23 January 2006

States Must Obey Bankruptcy Law

The 11th Amendment, by its terms, prohibits out of state residents from suing states in the federal courts. It reads:

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.

As originally enacted, Article III, Section 2 of the Constitution had provided (emphasis added) that:

The judicial power shall extend to all cases, in law and equity, arising under this Constitution, the laws of the United States, and treaties made, or which shall be made, under their authority; to all cases affecting ambassadors, other public ministers and consuls; to all cases of admiralty and maritime jurisiction; to controversies to which the United Stats, shall be a party; to controversies between two or more States; between a State and citizens of another State; between citizens of different States; betyween citizens of the same State claiming lands under grants of different states, and between a State, or the citizens thereof, and foreign states, citizens, or subjects.

The Courts, over the years, have twisted the1th Amendment far beyond its express terms to constitute evidence of a general sovereign immunity for states, both in its own courts and in the federal courts, from suits brought by residents and non-residents alike. In the early 1990s, the U.S. Supreme Court went so far as to provide that there were real limits on the ability of private individuals to enforce even rights arising under federal law due to the judicially created doctrine of state sovereign immunity.

Today, the U.S. Supreme Court, in a 5-4 decision in which soon to retire Justice O'Connor was a swing vote for the majority, stepped back from the brink a little, and reversed dicta in one of those early opinions that states could not be sued in federal court to return preferential payments made to it, in the course of a bankruptcy proceeding. Now, if a creditor overpays a state creditor on the eve of bankruptcy, the bankruptcy court can order the state to return the funds for the benefit of other creditors with a higher priority right to receive the funds under federal bankruptcy law. An earlier case Hood, had previously held that states must also honor a bankruptcy court determination discharging a debt owed to the state, but had not addressed the issue of whether the bankruptcy court could actually force a state to affirmatively pay money to the bankruptcy estate. Thus, the state is now more actively involved in a federal suit in a federal forum without its consent, rather than merely passively honoring the judgment of a federal court as it did in Hood.

Given the Supremacy Clause (Article V, Clause 2, which provides "The Constitution, and the laws of the United States which shall be made in pursuance thereof; and all treaties made or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, any thing in the Constitution or laws of any State to the contrary notwithstanding."), I don't think that there is ever a bona fide basis for a state to ignore a generally applicable federal substantive law in any area where the federal government is not expressly barred from legislating, although even under a fairly narrow reading of the 11th Amendment, a preference suit against a state creditor presents federal forum issues unless it is brought in state court.

The theory by which the objection to a federal forum is overcome in today's case with the legal fiction that a preference action is basically an "in rem" suit (i.e. concerns ownership of a particular piece of property, in this case the property transferred by the debtor to the state improperly), rather than an open ended suit for money damages, which has traditionally been the central type of suit from which sovereign immunity has sought to protect governments. (The reasoning of today's ruling would thus, for example, leave open the issue of whether a state could be sued in bankruptcy court for money damages arising from state action to intentionally violate the bankruptcy stay barring creditors from taking collection actions against a debtor - e.g. if a Governor directed state police to seize a known bankrupty debtor's car to collect a debt owed to the state pursuant to a state court judgment.)

The 11th Amendment appears, in my opinion (which is admittedly contrary to precedent), to be a limitation on which court had jurisdiction over suits that forces suits into state courts, for a variety of reasons including preventing federal courts from abrogating state sovereign immunity from suits under its own state law. But, there is nothing in the 11th Amendment that suggests to me and intent to overrule the Supremacy Clause (which by its terms states that even state courts are required to apply federal law). This is what the line of sovereign immunity cases decided in the early 1990s by the U.S. Supreme Court did.

Perhaps there is an argument that the bankruptcy trustee is really an agent of the federal government and hence a preference suit is really a suit between the United States and a State (although this wasn't the winning argument in the case decided today and would undesirably put all preference suits in the original and exclusive jurisdiction of the U.S. Supreme Court). But, I'm still not troubled by the decision today as it is simple, treats states no differently from any other creditor, and muddies the water only of an 11th Amendment jurisprudence that is already hopelessly muddled anyway.

No comments: