Zazzali v. United States (In Re DBSI, Inc.)
869 F.3d 1004
| 9th Cir. | 2017Background
- DBSI, an S-corporation operating a Ponzi-like real estate business, paid approximately $17 million in federal taxes (2005–2008) on behalf of shareholders; IRS later refunded about $3.6 million to shareholders as alleged overpayments.
- DBSI filed bankruptcy in November 2008; James R. Zazzali was appointed trustee and brought adversary claims to avoid fraudulent transfers to insiders and to the IRS.
- Trustee invoked 11 U.S.C. § 544(b)(1) using Idaho’s Uniform Fraudulent Transfer Act (UFTA) as the “applicable law” to avoid transfers within the UFTA’s four‑year limitation; he also pursued a small subset under 11 U.S.C. § 548 (two‑year limit).
- The United States moved to dismiss the § 544(b)(1) claims, arguing sovereign immunity barred an actual creditor from suing the government under Idaho law, so the trustee could not “stand in the creditor’s shoes.”
- Both the bankruptcy and district courts denied dismissal, holding 11 U.S.C. § 106(a)(1) unambiguously abrogates sovereign immunity “with respect to” § 544 (including the derivative state law claim); on summary judgment the IRS conceded avoidability but unsuccessfully asserted good‑faith/value defenses.
- The district court ordered return of about $13.4 million (excluding the ~$3.6 million refunded to taxpayers); the United States appealed on sovereign‑immunity grounds.
Issues
| Issue | Plaintiff's Argument (Zazzali) | Defendant's Argument (United States) | Held |
|---|---|---|---|
| Whether § 106(a)(1)’s waiver of sovereign immunity extends to § 544(b)(1) claims that rely on state law (the “applicable law”) | § 106(a)(1) unequivocally abrogates sovereign immunity “with respect to” § 544, so trustee may invoke § 544(b)(1) and the underlying state law despite sovereign immunity defenses | Waiver of immunity as to § 544 does not alter § 544(b)(1)’s triggering‑creditor requirement; because no actual creditor could sue the government under Idaho law (sovereign immunity), trustee cannot bring the claim | Affirmed: § 106(a)(1) abrogates sovereign immunity as to § 544(b)(1), including the underlying state law cause of action; trustee may avoid transfers to the IRS |
| Whether the Appropriations Clause or Supremacy Clause precludes trustee’s federal bankruptcy action to avoid tax payments | Waiver in § 106(a)(1) and recovery provisions (e.g., § 550) provide the congressional authorization needed to recover funds; avoidance is a federal bankruptcy remedy | Argued (and Seventh Circuit suggested) that constitutional/federal‑law limits (Appropriations, Supremacy) block such state‑law based recovery against federal government | Rejected: Congress authorized avoidance and recovery in the Bankruptcy Code; no Appropriations or Supremacy‑clause bar in bankruptcy context |
| Whether the IRS qualified for the UFTA good‑faith/for‑value defense | Trustee: transfers were proceeds of fraud and IRS did not take for value or in good faith | IRS: asserted it received payments in good faith/for value and refunded some overpayments | District court found IRS failed to prove the defense; government did not appeal this factual holding |
| Scope of recovery when IRS refunded amounts to taxpayers | Trustee: entire $17M was avoidable; refunds to taxpayers should be recoverable from IRS as initial transferee | IRS: ~$3.6M already refunded to shareholders is not recoverable from IRS as initial transferee under § 550(a)(1) | District court held refunded $3.6M not recoverable from IRS; appellate opinion affirms that portion (cross‑appeal handled separately) |
Key Cases Cited
- United States v. Nordic Village, 503 U.S. 30 (1992) (Congress must unequivocally waive sovereign immunity)
- FDIC v. Meyer, 510 U.S. 471 (1994) (two‑step framework: waiver inquiry and whether substantive law provides avenue for relief)
- In re Equipment Acquisition Resources, Inc. (EAR), 742 F.3d 743 (7th Cir. 2014) (held § 106(a)(1) waiver does not extend to § 544(b)(1)’s underlying state law claim)
- In re Acequia, Inc., 34 F.3d 800 (9th Cir. 1994) (trustee ‘‘stands in the shoes’’ of an actual creditor for § 544 purposes)
- Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356 (2006) (limits and purposes of bankruptcy power; Congress may abrogate state immunity under Bankruptcy Clause)
- Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198 (9th Cir. 2005) (interpretation of trustee avoidance powers and bankruptcy equitable distribution principles)