jurisdiction

The continuing saga of the impact of the U.S. Supreme Court’s Stern v. Marshall decision took a major turn Tuesday when the Court issued its ruling in the Wellness International Network, Limited v. Sharif case (follow link for copy of opinion). Before considering the decision and its significance, let’s first take a look at some past hits — bankruptcy court authority-style.

The Big Picture: The Stern v. Marshall Decision. In its 2011 summer blockbuster Stern v. Marshall, decided by a 5-4 vote, the U.S. Supreme Court held that even though Congress designated certain state law counterclaims as “core” proceedings, Article III of the U.S. Constitution prohibits bankruptcy courts from finally adjudicating those claims.  Like a good cliffhanger, Stern v. Marshall left a number of questions unanswered, including the following:

1. Can a bankruptcy court enter a final judgment on “Stern claims” with the parties’ consent?; and
2. Can a bankruptcy court treat a “core” Stern claim as “non-core” under 28 U.S.C. Section 157 and follow the statutory procedures for submitting proposed findings of fact and conclusions of law to the district court for de novo review, even though there appears to be a gap in the statute and it does not expressly provide for that approach?

A Limited Sequel: The Arkinson Decision. In a narrow 2014 decision in Executive Benefits Insurance Agency v. Arkinson, the Court answered only the second question, unanimously ruling that when hearing core Stern claims, bankruptcy courts can follow the non-core statutory procedure of submitting proposed findings of fact and conclusions of law to the district court for de novo review. However, the Court did not address the first question, leaving the issue of consent to live or die “another day.”

“Another Day” Finally Arrives: The Wellness Decision. With this week’s decision in Wellness, that other day arrived. In a 6-3 decision written by Justice Sotomayor, the Court held that parties to a Stern claim can constitutionally consent to having final judgment issued by a non-Article III bankruptcy judge. The Court further held, with the support of only five justices, that the requisite consent can be implied and need not be express as long as it’s “knowing and voluntary.”

The Wellness case involved an adversary proceeding by a creditor seeking declaratory relief on alter ego and other grounds, among other claims, that certain trust assets were property of the estate. In its decision, the Court apparently assumed without deciding that this presented a potential Stern claim.

In reaching its conclusion that “litigants may validly consent to adjudication by bankruptcy courts,” the Court relied heavily on the 1986 decision in Commodity Futures Trading Comm’n v. Schor, 478 U. S. 833 (1986), and two decisions involving federal magistrates, Gomez v. United States, 490 U. S. 858 (1989), and Peretz v. United States, 501 U. S. 923 (1991):

The lesson of Schor, Peretz, and the history that preceded them is plain: The entitlement to an Article III adjudicator is ‘a personal right’ and thus ordinarily ‘subject to waiver,’ Schor, 478 U. S., at 848. Article III also serves a structural purpose, ‘barring congressional attempts ‘to transfer jurisdiction [to non-Article III tribunals] for the purpose of emasculating’ constitutional courts and thereby prevent[ing] ‘the encroachment or aggrandizement of one branch at the expense of the other.” Id., at 850 (citations omitted). But allowing Article I adjudicators to decide claims submitted to them by consent does not offend the separation of powers so long as Article III courts retain supervisory authority over the process.

The question here, then, is whether allowing bankruptcy courts to decide Stern claims by consent would ‘impermissibly threate[n] the institutional integrity of the Judicial Branch.’ Schor, 478 U. S., at 851.

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[W]e conclude that allowing bankruptcy litigants to waive the right to Article III adjudication of Stern claims does not usurp the constitutional prerogatives of Article III courts. Bankruptcy judges, like magistrate judges, ‘are appointed and subject to removal by Article III judges,’ Peretz, 501 U. S., at 937; see 28 U. S. C. §§152(a)(1), (e). They ‘serve as judicial officers of the United States district court,’ §151, and collectively ‘constitute a unit of the district court’ for that district, §152(a)(1). Just as ‘[t]he ‘ultimate decision’ whether to invoke [a] magistrate [judge]’s assistance is made by the district court,’ Peretz, 501 U. S., at 937, bankruptcy courts hear matters solely on a district court’s reference, §157(a),which the district court may withdraw sua sponte or at the request of a party, §157(d). ‘[S]eparation of powers concerns are diminished’ when, as here, ‘the decision to invoke [a non-Article III] forum is left entirely to the parties and the power of the federal judiciary to take jurisdiction’ remains in place. Schor, 478 U. S., at 855.

Importantly, the Court distinguished and limited Stern:

Our recent decision in Stern, on which Sharif and the principal dissent rely heavily, does not compel a different result. That is because Stern—like its predecessor, Northern Pipeline—turned on the fact that the litigant “did not truly consent to” resolution of the claim against it in a non-Article III forum. 564 U. S., at ___ (slip op., at 27).

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Because Stern was premised on non-consent to adjudication by the Bankruptcy Court, the ‘constitutional bar’ it announced, see post, at 14 (ROBERTS, C. J., dissenting), simply does not govern the question whether litigants may validly consent to adjudication by a bankruptcy court.

An expansive reading of Stern, moreover, would be inconsistent with the opinion’s own description of its holding. The Court in Stern took pains to note that the question before it was ‘a ‘narrow’ one,’ and that its answer did ‘not change all that much’ about the division of labor between district courts and bankruptcy courts. Id., at ___ (slip op., at 37); see also id., at ___ (slip op., at 38) (stating that Congress had exceeded the limitations of Article III ‘in one isolated respect’). That could not have been a fair characterization of the decision if it meant that bankruptcy judges could no longer exercise their longstanding authority to resolve claims submitted to them by consent. Interpreting Stern to bar consensual adjudications by bankruptcy courts would ‘meaningfully chang[e] the division of labor’ in our judicial system, contra, id., at ___ (slip op., at 37).

Reacting to Chief Justice Roberts’s dissent predicting future encroachment by Congress on Article III courts, the Court responded with a memorable phrase:

To hear the principal dissent tell it, the world will end not in fire, or ice, but in a bankruptcy court.

(Some debtors and creditors might agree — great plot for a movie?)

On whether express consent is required, the Court stated:

Nothing in the Constitution requires that consent to adjudication by a bankruptcy court be express. Nor does the relevant statute, 28 U. S. C. §157, mandate express consent; it states only that a bankruptcy court must obtain“the consent”—consent simpliciter—“of all parties to the proceeding” before hearing and determining a non-core claim. §157(c)(2).

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It bears emphasizing, however, that a litigant’s consent—whether express or implied—must still be knowing and voluntary. Roell [v. Withrow, 538 U. S. 580 (2003)] makes clear that the key inquiry is whether ‘the litigant or counsel was made aware of the need for consent and the right to refuse it, and still voluntarily appeared to try the case’ before the non-Article III adjudicator.

The Critics. In a vigorous dissent, Chief Justice Roberts, the author of the Court’s Stern decision, accused the Wellness majority of “an imaginative reconstruction” of Stern:

As the majority sees it, Stern ‘turned on the fact that the litigant ‘did not truly consent to’ resolution of the claim’ against him in the Bankruptcy Court. Ante, at 15 (quoting 564 U. S., at___ (slip op., at 27)). That is not a proper reading of the decision. The constitutional analysis in Stern, spanning 22 pages, contained exactly one affirmative reference to the lack of consent. See ibid. That reference came amid a long list of factors distinguishing the proceeding in Stern from the proceedings in Schor and other ‘public rights’ cases. 564 U. S., at ___–___ (slip op., at 27–29). Stern’s subsequent sentences made clear that the notions of consent relied upon by the Court in Schor did not apply in bankruptcy because ‘creditors lack an alternative forum to the bankruptcy court in which to pursue their claims.’ 564 U. S., at ___ (slip op., at 28) (quoting Granfinanciera, 492 U. S., at 59, n. 14). Put simply, the litigant in Stern did not consent because he could not consent given the nature of bankruptcy.

There was an opinion in Stern that turned heavily on consent: the dissent. 564 U. S., at ___–___ (opinion of BREYER, J.) (slip op., at 12–14). The Stern majority responded to the dissent with a counterfactual: Even if consent were relevant to the analysis, that factor would not change the result because the litigant did not truly consent. Id., at ___–___ (slip op., at 28–29). Moreover, Stern held that ‘it does not matter who’ authorizes a bankruptcy judge to render final judgments on Stern claims, because the ‘constitutional bar remains.’ Id., at ___ (slip op., at 36). That holding is incompatible with the majority’s conclusion today that two litigants can authorize a bankruptcy judge to render final judgments on Stern claims, despite the constitutional bar that remains.

Chief Justice Roberts’s comment that it was the Stern dissent that relied heavily on consent highlights that two members of the Stern majority, Justices Kennedy and Alito, joined the four dissenting Justices in Stern to form the 6-3 majority in Wellness. Perhaps with practical considerations in mind, Justices Kennedy and Alito voted in Wellness to limit Stern’s constitutional bar to situations in which the parties do not consent to entry of a final judgment by the bankruptcy court.

Justice Thomas filed his own dissenting opinion, raising interesting questions he believed both the majority and Chief Justice Roberts overlooked. These included the nature of consent, separation of powers issues, and historical exceptions in which non-Article III adjudications have been permitted.

Bankruptcy Courts In A Leading Role. Together, Wellness and Arkinson mean that bankruptcy courts will continue to land a big part in hearing all types of bankruptcy matters, including Stern claims, despite the fears of some following the Stern decision.

• For a Stern claim, if the parties give “knowing and voluntary” consent, even if not express consent, the bankruptcy court will have constitutional authority to enter a final judgment. (As the Court noted in footnote 13 of the Wellness decision, if proposed revisions to Federal Rules of Bankruptcy Procedure 7008 and 7012 take effect, a statement giving or withholding express consent will be required by rule in adversary proceedings.)
• For a Stern claim, if the parties do not consent, the bankruptcy court will still be able to follow the non-core statutory procedure and submit proposed findings of fact and conclusions of law to the district court for de novo review.
• For core claims that are not Stern claims, as before, the bankruptcy court can enter a final judgment without consent of the parties.
• For non-core claims, as before, the bankruptcy court can enter final judgment if the parties consent and, if not, will submit proposed findings of fact and conclusions of law to the district court for de novo review.

Conclusion. In what will likely be a box office hit with bankruptcy attorneys, the Supreme Court in Wellness substantially limited the impact of the Stern v. Marshall decision, allowing bankruptcy courts to enter final judgments, even on Stern claims, with consent of the parties. Consent has to be knowing and voluntary, but as often happens with non-core claims, parties may well choose to buy a ticket and have the bankruptcy court enter final judgment on Stern claims. Had Wellness gone the other way, the already overloaded district courts could have been faced with many more de novo review proceedings. The prospect of such coming attractions has likely been averted with the Wellness opinion, written — perhaps not coincidentally — by the only former district court judge on the Supreme Court, Justice Sotomayor.

 

Image Courtesy of Flickr by David

 Image Courtesy of Mike M.S.

The Stern v. Marshall Decision. In its 2011 decision in Stern v. Marshall, decided by a 5-4 vote, the U.S. Supreme Court held that even though Congress designated certain state law counterclaims as “core” proceedings, Article III of the U.S. Constitution prohibits bankruptcy courts from finally adjudicating those claims. Stern v. Marshall left a number of questions unanswered, including the following:

1. Is a fraudulent conveyance claim under state law or the Bankruptcy Code a “Stern claim” for which a bankruptcy court is constitutionally prohibited from entering final judgment?;
2. Can a bankruptcy court enter a final judgment on “Stern claims” with the parties’ consent?; and
3. Can a bankruptcy court treat a “core” Stern claim as “non-core” under 28 U.S.C. Section 157 and follow the statutory procedures for submitting proposed findings of fact and conclusions of law to the district court for de novo review, even though there appears to be a gap in the statute and it does not expressly provide for that approach?

The Decision And Appeals Below. These issues were in play in cases around the country, including the Ninth Circuit’s decision in In re Bellingham, a case that involved a bankruptcy trustee’s fraudulent conveyance claims against Executive Benefits Insurance Agency (“EBIA”) and other defendants. The trustee ultimately filed a motion for summary judgment in the bankruptcy court, which granted judgment in favor the trustee, including on the fraudulent conveyance claims. EBIA appealed to the district court, which affirmed the bankruptcy court’s decision after a de novo review of the summary judgment ruling.

• EBIA appealed again to the Ninth Circuit and, after the Supreme Court’s Stern v. Marshall decision was issued, sought to dismiss its appeal, arguing that Article III did not permit the bankruptcy court to issue a final judgment on the fraudulent conveyance claims.
• The Ninth Circuit denied the motion, holding that although Article III did not permit a bankruptcy court to enter final judgment on a fraudulent conveyance claim against a noncreditor without consent of the parties, EBIA had impliedly consented to the bankruptcy court’s adjudication in the case.
• The Ninth Circuit also noted that the bankruptcy court’s judgment could be treated as its proposed findings of fact and conclusions of law under the “non-core” statutory scheme, subject to the de novo review given by the district court in the case.

When the Supreme Court granted review of the Ninth Circuit’s decision in Executive Benefits Insurance Agency v. Arkinson, many thought the Supreme Court’s decision would answer these questions. In fact, there was a palpable fear among bankruptcy professionals that the Supreme Court might hold consent of the parties to be insufficient to overcome Article III concerns, and further that the Supreme Court might limit bankruptcy court jurisdiction over fraudulent transfer claims and require their adjudication solely in the district court. Other commentators questioned whether a ruling could put the federal magistrate judges system at risk, since they too exercise jurisdiction to enter final judgments with the consent of the parties.

The Supreme Court’s Narrow Decision. However, in an unanimous 9-0 decision in Executive Benefits Insurance Agency v. Arkinson, issued on June 9, 2014 (follow link for copy of opinion), Justice Clarence Thomas, writing for the Supreme Court, reached the decision by addressing only the third question, the one involving statutory construction. In affirming the Ninth Circuit’s decision, the Supreme Court expressly “reserve[d] … for another day” a decision on the question of whether Article III permits a bankruptcy court to enter final judgment on a Stern claim with the consent of the parties. It also did not decide whether a fraudulent conveyance claim is actually a Stern claim, noting instead that because neither party contested that conclusion its opinion simply assumed, without deciding, that it was a Stern claim.

Here’s how the Supreme Court described its holding:

We hold today that when, under Stern’s reasoning, the Constitution does not permit a bankruptcy court to enter final judgment on a bankruptcy-related claim, the relevant statute nevertheless permits a bankruptcy court to issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court. Because the District Court in this case conducted the de novo review that petitioner demands, we affirm the judgment of the Court of Appeals upholding the District Court’s decision.

It restated that decision another way later in the opinion:

As we explain in greater detail below, when a bankruptcy court is presented with such a claim, the proper course is to issue proposed findings of fact and conclusions of law. The district court will then review the claim de novo and enter judgment. This approach accords with the bankruptcy statute and does not implicate the constitutional defect identified by Stern.

The reason the Supreme Court held its approach “accords with the bankruptcy statute,” and there is no “statutory gap” is because 28 U.S.C. Section 157 has a severability provision:

The plain text of this severability provision closes the so-called “gap” created by Stern claims. When a court identifies a claim as a Stern claim, it has necessarily “held invalid” the “application” of §157(b)—i.e., the “core” label and its attendant procedures—to the litigant’s claim. Note following §151. In that circumstance, the statute instructs that “the remainder of th[e] Act . . . is not affected thereby.” Ibid. That remainder includes §157(c), which governs non-core proceedings. With the “core” category no longer available for the Stern claim at issue, we look to §157(c)(1) to determine whether the claim may be adjudicated as a non-core claim—specifically, whether it is “not a core proceeding” but is “otherwise related to a case under title 11.” If the claim satisfies the criteria of §157(c)(1), the bankruptcy court simply treats the claims as non-core: The bankruptcy court should hear the proceeding and submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.

The Supreme Court also commented how it noted in Stern that its decision there had not meaningfully changed the division of labor between bankruptcy and district courts. Referring back to that point, the Supreme Court in Executive Benefits rejected EBIA’s argument that district courts are required to hear all Stern claims in the first instance, since such an approach would have dramatically altered the division of responsibility set by Congress.

The De Novo Review Solution. The Supreme Court did not have to reach the consent issue in this case because it concluded “that EBIA received the de novo review and entry of judgment to which it claims constitutional entitlement.” That happened when the district court on appeal reviewed de novo the bankruptcy court’s grant of summary judgment, and then the district court itself entered judgment for the trustee.

• The Supreme Court found that here appellate review alone provided sufficient de novo review to satisfy Article III because the bankruptcy court’s conclusions of law were reviewed de novo by the district court acting as an appellate court.
• A bankruptcy court decision to grant summary judgment on a Stern claim, at least if appealed and affirmed by a district court on appeal after a de novo review of the legal issues, should be constitutionally sufficient even without consent given Executive Benefits.  However, parties and bankruptcy courts may be uncomfortable relying on that narrow ruling given the uncertainty of a how a particular litigation may proceed.
• Importantly, the Supreme Court did not hold that appellate review alone is sufficient de novo review of Stern claims in all procedural settings.  Appellate courts typically review de novo only a bankruptcy court’s legal conclusions, not its findings of fact, which are entitled to greater deference on appeal. In contrast, the non-core procedure under 28 U.S.C. Section 157(c)(1), in which the bankruptcy court makes only proposed findings of fact and conclusions of law, requires the district court to engage in a full de novo review of both legal and factual issues.

Where Does This Leave The Consent Issue? By leaving for another day the consent question, and by assuming but not deciding whether fraudulent conveyance claims are Stern claims, the Supreme Court resolved the Executive Benefits case on the narrowest of grounds. As in Stern, the Supreme Court once again left bankruptcy courts and parties litigating these claims with important, unanswered questions.

• To address the consent issue, after Stern a number of bankruptcy courts adopted local rules and procedures to require parties either to make an affirmative decision indicating whether they consented to the bankruptcy court entering final judgment or implying such consent from the lack of a timely objection.
• Although the Supreme Court did not reach the consent issue in Executive Benefits, the decision may persuade bankruptcy courts to reconsider the focus on consent.
• The Supreme Court’s clear holding that there is no “statutory gap,” and its statement that bankruptcy courts “should” use the non-core procedure for Stern claims, may well lead bankruptcy courts to issue proposed findings of fact and conclusions of law on all Stern claims for de novo review by district courts.
• Although the report and recommendation approach adds another layer of delay and cost for parties, and places an additional burden on already overcrowded district courts, the Supreme Court has now gone on record calling this the “proper course” for Stern claims, while technically reserving the consent issue.
• Given this jurisprudence, more bankruptcy courts may conclude that the non-core approach is preferable to continuing down the unsettled consent path for Stern claims, although others may still test whether consent is sufficient.

Conclusion. Despite the fears of some, the Supreme Court’s decision did not take away the ability of bankruptcy courts to hear Stern claims in the first instance, reaffirming that they continue to have a role in the adjudication of these claims. While it remains to be seen how bankruptcy courts and parties will react, the Executive Benefits decision may increase the number of bankruptcy courts opting to issue reports and recommendations for de novo review by district courts, and fewer may continue to attempt to enter final judgments with consent of the parties. That said, the consent issue may yet have its day at the Supreme Court as other cases move through the bankruptcy system, so stay tuned.