Limited Liability Companies
Virginia Bankruptcy Court Holds that S Corporation Status Is Not “Property” for Purposes of the Bankruptcy Code
By Lawrence A. Goldman, Gibbons P.C.
Confronted with conflicting precedent, a bankruptcy court in Virginia held that “S corporation” status under federal income tax law does not constitute “property” for purposes of Sections 544(b) and 548 of the United States Bankruptcy Code. In In re Health Diagnostic Laboratory, Inc., et al., 2017 WL 6061579 (Bankr. E.D. Va., Dec. 6, 2017), a liquidating trustee alleged that the shareholders’ vote to terminate S corporation status prior to the corporation’s commencing a bankruptcy case was a fraudulent transfer subject to being voided, thereby creating value for the estate by generating tax refunds which could be claimed by the liquidating trustee. The issue was one of first impression within the Fourth Circuit. Only the Third Circuit had concluded that S corporation status does not constitute a property right in bankruptcy. In re Majestic Star Casino, LLC, 716 F.3d 736 (3rd Cir. 2013), with several lower courts having held to the contrary. The court reasoned that federal tax law governs any purported property tax right and that in applying an “essential property rights” analysis of the Fourth Circuit, the court determined that S corporation status is not a property right under federal tax law.