bankruptcy could not be challenged by the trustee.

A recent Bankruptcy Court case demonstrates a large loophole in this limitation, In that case, the debtor owed a substantial sum to the IRS. Section 544(b) of the Bankruptcy Code provides that:

the 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.

What this means for the benefit of those who do not deal much with bankruptcy is that if the debtor owes money to a creditor for an unsecured claim, and the statute of limitations on collection for that claim has not yet expired, the bankruptcy trustee can effectively step into the shoes of the creditor and seek to collect on that claim using the statute of limitations that the creditor could use. Since the IRS generally has 10 years to collect on a tax assessment under Code §6502(a)(1), a statute of limitations far longer than most state statutes involving fraudulent conveyances, the issue in the recent case was whether the bankruptcy trustee could avail himself of the 10 year statute of limitations instead of the 4 years allowable under state law to proceed on a fraudulent conveyance claim. The bankruptcy court held the extended 10 year statute applied, noting that most of the other bankruptcy courts that have taken on the issue have similarly ruled for the extended statute.

The court noted that this use of Section 544(b) has not been widely availed of. It did note that “[the IRS is a creditor in a significant percentage of bankruptcy cases. . . If so, widespread use of § 544(b) to avoid state statutes of limitations may occur and this would be a major change in existing practice.”

For debtors with this issue, consideration should be given to paying the IRS before bankruptcy (without running afoul of applicable voidable payment rules), if that is a viable option.

Thanks to Elizabeth Bowers for reporting on this case at the recent RPPTL Florida Bar meeting (Asset Protection Committee).

In re Kipnis, ---- B.R. ----, 2016 WL 4543772, 118 A.F.T.R.2d 2016-5639 (S.D. Fla. 2016)