Federal Bankruptcy Law and State Sovereign Immunity

Article excerpt

Although state governments are major players in the bankruptcy proceedings of private debtors,1 they have received relatively little attention in bankruptcy scholarship. Scholars of bankruptcy policy tend to view state governments-if they consider them at all-through the same lens that they view other private creditors and debtors in bankruptcy proceedings. While some writers on bankruptcy have acknowledged that state governments have a unique set of interests and constraints under federal bankruptcy law, we do not yet have a theoretical account of the appropriate relationship between federal bankruptcy law and state government.

One can see the unfortunate effects of this blind spot in the bankruptcy literature in recent attempts by various commentators to assess the effect of state sovereign immunity on the bankruptcy system. As a result of the Supreme Court's decision in Seminole Tribe v. Florida,2 states can now assert sovereign immunity from a variety of important bankruptcy provisions. The Bankruptcy Code automatically stays, or enjoins, most actions that might affect a debtor's assets once the debtor enters bankruptcy.3 It provides that certain preferential payments and transfers that the debtor makes before entering bankruptcy can be avoided, i.e., returned to the debtor's estate.4 Bankruptcy law also provides that certain debts can be permanently discharged in part or in whole.5 With the ability to assert sovereign immunity, states may be able to keep preferential transfers, thwart efforts during bankruptcy proceedings to discharge debts owed to them, collect debts that were successfully discharged in bankruptcy, and, perhaps most dramatically, take action in violation of bankruptcy law's automatic stay provision.6

Bankruptcy scholars who have written on the subject tend to agree that state sovereign immunity threatens the integrity of the American bankruptcy system.7 These commentators believe that states undermine fundamental policies and objectives of the bankruptcy system by asserting immunity from bankruptcy actions.8 They argue that, by asserting immunity, states get more than their "fair share" from a debtor's estate,9 frustrate corporate reorganizations,10 and undermine the efforts of individuals to obtain a "fresh start" in bankruptcy.11 Immunity has thus turned states into "super-creditors,"12 who are free to defy the bankruptcy rules that private parties must follow. To rectify this perceived threat to the bankruptcy system, various writers have proposed schemes by which Congress could "neutralize" states' immunity.13 These schemes include reenacting part of the Bankruptcy Code under the Fourteenth Amendment;14 creating self-executing Ex parte Young injunctions under the Code;15 and enforcing the Code against states in the name of the federal government.16 Due to the limitations of such schemes, however, there is an emerging consensus in the literature that Congress should force states to waive their immunity from bankruptcy law by requiring waiver as a condition of states' receiving federal funds17 or as a condition of states' participation in the bankruptcy system.18

This impulse to neutralize states' immunity from bankruptcy actions is based on an inadequate theory of the appropriate relationship between state governments and bankruptcy law. Those who would neutralize states' immunity assume along with many bankruptcy theorists that state governmental entities-taxing authorities, departments of transportation, regulatory commissions, environmental protection agencies, etc.-should be treated like other private parties in bankruptcy proceedings. One cannot evaluate the effect of states' immunity on the bankruptcy system without first examining this assumption, and one cannot examine this assumption without determining that it is untenable.

As Part II demonstrates, state governments are different from private parties in ways that are significant for bankruptcy law. In the first place, state governments are important regulatory agents. …