How do you go bankrupt? Two ways – first gradually, then suddenly. – Hemmingway, "The Sun Also Rises"

The coronavirus crisis has had two catastrophic impacts on the finances of New Jersey and other states. On the expense side, it has required great expenditures for medical equipment in short supply in a largely unregulated competitive market, as well as overtime for emergency workers. On the revenue side, the disruption of economic activity due to lockdowns has drastically cut sales tax receipts and will in time have the same impact on income taxes. In addition to those direct effects, there may well be a knock-on effect on local government property tax receipts because the ability of some business and individual property owners to pay will be impaired.

Most state constitutions require a balanced budget; only the federal government has the power to increase the money supply, and inflate the currency, by the unrestricted issuance of debt purchased by the Federal Reserve. As a result, the issue of federal emergency financial relief for state governments has come on to the political agenda. In response, Senate Majority Leader McConnell floated the suggestion that financially overstretched state governments should go bankrupt. Gov. Cuomo responded that the Bankruptcy Code does not provide for states—as opposed to local governments—to seek bankruptcy protection, and that legislation would be required to amend the code. Sen. McConnell replied that he intended no such legislation. It is just as well, because we agree with the governor that such legislation would send a disastrous signal to the financial markets in the present crisis.

Apparently Sen. McConnell was using "go bankrupt" in the colloquial sense of states not paying their debts rather than the strict legal sense. Even without any change in bankruptcy law, New Jersey and other states have the power to repudiate their bond and pension debts using sovereign immunity. It is well settled that under the Eleventh Amendment and general principles of state sovereignty, as interpreted by the U.S. Supreme Court, the federal courts have no jurisdiction over any suit for a money judgment against a state government. That leaves the scope of sovereign immunity and its reciprocal, consent to suit, to the law of each state. There are historical examples, both before the Civil War and after Reconstruction, of states successfully repudiating their bonded debt in the light of changed economic or political circumstances.

Here in New Jersey, our Supreme Court declared in Allen v. Fauver (2001) and reaffirmed in Royster v. NJ State Police (2017) that the state retains sovereign immunity, and that statutes regulating and waiving it must be narrowly construed in favor of immunity. "An essential and fundamental aspect of sovereignty," said the court in Allen, "is freedom from suit by private citizens for money judgments absent the State's consent." Payment of judgments against the state is ultimately subject to our constitution's prohibition of spending public funds without an appropriation. "Legislative consent to suit," the court continued, "remained integral to waiver of sovereign immunity, for without express legislative consent to suit there is no ability to secure satisfaction of the judgment."

The Contractual Liability Act, N.J.S.A. 59:13-3, expressly waives New Jersey's sovereign immunity for express contracts or those implied in fact. Bonds, of course, are express contracts, and our courts have stated that the state's liability to retired employees for pensions earned through service is contractual. Whether our courts would allow the statutory waiver to be withdrawn with respect to existing contracts, either by legislation or by state constitutional amendment, would have to be determined in light of the Contracts Clauses of both the federal and state constitutions. So would the question of whether the Legislature retains the ultimate constitutional power not to appropriate funds for payment.

We hope that these issues will never arise, but we note that they exist, and that the ultimate credit of New Jersey and other states is not certain regardless of federal bankruptcy law. Throughout history, sovereign defaults have ruined lenders and brought on constitutional crises. If the enactment of a federal bankruptcy law for state governments would arguably undermine confidence in the financial markets, an actual state default based on sovereign immunity would certainly do so. Transferring some of the burden to the federal government, as Hamilton did with unpaid state Revolutionary War debts, would not eliminate the burden, but it would rest it on the strongest shoulders.