From our friend and bankruptcy expert, Regent law professor Scott Pryor:
When I teach bankruptcy law I
regularly invoke the competing themes of property and contract. Without
belaboring the argument, property is a baseline concept from which American
common law generally and the Fifth Amendment to the Constitution generate
substantive legal protections. While I also believe the right to contract is
natural to humans, I argued in Principled Pluralism and Contract Remedies
(abstract here)
that state-sanctioned remedies for breach of contract were discretionary. In
other words, a polity need not provide a judicial forum for rectification of
rights arising from breaches. In case anyone wonders how someone who teaches
contract law could continue to justify collecting his paycheck, I went on
to argue that even if not required to do so, civil governments have the
legitimate discretionary authority to provide judicial remedies for breaches of
contracts, and that providing such remedies contributes to human flourishing.
The well-nigh universal regime of contract remedies for contract breaches seems
to bear out my conclusion.
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.
An ingenious argument but
Bankruptcy Judge Christopher Klein didn't buy it. (Judge Klein's lengthy
opinion, Assoc. of Retired Employees, et al. v. City of Stockton (In re City
of Stockton) can be found at 2012 WL 3193588.) First, he observed that §
904 of the Bankruptcy Code clearly prohibits the court from granting any
interim relief to the retirees. Second, and much more fully reasoned (in
anticipation of an appeal, one suspects), Judge Klein concluded that the
Bankruptcy Clause in effect trumps the Contracts Clause, at least in this case.
In short, the City of Stockton can "interfere" with its
"Obligation of Contracts" because the State of California has
permitted it to file for relief under Chapter 9 of the Bankruptcy Code.
The Contracts Clause is a
limit on the States; the Bankruptcy Clause permits the federal government to do
what the States cannot; and the Tenth Amendment implies that a State can
acquiesce to this exercise of federal power. QED. But stay tuned; one suspects
there's more to come.