Sovereign Immunity Tests Bankruptcy's Least Contested Axioms

• Publication year: 2023

Sovereign Immunity Tests Bankruptcy's Least Contested Axioms

Deborah L. Thorne

Luke L. Sperduto

SOVEREIGN IMMUNITY TESTS BANKRUPTCY'S LEAST CONTESTED AXIOMS Deborah L. Thorne^* Luke L. Sperduto^** ABSTRACT

Section 106 of the Bankruptcy Code expressly abrogates the sovereign immunity of governmental units with respect to fifty-nine other provisions of the Code. There are currently two distinct issues splitting circuit courts over the meaning of this provision. First, does section 106 waive the sovereign immunity of the Internal Revenue Service in avoidance actions brought against it by a bankruptcy trustee under section 544(b)? Second, are Native American Indian Tribes "governmental units" within the meaning of section 101(27), such that their sovereign immunity is abrogated to the extent set forth in section 106? Invoking conventional canons of statutory construction, this Article takes the minority position on both issues, arguing that the IRS may not be sued under section 544(b) and that Tribes are not governmental units within the meaning of the Code. Moreover, these issues illustrate a tension between two of bankruptcy's least contested axioms: (1) creditors with legally similar claims should be treated similarly; and (2) bankruptcy should not adjust nonbankruptcy entitlements unless necessary. A textualist reading suggests that, when it comes to sovereign immunity, the Code cuts this tension by privileging the second axiom over the first. It is for Congress—not the judiciary—to change that if necessary.

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TABLE OF CONTENTS

INTRODUCTION..............................................................................................2

I. THE IRS MAY NOT BE SUED UNDER SECTION 544(b)....................... 10

A. Section 544(b) in Context.......................................................... 10
B. Statutory Interpretation ............................................................ 14

1. First Argument.................................................................... 17
2. Second Argument................................................................ 18
3. Third Argument................................................................... 19

II. TRIBES ARE NOT GOVERNMENTAL UNITS UNDER THE CODE............21

A. Tribal Sovereign Immunity in Context ....................................... 22

1. Early Treaties Prefigured Subsequent Developments ........... 22
2. An Extravagant Pretense Justified Indian Removal .............. 25
3. Congress and the Supreme Court Now Aim to Protect Tribal Self-Government ....................................................... 27

B. Statutory Interpretation ............................................................ 31

1. First Argument .................................................................... 31
2. Second Argument ................................................................ 35

III. BANKRUPTCY'S AXIOMS CONFLICT..................................................37

A. The Axioms Improve the Efficiency and Integrity of the Bankruptcy System .................................................................... 38

1. Axiom 1 .............................................................................. 38
2. Axiom 2 .............................................................................. 42

B. Sovereign Immunity Creates a Conflict Between the Axioms ...... 44
C. The Choice Between Axioms is Inherently Political ................... 47

INTRODUCTION

Governments come in all shapes and sizes. In an incomplete but influential taxonomy, Article I of the Constitution distinguishes not only "the United States" and "the several States," but also "foreign Nations," "Indian Tribes," and a certain "District."¹ Whatever their obvious differences in the 1780s, today these different species of government all have two things in common: they all tax, and they all transact, as sovereigns. Taxation—like commerce—inevitably creates debtors and creditors. When financial distress ensues, there are a variety

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of postures in which governments may become party to proceedings in U.S. bankruptcy courts. For example, governments may be debtors seeking relief,² creditors seeking repayment,³ entities obliged to turn over property to the bankruptcy trustee,⁴ or recipients of an allegedly preferential or fraudulent transfer defending against an avoidance action.⁵ No matter how it becomes a party in interest, however, a government retains its sovereign immunity in bankruptcy unless that immunity is waived by the government itself or by section 106 of the U.S. Bankruptcy Code (the "Code").⁶ This Article investigates the scope of section 106's waiver of the sovereign immunity of the Internal Revenue Service (the "IRS") and Native American Indian Tribes ("Tribes").

Sovereign immunity is an ancient norm that prevents a tribunal from exercising authority over a sovereign without the sovereign's consent.⁷ In the United States, it operates as a jurisdictional defense that negates or constrains the court's personal jurisdiction over the government.⁸ There are nearly as many denunciations of this norm as there are justifications for it.⁹ Rather than plumb

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the historical and philosophical depths of the doctrine, our investigation proceeds on the basis of two long-settled tenets of Supreme Court case law. First, both the IRS (as an agency of the federal government)¹⁰ and Tribes (as "distinct, independent political communities" and "separate sovereigns pre-existing the Constitution") possess "the common-law immunity from suit traditionally enjoyed by sovereign powers."¹¹ Second, Congress can waive the immunity of the IRS or abrogate the immunity of Tribes in federal court, but only if it does so through an unequivocal expression of legislative intent.¹² Taking these tenets as given, the question becomes: Does section 106 unequivocally express Congress's intent to waive the immunity of the IRS and Tribes with respect to the fifty-nine Code sections (the "Target Sections") listed in section 106(a)(1)?¹³ The textualist interpretations of the Code advanced in Parts I and II (below) suggest that it does not.

Because section 106 was amended in 1994 to overrule two Supreme Court decisions finding it insufficiently explicit,¹⁴ one might have expected the meaning of the provision to have settled over the course of the ensuing twenty-eight years. To some extent, as applied to states, it has. Central Virginia Community College v. Katz, for instance, held that "in proceedings necessary to

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effectuate the in rem jurisdiction of the bankruptcy courts" section 106 does not need to abrogate states' immunity, because states waived their own immunity in such proceedings by ratifying Congress's bankruptcy power in the Constitution.¹⁵ Nonetheless, when it comes to the sovereign immunity of the IRS and Tribes, interpretive challenges persist.¹⁶

There are currently two distinct issues splitting circuit courts over the meaning of section 106. First, does section 106 waive the IRS's immunity to avoidance actions under section 544(b)? Under section 544(b), "the trustee may avoid any transfer . . . that is voidable under applicable law by a creditor holding an unsecured claim."¹⁷ Courts unanimously agree that, outside of bankruptcy, there is no applicable law under which an unsecured creditor could ever avoid its debtor's transfer to the IRS, because the IRS enjoys immunity from such suits.¹⁸ The minority of courts deduce that, for that reason, the trustee may not proceed under section 544(b) to avoid pre-petition transfers to the IRS.¹⁹ The majority of courts instead believe that, notwithstanding the absence of any actual unsecured creditor who could bring the action outside of bankruptcy, the trustee may bring state-law avoidance actions against the IRS under section 544(b) because section 106 operates "[n]otwithstanding an assertion of sovereign immunity."²⁰ As explained in Part I of this Article, the majority position is incompatible with the text of the Code.²¹

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The second circuit-splitting issue is this: Are Tribes governmental units within the meaning of section 101(27), such that their sovereign immunity is abrogated to the extent set forth in section 106? Section 101(27) provides in full that the term "governmental unit":

means United States; State; Commonwealth; District; Territory; municipality; foreign state; department, agency, or instrumentality of the United States (but not a United States trustee while serving as a trustee in a case under this title), a State, a Commonwealth, a District, a Territory, a municipality, or a foreign state; or other foreign or domestic government.²²

Most courts find it undeniable that Tribes are "other . . . domestic government[s]," and therefore their sovereign immunity is abrogated to the extent set forth in section 106.²³ A minority of courts disagree. They acknowledge that while Tribes are certainly governments in many respects, there are straightforward readings of section 101(27) under which Tribes are not "other foreign or domestic government[s]" for bankruptcy purposes.²⁴ Moreover, the Supreme Court requires a valid abrogation of tribal immunity to be "unequivocally expressed" in "explicit legislation"—and elsewhere in the U.S. Code, it is.²⁵ Invoking two linguistic canons of statutory construction to interpret section 101(27), Part II argues that Tribes are not governmental units within the meaning of the Code, so their sovereign immunity is unaffected by section 106.

Many able commentators and practitioners have described these circuit splits in detail.²⁶ This Article builds on that existing body of scholarship by advancing

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textualist interpretations of the Code that support the minority position on both issues (that is, the IRS may not be sued under section 544(b) and Tribes are not governmental units within the meaning of section 101(27)). The central methodological assumption underlying the statutory interpretations...