In Katz, the Supreme Court ruled that states waived sovereign immunity for some types of bankruptcy proceedings when the states ratified the Constitution with its Bankruptcy Clause.
Third Circuit Judge Thomas L. Ambro generously interpreted Katz to find a broad waiver of sovereign immunity when a debtor sues the state to augment the estate. More particularly, Judge Ambro ruled that sovereign immunity does not prevent a liquidating trustee from bringing an inverse condemnation suit against the state.
The Inverse Condemnation Suit
A company leased an offshore oil-production platform from the State of California and owned an onshore facility for processing and refining oil. A rupture in the pipeline forced the company into chapter 11, where it abandoned the lease for the platform. Walking away from the platform gave the state large claims for plugging and abandoning the wells.
Invoking police powers, the state took the position that it could take over the onshore facility without payment. After the company confirmed a liquidating chapter 11 plan, the liquidating trustee mounted an inverse condemnation suit against the state in bankruptcy court.
In his May 24 opinion, Judge Ambro explained that inverse condemnation occurs when an owner sues the government for the value of property that was taken. Direct condemnation is when the government initiates proceedings to acquire title under its eminent domain authority.
The state filed a motion to dismiss, claiming the suit was barred by sovereign immunity. The bankruptcy court denied the motion to dismiss, and the district court authorized a direct appeal, but only regarding sovereign immunity. The Third Circuit accepted the appeal and heard argument in late September 2020.
Constitutional Waiver via Katz
The opinion reads like a treatise laying out various circumstances when states have no sovereign immunity. Although not involved in the appeal, legislation can waive state sovereign immunity when “Congress unequivocally expresse[s] its intent to end immunity,” Judge Ambro said. See, e.g., Section 106.
Then came Central Virginia Community College v. Katz, 546 U.S. 356 (2006), where the Supreme Court ruled there was no sovereign immunity barring a debtor from suing a state instrumentality to recover a preference.
Judge Ambro identified three principles arising from Katz. First, by ratifying the Constitution containing the Bankruptcy Clause, states waived sovereign immunity in certain bankruptcy proceedings designed to “effectuate the in rem jurisdiction of the bankruptcy courts.” Id. at 378.
Second, Katz did not say that foreign immunity is waived in all bankruptcy proceedings. Id.
Third, Judge Ambro said that Katz “does not require a proceeding to be technically in rem” if the action is ancillary to and in furtherance of in rem jurisdiction, even if the action involves in personam process. Id. at 370 and 372.
Judge Ambro summarized Katz’s holding as follows: “States cannot assert a defense of sovereign immunity in proceedings that further a bankruptcy court’s in rem jurisdiction no matter the technical classification of that proceeding.”
Applying Katz to Inverse Condemnation
Judge Ambro read Katz as identifying three functions where proceedings are in furtherance of in rem jurisdiction: (1) exercising jurisdiction over estate property; (2) equitably distributing estate property; and (3) effectuating the debtor’s discharge. The court, he said, “must focus on function, not form.”
The inverse condemnation suit, Judge Ambro said, “furthers the Bankruptcy Court’s exercise of jurisdiction over property of the Debtors and their estates, as it seeks a ruling on rights in the Onshore Facility.” Although the suit was not clearly in rem, he said that “its function is to decide rights in [the debtor’s] property” and whether the state can use the debtor’s property “for free.”
Because the onshore facility was a “significant asset,” Judge Ambro said that the suit “also furthers the second critical function — facilitating equitable distribution of the estate’s assets.”
Confirming the plan did not reinstate the state’s immunity. Judge Ambro held that “critical in rem functions did not end when the Plan became effective, as the Trust exists primarily to facilitate the ‘equitable distribution of [the debtor’s property] among the debtor’s creditors,’” quoting Katz at 546. Moreover, he said that the estate’s in rem jurisdiction extended to estate property that was transferred to the liquidating trust.
Judge Ambro therefore held that the state’s “defense of Eleventh Amendment immunity fails.”
Finally, Judge Ambro rejected the idea that the state enjoyed sovereign immunity under California law. If that were true, he said that “state legislation [could] easily end-run the deemed waiver of state sovereign immunity effected by the Bankruptcy Clause and recognized in Katz.”
Having found a constitutional waiver of sovereign immunity, Judge Ambro did not reach the additional question of whether the state had waived immunity by filing a proof of claim.
In Katz, the Supreme Court ruled that states waived sovereign immunity for some types of bankruptcy proceedings when the states ratified the Constitution with its Bankruptcy Clause.
Third Circuit Judge Thomas L. Ambro generously interpreted Katz to find a broad waiver of sovereign immunity when a debtor sues the state to augment the estate. More particularly, Judge Ambro ruled that sovereign immunity does not prevent a liquidating trustee from bringing an inverse condemnation suit against the state.
The Inverse Condemnation Suit
A company leased an offshore oil-production platform from the State of California and owned an onshore facility for processing and refining oil. A rupture in the pipeline forced the company into chapter 11, where it abandoned the lease for the platform. Walking away from the platform gave the state large claims for plugging and abandoning the wells.
Invoking police powers, the state took the position that it could take over the onshore facility without payment. After the company confirmed a liquidating chapter 11 plan, the liquidating trustee mounted an inverse condemnation suit against the state in bankruptcy court.
In his May 24 opinion, Judge Ambro explained that inverse condemnation occurs when an owner sues the government for the value of property that was taken. Direct condemnation is when the government initiates proceedings to acquire title under its eminent domain authority.
The state filed a motion to dismiss, claiming the suit was barred by sovereign immunity. The bankruptcy court denied the motion to dismiss, and the district court authorized a direct appeal, but only regarding sovereign immunity. The Third Circuit accepted the appeal and heard argument in late September 2020.