Case Law Alert: Third Circuit Finds No Fraudulent Transfer Liability in Connection With Revocation of Pennsylvania Gaming License

In a June 29, 2021 decision concerning an alleged $50 million fraudulent transfer to the Commonwealth of Pennsylvania, the United States Court of Appeals for the Third Circuit affirmed the dismissal of an action by the liquidating trustee of Philadelphia Entertainment and Development Partners (d/b/a Foxwoods Casino Philadelphia) (the “Debtor”) under Bankruptcy Code Sections 544(b), 548, 550, and 551 to recover the value of a gaming license that had been revoked by the Commonwealth. The Third Circuit determined that, because the license was not a property right under Pennsylvania state law, sovereign immunity barred the trustee’s action against the Commonwealth. The decision turned on the distinction between transferable ownership rights in property versus mere “privileges.” Although the Third Circuit’s opinion in this matter is non-precedential, it nevertheless underscores the importance that state law plays in determining “property of the estate,” and the resulting consequences for debtors and their creditors. By way of example, we would expect to see the same result under New York law with respect to liquor licenses, which – unlike in New Jersey and certain other states – are non-transferable licenses and thus not estate property under Bankruptcy Code Section 541 and state law.

In Philadelphia Entertainment, the Debtor obtained a slot machine license from the Pennsylvania Gaming Control Board in exchange for a $50 million fee, but later lost the license to revocation when it failed to satisfy certain conditions. The Debtor thereafter filed a chapter 11 case and commenced a constructively fraudulent transfer action against the Commonwealth. After finding that the Debtor did not hold a property interest in the license, the bankruptcy court dismissed the action on sovereign immunity grounds; the district court then affirmed.

The Third Circuit began its analysis by asking whether the Commonwealth had waived its sovereign immunity to such suits, and focused narrowly on the bankruptcy court’s in rem jurisdiction, noting that “the sovereign immunity defense is unavailable for causes of action that ‘further[] a bankruptcy court’s in rem jurisdiction.’” (Citing In re Venoco LLC, 998 F.3d 94, 104 (3d Cir. 2021), and Central Virginia Community College v. Katz, 546 U.S. 356 (2006). Cf. 11 U.S.C. § 106(a). Thus, if the Debtor lacked a property interest in the gaming license, then the adversary proceeding would not concern property of the Debtor’s bankruptcy estate and would be barred by sovereign immunity because it did not further the Bankruptcy Court’s in rem jurisdiction.

Turning next to Pennsylvania state law pursuant to Butner v. United States, 440 U.S. 48, 55 (1979) (“Property interests are created and defined by state law . . . [u]nless some federal interest requires a different result.”), the Third Circuit found that neither the Pennsylvania Horse Racing Development and Gaming Act (“Gaming Act”) or the Pennsylvania Uniform Fraudulent Transfer Act (“PUFTA”) created a property interest in the license in favor of the Debtor that could be recovered by the estate. Notably, the Third Circuit reached that result even though the commentary to PUFTA specifically provides that governmental licenses constitute “property” subject to avoidance and recovery even if not transferable. Relying on the Pennsylvania doctrine that “more specific provisions control over the general ones” when two statutes are in conflict, citing Commonwealth, Dep’t of Pub. Welfare v. Eiseman, 125 A.3d 19, 32 (Pa. 2015), and 1 Pa. Cons. Stat. § 1933, the Third Circuit determined that the Gaming Act controlled. The Debtor’s gaming license was “a revocable, non-transferable privilege,” as opposed to property the Debtor owned, “and hence not res of the bankruptcy estate.” Therefore, the Commonwealth retained its sovereign immunity from a suit seeking to recover the license’s value, and dismissal of the action was upheld.

As noted above, although the Philadelphia Entertainment opinion is non-precedential and therefore non-binding, because it is grounded in solid Supreme Court precedents on both the determination of state law property interests (Butner) and state sovereign immunity (Katz), the decision provides a persuasive framework for future avoidance actions concerning government licenses. Of course, the reliance on state law also provides a clear reminder that results on this issue will not be uniform across bankruptcy courts.