Conflict of Laws: Which State Rules Govern
The recent wave of health care insolvencies involves ever more complex health care-related entities. The entities seeking bankruptcy protection are now more diverse and involve regional and national enterprises, including hospitals, health maintenance organizations (HMOs), nursing homes, physician practice groups and home health providers. These entities are often engaged in a variety of activities in many states, and their bankruptcy cases often involve questions of state law. However, the issue of which laws apply, though a complex analysis, is often overlooked even though treatment of many key issues is often not uniform. Issues that may require bankruptcy courts to apply applicable state or common law include whether the debtor is eligible for bankruptcy relief (whether it is deemed a domestic insurance company), questions involving set-off and recoupment of Medicare, Medicaid and private insurance payments, issues involving avoidance claims under §544 and employment agreement disputes. These and other matters all require bankruptcy courts to apply various state law or common law principles. However, the determination of which law should be applied is anything but certain at this point in time.
Before embarking on a choice-of-law analysis, one must first determine that more than one state has a significant interest in the matter, and that the pertinent laws of these states are in conflict. Having determined that a conflict exists, the starting point in analyzing it is to characterize the legal issue as pertaining to the area of tort, contract, property, etc., and as being substantive or procedural. This initial characterization is governed by the rules of the forum.1
Having thus characterized the issue, one then identifies and applies the forum's choice-of-law rules that apply to that type of issue. Those rules may direct the forum to apply its own law, the "law" of a foreign jurisdiction or the "local law" of a foreign jurisdiction. In conflicts terminology, "law" refers to the entirety of the foreign jurisdiction's law including its choice-of-law rules; "local law" means the foreign law excluding such rules.2
A chosen jurisdiction's laws may not necessarily apply to every issue; instead, a court might perform separate conflicts analyses for separate issues (e.g., statute of limitations vs. standing) with the result that different states' laws will govern different issues relating to a single claim.
Federal Choice-of-Law Rules
In addressing a choice-of-law issue in a bankruptcy proceeding, a preliminary uncertainty arises from the fact that bankruptcy involves federal concerns. After abolishing federal common law in Erie,3 the Supreme Court ruled in Klaxon4 that federal courts exercising diversity jurisdiction must apply the choice-of-law rules of the state in which they sit. Bankruptcy courts generally assumed that, to the extent they were deciding state-law issues, the Klaxon rule applied to them as well. This assumption was called into question by Vanston.5 In that case, the issue was whether a bankruptcy court should allow a claim for compound interest (as provided for by the bond in the event of default); this, in turn, raised the preliminary issue as to whether the compound interest provision was valid under state law, and that, in turn, raised the issue of which state's law should govern. Ultimately, the court decided that it did not matter which state's substantive law controlled because the compound interest provision was invalid as a matter of federal bankruptcy policy, to which the Erie doctrine does not apply. However, the court also included some suggestive dicta:
But obligations, such as the one here for interest, often have significant contacts in many states so that the question of which particular state's law should measure the obligation seldom lends itself to simple solution. In determining which contact is the most significant in a particular transaction, courts can seldom find a complete solution in the mechanical formulae of the conflicts of law. Determination requires the exercise of an informed judgment in the balancing of all the interests of the states with the most significant contacts in order best to accommodate the equities among the parties to the policies of those states.6
The import of this dicta is not clear. Was the court merely pointing out the difficulties of applying traditional situs-based conflicts rules in a class action-type of situation, or was the court going further and rejecting the traditional rules in favor of "the most significant contacts," as a matter of federal bankruptcy law? The basic point of the Erie doctrine (upon which Klaxon was based) is that a state law case ought not to turn out differently because it happened to be brought in a federal court exercising diversity jurisdiction. Vanston says this concern does not apply to a bankruptcy court deciding a question of federal law (what claims are allowable in bankruptcy). In contrast, the Erie/Klaxon concerns do apply to state-law issues that could have arisen independently of bankruptcy.7
Bankruptcy courts have reacted to Vanston in various ways. Some courts have simply continued to apply the conflicts rules of the forum state, with or without mentioning the issue.8 Other courts have raised the issue of whether Vanston requires them to do their own federal "most significant relationship" (MSR) analysis, but then concluded that they need not decide the issue, usually because the result comes out the same way under both federal and forum rules.9 A few courts have gone all the way, saying flatly that federal MSR analysis applies without regard to the rules of the forum state.10
The courts do at least agree on one thing: If the parties neglect to raise the conflicts issue, a court need not raise it sua sponte,11 unless it dislikes the result of the parties' implicit choice.12
State Conflicts Rules
There are three main choice-of-law methodologies currently used by the various states.
1. The "Unicontact" Approach. This is the older, traditional approach to choice of law, and is based on bright-line rules as reflected in the Restatement [First] of Conflict of Laws (1939). Under this approach, for any given "type" of action (e.g., malpractice claim), there will be one or more key events, the location of which determines the governing law (e.g., place of treatment). This approach affords certainty and predictability; however, as explained below, it is unclear whether a court will adopt it.
2. The MSR Approach. Dissatisfaction with the seemingly arbitrary results of the unicontact tests has led many jurisdictions to adopt the MSR approach,13 as set forth in the Restatement (Second) of Conflict of Laws (1971). Under this test, one first looks to certain overall "choice-influencing considerations," such as (a) the needs of the interstate and international systems, (b) the relevant policies of the forum, (c) the relevant policies of other interested states and the relative interests of those states in the determination of the particular issue, (d) the protection of justified expectations, (e) the basic policies underlying the particular field of law, (f) certainty, predictability and uniformity of result, and (g) ease in the determination and application of the law to be applied.14 Next, one evaluates these in light of the particular geographic "contacts" (if any) identified by the Restatement as being relevant to the type of issue in question. For example, the contacts relevant to contracts are "(a) the place of contracting, (b) the place of negotiation of the contract, (c) the place of performance, (d) the location of the subject matter of the contract, and (e) the domicile, residence, nationality, place of incorporation and place of business of the parties."15 Obviously, this approach maximizes a court's ability to reach its desired result; for the litigator, however, it makes planning rather difficult.
3. The "Government Interest/Comparative Impairment" Approach. This approach attempts to identify the jurisdiction with the greatest interest in having its law applied to the case. First, one asserts that the enacting legislatures intended that the laws in question would promote certain policy interests. Next, one verifies that these interests are implicated under the instant facts; if the policy behind the law of one of the jurisdictions would not be promoted by the application of its law to these facts, there is a "false conflict" and the other jurisdiction's law is applied. If in fact there is a "true conflict," one applies the law of the state whose interests or policies would be more impaired if its law were not applied (comparative impairment). Here again, counsel cannot predict outcomes because a court can reach unexpected results by asserting different "purposes" underlying similar statutes. This approach also suffers from a possible constitutional infirmity in that courts (particularly California courts) typically assert the enacting legislature intended to promote the interests of in-state residents at the expense of non-residents; a federal court may have difficulty squaring this with the mandates of the "privileges and immunities" clause.16
A bankruptcy case is not necessarily conducted entirely in one district; rather, various proceedings may be raised in (or transferred to) various districts in different states (and different federal circuits) as practical concerns may dictate. This split of federal court authority, then, may raise a pre-preliminary issue.
Title 28 of the U.S. Code contains provisions that govern district court venues for civil litigation in general. If a case is properly venued, then under §1404(a), "For the convenience of parties and witnesses, in the interest of justice, a district court may transfer any civil action to any other district or division where it might have been brought." If the case is improperly venued, however, then under §1406(a) the court may "in the interest of justice, transfer such case to any district or division in which it could have been brought." The Supreme Court has ruled that if a diversity-jurisdiction case is transferred for convenience under §1404(a), the transferee court must continue to apply the choice-of-law rules that the transferor court would have applied (i.e., the forum state rules of the transferor); however, if the transfer is under §1406(a) for improper venue, then the transferee court applies the choice-of-law rules of its own forum state.17 The (admitted) rationale for this rule is to afford plaintiffs the full benefit of their forum shopping efforts.
Title 28 also contains venue statutes that apply specifically to bankruptcy: §1408 determines the permissible initial venues for cases, §1409 determines the permissible initial venues for proceedings, and §1412 provides that "A district court may transfer a case or proceeding under Title 11 to a district court for another district, in the interest of justice or for the convenience of the parties." Although these bankruptcy venue provisions parallel somewhat the provisions of §§1404 and 1406, they also contain certain anomalies; under §1412, the transferee district need not be "proper," and the transferor district need not be improper, and nothing requires (nor, apparently, even permits) a court to dismiss an improperly venued case or proceeding.18 The decided cases disagree on whether these bankruptcy venue statutes actually mean what they plainly say, and whether they supplant the generally applicable rules of §§1404 and 1406.19 Note also that the implementing rule (Fed. R. Bankr. Proc. 1014) does not entirely respect the actual terms (and resulting anomalies) of §1412; the decided cases stray even further from the statutory text.20
In view of these anomalies, do the diversity-jurisdiction rules regarding post-transfer conflicts rules apply to bankruptcy cases and proceedings transferred among states following different choice-of-law approaches? Note also that these post-transfer conflicts rules generally do not apply regarding transfers between federal circuits that disagree on federal law (although there is judicial disagreement on this point itself!).21 What happens, then, if a bankruptcy case or proceeding involves a pending federal matter in a Klaxon circuit when the underlying case is in a Vanston circuit, or vice versa? No case has decided these issues.22
As noted above, the conflict-of-laws analysis appears to be anything but a simple mechanism by which a court can ascertain which is the applicable law to govern a pending dispute. These issues, however, are often overlooked by counsel in bankruptcy proceedings. Sophisticated counsel in certain circumstances could employ choice-of-law arguments to seek to utilize a more favorable law with respect to conflicting issues in health care cases (e.g., set-offs/recoupments, eligibility concerns or which state's statute of limitations should apply to avoidance actions). Although uncertain, the choice-of-law arguments can provide counsel with support for particular positions and perhaps provide some potential bargaining leverage in the bankruptcy process.
1 Restatement (Second) of Conflict of Laws §7 (1971). Note, however, that characterization may differ for purposes of choosing substantive law vs. a statute of limitations. In re Morse Tool Inc., 108 B.R. 384 (Bankr. D. Mass. 1989). Return to article
7 E.g., the usurious nature of a loan, the validity of a contract and the rights of a lien creditor are all state law issues. For further policy-based arguments, see Note, "Applicability of State Conflicts Rules When Issues of State Law Arise in Federal Question Cases," 68 Harv. L. Rev. 1212, 1218-1222 (1955); Cross, J.T., "State Choice of Law Rules in Bankruptcy," 42 Okla. L. Rev. 531 (1989); see, also, Woods-Tucker Leasing Corp. v. Hutcheson-Ingram Development Co., 642 F.2d 744 (5th Cir. 1981) (Klaxon should apply to issues that could have arisen independently of bankruptcy proceedings); In re Elder-Beerman Stores Corp., 221 B.R. 404 (Bankr. S.D. Ohio 1998) (same). Return to article
8 See Kalb, Voorhis & Co. v. American Fin. Corp., 8 F.3d 130 (2nd Cir. 1993); Robeson Indus. Corp. v. Hartford Accident & Indem. Co., 178 F.3d 160 (3rd Cir. 1999); In re Kaplan, 143 F.3d 807 (3rd Cir. 1998); In re Nantahala Village Inc., 976 F.2d 876 (4th Cir. 1992); In re Merritt Dredging Co. Inc., 839 F.2d 203 (4th Cir. 1988); Askanase v. Fatjo, 130 F.3d 657 (5th Cir. 1997); In re Iowa R.R. Co., 840 F.2d 535 (7th Cir. 1988); In re NWFX Inc., 881 F.2d 530 (8th Cir. 1989); Carlson v. Tandy Computer Leasing, 803 F.2d 391 (8th Cir. 1986); Cascade Energy & Metals Corp. v. Banks, No. 95-4045, 1996 U.S. App. LEXIS 4994 (10th Cir. March 21, 1996); Goldstein v. Madison Natl. Bank of Washington, D.C., 807 F.2d 1070 (D.C. Cir. 1986); In re B.S. Livingston & Co. Inc., 186 B.R. 841 (D. N.J. 1995); Elgin Sweeper Co. v. Melson Inc., 884 F.Supp. 641 (N.D.N.Y. 1995). Return to article
9 See In re Koreag, Controle et Revision S.A., 961 F.2d 341 (4th Cir. 1992); Woods-Tucker Leasing Corp. v. Hutcheson-Ingram Development Co., 642 F.2d 744 (5th Cir. 1981); Fahs v. Martin, 224 F.2d 387 (5th Cir. 1955); In re American Fuel & Power Co., 151 F.2d 470 (6th Cir. 1945); In re Morris, 30 F.3d 1578 (7th Cir. 1994); In re Stoecker, 5 F.3d 1022 (7th Cir. 1993); In re Lea Fabrics Inc., 226 F.Supp. 232 (D. N.J. 1964); In re Kaiser Steel Corp., 87 B.R. 154 (Bankr. D. Colo. 1988); In re O'Day Corp., 126 B.R. 370 (Bankr. D. Mass. 1991); In re Morse Tool Inc., 108 B.R. 384 (Bankr. D. Mass. 1989); In re Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1995); In re Consolidated Capital Equities Corp., 143 B.R. 80 (Bankr. N.D. Texas 1992). Return to article
10 See In re Lindsay, 59 F.3d 942 (9th Cir. 1995); In re Holiday Airlines Corp., 620 F.2d 731 (9th Cir. 1980); In re SMEC Inc., 160 B.R. 86 (M.D. Tenn. 1993); In re Gibson, 234 B.R. 776 (Bankr. N.D. Cal. 1999); In re Powerburst Corp., 154 B.R. 307 (Bankr. E.D. Cal. 1993); In re Ovetsky, 100 B.R. 115 (Bankr. N.D. Ga. 1989); In re McCorhill Publishing Inc., 86 B.R. 783 (Bankr. S.D.N.Y. 1988); In re Barney Schogel Inc., 12 B.R. 697 (Bankr. S.D.N.Y. 1981); In re Elder-Beerman Stores Corp., 221 B.R. 404 (Bankr. S.D. Ohio 1998); In re Professional Investors Ins. Group v. United Oversears Bank, 232 B.R. 870 (Bankr. N.D. Texas 1999). Return to article
11 In re Newport Plaza Assocs. L.P., 985 F.2d 640 (1st Cir. 1993); In re Pioneer Ford Sales, 729 F.2d 27 (1st Cir. 1984); In re Columbia Gas Sys., 50 F.3d 233 (3rd Cir. 1995); McDonnell v. American Leduc Petroleums Ltd., 456 F.2d (4th Cir. 1972); In re Stoecker, 5 F.3d 1022 (7th Cir. 1993); In re Iowa R.R. Co., 840 F.2d 535 (7th Cir. 1988); In re XYZ Options Inc. v. Keating, 154 F.3d 1262 (11th Cir. 1998); Head Injury Recovery Center v. Blue Cross, 206 B.R. 622 (1st Cir. B.A.P. 1997); In re Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1995). Return to article
13 Note, however, that states do not adopt this wholesale, but rather case by case and issue by issue; thus, a given state may apply the MSR in some areas while continuing to apply the unicontact approach in others. Return to article
17 Ferens v. John Deere Co., 494 U.S. 516, 110 S.Ct. 1274, 108 L.Ed.2d 443 (1990); Van Dusen v. Barrack, 376 U.S. 612, 84 S.Ct. 805, 11 L.Ed.2d 945 (1964); for a succinct summary, see Muldoon v. Tropitone Furniture Co., 1 F.3d 964 (9th Cir. 1993). Return to article
19 Id. (collecting cases); cf. also In re N. Parent Inc., 221 B.R. 609 (Bankr. D. Mass. 1998); In re Washington, Perito & Dubuc, 154 B.R. 853 (Bankr. S.D.N.Y. 1993); Chase Manahttan Bank N.A. v. Francini, No. 91 Civ. 2515, 1991 U.S. Dist. LEXIS 11381 (Bankr. S.D.N.Y. Aug. 16, 1991); In re St. Johnsbury Trucking Co., No. 93-B-43136, 1994 Bankr. LEXIS 1698 (Bankr. D. Vt. Oct. 21, 1994). Return to article
21 See Olcott v. Delaware Flood Co., 76 F.3d 1538 (10th Cir. 1996); Menowitz v. Brown, 991 F.2d 36 (2nd Cir. 1993); Marcus, "Conflicts Among Circuits and Transfers Within the Federal System," 93 Yale L.J. 677 (1984); cf. Kansas Pub. Employees v. Reimer & Koger Assoc., 61 F.3d 608, 611 n.4 (8th Cir. 1995); Eckstein v. Balcor Film Inv., 8 F.3d 1121 (7th Cir. 1993). Return to article
22 In fact, only one case has recognized in passing that an issue exists. Revco D.S. Inc. v. Government Employees Ins. Co., 791 F.Supp. 1254, 1262 n.10 (N.D. Ohio 1991) (dictum). Return to article