U.S. Supreme Court Bankruptcy Roundup - July 2023

Jones Day

Jones Day

Since May 2023, the U.S. Supreme Court has issued three decisions addressing or potentially impacting issues of bankruptcy law. These included rulings concerning the abrogation of sovereign immunity for Native American tribes under the Bankruptcy Code, and for instrumentalities of Puerto Rico under a similar statute enacted in 2016 allowing the Commonwealth to restructure its debts. The Court also handed down an opinion concerning a homeowner's entitlement to the surplus proceeds of a real estate tax foreclosure sale. That ruling could conceivably impact fraudulent transfer litigation in bankruptcy cases arising from real property foreclosures. Finally, the Court denied petitions to review three decisions concerning the "solvent-debtor exception," which has been applied by some courts to require the payment of postpetition interest to unsecured creditors under a cram-down chapter 11 plan. 

Tribal Sovereign Immunity

On June 15, 2023, the Court ruled in Lac du Flambeau Band of Lake Superior Chippewa Indians v. Coughlin, No. 22-227, 599 U.S. ___ (U.S. June 15, 2023), that section 106(a) of the Bankruptcy Code abrogates Native American tribal sovereign immunity because a Native American tribe satisfies the definition of a "governmental unit" in section 101(27). 

Recognized Native American tribes generally have inherent authority to govern themselves without interference by federal or state governments. An important element of this "tribal sovereignty" is immunity from lawsuits in federal, state, and tribal courts, or "tribal sovereign immunity." Under this principle, a tribe may be sued only if the tribe consents to being sued or if Congress has clearly authorized such a suit. 

Lac du Flambeau addresses the issue of whether the Bankruptcy Code provides such a clear congressional authorization. Bankruptcy Code Section 106(a) of the Bankruptcy Code abrogates the sovereign immunity of a "governmental unit" in connection with disputes relating to many provisions of the Bankruptcy Code, including actions to enforce the automatic stay, preference and fraudulent transfer avoidance actions, and proceedings seeking to establish the dischargeability of a debt.

Furthermore, pursuant to section 106(b) of the Bankruptcy Code, a governmental unit that files a proof of claim in a bankruptcy case "is deemed to have waived sovereign immunity with respect to a claim against such governmental unit that is property of the estate and that arose out of the same transaction or occurrence out of which the claim of such governmental unit arose." 

Section 101(27) of the Bankruptcy Code defines the term "governmental unit" as:

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.

11 U.S.C. § 101(27) (emphasis added). 

In July 2019, the debtor took out a payday loan from an indirect subsidiary of the Lac du Flambeau Band of Lake Superior Chippewa Indians (the "Band"). Later that year, the debtor filed a chapter 13 petition in the District of Massachusetts. 

After the lender repeatedly contacted the debtor seeking repayment of the debt despite the automatic stay, the debtor sought an order from the bankruptcy court enforcing the automatic stay against both the lender and its corporate parents, including the Band. In response, the Band and its affiliates asserted tribal sovereign immunity and moved to dismiss the enforcement proceeding. The bankruptcy court agreed with the Band and granted the motion to dismiss. The First Circuit permitted a direct appeal from that decision.

A divided three-judge panel of the First Circuit reversed on appeal, concluding that Congress unequivocally abrogated the tribal sovereign immunity in section 106(a) of the Bankruptcy Code because a Native American tribe falls within the "catch-all" phrase concluding the definition of "governmental unit" in section 101(27). See Coughlin v. Lac du Flambeau Band of Lake Superior Chippewa Indians (In re Coughlin), 33 F.4th 600 (1st Cir. 2022), aff'd sub nom. Lac du Flambeau Band of Lake Superior Chippewa Indians v. Coughlin, 22-227 (U.S. June 15, 2023), 599 U.S. ___, No. 22-227 (U.S. June 15, 2023)

In so ruling, the First Circuit deepened a split on this issue among the federal circuit courts of appeals. The First Circuit sided with the Ninth Circuit, which held in 2004 that section 106(a) abrogates tribal sovereign immunity. See Krystal Energy Co. v. Navajo Nation, 357 F.3d 1055, 1058 (9th Cir. 2004) ("[In sections 101(27) and 106(a),] Congress explicitly abrogated the immunity of any 'foreign or domestic government.' Indian tribes are domestic governments. Therefore, Congress expressly abrogated the immunity of Indian tribes."). The First Circuit rejected the contrary view expressed by the Sixth Circuit in In re Greektown Holdings, LLC, 917 F.3d 451, 460-61 (6th Cir. 2019) (Congress did not unequivocally express an intent to abrogate Indian tribes' sovereign immunity from bankruptcy avoidance litigation even though tribes might possess the characteristics of domestic governments), cert. dismissed sub nom. Buchwald Cap. Advisors LLC v. Sault Ste. Marie Tribe, 140 S. Ct. 2638 (2020).

The Supreme Court resolved the circuit split by affirming the First Circuit's ruling. Writing for an 8–1 majority, Justice Jackson viewed whether the Bankruptcy Code abrogates tribal sovereign immunity as "remarkably straightforward."

"We conclude," Justice Jackson wrote, "that the Bankruptcy Code unequivocally abrogates the sovereign immunity of any and every government that possesses the power to assert such immunity … [and] [f]ederally recognized tribes undeniably fit that description; therefore, the Code's abrogation provision plainly applies to them as well."

Explaining that a clear statement from lawmakers abrogating immunity "is not a magic-words requirement," the majority concluded that "Congress did not have to include a specific reference to federally recognized tribes in order to make clear that it intended for tribes to be covered by the abrogation provision." Instead, Justice Jackson reasoned, the "catchall phrase" included at the end of section 101(27) is expansive enough to capture tribes within the definition of "governmental unit," as "domestic" and "foreign" were the two extremes, and tribes were, if not precisely either domestic or foreign governments, at least somewhere along that spectrum. She wrote that "[t]ribes are indisputably governments … [and] [t]herefore, § 106(a) unmistakably abrogates their sovereign immunity too."

Justice Thomas concurred in the judgment. He reasoned that the court's tribal sovereign immunity doctrine was overbroad and should simply be abandoned. However, because the case involved the tribe's off-reservation commercial conduct, Justice Thomas concurred, stating that the tribe lacked sovereign immunity regardless of section 106(a).

In a dissenting opinion, Justice Gorsuch stated, quoting the Sixth Circuit, that "[u]ntil today, there was 'not one example in all of history where [this] Court ha[d] found that Congress intended to abrogate tribal sovereign immunity without expressly mentioning Indian tribes somewhere in the statute.'" (citation omitted). According to Justice Gorsuch, the majority mistakenly concluded that the catch-all phrase in section 101(27) demonstrates that Congress "unequivocally express[ed]" its intention to vitiate tribal sovereign immunity under section 106(a) without expressly mentioning tribes in either provision. Although such an interpretation is "plausible," Judge Gorsuch wrote, "Respectfully, I do not think the language here does the trick."

Waiver of Sovereign Immunity Under PROMESA

On May 11, 2023, the Court handed down its ruling in Fin. Oversight & Mgmt. Bd. for Puerto Rico v. Centro de Periodismo Investigativo, Inc., 598 U.S. __, 143 S. Ct. 1176 (2023). An 8–1 majority ruled that Puerto Rico's Financial Oversight and Management Board (the "Board") need not provide discovery to journalist group Centro de Periodismo Investigativo ("CPI") in litigation concerning the finances of the bankrupt Puerto Rico Electric Power Authority because nothing in the Puerto Rico Oversight, Management, and Economic Stability Act ("PROMESA") makes "unmistakably clear" lawmakers' intent to abrogate the Board's sovereign immunity. In so ruling, the Court reversed a decision by the U.S. Court of Appeals for the First Circuit that PROMESA abrogated the Board's immunity.

Patterned on chapter 9, which provides for the "adjustment of debts of a municipality," PROMESA was enacted by Congress in 2016 to deal with a fiscal crisis in Puerto Rico brought about by soaring public debt. PROMESA established a system for overseeing Puerto Rico's finances and authorized the Commonwealth and its instrumentalities to file for bankruptcy protection similar to that available to debtors eligible to seek relief under the Bankruptcy Code (which Puerto Rico is not). PROMESA created the Board as an "entity within the territorial government" of Puerto Rico. The Board approves Puerto Rico's fiscal plans and budgets, supervises its borrowing, and represents Puerto Rico in judicial debt-restructuring proceedings under Title III of PROMESA.

Beginning in 2016, CPI asked the Board to release various documents relating to CPI's work as a nonprofit media organization reporting on Puerto Rico's fiscal crisis. Rebuffed, CPI sued the Board in federal district court, citing a provision of the Puerto Rican Constitution interpreted to guarantee a right of access to public records. The Board moved to dismiss on sovereign immunity grounds, but the district court rejected that defense. The First Circuit affirmed, holding that the jurisdictional provision in PROMESA clearly abrogated the Board's immunity.

The Supreme Court reversed. Writing for an 8–1 majority, Justice Elena Kagan noted that the First Circuit and the district court "simply assumed the Board's immunity before turning to the abrogation issue." Working from that assumption without deciding whether it was justified, the majority wrote that, "[u]nder long-settled law, Congress must use unmistakable language to abrogate sovereign immunity." In this case, Justice Kagan explained, nothing in PROMESA satisfies that "high bar" because the statute does not expressly strip the Board of immunity, it does not explicitly authorize the litigation of claims against the Board and its "judicial review provisions and liability protections are compatible with the Board's generally retaining sovereign immunity."

Justice Thomas filed a dissenting opinion in which he stated that both the majority and the lower courts assumed without deciding "the logically antecedent question" whether the Board enjoyed sovereign immunity "in the first place." Justice Thomas would have addressed this antecedent question to hold that the Board did not have any immunity.

Entitlement to Surplus from Real Estate Tax Foreclosures

On May 25, 2023, a unanimous Court ruled in Tyler v. Hennepin County, No. 22-166, 2023 WL 3632754 (U.S. May 25, 2023), that a real estate tax foreclosure proceeding in which a local taxing authority refused to pay the surplus realized from the sale to the homeowner violated the Takings Clause of the Fifth Amendment to the U.S. Constitution. In so ruling, the Court reversed a 2022 decision by the U.S. Court of Appeals for the Eighth Circuit that a real estate tax foreclosure proceeding in which a local taxing authority refused to pay the sale surplus to the homeowner does not violate the Takings Clause. See Tyler v. Hennepin County, 26 F.4th 789 (8th Cir. 2022), rev'd, No. 22-166, 2023 WL 3632754 (U.S. May 25, 2023).

A circuit split arose after the Eighth Circuit's decision, when the Sixth Circuit reached the opposite conclusion. See Hall v. Meisner, 51 F.4th 185 (6th Cir. 2022), reh'g en banc denied, 2023 WL 370649 (6th Cir. Jan. 4, 2023), petition for cert. filed, No. 22-996 (U.S. Apr. 13, 2023).

 Although Tyler involved the Takings Clause, the ruling may shed light on a long-standing circuit split over whether a tax foreclosure can be challenged in bankruptcy as a fraudulent transfer. In BFP v. Resolution Trust, 511 U.S. 531 (1994), the Court held that a regularly conducted real estate mortgage foreclosure cannot be a fraudulent transfer, regardless of how much equity the debtor forfeits in excess of the mortgage debt. The Fifth, Ninth, and Tenth Circuits later expanded the reach of BFP by ruling that a real estate tax foreclosure cannot be deemed a fraudulent transfer. The Second, Third, Sixth, and Seventh Circuits have ruled to the contrary. Because the Supreme Court held in Tyler that the Fifth Amendment prohibits a state from retaining the equity after a tax foreclosure, debtors may not need to resort to a fraudulent transfer action because they will have a direct Takings Clause claim against the taxing authority.

Disposition of Notable Petitions for Review

Pursuant to the "solvent-debtor exception" developed under English law and applied in cases under the former Bankruptcy Act, a solvent debtor is obligated to pay interest accruing during a bankruptcy case to unsecured creditors if the payment of such interest is required under a contract or applicable non-bankruptcy law. Because section 502(b)(2) of the Bankruptcy Code generally disallows claims for "unmatured" interest, courts disagree whether the solvent-debtor exception survived enactment of the Bankruptcy Code in 1978 to require a solvent debtor to pay postpetition interest to unsecured creditors under a chapter 11 plan to render their claims unimpaired (and deem the claimants to have accepted the plan).

Five federal circuit courts—including three in 2022 (two with vigorous dissents)—have ruled or suggested that the solvent-debtor exception survived. See In re LATAM Airlines Grp. S.A., 55 F.4th 377 (2d Cir. 2022), cert. denied, No. 22-908 (U.S. June 12, 2023); In re Ultra Petroleum Corp., 51 F.4th 138 (5th Cir. 2022), cert. denied, No. 22-772 (U.S. May 22, 2023); In re PG&E Corp., 46 F.4th 1047 (9th Cir. 2022), cert. denied, No. 22-733 (U.S. May 22, 2023); Gencarelli v. UPS Capital Bus. Credit, 501 F.3d 1 (1st Cir. 2007); In re Dow Corning Corp., 456 F.3d 668 (6th Cir. 2006). The Third Circuit is expected to weigh in on the issue sometime during 2023. See In re The Hertz Corp., 637 B.R. 781 (Bankr. D. Del. 2021), motion for reconsideration denied and direct appeal certified, Adv. Pro. No. 21-50995 (MFW) (Bankr. D. Del. Nov. 9, 2022).

On May 22, 2023, the Supreme Court denied petitions for a writ of certiorari in the PG&E and Ultra Petroleum cases. On June 12, 2023, the Court also denied a petition for certiorari in the LATAM case.

Read the full Business Restructuring Review.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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