Whats Left of Sovereign Immunity after Katz

Journal Issue

May 2006

Column Name

Affairs of State

Citation

ABI Journal, Vol. XXV, No. 4, p. 10, May 2006

Bankruptcy Code

106

Topic Tags

Govt. Claims/Sovereign Immunity

Preferences

Journal HTML Content

Resolving a split among the circuits regarding the constitutionality of 11
U.S.C. §106(a), the Supreme Court held, in a 5-4 decision, that lawsuits
to avoid preferential transfers brought in federal bankruptcy court against
states or state agencies are not barred by the doctrine of sovereign immunity
established by the Eleventh Amendment. Central Virginia Community College
v. Katz, 126 S.Ct. 990 (2006). The decision retreated from statements contained
in Seminole Tribe of Florida v. Florida, 517 U.S. 44 (1996), in which
the Supreme Court indicated that the sovereign-immunity defense would apply
in bankruptcy-related proceedings. The decision constitutes the second decision
by the Supreme Court limiting, in the bankruptcy arena, the application of the
broad sovereign-immunity doctrine articulated in Seminole Tribe. In 2004,
the Supreme Court held that sovereign immunity did not bar an individual debtor's
action in federal bankruptcy court seeking a hardship discharge of student loan
debt. Tennessee Student Assistance Corp. v. Hood, 541 U.S. 440 (2004).

Tortured History
 States' sovereign immunity from suit in federal court began shortly after
ratification of the Constitution when the Supreme Court, in Chisholm v. Georgia,
2 U.S. (2 Dall.) 419 (1793), permitted a suit by a citizen of the state of South
Carolina against the state of Georgia to proceed in federal court based on diversity
of citizenship. The Eleventh Amendment, which provides that "the judicial
power of the United States shall not be construed to extend to any suit in law
or equity, commenced or prosecuted against one of the United States by citizens
of another state, or by citizens or subjects of any foreign state," was
enacted in response to the Chisholm decision. Young, Gordon, Comment:
Seminole Tribe v. Florida, 56 Md. L. Rev. 1411, 1413 (1997).
The presupposition underlying the Eleventh Amendment is that the states retain
certain attributes of sovereignty and that it would violate the sovereignty
retained by the states for the federal courts to exercise jurisdiction over
them without their consent. Hans v. Louisiana, 134 U.S. 1, 15 (1890).
Sovereign immunity under the Eleventh Amendment is not limited to suits based
on diversity of citizenship, but also bars suits against a state by its own
citizens (Edelman v. Jordan, 514 U.S. 651, 662-663 (1974)) and suits
invoking federal question jurisdiction under Article 3 of the Constitution.
Idaho v. Coeur d'Alene Tribe of Idaho, 517 U.S. 44 (1997).

The seminal modern case addressing sovereign immunity is Seminole Tribe
of Florida v. Florida, 517 U.S. 44 (1996). In Seminole Tribe, the
Supreme Court addressed a challenge by the state of Florida to certain provisions
of the Indian Gaming Regulatory Act, which Congress had passed pursuant to the
Indian Commerce Clause of Article 1 of the Constitution. Seminole Tribe, 517
U.S. at 47. The state of Florida contended that the Indian Gaming Regulatory
Act's provisions authorizing a tribe to bring suit in federal court in order
to compel performance of the statutory duty imposed upon states to negotiate
in good faith with the tribes regarding gaming activities violated the Eleventh
Amendment. Id.
Reasoning that the Eleventh Amendment restricts the judicial power under Article
III and that Article I cannot be used to circumvent the constitutional limitations
placed on the jurisdiction of the federal courts, the Supreme Court enunciated
a two-part test to determine whether specific legislation validly abrogates
state sovereign immunity. First, a court must determine whether there is an
unequivocal expression of congressional intent to overturn constitutionally
guaranteed immunity. If the congressional intent is clear, courts then must
determine whether Congress acted pursuant to a valid grant of power to it by
the states in the Constitution itself. Seminole Tribe, 517 U.S. 44, 72-73.
The Supreme Court determined that the provision of the Indian Gaming Regulatory
Act permitting tribes to sue states in federal court violated this test, stating
that "even when the Constitution vests complete lawmaking authority over
a particular area, the Eleventh Amendment prevents congressional authorization
of suits by private parties against unconsenting states." Seminole Tribe,
517 U.S. 44, 72-73.
This decision expressly overruled the Supreme Court's decision in Pennsylvania
v. Union Gas Co., 491 U.S. 1 (1989), in which the Supreme Court held that
Congress could enact legislation pursuant to its powers under Article I of the
Constitution, specifically the Interstate Commerce Clause of the Constitution,
abrogating the sovereign immunity of the states. After Seminole Tribe,
the Supreme Court reaffirmed its holding that Congress may not abrogate sovereign
immunity under the Eleventh Amendment based on powers enumerated in Article
I of the Constitution. See Board of Trustees of Univ. of Alabama v. Garrett,
531 U.S. 356, 362 (2001).

Relevant to bankruptcy practitioners, the majority in Seminole Tribe
addressed, in a footnote, Justice Stevens' assertion in his dissenting opinion
that the majority opinion prohibits "federal jurisdiction over suits to
enforce the bankruptcy, copyright and antitrust laws against the states."
Seminole Tribe, 517 U.S. at 73 n. 16. The majority dismissed this conclusion
as "exaggerated both in its substance and its significance," noting
that "although the copyright and bankruptcy laws have existed practically
since our nation's inception, and the antitrust laws have been in force for
over a century, there is no established tradition in the lower federal courts
of allowing enforcement of those federal statutes against the states."
Id.
The Circuits Split
In the wake of the Seminole Tribe decision, the majority of circuit
courts, relying, in part, on the language contained in footnote 16 of the Seminole
Tribe decision, concluded that §106(a) was unconstitutional and did
not abrogate state sovereign immunity. For example, the Fourth Circuit, in two
separate cases, concluded that §106(a) of the Code, as applied in the case
before it, was unconstitutional. Maryland v. Schlossberg (In re Creative
Goldsmiths of Washington D.C.), 119 F.3d 1140, 1147 (4th Cir. 1997); In
re NVR LP, 189 F.3d 442 (4th Cir. 1999) (despite federal court ruling that
debtor was exempt from Maryland and Pennsylvania transfer and recording taxes,
Fourth Circuit permitted Maryland and Pennsylvania to retain transfer and recording
taxes paid by debtor).

Likewise, in Sacred Heart Hosp. v. Department of Public Welfare (In
re Sacred Heart Hosp.), 133 F.3d 237, 243 (3d Cir. 1998), the Third Circuit
concluded that certain Pennsylvania agencies were immune from suit in federal
court by the debtor hospital under the Eleventh Amendment notwithstanding the
purported abrogation of sovereign immunity in §106(a). Relying on Seminole
Tribe, the Third Circuit reasoned that there simply was "no principled
basis to distinguish the Bankruptcy Clause from other Article 1 clauses."
In Mitchell v. Franchise Tax Bd. (In re Mitchell), 209 F.3d 1111,
1121 (9th Cir. 2000), the Ninth Circuit affirmed the dismissal of an adversary
proceeding brought by chapter 7 debtors seeking a determination of the dischargeability
of tax debt on the basis that the suit was barred by the Eleventh Amendment.
In contrast, the Sixth Circuit concluded that Congress could enact legislation
under the Bankruptcy Clause abrogating the immunity of the states from suit
in adversary proceedings in bankruptcy courts. Hood v. Tennessee Student
Assistance Corp. (In re Hood), 319 F.3d 755, 764-768 (6th Cir. 2003).
Hood involved an adversary proceeding brought by a chapter 7 debtor against
the Tennessee Student Assistance Corp. (TSAC) seeking a hardship discharge from
student loan debt pursuant to §523(a)(8) of the Code. TSAC moved to dismiss
the adversary proceeding on the basis of sovereign immunity. The Sixth Circuit
concluded that the suit was not barred by sovereign immunity because it was
not an instance in which a private party could drag a state into court against
its will but involved an adjudication of interests claimed in a res, in which
the TSAC could assert an interest or decline to do so. Id. at 768.

The Supreme Court granted certiorari to resolve the split among the
circuits regarding Congress' power to abrogate state sovereign immunity under
the Bankruptcy Clause, but ultimately determined the Hood case on different
grounds. Specifically, the Supreme Court held that sovereign immunity was not
implicated in the determination of whether the debtor was entitled to a hardship
discharge because that determination fell within the exercise of the bankruptcy
court's in rem jurisdiction. "A bankruptcy court's in rem
jurisdiction permits it to 'determin[e] all claims that anyone, whether named
in the action or not, has to the property or thing in question.'" Hood,
541 U.S. at 448.
 Adding to the confusion regarding the application of sovereign immunity were
holdings that, just as a creditor could waive its Seventh Amendment right to
a jury trial by filing a proof of claim pursuant to the Supreme Court's holding
in Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989), a state could
waive any sovereign immunity to which it may otherwise be entitled under the
Eleventh Amendment by merely filing a proof of claim in a bankruptcy case. See,
e.g., In re Barrett Refining Corp., 221 B.R. 795, 809-810 (Bankr.
W.D. Okla. 1998); In re Stoecker, 202 B.R. 429, 448 (Bankr. N.D. Ill.
1996). Reliance for this result was placed in part on the Supreme Court's holding
in New York v. Irving Trust Co., 288 U.S. 329, 333 (1933).

Katz Presents the Issue Squarely
In Katz, Bernard Katz (the trustee), the liquidating supervisor for
the bankruptcy estate of Wallace Bookstores Inc., filed complaints against four
Virginia state colleges that alleged that the state colleges received preferential
transfers during the 90-day period before Wallace commenced its chapter 11 case.
Wallace had operated a chain of college bookstores. Only one of the four institutions
sued by the trustee, Virginia Military Institute, had filed a proof of claim
in Wallace's bankruptcy case. In the adversary proceedings, Katz sought to avoid
the transfers and entry of money judgments against the state colleges pursuant
to §§547 and 550 of the Code. The state colleges filed motions to
dismiss the lawsuits on the grounds that the claims were barred by the doctrine
of sovereign immunity under the Eleventh Amendment. Central Virginia Community
College v. Katz, 126 S.Ct. 990, 994-995 (2006).
The Supreme Court primarily relied on the history surrounding the adoption
of the Constitution's Bankruptcy Clause in reaching the conclusion that the
lawsuits were not barred by the doctrine of sovereign immunity. The Court noted
the statements in the majority and dissenting opinions in Seminole Tribe
that indicated that the holding therein would apply to the Bankruptcy Clause,
but dismissed those statements as dicta. In reaching its conclusion that the
lawsuits were not barred by the Eleventh Amendment, the Supreme Court emphasized
that the "critical features" of every bankruptcy proceeding are the
exercise of exclusive jurisdiction over the debtor's property, the equitable
distribution of the debtor's property and the discharge of the debtor's indebtedness.
Id. at 996-997.
The Court further reasoned that one of the principal reasons the Bankruptcy
Clause was included in the Constitution was to resolve the inconsistency among
debt laws in the states (noting that the only consistency was the use of imprisonment
for debt by every state) and the perceived inequity of debtors discharged in
one state as a result of turning over all of their assets for liquidation being
imprisoned in another state for the same debts. The Supreme Court also noted
that the federal habeas corpus power was applied to prisoners held in
state prison after being discharged of their debts by another state for approximately
67 years before the federal habeas corpus power became applicable to
all prisoners. Id. at 1003.

After examining the historical context in which the Bankruptcy Clause was adopted,
the Supreme Court concluded that the Bankruptcy Clause was intended not only
to grant Congress power to enact a uniform federal bankruptcy law, but also
as a consent by the states to waive state sovereign immunity in the bankruptcy
arena, including in actions to avoid preferential transfers. Id. at 1002.
Accordingly, the state college defendants were not protected by sovereign immunity
under the Eleventh Amendment from suits to avoid preferential transfers.
In dissent, Justice Thomas (joined by Chief Justice Roberts and Justices Scalia
and Kennedy) argued that the grant of authority to enact a uniform federal bankruptcy
law and the use of habeas corpus to remove debtors from state prisons
did not mean that the states consented to being sued for the entry of money
judgments in federal court. Justice Thomas noted that for most of the Nineteenth
Century, no national bankruptcy law existed. He argued that this fact refuted
the majority's view that a national bankruptcy law was of such importance to
the framers that the states intended to consent to the jurisdiction of federal
courts in the bankruptcy arena through the Bankruptcy Clause. Katz, 126
S.Ct. at 1009-1010 (Thomas, J., dissenting). The dissent further argued that
the framers' concern with discharge orders entered by one state binding other
states implicated no more than the application of the full faith and credit
provisions of the Constitution and had nothing to do with state sovereign immunity.
Finally, the dissent noted that in Hood, the Supreme Court distinguished
avoidance actions against states from discharge proceedings and emphasized that
the majority's decision fell outside any possible in rem exception to
sovereign immunity. Id. at 1013.

Journal Authors

Joseph J. Bellinger

Matthew G. Summers

Journal Date

Monday, May 1, 2006 - 12:00

Bankruptcy Rule

2006

none