United States v. Equip. Acquisition Res., Inc. (In re Equip. Acquisition Res., Inc.)

• Decision Date: 04 January 2013
• Docket Number: Adversary No. 10–00099.,Bankruptcy No. 09 B 39937.,No. 11 C 05045.,11 C 05045.
• Citation: 485 B.R. 586
• Parties: In re EQUIPMENT ACQUISITION RESOURCES, INC., Debtor. United States of America, Appellant, v. Equipment Acquisition Resources, Inc., Appellee.
• Court: U.S. District Court — Northern District of Illinois

485 B.R. 586

In re EQUIPMENT ACQUISITION RESOURCES, INC., Debtor.United States of America, Appellant,

v.Equipment Acquisition Resources, Inc., Appellee.

Bankruptcy No. 09 B 39937.

Adversary No. 10–00099.

No. 11 C 05045.

United States District Court,

N.D. Illinois,

Eastern Division.

Jan. 4, 2013.

George P. Apostolides, Konstantinos Armiros, Barry A. Chatz, Robert E. McKenzie, Kevin H. Morse, Arnstein & Lehr LLP, Chicago, IL, Allan B. Diamond, Diamond McCarthy LLP, Houston, TX, Miriam R. Stein, Chuhak & Tecson, P.C., Chicago, IL, for Debtor.

Richard C. Friedman, Wilmette, IL, for U.S. Trustee Patrick S. Layng.

Memorandum Opinion and Order

EDMOND E. CHANG, District Judge.

Equipment Acquisition Resources went bankrupt and eventually filed, in an adversary proceeding in bankruptcy, a first amended complaint seeking recovery of money that the company made to cover tax liabilities of its shareholders. The United States of America, on behalf of the Internal Revenue Service, moved to dismiss one of the counts (Count 4) that sought recovery of the money, arguing that sovereign immunity barred the claim. Fed.R.Civ.P. 12(b)(1).¹ R. 1. The bankruptcy court denied the Government's motion to dismiss. R. 12–2. For the reasons stated below, the Court affirms the bankruptcy court's decision.

I. Background

Equipment Acquisition Resources (EAR) was an Illinois corporation that sold and serviced semiconductor-manufacturing equipment. R. 12 (Appellee Br.) at 3. ²EAR was a subchapter S corporation, meaning that the company itself was not subject to income taxation; instead, tax on the company's income or loss was passed through to the shareholders on a pro rata basis. Id. Beginning in at least 2005, Sheldon Player, one of EAR's shareholders, used company assets to perpetrate a “massive fraud.” Id. The fraud was uncovered in 2009, and all of EAR's officers and directors resigned. Id.; R. 12–2, Appellee's Exh. A (Bankr. Op.) at 4. EAR's shareholders elected William A. Brandt, Jr. as EAR's Chief Restructuring Officer and sole member of the company's board of directors. Bankr. Op. at 4–5. Shortly thereafter, in October 2009, Brandt filed a voluntary petition for relief on behalf of EAR under Chapter 11 of the Bankruptcy Code. R. 7–3 (Appellant Br.) at 4.

Between October 2007 and December 2008, EAR made nine payments on behalf of three shareholders, totaling $4,737,261.36, to cover the shareholders' individual pass-through federal tax liabilities. Appellee Br. at 3–4; R. 12–3, Appellee's Exh. B (First Am. Compl.) ¶ 11. In January 2010, EAR, as debtor-in-possession with the powers of a trustee under 11 U.S.C. § 1107, filed a two-count adversary complaint against the United States seeking to recover these tax payments. R. 12–4, Appellee's Exh. C (Compl.). In general, the complaint characterized all nine transactions from EAR to the IRS as “fraudulent transfers” recoverable under §§ 544(b), 548, and 550. Id.

Eight of the nine payments EAR made on behalf of its shareholders occurred within the two years before the Chapter 11 bankruptcy filing. Id. ¶ 10. Accordingly, in Count 1 of EAR's initial complaint, the trustee sought to recover these payments under sections 548(a)(1)(B) and 550 of the Bankruptcy Code. Id. ¶¶ 12–15. The ninth payment, however, occurred outside of this two-year period. Compl. ¶ 10. Count 2 of EAR's complaint sought to recover this payment pursuant to § 544(b). Id. ¶¶ 16–20.

In December 2010, EAR amended its complaint to add counts against the individual officers and shareholders whose tax liabilities were paid by EAR. First Am. Compl. Count 2 of the original complaint, seeking avoidance and recovery of all nine tax payments pursuant to § 544(b) of the Bankruptcy Code, is now labeled as Count 4 in the amended complaint. Id. ¶¶ 17–21. In its amended answer filed in January 2011, the government asserted ten defenses, the second of which states:

Count IV of the first amended adversary complaint is barred by the sovereign immunity of the United States of America for two reasons. First, a creditor holding an unsecured claim of the kind described in 11 U.S.C. § 544(b) could not avoid a fraudulent transfer to the United States under applicable non-bankruptcy law under similar circumstances. Second, under state law, the creditor of a debtor who fraudulently transfers money to the creditor of a relative or an affiliate in payment of the relative's or affiliate's debt to such creditor, where the creditor is aware of the fraud, cannot recover from the creditor of the relative or the affiliate. Since the IRS was without knowledge of the fraud when it accepted payment by the debtor for the tax debts of the Third–Party Defendants, there is no waiver of sovereign immunity for a state-law fraudulent transfer action against the United States. While § 544 is listed in § 106(a)(1), the statutory waiver of sovereignimmunity must be strictly construed with all ambiguities resolved in favor of immunity.

Bankr. Op. at 5 (emphasis in original).

The bankruptcy court dismissed all counts against the individual taxpayers and approved a settlement agreement reached by the parties in February 2011. Id. The settlement agreement resolved all claims pertaining to the eight transfers made between October 23, 2007 and October 23, 2009—the date Brandt filed the bankruptcy petition. Id. Additionally, the settlement agreement included a conditional settlement of EAR's § 544(b) claim pertaining to the transfer made outside the two-year period (Count 4). Appellant Br. at 5. For this claim, the government agreed to disgorge 37.5% of the $2,324,288 payment unless it prevails on its second asserted defense. ³Id. Shortly after the agreement was finalized, the government filed its motion to dismiss Count 4 pursuant to Federal Rules of Civil Procedure 12(b)(1) and 12(c). Id. at 6.

The government's motion to dismiss asserted three arguments. First, it contended that, although § 106(a)(1) lists § 544 as a provision for which sovereign immunity is abrogated, EAR's claim fails because no unsecured creditor could bring a § 544 claim outside of bankruptcy. Id. Second, the government argued that even if EAR may bring a § 544 claim against the IRS, § 7422 of the Internal Revenue Code suggests that the claim must be filed within two years of the petition date. Id. Lastly, the government asserted that the Illinois Uniform Fraudulent Transfer Act does not enable a creditor of a fraudulent transferor to impose liability on an innocent transferee (here, the IRS) that received a voluntary payment by the transferor in satisfaction of an antecedent debt of a related party (here, EAR's shareholders) with nothing to indicate the payment was actually fraudulent (meaning, an actual intent to defraud). Appellant Br. at 6–7.

In June 2011, the bankruptcy court issued an order denying the government's motion to dismiss Count 4. Bankr. Op. In its memorandum opinion, the bankruptcy court focused on the government's first argument. The bankruptcy court first addressed the “proper interpretation of § 106(a)(1) and the interplay of that provision with § 544(b)(1).” Bankr. Op. at 8. The bankruptcy court held that § 106(a)(1)'s plain language, which used the terms “immunity,” “sovereign immunity,” and “abrogate,” “clearly and unambiguously communicate congressional intent to abolish the government's immunity from being sued in bankruptcy causes of action pursuant to the fifty-nine statutory provisions listed under § 106(a)(1).” Id. at 9. The bankruptcy court rejected the government's argument that “sovereign immunity bars [EAR's] claim under [§ 544(b) ] because Illinois law does not allow an unsecured creditor to maintain a fraudulent transfer action against the United States.” Id. at 10. Based on In re C.F. Foods, L.P., 265 B.R. 71, 74 (Bankr.E.D.Pa.2001), the bankruptcy court concluded that “Congress intended to include those state law causes of action available under § 544(b)(1).” Id. at 11. Additionally, the bankruptcy court rejected the government's remaining arguments because the government could not meet its “ ‘exceptionally heavy’ burden of persuasion” where a party advances “an interpretation contrary to the plain meaning of the statute.” Bankr. Op. at 14 (quoting Patterson v. Shumate, 504 U.S. 753, 760, 112 S.Ct. 2242, 119 L.Ed.2d 519 (1992)).

The bankruptcy court also rejected the government's “last-ditch effort” to convince the court that §§ 7422 and 7426 of the Internal Revenue Code support the government's position that Count 4 must be dismissed. Id. at 13. The bankruptcy court refused to “speculate as to what Congress likely or unlikely envisioned” with the interplay of § 544(b) and §§ 7422 and 7426. Id. Finally, the bankruptcy court did not address the government's third argument pertaining to the Illinois Uniform Fraudulent Transfer Act, 740 ILCS 160/9.

II. Standard of Review

A federal district court has jurisdiction, pursuant to 28 U.S.C. § 158(a), to hear appeals from the rulings of a bankruptcy court. On appeal, the district court reviews the factual findings of the bankruptcy court under the clearly erroneous standard and reviews the bankruptcy court's legal findings under the de novo standard. Wiese v. Cmty. Bank of Cent. Wis., 552 F.3d 584, 588 (7th Cir.2009). Because this appeal only challenges the bankruptcy court's legal findings, the Court's review is de novo.

III. Analysis

On appeal, the government claims that the bankruptcy court erred by rejecting all three of the arguments presented in its motion to dismiss. Accordingly, the government seeks to vacate the bankruptcy court's order requiring it to disgorge 37.5% of the transfer made on October 21, 2007 pursuant to the settlement agreement. Because the Court disagrees with each of the government's arguments, the bankruptcy court's order is affirmed.

A. Sovereign Immunity against Fraudulent Transfer Claims

The government's first—and most important—argument is that § 106(a)(1) does not waive sovereign...