Two recent Supreme Court decisions—Central Virginia Comm. College v. Katz, 126 S.Ct. 990 (2006), and Marshall v. Marshall, 126 S.Ct. 1735 (2006)—expand the bankruptcy court's jurisdiction and, in doing so, mark a departure from prior case law. In Katz, a sharply divided Court concluded that the states conceded much of their sovereign immunity in bankruptcy matters at the Constitutional Convention and thus are not immune from suit by a trustee to avoid and recover a preferential transfer.

The decision is far-reaching enough to defeat claims of sovereign immunity in other types of bankruptcy proceedings, including lawsuits against a state alleging a violation of the automatic stay or seeking the turnover of property. Marshall holds that the "probate exception" to federal jurisdiction does not deprive the bankruptcy court of jurisdiction over a claim for tortious interference with an award under a will. The case is more significant, however, because it evidences the Court's desire to cabin the "probate exception" and restore federal jurisdiction over a host of probate matters for which it was believed federal jurisdiction was lacking.

The Katz Decision: Background

Katz involved a lawsuit commenced in the U.S. Bankruptcy Court for the Eastern District of Kentucky by Bernard Katz, the court-appointed liquidating supervisor of the debtor's estate, seeking to avoid and recover as preferential certain pre-bankruptcy payments the debtor, Wallace's Bookstores, made to Central Virginia Community College (CVCC) and certain other Virginia institutions of higher education with whom Wallace's did business.¹ CVCC and the other defendants moved to dismiss the suits on the basis that each was immune from suit under the Eleventh Amendment and related principles of sovereign immunity.² The bankruptcy court denied the motions to dismiss, and on appeal, the district court and the Sixth Circuit Court of Appeals affirmed on the basis that §106(a) of the Bankruptcy Code constituted a valid abrogation by Congress of state sovereign immunity from preference lawsuits. The Supreme Court granted certiorari to consider the question it left open in Tennessee Student Assistance Corp. v. Hood, 541 U.S. 440 (2004): "whether Congress' attempt to abrogate state sovereign immunity in 11 U.S.C. §106(a) is valid." Katz, 126 S.Ct. at 995.³

Section 106(a) of the Code

Section 106(a) of the Code provides, in pertinent part, that:

Notwithstanding 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 the following [enumerating a number of Bankruptcy Code sections including §§547 and 550]. 11 U.S.C. §106(a).

Though the Supreme Court never before passed on §106(a)'s validity, the prevailing view prior to Katz was that §106(a) unconstitutionally abrogated state sovereign immunity. That view was premised mainly upon the Supreme Court's landmark Seminole Tribe decision,⁴ as well as the majority of circuit court decisions that addressed the issue.

At issue in Seminole Tribe was whether the Eleventh Amendment prevented Congress from authorizing suits by Indian tribes against states to enforce legislation enacted pursuant to the Indian Commerce Clause. The Supreme Court held that Congress did not have the authority to abrogate state sovereign immunity by means of a statute—there the Indian Commerce Clause—enacted pursuant to Congress' Article I powers. Though not involving bankruptcy at all, Seminole Tribe's implication for bankruptcy cases was clear. The source of Congress' bankruptcy power is Article I of the Constitution.⁵ Thus, one could logically conclude from Seminole Tribe that if Congress' Article I powers were insufficient to abrogate state sovereign immunity, then §106(a), unless enacted pursuant to a different congressional grant, must be unconstitutional. As if to presage the outcome in a bankruptcy case, the Supreme Court in dicta indicated that its holding in Seminole Tribe presumably applied equally to bankruptcy legislation.⁶

In the post-Seminole Tribe era, and before Katz, a number of circuit courts considered §106(a)'s constitutionality. In view of Seminole Tribe's holding and its dicta, seven circuit courts concluded that Congress lacked the power to abrogate sovereign immunity through bankruptcy legislation and thus held that §106(a) was unconstitutional.⁷ Only one circuit—the Sixth, where Katz originated—upheld §106(a)'s validity.

Supreme Court Revisits the Constitutional Convention

In Katz, the Supreme Court confronted its dicta in Seminole Tribe. Indeed, Justice Stevens, writing for the majority, acknowledges that "statements in both the majority and dissenting opinions in [Seminole Tribe] reflected an assumption that the holding in that case would apply to the Bankruptcy Clause." Katz, 126 S.Ct. at 996. Yet in an unabashed about-face, the majority concedes that "[c]areful study and reflection have convinced us, however, that that assumption was erroneous." Id. Why? Well, according to Justice Stevens, Congress need not rely on its Article I powers to abrogate state sovereign immunity by legislating §106(a) because:

[t]he history of the Bankruptcy Clause, the reasons it was inserted in the Constitution, and the legislation both proposed and enacted under its auspices immediately following ratification of the Constitution demonstrate 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 area.

Id. at 996 (emphasis added).

Legal Context at the Time of the Bankruptcy Clause's Adoption

The Bankruptcy Clause was ratified against the backdrop of the "debtors prison," a time in our nation's history where debtors could be, and often were, imprisoned for failing to pay their debts. The Court observed that during that period in American history "the American Colonies, and later the several states, had wildly divergent schemes for discharging debtors and their debts." Id. at 997. This patchwork of divergent insolvency and bankruptcy laws resulted in "one state's imprisoning of debtors who had been legally discharged (from prison and of their debts) in and by another state." Id. at 996.

According to the majority, the Bankruptcy Clause was adopted in large measure to ensure uniformity in the nation's bankruptcy laws "to prevent competing sovereigns' interference with the debtor's discharge...." Id. at 1002. The Bankruptcy Clause, however, is drafted more broadly to achieve uniformity not just as to dischargeability issues, but also as to the entire "subject of Bankruptcies." According to the majority, "[t]he Framers would have understood that laws 'on the subject of Bankruptcies' included laws providing, in certain limited respects, for more than simple adjudications of rights in the res." Id. at 1000. The majority thus reaches "[t]he ineluctable conclusion that states agreed in the plan of the Convention not to assert any sovereign immunity defense they might have had in proceedings brought pursuant to 'Laws on the subject of Bankruptcies.'" Id. at 1004.⁸

Extent of Surrender of Immunity Just how much immunity the states surrendered during the Convention is open to debate and remains unanswered, even after Katz. What Katz tells us is that the scope of the waiver was limited to the in rem jurisdiction commonly understood today and at the time of the Convention to comprise the bankruptcy court's principal jurisdiction and proceedings necessary to effectuate that in rem jurisdiction.

Turning then to the facts before it, the Court observed that the same "interplay between in rem adjudications and orders ancillary thereto is evident" in Katz. Id. at 1001. That is, the bankruptcy trustee in Katz sought an in rem adjudication that the subject transfers were voidable as preferences, as well as an ancillary determination that such transfers were recoverable.⁹ The Court concluded that the Framers would have understood that the Bankruptcy Clause granted Congress the power to authorize courts to avoid transfers and recover the transferred property "free and clear of the state's claim of sovereign immunity." Id. at 1002. The Court thus affirmed the lower courts' denial of defendants' motions to dismiss on sovereign immunity grounds.

Katz's Ramifications

So what does Katz mean for states? Certainly, it means that states are no longer immune from preference avoidance and recovery suits. However, the decision's implications are far broader. By concluding that "[i]n ratifying the Bankruptcy Clause, the states acquiesced in a subordination of whatever sovereign immunity they might otherwise have asserted in proceedings necessary to effectuate the in rem jurisdiction of the bankruptcy courts" (emphasis added), state claims of sovereign immunity are now vulnerable in a variety of bankruptcy proceedings. For instance, suits to enforce the automatic stay or to compel turnover of property are certainly necessary to effectuate the bankruptcy court's in rem jurisdiction. After Katz, those proceedings arguably could withstand a state's sovereign-immunity defense. Unfortunately, the Court provides little guidance for discerning where to draw the line on what constitutes a proceeding necessary to effectuate a bankruptcy court's in rem jurisdiction.¹⁰

That issue, together with the issue of the constitutionality of §106(a) as it relates to proceedings that are unrelated to the bankruptcy court's in rem jurisdiction, remain open.

The Marshall Decision

Like Katz, the Supreme Court's Marshall decision expands federal court jurisdiction and represents somewhat of a departure from prior case law. However, as the Supreme Court states—and the authors agree—the decision seems an easy one to reach.

Marshall involved the issue of whether the "probate exception"¹¹ to federal jurisdiction deprives a bankruptcy court of jurisdiction over a debtor's claim of tortious interference with an expectancy under a will. The facts are noteworthy.

Vicki Lynn Marshall, a.k.a. Anna Nicole Smith (Ms. Marshall), the former Playboy model, was embroiled in a dispute in Texas Probate Court over the estate of her deceased husband, J. Howard Marshall (J. Howard). J. Howard died without providing for Ms. Marshall in his will, and E. Pierce Marshall (Pierce), one of J. Howard's sons, was the beneficiary of J. Howard's estate. While the state probate proceedings were ongoing, Ms. Marshall filed for bankruptcy protection in the Central District of California. Pierce asserted a claim for defamation in Ms. Marshall's bankruptcy case and sought a declaratory judgment that the claim was not dischargeable. Ms. Marshall answered, asserting truth as a defense, and also counterclaimed against Pierce for, among other things, tortiously interfering with her expectancy under J. Howard's will.

After a trial on the merits of the counterclaim, the bankruptcy court ruled for Ms. Marshall. The district court upheld the bankruptcy court's determination; however, the Ninth Circuit Court of Appeals subsequently reversed the district court's decision holding that the "probate exception" bars federal jurisdiction to hear and determine Ms. Marshall's tortious interference claim. The Ninth Circuit, like many of the other courts before it, viewed the probate exception expansively to include "questions which would ordinarily be decided by a probate court in determining the validity of the decedent's estate-planning instrument," whether those questions involve "fraud, undue influence [or] tortious interference with the testators' intent." Marshall, 126 S.Ct. at 1744. The Supreme Court granted certiorari to "resolve the apparent confusion among federal courts concerning the scope of the probate exception." Id.

The Supreme Court Reigns in the "Probate Exception" The Supreme Court reversed the Ninth Circuit. Writing for a unanimous Court, Justice Ginsberg narrowed the "probate exception" substantially. Prior to Marshall, the Supreme Court's most "recent and pathmarking pronouncement on the probate exception" was made in Markham v. Allen, 326 U.S. 490 (1946). In Markham, the Court discussed federal jurisdiction in the context of probate administration and stated that:

It is true that a federal court has no jurisdiction to probate a will or administer an estate... But it has been established by a long series of decisions of this Court that federal courts of equity have jurisdiction to entertain suits 'in favor of creditors, legatees and heirs' and other claimants against a decedent's estate 'to establish their claims' so long as the federal court does not interfere with the probate proceedings or assume general jurisdiction of the probate or control of the property in the custody of the state court. Markham, 216 U.S. at 494 (quoting Waterman, 215 U.S., at 43) (emphasis added).

The Markham Court then proceeded to describe a probate exception with narrow limits:

[W]hile a federal court may not exercise its jurisdiction to disturb or affect the possession of property in custody of a state court...it may exercise its jurisdiction to adjudicate rights in such property where the final judgment does not undertake to interfere with the state court's possession save to the extent that the state court is bound by the judgment to recognize the right adjudicated by the federal court. Markham, 326 U.S. at 494.

Justice Ginsberg observed that the words "interfere with probate proceedings" in the first of the above-quoted passages from Markham puzzled federal courts and caused some to conclude that federal jurisdiction was lacking "over a range of matters well beyond probate of a will or administration of decedent's estate." Id. at 1748. Justice Ginsberg then proceeded to delineate the scope of the "probate exception" by reference solely to the second above-quoted passage, and clarified that it proscribes "disturb[ing] or affect[ing] the possession of property in the custody of a state court." Id.

Thus, the Court held that the probate exception reserves to state probate courts only the probate or annulment of a will and the administration of a decedent's estate and precludes federal courts from disposing of property in the custody of a state probate court. The court further held that the probate exception does not preclude federal courts from "adjudicating matters outside those confines and otherwise within federal jurisdiction." Id.

Application of Revised "Probate Exception" to the Tortious Interference Claim

Having so narrowed the "probate exception," the Court held that Ms. Marshall's claim easily fell outside of its scope. The Court concluded that Ms. Marshall's tort claim against Pierce Marshall does not "involve the administration of an estate, the probate of a will or any other purely probate matter." Id. Nor was Ms. Marshall seeking the probate or annulment of a will or the res in the custody of a state court, but instead was seeking an in personam judgment against Pierce.

The Court also could not find any "sound policy considerations" that would militate in favor of extending the probate exception to encompass Ms. Marshall's claim. Id. The Court observed that state probate courts have no "special proficiency" in handling tort issues and, moreover, both state and federal trial courts frequently address tortious-interference matters. Id. at 1749.

For those reasons, the Court concluded that the "probate exception" was not a bar to the bankruptcy court's jurisdiction over Ms. Marshall's tortious-interference claim. The case was remanded to the Ninth Circuit to consider whether her claim was "core" under 28 U.S.C. §157 and to adjudicate Pierce's claim and issue preclusion arguments.

Conclusion

Both Katz and Marshall expand the scope of bankruptcy court jurisdiction. Each also represents a departure from previously established case law. While Marshall can be viewed as an easy decision, Katz is far more controversial and leaves open as many questions as it answers.

Footnotes

1 CVCC and the other Virginia institutions of higher education qualified as "arms[s] of the state entitled to sovereign immunity." Katz, 126 S.Ct. at 994.

2 The Eleventh Amendment of the U.S. Constitution provides that "[t]he 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." U.S. Const. Amend. XI.

3 In Hood, the Supreme Court held that the bankruptcy court possessed in rem jurisdiction to determine the dischargeability of a student loan debt owed to a state agency.

4 Seminole Tribe of Fla. v. Florida, 116 S.Ct. 1114 (1996).

5 The Bankruptcy Clause in Article I, §8, Clause 4 of the Constitution provides that: "Congress shall have the power...to establish...uniform Laws on the subject of Bankruptcies throughout the United States." U.S. Const. Art. I, §8, cl. 4.

6 See Seminole Tribe, 116 S.Ct. at 1132, n. 16; see also id. at 1134, n. 1; 1142 (Stevens, J., dissenting)

7 See Georgia Higher Educ. Assistance Corp. v. Crow (In re Crow), 394 F.3d 918, 921 (11th Cir. 2004); Ossen v. Dep't of Social Servs. (In re Charter Oak Assocs.), 361 F.3d 760, 766 (2d Cir. 2004), cert. denied, 543 U.S. 955 (2004); Nelson v. La Crosse County Dist. Attorney, 301 F.3d 820, 832 (7th Cir. 2002); Mitchell v. Franchise Tax Bd. (In re Mitchell), 209 F.3d 1111, 1121 (9th Cir. 2000); Sacred Heart Hosp. v. Pennsylvania (In re Sacred Heart Hosp.), 133 F.3d 237, 245 (3d Cir. 1998); Dep't of Trans. & Dev. v. PNL Asset Mgmt. Co. (In re Estate of Fernandez), 130 F.3d 1138, 1139 (5th Cir. 1997); Schlossberg v. Maryland (In re Creative Goldsmiths), 119 F.3d 1140, 1145 (4th Cir. 1997).

8 The majority found additional support for this view in the Bankruptcy Act of 1800's grant by Congress to federal courts of the power to issue writs of habeas corpus effective to release debtors from state prisons. According to the majority, this grant suggests that "the power to enact bankruptcy legislation was understood to carry with it the power to subordinate state sovereignty, albeit within a limited sphere." Id. at 1004.

9 The Court was content to characterize an order directing the repayment of a preferential transfer as ancillary to its in rem jurisdiction because its characterization as in rem or ancillary did not affect the outcome. Id. at 1002.

10 The Court does, however, clarify that it does "not mean to suggest that every law labeled a 'bankruptcy' law could, consistent with the Bankruptcy Clause, properly impinge upon state sovereign immunity." Id. at 1005, n.15.

11 The "probate exception" reserves to state probate courts the probate or the annulment of a will and the administration of a decedent's estate, and precludes federal courts from disposing of property that is in the custody of a state probate court.