By Ralph Brubaker (University of Illinois College of Law)
State law pervades bankruptcy litigation, as all parties’ relative rights in bankruptcy are governed by nonbankruptcy law, except to the extent modified by federal bankruptcy law itself. Indeed, that result is constitutionally compelled with respect to parties’ substantive state-law rights and obligations, under the holding of Erie R.R. v. Tompkins. How should a federal bankruptcy court choose the applicable state law, though, when the law of two or more states could apply to a particular matter before the court? In diversity cases, the Supreme Court’s enduring decision in Klaxon Co. v. Stentor Electric, compels a federal court to choose applicable state law by employing the choice-of-law rules of the state in which the federal court sits. There is considerable uncertainty, however, regarding the extent to which the Klaxon rule should apply, if at all, in federal bankruptcy proceedings, as revealed by the recent exchange between Third Circuit Judges Ambro and Krause, in separate concurring opinions in In re Whittaker Clark & Daniels Inc., 152 F.4th 432 (3d Cir. 2025).
This two-part article critiques the position that the Klaxon rule (i.e., use forum state choice-of-law rules) also applies in bankruptcy cases and argues that, instead, independent federal common law rules regarding choice of law should be applied in federal bankruptcy proceedings. The Klaxon rule is not compelled by either the Constitution or the Rules of Decision Act; rather, it is a product of Erie’s jurisdictional policy—the so-called “twin aims” of combating intrastate (vertical) forum shopping and intrastate inequality in administration of the law. Unlike diversity litigation, though, because of the conjunction of bankruptcy’s expansive nationwide personal jurisdiction and its exceedingly permissive venue provisions, bankruptcy courts regularly decide state-law disputes in a district whose state courts could and/or would not entertain those disputes in the absence of a bankruptcy filing. Intrastate forum shopping and inequality is, therefore, not a relevant concern for such disputes, and consequently, the Klaxon rule unjustifiably amplifies interstate (horizontal) forum shopping and inequality, above and beyond that which is endemic to our federal system.
The stated concern that abandonment of the Klaxon rule is an illegitimate exercise of federal common lawmaking powers, improperly infringing state sovereignty, is misplaced because Klaxon itself is a federal common law rule that (under the influence of Erie’s “twin aims”) simply incorporates the forum state’s law as the operative federal common law. Whatever choice-of-law rules are applied in federal bankruptcy proceedings are federal choice of law rules, and that is especially so when a bankruptcy court hears a state-law dispute that could and/or would never be presented to a forum-state court. Indeed, in those cases it is particularly unproductive to assume that state sovereignty is even implicated, and the Klaxon rule produces a kind of “upside-down” or “inside-out” federal common law—indiscriminate invocation of state law to resolve a uniquely federal problem. The forum-specific nature of conflicts principles inevitably leads to federal choice-of-law rules in bankruptcy, whether by design or accident.
Incorporating the choice-of-law rules of the state in which a particular dispute would be heard (hypothetically) in the absence of a bankruptcy filing (as the operative federal common law) would be cumbersome, speculative, and in many cases, simply impossible. Indeed, choice of law seems to be an area in which bankruptcy simply cannot accurately or consistently replicate state-court outcomes and is just another instance in which the unique nature of the bankruptcy process (which is radically different than nonbankruptcy judicial processes) frustrates efforts to fully translate parties’ state-law rights into the bankruptcy context. Congress’s administrative efficiency objectives in creating the centralized, consolidated, collective bankruptcy process counsel in favor of uniform federal choice of law rules in bankruptcy, as does the constitutional concern for uniform federal bankruptcy laws, whereby a debtor’s rights and obligations are (in the words of Justice Frankfurter) “treated alike by the bankruptcy administration throughout the country regardless of the State in which the bankruptcy court sits.”
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