Immunity Blackouts In re Lazar Toxic Torts and the 11th Amendment

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Sep 2001

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In January 2001, the Ninth Circuit, in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lazar, 237 F.3d 967
(9th Cir. 2001)</a>, considered several interesting sovereign immunity and priority
issues. These issues stemmed from a chapter 11, turned chapter 7, involving the
California Underground Storage Tank Cleanup Fund. Because these issues are not novel
to the California State Water Resources Control Board (SWRCB) and have "reared
their ugly heads" in garden-variety bankruptcy cases, I have devoted this article to
examining In re Lazar.

In re Lazar involves the consolidated bankruptcy appeals of the SWRCB and the
cleanup fund. Both the state board and the fund raised Eleventh Amendment issues.
On cross-appeal, the bankruptcy trustee, under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §507</a> (a)(8),
sought the reversal of a district court order holding that "fees payable to the fund
are 'taxes' for bankruptcy purposes." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3d at 971</a>.

On July 27, 1992, Grace and Gary Lazar voluntarily filed for chapter 11
reorganization on behalf of their corporations as well as for themselves. The Lazars
took this action because the state of California seized their bank accounts due to
their failure to pay gasoline taxes. Particularly, the Lazars did not make
contributions to the fund. Subsequently, on Sept. 14, 1994, these cases were
converted to chapter 7. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

The Barry Keane Underground Storage Cleanup Trust Fund Act established the fund,
which is a state board-administered reimbursement program. Small gasoline purveyors use
the fund so that they may comply with the <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Conservation and Recovery Act,
42 U.S.C. §6901</a> et seq. (1994). The act requires small gasoline
purveyors "to demonstrate financial ability to pay clean-up claims for damages caused
by their leaking underground storage tanks." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 972</a>. California created the
fund so that small gasoline purveyors could make claims from "the fund to recover costs
associated with corrective action taken in response to unauthorized releases. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=….
Health & Safety Code §25299.54 (West 1999 & Supp. 2000)</a>." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

The small gasoline purveyors finance the fund by paying a fee based on the amount of
gasoline or other petroleum products that they store in permitted tanks. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

The Lazars failed to make necessary payments to the fund. For that reason, during
the 1993-95 bankruptcy proceedings the controller of the state of California
and the California State Board of Equalization (BOE) filed proofs of claim for
$31 million and $13 million, respectively. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

Additionally, the trustee filed 20 claims for reimbursement from the fund.
However, the state board denied each of these claims due to a finding of misconduct
by the Lazars. Appealing this decision, the trustee exhausted his administrative
remedies and filed a petition for Peremptory Writ of Administrative Mandamus or Other
Appropriate Writ against the state board in California's superior court. Shortly
thereafter, in accordance with <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §1452</a>, the trustee filed a Notice
of Removal of the Mandamus Adversary to the U.S. Bankruptcy Court. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 972</a>

In response, the state board filed a Motion for Remand or in the Alternative
Abstention and Remand, claiming that "the bankruptcy court's subject matter jurisdiction
over the action was foreclosed by the Eleventh Amendment." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 973</a>. The
bankruptcy court rejected this, as well as the other state board arguments. The state
board appealed. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

During that time, the trustee moved for partial summary judgment against the state
of California, the state board and the fund (tax adversary). He asked that the
court determine "(1) whether the fund is an arm of the state capable of invoking
immunity under the Eleventh Amendment, and (2) whether the monies paid into the
fund are properly characterized as 'fees,' not 'taxes.'" <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 973-74</a>
(footnote omitted). On appeal, the district court found that the fund was not an
arm of the state and that the monies were "taxes." Both the fund and the trustee
appealed to the Ninth Circuit.

<h3>Did Filing Proofs of Claim Waive the State's Immunity?</h3>

When making its ruling, the court set forth the following case law that
establishes states' rights under the Eleventh Amendment.

In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Tribe v. Florida, 517 U.S. 44, 72-73, 116 S.Ct.
1114, 134 L.Ed.2d 252 (1996)</a>, the U.S. Supreme Court indicated
that the Eleventh Amendment applies to bankruptcy proceedings. However, the states'
immunity under the Eleventh Amendment is not absolute. In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Sav. Bank v.
Florida Prepaid Post-secondary Educ. Expense Bd., 527 S.S. 666, 119
S.Ct. 2219, 2223, 144 L.Ed.2d 605 (1999)</a>, the Supreme
Court ruled that "[a] state may waive its sovereign immunity by consenting to suit."
"When the state becomes the actor and files a claim against the fund, it waives
any immunity which it otherwise might have had respecting the adjudication of the
claim.'" <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. New Jersey, 329 U.S. 565, 573-74, 67 S.Ct.
467, 91 L.Ed. 504 (1947)</a>.

In accordance with the above case law, the court found that the state board did,
in fact, waive its sovereign immunity by filing its proofs of claim against the
debtors. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 237 F.3d at 976</a>. The court then considered the extent of
this waiver. Looking to the (often varying) rulings of other circuits, the court
held the following:

<blockquote>
We hold today that when a state or an arm of the state files a proof of claim
in a bankruptcy proceeding, the state waives its Eleventh Amendment immunity
with regard to the bankruptcy estate's claims that arise from the same transaction
or occurrence as the state's claim.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 978</a> (emphasis added).

Based on this rule, the court held:

<blockquote>
Accordingly, because the BOE filed proofs of claim in the bankruptcy proceeding
that arise out of the same transaction or occurrence as the trustee's claims
against the state board in the Mandamus Adversary, the state board has waived
its Eleventh Amendment immunity in the Mandamus Adversary.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 980</a>.

Consequently, by filing a proof of claim in the bankruptcy proceeding, the state
board effectively waived its sovereign immunity in the subsequent Mandamus Adversary.

<h3>The Fund Is an Arm of the State</h3>

When deciding whether the fund could avail itself of the protections under the
Eleventh Amendment (whether the fund was an arm of the state), the court looked to
(1) whether a money judgment would be satisfied out of state funds, (2) whether
the entity performs central governmental functions, (3) whether the entity may sue or
be sued, (4) whether the entity has the power to take property in its own name
or only in the name of the state, and (5) the corporate status of the entity.
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 982</a> (quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Citibank N.A., 950 F.2d 1419,
1423 (9th Cir. 1991)</a>).

The court decided that the fund is an arm of the state, and in so ruling
primarily relied on the second Durning factor. The court examined the purpose of the
fund and stated that "the California legislature created the fund to protect public
health and safety and the environment in light of the perception that 'a significant
number of the underground storage tanks containing petroleum in the state may be
leaking.'" <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 983</a> (quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. Health & Safety Code
§25299.10(b)(1), (3) (West 1999 & Supp. 2000)</a>). Based on
its purpose as well as the fact that the California Health and Safety Code
established the state as the fund's "source of power and its ultimate regulator," the
court concluded that the fund performs "central governmental functions" under the second

Durning factor. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; Hence, given the weight of this factor, the court held that
the fund is an arm of the state and, as such, may assert its immunity under the
Eleventh Amendment.

<h3>Because the District Court's Decision That Fees Paid into the Fund Were Taxes Under 11
U.S.C. §507(a)(8) Was Not Final, the Court Could Not Consider the Trustee's Appeal</h3>

When determining the validity of the district court's ruling that the fees paid into
the fund constituted taxes, the court looked to whether it had jurisdiction to consider
this issue. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 984-85</a>. The court then set forth the basic rules of
district court and appellate review. Citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §158(d)</a>, the court
stated that a court of appeals has "jurisdiction of appeals from all final decisions,
judgments, orders and decrees entered under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §158(a)</a>." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at
984-85</a>. Further, according to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §158(a)</a>, "[a] district court
has jurisdiction over a bankruptcy appeal from (1) final judgments, orders or
decrees, and (2) interlocutory orders with leave from the bankruptcy court." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

(quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §158(a)</a>). A bankruptcy order is final "where it (1)
resolves and seriously affects substantiate rights and (2) finally determines the
discrete issue to which it is addressed." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 985</a> (quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Offices of
Nicholas A. Franke v. Tiffany (In re Lewis), 113 F.3d 1040, 1043
(9th Cir. 1997)</a>).

In this case, the trustee averred that the order concerning the motion for partial
summary judgment was final. In so arguing, the trustee stated that "characterization
[of the monies payed into the fund] will determine the priority of payments...because
taxes have priority and fees do not." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 985</a>. The court pointed out,
however, that the tax adversary actually is the trustee's action seeking subordination
of the BOE's post-petition claims for (underground storage tank (UST)) fees. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

Quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… States v. Noland, 517 U.S. 535, 116 S.Ct. 1524,
134 L.E.d.2d 748 (1996)</a>, the court set forth the following rule
relevant to the case at bar: "'principles of equitable subordination' permit a court
to make exceptions to a general rule when justified by particular facts." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at
985</a>. The court stated that the trustee averred these "particular facts" and
"inequitable conduct" in his complaint. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 986</a>. The court then found that
"if the bankruptcy court rules in favor of the trustee on his equitable subordination
claim, the BOE's claims for UST fees, be they 'taxes' or not, will be
subordinated." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; Therefore, since the bankruptcy court's order did not resolve the
priority issue, the court found that the order was not final. For that reason, the
court dismissed the cross-appeal for lack of jurisdiction under §158(a). <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

<h3>Conclusion</h3>

Even though Lazar deals primarily with the SWRCB, the Ninth Circuit's decision
is relevant to a multitude of bankruptcy situations—whether involving environmental issues
or not. Primarily, its analysis of sovereign immunity and finality issues will arise
consistently in a variety of bankruptcy cases. Thus, knowledge concerning the case law
underlying the Ninth Circuit's reasoning will assist all bankruptcy attorneys in
identifying critical issues in their practices.

Journal Authors

Christy Ames

John W. Ames

Journal Date

Saturday, September 1, 2001 - 12:00

Bankruptcy Rule

2001