Constitutional Status of State Insolvency Laws: Preemption

BANKRUPTCY

Persons Who May Be Released From Debt

In an early case on circuit, Justice Livingston suggested that inasmuch as the English statutes on the subject of bankruptcy from the time of Henry VIII down had applied only to traders it might “well be doubted, whether an act of Congress subjecting to such a law every description of persons within the United States, would comport with the spirit of the powers vested in them in relation to this subject.”1325 Neither Congress nor the Supreme Court has ever accepted this limited view. The first bankruptcy law, passed in 1800, departed from the English practice to the extent of including bankers, brokers, factors and underwriters as well as traders.1326 Asserting that the narrow scope of the English statutes was a mere matter of policy, which by no means entered into the nature of such laws, Justice Story defined bankruptcy legislation in the sense of the Constitution as a law making provisions for cases of persons failing to pay their debts.1327

This interpretation has been ratified by the Supreme Court. In Hanover National Bank v. Moyses,1328 it held valid the Bankruptcy Act of 1898, which provided that persons other than traders might become bankrupts and that this might be done on voluntary petition. The Court has given tacit approval to the extension of the bankruptcy laws to cover practically all classes of persons and corporations,1329 including even municipal corporations1330 and wage-earning individuals. The Bankruptcy Act has, in fact been amended to provide a wage-earners’ extension plan to deal with the unique problems of debtors who derive their livelihood primarily from salaries or commissions. In furthering the implementation of this plan, the Supreme Court has held that a wage earner may make use of it, notwithstanding the fact he has been previously discharged in bankruptcy within the last six years.1331

1325 Adams v. Storey, 1 Fed. Cas. 141, 142 (No. 66) (C.C.D.N.Y. 1817).

1326 2 Stat. 19 (1800).

1327 2 J. STORY, COMMENTARIES ON THE CONSTITUTION OF THE UNITED STATES 1113 (1833).

1328 186 U.S. 181 (1902).

1329 Continental Bank v. Rock Island Ry., 294 U.S. 648, 670 (1935).

1330 United States v. Bekins, 304 U.S. 27 (1938), distinguishing Ashton v. Cameron County Dist., 298 U.S. 513 (1936).

1331 Perry v. Commerce Loan Co., 383 U.S. 392 (1966).

Liberalization of Relief Granted and Expansion of the Rights of the Trustee

As the coverage of the bankruptcy laws has been expanded, the scope of the relief afforded to debtors has been correspondingly enlarged. The act of 1800, like its English antecedents, was designed primarily for the benefit of creditors. Beginning with the act of 1841, which opened the door to voluntary petitions, rehabilitation of the debtor has become an object of increasing concern to Congress. An adjudication in bankruptcy is no longer requisite to the exercise of bankruptcy jurisdiction. In 1867, the debtor for the first time was permitted, either before or after adjudication of bankruptcy, to propose terms of composition that would become binding upon acceptance by a designated majority of his creditors and confirmation by a bankruptcy court. This measure was held constitutional,1332 as were later acts, which provided for the reorganization of corporations that are insolvent or unable to meet their debts as they mature,1333 and for the composition and extension of debts in proceedings for the relief of individual farmer debtors.1334

Nor is the power of Congress limited to adjustment of the rights of creditors. The Supreme Court has also ruled that the rights of a purchaser at a judicial sale of the debtor’s property are within reach of the bankruptcy power, and may be modified by a reasonable extension of the period for redemption from such sale.1335 Moreover, the Court expanded the bankruptcy court’s power over the property of the estate by affording the trustee affirmative relief on counterclaim against a creditor filing a claim against the estate.1336

1332 In re Reiman, 20 Fed. Cas. 490 (No. 11,673) (D.C.S.D.N.Y. 1874), cited with approval in Continental Bank v. Rock Island Ry., 294 U.S. 648, 672 (1935).

1333 Continental Bank v. Rock Island Ry., 294 U.S. 648 (1935).

1334 Wright v. Vinton Branch, 300 U.S. 440 (1937); Adair v. Bank of America Ass’n, 303 U.S. 350 (1938).

1335 Wright v. Union Central Ins. Co., 304 U.S. 502 (1938).

1336 Katchen v. Landy, 382 U.S. 323 (1966).

Underlying most Court decisions and statutes in this area is the desire to achieve equity and fairness in the distribution of the bankrupt’s funds.1337 United States v. Speers,1338 codified by an amendment to the Bankruptcy Act,1339 furthered this objective by strengthening the position of the trustee as regards the priority of a federal tax lien unrecorded at the time of bankruptcy.1340 The Supreme Court has held, in other cases dealing with the priority of various creditors’ claims, that claims arising from the tort of the receiver is an “actual and necessary” cost of administration,1341 that benefits under a nonparticipating annuity plan are not wages and are therefore not given priority,1342 and that when taxes are allowed against a bankrupt’s estate, penalties due because of the trustee’s failure to pay the taxes incurred while operating a bankrupt business are also allowable.1343 The Court’s attitude with regard to these and other developments is perhaps best summarized in the opinion in Continental Bank v. Rock Island Ry.,1344 where Justice Sutherland wrote, on behalf of a unanimous court: “[T]hese acts, far-reaching though they may be, have not gone beyond the limit of Congressional power; but rather have constituted extensions into a field whose boundaries may not yet be fully revealed.”1345

Constitutional Limitations on the Bankruptcy Power

In the exercise of its bankruptcy powers, Congress must not transgress the Fifth and Tenth Amendments. The Bankruptcy Act provides that oral testimony cannot be used in violation of the bankrupt’s right against self-incrimination.1346 Congress may not take from a creditor specific property previously acquired from a debtor, nor circumscribe the creditor’s right to such an unreasonable extent as to deny him due process of law;1347 this principle, however, is subject to the Supreme Court’s finding that a bankruptcy court has summary jurisdiction for ordering the surrender of voidable preferences when the trustee successfully counterclaims to a claim filed by the creditor receiving such preferences.1348

1337 Bank of Marin v. England, 385 U.S. 99, 103 (1966).

1338 382 U.S. 266 (1965). Cf. United States v. Vermont, 337 U.S. 351 (1964).

1339 Act of July 5, 1966, 80 Stat. 269, 11 U.S.C. § 501, repealed.

1340 382 U.S., 271–72.

1341 Reading Co. v. Brown, 391 U.S. 471 (1968).

1342 Joint Industrial Bd. v. United States, 391 U.S. 224 (1968).

1343 Nicholas v. United States, 384 U.S. 678 (1966).

1344 294 U.S. 648 (1935).

1345 294 U.S. at 671.

1346 11 U.S.C. § 344.

1347 Louisville Bank v. Radford, 295 U.S. 555, 589, 602 (1935).

1348 Katchen v. Landy, 382 U.S. 323, 327–340 (1966).

Since Congress may not supersede the power of a State to determine how a corporation shall be formed, supervised, and dissolved, a corporation, which has been dissolved by a decree of a state court, may not file a petition for reorganization under the Bankruptcy Act.1349 But Congress may impair the obligation of a contract and may extend the provisions of the bankruptcy laws to contracts already entered into at the time of their passage.1350 Although it may not subject the fiscal affairs of a political subdivision of a State to the control of a federal bankruptcy court,1351 Congress may empower such courts to entertain petitions by taxing agencies or instrumentalities for a composition of their indebtedness where the State has consented to the proceeding and the federal court is not authorized to interfere with the fiscal or governmental affairs of such petitioners.1352 Congress may recognize the laws of the State relating to dower, exemption, the validity of mortgages, priorities of payment and similar matters, even though such recognition leads to different results from State to State;1353 for although bankruptcy legislation must be uniform, the uniformity required is geographic, not personal.

The power of Congress to vest the adjudication of bankruptcy claims in entities not having the constitutional status of Article III federal courts is unsettled. At least, it may not give to non-Article III courts the authority to hear state law claims made subject to federal jurisdiction only because of their relevance to a bankruptcy proceeding.1354

Constitutional Status of State Insolvency Laws: Preemption

Prior to 1898, Congress exercised the power to establish “uniform laws on the subject of bankruptcy” only intermittently. The first national bankruptcy law was not enacted until 1800 and was repealed in 1803; the second was passed in 1841 and was repealed two years later; a third was enacted in 1867 and repealed in 1878.1355 Thus, during the first eighty-nine years under the Constitution, a national bankruptcy law was in existence only sixteen years altogether. Consequently, the most important issue of interpretation that arose during that period concerned the effect of the clause on state law.

1349 Chicago Title and Trust Co. v. Wilcox Bldg. Corp., 302 U.S. 120 (1937).

1350 In re Klein, 42 U.S. (1 How.) 277 (1843); Hanover National Bank v. Moyses, 186 U.S. 181 (1902).

1351 Ashton v. Cameron County Dist., 298 U.S. 513 (1936). See also United States v. Bekins, 304 U.S. 27 (1938).

1352 United States v. Bekins, 304 U.S. 27 (1938).

1353 Stellwagon v. Clum, 245 U.S. 605 (1918); Hanover National Bank v. Moyses, 186 U.S. 181, 190 (1902).

1354 Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982). And see Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989) (Seventh Amendment right to jury trial in bankruptcy cases).

1355 Hanover National Bank v. Moyses, 186 U.S. 181, 184 (1902).

The Supreme Court ruled at an early date that in the absence of congressional action the States may enact insolvency laws, since it is not the mere existence of the power but rather its exercise that is incompatible with the exercise of the same power by the States.1356 Later cases settled further that the enactment of a national bankruptcy law does not invalidate state laws in conflict therewith but serves only to relegate them to a state of suspended animation with the result that upon repeal of the national statute they again come into operation without re-enactment.1357

A State is, of course, without power to enforce any law governing bankruptcies which impairs the obligation of contracts,1358

extends to persons or property outside its jurisdiction,1359 or conflicts with the national bankruptcy laws.1360 Giving effect to the policy of the federal statute, the Court has held that a state statute regulating this distribution of property of an insolvent was suspended by that law,1361 and that a state court was without power to proceed with pending foreclosure proceedings after a farmer-debtor had filed a petition in federal bankruptcy court for a composition or extension of time to pay his debts.1362 A state court injunction ordering a defendant to clean up a waste-disposal site was held to be a “liability on a claim” subject to discharge under the bankruptcy law, after the State had appointed a receiver to take charge of the defendant’s property and comply with the injunction.1363 A state law governing fraudulent transfers was found to be compatible with the federal law.1364

1356 Sturges v. Crowninshield, 17 U.S. (4 Wheat.) 122, 199 (1819); Ogden v. Saunders, 25 U.S. (12 Wheat.) 213, 368 (1827).

1357 Tua v. Carriere, 117 U.S. 201 (1886); Butler v. Goreley, 146 U.S. 303, 314 (1892).

1358 Sturges v. Crowninshield, 17 U.S. (4 Wheat.) 122 (1819).

1359 Ogden v. Saunders, 25 U.S. (12 Wheat.) 213, 368 (1827); Denny v. Bennett, 128 U.S. 489, 498 (1888); Brown v. Smart, 145 U.S. 454 (1892).

1360 In re Watts and Sachs, 190 U.S. 1, 27 (1903); International Shoe Co. v. Pinkus, 278 U.S. 261, 264 (1929).

1361 International Shoe Co. v. Pinkus, 278 U.S. 261, 265 (1929).

1362 Kalb v. Feurerstein, 308 U.S. 433 (1940).

1363 Ohio v. Kovacs, 469 U.S. 274 (1985). Compare Kelly v. Robinson, 479 U.S. 36 (1986) (restitution obligations imposed as conditions of probation in state criminal actions are nondischargeable in proceedings under chapter 7), with Pennsylvania Dep’t of Public Welfare v. Davenport, 495 U.S. 552 (1990) (restitution obligations imposed as condition of probation in state criminal actions are dischargeable in proceedings under chapter 13).

1364 Stellwagon v. Clum, 245 U.S. 605, 615 (1918).

Substantial disagreement has marked the actions of the Justices in one area, however, resulting in three five-to-four decisions first upholding and then voiding state laws providing that a discharge in bankruptcy was not to relieve a judgment arising out of an automobile accident upon pain of suffering suspension of his driver’s license.1365 The state statutes were all similar enactments of the Uniform Motor Vehicle Safety Responsibility Act, which authorizes the suspension of the license of any driver who fails to satisfy a judgment against himself growing out of a traffic accident; a section of the law specifically provides that a discharge in bankruptcy will not relieve the debtor of the obligation to pay and the consequence of license suspension for failure to pay. In the first two decisions, the Court majorities decided that the object of the state law was not to see that such judgments were paid but was rather a device to protect the public against irresponsible driving.1366 The last case rejected this view and held that the Act’s sole emphasis was one of providing leverage for the collection of damages from drivers and as such was in fact intended to and did frustrate the purpose of the federal bankruptcy law, the giving of a fresh start unhampered by debt.1367

If a State desires to participate in the assets of a bankruptcy, it must submit to the appropriate requirements of the bankruptcy court with respect to the filing of claims by a designated date. It cannot assert a claim for taxes by filing a demand at a later date.1368

1365 Reitz v. Mealey, 314 U.S. 33 (1941); Kesler v. Department of Public Safety, 369 U.S. 153 (1962); Perez v. Campbell, 402 U.S. 637 (1971).

1366 Reitz v. Mealey, 314 U.S. 33, 37 (1941); Kesler v. Department of Public Safety, 369 U.S. 153, 169–174 (1962).

1367 Perez v. Campbell, 402 U.S. 637, 644–648, 651–654 (1971). The dissenters, Justice Blackmun for himself and Chief Justice Burger and Justices Harlan and Stewart, argued, in line with the Reitz and Kesler majorities, that the provision at issue was merely an attempt to assure driving competence and care on the part of its citizens and had only tangential effect upon bankruptcy.

1368 New York v. Irving Trust Co., 288 U.S. 329 (1933).

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