Central Virginia Community College, et al. v. Katz, Bernard (01/23/2006)

Question presented: Whether Article I, "8, cl. 4, of the Constitution on bankrupty grants Congress the authority to abrogate state sovereign immunity from private suits involving the dischargeability of a student loan debt?

BY CARMEN JONES & ETAN HARMELecH, MEDILL NEWS SERVICE

At its height, Wallace's Bookstores Inc., was worth more than $450 million. With more than 90 locations on or near college campuses across the U.S., the Kentucky-based business relied heavily on income generated from educational institutions. By 2001, Wallace's Bookstores was $152.3 million in debt. Owner Thomas Wilkinson, a former governor of Kentucky, also carried more than $418 million in personal debt.

Creditors initially requested that Wilkinson be forced to file for bankruptcy under Chapter 7, which would have liquidated his assets, including shares in Wallace's Bookstores and online bookseller ecampus.com, and then paid off debt in order of priority. Chapter 7 also would have ensured that stockholders received nothing. In February of 2001, Wilkinson instead filed bankruptcy under Chapter 11, which allowed Wallace's Bookstores to continue operating and enabled creditors and shareholders to make reorganization decisions before a bankruptcy court confirmed their decision.

The bankruptcy court appointed Bernard Katz as the liquidating supervisor for Wallace's Bookstores. In 2003, Katz filed a lawsuit in Kentucky for more than $400,000 against four state-run Virginia schools -- Central Virginia Community College, Virginia Military Institute, New River Community College, and Blue Ridge Community College. Katz's suit was filed in an attempt to retrieve rent payments that Wallace's Bookstores had paid the schools earlier in the bankruptcy process. The suit claimed that the schools owed the struggling bookstore not only for preferential transfers, which occurs when a company on the verge of bankruptcy preferentially pays off debt, but also for unsold books.

The Virginia Attorney General's office fought Katz's attempt. The state's Solicitor General William Thro called the lawsuit "an attempt to get money from the treasury. It is money that could be better spent on books, on school rooms."

In essence, Virginia argued that the 11th Amendment of the Constitution grants states sovereign immunity and, therefore, protects states and state institutions from bankruptcy measures. The 11th amendment states: "The Judicial power of the United States shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State."

According to Thro, "The principal of sovereign immunity is that the states cannot be sued for money damages in courts. This has been true since the beginning of the United States and is generally true today."

Generally true, but not always. The Constitution's Bankruptcy Clause, Article I, section 8, made bankruptcy issues a matter of federal jurisdiction, and the general argument was that with it, state sovereign immunity was abrogated.

However, in 1996, Seminole Tribe of Florida v. Florida raised doubt about that general proposition. In that case, the Supreme Court ruled that the 11th Amendment restricts the judicial power under Article III, and Article I cannot be used to circumvent the constitutional limitations placed upon federal jurisdiction. However, that case did not involve the bankruptcy clause of Article I.

In 2003, the 6th Circuit Court of Appeals in Hood v. Tennessee Student Assistance Corp. addressed the issue of sovereign immunity relating to the bankruptcy clause and held that Congress could validly abrogate state sovereign immunity relying on its Bankruptcy Clause powers. Other circuits concluded differently and the U.S. Supreme Court accepted review. But in deciding the case in 2004, the Supreme Court did not reach the Constitutional question.

When the U.S. District Court in Kentucky considered Katz's arguments on behalf of Wallace's Bookstores, it deferred to the 6th Circuit's opinion in Hood, which had held that Congress could abrogate Virginia's sovereign immunity, relying on its Bankruptcy Clause powers. The court sided with Katz.

The 6th Circuit followed suit, in an unsigned one-paragraph opinion.

"Because we are bound to follow a decision of a prior panel, and because the parties agree that Hood applies here," the 6th Circuit affirmed in August 2004.

Virginia's Office of the Attorney General then sought to take its case to the high court. On March 2, 2005, Ohio and 48 other states filed an amicus brief in support of Virginia. Ohio Assistant Attorney General Elise Porter called the unanimity of states in support of Virginia "relatively unusual," but necessary because "this case is a continuation of a long line of cases that are important to all states."

On April 4, 2005, the Supreme Court accepted review in the case. According to Thro, the ramifications are "potentially very severe," adding that "in the bankruptcy context, this is extremely important. It is one thing for Virginia to be sued in Virginia. It is quite another for us to be sued in California or Kentucky and go to other states and litigate there."

The issue of out-of-state claims, however, proved to be a mere sidebar in oral arguments on Oct. 31, 2005.

"Regardless of context, sovereign immunity bars monetary judgment claims," Thro argued. "States are immune to actions by theee to augment the estate; private parties are not."

Although Thro agreed that individuals could and should be allowed to defer, or even withhold, payment to states under the bankruptcy laws, he contended that a line needed to be drawn when individuals, organizations, or others sought hard currency from state coffers.

To buttress his assertions, Thro referred to the Court's 1996 opinion in Seminole Tribe, saying that any kind of ruling in favor of Katz would require "certain fundamental changes in the Court's jurisprudence."

Justice Anthony Kennedy questioned how the state could claim sovereignty when one of the universities in question, VMI, had already waived its right to sovereign immunity.

"It seems to me somewhat unfair that the state can…fractionate its immunity," Kennedy said. "It seems to me that if one state entity is subject to offset, then all of them are."

VMI, Kennedy said, had forfeited immunity when it entered a claim against Wallace's Bookstores after the initial bankruptcy filing.

Although Kim Martin Lewis, the attorney representing Katz, eventually fell back upon the idea of uniform immunity as well, she initially focused on the sanctity of the bankruptcy process.

"There's a very basic bankruptcy policy to prevent abusive debt-collection practices on the eve of bankruptcy," Lewis said.

She essentially argued that granting states sovereign immunity would undermine the bankruptcy laws Congress had intended to be broadly applicable to all entities, states included. If so, that line of reasoning would render the Seminole Tribe decision a moot point, and perhaps win the day for Katz, Justice David Souter said.

After Lewis had weighed in on Congress' intent, Thro took his own stab at gauging the Founders' purposes. He said it was clear that the original Congress had not intended to abrogate state sovereignty, invoking documents such as the Federalist Papers and the ratification of the Constitution in support.

During Thro's rebuttal, Justice Ruth Bader Ginsburg introduced the idea that, as it had done in Hood, the Court could decide the case on grounds other than state sovereignty, thereby skirting the monetary immunity question for the second time.

In allowing for that possibility, Thro acknowledged that if the case were remanded to the 6th Circuit, Wallace's Bookstores would likely employ a very different strategy. In so doing, he made sure to remind the justices that an ambiguous ruling would still be better than a vote to uphold the circuit court's decision.

"All of Katz's novel arguments raise complex constitutional issues, and, quite frankly, ask for radical alteration of this Court's jurisprudence," he said.

On Jan. 23, 2006, a divided Court found Katz's arguments neither novel nor radical, holding 5-4 that Congress acted within its power in revoking the sovereign immunity of states in bankruptcy proceedings.

In writing the Court's majority opinion, Justice John Paul Stevens reasoned that the the history of the Constitution's Bankruptcy Clause demonstrates that it was intended not just as a grant of legislative authority to Congress, but also to authorize limited subordination of state sovereign immunity in the bankruptcy arena. In so concluding, the majority conceded that language in the Court's 1996 opinion in Seminole Tribe of Fla. v. Florida may have been ill-advised.

Nonetheless, the majority concluded, states should be bound by a bankruptcy court's order discharging a debtor no less than are other creditors. The majority viewed the case less as one in which Congress encroaches on the sovereign immunity of states than one in which Congress can choose either to treat states in the same way as other creditors or exempt them from the operation of the nation's bankruptcy laws.

Justice Clarence Thomas wrote a dissent for himself, Justices Antonin Scalia, Anthony Kennedy and Chief Justice John Roberts.