Can U.S. Government Be Sued For Receipt of Fraudulent Transfer?

Here’s is an interesting case where a bankruptcy trustee sued the U.S. government for their receipt of a fraudulent transfer. Within two years of filing bankruptcy a company, taxable as an S-Corp, paid the IRS money to satisfy their owners’ tax liability attributable to company income. The bankruptcy trustee argued that these tax liability payments were fraudulent transfers, and he sued to U.S. government to recover the money received by the IRS.

The government’s first argument was that it had sovereign immunity against a claim to recover a fraudulent transfer made by a bankruptcy debtor. The issue involved technical interpretations of §§ 106(a)(1) and 544(b) of the Bankruptcy Code. The court found that sovereign immunity did not prevent the trustee from bringing a state law cause of action for fraudulent transfer against the U.S. government.

The government also argued that the company’s income tax payments are not fraudulent transfers under state law because they made on behalf of a third-party (individual debtors) and were in good faith by the IRS. The court said the “good faith” defense does not bar the action under statutes for “constructive fraudulent transfer” because constructive fraud is presumed when there is a lack reasonably equivalent value in exchange for the transfer and the transfer rendered the debtor unable to pay its debts as they became due. Fraudulent intent need not be proven to assert constructive fraud where the transfers render the debtor insolvent.

Page last updated on May 22, 2020

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