In Re Service Merchandise Co., Inc., 265 B.R. 917 (M.D. Tenn. 2001)

*918 *919 Jeffrey S. Ogilvie, Massachusetts Dept. of Revenue, Litigation Bureau, Boston, MA, David Thomas Axford, Kitch & Axford, Mashville, TN, for appellant.

Paul G. Jennings, Beth A. Dunning, Bass, Berry & Sims, Nashville, TN, John W. Butler, Jr., George N. Panagakis, Skadden, Arps, Slate, Meagher & Flom, Chicago, IL, Alesia Ranney-Marinelli, Skadden, Arps, Slate, Meagher & Flom, New York City, for appellee.

CAMPBELL, District Judge.

This is an appeal from the Bankruptcy Court's Order of February 9, 2001, denying the Defendant/Appellant Commonwealth of Massachusetts' Motion to Dismiss for Lack of Jurisdiction and Motion for Determination that this Adversary Proceeding Is Not a Core Proceeding and Motion for Mandatory Abstention or, in the alternative, for Permissive Abstention. For the reasons stated herein, the Bankruptcy Court's Order is REVERSED and the case is REMANDED for disposition not inconsistent with this opinion.

The fundamental question presented in this appeal is whether the Bankruptcy Court has jurisdiction over the Commonwealth of Massachusetts or if the Commonwealth is entitled to sovereign immunity from this action under the Eleventh Amendment. The question primarily turns on whether States surrendered their sovereign immunity in bankruptcy matters when they ratified the Constitution.

The standard of review is de novo for questions of law. Investors Credit Corp. v. Batie (In re Batie), 995 F.2d 85, 88 (6th Cir. 1993). The findings of fact of the Bankruptcy Court are subject to a "clearly erroneous" standard of review. Fed. R. Bankr.P. 8013.

H.J. Wilson Co., Inc. ("HJW") seeks to recover from the Commonwealth of Massachusetts ("the Commonwealth") a corporate excise tax refund for the tax years 1987 1992. HJW filed timely petitions for abatement with the Massachusetts Appellate Tax Board, which petitions are still pending. On March 27, 1999, HJW commenced voluntary proceedings under Chapter 11 of the United States Bankruptcy *920 Code. On August 7, 2000, HJW filed this adversary complaint against the Commissioner of Revenue for the Commonwealth, seeking a determination that HJW does not owe the 1987-1992 corporate excise tax deficiency assessed against it and seeking a refund from the Commonwealth. The tax refund would necessarily have to be paid out of the Commonwealth's state treasury.

The Commonwealth moved to dismiss the adversary proceeding for lack of jurisdiction, based upon the Eleventh Amendment and principles of sovereign immunity. Alternatively, the Commonwealth moved to dismiss because it was not a core proceeding and moved for mandatory or permissive abstention.

The Bankruptcy Court denied the Commonwealth's Motions, finding no sovereign immunity and concluding that each State surrendered its sovereign immunity on matters of bankruptcy upon joining the Union "upon equal footing with the other states." Bankruptcy Court Order of February 9, 2001, p. 6. Therefore, the Bankruptcy Court concluded, it could assert jurisdiction over the Commonwealth in this adversary proceeding.

This appeal was taken from that ruling, and this Court granted the Commonwealth's Motion for Stay Pending Appeal (see Docket No. 19) and Motion for Leave to Appeal (see Docket No. 28).

Pending before the Court in this appeal are HJW's Motion for Order Vacating Stay Pending Appeal (Docket No. 27) and the Commonwealth's Motion for Entry of an Order, Nunc Pro Tunc or Otherwise, Allowing its Motion for Leave to Appeal (Docket No. 31). In light of this Order and the Court's Order of June 6, 2001 (Docket No. 28), both Motions are moot.

The Eleventh Amendment to the United States Constitution provides:

The 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 a Foreign State.

U.S. Const., amend. XI.

The concept of sovereign immunity arises out of the sovereign status of each State and the inherent nature of sovereignty not to be amenable to the suit of an individual without its consent. Seminole Tribe of Florida v. Florida, 517 U.S. 44, 116 S. Ct. 1114, 1122, 134 L. Ed. 2d 252 (1996). HJW argues that sovereign immunity is not available as a defense to this litigation because the States surrendered sovereign immunity over bankruptcy matters in the U.S. Constitution on the circumstances presented here. See Appellee's Brief (Docket No. 24), p. 10. HJW contends, and the Bankruptcy Judge found, that the States surrendered their sovereign immunity with regard to bankruptcy matters when they agreed to Article I, Section 8, in which Congress is given the power to establish uniform bankruptcy laws.

The Court is not persuaded by this argument, particularly in light of the Supreme Court's explanation in Seminole Tribe:

[C]ontrary to the implication of [the Dissent], it has not been widely thought that the federal antitrust, bankruptcy, or copyright statutes abrogated the States' sovereign immunity. This Court never has awarded relief against a State under any of those statutory schemes; . . . Although the copyright and bankruptcy laws have existed practically since our Nation's inception, . . . there is no established *921 tradition in the lower federal courts of allowing enforcement of those federal statutes against the States.

Seminole Tribe, 116 S. Ct. at 1132, n. 16. If there were no such sovereign immunity in bankruptcy matters, this language, as it relates to bankruptcy, would be rendered meaningless.

Numerous courts have applied the sovereign immunity doctrine in the bankruptcy context. See, e.g., Sacred Heart Hospital v. Commonwealth of Pa. (In re Sacred Heart Hospital), 133 F.3d 237 (3d Cir. 1998); Arecibo Community Health Care, Inc. v. Commonwealth of Puerto Rico, 244 F.3d 241 (1st Cir.2001); NVR Homes, Inc. v. Clerks of Circuit Courts for Anne Arundel County, Md. (In re NVR, LP), 189 F.3d 442 (4th Cir.1999); Seay v. Tennessee Student Assistance Corp. (In re Seay), 244 B.R. 112 (Bankr.E.D.Tenn.2000); Scarborough v. Michigan Collection Div. (In re Scarborough), 229 B.R. 145 (Bankr. W.D.Mich.1999); Pitts v. Ohio Dep't of Taxation (In re Pitts), 241 B.R. 862 (Bankr.N.D.Ohio 1999); and Peterson v. State of Florida (In re Peterson), 254 B.R. 740 (Bankr.N.D.Ill.2000) (citing cases). In these cases, courts found either that the State did not waive its sovereign immunity or that Congress did not effectively abrogate that immunity. Such findings impliedly assume that such sovereign immunity exists.

In light of the above authorities, the Court finds the reasoning of Hood v. Tennessee Student Assistance Corp., 262 B.R. 412 (6th Cir. BAP 2001) and Bliemeister v. Industrial Comm'n of Az. (In re Bliemeister), 251 B.R. 383 (Bankr.D.Ariz.2000) unpersuasive. In addition, both Hood and Bliemeister involved claims for discharge of certain debts, not a claim to recover money from the State, as we have here. See also Commonwealth of Va. v. Collins (In re Collins), 173 F.3d 924, 929 (4th Cir.1999) (jurisdiction over dischargeability of debt derives not from jurisdiction over the State but rather from jurisdiction over the debtors and their estates.).

The Supreme Court has recognized only two circumstances in which an individual may sue a State: (1) Congress may authorize such a suit in the exercise of its power to enforce the Fourteenth Amendment, and (2) a State may waive its sovereign immunity by consenting to suit. College Sav. Bank v. Florida Prepaid Postsecondary Educ. Expense Bd., 527 U.S. 666, 119 S. Ct. 2219, 2223, 144 L. Ed. 2d 605 (1999).

By adding Section 106 to the Bankruptcy Code in 1978 and amending it in 1994,^[1] Congress attempted to abrogate the Eleventh Amendment sovereign immunity in certain bankruptcy matters. 11 U.S.C. § 106. If no such immunity existed, there would have been no need to make such legislative attempts to abrogate it.

In order to determine whether Congress has abrogated a State's sovereign immunity, a court must ask: (1) whether Congress has unequivocally expressed its intent to abrogate immunity, and (2) whether Congress has acted pursuant to a valid exercise of power. Seminole Tribe, 116 S. Ct. at 1123. The Seminole Tribe decision in 1996 raised serious questions about the constitutionality of Section 106. In Seminole Tribe, the Court held that Congress had the power to abrogate a State's sovereign immunity only under the Fourteenth Amendment.

*922 A majority of courts, finding Section 106 to have been enacted pursuant to Congress' bankruptcy powers under Article I, not pursuant to the Fourteenth Amendment, have held Section 106 to be unconstitutional. See, e.g., Arecibo Community Health Care, Inc.; Mitchell v. Franchise Tax Bd., State of California (In re Mitchell), 209 F.3d 1111 (9th Cir.2000); Dodson v. Tennessee Student Assistance Corp. (In re Dodson), 259 B.R. 635 (Bank.E.D.Tenn. 2001); Grabscheid v. Michigan Employment Sec. Comm'n (In re C.J. Rogers, Inc.), 212 B.R. 265 (E.D.Mich.1997); Pitts; and Seay. These cases make no mention of sovereign immunity having been surrendered at the adoption of the U.S. Constitution.

As the Court noted in Seminole Tribe:

Even when the Constitution vests in Congress complete law-making 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 constitutional limitations placed upon federal jurisdiction.

Seminole Tribe, 116 S. Ct. at 1131-32.

In addition, the Court notes that this case involves an attempt by HJW to "reach into the State treasury" for the recovery of property, an action the Eleventh Amendment and sovereign immunity were specifically designed to prevent. See, e.g., MacDonald v. Village of Northport, Michigan, 164 F.3d 964, 970 (6th Cir.1999) (citing Edelman v. Jordan, 415 U.S. 651, 94 S. Ct. 1347, 39 L. Ed. 2d 662 (1974)) and Hutsell v. Sayre, 5 F.3d 996, 999 (6th Cir.1993).

For all these reasons, the Court finds that the defense of sovereign immunity is available to the Commonwealth in this case.

HJW also argues that the Commonwealth has waived its sovereign immunity by filing a proof of claim. The Bankruptcy Judge did not reach this issue. In Gardner v. New Jersey, 329 U.S. 565, 67 S. Ct. 467, 91 L. Ed. 504 (1947), the Court concluded that when a State becomes the actor and files a claim against the fund, it waives any immunity which it otherwise might have had respecting the adjudication of the claim. A State waives its immunity and consents to suit in federal court by specific declaration or act, such as filing a general appearance, or by the State becoming a plaintiff or an intervenor in the federal lawsuit. Grabscheid, 212 B.R. at 273.

Section 106 of the Bankruptcy Code contemplates such a waiver and provides that the filing of a proof of claim waives sovereign immunity only with respect to a claim against the governmental unit that is property of the estate and that arose out of the same transaction or occurrence out of which the claim of the governmental unit arose. 11 U.S.C. § 106(b).^[2]

The test for finding a waiver of sovereign immunity is a stringent one. College Savings Bank, 119 S. Ct. at 2226. The "same transaction or occurrence" language mirrors the compulsory counterclaim language of Fed.R.Civ.P. 13, which essentially defines a compulsory counterclaim as one arising out of the transaction or occurrence that is the subject matter of the opposing party's claim. The Sixth Circuit's *923 test for determining whether a counterclaim is compulsory is to determine whether the issues of fact and law raised by the claims are largely the same and whether substantially the name evidence would support or refute both claims. Seay, 244 B.R. at 117 (citing Sanders v. First Nat'l Bank & Trust Co., 936 F.2d 273, 277 (6th Cir.1991)).

When a State files a proof of claim in a bankruptcy proceeding, the State waives its sovereign immunity only with respect to the adjudication of that particular claim. Grabscheid, 212 B.R. at 274 (citing Gardner, 329 U.S. at 571, 67 S.Ct. 467). Otherwise, the adjudication of the State's claim would be transmitted into a suit against the State for monetary damages which would violate the principle that no judgment is sought against the State. Id.

Here, the Court finds that HJW's claim for refund of corporate excise tax for the years 1987 to 1992 (the subject of this adversary proceeding) is not the same transaction or occurrence or claim as the Commonwealth's claim for sales and use tax from September 1996 to March 1999 (the subject of its proof of claim). The taxes arise under different state statutes and from different time periods. There is nothing before this Court which would show that the same evidence would support or refute both claims or that the issues of law and fact would be the same.

The Court finds that the Commonwealth's proof of claim does not waive its sovereign immunity and subject it to federal court jurisdiction for purposes of this adversary proceeding.

Having found that the Commonwealth is entitled to sovereign immunity from this adversary proceeding, the Court need not address its other arguments. The Order of the Bankruptcy Court is REVERSED and this case is remanded for disposition not inconsistent with this opinion.

IT IS SO ORDERED.

[1] The Supreme Court held, in Hoffman v. Connecticut Dep't of Income Maintenance, 492 U.S. 96, 109 S. Ct. 2818, 106 L. Ed. 2d 76 (1989), that Section 106(c) of the Bankruptcy Code did not effectively abrogate a State's Eleventh Amendment immunity with respect to a money judgment, if the State had not filed a proof of claim in the case. Thus, in 1994, Congress amended the section to express its intention more clearly.

[2] As noted above, however, the majority of courts which have found this code provision to be unconstitutional.