The U.S. Supreme Court’s 5-4 ruling in Stern v. Marshall was the capstone in the epic battle involving the late tabloid siren Anna Nicole Smith over oil tycoon J. Howard Marshall II’s estimated $1.6 billion estate. The opinion by Chief Judge John Roberts Jr. likened the 16 years of litigation to the protracted lawsuit in Charles Dickens’ Bleak House, which “drags its weary length before the Court.” (For a timeline of events in the case, scroll down.)
The case is perhaps the most publicized piece of estate and bankruptcy litigation ever to reach the high court. But that had everything to do with celebrity and very little to do with substance.
So what does the Court’s June 23 ruling really mean for bankruptcy cases? The short answer is that bankruptcy judges may no longer rule on state law-based counterclaims in bankruptcy proceedings. But bankruptcy practitioners, like the Court itself, are divided over whether Stern represents a ripple or a depth charge in the flow of bankruptcy litigation. Some say it clarifies the law and discourages forum shopping. Others say it will result in delays and increased costs.
The decision clarifies the law more than changes it, but it is likely to make some bankruptcy cases longer and more expensive, said William Heuer, a partner in Duane Morris’ New York office who submitted an amicus brief on behalf of four law professors in support of Marshall’s son’s side of the case. “I believe the inclusion of counterclaims in the [bankruptcy] statute was viewed by Congress as a matter of administrative convenience, and for good reason,” Heuer said. “But…there are limitations. Stern v. Marshall makes clear that in some cases, those limitations impose an additional layer of delay and increased cost upon all parties.”
Marshall and Smith married in 1994, and he died the following year. Although he “lavished gifts and significant sums of money” on Smith, whose real name was Vickie Lynn Marshall, he named his son E. Pierce Marshall beneficiary of his estate. Smith and another son, J. Howard Marshall III, challenged the estate, however. And thus began a tabloid-ready battle.
The dispute between Smith and E. Pierce Marshall involved two parallel proceedings, one in Texas probate court and one in the U.S. Bankruptcy Court for the Central District of California, where Smith filed for bankruptcy in 1996. After Marshall filed an adversary proceeding in the bankruptcy court based on a defamation claim, Smith filed a counterclaim alleging that Marshall interfered with her late husband’s intent to leave her assets. The bankruptcy court ruled in Smith’s favor in late 2000. In March 2001, the Texas probate court ruled in Marshall’s favor. Because the bankruptcy ruling came first, it would have preclusive effect — that is, unless the bankruptcy court didn’t have authority to rule on Marshall’s counterclaim.
In 2006, the Supreme Court reversed a ruling by the U.S. Court of Appeals for the 9th Circuit, reinstated Smith’s case and remanded the case. In an opinion by Justice Ruth Bader Ginsburg, the Court ruled that the bankruptcy case did not “fall within the ambit of the narrow [probate] exception.” The Court did not at the time address the issue of the bankruptcy court’s authority. Shortly after the ruling, E. Pierce Marshall died; the executor of his estate, Elaine Marshall, continued the litigation. Then, in February 2007, Smith died; the executor of her estate, Howard K. Stern, continued the litigation.
In a 2010 ruling, the 9th Circuit determined that Smith’s counterclaim was not a “core proceeding” under the applicable statute “for which the bankruptcy court is empowered to enter a final judgment.” It found that the bankruptcy court lacked the authority to rule on the counterclaim and that the Texas probate court’s ruling in favor of Marshall should be given preclusive effect.
In the recent Supreme Court decision, the majority ruled that bankruptcy judges have the statutory authority, but lack the constitutional power, to issue a final judgment on a state law-based counterclaim in a bankruptcy case. That’s because bankruptcy judges are not Article III judges under the Constitution — those appointed by the president and confirmed by the U.S. Senate according to the Constitution’s directives. Instead, their authority springs from Congress under Article I. Since Congress passed the Bankruptcy Amendments and Federal Judgeship Act of 1984, the circuit courts of appeals have appointed bankruptcy judges in their district for 14-year terms.
Roberts wrote that only judges who have access to Article III protections could exercise its judicial power: “The Bankruptcy Court below lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s proof of claim.” Roberts added, “We do not think the removal of counterclaims such as [Smith's] from core bankruptcy jurisdiction meaningfully changes the division of labor in the current statute.”
Justices Antonin Scalia, Anthony Kennedy, Clarence Thomas and Samuel Alito Jr. joined in Roberts’ opinion, and Scalia also filed a concurring opinion.
Justice Stephen Breyer wrote a dissent, joined by justices Ruth Bader Ginsburg, Sonia Sotomayor and Elena Kagan. Breyer relied on the approach taken by the Court’s 1986 ruling in Commodity Futures Trading Commission v. Schor, which held that the Commodity Futures Trading Commission could rule on some state law counterclaims. Breyer noted that the Schor Court “declined to adopt formalistic and unbending rules,” instead weighing numerous factors. “Applying Schor‘s approach here, I conclude that the delegation of adjudicatory authority before us is constitutional,” Breyer wrote. “A grant of authority to a bankruptcy court to adjudicate compulsory counterclaims does not violate any constitutional separation-of-powers principle related to Article III.”
Breyer concluded by opining that the majority ruling creates “a constitutionally required game of jurisdictional ping-pong between courts that would lead to inefficiency, increased cost, delay, and needless additional suffering among those faced with bankruptcy.”
Bankruptcy practitioners are similarly divided over whether the ruling maintains the status quo or will slow down bankruptcy cases, drive up costs and overburden district court judges with bankruptcy matters.
Kent Richland, a partner at Greines, Martin, Stein & Richland in Los Angeles who represented Smith’s estate, said, “I think that everyone agrees that it’s going to make it more costly” to litigate a bankruptcy case. Richland said he also expects bankruptcy cases to drag on longer because overtaxed district courts must now shoulder some of the work. “Federal courts are already overcrowded. This will add to district court dockets substantially.” He noted that many bankruptcies, whether corporate or individual, involve some state law claims, such as contract or tort claims that would need district court review.
G. Eric Brunstad Jr., a partner in Dechert’s Hartford, Conn., office who represented Marshall’s estate, agreed with the Supreme Court’s assessment that the ruling’s impact on cases will be relatively narrow, but he emphasized that its constitutional significance is far more important: “The importance is to vindicate the constitutional principal of judicial independence” for judges who decide such state law claims.
Lynne Riley of Riley Law Group, a Boston bankruptcy boutique, said the problem is that district courts in different jurisdictions will get involved at various points in the case, either withdrawing a matter and trying it themselves or engaging in de novo review of the bankruptcy court’s proposed findings of fact and conclusions of law. Riley submitted an amicus for the National Association of Bankruptcy Trustees supporting the Smith side.
“The practical [issue] is: You’re going to have more matters submitted on recommendation when there’s any question about the bankruptcy court’s jurisdiction to finally decide matters, leading to another layer of delay and potential expense because you have to wait for the district court to do its de novo review,” Riley said. She predicts that “litigation over what the bankruptcy court does and does not have the authority to finally determine” will start out as bankruptcy court jurisdictional challenges and likely rise to the appeals court level.
Other lawyers believe that the ruling clarifies bankruptcy judges’ authority and that the opposite outcome would have had a seismic impact.
Richard Samp, chief counsel for the Washington Legal Foundation, whose organization filed a brief for the Marshall side, said the ruling isn’t going to have a huge effect on case flow because bankruptcy judges will still be able to review such claims and issue findings and recommendations instead of final orders. Samp believes the ruling will help counter bankruptcy judges’ institutional bias in favor of helping debtors get back on their feet. “That oftentimes means that if there is a dispute between the person who has filed for bankruptcy and some third party who has nothing to do with the bankruptcy, there is a tendency among bankruptcy judges to say ‘I’m going to rule in favor of the bankrupt [party] and he’ll be able to successfully reorganize,’???” he said.
Robert Alt, a fellow at Ashland University’s John M. Ashbrook Center for Public Affairs, said the ruling will generally preserve the way things have been done. “Had the decision gone the other way, the consequences would have been far more stark in terms of the way bankruptcy courts do business and the incentives they create,” Alt said. The opposite ruling “would have created a precedent for forum shopping,” he said. “The story of the law is that once an avenue is clear and opened others will attempt to drive down that avenue.”
Heuer of Duane Morris said that some disputes that arise in bankruptcy cases may now take longer to get resolved because most bankruptcy courts were ruling on all counterclaims as core matters. “It will slow down some aspects of bankruptcy practice and it may increase delay and expenses,” Heuer said, adding that the most efficient solution would be for Congress to make bankruptcy judges Article III judges. “I do think that structurally that’s the right fix,” Heuer said. “It’s a very awkward structure we’ve got for bankruptcy court jurisdiction.”
Sheri Qualters can be contacted at email@example.com.