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Hangley Aronchick Segal & Pudlin

Court Holds Sovereign Immunity Surrendered by States
The Legal Intelligencer


By: Myron A. Bloom
Special to the Legal

Last week, the U.S. Supreme Court issued an opinion which many believe reveals a shift in its thinking concerning the scope of bankruptcy jurisdiction.

Article I, Section 8 of the Constitution provides in part that Congress shall have the power to "establish . . . uniform laws on the subject of bankruptcies throughout the United States." Some 10 years ago, in Seminole Tribe of Florida v. Florida, the Supreme Court, in both the majority and dissenting opinions, seemed to recognize that this power did not abrogate states' sovereign immunity rights under the 11th Amendment.

That amendment, it has been thought thereafter, would act as a bar to suits by debtors or trustees in bankruptcy from suing a state because of immunity. And while two years ago, in Tennessee Student Assistance Corporation v. Hood, the court held that a debtor could sue a state agency to determine the dischargeability of a student loan debt, it avoided confronting the issue of sovereign immunity as a complete defense to suit.

Most recently, in Central Virginia Community College v. Katz, the Supreme Court was confronted with the following question: is a trustee barred from bringing suit against a state agency - in this case for the avoidance and recovery of an allegedly preferential payment - based on the 11th Amendment, or did the states, in ratifying the Constitution, and specifically in ratifying Article I, Section 8, waive immunity from suit in bankruptcy cases? In a 5-4 decision, the Supreme Court stated that sovereign immunity did not bar the suit.

The facts that gave rise to the Supreme Court's decision were not complicated. Certain Virginia institutions of higher education, clearly entitled to assert Virginia's sovereign authority, were sued by a trustee under sections 547(b) and 550(a) of the Bankruptcy Code to avoid and recover preferential payments allegedly made to them by a debtor. The institutions all moved to dismiss the actions, asserting sovereign immunity as a total defense to suit. The bankruptcy court, the district court and the 6th U.S. Circuit Court of Appeals uniformly ruled in favor of the trustee.

The 6th Circuit in particular concluded that because of its own prior ruling in Hood, which held that 1994 Congressional amendments to Section 106(a) of the Bankruptcy Code specifically abrogated states' sovereign immunity, a ruling in favor of the trustee was mandated. The Supreme Court granted certiorari, not to face the issue of whether the 1994 amendments to the code were constitutional, but rather to consider whether the Constitution as originally ratified, and specifically Article I, Section 8, created a waiver of sovereign immunity in bankruptcy cases. Justice John Paul Stevens, writing for the majority, concluded that a waiver of sovereign immunity in bankruptcy cases had indeed been created.

The court began its analysis by reflecting on the state of insolvency proceedings as they existed at the time of the drafting of the Constitution. First, the court stated that a "critical feature" of all bankruptcy proceedings, going back to early English concepts, is that they are essentially in rem proceedings. A court exercises control of the debtor's property, distributes that property among various entities that have an interest in it, and grants the debtor a discharge. That discharge, all concede, is effective as against not only persons, but to sovereigns, including states, whether or not states choose to participate in the bankruptcy case.

At the time the framers of the Constitution were focusing attention on the issue of bankruptcy, the concept of discharge was confused by the lack of respect given to the sovereign's grant of discharge. Discharge, in the main, had two common threads - the release of the debtor from civil liability for his debt and a directive to the authorities to discharge the debtor from the consequences of debt, which was most often, at the time, imprisonment.

Early state laws, however, were widely divergent regarding the method and scope of the discharge; some laws required passage of a private bill releasing a debtor from prison upon surrender of all property, others were general laws authorizing release, and yet others called for release conditioned upon indentured servitude. Some states had no provisions at all for debt relief. Perhaps more importantly, states often did not recognize the discharge granted by another state, so that a person granted a discharge in one state could, if found in another, still be imprisoned by that other state if a creditor resided in that second state.

This fundamental unfairness resulted in a call to establish uniform rules, and it was against this backdrop that the Bankruptcy Clause was adopted. At first, it was suggested that the problem of inconsistency could be resolved within the Full Faith and Credit Clause. After some deliberation, however, the recommendation was made to head in another direction. That direction was to add to the Naturalization Clause of what ultimately became Article I of the Constitution, congressional power to establish uniform bankruptcy laws. This adoption, the court stated, "indicates that there was general agreement on the importance of authorizing a uniform federal response to the problems" presented by the widely divergent approaches to insolvency then existing among the several states.

Bankruptcy jurisdiction, stated the court, is principally in rem jurisdiction and thus does not usually interfere with state sovereignty. Though the interest in avoiding unjust imprisonment of a debtor post-discharge may have been a primary motivating factor in adoption of the Bankruptcy Clause, the clause covers the whole ambit of bankruptcies, and not just adjudications of rights in the res. Earlier, this meant that courts could, as ancillary to administration of the res, order the imprisonment of those who failed to turn over estate property. More recently, as evidenced by the court's decision in Hood, the dischargeability of a debt was found not to implicate sovereign immunity because that determination was merely an ancillary proceeding in aid of proper administration of a debtor's estate.

Is an action to recover an allegedly preferential payment a similar, ancillary proceeding? Perhaps. Perhaps not. Under the facts presented, in which the trustee sought both a declaration of avoidance and a turnover of property, the turnover, while ancillary to the court's declaration that a transfer is a preference, may very well be viewed as an in personam proceeding. However, stated the court, determination of this issue was not necessary, because the framers of the Constitution "would have understood [the Bankruptcy Clause] to give Congress the power to authorize courts to avoid preferential transfers and recover the transferred property." To the extent that orders ancillary to a court's in rem jurisdiction implicate sovereign immunity, stated the court, the states agreed at the Constitutional Convention not to assert that immunity.

This conclusion is evident, the court stated, not only by the history of the Bankruptcy Clause, but also by legislation enacted in the wake of the Constitution's ratification. The first federal bankruptcy legislation, the Bankruptcy Act of 1800, unlike its English counterpart, specifically granted federal courts to issue writs of habeas corpus to release debtors from state prisons, an act clearly implicating and intruding upon the state's sovereignty. This grant was provided at a time when state sovereign immunity was a prominent issue among the states and indeed culminated in the adoption of the 11th Amendment.

Yet during this time of fierce debate over sovereign immunity, no one questioned the bankruptcy legislation's grant of habeas corpus powers that clearly intruded on state sovereignty. What this shows, stated the court, was that the Bankruptcy Clause effected an intrusion into state sovereignty which, in the view of the framers of the Constitution, "did not contravene the norms this court has understood the 11th Amendment to exemplify."

Even though the words of the Bankruptcy Clause do not precisely so state, the "background principle of state sovereign immunity" suggests strongly that the absence of specific language was not necessary. In other words, in adopting the Bankruptcy Clause, the framers of the Constitution plainly intended to give Congress the power to redress the "rampant injustice" of one state's refusal to respect the discharge order of another, and in the process subordinate state sovereignty in this limited sphere - a subordination to which the states agreed, in order to fully effectuate the broad jurisdiction of the bankruptcy courts.

As for the court's prior holding in Seminole Tribe, Stevens noted that that decision was based on an erroneous assumption that the holding in that case would apply to the Bankruptcy Clause. However, he stated, "careful study and reflection convinced us that, however, that that assumption [which was dicta] was erroneous."

The court concluded by stating as follows: "Congress may, at its option, either treat states in the same way as other creditors insofar as concerns laws on the subject of bankruptcies or exempt them from operation of such laws. Its power to do so arises from the Bankruptcy Clause itself; the relevant 'abrogation' is the one effected in the plan of the [Constitutional] Convention, not by statute." Thus, the preference action was not barred by the 11th Amendment.

The four-person dissent, authored by Justice Clarence Thomas, was vigorous. Article I, Section 8 did not, he stated, constitute a subordination of sovereign immunity. The fact that the framers were concerned in establishing uniform laws to prevent the failure of one state to recognize the discharge granted by another did not manifest an intent to waive sovereign immunity. The sovereign immunity so hotly debated in the wake of ratification of the Constitution was recognized by early Supreme Court decisions predating the enactment of the first bankruptcy legislation in 1800.

The 11th Amendment, noted the dissent, restricts the Article III judicial power, and Article I cannot be used to circumvent the constitutional limitations placed on federal jurisdiction. Article I has never before, stated Thomas, been interpreted to evidence an intent to abrogate sovereign immunity. Moreover, the majority's holding, he stated, actually overrules a prior precedent, Hoffman v. Connecticut Department of Income Maintenance. Thomas went on to state that the majority confused the distinction between the authority of a sovereign to enact legislation covering its own citizens and the immunity of a sovereign from suit by a private citizen.

The majority, stated Thomas, also "greatly exaggerated" the sense of the framers, the implications of the habeas corpus provisions of the 1800 Act, and the conclusion derived that a surrender of immunity was contemplated. Finally, the dissent asserted that whether bankruptcy court jurisdiction was in rem or not, this determination had no essential bearing on the question of whether states do or do not enjoy sovereign immunity. Thomas stated: "Nothing in the text, structure or history of the Constitution indicates that the Bankruptcy Clause, in contrast to all of the other provisions of Article I, manifests the states' consent to be sued by private citizens."

The opinions, both majority and dissent, are more than many in this area must-reads for anyone wishing to delve into the early history of the Bankruptcy Clause and the actions of its framers. The practical impact of the majority opinion, too, is wide ranging. Even though in 1994 Congress enacted a broad abrogation of sovereignty provision in Section 106(a)(1) of the Bankruptcy Code, this decision would seem to settle its effectiveness. And the practitioner now knows that the sovereign cannot hide behind the 11th Amendment.



This article is reprinted with permission from the February 3, 2006 issue of The Legal Intelligencer. Copyright 2006 ALM Properties, Inc. Further duplication without permission is prohibited. All rights reserved.



02-03-2006

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Halloran & Sage LLP

Sixteen Halloran & Sage Attorneys selected as 2006 Connecticut Super Lawyers
Congratulations to the following attorneys who were named “2006 Connecticut Super Lawyers” by Law & Politics magazine:John B. Farley, AppellateGeorge D. Royster, Jr., Business LitigationRobert B. Cox, Business/CorporateWilliam J. McGrath, Jr., Civil Litigation DefenseJoseph T. Sweeney, Civil Litigation DefenseJames J. Szerejko, Civil Litigation DefenseAnn M. Catino, Environmental/Land UseDuncan Forsyth, Environmental/Land UseDavid B. Losee, Environmental/Land UseJeffrey F. Gostyla, Insurance CoverageJames V. Somers, Insurance CoverageRichard C. Tynan, Medical Malpractice: DefenseThomas J. Hagarty, Professional Liability: DefenseDavid G. Hill, Professional Liability: DefenseEach year Law & Politics mails a ballot to the approximately 13,000 active lawyers in Connecticut who have been in practice five years or more. The ballot asks lawyers to nominate the best attorneys they’ve personally observed in action. The intent is to discourage votes based purely on reputation..

02-03-2006

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Hall & Evans, L.L.C.

Bruce Menk to speak at the AMERICAN TRUCKING ASSOCIATION FORUM on August 6-9, 2006
Bruce Menk will be a speaker on the subject of mediation at the American Trucking Association Forum for Motor Carrier General Counsel on August 6-9, 2006.

02-03-2006

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Hall & Evans, L.L.C.

TRENDS AND KEY CONCEPTS REGARDING EMPLOYMENT LAW" co-presented by Tom Lyons and John Bolmer, February 1, 2006 Tom Lyons and John Bolmer co-presented regarding employment law at the WestEx 2006 Rocky Mountain Regional Foodservice & Restaurant Exposition at
http://www.hallevans.com/news_publications/pressDetails.cfm?id=88

02-03-2006

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Hall & Evans, L.L.C.

MOTIONS PRACTICE" at the Litigation Boot Camp - presented by Alan Epstein, May 24, 2006
Alan Epstein will present for Colorado CLE -- “Motions Practice” portion of the Litigation Boot Camp series on May 24, 2006.

02-03-2006

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Hahn, Loeser & Parks, L.L.P.

Candace Jones is quoted in, "Internet May Soon Act Locally."
ABA Journal Report
Candace Jones comments on the trend to let national restrictions rule the internet.

02-03-2006

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Groom Law Group, Chartered

SEC Proposes Increased Proxy Disclosures on Benefits
On January 27, the Securities and Exchange Commission (the “SEC”) released new rules
proposing extensive changes to the rules that govern public company disclosures of executive
and director compensation.1 The SEC intends the new rules to improve the clarity and
completeness of these disclosures.
One of the major changes is a requirement that a single figure for total compensation be
provided for covered executives each year. This annual figure would include the value of option
and other equity grants made and retirement benefits earned during a year. In addition, the rules
would require dramatic changes to the disclosures on both retirement benefits and equity grants.
We highlight below some of the key changes in the proposed rules.
Overview
The proposed rules follow the approach of the current rules with tables providing dollar
amounts of particular compensation types and footnotes adding narrative explanations of the
amounts shown on the chart. However, major changes are made to the current tables, including
the elimination of certain tables. The proposed rules also require that narrative explanations be
written in “plain English” and provide any information necessary to understand the numbers in
the tables.
In addition to the revised compensation tables, a new “Compensation Discussion and
Analysis” section would be required. This new section will discuss material factors underlying
policies and decisions reflected in the compensation amounts disclosed. The report will replace
the compensation committee report and company performance graph, which will no longer be
required.
Expanded Summary Compensation Table
As noted above, the proposed rules require that a total compensation figure be included in
the Summary Compensation Table (the “SCT”) for each covered executive for each of the last
three completed fiscal years. The amount in the new “total compensation” column of the SCT
will equal the sum of the amounts in all the other columns (e.g., salary, bonus, equity awards).
And as noted above, the value of equity grants made and retirement benefits earned during a year
must be included in the SCT. Additional changes of interest to the SCT are as follows:
1 SEC Release 33-8655. The Release also limits to some extent the benefits-related
information required to be filed on a Form 8-K and provides new rules in the following areas that
we do not address: related party transactions, director independence and other corporate
governance matters.

02-03-2006

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