Sovereign Immunity In Bankruptcy

When you think of the term “bankruptcy,” you probably think of something that occurs between two parties, namely the debtor (the one who owes a sum of money) and the creditor (the one who is owed the sum of money). However, several other entities are often involved as well. For example, if a creditor decides to sue the debtor in an attempt to recoup the money he/she is due, then the judicial system becomes an immediate and important player. What happens next is the case is brought before a court and that court could be at various levels, ranging from state to federal.

Surely there are lots of different scenarios to consider and one looming question is as follows: what happens if one of the parties involved in a suit is considered part of the government?

Is it Possible to Sue the Government?

The issue of “sovereign immunity” in bankruptcy addresses this very question. To sum it up in layman’s terms, what it means is that the government cannot commit a legal wrongdoing and, therefore, is immune to civil or criminal prosecution. That said, there are times when the government waives this immunity and allow suits to proceed.

Certainly, not everyone agrees that the government should be treated differently than private citizens. One could argue that if a government screws up they should be held accountable for its actions just like individuals are responsible for whatever they do. And while this sounds good on paper, one thing to consider is that the government’s role is much broader in scope than an individual’s. Since the government aims to improve and benefit society in general, it makes sense for them to have their own special set of rules.

In the Bankruptcy Code there are many examples of when the government should be granted or denied the defense of sovereign immunity. Here’s one example:

In 1992 Nordic Village, Inc. filed for Chapter 11 after which one of its employees withdrew some of the company’s funds to pay his personal taxes. When Nordic Village realized this, they filed a bankruptcy suit against the IRS. At the time, Section 106 of the Bankruptcy Code did not waive the United States' sovereign immunity from this action seeking monetary recovery.

The Role of the Eleventh Amendment

Soon after, the Supreme Court realized that when discussing sovereign immunity, it had to take into account non-bankruptcy cases as well. When they did this, the Eleventh Amendment (which protects states from legal suits) came into play. Here’s an example:

A man hoped his state and federal tax debts would be dismissed because they stretched beyond his original court ordered two year payment plan. While the state tax was dismissed because the Eleventh Amendment would not allow him to proceed against the state, the federal tax debt remained in place.

This scenario may raise a few eyebrows because one government party is granted immunity while another is not. No doubt, as more cases are brought to the courts, the Bankruptcy Code will be reviewed and the role of the Eleventh Amendment will be questioned time and again.