In January 2001, the Ninth Circuit, in In re Lazar, 237 F.3d 967 (9th Cir. 2001), considered several interesting sovereign immunity and priority issues. These issues stemmed from a chapter 11, turned chapter 7, involving the California Underground Storage Tank Cleanup Fund. Because these issues are not novel to the California State Water Resources Control Board (SWRCB) and have "reared their ugly heads" in garden-variety bankruptcy cases, I have devoted this article to examining In re Lazar.

In re Lazar involves the consolidated bankruptcy appeals of the SWRCB and the cleanup fund. Both the state board and the fund raised Eleventh Amendment issues. On cross-appeal, the bankruptcy trustee, under 11 U.S.C. §507 (a)(8), sought the reversal of a district court order holding that "fees payable to the fund are 'taxes' for bankruptcy purposes." 237 F.3d at 971.

On July 27, 1992, Grace and Gary Lazar voluntarily filed for chapter 11 reorganization on behalf of their corporations as well as for themselves. The Lazars took this action because the state of California seized their bank accounts due to their failure to pay gasoline taxes. Particularly, the Lazars did not make contributions to the fund. Subsequently, on Sept. 14, 1994, these cases were converted to chapter 7. Id.

The Barry Keane Underground Storage Cleanup Trust Fund Act established the fund, which is a state board-administered reimbursement program. Small gasoline purveyors use the fund so that they may comply with the Resource Conservation and Recovery Act, 42 U.S.C. §6901 et seq. (1994). The act requires small gasoline purveyors "to demonstrate financial ability to pay clean-up claims for damages caused by their leaking underground storage tanks." Id. at 972. California created the fund so that small gasoline purveyors could make claims from "the fund to recover costs associated with corrective action taken in response to unauthorized releases. Cal. Health & Safety Code §25299.54 (West 1999 & Supp. 2000)." Id. The small gasoline purveyors finance the fund by paying a fee based on the amount of gasoline or other petroleum products that they store in permitted tanks. Id.

The Lazars failed to make necessary payments to the fund. For that reason, during the 1993-95 bankruptcy proceedings the controller of the state of California and the California State Board of Equalization (BOE) filed proofs of claim for $31 million and $13 million, respectively. Id.

Additionally, the trustee filed 20 claims for reimbursement from the fund. However, the state board denied each of these claims due to a finding of misconduct by the Lazars. Appealing this decision, the trustee exhausted his administrative remedies and filed a petition for Peremptory Writ of Administrative Mandamus or Other Appropriate Writ against the state board in California's superior court. Shortly thereafter, in accordance with 28 U.S.C. §1452, the trustee filed a Notice of Removal of the Mandamus Adversary to the U.S. Bankruptcy Court. Id. at 972

In response, the state board filed a Motion for Remand or in the Alternative Abstention and Remand, claiming that "the bankruptcy court's subject matter jurisdiction over the action was foreclosed by the Eleventh Amendment." Id. at 973. The bankruptcy court rejected this, as well as the other state board arguments. The state board appealed. Id.

During that time, the trustee moved for partial summary judgment against the state of California, the state board and the fund (tax adversary). He asked that the court determine "(1) whether the fund is an arm of the state capable of invoking immunity under the Eleventh Amendment, and (2) whether the monies paid into the fund are properly characterized as 'fees,' not 'taxes.'" Id. at 973-74 (footnote omitted). On appeal, the district court found that the fund was not an arm of the state and that the monies were "taxes." Both the fund and the trustee appealed to the Ninth Circuit.

Did Filing Proofs of Claim Waive the State's Immunity?

When making its ruling, the court set forth the following case law that establishes states' rights under the Eleventh Amendment.

In Seminole Tribe v. Florida, 517 U.S. 44, 72-73, 116 S.Ct. 1114, 134 L.Ed.2d 252 (1996), the U.S. Supreme Court indicated that the Eleventh Amendment applies to bankruptcy proceedings. However, the states' immunity under the Eleventh Amendment is not absolute. In College Sav. Bank v. Florida Prepaid Post-secondary Educ. Expense Bd., 527 S.S. 666, 119 S.Ct. 2219, 2223, 144 L.Ed.2d 605 (1999), the Supreme Court ruled that "[a] state may waive its sovereign immunity by consenting to suit." "When the state becomes the actor and files a claim against the fund, it waives any immunity which it otherwise might have had respecting the adjudication of the claim.'" Gardner v. New Jersey, 329 U.S. 565, 573-74, 67 S.Ct. 467, 91 L.Ed. 504 (1947).

In accordance with the above case law, the court found that the state board did, in fact, waive its sovereign immunity by filing its proofs of claim against the debtors. Lazar, 237 F.3d at 976. The court then considered the extent of this waiver. Looking to the (often varying) rulings of other circuits, the court held the following:

We hold today that when a state or an arm of the state files a proof of claim in a bankruptcy proceeding, the state waives its Eleventh Amendment immunity with regard to the bankruptcy estate's claims that arise from the same transaction or occurrence as the state's claim.

Id. at 978 (emphasis added).

Based on this rule, the court held:

Accordingly, because the BOE filed proofs of claim in the bankruptcy proceeding that arise out of the same transaction or occurrence as the trustee's claims against the state board in the Mandamus Adversary, the state board has waived its Eleventh Amendment immunity in the Mandamus Adversary.

Id. at 980.

Consequently, by filing a proof of claim in the bankruptcy proceeding, the state board effectively waived its sovereign immunity in the subsequent Mandamus Adversary.

The Fund Is an Arm of the State

When deciding whether the fund could avail itself of the protections under the Eleventh Amendment (whether the fund was an arm of the state), the court looked to (1) whether a money judgment would be satisfied out of state funds, (2) whether the entity performs central governmental functions, (3) whether the entity may sue or be sued, (4) whether the entity has the power to take property in its own name or only in the name of the state, and (5) the corporate status of the entity. Id. at 982 (quoting Durning v. Citibank N.A., 950 F.2d 1419, 1423 (9th Cir. 1991)).

The court decided that the fund is an arm of the state, and in so ruling primarily relied on the second Durning factor. The court examined the purpose of the fund and stated that "the California legislature created the fund to protect public health and safety and the environment in light of the perception that 'a significant number of the underground storage tanks containing petroleum in the state may be leaking.'" Id. at 983 (quoting Cal. Health & Safety Code §25299.10(b)(1), (3) (West 1999 & Supp. 2000)). Based on its purpose as well as the fact that the California Health and Safety Code established the state as the fund's "source of power and its ultimate regulator," the court concluded that the fund performs "central governmental functions" under the second Durning factor. Id. Hence, given the weight of this factor, the court held that the fund is an arm of the state and, as such, may assert its immunity under the Eleventh Amendment.

Because the District Court's Decision That Fees Paid into the Fund Were Taxes Under 11 U.S.C. §507(a)(8) Was Not Final, the Court Could Not Consider the Trustee's Appeal

When determining the validity of the district court's ruling that the fees paid into the fund constituted taxes, the court looked to whether it had jurisdiction to consider this issue. Id. at 984-85. The court then set forth the basic rules of district court and appellate review. Citing 28 U.S.C. §158(d), the court stated that a court of appeals has "jurisdiction of appeals from all final decisions, judgments, orders and decrees entered under 28 U.S.C. §158(a)." Id. at 984-85. Further, according to 28 U.S.C. §158(a), "[a] district court has jurisdiction over a bankruptcy appeal from (1) final judgments, orders or decrees, and (2) interlocutory orders with leave from the bankruptcy court." Id. (quoting 28 U.S.C. §158(a)). A bankruptcy order is final "where it (1) resolves and seriously affects substantiate rights and (2) finally determines the discrete issue to which it is addressed." Id. at 985 (quoting Law Offices of Nicholas A. Franke v. Tiffany (In re Lewis), 113 F.3d 1040, 1043 (9th Cir. 1997)).

In this case, the trustee averred that the order concerning the motion for partial summary judgment was final. In so arguing, the trustee stated that "characterization [of the monies payed into the fund] will determine the priority of payments...because taxes have priority and fees do not." Id. at 985. The court pointed out, however, that the tax adversary actually is the trustee's action seeking subordination of the BOE's post-petition claims for (underground storage tank (UST)) fees. Id.

Quoting United States v. Noland, 517 U.S. 535, 116 S.Ct. 1524, 134 L.E.d.2d 748 (1996), the court set forth the following rule relevant to the case at bar: "'principles of equitable subordination' permit a court to make exceptions to a general rule when justified by particular facts." Id. at 985. The court stated that the trustee averred these "particular facts" and "inequitable conduct" in his complaint. Id. at 986. The court then found that "if the bankruptcy court rules in favor of the trustee on his equitable subordination claim, the BOE's claims for UST fees, be they 'taxes' or not, will be subordinated." Id. Therefore, since the bankruptcy court's order did not resolve the priority issue, the court found that the order was not final. For that reason, the court dismissed the cross-appeal for lack of jurisdiction under §158(a). Id.

Conclusion

Even though Lazar deals primarily with the SWRCB, the Ninth Circuit's decision is relevant to a multitude of bankruptcy situations—whether involving environmental issues or not. Primarily, its analysis of sovereign immunity and finality issues will arise consistently in a variety of bankruptcy cases. Thus, knowledge concerning the case law underlying the Ninth Circuit's reasoning will assist all bankruptcy attorneys in identifying critical issues in their practices.