Opinion
Case No. 16-32161 Adv. No. 18-3008
08-30-2018
In re: RALPH LOUIS CITRO LISA A. CITRO, Debtors DONALD F. HARKER, III, Plaintiff v. INTERNAL REVENUE SERVICE ET AL., Defendants
Copies to: Patricia J. Friesinger (Counsel for the Plaintiff) Mary Stallings (Defendant The United States of America, Internal Revenue Service) Victoria D. Garry (Defendant Ohio Department of Taxation)
Chapter 7
Decision Denying The United States' Motion to Dismiss Complaint
This decision concerns whether a Chapter 7 trustee can pursue the debtors' pre-petition waiver of a net operating loss carryback on a tax return as a fraudulent transfer.
Introduction
In this Chapter 7 case, the trustee, Donald F. Harker (the "Trustee"), has filed a complaint to recover a fraudulent transfer under 11 U.S.C. §§ 548 and 550 of the Bankruptcy Code against the Ohio Department of Taxation, and the United States, sued in the name of the Internal Revenue Service (the "IRS"). The IRS has moved to dismiss the complaint for failure to state a claim for which relief can be granted.
All statutory references are to the Bankruptcy Code of 1978, as amended, 11 U.S.C. §§ 101-1532, cited in the decision as "§ ___".
The Trustee's legal theory is based upon a net operating loss ("NOL") claimed by the debtors on their 2015 federal tax return totaling $326,273. According to the complaint, had the debtors, Ralph and Lisa Citro (the "Citros"), applied this NOL to past tax returns, rather than affirmatively electing to waive this "carryback," they would have been entitled to refunds from prior tax returns, including, but not limited to, a $53,092 refund on their 2013 federal tax return. See 26 U.S.C. § 172(b)(1)(A) [I.R.C. § 172(b)(1)(A)] (providing that a NOL carryback generally may be claimed in the two prior taxable years from the taxable year of the NOL). The Trustee argues the waiver of the carryback constitutes a constructive fraudulent transfer of a property interest under § 548(a)(1)(B) because the Citros were insolvent, and the decision to apply the NOL to future tax years is worth less than the carryback would have been. Therefore, the carryback waiver was for less than reasonably equivalent value. The Trustee also asserts actual fraud under § 548(a)(1)(A), claiming that the waiver was made by the Citros with the actual intent to hinder, delay or defraud the Citros' creditors. Further, the Trustee seeks to recover the carryback under § 550 and an order requiring "the [IRS] pay to [the Trustee] an amount equal to all revenue produced by the waived NOL carryback while under the control of the defendant" and requiring "a reconveyance or repayment thereof by the [IRS] to The Trustee for the benefit of the bankruptcy estate." doc. 1, Complaint, ¶15.
The complaint states a regular NOL of $172,285 and what is referred to as an AMT (alternative minimum tax) NOL of $153,988.
Statutory references to the Internal Revenue Code are to "I.R.C. § ___". I.R.C. § 172(b)(1)(A) was amended as of December 22, 2017, but the prior version applies to the Debtors' 2015 tax return.
The IRS has moved to dismiss for a number of reasons, including that the proceeding is barred by the sovereign immunity of the United States and that the complaint does not plead facts which establish that: a) the NOL election was a transfer under § 101(54); b) the Citros failed to receive reasonably equivalent value; c) actual fraud occurred; and d) the IRS was a transferee of the election. Finally, the IRS asserts the Trustee's complaint fails to plead fraud with the required particularity. The Trustee has opposed the motion and, alternatively, moves to amend the complaint to cure any pleading deficiencies.
The IRS has withdrawn its argument that the Citros are necessary parties because, regardless of the outcome of this adversary proceeding, the NOL is lost to the Citros' post-discharge. The Citros' discharge was issued on November 15, 2016.
Jurisdiction and Constitutional Authority
This court has jurisdiction pursuant to 28 U.S.C. § 1334(b) and the Standing Order of Reference, Amended General Order No. 05-02 (S.D. Ohio Sept. 16, 2016). This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(H). Nevertheless, in Stern v. Marshall, the Supreme Court determined that bankruptcy courts do not have constitutional authority to enter final judgment over certain core proceedings. 564 U.S. 462 (2011). In Waldman v. Stone, the Sixth Circuit determined that bankruptcy courts do not have constitutional authority to enter final judgment on state law fraud claims and, citing Granfinanceira, S.A. v. Nordberg, 492 U.S. 33, 55 (1989), also noted that fraudulent conveyance claims require an Article III court to enter final judgment. 698 F.3d 910, 921 (6th Cir. 2012). In light of Stern and Waldman, the court requested the parties to file a statement as to whether they consent to the bankruptcy court entering final judgment on any "Stern" claims involved in this proceeding. See Wellness Int'l Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015) (parties may consent to bankruptcy court hearing Stern claims). On August 9, 2018 the parties filed a joint statement which provided that one or more of the parties declined to consent to the bankruptcy court's entry of final judgment on any "Stern" claims. doc. 31. Therefore, it appears this court cannot enter final judgment. See General Order 05-02 of the United States District Court for the Southern District of Ohio (providing the bankruptcy court can submit proposed findings to the district court when it may lack constitutional authority to enter final judgment). However, the court's determination to deny the IRS's motion to dismiss is interlocutory and does not implicate Stern. Lehman Brothers Holdings Inc. v. JPMorgan Chase Bank, N.A. (In re Lehman Brothers Holdings Inc.), 469 B.R. 415, 424 n.5 (Bankr. S.D.N.Y. 2012) (decision granting in part, and denying in part motion to dismiss is interlocutory); Jones v. Brand (In re Belmonte), 551 B.R. 723, 726 n.3 (Bankr. E.D.N.Y. 2016) (denial of motion for judgment on the pleadings is interlocutory).
Standard for Dismissal under Rule 12(b)(6)
A motion to dismiss an adversary proceeding for "failure to state a claim upon which relief can be granted" is governed by Federal Rule of Civil Procedure 12(b)(6) (applicable by Federal Rule of Bankruptcy Procedure 7012(b)). The factual allegations must put the defendant on notice as to the claims being alleged and provide a sufficient factual predicate to make the allegations plausible, and not merely possible. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Federal courts are not obligated to accept as true legal conclusions couched as factual allegations. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007). While detailed factual allegations are not necessary, the allegations must be sufficiently detailed to create more than speculation of a cause of action. Id. A claim is plausible if the factual allegations are sufficient to allow "the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." HDC, LLC v. Ann Arbor, 675 F.3d 608, 611 (6th Cir. 2012) (citations and internal quotation marks omitted). See Fed. R. Civ. P. 8(a)(2), applicable by Fed. R. Bankr. P. 7008, which requires "a short and plain statement of the claim showing that the pleader is entitled to relief[.]").
Does Sovereign Immunity Bar the Trustee's Complaint?
The IRS argues that the relief sought by the Trustee is barred by the doctrine of sovereign immunity and, as a corollary, such relief is beyond this court's jurisdiction. The United States may not be sued without its consent and any waiver must be unequivocal. U.S. Dep't of Energy v. Ohio, 503 U.S. 607, 615 (1992). Section 106 of the Bankruptcy Code provides that government units waive their sovereign immunity for fraudulent transfer actions brought under § 548 and a recovery of such transfer under § 550. 11 U.S.C. § 106(a)(1). However, the IRS has taken the position that the relief sought by the Trustee, by requesting a refund of the 2013-year tax paid based on the 2015 NOL, requires compliance with both I.R.C. § 7422(a) and § 505(a)(2).
I.R.C. § 7422(a) provides:
No suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof.In addition, § 505(a)(2) provides that the bankruptcy court may not determine the right of the estate to a tax refund before either the IRS determines the amount of the refund or "120 days after the trustee properly requests such refund from the government unit for which such refund is claimed." 11 U.S.C. § 505(a)(2). A "proper" request is one that complies with the taxing authority's procedure to seek a refund. United States v. Kearns, 177 F.3d 706, 710 (8th Cir. 1999) ("[A] 'proper' request is on that, first, meets the filing requirements of I.R.C. § 7422(a). . . ."); U.S. v. Bond, 762 F.3d 255, 260 (2d Cir. 2014) (similarly determining that the trustee must properly request a tax refund) United States v. Neary (In re Armstrong), 206 F.3d 465, 471-72 (5th Cir. 2000) (trustee must comply with § 505(a)(2) and I.R.C. § 6511 in a turnover action).
The exhaustion of remedies requirement under § 7422(a) is mandatory. U.S. v. Williams, 514 U.S. 527, 533 (1995) ("It is undisputed that § 7422 requires administrative exhaustion."). See Berera v. Mesa Medical Group, PLLC, 779 F.3d 352, 359 (6th Cir. 2015) (finding that a plaintiff could not pursue a FICA refund claim from an employer without exhausting the administrative remedies required by § 7422(a)). Earlier decisions also have concluded refund claims must comply with § 7422(a). See, e.g. McDonnell v. United States, 180 F.3d 721, 722 (6th Cir. 1999) (tax refund claim for investment interest deduction requires an administrative claim be brought consistent with § 7422(a)).
Specifically, the IRS asserts that a taxpayer must file an administrative claim within three years of the date the return was filed or 2 years from when the tax was paid. I.R.C. § 6511(a). Because this claim involved a carryback election, the three years runs from the loss-year return, i.e. the 2015 return. I.R.C. § 6511(d)(2). It follows that the Trustee would have, assuming the election to waive NOL carryback was avoided, until April of 2019 to file an amended return on behalf of the Citros for 2015 without the election and, additionally, file an amended 2013 return to claim the NOL carryback. If the IRS denied the claim or failed to act within 120 days, the Trustee could only then pursue the refund under § 505(a)(2).
But the question is whether I.R.C. § 7422 applies to a § 548 fraudulent transfer claim. The court is persuaded that it does not apply because this is not a straight-forward case of the debtor seeking a refund it is owed from the IRS such as in Berera or McDonald. The 2013 return is not erroneous nor were the taxes from the 2013 return illegally collected, or collected without authority as required by I.R.C. § 7422. See In re Pharmacy Distrib. Svcs., Inc., 455 B.R. 817, 822 (Bankr. S.D. Fla. 2011) (Court, in a fraudulent transfer case against the United States, noting that "there is no dispute that the taxes paid by the Debtor were actually due and owing to the United States. . . . The Trustee does not seek a refund of taxes on behalf of the Debtor or the taxpayer. Rather, the Trustee seeks a money judgment under sections 544 and 550 on behalf of the bankruptcy estate."). Citros are not owed a refund from the IRS presently and cannot revoke the NOL carryback waiver under indisputable tax law. But here, the Trustee is seeking to recover that waiver as a fraudulent transfer on behalf of the estate's creditors. The Trustee, as trustee, is cloaked with those powers because Congress specifically provided it in the Bankruptcy Code and also specifically waived sovereign immunity under § 106 for such actions. The IRS does not cite any cases which apply § 7422 in the context of a fraudulent transfer action under § 548.
It appears that the IRS has litigated this issue as to § 544(b)(1) as to whether sovereign immunity applies to fraudulent transfer claims grounded in state law. For example, in Zazzali v. United States (In re DBSI, Inc.), the Ninth Circuit found that the trustee could pursue pre-petition tax payments under Idaho fraudulent transfer law based on § 544(b)(1)). 869 F.3d 1004, 1016 (9th Cir. 2017). Interestingly, no challenge was made to the § 548 action, only the action under § 544(b)(1). Id. at 1008. The same thing apparently happened in In re Equip. Acquisition Res., Inc., in which the Seventh Circuit found that sovereign immunity was not waived, but the United States agreed to disgorge payments that could be recovered under § 548. 742 F.3d 743, 744 (7th Cir. 2014). The Seventh Circuit found that an action under § 548 was different than § 544(b)(1) because the trustee under § 544(b)(1) stands in the shoes of an actual unsecured creditor and such a creditor could not bring such a suit outside of bankruptcy. Id. at 746. But under § 548, "[t]he trustee stands in his own shoes and exercises rights bestowed by the Bankruptcy Code itself." Id. See also In re SK Foods, L.P., Bankr. No. 09-29162-D-11, Adv. No. 10-2117-D, 2010 WL 6431702, at *1 n.2 (Bankr. C.D. Cal. July 14, 2010) (in discussing whether sovereign immunity was waived under § 544(b)(1), the court noted that the IRS made no such argument under § 548).
The court finds that the United States has waived its sovereign immunity pursuant to § 106 with respect to fraudulent conveyance claims under § 548 and that the Trustee's proceeding is first and foremost a proceeding to avoid the NOL election as a fraudulent conveyance. The court must adjudicate the fraudulent conveyance claim prior to the Trustee's ability to file a claim for a tax refund and only if he prevails in this proceeding to avoid the NOL election. For these reasons, the court has jurisdiction over the fraudulent conveyance claim under § 548 and the United States has waived its sovereign immunity with respect to those claims.
If the Trustee succeeds on his fraudulent conveyance claim under § 548, the court reserves ruling on whether the Trustee may recover the 2013 tax refund without complying with I.R.C. § 7422 or only the right to elect the NOL carryback. Under § 550, the Trustee is entitled to "the property transferred, or, if the court so orders, the value of such property[.]" See Slone v. Lassiter (In re Grove-Merritt), 406 B.R. 778, 811 (Bankr. S.D. Ohio 2009) (trustee can recover the property fraudulently transferred or the value of such property). One concern with the IRS' position that the Trustee must eventually pursue the refund through the I.R.S.' administrative procedures is that I.R.C. § 6511(d) could effectively create a new, de facto statute of limitation for the fraudulent transfer action since the Trustee apparently would only have until April 2019 to file an amended return. The IRS has also stated if a fraudulent transfer is found, it would challenge the NOL itself.
Does the Complaint Allege a Transfer of a Property Interest?
The IRS asserts that the election to waive a NOL carryback is not a transfer because the NOL remained with the Citros after the election. A transfer is defined, in relevant part, as "each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with — (i) property; or (ii) an interest in property." 11 U.S.C. § 101(54)(D). The Trustee asserts that the item transferred is not the NOL itself, but the right to attribute the NOL to prior tax returns by the carryback. The IRS insists that it is not a transferee of a property interest because it did not receive any "property" or "interest in property." The IRS explains that the taxpayer "does not own the money paid to the IRS years earlier as tax—he only has a potential right to claim a refund by carrying back the NOL." doc. 28 at 4. A transfer, at a minimum, requires the transferee to exercise some dominion or control over the asset. Meoli v. Huntington Nat'l Bank, 848 F.3d 716, 725 (6th Cir. 2017).
In United States v. Kapila, the district court, in affirming the bankruptcy court, determined that the right to a NOL carryback was an interest in property and did constitute a transfer. 402 B.R. 56, 60-63 (S.D. Fla. 2008). The decision noted that, in a pre-Bankruptcy Code Supreme Court case, Segal v. Rochelle, 382 U.S. 375 (1966), a debtor's interest in a NOL was property of the estate. The only two circuit decisions addressing this issue have also concluded that an NOL carryback waiver is an avoidable property transfer. See Gibson v. United States (In re Russell), 927 F.2d 413, 417 (8th Cir. 1991) (bankruptcy trustee has authority to avoid an otherwise irrevocable election by a debtor to carry forward net operating losses); United States v. Sims (In re Feiler), 218 F.3d 948, 956-57 (9th Cir. 2000) (similar). See also Guinn v. Lines (In re Trans-Lines West, Inc.), 203 B.R. 653, 662 (Bankr. E.D. Tenn. 1996) (citing Russell for support, court finds that revocation of a Subchapter S status could constitute a transfer under § 548). But see also Majestic Star Casino, LLC v. Barden Dev't, Inc. (In re Majestic Star Casino, LLC), 716 F.3d 736, 762-63 (3d Cir. 2013) (trustee lacks standing to avoid a Subchapter S revocation without the consent of the shareholders that consented to the revocation). This court is not aware of any decisions, and the IRS has not cited any decisions, that directly support the position of the IRS on this narrow issue.
One decision did determine that an election to apply a federal tax overpayment to the following year's estimated tax could not be avoided under turnover or theories under §§ 548 or 549. Grant v. United States (In re Simmons), 124 B.R. 606 (Bankr. M.D. Fla. 1991). The court noted that reasonably equivalent value was given for the debtor's early payment of taxes. Id. at 608. The Ninth Circuit rejected this analysis, following Feiler, determining that the credit for future taxes was estate property that was subject to turnover. Nichols v. Birdsell, 491 F.3d 987, 990 (9th Cir. 2007). See also Weinman v. Graves (In re Graves), 609 F.3d 1153, 1159 (10th Cir. 2010) (concluding that the amount of the refund in the subsequent tax year attributable to pre-petition earnings was subject to turnover). Another case arguably providing some support is Official Committee of Unsecured Creditors of Forman Enters., Inc. v. Forman (In re Forman Enters.), 281 B.R. 600 (Bankr. W.D. Pa. 2002) (without discussing Segal, concluding a S corporation's right to use a NOL is not property of the estate.").
The IRS also argues that I.R.C. § 1398 addresses rules related to individual bankruptcy cases and forecloses the Trustee's ability to avoid the transfer. Section 1398(g)(1) states that "[t]he estate shall succeed to and take into account the following items (determined as of the first day of the debtor's taxable year in which the case commences) of the debtor . . . The net operating loss carryovers determined under section 172." IRC § 1398(g)(1). The IRS notes that the property of the estate is based on the NOL left upon the bankruptcy filing and therefore it defines, and limits, the Trustee's rights concerning any NOL of the Citros. But the property at issue is not the NOL itself (which is property of the estate as Segal stated), but is, as noted earlier, the carryback election that the Trustee seeks to recover. See Feiler, 218 F.3d at 953 ("What a trustee 'succeeds to' under I.R.C. § 1398 is not the same as what he may avoid under § 548; what property is part of the bankruptcy estate and what property may be recovered with a trustee's avoidance powers are two separate questions."). But see Russell, 927 F.2d at 419 ("The application of section 1398(g)(1) defeats this court's conclusion that the taxpayer's irrevocable elections may be avoided by the trustee.") (Gibson, J., dissenting).
Section 172 provides the parameters for a NOL deduction, including a carryback or carryover. I.R.C. § 172.
For these reasons, the court determines that the waiver of the NOL carryback is an avoidable property interest.
Is the United States a Transferee of the NOL Carryback Waiver?
The IRS also has argued that it is not a transferee. But as noted in Kapila: "[t]his assertion . . . ignores the practical effect of the NOL waiver. . . . Had [the debtor] failed to make an affirmative election, the United States would have been required to pay him a tax refund." 402 B.R. at 63. The NOL carryback waiver benefited the government because it increased the debtors' tax liability "and absolved the United States of its obligation to pay a refund it otherwise would have been required to make." Id. But the IRS states that the NOL still exists. The only difference is the NOL is maintained for future tax years, which could increase in value based on the tax bracket of the Citros in future years. However, because the amount of the debts the Citros discharged in their bankruptcy exceeded the amount of their NOL carry-forward, once the Citros received a bankruptcy discharge, they lost their right to use the NOL.
See I.R.C. § 108(b)(2)(A). As noted earlier, the Citros received their discharge on November 15, 2016.
By making the election to waive the NOL carryback, the Citros effectively traded actual funds for a future, contingent tax deduction and the United States was the transferee that benefited from this decision. As the Kapila court stated:
[B]y electing to carry-forward his NOL, Taylor waived his right to a present tax refund of $11,201 in favor of a future tax attribute. Had Taylor failed to make an affirmative election, the United States would have been required to pay him a tax refund. Thus, Taylor's NOL waiver absolved the United States of its obligation to pay a refund it would otherwise have been required to make. See In re Feiler, 218 F.3d at 956 (Debtors "traded [their] right to a refund to the IRS in exchange for the right to carry the NOLs forward, and as a result, the IRS was no longer required to pay the $287,493 refund. Rather than require that the IRS actually pay itself the amount of the tax refund to be considered a 'transferee' of the benefit, it is enough that the IRS traded one obligation for another...."). As Taylor was insolvent at the time of the election, the effect of his NOL carryback waiver was to constructively place that refund amount in the possession of the United States and out of the reach of Taylor's creditors. The United States' contention that it did not physically receive a transfer of cash amounts to little more than semantics. The undersigned therefore concludes Taylor's waiver of a present tax refund falls within the indisputably broad definition of "transfer" under the Bankruptcy Code.Kapila, 402 B.R. at 63. Stated differently, the NOL election had value and in electing to transfer the NOL to future years and then filing bankruptcy, the Citros conveyed the value of the NOL to the IRS. Thus, the complaint sufficiently pleads that the IRS was a transferee of the value represented by the NOL election under § 548.
Did the Citros Receive Reasonably Equivalent Value in Exchange
for the NOL Carry-Forward Election?
The IRS also argues that the Trustee's Complaint should be dismissed because the Citros received reasonably equivalent when the waiver of the NOL carry forward occurred. For constructive fraud under § 548(a)(1)(B), the Trustee must show that the Citros received less than equivalent value, and as alleged in the Complaint, the Citros were insolvent at the time of the transfer. Complaint, ¶ 11. Reasonably equivalent value compares the value of the property transferred with the property received in exchange. See Corzin v. Fordu (In re Fordu), 201 F.3d 693, 707 (6th Cir. 1999) (quoted in Rieser v. Hayslip (In re Canyon Coins Sys. Corp.), 343 B.R. 615, 639 (Bankr. S.D. Ohio 2006) ("A fundamental element of a constructive fraudulent transfer is a transfer made for less than reasonably equivalent value."). Reasonably equivalent value compares what was given and what was received, from the viewpoint of the debtor. Canyon Coins, 343 B.R. at 639.
The IRS appears to raise this issue as an issue of law, seeking a determination that the Citros received reasonably equivalent value in exchange for making the NOL carry-forward election. See fn. 11 infra (noting that the IRS does not raise the constructive fraud value issue as a pleading issue).
It appears beyond debate that, absent the bankruptcy discharge, the Citros' NOL could have been applied to future income for up to 20 years. I.R.C. § 172(b)(1)(A)(ii). Therefore, the argument goes, reasonably equivalent value was given because none of the NOL was lost at the time of the transfer because it carried forward to future returns. It was only once the Citros filed bankruptcy and received a discharge that the NOL was lost. Moreover, the Citros' decision to waive the NOL carryback would appear illogical if bankruptcy had been contemplated when that decision was made (assuming the Citros understood the tax law) because the NOL carry forward is lost to the extent of the amount of debt discharged. In this case, the amount of debt discharged in this bankruptcy exceeded the NOL.
When the Citros waived the NOL carryback, they forfeited the proverbial "bird in the hand" tax refund for a possible, uncertain future refund. Moreover, if the Citros did this while insolvent, regardless of their motive, a valuable NOL carryback was ultimately lost due to the bankruptcy discharge. It would appear to only be reasonably equivalent value if the record supported that the Citros had an expectation of future income at a higher tax rate and did not anticipate filing bankruptcy in the near future, and, therefore, the NOL would have more value in future years.
Ultimately, the determination of whether the Citros received reasonably equivalent value in exchange for the NOL carry-forward election is an issue of fact which is not appropriate for determination on a motion to dismiss. See Onkyo Eur. Elecs. GMBH v. Glob. Technovations, Inc. (In re Glob. Technovations), 694 F.3d 705, 719 (6th Cir. 2012) ("whether [a debtor] received reasonably equivalent value [in a fraudulent-transfer case] is a question of fact."); Wells v. Salmo (Select One, Inc.), 556 B.R. 826, 847 (Bankr. E.D. Mich. 2013) (quoting BankEast v. Shirley (In re Shirley), Nos. 10-3031, 10-3032, 2011 WL 4054773, at *8 (Bankr. E.D. Tenn. Sept. 12, 2011)) ("[B]ecause considerations of valuation are inherently factual, courts must examine the case-specific circumstances surrounding the decision to enter into the challenged transaction."). A motion to dismiss should not be used to "resolve contests surrounding the facts, the merits of a claim, or the applicability of defenses." Campbell v. Cathcart (In re Derivium Capital, LLC), 380 B.R. 407, 416 (Bankr. D.S.C. 2006) (citing Republican Party of N.C. v. Martin), 980 F. 2d 943, 952 (4th Cir. 1992) and Richmond Fredericksburg & Potomac R.R. Co. v. Forst, 4 F. 3d 244, 250 (4th Cir. 1993)). For this reason, the constructive fraud claim cannot be dismissed as a matter of law.
Does the Complaint Adequately Plead Actual Fraud?
The IRS argues the Trustee has failed to plead actual fraud with the necessary specificity required by Federal Rule of Civil Procedure 9(b), incorporated into adversary proceedings through Federal Rule of Bankruptcy Procedure 7009. Rule 9(b) requires that when "alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally." Otherwise, pleadings need only comply with the requirements of Federal Rule of Civil Procedure 8(a), applicable to adversary proceedings by Federal Rule of Bankruptcy Procedure 8, requiring a "short and plain statement of the claim showing that the pleader is entitled to relief[.]"
The IRS only appears to argue that the actual fraud claims under § 548(a)(1)(A) are not plead with sufficient particularity under Rule 9(b). See IRS Motion (doc. 22 at 9) and IRS Reply (doc. 28 at 9). The IRS did not raise this issue with respect to the constructive fraud claim under § 548(a)(1)(B). A number of courts, including the District Court for the Southern District of Ohio, have held that Rule 9(b) requiring that fraud be plead with particularity does not apply to constructive fraud claims. See In re Petters Co., 495 B.R. 887, 916 (Bankr. D. Minn. 2013); Campbell v. Cathcart (In re Derivium Capital, LLC), 380 B.R. 407, 422 (Bankr. D.S.C. 2006); Van-American Ins. Co. v. Schiappa, 191 F.R.D. 537, 542 (S.D. Ohio 2000).
To set aside a transfer based upon actual fraud, The Trustee must show the transfer was made with "actual intent to hinder, delay, or defraud" the Citros' creditors. 11 U.S.C. § 548(a)(1)(A). Slone v. Lassiter (In re Grove-Merritt), 406 B.R. 778, 793 (Bankr. S.D. Ohio 2009). Actual fraud is rarely established by direct evidence, and "courts infer fraudulent intent from the circumstances surrounding the transfer." Id. at 793-94 (quoting Schilling v. Heavrin (In re Triple S. Rests., Inc.), 422 F.3d 405, 416 (6th Cir. 2005). Rule 9(b) does not require intent to be pleaded with particularity. Degirolamo v. McIntosh Oil Co. (In re Laurel Valley Oil Co.), Bankr. No. 05-64330, Adv. No. 12-6014, 2012 WL 2603429, at *3 (Bankr. N.D. Ohio July 5, 2012). However, the complaint should still provide specific facts, or indicia of fraud and cannot rely on bare bones pleading of elements of § 548. Id.
In order to determine whether the Complaint pleads with particularity the circumstances constituting fraud, including whether sufficient badges of fraud have been alleged, the Complaint must be reviewed. The pertinent allegations of the Complaint are as follows:
6. The Debtors filed a federal income tax return, on Form 1040 for the taxable and calendar year 2015 (the "2015 Federal Return"). Such was filed on or about February 26, 2016. . . . Th[e] 2015 Returns established the existence of a regular net operating loss ("NOL") for 2015 of $172,285.00 and a "so-called" AMT NOL of $153,988.00. All of such NOLs arose out of the Debtors' operation of R and L Sports LLC and losses from the liquidation of business assets.
7. The 2015 Returns each contained an affirmative election to waive the carryback of the NOL and to carry the entire NOL forward to be applied against the Debtors' income in future tax years.
8. Absent that election, the Debtors would have then been entitled to a refund of income taxes paid for one or more prior taxable years including, upon information and belief, a refund for tax year 2013 from the Internal Revenue Service of $53,092. . . .
9. By virtue of the bankruptcy filing in 2016, the NOL and tax attributes of the Debtors as of January 1, 2016 became property of the estate.
10. Notwithstanding the Debtors'/taxpayers' purported waiver, the NOL may be carried back to 2013 under 26 U.S.C. 172(b)(1) . . . which carryback results in a substantial recovery or receivable for the Debtors' Bankrupt Estate.
FIRST CLAIM OF RELIEF - 11 U.S.C. § 548
11. The election to waive the carryback of the NOL in the 2015 Returns were each a transfer of an interest of the Debtors in property under 11 U.S.C. §548(a). The election was exercised within two years of the Debtors' bankruptcy filing and at a time when the Debtors were insolvent.Complaint at 3-4. These allegations sufficiently state the circumstances constituting the Trustee's actual fraud claim, raise sufficient indicia of an intent to hinder, delay, or defraud Citros' creditors to overcome the IRS' motion to dismiss, and are sufficiently detailed so as not to create speculation as to the basis for the cause of action.
12. The election to waive, being a transfer of an interest, was done in return for future tax benefits with a value less than and not reasonably equivalent to the value of the tax refund that was relinquished when the election was exercised. The election was made while the Debtors were insolvent or the transfer rendered the Debtors insolvent.
13. The election to waive, being a transfer of an interest, was also made with the actual intent to hinder, defraud and delay the Debtors' creditors.
Actual fraud under § 548(a)(1)(A) requires an intent to hinder, delay, or defraud his creditors. The Citros' intent to hinder, delay, or defraud creditors could be generally alleged, as it was. The Citros must have an interest in the property transferred. 11 U.S.C. § 548(a)(1). Intent may be based upon circumstantial evidence because direct evidence of fraudulent intent usually does not exist. The court must consider the intent of the Citros in waiving the property interest that the NOL carryback waiver constituted but can do through indicia of fraud. As alleged in the complaint, the NOL "arose of the Debtors' operation of R and L Sports LLC and losses from the liquidation of business assets" and the Citros filed their tax returns approximately February 26, 2016. Complaint, ¶ 6. The Citros filed the Chapter 7 case on July 13, 2016. estate doc. 1. Thus, it appears that had the Citros used the carryback any refund from the amendment of the 2013 return would have been property of the estate. Again, it is unclear why the Citros made the decision in 2016 to not try to recover these funds. The Trustee is entitled to explore these issues through discovery to evaluate the circumstances that led to that decision. Gowan v. Patriot Group (In re Dreier LLP), 452 B.R. 391, 408 (Bankr. S.D.N.Y. 2011) (courts take a more liberal view of actual fraud allegations for pleading a fraudulent conveyance for a trustee). What is clear is the decision and the subsequent bankruptcy led to the NOL being eliminated without ever being exercised.
"Because proof of actual intent to hinder, delay or defraud creditors may rarely be established by direct evidence, courts infer fraudulent intent from the circumstances surrounding the transfer." Schilling v. Heavrin (In re Triple S. Rests., Inc.), 422 F.3d 405, 416 (6th Cir. 2005) (citation and internal quotation marks omitted).
Conclusion
For these reasons, the IRS' motion to dismiss the Trustee's complaint is denied. The court will enter a separate order consistent with this decision.
This document has been electronically entered in the records of the United States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
/s/ _________
Guy R. Humphrey
United States Bankruptcy Judge
Dated: August 30, 2018
Copies to:
Patricia J. Friesinger (Counsel for the Plaintiff) Mary Stallings (Defendant The United States of America, Internal Revenue Service) Victoria D. Garry (Defendant Ohio Department of Taxation)