State Sovereign Immunity--Bankruptcy.--Bankruptcy law has come a long way since the eighteenth century, when debtors were often punished with imprisonment and fared worse in colonial jails than common criminals. (1) Thanks partly to the U.S. Constitution's Bankruptcy Clause, (2) a debtor can no longer be stripped of all his assets in New Jersey and then thrown in jail in Pennsylvania for not having paid his debts. (3) Likewise, federal bankruptcy law now provides more protection to creditors than was available in the eighteenth century by striving toward an equitable distribution of assets--a development especially important for small creditors, who might otherwise suffer significantly from a debtor's bankruptcy. (4) Last Term, in Central Virginia Community College v. Katz, (5) the Supreme Court advanced equitable distribution doctrine a step further. Grounding its decision in original intent, the Court held that a state acting as a creditor cannot claim sovereign immunity as a defense when a bankruptcy trustee attempts to recover assets from the state in order to redistribute those assets more equitably among all creditors. (6) But although its holding saved bankruptcy from the reach of the Eleventh Amendment, the Court neither specified what other bankruptcy proceedings will similarly overcome a sovereign immunity defense nor sufficiently explored the implications of its original intent analysis. With its bare 5-4 majority and the replacement since the decision of one of the majority Justices (7) by a states' rights advocate, (8) Katz's step forward for bankruptcy law remains tenuous.
Bernard Katz was the bankruptcy trustee for Wallace's Bookstores, which conducted business with Central Virginia Community College. (9) After becoming insolvent but prior to filing for bankruptcy, Wallace's Bookstores made payments to the college, which Katz subsequently attempted to recover as "preferential" payments. (10) Under federal bankruptcy law, such payments must be disgorged so that the total assets of a bankrupt entity can be fairly distributed among all creditors. (11) To prevent the debtor from giving more of her assets to the creditors she favors (for example, a relative) than to those she disfavors (a credit card company), the trustee can sue the preferred creditors to get those "preferential" payments back. (12) The College raised the defense of sovereign immunity: as a state institution of higher education, the College is considered an arm of the state of Virginia. (13)
The United States Bankruptcy Court for the Eastern District of Kentucky rejected the petitioner's motion to dismiss the proceedings on the basis of sovereign immunity. (14) It anchored its decision to the Sixth Circuit case In re Hood, (15) which held that the Bankruptcy Clause grants Congress the authority to abrogate states' sovereign immunity. (16) The district court and the court of appeals for the Sixth Circuit affirmed. (17)
The Supreme Court affirmed. In rejecting the sovereign immunity defense, Justice Stevens, writing for the majority, (18) focused on the intent of the Constitution's Framers. The Court first outlined the historical context of the Bankruptcy Clause (19): Foremost on the Framers' minds were the "intractable problems" and injustices caused by states' imprisonment of debtors who had already been cleared through the bankruptcy process of another state. (20) The absence of debate preceding the passage of the Bankruptcy Clause, the Court determined, suggests that the Framers generally agreed that uniform bankruptcy laws were necessary to prevent the problems caused by inconsistent state laws. (21)
Justice Stevens went on to assert that bankruptcy jurisdiction is at its core in rem. (22) Bankruptcy proceedings focus on an estate rather than on a person and thus, as a baseline, do not significantly implicate states' sovereignty. (23) To the extent an action seeking the return of preferential payments goes beyond in rem, the text of the Bankruptcy Clause provides a more expansive power to establish "uniform laws on the subject of Bankruptcies throughout the United States. …