Defining the Governmental Unit

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Apr 2004

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An array of policy considerations are embodied in the Bankruptcy Code and its treatment of "governmental units."
For example, §362(b)(4) provides that the automatic stay does not apply to the exercise of the "police and regulatory
power of a governmental unit." Section 106 provides that "sovereign immunity is abrogated as to a governmental
unit" as set forth in that section. Section 523(a)(7) provides an exception to the discharge of individual debtors for
certain debts payable to "governmental units." Section 525(a) provides that a "governmental unit" may not
discriminate against persons solely because of a bankruptcy or pre-bankruptcy insolvency.

In order to effectuate these and other provisions of the Bankruptcy Code and the Federal Rules of
Bankruptcy Procedure, it is necessary to determine whether the acting organization is a "governmental
unit." Governmental unit is defined in §101(27) of the Bankruptcy Code as the

United States, state, commonwealth, district, territory, municipality, foreign state, department, agency or
instrumentality of the United States (but not a U.S. Trustee while serving as a trustee in case under this title), a
state, a commonwealth, a district, a territory, a municipality or a foreign state; or other foreign or domestic
government.
</blockquote>

The Bankruptcy Code also provides that a "governmental unit" is an "entity," but in most cases, is not a
"person."<a href="#1" name="1a">1</a> The legislative history states an intention to define

<blockquote>
"governmental unit" in the broadest sense... "Department, agency or instrumentality" does not include entities that
owe their existence to state action, such as the granting of a charter or license, but that have no other connection
with a state or local government or the federal government. The relationship must be an active one in which the
department, agency or instrumentality is actually carrying out some government function.<a href="#2" name="2a">2</a>
</blockquote>

"United States," "state," "district" and "territory" are relatively unambiguous manifestations of the government. At
the level of "department," "agency" and "instrumentality," however, the definitional line begins to blur, and
additional analysis is necessary. Courts have held that utility commissions,<a href="#3" name="3a">3</a> transit authorities,<a href="#4" name="4a">4</a> liquor authorities<a href="#5" name="5a">5</a>

and state universities<a href="#6" name="6a">6</a> are "governmental units." Private organizations that are wholly or in part funded by public
funds have been found not to be "governmental units."<a href="#7" name="7a">7</a>

Some case law intimates that an organization may be a "governmental unit" for some purposes and not others.<a href="#8" name="8a">8</a> In
Wade v. State Bar of Arizona (In re Wade), 948 F.2d 1122, 1123-24 (9th Cir. 1991), the appeals court for the
Ninth Circuit affirmed Bankruptcy Appellate Panel (BAP) and bankruptcy court decisions that found that the State
Bar of Arizona was not stayed, as a "governmental unit" under §362(d)(4), from instituting post-petition
disciplinary proceedings against a debtor attorney. The state bar acknowledged that it was not a "governmental unit"
in every instance, but persuasively argued that the prosecution of disciplinary proceedings made the bar an
"instrumentality" of the Arizona Supreme Court, and thus, a "governmental unit." Id. at 1123.

In support of its decision, the Wade appeals court noted that the U.S. Supreme Court had held that the State Bar of
Arizona engaged in "state action" in the conduct of disciplinary proceedings in Bates v. State Bar of Arizona, 433
U.S. 350, 359, 97 S. Ct. 2691, 2696, 53 L.Ed.2d 810 (1977).<a href="#9" name="9a">9</a> Although the Supreme Court's "state action"
analysis in Bates arose in a non-bankruptcy context, courts routinely look to non-bankruptcy case law, policy and
legislation to determine "governmental unit" status for purposes of §101(27) of the Bankruptcy Code.

<h3>The "Important Government Function" Test</h3>

In TI Federal Credit Union v. DelBonis, 72 F.3d 921 (1st Cir. 1995), the First Circuit Court of Appeals examined
the question of whether a federal credit union was an "instrumentality" and a "governmental unit" for the purpose of
determining the dischargeability of student loans pursuant to §523(a)(8) of the Bankruptcy Code.<a href="#10" name="10a">10</a> Finding no
"settled process" for its analysis, the appeals court undertook an approach based on a "combination of statutory
interpretation, case law and consideration of the factors relevant to federal instrumentality determination." Id. at 931.

The paramount consideration articulated by the DelBonis court was whether the entity in question "performs an
important governmental function."<a href="#11" name="11a">11</a> The appeals court, drawing from a variety of sources, reviewed in detail the
history of the Federal Credit Union Act, and the multifarious salutary purposes served by federal credit unions,
including the provision of credit to the working class and as "fiscal agents of the United States and depositories of
public monies." Id. at 931-32. The court noted that for decades, federal court decisions had recognized the
importance of the functions served by credit unions in a variety of contexts. Id. at 931-35. Tax exemption, and
extensive federal regulation, also weighed in favor of federal credit union status as a federal "instrumentality."<a href="#12" name="12a">12</a> The
appeals court acknowledged the similarities between modern credit unions and private banks, but rejected the
debtor's argument that such similarities precluded a finding that federal credit unions "perform a predominantly
governmental purpose." Id. at 933.

Interestingly, the DelBonis court did not conclude its analysis upon finding that federal credit unions are
government "instrumentalities." The court went on, in some detail, to determine whether "treating federal credit
unions as...governmental units is consistent with purposes of 11 U.S.C. §523(a)(8)." Id. at 935-36. The court
opined at length on the merits of the exception to dischargeability set forth at §523(a)(8) of the Code, and the
importance of maintaining the viability of federal student loan programs, and found that its conclusions were
consistent with the purposes of the Code as indicated by Congress. Id. at 935-38.

Like Wade, the DelBonis analysis embraces the concept that an organization may be a governmental unit for some
purposes, but not others. The DelBonis court went further, however, and was willing to examine the validity of the
governmental unit designation when the "purpose" in question was the effectuation of a provision of the Bankruptcy
Code.

<h3>The Question of "State Action"</h3>

As noted above, the Wade court made a brief reference to "state action" jurisprudence. Other courts have apparently
been less willing to engage the substantial and complex body of "state action" law arising in the federal
constitutional context to resolve "governmental unit" questions under the Bankruptcy Code. Indeed, "state action"
opinions have been criticized for having the appearance of being "outcome determinative."<a href="#13" name="13a">13</a>

In 2001, the U.S. Supreme Court decided Brentwood Academy v. Tennessee Secondary School Athletic
Association.<a href="#14" name="14a">14</a> In Brentwood, the Supreme Court attempted to clarify the analytical framework for deciding "state
action" questions. Justice Souter, writing for the majority, noted that "state action" has been traditionally found
under three scenarios: first, when the actor is beholden to the "coercive power" of the state; second, when the actor
has been tasked with a "public function" of the state; and third, when the actor is "entwined with governmental
policies...management or control."<a href="#15" name="15a">15</a> Following Brentwood, at least one bankruptcy court has taken up the
challenge of directly relating traditional "state action" principals to the question of "governmental unit" status.

In In re Marcano, 288 B.R. 324 (Bankr. S.D.N.Y. 2003), the U.S. Bankruptcy Court for the Southern District of
New York consolidated, for purposes of a memorandum opinion, a pair of cases with similar issues. Both
individual debtors treated in the opinion argued that their separate landlords were "governmental units," and thus the
landlords' eviction attempts based on failure to pay pre-petition dischargeable rent were in violation of §525(a) of
the Code.

Both cases implicated In re Stoltz, 315 F.3d 80, 90 (2d Cir. 2002), in which the Second Circuit Court of Appeals,
applying §525(a), held that a governmental unit may not evict a tenant from public housing solely for failure to pay
dischargeable pre-petition rent. The question in both Marcano cases was whether the landlord was a "governmental
unit" for purposes of §525(a).

The Marcanos were an elderly couple with a social security income renting a residence in a building owned by the
city. Marcano, 288 B.R. at 326. Under a city-sponsored renewal program, the building's residents had formed a
private tenant's association (TA) to lease the building from the city, and to take on the responsibility for its
maintenance and management. Id. at 326-27. Thus, the TA acted as landlord for the property. Pursuant to the city's
renewal program, the TA had the option of purchasing the building from the city, but had not done so. Id. at 327.

The TA obtained a warrant for eviction against the Marcanos for failure to pay rent. Id. Execution of the warrant,
however, was stayed pursuant to a stipulation between the parties that required the Marcanos to make payments. Id.
At that point, Mr. Marcano filed a petition for relief under chapter 7. Id. Marcano argued that the TA was a
governmental unit by virtue of the city's "control and influence" over the TA under the city's renewal program, and
thus, following Stoltz, his eviction for non-payment of pre-petition dischargeable rent was improper under §525(a)
of the Code. Id.

The Marcano court, citing Brentwood, characterized Marcano's argument as falling under the concept of
"entwinement." Id. at 334. The court noted that although the landlord TA was ostensibly a private entity, the city's
renewal program provided a highly regulated framework for the TA's activities. Id. at 334-35. These activities were
intricately supervised by the city or a city agency at several levels, including the setting of rents, access to tenant
bank accounts, rights of physical access and an approval requirement for any sale of the property. Id.

Moreover, the Marcano court noted that other courts had found that private tenant associations organized under the
city's renewal program were subject to constitutional restraints as "state actors," entitling tenants to due-process
protections in the non-bankruptcy context. Id. at 335. The Marcano court found that "[u]nder these cases, where the
state is so clearly 'entwined' with the tenant association that the tenant has a right to due process before being
evicted, it would be anomalous to conclude that the TA is not a 'governmental unit' for purposes of the
anti-discrimination provisions of §525(a)." Id.

In the second matter decided in the Marcano opinion, another elderly tenant with a social security income, Gayle,
was faced with eviction and filed a petition for chapter 7 relief. Id. at 328-29. Gayle lived in a dormitory-style
residence designed primarily to "alleviate the problem of homelessness" in New York City. Id. at 328. The
residence was owned and operated by landlord Volunteers of America Inc. (VOA), a private faith-based organization.

Id. VOA's activities were overwhelmingly funded from government sources. Id.

Gayle argued that the VOA, as the largest provider of homeless services in New York City, performed a "public
function," and thus was a governmental unit subject to the restrictions set forth under §525(a) of the Bankruptcy
Code. Id. at 334. The Marcano court found that Gayle's position predominantly fell within Brentwood's "public
function" test for determining "state action." Id.

The Marcano court, citing Rendell-Baker v. Kohn, 457 U.S. 830, 102 S. Ct. 2764, 73 L.Ed.2d 418 (1982), first
noted that the mere performance of a "public function" by an organization did not support a finding of "state action"
unless the function in question has been "traditionally the exclusive prerogative of the state."<a href="#16" name="16a">16</a> Thus, the VOA's
receipt of public funds was not determinative, nor was its tax-exempt status. Marcano, 288 B.R. at 336-37. The

Marcano court acknowledged that shelter was of "critical importance to life and health," but also stated that
"housing is not a function essentially reserved for the state."<a href="#17" name="17a">17</a> Concluding that VOA's important public services
were nonetheless not "exclusive" state functions, the court held that VOA was not a governmental unit, and Gayle's
eviction could proceed notwithstanding §525(a) of the Bankruptcy Code. Id. at 337-38.

The Marcano decisions highlight some of the challenges associated with the application of traditional "state action"
analysis. While Brentwood has some appeal as a relatively coherent articulation of "state action" jurisprudence, the
application of unique facts into a single categorization—classification as a "public function" or "entwinement"
argument—appears somewhat arbitrary. It is difficult to imagine an organization meeting the "public function" test if the function at issue must be shown to be
otherwise the "exclusive prerogative of the state." Under that strict standard, even DelBonis may have been decided
differently.

<h3>Conclusion</h3>

As the case law demonstrates, the determination of "governmental unit" status can be critical to the outcome of a
case. Beyond the obvious incarnations of "the government," no universal test exists for the determination, and the
courts have adopted a variety of approaches. On either side of the issue, a savvy practitioner should be familiar with
the line of reasoning favored by the jurisdiction, or the judge called upon to decide whether an organization is a
"governmental unit."

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> See 11 U.S.C. §101(15) ("entity"); 11 U.S.C. §101(27) ("person"). <a href="#1a">Return to article</a>

<a name="2">2</a> H.Rep. No. 95-595, 95th Cong., 1st Session 311 (1977), U.S. Code Cong. & Admin. News 1978, p. 5787 (1977), reprinted in App. C Collier on Bankruptcy, Pt. 4(d)(i), 4-1437. <a href="#2a">Return to article</a>

<a name="3">3</a> See In re Begley, 46 B.R. 707 (E.D. Pa. 1984). <a href="#3a">Return to article</a>

<a name="4">4</a> See In re Marine Electric Railway Products Division Inc., 17 B.R. 845 (Bankr. E.D.N.Y. 1982). <a href="#4a">Return to article</a>

<a name="5">5</a> See In re Maley, 9 B.R. 832 (Bankr. W.D.N.Y. 1981). <a href="#5a">Return to article</a>

<a name="6">6</a> See In re Howen, 10 B.R. 303 (Bankr. D. Kan. 1980). <a href="#6a">Return to article</a>

<a name="7">7</a> See, e.g., In re Joliet-Will County Community Action Agency, 847 F.2d 430 (7th Cir. 1988). <a href="#7a">Return to article</a>

<a name="8">8</a> See, e.g., In re Reliance Holdings Inc., 273 B.R. 374, 387 & n. 19 (Bankr. E.D. Pa. 2002) ("A court may consider whether an entity is a 'governmental unit' when performing a
particular activity."). <a href="#8a">Return to article</a>

<a name="9">9</a> Wade, 948 F.2d at 1124. <a href="#9a">Return to article</a>

<a name="10">10</a> The appeals court in DelBonis dealt with a prior version of §523(a)(8) of the Bankruptcy Code. The result reached in the case, however, would presumably not be affected by the
changes to §523(a)(8) effected by the Higher Education Amendments of 1998. Due to an erroneous stipulation between the parties at the bankruptcy court level, the bankruptcy
court and district court rulings in DelBonis were decided upon the status of the credit union as a "nonprofit" under §523(a)(8), and the status of the credit union as a
"governmental entity" was not addressed by the lower courts. DelBonis, 72 F.3d at 927. <a href="#10a">Return to article</a>

<a name="11">11</a> DelBonis, 72 F.3d at 931 (quoting United States v. Michigan, 851 F.2d 803, 806 (5th Cir. 1988)). <a href="#11a">Return to article</a>

<a name="12">12</a> Id. at 933-34. The DelBonis court took care to note that tax-exempt status alone does not indicate the existence of a federal instrumentality. <a href="#12a">Return to article</a>

<a name="13">13</a> See, e.g., Drew, Josaih N., "Note: The Sixth Circuit Dropped the Ball: An Analysis of Brentwood Academy v. Tennessee Secondary School Athletic Ass'n. in the Light of the
Supreme Court's Recent Trends in State Action Jurisprudence," 2001 B.Y.U. L. Rev. 1313, 1343 (2001). <a href="#13a">Return to article</a>

<a name="14">14</a> 531 U.S. 288, 121 S. Ct. 924, 148 L.Ed.2d 807. <a href="#14a">Return to article</a>

<a name="15">15</a> Brentwood Academy, 531 U.S. at 296. <a href="#15a">Return to article</a>

<a name="16">16</a> Marcano, 288 B.R. at 336-37 (quoting from Rendell-Baker, 457 U.S. at 842). <a href="#16a">Return to article</a>

<a name="17">17</a> Id. at 337 (quoting from Young v. Halle Housing Assoc., 152 F.Supp.2d 355, 365 (S.D.N.Y. 2001)). <a href="#17a">Return to article</a>

Journal Authors

Marvin E. Sprouse

Journal Date

Thursday, April 1, 2004 - 12:00

Bankruptcy Rule

2004