June 23 marked the first anniversary of the U.S. Supreme Court’s decision in Stern v. Marshall, 131 S. Ct. 2594 (2011), which many practitioners foresaw as the beginning of epic change in the battle for jurisdiction over claims that had routinely been handled by bankruptcy courts. This article examines whether the case provides sweeping change or minor disruption in how practitioners and courts handle disputes.

With the 1978 Bankruptcy Reform Act (Act), Congress replaced referees, who oversaw bankruptcy cases, with judges with power over bankruptcy estate administration, including adjudication of all controversies involving the debtor. Unlike Article III judges with salary protection and lifetime tenure, bankruptcy judges were to be appointed by the president for 14- year terms but could be removed by their circuit’s judicial council.

In 1982, the issue of whether it was permissible for non-Article III judges to be imbued with such extensive power reached the Supreme Court in the case of Northern Pipeline v. Marathon Pipe Line, 458 U.S. 50 (1982). In a plurality decision, Justice William Brennan found that the act unconstitutionally granted judicial power to non-Article III courts. In 1984, Congress responded with legislation to create a system whereby bankruptcy judges were delegated the authority to enter final orders on matters designated core proceedings under 28 U.S.C. §157(b), but were authorized to propose orders, subject to district court de novo review, on noncore matters only. Until Stern, this hybrid system was accepted as constitutional.

‘Stern v. Marshall’

When the Supreme Court decided Stern, Vickie Lynn Marshall, aka Anna Nicole Smith, and her stepson, E. Pierce Marshall (Pierce), were fighting over the estate of Smith’s deceased husband. Smith claimed Pierce exerted undue influence on his father to limit Smith’s inheritance; Pierce charged Smith with defamation. Smith filed for bankruptcy protection in the Central District of California. Pierce filed a non-dischargeability complaint and proof of claim for defamation against Smith in her bankruptcy case. Smith counterclaimed, alleging tortious interference.

The court disallowed Pierce’s claim against Smith’s bankruptcy estate and determined, pursuant to §157(b)(2)(C), that it had core jurisdiction over the counterclaim. It entered a large judgment in her favor on the counterclaim. Pierce appealed the decision to the district court, which found the bankruptcy court erred in deeming the counterclaim a core proceeding. The district court instead treated the bankruptcy court’s order as containing proposed findings of fact and conclusions of law. The district court agreed with those findings and conclusions and ruled for Smith on her counterclaim. Before the district court’s order, however, a Texas jury addressing the same issues entered judgment for Pierce.

On appeal, the U.S. Court of Appeals for the Ninth Circuit decided Smith’s counterclaim was noncore, but reversed the district court’s judgment in favor of Smith because the Texas court had entered judgment first. Smith appealed, and the Supreme Court granted certiorari to resolve the question of whether the bankruptcy court had authority to enter a final judgment on a counterclaim for tortious interference.

Majority and Dissent

Writing for a 5-4 majority, Chief Justice John Roberts affirmed the Ninth Circuit’s result, but disagreed that the bankruptcy court lacked jurisdiction to enter a final order because Smith’s counterclaim was noncore under §157(b). Framing the issue in terms of the separation of powers rather than jurisdiction, the court determined that, while “§157(b)(2)(C) permits the Bankruptcy Court to enter final judgment on [the] counterclaim, Article III of the Constitution does not.”1

The court rejected arguments that structural changes to bankruptcy courts following the Marathon decision resolved constitutional concerns by making bankruptcy courts adjuncts of district courts. It ruled the bankruptcy courts created under the 1984 Act

[could not] be dismissed as mere adjuncts of Article III courts, any more than could the bankruptcy courts under the 1978 Act. The judicial powers the courts exercise in cases such as this remain the same, and a court exercising such broad powers is no mere adjunct of anyone.2

The court then addressed the “public rights” exception first articulated in Murray’s Lessee v. Hoboken Land & Improvement,3 in which it held that Congress could authorize the adjudication of “public rights” by non-Article III judges in certain cases. It traced case law and reaffirmed that, excepting certain public rights, Congress cannot withdraw from adjudication by Article III judges any matter that traditionally would constitute a suit at common law, or in equity, or admiralty.4 Because Smith’s counterclaim involved a traditional common law tort claim involving private rather than public rights, Congress could not withdraw adjudication from Article III courts. Noting the case “involves the most prototypical exercise of judicial power[,] the entry of a final, binding judgment by a court with broad substantive jurisdiction, on a common law cause of action,” the court held the bankruptcy court lacked constitutional authority to enter final judgment.5

Finally, it rejected the argument that by filing a proof of claim, Pierce consented to the bankruptcy proceeding and thus the bankruptcy court could adjudicate the counterclaim. The court noted that the counterclaim had little to do with his proof of claim and that the bankruptcy court would necessarily have had to adjudicate issues unrelated to Pierce’s original defamation claim.

Writing in dissent, Justice Stephen Breyer argued the majority had placed too much weight on the Murray’s Lessee decision and the plurality decision in Northern Pipeline, and paid inadequate attention to the court’s decisions in Crowell6 and Schor,7 which recognized the constitutional propriety of non-Article III adjudication of certain matters. He argued the majority paid insufficient attention to the ramifications of its decision on the adjudication of bankruptcy cases, and that Stern will cause a “game of jurisdictional ping-pong” leading to “inefficiency, increased cost, delay, and needless additional suffering among those faced with bankruptcy.”8

‘Core’ Proceedings

In the year since Stern was decided, courts have grappled with how broadly to read the decision while also addressing practical issues arising in bankruptcy cases. Courts finding that Stern has a broad application focus on public/private rights analysis;9 courts with narrow interpretations focus on the conclusion of Roberts’ opinion: “[T]he question presented here is a ‘narrow’ one…[and] does not change all that much.”10 How a court reads Stern informs how it has resolved various disputes.

For example, courts remain divided on whether Stern limits a bankruptcy court’s ability to enter final orders concerning fraudulent conveyance and preference claims. Several courts, focusing on repeated statements in Stern that the holding is narrow, have determined that notwithstanding Stern, a bankruptcy court may enter a final order concerning fraudulent conveyances.11 Conversely, courts that find Stern limits bankruptcy courts’ power to enter final orders concerning conveyances stress the Supreme Court’s distinction between private and public rights and note the majority’s reliance on Granfinanciera v. Norberg.12

The Southern District of New York has been favoring the broader reading. On Jan. 30, 2012, Judge Paul Crotty found that Stern precluded the bankruptcy court from entering final judgment on fraudulent conveyance claims brought by the Adelphia Recovery Trust, but denied a motion to withdraw the reference to the bankruptcy court because the court could issue findings of fact and conclusions of law that could be reviewed de novo. On May 9, Judge Jed Rakoff found Stern precluded the bankruptcy court from entering a final judgment on fraudulent conveyance claims brought by the Refco Litigation Trust Trustee, but denied the motion to withdraw on the basis the bankruptcy court could issue a report and recommendation that the district court would review de novo.13

Although circuit courts of appeals have not yet weighed in, the Ninth Circuit will address the issue in Bellingham Ins. Agency and has requested additional briefing on whether Stern should be construed broadly or narrowly.14 The United States filed an amicus brief arguing against the narrow interpretation,15 stating that reading Stern and Granfinanciera together establishes that Article III

bars bankruptcy courts from entering final judgment in a fraudulent conveyance action brought against a noncreditor in the bankruptcy proceedings, absent the parties’ consent to bankruptcy court adjudication.16

Defendants in preference actions have argued that pursuant to Stern, bankruptcy courts lack authority to enter final orders in preference claims.17 As with fraudulent conveyances, courts struggle with bankruptcy courts’ authority to enter final orders concerning preference actions.18 Whether it is ultimately determined that bankruptcy courts may enter final orders concerning fraudulent transfers and preferences remains unclear. The Ninth Circuit’s decision in Bellingham may add clarity.

Counterclaim Resolution

The Supreme Court determined in Stern that bankruptcy courts lack “constitutional authority to enter final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s proof of claim.”19 Presumably, however, a bankruptcy court can enter a final order on a state law counterclaim that must necessarily be resolved to determine whether a proof of claim is valid. Such was the recent Middle District of Pennsylvania bankruptcy court holding in In re McElwee, that a defensive counterclaim to reduce what debtors owed a creditor is dissimilar from the Stern situation, where the “bankruptcy estate is seeking affirmative monetary relief from a claimant to augment the bankruptcy estate.”20 The McElwee court determined the proof of claim and

defensively interposed counterclaim in this case are inextricably intertwined both factually and legally. Resolution of the counterclaim is necessarily implicated in ruling on the allowability of [the proof of claim].21

Cases in Which Stern Is Implicated

How will cases triggering application of Stern be adjudicated? Attempting to deal with uncertainties it created, several courts have entered amended standing orders of reference. On Jan. 31, 2012, the Southern District of New York entered an amended reference order directing bankruptcy courts to enter proposed findings of fact and conclusions of law for any matter in which the court determines it would be inconsistent with Article III of the Constitution to enter a final order.22 Its reference order states that if a bankruptcy court did enter a final order that was later determined to be contrary to Article III, the district court would treat it as containing proposed findings of fact and conclusions of law.

Amended reference orders and denial of motions to withdraw the reference are clear attempts to keep matters traditionally adjudicated in bankruptcy court out of the district courts, or at least place the onus on bankruptcy courts initially. Whether these attempts minimize the impact of Stern remain unclear.

One issue raised in a motion to withdraw the reference in the Southern District of New York is whether it is appropriate for the district court to conduct a de novo review of a bankruptcy court’s proposed findings of fact and conclusions of law without the benefit of live testimony.23 The court suggested this argument might be valid but chose not to rule in the case’s early stages.24

Consent to Adjudication

Generally, courts held that if parties consent to bankruptcy court adjudication, the court may enter a final order.25 Considering Stern, questions emerge: Can consent be implied, and if a creditor files a proof of claim, has that party consented to have all issues determined by the bankruptcy court?

In Coudert Brothers, the U.S. District Court for the Southern District of New York determined a party could consent to the bankruptcy court entering final orders on matters implicated by Stern.26 It also determined a creditor filing proof of claim consented to have the bankruptcy court resolve matters necessary to adjudicate the proof.27 It determined, however, that merely filing a proof of claim did not mean a creditor had consented to the bankruptcy court entering final orders concerning unrelated issues.28

Conclusion

Stern has sparked significant debate about the constitutionality of bankruptcy courts to enter final orders on a wide range of matters. The ultimate resolution of these questions likely will be resolved in the circuit courts of appeals, if not the Supreme Court. In the meantime, whether the standing orders of reference provide comfort to bankruptcy courts and practitioners that Stern “does not change all that much,” or whether parties will engage in “games of jurisdictional ping-pong,” remains a subject of interest for courts and practitioners alike.

Barry Kazan is a partner in Thompson Hine’s litigation, business restructuring, and creditors rights and bankruptcy groups in New York. Jim Henderson is an associate in the business restructuring and creditors rights and bankruptcy group.

Endnotes:

1. Stern v. Marshall, 131 S. Ct. 2594, 2608 (2011).

2. Id. at 2611.

3. Id. (citing Murray’s Lessee v. Hoboken Land & Improvement, 18 How. 272 (1856)).

4. Id. at 2611-12.

5. Id. at 2615.

6. Id. (citing Crowell v. Benson, 285 U.S. 22, 52 S. Ct. 285, 76 L. Ed. 598 (1932)).

7. Id. (citing Commodity Futures Trading Comm’n v. Schor, 478 U.S. 833, 106 S. Ct. 3245, 92 L. Ed. 2d 675 (1986)).

8. Id. at 2629-30.

9. See, e.g., Weisfelner v. Blavatnik (In re Lyondell Chem.), No. 11 Civ. 8251, 2012 U.S. Dist. LEXIS 44329 *23-24 (S.D.N.Y. March 29, 2012).

10. Stern v. Marshall, 131 S. Ct. at 2620; see also Feuerbacher v. Moser, 4:11-CV-272, 2012 U.S. Dist. LEXIS 44396, *24 (E.D. Tex. March 29, 2012) (“Indeed the Stern decision is ‘replete with language emphasizing that the ruling should be limited to the unique circumstances of that case.’”) (quoting In re Salander O’Reilly Galleries, 453 B.R. 106, 115 (Bankr. S.D.N.Y. 2011)).

11. See Feuerbacher, 2012 U.S. Dist. LEXIS 44396, at *24-25; In re Arbogast, B.R., No. 10-2092, 2012 Bankr. LEXIS 374, 2012 WL 390214, (Bankr. W.D. Pa. Feb. 7, 2012); In re Direct Response Media, B.R, No. 10-10058, 2012 Bankr. LEXIS 41, 2012 WL 112503, (Bankr. D. Del. Jan. 12, 2012); In re Am. Bus. Fin. Servs., 457 B.R. 314, 319 (Bankr. D. Del. 2011).

12. Heller Ehrman v. Arnold & Porter (In re Heller Ehrman), 464 B.R. 348, 354 (N.D. Cal. 2011). (“By likening the claim in question explicitly to the fraudulent conveyance claims in Granfinanciera, this Court believes that Stern clearly implied that the bankruptcy court lacks constitutional authority to enter final judgment on the fraudulent conveyance claims presented here”); Development Specialists v. Orrick Herrington & Sutcliffe, No. 11 civ. 6337, 2011 U.S. Dist. LEXIS 148720 (S.D.N.Y. Dec. 23, 2011).

13. Kirschner v. Agoglia, 11 Civ. 8250 (JSR), 2012 U.S. Dist. LEXIS 65148 (S.D.N.Y. May 9, 2012).

14. Executive Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency), No. 11-35162 (9th Cir.).

15. Brief for the United States as Amicus Curiae, In re Bellingham Ins. Agency, No. 11-35162 (9th Cir. Jan. 19, 2012).

16. Id. at 13-14.

17. In American Housing Foundation, No. 09-20232, 2012 Bankr. LEXIS 449 at *26 n.1 (Bankr. N.D. Tex. Feb. 10, 2012).

18. Id. at *27.

19. Stern v. Marshall, 131 S. Ct. at 2620.

20. McElwee v. Scarff Brothers (In re McElwee), No 1-10-bk-02566, 2012 Bankr. LEXIS 1949 (Bankr. M.D. Penn. May 3, 2012), at *23.

21. Id. at *25.

22. Amended Standing Order of Reference, Case No. 12 Misc. 00032 (S.D.N.Y. Jan. 31, 2012).

23. Weisfelner v. Blavatnik (In re Lyondell Chem.), No. 11 Civ. 8251, 2012 U.S. Dist. LEXIS 44329 *33 (S.D.N.Y. March 29, 2012).

24. Id.

25. Retired Partners of Coudert Bros. Trust v. Baker & McKenzie (In re Coudert Bros.), No. 11-2785, 2011 U.S. Dist. LEXIS 154773, at *27 (S.D.N.Y. April 12, 2011); In re American Housing Foundation, 2012 Bankr. LEXIS 449 at *12.

26. Id. at 29-30.

27. Id. at 32-33.

28. Id. (filing a proof of claim “constitutes consent to final adjudication of the Trust members’ contractual rights against Coudert, and any other state law private rights necessarily determined therewith, it does not constitute consent to resolution of any other private rights”).