Third Circuit: Assertions of Sovereign Immunity Can Be Scrutinized In the Bankruptcy Context

The recent decision in Davis v. State of California (In re Venoco), 998 F.3d 98 (3d Cir. 2021) extends the third exception in reliance upon Katz to a claim for monetary damages asserted against a state agency in an adversary proceeding commenced by a litigation trust established under a plan of reorganization. The rationale of Venoco provides an analytical framework for assessing the extent of such waiver. In an era of increasing participation and regulation by various governmental agencies in businesses eligible for bankruptcy relief, the Venoco decision is an important development for assessing the extent to which a distressed business can address action by a governmental unit through a bankruptcy case.

Background

Venoco LLC and its affiliated debtors operated a drilling rig off the coast of Santa Barbara, Calif., processing and refining the oil and gas in a nearby facility. Venoco owned the processing facility. It did not own the drilling rig, but instead leased it from the state of California, acting through its Lands Commission. A pipeline rupture in 2015 drove Venoco to seek relief under Chapter 11, reorganizing and emerging in 2016. Its difficulties, however, continued and Venoco filed for Chapter 11 bankruptcy again in 2017. The day Venoco commenced its second case, it abandoned its leases and operations of the drilling rig. The Lands Commission took over, decommissioning the rigs and plugging the abandoned wells. Initially there was an agreement to pay Venoco to continue to operate the drilling rig and processing facility, which was later supplanted by a third-party contractor taking over Venoco's operations. At that point the Lands Commission and Venoco entered into an agreement whereby the Commission would compensate Venoco for use of the processing facility still owned by Venoco. During the Chapter 11 case, the Lands Commission asserted its rights as a creditor of Venoco, filing a claim for reimbursement of plugging and decommissioning costs as well as operational costs for the rig and the processing facility. After negotiations to sell the processing facility to the Lands Commission fell apart, the Commission ceased payments to Venoco under the agreement but continued using the processing facility, arguing that protecting the environment and public safety in reliance upon its police powers justified that action. Under the Chapter 11 plan, Venoco's assets, including the processing facility, were transferred to a liquidation trust. The trustee then filed an adversary proceeding against the state of California and its Lands Commission to recover the value of the processing facility which the trustee argued was taken in fact by the governmental defendants, asserting a claim for inverse condemnation.