In re Applied Machinery Rentals, LLC

The Bankruptcy Court for the Western District of North Carolina (the Court) recently ruled that a chapter 7 trustee could use Bankruptcy Code §§ 548 and 550 to recover from the Internal Revenue Service (IRS) taxes which had been paid on behalf of the Debtor’s principal with property of the estate.  It held that the IRS was the initial transferee even though the payment came from a bank account in the principal’s name and that the recent Supreme Court case, United States v. Miller, 145 S. Ct. 839 (2025), prohibited recovery from the IRS only if the fraudulent transfer action is brought under §544, utilizing state law.  Hayes v. United States of America (In re Applied Machinery Rentals, LLC), 2025 WL 1297432 (April 30, 2025).  View the opinion here.

Facts

Applied Machinery Rentals, LLC (the Debtor) filed a chapter 7 case on July 17, 2023. Garth Errol McGillewie Jr was the Debtor’s sole member, manager, and principal. On September 16, 2021, the Debtor, acting through McGillewie, obtained a commercial loan from Security Bank & Trust Company (“Security Bank”) for $1,520,036.00.  Security Bank funded the loan by wiring $1,500,000 to McGillewie’s personal bank account at SouthState Bank (the “SouthState Account”).  The next day McGillewie caused SouthState Bank to issue a cashier’s check from the SouthState Account payable to the IRS in the sum of $1,052,682.67 (the “2021 Tax Payment”) to be applied to the personal tax obligations of McGillewie and his wife. 

In April 2024, Chapter 7 trustee Cole Hayes (the trustee) filed an adversary proceeding seeking to avoid and recover the 2021 Tax Payment from the IRS under Bankruptcy Code §§ 544, 548 and 550. The IRS filed an answer asserting two defenses: (1) that the trustee could not recover under § 544 because no creditor could sue under applicable state law based on the government’s sovereign immunity; and (2) the trustee could not recover from the IRS because it was a subsequent transferee that took for value, in good faith, and without knowledge of the voidability of the transfer under § 550(b).  After the case was filed but prior to the summary judgment motions this decision addresses, the Supreme Court decided United States v. Miller, which held that a trustee could not use § 544 and state law to avoid a fraudulent transfer because the government was shielded by sovereign immunity, notwithstanding § 106(a) which waived this immunity in certain bankruptcy proceedings.  The trustee then amended the complaint by stipulation to dismiss the claims under § 544.

The parties filed cross partial summary judgment motions. The trustee moved for judgment as to the voidability and recoverability of one of the tax payments under §§ 548 and 550.  The IRS requested judgment in its favorite as a subsequent transferee for value.  The Court granted partial summary judgment to the trustee and denied the IRS’s motion.

Reasoning

A trustee can avoid transfers  of an interest of the debtor in property under § 548(a)(1). The Court found there was no factual dispute that the 2021 Tax Payment was a transfer of an interest of the debtor in property, in other words a transfer of property of the estate.  Under South Carolina law a manager of an LLC has a fiduciary duty to such company and holds in trust any property received by the manager while conducting the business of the company.  The purpose of the Security Bank loan was to fund business operations.  That the funds were wired to the SouthState Account did not divest the Debtor of its property interest, as McGillewie held them in trust for the Debtor.  Therefore, when McGillewie  used the funds to pay his own taxes, he transferred property of the Debtor.

The Court concluded the other elements of § 548(a)(1) (A)  (an actual fraudulent transfer) were also not in dispute.  The 2021 Tax Payment was within two years of the Debtor’s petition date, satisfying the two year statute of limitations.  The IRS conceded that the Debtor made the payment with actual intent to defraud its creditors.  The Court ruled in the alternative that the transfer could also be avoided under § 548(a)(1)(B) as a constructive fraudulent transfer.  The IRS conceded that the Debtor was insolvent on the date of the transfer.  There was no dispute that the funds paid the insider’s taxes, not the Debtor’s obligation, so the estate did not receive reasonably equivalent value in return.  The trustee satisfied the elements necessary to avoid and recover a constructive fraudulent transfer.

The first of the IRS’s defenses had been mooted when the § 544 claim was dismissed after the United States v. Miller decision.  The IRS asserted, however, that it was a subsequent transferee, not an initial transferee, because the funds in question were paid to it from the SouthState Account into which Security Bank had wired the money.  It argued the initial transfer was to McGillewie and his issuance of a cashier’s check to it was a subsequent transfer.  The Court rejected that argument, concluding the IRS was the initial transferee, a term not defined by the Bankruptcy Code.  The Court noted that many courts, including the Fourth Circuit, used the definition of initial transferee set forth by the Seventh Circuit in Bonded Fin. Servs., Inc. v. Eur. Am. Bank, 838 F. 2d 890 (7th Cir. 1988).  By that definition, a transferee is different from a possessor or holder, with transferee status requiring “dominion over the money or other asset, the right to put the money to one’s own purposes.”  Id.  at 893-894.  An agent or fiduciary, such as McGillewie, does not have control  over funds unless he has a right to put the funds to his own purpose.  The ability to do so is insufficient; it must be  a legal right.

Using this precedent the Court found no transfer from the Debtor to McGillewie because he received them as the Debtor’s agent.  The Debtor’s property interest in the money was not transferred; it remained with the Debtor.  As a result the IRS was the direct transferee when the funds were paid to it from the SouthState Account. Because the IRS was not a subsequent transferee, whether it took in good faith, for value and without knowledge of wrongdoing was not relevant.

Author’s Comments

This case is a good reminder that United States v Miller does not mean a trustee can never recover tax payments made by a debtor on behalf of its insiders, a circumstance which happens frequently.  The key will be whether those payments  were made within two years of the bankruptcy filing so that § 548 can be used.  The discussion about initial versus subsequent transfer turned on whether the insider with the funds had dominion or control over the funds; in other words, whether he had a legal right to use the funds as he wished.  If there is no dominion and control no transfer has occurred and the next transfer will be to an initial transferee.  Several circuit courts and many bankruptcy courts use the dominion and control test.

[The Commercial Finance Newsletter is written by an ad hoc group of layers in the Business Law Section of the California Lawyers Association.  This review was written by the Hon. Meredith Jury, U.S. Bankruptcy Judge, Central District of California (Ret.), a member of the ad hoc group.   The opinions contained herein are solely those of the author.]