SCOTUS’s Latest Proclamation on the Limits of Sovereign Immunity

By Thomas J. Salerno, Anthony P. Cali and Kenneth C. Bellows1

“Abrogate: to abolish by authoritative action; annul; to treat as nonexistent.” Synonyms include “vacate,” “cancel,” “nullify,” “rescind,” “void,” “repeal” and “dissolve.”

— Merriam-Webster Dictionary

The problem with broad pronouncements in reported decisions is that they have a pesky way of coming back to bite you later. Consider, if you will, the March 26 U.S. Supreme Court’s 8-1 decision in United States v. Miller,2 wherein the Court resolved a split in the circuits that have considered the issue of the scope and extent of the Bankruptcy Code’s “abrogation” of sovereign immunity found in § 106(a)(1) as it applies to the Internal Revenue Service (IRS) in a fraudulent-transfer action brought under § 544(b) of the Bankruptcy Code. For reasons discussed in this article, the authors find it significant that the majority opinion was authored by Justice Ketanji Brown Jackson, with a dissent by Justice Gorsuch.

The dispute in Miller was fairly straightforward: Unscrupulous officers of a corporation embezzled money from the corporation to pay about $145,000 of their personal tax liabilities to the IRS. The company wound up in chapter 7 three years later, and, not surprisingly, the trustee in the corporate bankruptcy sued the IRS to recover the embezzled money, as the IRS was the recipient of a fraudulent transfer.3 As the transfer to the IRS had occurred longer than two years before the bankruptcy, the trustee was left to recover the money from the IRS using § 544(b), which essentially incorporates state law fraudulent-transfer provisions that applied for longer than the two-year look-back period of § 548. The applicable nonbankruptcy law in Miller was Utah state law.

There was nothing unusual here. The IRS stipulated that the elements of a constructive fraudulent transfer had been satisfied, but argued that sovereign immunity protected the IRS from any action under § 544(b). The IRS argued that under state law, no creditor could sue the IRS to recover the money because of sovereign immunity. As the trustee was standing in the shoes of an actual (not hypothetical) creditor who had standing to bring the action (the existence of which was an element of a § 544(b)(1) action),4 the trustee likewise was barred from bringing such a suit using state law under § 544(b). Not surprisingly, the trustee argued that sovereign immunity — as a defense — is abrogated by § 106(a).5 The bankruptcy court, district court and Tenth Circuit Court of Appeals all agreed with the trustee.6 The Tenth Circuit’s decision was in line with the Ninth and Fourth Circuits7 but contrary to the Seventh Circuit, which held that § 106(a) did not modify the actual creditor requirement in § 544(b) (and presumably, therefore, any defenses that could be raised in connection with any lawsuit had it been brought by the actual creditor).8

On March 26, the Supreme Court issued the Miller decision and sided with the Seventh Circuit’s approach. There’s no need to reiterate the insightful Rochelle’s Daily Wire analysis of the reasoning for the decision.9 The focus of this article is on the glaring philosophical disconnect between the broad pronouncements on this issue in a prior Court decision (also authored by Justice Jackson) on the scope and meaning of § 106(a), and the Miller decision.

The Coughlin June 2023 Decision

Lac Du Flambeau Band of Lake Superior Chippewa Indians v. Coughlin10 involved a dispute between a borrower and an American Indian tribe involving a violation of the automatic stay in a chapter 13 in which the tribe continued collection efforts for a $1,100 debt. This resulted in a decision that heralded serious consequences for “governmental units” everywhere.11 Coughlin, with the identical Court composition, was another 8-1 decision (the majority opinion authored by Justice Jackson, with Justice Gorsuch being the sole dissenter), suggesting that the vast majority of the Justices felt pretty strongly about the analysis in Coughlin.

Coughlin represented a sea change when its rationale was applied to bankruptcy courts exercising jurisdiction over state agencies. The decision also was significant because of the sweeping language used in answering the more limited question before the Court.

Justice Jackson authored the majority opinion in Coughlin and held that the Bankruptcy Code “unequivocally abrogates” sovereign immunity for “any and every” and “all” governmental entities “that possesses the power to assert such immunity,” and that includes federally recognized tribes.12 The Court narrowly framed the issue before it as follows: “The question presented in this case is whether the express abrogation [in § 106(a) of the Bankruptcy Code] extends to federally recognized Indian tribes.”

The specific “governmental unit” before the Court was the American Indian tribe, which asserted sovereign immunity when the bankruptcy court tried to exercise jurisdiction over it for the stay violation at issue. While the issue was narrowly framed, the holding and analysis were unequivocally sweeping. The two Code sections at issue in Coughlin were §§ 106(a)13 and 101(27) (the definitional section for “governmental units”14). While the Coughlin decision was noteworthy, for purposes of this article the focus is on the broad and sweeping pronouncements supporting the Court’s holding in Coughlin:

We conclude that the Bankruptcy Code unequivocally abrogates the sovereign immunity of any and every government that possesses the power to assert such immunity.15

There is not a lot of ambiguity here. The Coughlin Court went out of its way to make sweeping pronouncements about the scope and extent of § 106(a). After discussing various metaphors, the majority decision doubled down on its earlier sweeping pronouncement and held:

Accordingly, we find that ... Congress unmistakably intended to cover all governments in § 101(27)’s definition, whatever their location, nature, or type. It is also significant that the abrogation of sovereign immunity in § 106(a) plainly applies to all “governmental unit[s]” as defined by § 101(27). Congress did not cherry-pick certain governments from § 101(27)’s capacious list and only abrogate immunity with respect to those it had so selected. Nor did Congress suggest that, for purposes of § 106(a)’s abrogation of sovereign immunity, some types of governments should be treated differently than others. Instead, Congress categorically abrogated the sovereign immunity of any governmental unit that might attempt to assert it.16

It is hard to envision a more sweeping pronouncement than that. In case the majority was not clear enough in the Supreme Court’s pronouncements prior to Coughlin, the Court recognized that the Bankruptcy Code of 1978 represented a “new, unprecedented era in bankruptcy practice” and further held that while “Congress may have treated governmental entities in bankruptcy law prior to 1978, it clearly altered its view about the scope of coverage relative to governments by the time it enacted § 101(27) and § 106(a). Those provisions unequivocally extend to all governments ... and we decline to read ambiguity into the statute where none exists.”17 Not a lot of wiggle room in that statement.

Hence, at least certainly philosophically, the same eight justices in Coughlin (and indeed the same Justice that authored the majority opinion) — who went out of their way to make sweeping pronouncements about the expansive scope of the “unequivocal,” “unprecedented and “categorically abrogated” nature of sovereign immunity in Coughlin as it pertains to governmental units — proceeded in Miller to go out of their way to find a workaround as to the federal government (indisputably the recipient of a fraudulent transfer) based on a perceived ambiguity in § 106(a).18

Simply put, the Supreme Court’s declining “to read ambiguity into the statute [§§ 101(27) and 106(a)] where none exists” in Coughlin apparently was not the order of the day by those same eight Justices (and indeed, the same Justice who authored Coughlin) when Miller was being decided. Moreover, nowhere in the Miller decision (majority or dissent) is there any reference to the broad proclamations of Coughlin.

While Coughlin found ultimately controlling the unambiguous language of the Bankruptcy Code, the Miller decision ignores the unambiguous language of § 106(a) and its unconditional reference to § 544 actions.19 The majority threads this needle by stating that the peculiar language of § 544(b) requiring that there be an actual creditor that could bring a fraudulent-transfer suit leads to the conclusion that § 106 would not have abrogated that defense had the actual creditor brought the action in a nonbankruptcy litigation setting prior to the bankruptcy filing. The majority opinion held that this does not completely eviscerate the Code’s abrogation of sovereign immunity by doing a good news/bad news conclusion. The good news is that the bankruptcy court still has jurisdiction over the IRS in what is undeniably a core bankruptcy proceeding.20 The bad news is that it just cannot provide any relief while exercising that jurisdiction as it relates to § 544(b) adversary proceedings.

Words Matter: Of “Waiver,” “Abrogation” and Springing “Annulled” Sovereign Immunity?

Words matter, especially when those words are being used by the highest court in the land. So, let’s look at the words at issue in § 106. While the title of § 106 is “Waiver of Sovereign Immunity,” the statute’s text never states that sovereign immunity is waived, but rather “abrogated.”21 Who cares? Potato/potahto? Hardly. One (waiver) focuses on the holder of a right relinquishing that right (through acquiescence or action). The other (abrogation) is the nonconsensual taking of a legal right by authoritative act.

The legal gymnastics in Miller aside, there is no discussion in the majority or dissenting opinions about what these words actually mean. Neither “waiver” nor “abrogation” are found in the defined terms of § 101. So, what do we do with this pesky “unambiguous” word found in § 106(a) that the Supreme Court felt so compelled by in Coughlin: “abrogated”? It is one of those words that lawyers like to say but when you look at what it actually means, one realizes it is a powerful transitive verb. According to the Merriam-Webster Dictionary (established in 1828), the verb “abrogate” means “to abolish by authoritative action; annul; to treat as nonexistent.” Synonyms include “vacate,” “cancel,” “nullify,” “rescind,” “void,” “repeal” and “dissolve” (among others).

Like an act that is deemed void ab initio, an abrogation is dead on arrival. Compare this to the noun “waiver,” which Webster defines as “the act of intentionally relinquishing or abandoning a known right, claim, or privilege,” with synonyms being “surrender,” “relinquishment” and “handover.” These are the opposite ends of the legal spectrum: The holder of a legal right is the only party that can “waive” that right; Congress, conversely, can “abrogate” a legal right — whether the holder likes it or not.

These are not legally inconsequential words. Indeed, § 106 was amended in 1994 to specifically replace the phrase “deemed to have waived sovereign immunity” with “sovereign immunity is abrogated.”22 The statutory changes were enacted to deal with the uncertainty surrounding sovereign immunity issues in avoidance actions as highlighted in two Supreme Court decisions.23 It is unclear what else Congress would need to do to convince the Supreme Court that “abrogate” means abrogate! The Court’s failure to even acknowledge the word choice issue is noteworthy in the face of both Coughlin and the amicus brief filed in Miller.24

As Coughlin recognized that the Bankruptcy Code’s adoption ushered in a “new, unprecedented era in bankruptcy practice,” and that “however Congress may have treated governmental entities in bankruptcy law prior to 1978, it clearly altered its view about the scope of coverage relative to governments by the time it enacted ... § 106(a).”25 Hence, the question becomes how precisely does one remain philosophically consistent by asserting that Congress unambiguously and categorically abolished sovereign immunity, but it is somehow revived for certain actions arising in a bankruptcy (indeed, a chapter 5 avoidance action, which is a fundamental core proceeding in a bankruptcy)? It seems to us as though dead is dead and should be construed as such.

Conclusion

We understand and appreciate that certain chapter 5 avoidance actions exist only upon filing for bankruptcy (such as preferences and unlawful post-petition transactions), while others straddle the pre- and post-bankruptcy universes (such as fraudulent transfers, which are always rooted in a prebankruptcy event, although the Bankruptcy Code provides two distinct bases to avoid such transfers). When the highest Court in the land uses absolute terms in a ruling like “unambiguous,” “unequivocal” and “categorical,” one would hope that the Justices would appreciate that word choice means something to those of us trying to apply their decisions. Perhaps the word choice in the title of § 106 (“waiver of sovereign immunity”), in contrast to the text of the statute itself (providing for “abrogation” of sovereign immunity), conceivably provides the ambiguity on which the Miller Court wanted to premise the Miller decision.26 Seems like a pretty thin thread, but the Supreme Court gets to do whatever it wants to. They rule, and lawyers react.

Miller is likely not the end of the discussion, but rather a doorway for other disputes as it is implemented. At least the open issues seem to present themselves.

Does Miller also preserve that same § 544(b) defense for state government agencies? States have an Eleventh Amendment claim to sovereign immunity, after all. Coughlin notwithstanding, if Miller is simply applied to the federal government and not states, states have been relegated to “second-class citizenship” in the federal scheme. One is left to wonder whether the IRS could file a claim in a bankruptcy and assert sovereign immunity when the trustee objects to that claim on the basis of the IRS having received a § 544(b) fraudulent transfer as a defense/setoff to the IRS claim.

The case also reinforces that all defendants should be named in these chapter 5 avoidance actions. While the obvious target of this § 544(b) action was the IRS (the “deep pockets”), one wonders whether the trustee also sued the embezzling officers for whose benefit the corporate money was used. Seems that they would certainly have liability for that amount, and to the extent that they themselves filed personal bankruptcies, the unauthorized use of corporate funds for personal tax obligations would likely trigger an exception-to-discharge action under § 523(a)(4) (fraud or defalcation while in a fiduciary capacity).

One is also left to ponder whether immediate or mediate transferees will indirectly get the benefit of this springing sovereign immunity. If the fraudulent transfer in question in Miller went from the corporation to the IRS (who would be the initial transferee), but for the benefit of the officers who had tax liability, the officers here would presumably be immediate transferees under § 550(a)(1) and (2) of the Bankruptcy Code. If the transfer to the initial transferee under state law is barred (hence, it cannot be recovered), would that give the immediate and mediate transferees a defense of saying that there was no avoidable transfer to start with, so that they have no “down the line” liability?

Timing in bankruptcy — as in life — is everything. If the same fraudulent transfer to the IRS as in Miller occurs 729 days before a filing, all bets are off and sovereign immunity remains “annulled.” Conversely, if the fraudulent transfer occurs 731 days before a filing, like a zombie, the annulled sovereign immunity rises from the dead.

Finally, to go from the sublime to perhaps the surreal, on the need for an actual creditor as a prerequisite to bring a § 544(b) action, what if the creditor is itself the federal government? What if the debtor corporation owed money because of overpayments of Medicare amounts or Environmental Protection Agency remediation fines, and the fraudulent transfer at issue was the embezzled funds going to the IRS at issue in Miller? Could the IRS assert sovereign immunity in that case?

And the beat goes on....

Thomas Salerno and Anthony Cali are partners in the Restructuring Group, and Ken Bellows is a law clerk, with Stinson LLP in Phoenix. Mr. Salerno is also a past ABI Vice President-Development.