Central Virginia Community College v. Katz, 126 S. Ct. 990 (U.S. 2006), has significantly expanded the scope of the bankruptcy exception to states’ constitutional sovereign immunity. In this 5-4 opinion, the U.S. Supreme Court held that state agencies do not enjoy sovereign immunity with respect to a proceeding to set aside a debtor’s preferential transfer because states implicitly subordinated their immunity to the Bankruptcy Clause (Article I, Section 8 of the Constitution) when the United States Constitution was ratified.

In so holding, the Court relied in part on Tennessee Student Assistance Corp. v. Hood, 541 U.S.440 (2004), which had recognized a bankruptcy exception to states’ constitutional sovereign immunity at least in connection with dischargeability proceedings. After an extensive analysis of the historical background to the inclusion of the Bankruptcy Clause in the Constitution, the Court concluded that: "The 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 arena." Furthermore, while the Court considered the matter primarily in the context of in rem actions, it left open the question of whether the scope of that consent might also extend to other types of proceedings.

The Court’s prior opinion in Seminole Tribe of Fla. v. Florida, 517 U.S. 44 (1996)—which held that Congress’s legislative powers could not be used to abrogate states’ constitutional sovereign immunity from suit in federal court—reflected what came to be a widely-recognized assumption that sovereign immunity would apply to bankruptcy cases. But in Katz, the Court concluded that Seminole’s assumption was erroneous. Rather, the Court determined that the enactment of Section 106(a) was not necessary to authorize the Bankruptcy Court’s jurisdiction over avoidance actions, concluding instead that "[i]n ratifying the Bankruptcy Clause [of the Constitution], 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."  Accordingly, the Court concluded that Congress may, at its option, enact provisions such as Section 106 that "either treat States in the same way as other creditors insofar as concerns ‘Laws on the subject of Bankruptcies’ or exempt them from operation of such laws." (Section 106(a) provides that "sovereign immunity is abrogated as to a governmental unit" with respect to various enumerated sections of the Bankruptcy Code, including Sections 547, 548, and 550.)

Katz, however, may not be the final word on the subject of sovereign immunity. Notably, the majority opinion by Justice Stevens was joined by Justice O’Connor, who has since retired. Justice Kennedy, Roberts, and Scalia joined in a dissent by Justice Thomas. Citing Alden v. Maine, 527 U.S. 706 (1999) and Hoffman v. Connecticut Dept. of Income Maintenance, 492 U.S. 96 (1989), the dissenting opinion remarked that "[u]nder our Constitution, the States are not subject to suit by private parties for monetary relief absent their consent or a valid constitutional abrogation, and it is ‘settled doctrine’ that nothing in Article I of the Constitution establishes those preconditions." According to the dissent, the adoption of the Constitution merely established federal power to legislate in the area of bankruptcy law; it did not rise to the level of an abrogation of states’ sovereign immunity.

Mette Kurth is Special Counsel in the Bankruptcy Practice Group in Sheppard Mullin’s Los Angeles office.