Katz — The Supreme Court’s Most Important Bankruptcy Opinion

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Uniform authority

By: Donald L. Swanson

The most important bankruptcy opinion from the U.S. Supreme Court, since enactment of the Bankruptcy Code in 1978, is this:

Central Virginia Community College v. Katz, 546 U.S. 356 (2006).

Here’s why:

Katz evaluates the U.S. Constitution’s Bankruptcy Clause against a conflicting part of the Constitution—i.e., the Eleventh Amendment; and

Katz  determines that the Bankruptcy Clause wins!

Here’s the ruling:

Congress’s power to abrogate Eleventh Amendment sovereign immunity rights, “as concerns ‘Laws on the subject of Bankruptcies,’ . . . arises from the Bankruptcy Clause itself.”

Conflicting Constitution Provisions

The Bankruptcy Clause of the U.S. Constitution is in Article I, §8, cl. 4. Here’s what it says:

“The Congress shall have Power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.“

The Eleventh Amendment to the U.S. Constitution says:

“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.”

Katz Facts, Question and Decision

Central Virginia Community College is an “arm of the State of Virginia” and is, therefore, entitled to sovereign immunity. Katz, as bankruptcy Trustee, filed a preference lawsuit against the College, and the College asserted a sovereign immunity defense.

The question in Katz is this: Whether the Bankruptcy Clause empowers Congress to abrogate a State’s Eleventh Amendment sovereign immunity rights for a preference suit in bankruptcy.

The Bankruptcy Court denied the College’s sovereign immunity defense, and both the District Court and Court of Appeals affirmed. The Supreme Court also affirmed in a 5-Justice majority (Stevens, joined by O’Connor, Souter, Ginsburg and Breyer) over a 4-Justice dissent (Thomas, joined by Roberts, Scalia and Kennedy).

Bankruptcy Clause Preeminence–Two Reasons

The Bankruptcy Clause prevails in Katz for two reasons, each of which arises “from the Bankruptcy Clause itself”:

(i) uniformity mandate, and

(ii) jurisdiction.

The following is what the Supreme Court says in Katz on these two reasons.

Reason # 1: “Uniform” Bankruptcy Laws

The U.S. constitution empowers—and requires—Congress to establish “uniform” bankruptcy laws.

–Both Practical and Theoretical Uniformity

The Katz majority explains:

The Bankruptcy Clause is “a grant of congressional power” to address “the pressing goal of harmonizing bankruptcy law”;

“Foremost on the minds of those who adopted” that clause, with its uniformity mandate, were practicalities—i.e., the “intractable problems” and “injustice” of one State imprisoning debtors who “had been discharged (from prison and of their debts) in and by another State”;

The adopters of the Bankruptcy Clause also wanted theoretical uniformity—i.e., a body of law that “encompasses the entire ‘subject of Bankruptcies,’” eschewing “an amalgam of discrete segments”;

“Congress is not authorized merely to pass laws, the operation of which shall be uniform, but to establish uniform laws on the subject throughout the United States”; and

Congress acted quickly, thereafter, on bankruptcy legislation, authorizing federal courts to “issue writs of habeas corpus directed at state officials ordering the release of debtors from state prisons” and making bankruptcy discharges “enforceable in every State.”

–Historical Background: Debtor’s Prison

The focus on uniformity arises from debtor prison concerns:

The term “discharge” in England had a dual meaning, referring to both “release of debts and release of the debtor from prison”;

Earliest bankruptcy statutes in England, however, only “authorized discharges of persons, not debts” (e.g., a 1649 statute was titled “An act for discharging Poor Prisoners unable to satisfy their creditors”);

Well into the 1700s, imprisonment for debt was still ubiquitous in England and the American Colonies, with bankruptcy laws focused on “preventing debtors’ flight to parts unknown” and on treating debtors harshly (debtors “often fared worse than common criminals in prison,” having to “provide their own food, fuel, and clothing while behind bars”);

[Editorial Comment: Debtor’s prison is an odd concept (i.e., how can incarcerated debtors earn money to pay their debts?). Presumably, a debtor’s prison assumes that, (i) debtor has hidden assets, and (ii) incarceration will, sooner-or-later, persuade the debtor to give those assets up.]

The American Colonies and States had wildly divergent schemes for discharging debtors and their debts—some released debtors from prison and discharged their debts upon surrender of their property, while others provided no relief at all, with multiple variations in between;

The first U.S. Bankruptcy Act (of 1800) was designed to benefit creditors and authorized “commissioners” to “arrest the debtor,” to “cause the doors of the dwelling-house of the bankrupt to be broken,” to seize and collect the debtor’s assets, and to “issue a certificate of discharge” once the estate had been distributed; and

The 1800 Act also granted authority to federal courts “to issue writs of habeas corpus effective to release debtors from state prisons.”

–Two Illustrative Cases

The Katz majority cites two Pennsylvania cases illustrating the lack-of-uniformity problem adopters of the Bankruptcy Clause had in mind. [Note: the same Pennsylvania attorney represented the creditor in the first case and the debtor in the second—arguing opposite positions in the two cases.]

First case (James v. Allen). A debtor, newly released from debtor’s prison in New Jersey, traveled to Pennsylvania and was arrested for nonpayment of a Pennsylvania debt. He sought release, arguing that his debt had been discharged by the New Jersey court. The creditor’s attorney argued that the New Jersey order “only discharged the person of the debtor from arrest within the State of New Jersey.” The court agreed: the New Jersey order “goes no further than to discharge” him from “imprisonment in the Gaol of Essex County in the State of New Jersey.”

Second case (Millar v. Hall). A debtor named Hall had been “discharged” under a bankruptcy law in Maryland. Then, Hall traveled to Pennsylvania and was promptly arrested for the unpaid debt to Millar. The Pennsylvania court accepted the argument of Hall’s attorney that a debtor “having already been obliged to surrender all of his effects” under the laws of another state ought not be imprisoned in Pennsylvania: that would “attempt to compel him to perform an impossibility”—i.e., imprisoning him to compel payment of a debt (“after he has been deprived of every means of payment”) would “amount to perpetual imprisonment, unless the benevolence of his friends should interfere to discharge his account.”

–Framers of the Constitution

The Bankruptcy Clause was adopted by the Framers with little debate:

The lone vote against it occurred because of a concern “that it would authorize Congress to impose upon American citizens the ultimate penalty for debt then in effect in England: death”; and

The absence of extensive debate indicates a “general agreement on the importance of authorizing a uniform federal response to the problems presented” in cases like James and Millar noted above.

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,” by mandating uniformity.

–A Conclusory Finding

“The ineluctable conclusion, then, is” this:

–“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.’”

Reason # 2: Jurisdiction

While the Katz opinion does not decide any issue of bankruptcy court jurisdiction, the majority opinion talks a lot about bankruptcy jurisdiction and its foundation in the Bankruptcy Clause. Here are examples.

1. Bankruptcy jurisdiction, at its core, is in rem: “The whole process of proof, allowance, and distribution is, shortly speaking, an adjudication of interests claimed in a res.”

2. “Critical features of every bankruptcy” are:

“the exercise of exclusive jurisdiction over all of the debtor’s property,”
“the equitable distribution of that property among the debtor’s creditors,” and
“the ultimate discharge that gives the debtor a ‘fresh start’ by releasing him, her, or it from further liability for old debts.”

3. Bankruptcy jurisdiction is, and has always been, “principally in rem jurisdiction”—in bankruptcy, “the court’s jurisdiction is premised on the debtor and his estate, and not on the creditors.”

4. Nevertheless, the Framers would have understood the Constitution’s phrase, “Laws on the subject of Bankruptcies,” as authorizing “more than simple adjudications of rights in the res” because, historically, bankruptcy courts could “issue ancillary orders” to enforce “their in rem adjudications,” such as imprisoning debtors, using any “legal method of recovering the debtor’s property,” and using any “equity” method “with the consent of the creditors.”

5. In Katz, the Trustee first seeks a determination that the transfers are voidable preferences but might also want an order “mandating turnover of the property,” which would be an “in personam process” that is “ancillary to and in furtherance of the court’s in rem jurisdiction.”

6. Framers of the Constitution would have understood its Bankruptcy Clause as empowering Congress to grant jurisdiction to bankruptcy courts to avoid preferential transfers and to recover the transferred property, whether such processes be in rem or in personam.

7. While the “principal focus of the bankruptcy proceedings is and was always the res,” certain “exercises of bankruptcy courts’ powers,” such as writs of habeas corpus, “unquestionably involve more than mere adjudication of rights in a res”—and the States, in ratifying the Bankruptcy Clause, “acquiesced in a subordination” of their sovereign immunity “in proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts.”

8. The Supreme Court majority opinion makes this conclusory statement on jurisdiction [in Footnote 9]:

–“the Bankruptcy Clause’s unique history, combined with the singular nature of bankruptcy courts’ jurisdiction” persuade us that “the ratification of the Bankruptcy Clause” represents “a surrender by the States of their sovereign immunity in certain federal proceedings.”

Conclusion

Hopefully, the U.S. Supreme Court will return, one day, to utilizing the Constitution’s Bankruptcy Clause as a basis for jurisdiction and authority of bankruptcy courts, when conflicts arise with other provisions in the Constitution, like Article III.

The “arises from the Bankruptcy Clause itself” language in the following quote (from the Katz majority opinion) will always be, I suggest, a good place to start:

“Congress may, at its option,” abrogate the States’ Eleventh Amendment sovereign immunity or leave it in place, “as concerns ‘Laws on the subject of Bankruptcies.’ . . . Its power to do so arises from the Bankruptcy Clause itself.”
(Emphasis added.)

[Note: For a recent opinion applying the Katz ruling in a bankruptcy case, see In re La Paloma Generating Co., Case No. 16-12700 (Bankry.D.Del., decided July 25, 2018, Doc. 1206).  An earlier opinion is Zazzali v. Swenson (In re DBSI, Inc.), 463 B.R. 709 (Bankry.D.Del. 2012).]

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