In 2011, the U.S. Supreme Court issued Stern v. Marshall, 564 U.S. ___ (2011), which declared unconstitutional the statutory authorization permitting bankruptcy courts to finally adjudicate state law counterclaims not otherwise resolved in the claims allowance process. Although Stern is relatively old news, a recent decision clarifying and arguably broadening its holdings is not. In Carr v. Loeser (In re International Auction and Appraisal Services LLC), Ch. 7 No. 1-11-bk-00813, Adv. No. 1-13-ap-00018, 2013 Bank. LEXIS 2306, at *7 (Bankr. M.D. Pa. June 4, 2013), the U.S. Bankruptcy Court for the Middle District of Pennsylvania held that it lacked jurisdiction to issue a final judgment in any fraudulent transfer action where the defendant has not consented to jurisdiction, unless resolution of the claim is otherwise part of the claims allowance process.

In Loeser, the Chapter 7 trustee filed an adversary proceeding seeking to recover, among other claims, certain alleged fraudulent transfers pursuant to Section 548 of the Bankruptcy Code and Pennsylvania's Uniform Fraudulent Transfer Act, 12 Pa. Cons. Stat. § 5104 (applicable by way of 11 U.S.C. § 544(b)). The defendants filed a motion to dismiss, arguing that pursuant to Stern, the bankruptcy court lacked the "constitutional authority to enter a final judgment in a fraudulent transfer action without their consent." The trustee argued in response that the bankruptcy court "clearly" has jurisdiction over "core bankruptcy matters such as fraudulent transfer actions" and that the defendants' "interpretation of Stern [was] too broad."

U.S. Bankruptcy Chief Judge Mary France of the Middle District of Pennsylvania began her analysis by acknowledging the court's "clear statutory authority" to enter a final judgment under the circumstances. As set forth in 28 U.S.C. § 157(b)(2)(H), "fraudulent conveyance actions are specifically denoted as 'core' proceedings arising under the Bankruptcy Code and subject to final determination by the bankruptcy court." (See § 157(b)(1) and (2) ("Bankruptcy judges may hear and determine all cases under Title 11 … and may enter appropriate orders and judgments. … (2) Core proceedings include … (H) proceedings to determine, avoid, or recover fraudulent conveyances.").)

Nevertheless, the court, in accord with Stern, found that "although these types of claims are designated as 'core,' and the bankruptcy court is authorized by statute to decide core matters, this power exceeds constitutional limits placed on an Article I judge." Thus, without consent to the entry of judgment, a bankruptcy court cannot adjudicate a fraudulent transfer claim unless (1) "resolution of the claim against the defendant is part of the claim allowance process" or (2) "the claim against the defendant falls within the public rights exception." Since the defendants did not consent to the entry of judgment, nor was the adversary proceeding "part of the claims allowance process," the court was left to determine whether or not the adversary proceeding fell within the "public rights exception."

The public rights exception "permits an Article I court [such as the bankruptcy court] to enter final orders in cases that otherwise must be determined by an Article III court." However, as noted in Loeser, judicial interpretation of the public rights exception has "varied." At its core, it involves the distinction between "public" and "private" rights. The Stern court relied heavily on its prior decision in Granfinanciera S.A. v. Nordberg, 492 U.S. 33 (1989), which explained the distinction as follows: "If a statutory right is not closely intertwined with a federal regulatory program Congress has power to enact, and if that right neither belongs to nor exists against the federal government, then it must be adjudicated by an Article III court." The Granfinanciera court also recognized that fraudulent transfer actions are "quintessentially suits at common law that more nearly resemble state-law contract claims brought by a debtor to augment the bankruptcy estate than they do creditors' hierarchically ordered claims to a pro rata share of the bankruptcy res." The Loeser court also emphasized the U.S. Court of Appeals for the Ninth Circuit's decision in Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency), 702 F.3d 553, 561 (9th Cir. 2012), which interpreted Stern's reliance upon Granfinanciera to require a finding that "fraudulent transfer actions may not be decided by an Article I court."

In Loeser, France therefore concluded that the "right to recover fraudulent transfers is a private, not public right." Accordingly, while inserting a caveat that circumstances may vary, the court held that "a bankruptcy court may not decide a fraudulent transfer action" under the circumstances presented. Interestingly, however, this jurisdictional issue remains open in the Third Circuit. The court within the opinion acknowledges that its ruling represents a clear departure from other lower court post-Stern decisions — including a recent opinion from the Loeser court itself. (See, e.g., Black, Davis and Shue Agency v. Frontier Insurance Co. in Rehabilitation(In re Black, Davis and Shue Agency), 471 B.R. 381, 401 (Bankr. M.D. Pa. 2012) (France, C.B.J.); Zazzali v. 1031 Exchange Group (In re DBSI), 467 B.R. 767, 772 (Bankr. D. Del. 2012); Bohm v. Titus (In re Titus), 467 B.R. 592, 633 (Bankr. W.D. Pa. 2012).)

Having determined that it lacked constitutional authority to enter a final judgment, France next considered whether proposed findings of fact and conclusions of law could be issued. Turning to statutory authority, the court, not surprisingly, determined that it could "hear a matter and 'submit proposed findings of fact and conclusions of law to the district court' in a non-core proceeding." (See § 157(c)(1) and Fed. R. Bankr. P. 9033.) Quoting the Ninth Circuit's recent Bellingham decision, the court found that "'the power to "hear and determine" a proceeding surely encompasses the power to hear the proceeding and submit proposed findings of facts and conclusions of law.'" Noting that it was joining "most" federal courts to have addressed the issue, the court concluded that it "may hear the trustee's amended complaint and issue findings of fact and conclusions of law." As a result, the court denied the defendants' motion in its entirety.

A fraudulent conveyance action is a powerful tool often used to recover significant assets in a bankruptcy proceeding for distribution to creditors. Restrictions on a bankruptcy court's ability to hear and finally resolve these types of claims are likely to slow the final resolution of cases and increase the costs of winding up estates. Moreover, it will introduce an additional layer of procedural gamesmanship to the overall process. Inasmuch as the ultimate power of the bankruptcy judge to finally determine these types of actions appears to remain a somewhat open question in the Third Circuit and elsewhere, maybe the answer is for Congress to simply appoint bankruptcy judges as Article III judges and end the procedural and jurisdictional morass.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice in national bankruptcy and reorganization matters. He routinely lectures to various creditor groups concerning general bankruptcy issues, including preferences, reclamation, the role of creditors committees and related issues.

Erik L. Coccia is an associate in the firm's Philadelphia office and concentrates his practice in national bankruptcy and reorganization matters.