North Carolina Bankruptcy Court Allows Trustee to Avail Look-Back Period under IRS for Avoidance of Transfers

The U.S. Bankruptcy Code provides for certain avoidance powers to trustees, which a trustee can avail to avoid fraudulent transfers. With respect to the avoidance powers, the Bankruptcy Court for the Western District of North Carolina delivered an interesting judgment. The Court in Mitchell v. Zagaroli (In re Zagaroli)[1] held that a Chapter 7 trustee could step into the shoes of the Internal Revenue Services (IRS) and utilize its longer look-back period, in order to avoid fraudulent transfers.

The debtor, Peter Zagaroli, an individual, filed for Chapter 7 bankruptcy before the North Carolina Bankruptcy Court in 2018. Thereby, the IRS filed a proof of claim for around $4,200.00. During the proceedings, the trustee discovered that in the year 2010 and thereafter in 2011, the defendant transferred several parcels of his land to the defendants, parents of the debtor, without any consideration, even though the debtor was insolvent. Thereafter, in 2020, the trustee filed an adversary proceeding in order to avoid the property transfers to the defendants. In response, the defendants filed a motion to dismiss, arguing that the trustee did not have the power to avoid the transfers of real property. Section 544 (b) (1)[2] of the Code provides the trustee with avoidance powers in order to avoid “any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable” by creditor under applicable law. Further, the statute of limitation under the North Carolina Uniform Voidable Transactions Act (NCUVTA) (the applicable law in this case), is four years. However, the IRS is exempt from the NCUVTA’s statute of limitations. And under the Internal Revenue Code (IRC), the law allows a ten-year look-back period to avoid transfers. Considering the facts and arguments presented in the case, the Court formulated two issues to adjudge upon. The issues were, a) whether Section 544(b) allows a trustee to step into the shoes of IRS and use the NCUVTA in order to avoid the pre-petition transfers of real property made by the debtor, and b) whether the trustee can take the resort of the longer look-back period under the IRC.  

The defendants argued that the trustee did not have the power to avoid the transfers grounded in tax evasion claims, that are only available with the United States outside of bankruptcy, and therefore, the trustee could not take the advantage of the longer look-back period. However, denying the arguments put forth by the defendants, the Court dismissed the defendant’s motion to dismiss. It held that the plain language of Section 544(b) (1) reads as a provision allowing the trustee to step into the shoe of the IRS. It further stated that, if ruled in favor of the defendants, it would devoid the trustee and IRS from the right to avoid the transfers. Further, the IRS would not be able to pursue its right to recover the transfers in bankruptcy and also, the trustee would be too late as per NCUVTA to avoid the transfers. Such a circumstance would obviously be unfair to the creditors. Therefore, the Court concluded that the trustee could step into the shoes of the IRS and invoke the applicable law which states that the IRS could use outside of bankruptcy to avoid the transfers. Therefore, the trustee was allowed to resort to the longer look-back period.

Vide the above-discussed judgment, the Court has resolved the ongoing issue of whether a trustee can utilize the extended look-back period of 10 years available under IRC. This is to allow the trustees to avail their avoidance power to avoid pre-petition fraudulent or preferential transfers, even though the transfers have exceeded the statute of limitation under the applicable law.  

[1] 18-50508 (Bankr. W.D.N.C. Nov. 3, 2020)

[2] 11 U.S.C. § 544(b)

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