Typically, a state governmental entity is immune from suit unless the state explicitly waives its own sovereign immunity with respect to a particular claim or issue. Moreover, our federal government can only act to limit or override a state's sovereign immunity in certain limited circumstances. The interplay between a state's sovereign immunity and the rights granted to a Chapter 7 trustee pursuant to the Federal Bankruptcy Code was addressed in the recent case of Rescia v. Eastern Connecticut State University (In re Harnett), 558 B.R. 655 (Bankr. D. Conn. 2016). In Rescia, the U.S. Bankruptcy Court for the District of Connecticut addressed whether a state-owned university could assert a sovereign immunity defense to an avoidance action brought by a Chapter 7 bankruptcy trustee. In ruling that the state had waived its own sovereign immunity with respect to the claim at issue, the court addressed the specific provisions of the Bankruptcy Code, as well as the state's actions in ratifying the Bankruptcy Clause of the U.S. Constitution at the Constitutional Convention more than 200 years ago.

Facts and Arguments of the Parties

After being appointed Chapter 7 trustee for the bankruptcy estate of Kara S. Rescia, Elizabeth Harnett (as trustee) filed a complaint against Eastern Connecticut State University (ECSU). Through the complaint, the trustee sought to avoid and recover, as fraudulent transfers, certain tuition payments made by the debtor to ECSU related to the undergraduate education of the debtor's son. ECSU filed a motion to dismiss the count of the complaint that was brought under applicable Connecticut law and 11 U.S.C. 544(b)(1), which allows a trustee to step into the shoes of an unsecured creditor of a debtor for purposes of asserting avoidance actions. In the motion to dismiss, ECSU asserted that the doctrine of sovereign immunity prevented the trustee from using section 544(b)(1) of the Bankruptcy Code to recover transfers from a state entity.

In support of its motion to dismiss, ECSU argued that it was a political subunit of the state of Connecticut and consequently that, absent its consent, it was immune from suit under Section 544(b)(1). Specifically, ECSU argued that it would be immune from a suit brought by any of the debtor's unsecured creditors due to its sovereign immunity and, because the trustee had no greater rights than such hypothetical unsecured creditors under section 544(b)(1), by extension the trustee's suit was improper as well.

In response, the trustee relied upon section 106(a) of the Bankruptcy Code, which provides, in part, that “[n]otwithstanding an assertion of sovereign immunity, sovereign immunity is abrogated as to a governmental unit to the extent set forth in this section” with respect to a number of Bankruptcy Code provisions, including section 544. The trustee asserted that section 106(a) of the Bankruptcy Code expressly waives the sovereign immunity of the states, and that therefore the trustee's suit against ECSU was proper.

The Court's Analysis

In addressing the sovereign immunity arguments, the court first noted that the application of Bankruptcy Code section 106(a) is not as straightforward as one would expect from the text of that section. Section 106(a) was revised in connection with the Bankruptcy Reform Act of 1994 to clarify Congress' intent to abrogate sovereign immunity with respect to certain specific sections of the Bankruptcy Code. However, two years later, the U.S. Supreme Court decided Seminole Tribe v. Florida, 517 U.S. 44 (1996), in which the Supreme Court ruled that Congress lacked the authority to abrogate sovereign immunity on behalf of the states. Although the statute at issue in Seminole was not the Bankruptcy Code, the ruling in Seminole was generally interpreted as rendering section 106(a) unconstitutional as applied to the states. The court noted, however, that Seminole did not end its inquiry.

Ten years after Seminole, the Supreme Court decided another case related to the waiver of sovereign immunity: Virginia Community College v. Katz, 546 U.S. 356 (2006). The Katz case did involve the Bankruptcy Code, and in that case the Supreme Court held that Section 106(a) of the Bankruptcy Code was unnecessary to abrogate the states' sovereign immunity, because in ratifying the Bankruptcy Clause of the U.S. Constitution, all of the states had effectively waived their sovereign immunity defense to “proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts.”

In applying Katz, the bankruptcy court determined that the trustee's section 544 claim was an in rem proceeding seeking a declaration of avoidance of a fraudulent transfer, and that therefore ECSU was not entitled to assert a sovereign immunity defense to that action due to Connecticut's ratification of the Bankruptcy Clause. The court further determined that based on a similar statement in Katz, the fact that some in personam process was required to fully resolve the trustee's action against ECSU was not sufficient to nullify Connecticut's abrogation of its sovereign immunity with respect to in rem bankruptcy proceedings through the ratification of the Bankruptcy Clause.

Finally, the court again briefly addressed Section 106(a) of the Bankruptcy Code, and held, based upon review of another case decided under similar circumstances, that section 106(a)'s waiver of sovereign immunity was clear on its face, and that it is essentially a codification of the states' waiver of their sovereign immunity through the ratification of the Bankruptcy Clause. Accordingly, the court held that ECSU was not immune from the trustee's suit due to both  Connecticut's ratification of the Bankruptcy Clause of the U.S. Constitution and resulting waiver of sovereign immunity, and Section 106(a)'s codification of the waiver (even though, according to Katz, it was not necessary for the waiver of sovereign immunity to be codified).

Conclusion

Although the sovereign immunity of our states is broad, it is not limitless, and this case clarifies that governmental units are subject to certain lawsuits brought under the Bankruptcy Code.  Indeed, courts have a long memory, and actions taken more than two hundred years ago remain relevant in determining how to apply the laws of the land. This case is therefore germane to estate representatives seeking to assert claims against any governmental unit, including state-run universities, taxing authorities and utility providers, to name a few.

Rudolph J. Di Massa Jr. is a senior partner and chair of the firm's business reorganization and financial restructuring group, concentrates his practice in the areas of commercial litigation and creditors' rights. He currently represents various secured and unsecured lenders in bankruptcy cases pending in the Eastern District of Pennsylvania and the Southern District of New York, as well as a number of European companies doing business in the United States. Catherine B. Heitzenrater, an associated with the firm, practices in the areas of bankruptcy, corporate reorganization, creditors' rights, commercial finance and secured transactions. 

Typically, a state governmental entity is immune from suit unless the state explicitly waives its own sovereign immunity with respect to a particular claim or issue. Moreover, our federal government can only act to limit or override a state's sovereign immunity in certain limited circumstances. The interplay between a state's sovereign immunity and the rights granted to a Chapter 7 trustee pursuant to the Federal Bankruptcy Code was addressed in the recent case of Rescia v. Eastern Connecticut State University (In re Harnett), 558 B.R. 655 (Bankr. D. Conn. 2016). In Rescia, the U.S. Bankruptcy Court for the District of Connecticut addressed whether a state-owned university could assert a sovereign immunity defense to an avoidance action brought by a Chapter 7 bankruptcy trustee. In ruling that the state had waived its own sovereign immunity with respect to the claim at issue, the court addressed the specific provisions of the Bankruptcy Code, as well as the state's actions in ratifying the Bankruptcy Clause of the U.S. Constitution at the Constitutional Convention more than 200 years ago.

Facts and Arguments of the Parties

After being appointed Chapter 7 trustee for the bankruptcy estate of Kara S. Rescia, Elizabeth Harnett (as trustee) filed a complaint against Eastern Connecticut State University (ECSU). Through the complaint, the trustee sought to avoid and recover, as fraudulent transfers, certain tuition payments made by the debtor to ECSU related to the undergraduate education of the debtor's son. ECSU filed a motion to dismiss the count of the complaint that was brought under applicable Connecticut law and 11 U.S.C. 544(b)(1), which allows a trustee to step into the shoes of an unsecured creditor of a debtor for purposes of asserting avoidance actions. In the motion to dismiss, ECSU asserted that the doctrine of sovereign immunity prevented the trustee from using section 544(b)(1) of the Bankruptcy Code to recover transfers from a state entity.

In support of its motion to dismiss, ECSU argued that it was a political subunit of the state of Connecticut and consequently that, absent its consent, it was immune from suit under Section 544(b)(1). Specifically, ECSU argued that it would be immune from a suit brought by any of the debtor's unsecured creditors due to its sovereign immunity and, because the trustee had no greater rights than such hypothetical unsecured creditors under section 544(b)(1), by extension the trustee's suit was improper as well.

In response, the trustee relied upon section 106(a) of the Bankruptcy Code, which provides, in part, that “[n]otwithstanding an assertion of sovereign immunity, sovereign immunity is abrogated as to a governmental unit to the extent set forth in this section” with respect to a number of Bankruptcy Code provisions, including section 544. The trustee asserted that section 106(a) of the Bankruptcy Code expressly waives the sovereign immunity of the states, and that therefore the trustee's suit against ECSU was proper.

The Court's Analysis

In addressing the sovereign immunity arguments, the court first noted that the application of Bankruptcy Code section 106(a) is not as straightforward as one would expect from the text of that section. Section 106(a) was revised in connection with the Bankruptcy Reform Act of 1994 to clarify Congress' intent to abrogate sovereign immunity with respect to certain specific sections of the Bankruptcy Code. However, two years later, the U.S. Supreme Court decided Seminole Tribe v. Florida , 517 U.S. 44 (1996), in which the Supreme Court ruled that Congress lacked the authority to abrogate sovereign immunity on behalf of the states. Although the statute at issue in Seminole was not the Bankruptcy Code, the ruling in Seminole was generally interpreted as rendering section 106(a) unconstitutional as applied to the states. The court noted, however, that Seminole did not end its inquiry.

Ten years after Seminole , the Supreme Court decided another case related to the waiver of sovereign immunity: Virginia Community College v. Katz , 546 U.S. 356 (2006). The Katz case did involve the Bankruptcy Code, and in that case the Supreme Court held that Section 106(a) of the Bankruptcy Code was unnecessary to abrogate the states' sovereign immunity, because in ratifying the Bankruptcy Clause of the U.S. Constitution, all of the states had effectively waived their sovereign immunity defense to “proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts.”

In applying Katz, the bankruptcy court determined that the trustee's section 544 claim was an in rem proceeding seeking a declaration of avoidance of a fraudulent transfer, and that therefore ECSU was not entitled to assert a sovereign immunity defense to that action due to Connecticut's ratification of the Bankruptcy Clause. The court further determined that based on a similar statement in Katz, the fact that some in personam process was required to fully resolve the trustee's action against ECSU was not sufficient to nullify Connecticut's abrogation of its sovereign immunity with respect to in rem bankruptcy proceedings through the ratification of the Bankruptcy Clause.

Finally, the court again briefly addressed Section 106(a) of the Bankruptcy Code, and held, based upon review of another case decided under similar circumstances, that section 106(a)'s waiver of sovereign immunity was clear on its face, and that it is essentially a codification of the states' waiver of their sovereign immunity through the ratification of the Bankruptcy Clause. Accordingly, the court held that ECSU was not immune from the trustee's suit due to both  Connecticut's ratification of the Bankruptcy Clause of the U.S. Constitution and resulting waiver of sovereign immunity, and Section 106(a)'s codification of the waiver (even though, according to Katz, it was not necessary for the waiver of sovereign immunity to be codified).

Conclusion

Although the sovereign immunity of our states is broad, it is not limitless, and this case clarifies that governmental units are subject to certain lawsuits brought under the Bankruptcy Code.  Indeed, courts have a long memory, and actions taken more than two hundred years ago remain relevant in determining how to apply the laws of the land. This case is therefore germane to estate representatives seeking to assert claims against any governmental unit, including state-run universities, taxing authorities and utility providers, to name a few.

Rudolph J. Di Massa Jr. is a senior partner and chair of the firm's business reorganization and financial restructuring group, concentrates his practice in the areas of commercial litigation and creditors' rights. He currently represents various secured and unsecured lenders in bankruptcy cases pending in the Eastern District of Pennsylvania and the Southern District of New York, as well as a number of European companies doing business in the United States. Catherine B. Heitzenrater, an associated with the firm, practices in the areas of bankruptcy, corporate reorganization, creditors' rights, commercial finance and secured transactions.