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Choice-Of-Law Rules in Bankruptcy: an Opportunity for Congress to Resolve Conflicting Approaches

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Choice-Of-Law Rules in Bankruptcy: an Opportunity for Congress to Resolve Conflicting Approaches SEVENTH CIRCUIT REVIEW Volume 5, Issue 2 Spring 2010 CHOICE-OF-LAW RULES IN BANKRUPTCY: AN OPPORTUNITY FOR CONGRESS TO RESOLVE CONFLICTING APPROACHES ∗ VIKTORIA A. D. ZIEBARTH Cite as: Viktoria A. D. Ziebarth, Choice-of-Law Rules in Bankruptcy: An Opportunity for Congress to Resolve Conflicting Approaches, 5 SEVENTH CIRCUIT REV. 309 (2010), at http://www.kentlaw.edu/7cr/v5-2/ziebarth.pdf. INTRODUCTION When a dispute arises and the parties are from different states or more than one law within a single jurisdiction applies to the dispute, which law should govern? Choice-of-law rules answer that question. In the early years following the founding of the United States, state law was fairly uniform, so it usually did not matter which state’s law was applied.1 However, in subsequent years, states enacted statutes that conflicted with those of their sister states.2 Choice-of-law “is a device for choosing among states’ substantive laws.”3 Writing in 1927, Justice Benjamin Cardozo called conflict of ∗ J.D. candidate, May 2010, Chicago-Kent College of Law, Illinois Institute of Technology; B.A., International Studies, 1997, Rhodes College. 1 Robert H. Jackson, Full Faith and Credit—The Lawyer’s Clause of the Constitution, 45 COLUM. L. REV. 1, 11 (1945). Justice Jackson’s article, which was given as the fourth annual Benjamin N. Cardozo Lecture on December 7, 1944, provides excellent insight into the origins of the Full Faith and Credit Clause and the Supreme Court’s full faith and credit jurisprudence through the early 1940s. 2 Id. 3 Scott Fruehwald, Choice of Law in Federal Courts: A Reevaluation, 37 BRANDEIS L.J. 21, 40 (1998). 309 SEVENTH CIRCUIT REVIEW Volume 5, Issue 2 Spring 2010 laws “one of the most baffling subjects of legal science.”4 At that time, American conflict of laws jurisprudence was in its infancy, and U.S. courts were following a single choice-of-law methodology.5 Over twenty-five years later, Dean William Prosser wrote, “[t]he realm of the conflict of laws is a dismal swamp, filled with quaking quagmires, and inhabited by learned but eccentric professors who theorize about mysterious matters in a strange and incomprehensible jargon. The ordinary court, or lawyer, is quite lost when engulfed and entangled in it.”6 Today, resolving conflicts between competing state laws is a complex endeavor because states have adopted a variety of choice-of- law approaches. Conflicts in bankruptcy cases usually occur when the debtor and creditors are from more than one state, but they can also involve a conflict between U.S. bankruptcy law and a foreign nation’s bankruptcy law.7 In determining the parties’ rights in a bankruptcy proceeding, the bankruptcy court must first determine whether state or federal law governs the parties’ rights.8 If state law governs a right, then the court must determine which state’s law applies.9 For example, a court will look to state law to determine whether a contract, on which a creditor’s claim is based, is valid.10 If the contract was made 4 BENJAMIN N. CARDOZO, THE PARADOXES OF LEGAL SCIENCE 67 (Columbia Univ. Press 1945) (1928). 5 The terms approaches and methodologies are all used in describing various choice-of-law schemes. Generally, the choice-of-law approaches or methodologies provide the broad choice-of-law standards, which include specific choice-of-law rules for various areas of law. 6 William L. Prosser, Interstate Publication, 51 MICH. L. REV. 959, 971 (1953). 7 Patrick J. Borchers, Choice of Law Relative to Security Interests and Other Liens in International Bankruptcies, 46 AM. J. COMP. L. 165, 171 (1998). 8 John T. Cross, State Choice of Law Rules in Bankruptcy, 42 OKLA. L. REV. 531, 533 (1989). 9 Id. 10 “Claim” is defined as a: (A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, 310 SEVENTH CIRCUIT REVIEW Volume 5, Issue 2 Spring 2010 between parties from different states and the contract would be valid under the law of one state but not the other, a choice-of-law issue can arise. With the exception of the choice-of-law rule provided in 11 U.S.C. § 522(b)(3)(A) for determining which state’s exemptions a debtor may claim to exempt property from the bankruptcy estate,11 federal bankruptcy law does not provide choice-of-law rules for bankruptcy cases or guidance on how state law conflicts should be unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or (B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured. 11 U.S.C. § 101(5) (2006). 11 An individual debtor may exempt property under the: State or local law that is applicable on the date of the filing of the petition at the place in which the debtor’s domicile has been located for the 730 days immediately preceding the date of the filing of the petition or if the debtor’s domicile has not been located at a single State for such 730-day period, the place in which the debtor’s domicile was located for 180 days immediately preceding the 730-day period or for a longer portion of such 180- day period than in any other place. 11 U.S.C. § 522(b)(3)(A). Congress amended the provision in 2005 to prevent forum shopping by debtors who move from one state to another prior to filing bankruptcy to take advantage of a more generous state exemption statute. In re Jevine, 387 B.R. 301, 303 (Bankr. S.D. Fla. 2008). Both the Eighth and Ninth Circuit Courts of Appeals have stated that 11 U.S.C. § 522(b)(3), formerly 11 U.S.C. § 522(b)(2), is a federal choice-of-law provision that does not incorporate the state choice-of-law rules. See In re Drenttel, 403 F.3d 611, 613–14 (8th Cir. 2005); In re Arrol, 170 F.3d 934, 936 (9th Cir. 1999) (“This is a federal choice of law in which the choice has been made. That choice is the applicable state exemption law, and in this case the exemption is California’s statutory homestead exemption. Whatever California’s conflicts of law jurisprudence may be is simply irrelevant.”). 311 SEVENTH CIRCUIT REVIEW Volume 5, Issue 2 Spring 2010 resolved.12 The U.S. Supreme Court has never directly addressed whether federal courts should apply state choice-of-law rules in bankruptcy cases or other federal question jurisdiction cases.13 Klaxon Co. v. Stentor Electric Manufacturing Co. requires federal courts exercising diversity jurisdiction to apply the choice-of-law rules of the state in which the court is sitting.14 However, Klaxon has never been extended to federal question cases.15 Thus, it remains an open question whether federal courts should apply state or federal choice-of-law rules in bankruptcy cases. Left to grapple with the choice-of-law issue on their own without any clear direction from the Bankruptcy Code16 or the Supreme Court, the federal courts have been divided over the correct approach in bankruptcy and other federal question cases. Some courts apply the choice-of-law rules of the forum state and cite Klaxon as authority, while other courts reject application of Klaxon and apply a federal common law choice-of-law rule.17 A third group tempers its approach by considering whether there is a compelling federal interest before applying the forum state’s choice-of-law rules.18 The Seventh Circuit recently had an opportunity to take a position on whether state choice-of-law rules or a federal choice-of-law approach should be applied in bankruptcy cases, but it declined to do 12 See Jackie Gardina, The Perfect Storm: Bankruptcy, Choice of Law, and Same-Sex Marriage, 86 B.U. L. REV. 881, 883 (2006); Cross, supra note 8, at 534; In re SMEC, Inc., 160 B.R. 86, 89 (M.D. Tenn. 1993). 13 See Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156 (1946), reh’g denied, 329 U.S. 833 (1947); D’Oench, Duhme & Co. v. Fed. Deposit Ins. Corp., 315 U.S. 447 (1942), reh’g denied, 315 U.S. 830 (1942). The Supreme Court had an opportunity to determine whether federal courts should apply federal or state choice-of-law rules when exercising federal question jurisdiction in both cases but resolved the cases on other grounds. Vanston, 329 U.S. at 161–67; D’Oench, 315 U.S. at 455–56. 14 313 U.S. 487, 496 (1941). 15 Gardina, supra note 12, at 907–09. 16 11 U.S.C. §§ 101–1527 (2006). 17 Gardina, supra note 12, at 909–10. 18 Id. at 910. 312 SEVENTH CIRCUIT REVIEW Volume 5, Issue 2 Spring 2010 so.19 While the outcome of In re Jafari would not have been altered by the application of federal choice-of-law rules, the court failed to elevate discussion of the issue. If the Seventh Circuit had applied the federal common law choice-of-law approach used by the First and Ninth Circuits in bankruptcy and other federal question cases,20 the enlarged circuit split might have garnered the interest of Congress or the Supreme Court in resolving the issue.21 The traditional and modern choice-of-law approaches are flawed, and legal scholars have advocated the creation of a new set of choice- of-law rules.22 Application of state choice-of-law rules in bankruptcy cases results in inconsistent outcomes, which is at odds with the uniform nature of the federal bankruptcy system.
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