Fighting Fiction with Fiction—The New Federalism in (a Tobacco Company) Bankruptcy

This article examines the effect that recent shifts in federalism jurisprudence may have on the chapter 11 reorganizations of large corporate debtors with significant, non-tax debts to states. The thesis of the article is that, by orienting our analysis of state/federal relations around "power," we have made immunity unpredictable in the bankruptcy reorganization context. Using the example of a tobacco company in a chapter 11 reorganization, this article assesses three strands of the "new federalism": (i) immunity from federal court jurisdiction under such decisions as Alden, Seminole, Florida Prepaid and College Savings Bank; (ii) diminishing Congressional power to regulate within "traditional" state spheres under such cases as Lopez and Morrison; and (iii) state freedom from Congressional "commandeering" under such cases as Printz and New York. If these decisions are about shifting power from the national to the state governments, then it is no longer clear that federal bankruptcy courts have the power to subordinate or discharge claims held by states including, for example, the more than $200 billion in claims held by states against major tobacco companies under the tobacco Master Settlement Agreement. This article then surveys doctrinal responses to this shift in power. Not surprisingly, courts and commentators have struggled to preserve to chapter 11 debtors (and Bankruptcy Courts) the important power to subordinate and discharge claims, even if held by states. Thus, courts and commentators offer three countervailing doctrines to contain the new federalism in chapter 11: (i) the Ex parte Young doctrine, which permits a federal court to enjoin a state agent prospectively, even if the state "itself" may be immune from suit, (ii) the in rem doctrine, which holds that the subordination and discharge of claims are actions against assets in the constructive possession of courts, and involve no jurisdiction over states; and (iii) the closely related "non-suit" doctrine, which holds that the subordination and discharge of claims is not a "suit," but an "interpretive" process. A careful analysis of these doctrines in the highly strategized context of a complex corporate reorganization suggests that they are weak, formalistic and unrealistic. Most disputes in chapter 11 reorganizations are settled, not litigated. Thus, rational debtors and creditor-states will settle state claims, but at a premium reflecting the uncertainty created by the new federalism. Since (non-tax) state claims are legally the same as the claims of other, similarly situated unsecured creditors (e.g., tort claimants, in the case of tobacco companies) it is not clear why states should enjoy this preferential treatment. Rather than linking the important power to subordinate or discharge claims to these doctrinal fictions, I argue that courts can reconcile the new federalism and the bankruptcy framework through the Bankruptcy Clause, which gives Congress power to make uniform laws on the subject of bankruptcy. Uniformity should mean uniformity of result, and (non-tax) state claims should be subject to subordination or discharge just as if they were held by private creditors.