Central Virginia Community College v. Katz: Article I’s Bankruptcy Clause Construed as Implied Consent to Preference Actions by the States
April 14, 2006
On January 23, 2006, a sharply divided United States Supreme Court ruled 5-4 in Central Virginia Community College, et al. v. Katz, _______U.S. _______, 126 S.Ct. 990 (2006), that the defense of sovereign immunity is not available to states in lawsuits brought in bankruptcy cases to recover preferential transfers.
The Katz decision came as a surprise to many commentators because of the decision’s apparent departure from the Court’s sovereign immunity jurisprudence. Generally, states are immune from suits seeking money damages brought by private parties in federal court in the absence of: (1) explicit waiver; or (2) valid abrogation by Congress pursuant to its constitutional powers. With respect to abrogation, the Court previously has held that various clauses under Article I of the Constitution did not abrogate state sovereign immunity. See, e.g., Seminole Tribe of Fla. v. Florida, 517 U.S. 44, 116 S.Ct. 1114 (1996) (the Interstate and Indian Commerce Clauses); Florida Prepaid Postsecondary Ed. Expense Bd. v. College Savings Bank, 527 U.S. 627, 119 S.Ct. 2199 (1999) (the Patents Clause). This holding was assumed to extend to the Bankruptcy Clause, found in Article I, Section 8, which grants Congress the power to establish uniform laws on the subject of bankruptcy. The majority in Katz circumvented this apparent hurdle by stating that “[t]he relevant question is not whether Congress has ‘abrogated’ States’ immunity in proceedings to recover preferential transfers.” Instead, the Court focused on the availability of waiver as a means to bar the defense of state sovereign immunity in preference actions.
The debtor below was Wallace’s Bookstores, Inc., which operated bookstores on the campus of Central Virginia Community College and on other campuses. During the course of the debtor’s bankruptcy case, Bernard Katz acted as the trustee of the bankruptcy estate, and in that capacity, Katz collected the debtor’s assets for distribution among creditors. Among the powers accorded a bankruptcy trustee is the right to sue creditors to recover preferences. Under Section 547 of the Bankruptcy Code, certain transfers of assets made by a bankrupt company in the 90 days prior to the filing of a bankruptcy petition can be declared avoidable preferences.
In the course of the debtor’s bankruptcy case, Katz initiated suit against the community college and against other Virginia institutions of higher learning to recover as preferences transfers made by the debtor. The community college and the other educational institutions are considered “arm[s] of the State” entitled to sovereign immunity. See, e.g., Alden v. Maine, 527 U.S. 706, 756, 119 S.Ct. 2240 (1999) (observing that only arms of the state can assert the state’s immunity). The bankruptcy court, the district court and the Sixth Circuit all agreed that the state sovereign immunity defense was unavailable in a preference action, and the United States Supreme Court affirmed. Justice Stevens wrote the majority opinion, and was joined by Justices O’Connor, Souter, Ginsburg and Breyer.
The majority in Katz held that the states implicitly waived the defense of sovereign immunity in preference actions by virtue of having ratified the Bankruptcy Clause. The majority drew this conclusion based, in part, on the Supreme Court’s examination of the historical backdrop against which the Bankruptcy Clause was drafted and ratified. Prior to the states’ ratification of the Bankruptcy Clause, the states were rife with the complexities associated with multiple state sovereigns administering discharges from bankruptcy, many of which were not honored from one state to the next. Consequently, an insolvent debtor could be discharged from bankruptcy in Pennsylvania, only to be jailed in Maryland for unpaid debts that pre-dated the Pennsylvania discharge. In short, prior to the ratification of the Bankruptcy Clause, the goal and purpose of the vehicle of bankruptcy (allowing the debtor a fresh start) was unattainable. Accordingly, due to the paramount importance of attaining uniform bankruptcy laws ascribed by the Supreme Court to Congress, the majority in Katz concluded that the ratification of the Bankruptcy Clause carried with it an acquiescence by the states to Congress’ authority to establish such laws – an acquiescence that has now been interpreted by the Court as including an implicit waiver of sovereign immunity in preference actions.
The Supreme Court was further convinced of the soundness of its decision based on the notion that jurisdiction in bankruptcy cases is principally in rem jurisdiction (meaning that the bankruptcy court’s jurisdiction is premised on the property of a bankruptcy estate, and not on creditors), and as such, bankruptcy jurisdiction usually does not implicate the traditional concerns of sovereign immunity. As a result of this jurisdictional distinction, the Court stated that, ultimately, the implicit waiver of state sovereign immunity inherent in the ratification of the Bankruptcy Clause extends to all proceedings “necessary to effectuate the in rem jurisdiction of the bankruptcy courts.” Unfortunately, the Court left open the question of precisely which bankruptcy proceedings are necessary to effectuate in rem jurisdiction. Most likely, that which falls into the category of a “core” bankruptcy proceeding is implicated, and accordingly, states might assume that the defense of sovereign immunity is unavailable in any “core” proceeding. However, the Court’s failure to indicate whether and how this holding should interact with the distinction between “core” and “noncore” proceedings will likely spawn future battles in the lower courts with the very real potential for the issue of sovereign immunity in bankruptcy to be revisited by a reconfigured Supreme Court.
For more information, e-mail Christina LaRosa at christina.larosa@hklaw.com or call toll free, 1-888-688-8500.