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Friday, September 7, 2012

Bankruptcy Versus Contract - The Legal Version of Animal Face-Off?

Animal face offWhen I was in law school, plenty of people told me to take Bankruptcy Law.  Their pitch was something along the lines of "Bankruptcy Law trumps everything."  I think someone even told me, "When God wants to do something, he looks at the Bankruptcy Code first."  Of course, I didn't believe them.  I didn't take Bankruptcy Law.  And when all of the telecom-related bankruptcies erupted while I was practicing media and telecommunications law in Washington, DC, I learned a lot of bankruptcy law on the fly. And you know what?  Those people in law school were right.  Bankruptcy law really did beat everything!  I was fascinated.  I was awed!  So, it should be no surprise that when I read of the recent rumble involving bankruptcy law, contract law *and* the U.S. Constitution, I was intrigued.  And you should be, too.  Prof. Scott Pryor over at the Faculty Lounge sets up the battle as follows.

Two clauses of Article I of the U.S. Constitution are relevant to the intersection of property, contract remedies, and bankruptcy in the American context. First, Section 10, clause 1 provides that "No State shall pass any Law impairing the Obligation of Contracts" while Section 8, clause 4 empowers Congress "To establish uniform Laws on the subject of Bankruptcies throughout the United States." Oh, and we can't forget about the Tenth Amendment, which, when it comes to the system of dual state-federal sovereignty in the United States, preserves (at least sometimes) the States from federal interference.

Taken together we can conclude that (i) states cannot impair remedies for breach of contract (i.e., cannot discharge contract debts) but that (ii) the federal government can provide for discharge of debts while (iii) neither can take away one's property and, finally, (iv) when it comes to debts of municipalities, the federal bankruptcy powers cannot interfere with them without the consent of their State.

So what? Let's consider the bankruptcy of the City of Stockton, California. Like many municipalities (and states, for that matter) Stockton owes its retired employees far more in pensions than it can hope to pay. (Check the news report here and see here for my previous post on the topic.  For a slightly different take on the immediate cause of Stockton's financial crisis, check the NYT article here.)

Stockton filed bankruptcy to avoid paying the benefits it had contracted to pay but could no longer afford. But wait, the retirees argued, Stockton is an instrumentality of the State of California and, as we have seen, the U.S. Const. Art. 1, Sec. 10 specifically prohibits the states from messing around with contracts. While admitting that the federal government's constitutional bankruptcy power can discharge most contractual obligations, the retirees asserted that it cannot be permitted to do so in Stockton's case without contradicting the constitutional text. The irresistible force meets the immovable object.

You'll have to read the rest of Prof. Pryor's post to reach the exciting, but perhaps temporary, conclusion of Bankruptcy Law v. Contract Law.  It's almost as exciting as Gorilla v. Leopard.  Almost.  (And if you're not familiar with the old Discovery & Animal Planet Series, Animal Face-Off, check it out over at Netflix.  Hippo versus Shark was a personal fave.  Online game version here.)

[Heidi R. Anderson]

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