The United States Bankruptcy Court for the District of Delaware (the “Court”) concluded in a February 11, 2011 memorandum opinion that Congress fully abrogated sovereign immunity for suits brought pursuant to Bankruptcy Code section 544(b)(1) that apply state law causes of action. In the case of James R. Zazzali v. Douglas L. Swenson et al. (In re DBSI, Inc.), Bankr. Case No. 10-12199 (CSS), 2011 WL 607442, (Bankr. D. Del. Feb. 11, 2011), James R. Zazzali, as trustee of the DBSI litigation trust (the “Trustee”) commenced an action seeking, among other items, to recover certain alleged fraudulent transfers from the Internal Revenue Service (“IRS”) pursuant to section 544(b))(1) applying applicable Idaho fraudulent transfer law.1
The Court first noted that in 1994, Congress revised section 106(a)(1) to provide an explicit abrogation of the sovereign immunity of the United States with respect to sixty specific sections of the Bankruptcy Code, including section 544.<2sup>2 At issue was the specific “applicable law” language of section 544(b)(1) which permits a trustee to avoid “any transfer of an interest of the debtor in property or any obligation by the debtor that is voidable under applicable law by a creditor holding an unsecured claim….”
The United States argued that the trustee could not sue the IRS under section 544 since Congress has not abrogated sovereign immunity with respect to Idaho fraudulent transfer actions by unsecured creditors. In addressing this position, the Court relied upon section 544’s long history of empowering bankruptcy trustees to bring certain state law causes of action3 and concluded that Congress knowingly included state law causes of action within the category of suits to which a sovereign immunity defense could no longer be asserted when it included section 544 in the list of sixty bankruptcy sections set forth in section 106(a)(1). 1). If such were not the case, the Court pointed out that section 106(a)(1) would be rendered practically meaningless.
Click here for a copy of the opinion.
1 The Trustee sought to recover alleged fraudulent transfers made within the four years prior to the petition date pursuant to section 544(b)(1) and Idaho law. The Trustee also sought to recover alleged fraudulent transfers made within the tow-year period prior to the petition date pursuant to Bankruptcy Code section 548.
2 See Hoffman v. Conn. Dept of Income Maint., 492 U.S. 96 (1989) and United States v. Nordic Village, Inc., 503 U.S. 30 (1992).
3 In re C.F. Foods, 265 B.R. 71 (Bankr. E.D. PA. 2001).