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The Resurrection of the Eleventh Amendment in Chapter 9 Cases

By: Christopher J. Pedraita

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Reversing the bankruptcy court, in In re City of San Bernardino, a district court recently held that the Eleventh Amendment barred a chapter 9 debtor’s claims against certain state agencies.[1]  In San Bernardino, the City of San Bernardino (the “City”) sought to protect funds, which the State of California (the “State”) demanded that the City remit to the State.  The funds at issue in San Bernardino had been parceled out to the City’s redevelopment agency (“RDA”) and earmarked for redeveloping urban neighborhoods.[2] In light of the fiscal emergency experienced by State in 2011, however, its legislature supplanted the existing RDAs with “successor agencies” to conclude all remaining matters of the RDAs, including returning the funds to the county auditor-controller that the RDAs had not already been committed to a project.[3]  As part of this process, the State ordered the City’ successor agency to return millions of dollars in tax revenues to the State’s Department of Finance (the “DOF”).[4]  If the successor agency failed to remit the funds to the DOF, the State warned that it could withhold tax revenue from the successor agency or the City.[5]  The warning prompted the City to commence adversary proceedings against the various state agencies[6] seeking injunctive and declaratory relief to, among other things, prevent the State agencies from withholding tax revenue from the successor agency (and the City itself).[7]  The State agencies moved to dismiss the City’s complaint on several grounds, including that claims were barred under the Eleventh Amendment.[8]  While the bankruptcy court granted the State agencies’ motion to dismiss with leave to amend,[9] believing that the City could show imminent injury if the state agencies withheld the tax money, the court rejected the state agencies’ Eleventh Amendment defense.[10]  In particular, the bankruptcy court ruled that when the subject of litigation was unquestionably within the court’s control state sovereign immunity could not prevent the adversary proceeding.[11]  On appeal, the district court reversed the bankruptcy court holding the Eleventh Amendment to apply in order to protect the State’s rights to run its own finances.[12]

Sovereign immunity is a protection offered to the states out of respect for their status as self-governing bodies.[13]  The states enjoyed this protection even before the Constitution was ratified.[14]  Broadly construed in the past by the Supreme Court, the Eleventh Amendment has been held to even bar suits against a state by its own citizens, including municipalities, except in areas to which the state has consented to be sued.[15]  In the bankruptcy context, however, two Supreme Court cases — Tennessee Student Assistance Corporation v. Hood[16] and Central Virginia Community College v. Katz[17] — have limited the application of sovereign immunity under the Eleventh Amendment.  First, in Hood, the Supreme Court held that a bankruptcy court’s “exercise of its in rem jurisdiction to discharge a debt does not infringe state sovereignty” because the bankruptcy proceeding is centered on the debtor’s estate not the creditor’s (in that case the state’s) interests.[18]  Comparing bankruptcy and admiralty law, the Supreme Court opined that if the exercise of control over the res in an admiralty case did not infringe upon state sovereignty neither should such exercise of control in a bankruptcy case.[19]   The Supreme Court also pointed out in Hood that regardless of whether it chooses to participate in the proceedings, a state is “bound by a bankruptcy court’s discharge order no less than other creditors.”[20]  Similarly, in Katz, the Supreme Court again held that the Eleventh Amendment did not bar preference claims against a state in bankruptcy.[21]  Citing to Hood, the Katz Court reiterated that state sovereignty is not infringed by the bankruptcy court’s in rem jurisdiction.[22]   Moreover, based on legislation passed soon after the ratification of the Constitution, the Supreme Court reasoned that state sovereignty was to be at least to some extent subordinate to the court’s power in bankruptcy matters.[23] Furthermore, the Supreme Court pointed out that the Founders enacted the Bankruptcy Clause in order to ensure that states respected the discharge of the citizen(s) of other states.[24]  The district court in San Bernardino challenged the notion that there is a blanket rule that the Eleventh Amendment does not apply in bankruptcy, however, and held that the Eleventh Amendment bars causes of action asserted by municipalities against state agencies in chapter 9 cases.[25]

The San Bernardino court grounded its reasoning on the basis that bankruptcy jurisdiction depends on the debtor and its estate, and Congress may limit state authority at least somewhat in the bankruptcy area because the Framers included the Bankruptcy Clause in the Constitution.[26]  First, in San Bernardino, the court emphasized “[t]he disputed property…is not, was not, and will not be the property of the City, and the Court will never have exclusive in rem jurisdiction over it.”[27] If the City could prove that the threats credibly threatened its property, then the San Bernardino Court could exercise unquestioned in rem jurisdiction of the property and prevent the State agencies from an Eleventh Amendment defense.[28]  Second, the court emphasized that the prior cases involving the Eleventh Amendment in bankruptcy, including Hood and Katz differed from San Bernardino because the debtor in San Bernardino was a municipality, not a private individual, which are nothing more than entities created by the state to administer to the people on a local level. [29]  As the San Bernardino court stated, “[a]llowing the City to proceed risks inviting the sort of inference with the State’s control of its fiscal affairs that the Supreme Court sought to avoid when it allowed municipal bankruptcies.”[30]  Finally, the district court concluded that the Ex Parte Young Doctrine would apply, which prevents a state official enforcing an unconstitutional law from asserting sovereign immunity, did not apply.[31]

While limited to the municipal bankruptcy context, the San Bernardino decision importantly revives the doctrine of sovereign immunity under the Eleventh Amendment in bankruptcy cases.  As such, San Bernardino represents a departure from recent case law that seemingly eviscerated the doctrine in bankruptcy cases.[32]  Indeed, the San Bernardino court itself emphasized that while the Supreme Court’s reasoning in Hood and Katz was broad, it “[wa]s not all encompassing.”[33]  Although the San Bernardino decision may be relevant to the area of municipal bankruptcies, its impact may be localized to California because the issue arose out of the unique tax scheme that California created. Moreover, given the low number of chapter 9 cases filed each year, it is unlikely that the issue of whether the Eleventh Amendment applies in chapter 9 cases will arise with any frequency.[34]



[1] Nos. 6:13–AP–01127–MJ, 2014 WL 2511096 (C.D. Cal. June 4, 2014).

[2] Id. at *1.

[3] Id.

[4] Id. at *2.

[5] Id.

[6] State Agencies include John Chiang in his official capacity as State Controller, the Office of the State Controller, the California Department of Finance, and Michael Cohen in his official capacity as Director of Finance.

[7] In re City of San Bernardino, 2014 WL 2511096, at *2.

[8] Id. at *3.

[9] Id.

[10] Id.

[11] Id. at *4.

[12] Id. at *15. 

[13] In re City of San Bernardino, 2014 WL 2511096, at *10.

[14] Id.

[15] Id.

[16] 541 U.S. 440 (2004).

[17] 546 U.S. 356 (2006).

[18] Hood, 541 U.S. at 448.

[19] Id. at 452.

[20] Id. at 448.

[21] Katz, 546 U.S. at 360.

[22] Id. at 362.

[23] Id. at 363.

[24] Id. at 377.

[25] In re City of San Bernardino, 2014 WL 2511096, at *14

[26] Id. at *11.

[27] Id. at *14.

[28] Id.

[29] Id. at *12.

[30] Id. at *13 (citing U.S. v. Bekins, 304 U.S. 27, 51–52 (1938)).

[31] In re City of San Bernardino, 2014 WL 2511096, at *14.

[32] See, e.g., Hood, 541 U.S. 440; Katz, 546 U.S. 356; In re G-1 Holdings Inc, 420 B.R. 216 (Bankr. D. N.J. 2009) (confirming that a settlement plan met 11 U.S.C.S. § 1126(f) over I.R.S. objections); Fla. Dep’t of Revenue v. Diaz (In re Diaz), 647 F.3d 1073 (11th Cir. Fla. 2011) (reversing and remanding the issue for dismissal based on a lack of jurisdiction over contempt proceedings).

[33] In re City of San Bernardino, 2014 WL 2511096, at *11.

[34] Mike McCaig, How Rare Are Municipal Bankruptcies?, By the Numbers (January 24, 2013), http://www.governing.com/blogs/by-the-numbers/municipal-bankruptcy-rate-....