Missing the Forest for the Trees

Missing the Forest for the Trees

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This month's article is actually four sets of comments dealing with cases or articles where the writers have, I believe, missed a critical issue, losing sight of the forest in the midst of analyzing the trees. Three comments are on articles in the April ABI Journal; the fourth is on In re Rashid, 2000 WL 382727 (3rd Cir. 4/14/00).

The first article, by Gregory Hesse, "More from the Labor Law Front," describes United Healthcare Systems Inc., 200 F.3d 170 (3rd. Cir. 1999), interpreting the Worker Adjustment and Retraining Notification (WARN) Act. This act, as the article notes, dealt with companies that "abruptly clos[ed] or laid off substantial numbers of employees without warning." United had struggled for a time and finally filed bankruptcy when its secured lender abruptly placed it in default and refused to advance additional funds. The debtor closed its facility and began to liquidate, but planned to provide employees with the 60 days notice (and pay) required by the WARN Act. The creditors' committee, however, demanded that the employees be terminated immediately. The Third Circuit concluded that this could be done without violating the WARN Act because, it held, when the debtor began liquidation, it was no longer a "business enterprise" as defined by the Act and, hence, no longer subject to the Act's requirements. Each step of its analysis seems logical, but the opinion boils down to saying that once a business shuts down, it is not subject to the WARN Act. In other words, the precise action that triggers liability—closing abruptly without compensation—also serves to eliminate that liability. The court noted various equitable factors in the debtor's favor as reasons to eliminate liability, but ignored the fact that the Act already takes those matters into account as affirmative defenses. The court seems to think its opinion can be confined to bankruptcy cases, but its logic could well eliminate any meritorious WARN Act case—a result to which the court seems blissfully oblivious.

The second article, "On the Evidence of These Numbers: Why Consumers File for Bankruptcy," by Gordon Bermant and Ed Flynn, suggests that the supporters of the consumer amendments in the pending bankruptcy bills are arguing from a stereotype—namely, that if bankruptcies are increasing in an era of strong economic growth, then those filing bankruptcy must be irresponsible, unscrupulous or both. The article asserts that it is unfair to assume that filings will move in immediate correlation with the state of the economy and proves that there is a strong, albeit delayed, correlation between levels of debt and bankruptcy filings. But all that shows is that most people don't file bankruptcy when they have no need to do so at all, although proving that merely disproves a red herring. Even if bankruptcy has lost its stigma, no one suggests that it has become so pleasurable that people file just for the heck of it. No one, least of all the creditors, would deny that people file bankruptcy because they have large debts.

But by the same token, proving that filers have high levels of debt does nothing in and of itself to rebut the claim that those persons are irresponsible or unscrupulous. Even accepting Bermant's and Flynn's proof that increasing debt leads to increasing bankruptcy, one may still validly ask, "Why is consumer debt increasing in an era of robust economic growth and low unemployment?" One hypothesis is that individuals, believing that they can easily and painlessly rid themselves of their debts in bankruptcy, voluntarily take on more debt, especially for luxury items, than they would have in an earlier, more responsible age. Another hypothesis is that the state of the overall economy does not adequately reflect the status of ordinary wage earners and that they are increasingly hard-pressed to maintain an adequate standard of living and to deal with holes in the social safety net. Thus, the additional debt is being taken on not for luxuries and baubles, but for day-to-day necessities. Since we can reasonably assume that those who file bankruptcy have always had difficulty in making ends meet, the question still remains: Is it harder for people with equivalent incomes to survive now than 15 or 20 years ago? In short, this is a chicken-or-the-egg question: Is the easy availability of bankruptcy driving the increase of consumer debt or is the increase in debt driving the rising number of bankruptcies? The article's analysis rules out neither possibility. Each explanation undoubtedly has some validity and there are many subhypotheses that are also likely to be part of the answer. It would take a book many times the size of this article to attempt to fully discuss those issues, but I confidently predict we will get nowhere until we start asking the right questions, not merely knocking down straw men.

My third comment is on "The Toxic Avenger: Bankruptcy Court Jurisdiction over States." John W. Ames and C.R. "Chip" Bowles argue that a state that objects to the abandonment of a piece of property should be deemed to have made a general waiver of its sovereign immunity as to all aspects of the case. This then would, in their view, allow the debtor to litigate any claims it has against the state. They assert that if a state files a claim, it has agreed to at least a limited waiver of its rights and that the Supreme Court has held that a state that invokes federal court jurisdiction outside of bankruptcy has consented to a general waiver of immunity. They then argue that opposing an abandonment action should result in the same supposed general waiver of immunity by the state. "This type of legislation [sic—action?]", they assert, "constitutes the voluntary, unequivocal and clearly expressed submission to the jurisdiction of the federal courts that courts have held will waive a state's Eleventh Amendment jurisdiction [sic—immunity?]." Finally, they argue that, unlike the "Hobson's Choice" states face in deciding whether to either file a claim and lose immunity or refrain from doing so and lose their rights to payment, the state has a real choice where property is abandoned: It can take action in state court against the property and later seek to assert a claim against the estate, or it can oppose the abandonment and ask the court to require the estate to comply with state laws. This "choice," they argue, should lead courts to broadly construe the state's waiver when it challenges an abandonment request.

Virtually every aspect of that analysis, though, is dead wrong in that it merely resurrects the "constructive" or "deemed" waiver notions that were expressed in Parden v. Terminal Railway Co., 377 U.S. 184 (1964), and overruled by the Supreme Court in College Savings Bank v. Florida Prepaid Postsecondary Education Board, ___ U.S. ___, 119 S.Ct. 2199 (1999). To begin with, Ames and Bowles, like most commentators, misunderstand the nature of the "waiver" of immunity that arises from the filing of a claim. Properly understood, the filing of a claim (or any other court action by a governmental entity) is not a waiver at all. See, e.g., U.S. v. Murdock Machine & Engineering, 81 F.3d 922, 931 (10th Cir. 1996). Rather, the filing of a federal action simply signals that the state has asked the federal court to resolve a controversy that the state has brought to it. It has not "waived" its immunity because immunity is not at issue when the state is not being sued.1 Instead, immunity issues only arise when the debtor tries to use the occasion of the state's suit to bring its own (counter) claim against the state. It is black-letter law that a defendant may only assert rights of recoupment, i.e., mandatory counterclaims asserted up to the amount that would defeat the state's claim, in response to the state's case.

Why? For the same reason that recoupment does not violate the stay or the Code's priority rules even though it is nowhere provided for in the Code. Recoupment, by definition, involves mandatory counterclaims that are not independent claims at all. They are a defense to the original claim—recoupment is not a right to payment; it is a right not to pay the claim of the other side. When the state litigates its claim in federal court, that litigation must obviously include the defenses of the other party, including recoupment. Indeed, mandatory counter-claims are waived if they are not raised in response to the original claim. As such, they are inherently part of the litigation that the state chooses to bring in federal court. But, because they are defenses, they may only be raised so long as they serve a defensive purpose. If there is an attempt to go further and obtain affirmative relief, the claims cease being a defense and become an affirmative claim of the debtor, for which the Eleventh Amendment would apply.

The Second Circuit stated in U.S. v. Forma, 42 F.3d 759, 765 (1992), that "it has long been absolutely clear that the exception [for mandatory counterclaims] does not permit any affirmative recovery against the United States on a counterclaim that lacks an independent jurisdictional basis."2 Similarly, in United States v. Shaw, 309 U.S. 495, 504 (1940), the Supreme Court held that where the government has not explicitly waived its immunity, "no judgment may be entered against the government, even though the court has ascertained, through its processes, that the government is actually indebted to the defendants." In short, a defense is a defense is a defense; while in football the best defense is a good offense, the same does not hold true in immunity litigation. It is for that reason, then, that the type of counterclaims that the debtor may bring is not simply an arbitrary limit that can be expanded or contracted at will by Congress. To say, as Congress did in §106(b), that by filing a claim the state is "deemed" to have waived its immunity from affirmative recovery on mandatory counterclaims, is to admit that the state did not actually waive that immunity. As Justice Scalia noted, "There is a fundamental difference between a state's expressing unequivocally that it waives its immunity, and Congress expressing unequivocally its intention that if the state takes certain action it shall be deemed to have waived that immunity...Forced waiver and abrogation are not even different sides of the same coin; they are the same side of the same coin." The same principle applies with even greater force to the attempt in §106(c) to allow a debtor to raise any claim as a defense against the claim of a state. This is clearly not allowed under the common law, and the statutory change cannot survive College Savings.

If all this is true, then the attempts to distinguish the abandonment issue from the claim filing issue in order to find a waiver based on the state's action make even less sense. In one case, the state files a claim to receive a benefit from the debtor; in the other, it objects to the debtor's efforts to obtain a benefit by abandoning burdensome property. In either case, the state is doing something that takes away from the value of the estate. Moreover, filing the objection clearly does not establish that the state actually agreed to be sued with respect to any other matter.3 Nor are the authors correct about does the purported absence of a Hobson's Choice—even assuming such a choice is required for the state to be entitled to retain its immunity. The reality is that the issues are just as difficult with respect to abandonment motions as with respect to filing a claim.

The point of an abandonment, after all, is to remove property from the estate so it cannot be asserted that it would benefit the estate to have it cleaned up, thereby precluding any attempt to obtain administrative priority for the remedial costs. At best, the state may be able to file a general unsecured claim for the costs that it incurs in dealing with the abandoned land. On the other hand, if the property remains in the estate, 28 U.S.C. §959(b) obligates the debtor and the trustee to obey all valid state laws, including those requiring remediation of the contamination, and to pay for that cleanup in administrative dollars with no out-of-pocket expenses for the state. Making the state choose between that outcome and the alternative of acquiescing in the abandonment, doing the work itself and being paid in tiny bankruptcy dollars so it can retain its general immunity obviously presents a highly unpalatable dilemma. Indeed, the amounts at issue in many environmental cases often dwarf the size of the claims in other situations. The fact is that the fight over abandonment is really just an argument about claims priority. And, since priority issues are just another aspect of claims allowance, disputes over such issues provide no more reason to find a general waiver of immunity than disputes over liability for claims in general.

Moreover, one reason why there have been very few cases about what actions in a case may waive the state's immunity may be that Congress has only tried to rely on the act of claims filing to impose a limited restriction on the state's immunity. Yet the authors here rush in where Congress has feared to tread! Where would this argument stop? Can the state oppose a motion to strip its lien without generally waiving its immunity?4 Can it request adequate protection for its cash collateral? Can it vote on the plan? Can it even file a notice of appearance? Or read the pleadings? Once one starts allowing Congress to consent for a state, it is hard to find a stopping point. The correct analysis, on the other hand, is simple and clear: When the state enters the federal arena, the court may litigate the matter the state brings before it and the inherent defenses thereto. To do anything more is to lose sight of the notion of what voluntary waiver is all about.

My final concern is with the Rashid case, which deals with the dischargeability of criminal restitution paid to a victim in a federal prosecution. In Kelly v. Robinson, 479 U.S. 36 (1986), the court held that any condition imposed in a state sentence—including restitution—was not subject to discharge under §523(a)(7). It based that conclusion on the well-established belief that bankruptcy should not be allowed to interfere with criminal sentences. Although Kelly involved a payment to the state, and the court stressed the comity concerns between state and federal courts, later courts had no difficulty in concluding that the same principle should apply to cases ordering restitution to go directly to victims and to federal cases. See, e.g., U.S. v. Grundhoefer, 916 F.2d 788 (2nd Cir. 1990) (court-ordered restitution should go to government but be applied to loan obligations owed by victims to the government); HUD v. Cost Control Marketing & Sales Mgmt. of Virginia Inc., 64 F.3d 920 (4th Cir. 1995) (Kelly and Davenport make all restitution orders, even those owed to private parties and entered in civil cases, non-dischargeable); U.S. v. Carson, 669 F.2d 216 (5th Cir. 1982) (restitution may be a condition of probation even though underlying debt is discharged; probation reforms offender and protects the state from recidivism); U.S. v. Caddell, 830 F.2d 36 (5th Cir. 1987) (Kelly applies to federal orders, even though it talked of comity with states; upholds restitution to government as condition of probation); In re Fussell (Fussell v. Price), 928 F.2d 712 (5th Cir. 1991), cert. denied, 502 U.S. 1107 (1992) (prosecution of debtor allowed even though prosecution intended to provide restitution to victim; Kelly says restitution is for the benefit of the state even if the money goes to victims); U.S. v. Pepper, 51 F.3d 469 (5th Cir. 1995) (order of restitution to victims not subject to discharge); In re Vetter, 895 F.2d 486 (8th Cir. 1990) (Kelly applies to federal criminal restitution to victim, order allowed even though debtor and victim had settled); United States v. Cloud, 872 F.2d 846 (9th Cir.), cert. denied, 110 S.Ct. 561 (1989) (restitution to victim allowed even though victim had settled own suit); In re Soderling, 998 F.2d 730 (9th Cir. 1993) (Kelly rationale is equally applicable to federal cases; restitution to FSLIC); U.S. v. Lombardo, 35 F.3d 526 (11th Cir. 1994) (criminal restitution orders to victim are not dischargeable) Cf. In re Daulton, 966 F.2d 1028 (6th Cir. 1992) (criminal prosecution of a debtor may not be enjoined even after debt is discharged; but holds in dicta that restitution is not allowed; case does not discuss Kelly, and simply assumes debt is discharged).

Notwithstanding that panoply of case law, the Third Circuit held that restitution that was directed to the victims would not be excepted from discharge because it was not "payable to and for the benefit of a governmental unit." It cited In re Towers, 162 F.3d 952 (7th Cir. 1998), cert. denied, 119 S.Ct. 2340 (1999), which had made that distinction in a civil case and, in a two-sentence footnote, equated federal criminal and state civil restitution orders by saying that neither dealt with comity issues in the criminal context. In doing so, though, the court ignored language in Kelly that specifically discusses restitution to the victim as an example of what should be protected, as well as its discussion of how criminal restitution serves to protect society as a whole. It is bad enough that the court in Towers brushed aside the assertion that the interests of the government and those of its citizens are congruent in the civil context. But to do so in the criminal context, where the government acts as the representative of "the people," is to ignore the entire rationale on which Kelly was based. Even worse, it results in the anomaly that criminal restitution paid to a victim can be discharged in a chapter 7 case, but not in chapter 13 (since the language added to §1328(a) in 1990 merely refers to criminal restitution generally). This turns the superdischarge on its head.

In light of the circuit split, this case would be a good candidate for certiorari except for one problem—Congress amended §523 to add subsection (13), which explicitly excepts all restitution ordered under title 18 of the U.S. Code. Thus, this problem may well not occur again in the future for the federal government.5 It is unclear why Congress did this, since no appellate court had ever before held that Kelly did not apply to federal orders, but it has, in any event, been an occasion for mischief ever since its passage. Its presence led the bankruptcy court in Towers to hold that, by adding this language, Congress intended to eliminate all other restitution from the discharge exception. The Seventh Circuit rejected that argument, holding that the provision was more likely enacted in an excess of caution than as an attempt to overrule, sub silentio, the line of cases set forth above. The presence of that section here, though, apparently convinced the court that it need not apply the Kelly analysis to victim restitution. The problem for the states, though, is that they do not have any counterpart to subsection (13)—and the Third Circuit's analysis would undercut their use of subsection (7) in victim restitution cases. Thus, they are left with the unenviable position of having bad law made in a federal case where the federal government may see no need to appeal.


1The Eleventh Amendment limits the exercise of the judicial power of the United States with respect to "a suit in law or equity against a state," not a suit brought by the state. Return to article

2These cases happen to deal with the sovereign immunity of the United States, but the principles are essentially identical in this respect regarding state immunity. Return to article

3Both cases cited by the article for believing that such a general waiver would be allowed, In re Straight, 143 F.3d 1387 (10th Cir.), cert. denied, 119 S.Ct. 446 (1998), and In re White, 139 F.3d 1268 (9th Cir. 1998), were decided before College Savings. Both cases were problematic before and are subject to even more serious doubt now. Return to article

4 See, e.g., ,i>In re Lazar, 200 B.R. 358, 381 (Bankr. C.D. Cal. 1996), where Judge Bufford held that the state had entered a general appearance because it had appeared "numerous times" to protect its security interest. He gives no clue as to how many times it takes in order for a limited appearance to morph into a general appearance. Return to article

5The problem with the court's opinion is perhaps best exemplified by the fact that it had no idea when the amendment was actually enacted. In at least four places, it refers to the change as having been made in October 1998, but then cites two 1995 cases that had refused to apply the amendment retroactively. The fact is that the amendment was passed in 1994, not 1998, although still just too late to be effective in this case. Perhaps the chance to correct that glaring error will convince the court to accept a petition for rehearing and correct the rest of the opinion. Return to article

Journal Date: 
Thursday, June 1, 2000