US Supreme Court Rules in Central Virginia v. Katz That States Are Not Immune from Preference Actions

As reported here (SCOTUS blog), here (PrawfsBlawg), here (Volokh), here (Crime & Federalism), and here (Althouse), the US Supreme Court today ruled, in a 5-4 decision (pdf) authored by Justice Stevens, that states are not immune from bankruptcy preference actions. Central Virginia Community College v. Katz, No. 04-885, 2006 WL 151985. Here, I'll try and expand upon, not repeat, the above posts.

I think most would agree that the result in this case is a surprising one given the ample precedent that pointed to a contrary result. As noted here, the oral argument left many believing that the Court had again "dodged a bullet" and would not tackle the question directly, but instead would decide on the "lesser ground" of waiver (as suggested at oral argument by Justice Ginsburg, who ultimately sided with the majority). Indeed, Justice Souter, who also sided with the majority, himself signaled his deep reservation with the bankruptcy trustee's entire abrogation argument when he told the trustee's counsel at oral argument:

I'm not a big fan of sovereign immunity in these circumstances, but I'm not quite sure how to get around it, based on the fact that there is no alternative remedy here.... [B]asically, you're making the argument from the uniformity phrase - uniform bankruptcy laws.... And you're saying, in this case, that that trumps the sovereign immunity, and that gets you out of Seminole Tribe.

Looking back at the oral argument, we find the kernel of today's opinion in the following seemingly innocuous penultimate question posed by Justice Stevens himself, when he asked the state's counsel about "this argument out there" that had not yet been discussed during the entire preceding 59 minutes of argument:

May I ask if you think, within the text of the question presented, we could decide whether the sovereign immunity was abrogated by the convention itself, not by Congress? There is that argument out there, you know.

In response, the petitioner's counsel perhaps sealed his client's fate by conceding that "if you decided that the convention itself had intended for the States not to have sovereign immunity in bankruptcy, then you would conclude that the Article I Bankruptcy Clause includes the abrogation power." [Practice reminder: Be careful about those last couple of seemingly innocuous questions thrown at you at the end of oral argument; they're often not as simple as they sound.]

Well, to the sure chagrin of petitioner's counsel (and many Supreme Court watchers), that's exactly what the majority decided! Indeed, virtually the entire opinion focuses on this historical argument as to whether sovereign immunity was both considered and abrogated at the Constitutional Convention. As noted here, Professor Bruce Mann believed it had been, and Justice Stevens significantly amplified upon Professor Mann's historical review with an impressive, though selective, array of supporting historical sources, all pointing to a final, "ineluctable conclusion":

[T]ext aside, the Framers, in adopting the Bankruptcy Clause, plainly intended to give Congress the power to redress the rampant injustice resulting from States' refusal to respect one another's discharge orders. As demonstrated by the First Congress' immediate consideration and the Sixth Congress' enactment of a provision granting federal courts the authority to release debtors from state prisons, the power to enact bankruptcy legislation was understood to carry with it the power to subordinate state sovereignty, albeit within a limited sphere.

The ineluctable conclusion, then, is that States agreed in the plan of the Convention not to assert any sovereign immunity defense they might have had in proceedings brought pursuant to "Laws on the subject of Bankruptcies." See Blatchford, 501 U.S. at 779 (observing that a State is not "subject to suit in federal court unless it has consented to suit, either expressly or in the 'plan of the convention' "); Alden v. Maine, 527 U.S. at 713 (same). The scope of this consent was limited; the jurisdiction exercised in bankruptcy proceedings was chiefly in rem--a narrow jurisdiction that does not implicate state sovereignty to nearly the same degree as other kinds of jurisdiction. But while the principal focus of the bankruptcy proceedings is and was always the res, some exercises of bankruptcy courts' powers--issuance of writs of habeas corpus included--unquestionably involved more than mere adjudication of rights in a res. In ratifying the Bankruptcy Clause, the States acquiesced in a subordination of whatever sovereign immunity they might otherwise have asserted in proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts. (Emphasis added)

In the end, the legacy of this opinion for future lower court cases grappling with this momentous decision may well be found in the last bolded sentence quoted above. States defending themselves in bankruptcy litigation are sure to question whether the suit against them involves "proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts." In applying this murky test, perhaps these lower courts will frame the question in the more traditional manner in which they're used to speaking: that is, whether -- for sovereign immunity purposes -- the proceeding is "core" or "non-core." The Supreme Court first posed this question regarding the "core" jurisdiction of federal bankruptcy courts in Northern Pipeline Const. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), when it turned the bankruptcy world upside-down by deciding that the broad statutory grant of jurisdiction to bankruptcy courts over "related to" (i.e., "non-core") proceedings violates Article III of the Constitution.

Adopting this approach, "proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts" would be equated with those traditionally designated as "core" proceedings (like preference actions), whereas "proceedings [not] necessary to effectuate [such] in rem jurisdiction" would be equated with "non-core" proceedings (like breach of contract actions).

Either way, guess who benefits most from this decision?

© Steve Jakubowski 2006

Written By:Max Tucker On January 24, 2006 1:13 PM

Thanks for your insights, in particular with respect to the remarkable variance from what was said at oral argument, with the majority opinion.

As I expressed to a email group yesterday, I cannot help but wonder whether Katz's seeming expansion of a bankruptcy trustee's (and thus bankruptcy court's) power - perhaps in an effort to avoid a larger constitutional question - will later prove to restrict the bankruptcy judge's "core" jurisdiction.

Note how the Katz majority says that bankruptcy jurisdiction "is chiefly in rem" which is a " narrow jurisdiction" and so forth.

Recall we have a bankruptcy jurisdiction statute, namely 28 U.S.C. section 1334(e), which codifies this in rem aspect to bankruptcy jurisdiction, namely that the district court has exclusive jurisdiction of all property of the debtor and of the estate.

However, in practice, bankruptcy courts rarely premise their jurisdiction on section 1334(e). Far more often it is on section 1334(a) - the "arising in, under or related to" subject matter jurisdiction.

Yet under Katz, it might be argued that the "arising in, under or related to" jurisdiction of section 1334(a) - where we normally look for the source of jurisdiction - has been relegated to a "ancillary" (perhaps "non-core") status. The majority opinion refers to a preference case under Section 547 as a "mere declaration of avoidance" and thus an exercise of in rem jurisdiction. It is only when the trustee seeks to collect the preference under Section 550, that the "ancillary" jurisdiction in furtherance of the in rem jurisdiction comes in play.

Further according to footnote 10 of the majority opinion, it appears critical that the Katz trustee's request under Section 550 sought return of both the "value" of the preference and alternatively the return of the "actual property transferred." It appears that absent the demand for a return of the "actual property transferred" that the case at hand would have been considered in personam, rather than an in rem action against the State.

Yet, in your garden variety lawsuit, the plaintiff is not requesting a return of "actual property transferred" but rather is seeking money damages. It would seem that such money damage suits would invariably fail the in rem jurisdiction test.

And if such a traditional suit for money damages is not in rem, and therefore outside the "core" jurisdiction (i.e., it's non-core), the end result is that potentially more disputes in bankruptcy become subject to the more restrictive rules of 28 USC section 157(c) - i.e., bankruptcy judges may only make proposed findings of fact, subject to de novo district court review.

I certainly tend to agree that our core/non-core jurisprudence will now spill over to sovereign immunity disputes between a trustee or d-i-p and the States.

These are only my initial musings on this remarkable case that all should take a moment to read. I wonder if by the end of the term on June 30 (by which date presumably we will have a slightly different supreme court composition having decided the Anna Nicole Smith case), whether any of this will be clearer.

Written By:ohwilleke On January 26, 2006 6:00 AM

It isn't the bankrputcy lawyers who would benefit, so much as it is other lawyers with federal claims against states. If bankruptcy contains a limited waiver of sovereign immunity, why shouldn't copyright, e.g., so long as the recovery is limited to restitution and hence pseudo-in-rem.

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