The Ninth Circuit bent over backwards to hold that sovereign immunity protects a state from the imposition of compensatory and punitive damages for filing an involuntary bankruptcy petition that was dismissed.

The appeal involved Timothy Blixseth, the former owner of the bankrupt Yellowstone Mountain Club LLC, whose own financial problems spawned a mountain of litigation and appeals. The State of Montana and two other states filed an involuntary bankruptcy petition against Blixseth based on allegedly unpaid taxes.

Two states settled with Blixseth and withdrew as involuntary petitioners. The bankruptcy court dismissed the petition after deciding that Montana’s claim was subject to bona fide dispute. The district court and the Ninth Circuit both affirmed dismissal.

While the involuntary case was pending, the attorney for Montana answered questions from the bench that appeared to waive the state’s sovereign immunity.

After the bankruptcy was dismissed, Blixseth commenced an adversary proceeding under Section 303(i) seeking attorneys’ fees, costs and punitive damages. Asserting sovereign immunity, the state moved to dismiss. The bankruptcy court denied the motion to dismiss, ruling that the state had invoked the jurisdiction of the bankruptcy court and had waived sovereign immunity.

The Ninth Circuit Bankruptcy Appellate Panel dismissed the appeal for lack of appellate jurisdiction, believing that the collateral order doctrine did not apply. The state appealed to the Ninth Circuit and won in an August 14 opinion by Circuit Judge Johnnie B. Rawlinson.

Collateral Order and Appellate Jurisdiction

Judge Rawlinson laid out the contours of the collateral order doctrine based on Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541 (1949). She explained that there is appellate jurisdiction with regard to an interlocutory order “if the case finally determines a claim or claims collateral to claims asserted in the underlying action and the collateral claims are ‘too important to be denied review and too independent of the cause itself to require that appellate consideration be deferred until the whole case is adjudicated.’ Cohen, 337 U.S. at 546.”

Judge Rawlinson said that the Ninth Circuit and the Supreme Court “have applied Cohen and concluded that denials of sovereign immunity are immediately appealable under the collateral order doctrine.”

Judge Rawlinson reversed the BAP, found appellate jurisdiction via the collateral order doctrine, and proceeded to the merits.

The Involuntary Petition as a Waiver of Immunity

On the merits, Judge Rawlinson first examined whether the state had waived sovereign immunity by invoking the jurisdiction of the bankruptcy court. Of course, a state that files a proof of claim waives immunity, but Montana never filed a claim, just an involuntary petition.

Judge Rawlinson said she was not “persuaded” that a debtor’s claim under Section 303(i) was a compulsory counterclaim following the filing of an involuntary petition, because the claim and the Section 303(i) adversary proceeding did not arise from the same “factual predicate.” Similarly, she did not believe that Section 303(i) damages were analogous to Rule 11 sanctions.

Judge Rawlinson saw no waiver based on the filing of the involuntary petition given that “Blixseth’s allegations fail the logical relationship test in any event because Blixseth’s claim does not arise from the same ‘aggregate set of operative facts’ as the State’s involuntary petition.”

Counsel’s Waiver of Immunity

Citing the Supreme Court, Judge Rawlinson said that a state must make a “clear” and “unequivocal” declaration to waive immunity.

Judge Rawlinson said that the state’s “counsel could not and did not effect an ‘unequivocal’ waiver of [Montana’s] sovereign immunity through his statements to the court.” The opinion could be read to mean that counsel does not have authority to waive a governmental unit’s immunity.

Katz

Leading Supreme Court authority on the waiver of immunity in bankruptcy cases is Central Va. Cmty. Coll. v. Katz, 546 U.S. 356 (2006), where the Court held that the states’ ratification of the Constitution containing the Bankruptcy Clause effected a waiver for “core” bankruptcy proceedings.

Proceedings are “core,” and there is waiver, in three circumstances: (1) the exercise of exclusive jurisdiction over the debtor’s property; (2) the equitable distribution of the estate; and (3) the discharge giving the debtor a fresh start.

With regard to the first and second factors, Judge Rawlinson said that recovering damages under Section 303(i) was a remedial scheme neither necessary to the jurisdiction of the bankruptcy court nor related to the equitable distribution to creditors. Likewise, it did not fall under the third factor because the debtor’s Section 303(i) suit aimed to recover costs and was not part of the debtor’s fresh start.

Holding that the state properly asserted sovereign immunity, Judge Rawlinson reversed and remanded with instructions to dismiss the debtor’s Section 303(i) claims.