Richard Cook v. United States

Citation: Not availableDocket: 20-1685

Court: Court of Appeals for the Fourth Circuit; March 7, 2022; Federal Appellate Court

Original Court Document: View Document

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The United States Court of Appeals for the Fourth Circuit addressed an appeal regarding the Yahweh Center, Inc., which had filed for Chapter 11 bankruptcy in 2016. Richard P. Cook, the appointed plan trustee, sought to void tax penalty obligations owed to the IRS and recover associated payments, arguing that these obligations were constructively fraudulent as Yahweh Center received no "reasonably equivalent value" in exchange. The bankruptcy court dismissed Cook's claims, determining that tax penalty obligations are not subject to being voided under the Bankruptcy Code or relevant state fraudulent transfer laws. The district court affirmed this dismissal, rejecting both the claim of sovereign immunity as a barrier to the lawsuit and the theory of constructive fraud. The appellate court upheld the lower courts' decisions, concluding that tax penalties and payments related to them are not recoverable, thereby confirming the dismissal of the trustee’s claims. The case was decided by a panel of Circuit Judges, with Judge Quattlebaum authoring the opinion.

Constructive fraudulent transfers differ from actual fraudulent transfers as they do not require proof of the debtor's intent to defraud. Instead, the focus is on whether the debtor received reasonably equivalent value for the transferred property or incurred obligation. The legal questions in Cook's appeal involve whether sovereign immunity prevents bankruptcy trustees from avoiding a debtor's tax penalty obligations and recovering payments made on those penalties, and if not, whether these claims fall under the Bankruptcy Code and fraudulent transfer statutes.

Under Section 544 of the Bankruptcy Code, a Chapter 11 trustee may avoid any transfer of the debtor's property or any obligation incurred that is voidable by a creditor with an unsecured claim. Avoiding a transfer renders it null and void, effectively restoring the transferred property to the debtor and eliminating the obligation. The review process follows a standard of accepting factual allegations as true while not assuming the legal conclusions drawn from those facts.

For a transfer or obligation to be voided, it must be voidable under applicable law, which in this case is the North Carolina Uniform Voidable Transactions Act. This Act allows a creditor to void obligations if the debtor did not receive reasonably equivalent value at the time of the transfer or obligation, especially if the debtor was insolvent then or became insolvent as a result of the transaction. An unsecured creditor must demonstrate that the debtor received little or no value in exchange for the property or obligation, which harms unsecured creditors by reducing the assets available for repayment.

The Act mirrors the federal code, allowing avoidance of debt obligations if the transfer or obligation did not provide "reasonably equivalent value." The key distinction lies in the statute of limitations, with the federal law allowing two years and North Carolina's law permitting four years. If unsecured debts remain constant while asset values decrease, unsecured creditors will receive less. Additionally, incurring obligations creates further debt, which dilutes the creditors’ potential recovery. To remedy this, North Carolina law permits unsecured creditors to sue the entity that received a property transfer or to whom an obligation is owed, known as the "transferee." The bankruptcy trustee can also act on behalf of unsecured creditors, as defined by 11 U.S.C. 544(b)(1), to avoid similar transfers or obligations, benefiting the bankruptcy estate and, by extension, the creditors. Given that debtors typically cannot repay unsecured debts in full, returning previously transferred property to the estate or eliminating obligations increases asset availability for creditors. In this case, Cook claims that Yahweh Center received no "reasonably equivalent value" for tax penalties, seeking to annul these penalties and recover payments made, thereby benefiting the unsecured creditors. The government argues for dismissal based on sovereign immunity, asserting that no applicable law exists for an unsecured creditor to void a fraudulent transfer against the United States under 544(b)(1). However, the Bankruptcy Code contradicts this stance, indicating that sovereign immunity does not prevent unsecured creditors from pursuing claims under the Act.

Section 106(a) of the Bankruptcy Code abrogates sovereign immunity for governmental units to the extent specified, particularly in relation to provisions such as Section 544, the avoidance statute. Subsection (a)(2) allows courts to address issues concerning the application of these sections to governmental units. If the government files a proof of claim, as the IRS did against Yahweh Center’s property, it waives its sovereign immunity for claims related to the same transaction. This principle aligns with traditional bankruptcy law, which states that entities invoking the court's assistance must accept the court's jurisdiction.

There is a noted split among circuits regarding these issues, with the Seventh Circuit supporting the government's stance and the Ninth Circuit aligning more with Cook’s perspective. The current analysis leans towards the Ninth Circuit's conclusion, albeit with different reasoning. 

Regarding Cook's argument to void Yahweh Center's tax penalties and payments, the Circuit has not previously ruled on this matter. However, in **In re Southeast Waffles, LLC**, the Sixth Circuit rejected similar arguments, determining that tax penalty obligations are not avoidable under either the Bankruptcy Code or associated state fraudulent transfer statutes. The court emphasized that noncompensatory tax penalties, which are imposed by statute, do not constitute "exchanges" targeted by fraudulent transfer laws, as they arise by operation of law and not through contract, treating the IRS as an involuntary creditor.

Tax penalties do not fall under the obligations defined by the Act, as they do not involve a voluntary exchange between debtor and creditor. North Carolina’s Act requires an exchange for liability under N.C. Gen. Stat. 39-23.5(a), which pertains to fraudulent obligations incurred without receiving reasonably equivalent value. The Act specifies that obligations arise from oral or written agreements, which did not occur regarding IRS tax penalties. The IRS's imposition of tax penalties is mandated by law, not a choice based on a voluntary transaction, making it an involuntary creditor. Legal precedents underscore that the government must enforce tax liabilities without discretion to enter forbearance agreements. Thus, applying fraudulent transfer provisions to tax penalties misaligns with the Act’s framework, leading to the dismissal of Cook’s claims under 11 U.S.C. 544(b)(1) due to the absence of applicable law. The district court correctly dismissed Cook's challenge and his claims regarding previous payments of tax penalties, as these payments reduced the tax obligation dollar for dollar, constituting "reasonably equivalent value." However, this principle only applies to legitimate obligations; if an obligation lacks reasonably equivalent value, payments toward it could still be voidable despite reducing the obligation. The judgment of the district court is affirmed.