The United States Court of Appeals for the Fourth Circuit recently held that the State of Maryland has immunity from a bankruptcy trustee's suit to avoid as a preference the debtor's payment of state income taxes within 90 days of filing for bankruptcy.
In Schlossberg v. State of Maryland, No. 96-1895, 1997 U.S. App. LEXIS 18206 (4th Cir. July 22,1997), Roger Schlossberg, a trustee in bank-ruptcy, initiated an action in federal bankruptcy court to avoid, as a pref-erence, a $4,382 payment of income taxes made by the debtor to the State within 90 days of the filing of the debtor's bankruptcy petition. The State won in bankruptcy court, successfully arguing that the payment was not a preference because it was made in the "ordinary course of business." The district court affirmed, and the trustee appealed the decision to the Fourth Circuit.
On appeal, the State contended for the first time that, under the Eleventh Amendment to the United States Constitution, it was immune from the trustee's suit. The trustee countered that a provision of the bankruptcy code, 11 U. S.C. § 106, as amended in 1994, expressly abrogates the State's sovereign immunity from suit in federal court. In addition, the trustee maintained that the State had waived any right it had to immunity under the Eleventh Amendment.
Relying on Seminole Tribe of Florida v. Florida, 116 S. Ct. 1114 (1996), the Fourth Circuit concluded that "Congress' effort to abrogate the states' Eleventh Amendment immunity through its 1994 enactment of II U. S.C. § 106(a) is unconstitutional and ineffective." The trustee argued that the Bankruptcy Clause of Article I of the Constitution, read in conjunction with Article III, gives Congress the authority to enact bankruptcy laws for enforcement in federal courts which would have jurisdiction over the states. The court rejected the argument and, quoting Seminole, continued: "'Even when the Constitution vests in Congress complete lawmaking authority over a particular area, the Eleventh Amendment prevents congressional authorization of suits by private parties against unconsenting States. The Eleventh Amendment restricts the judicial power under Article III, and Article I cannot be used to circumvent the constitution limitations placed upon federal jurisdiction.'"
Although a state's immunity may not be abrogated under Articles I and III, the court recognized that this may be accomplished under section five of the Fourteenth Amendment. Section five "appears to take back some of the [Eleventh] amendment's limitations." The court, however, determined that there was no indication that Congress acted under this provision in adopting the Bankruptcy Reform Act of 1994. Instead, the court concluded, it appeared that Congress was exercising, as it had in the past, its authority under the bank-ruptcy power enumerated in Article 1.
Finally, the court briefly addressed whether the State of Maryland had waived its sovereign immunity (1) by filing a proof of claim for sales and unemployment taxes, or (2) by de-fending the earlier action in federal bankruptcy court. Although the court recognized that a state may waive its immunity, "an unequivocal indica-tion that the State intends to consent to federal jurisdiction that otherwise would be barred by the Eleventh Amendment" is required to effectuate such a waiver. The court deter-mined that none of the actions taken by the State would constitute a waiver of sovereign immunity. For example, the proof of claim did not even relate to the transactions at issue in this case. The State filed that proof of claim in connection with the debtor's sales and withholding taxes, not the debtor's corporate income taxes that are the subject of the suit. In addition, although the Maryland Constitution grants the Attorney General authority to defend the State in federal suits, it does not convey authority to waive the State's sovereign immunity.
Under the court's reasoning, the Eleventh Amendment shields a state from suit by an individual unless the state otherwise consents to jurisdiction. Maryland did not consent to jurisdiction in the action brought by the trustee. Accordingly, the court vacated the district court's judgment and remanded the case with instructions to dismiss.
For more information on this article and other bankruptcy issues, contact Alan M. Grochal at 410/752-9715.