Contracts vs. Bankruptcy || Alien vs. Predator ??

(This is largely a repeat of something I posted yesterday at The Faculty Lounge (see here). However, I think the addition of the picture makes this way cooler.)

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." In addition, the Fifth Amendment commands that "No person shall be deprived of property without due process of law" by the federal government. Moreover, section 1 of the Fourteenth Amendment similarly limits the States: "No State shall deprive any person of property, without due process of law." 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.