United States Supreme Court clarifies procedure in "core" bankruptcy matters that are outside the jurisdiction of bankruptcy courts

On June 9, 2014, the United States Supreme Court issued a unanimous opinion clarifying the procedure to be followed in a "Stern"case, a case involving a matter which Congress classified as within a Bankruptcy Court's "Core" jurisdiction, but which the Constitution does not permit to be decided by a non-Article III judge. The Court held the appropriate procedure in such a case is for the Bankruptcy Court to submit proposed findings of fact and conclusions of law, for the District Court to consider de novo and render judgment. Executive Benefits Insurance Agency v. Arkison, Chapter 7 Trustee of Estate of Bellingham Insurance Agency, Inc., 2014 WL 2560461 (Case No. 12-1200, June 09, 2014).

The recent decision comes three years after Stern v. Marshall, 564 U.S. ___, 131 S.Ct. 2594 (2011), involving a dispute between Vickie Marshall (known as Anna Nicole Smith) and the estate of her late husband. Stern held that Congress' attempt to provide bankruptcy courts with jurisdiction over a tortious interference counterclaim asserted by a debtor in bankruptcy against a creditor's proof of claim violated the Constitution's separation of powers. Although Congress classified such counterclaims as "Core" proceedings which bankruptcy court judges could hear and determine, the Supreme Court had held that Article III does not permit such claims to be finally determined by a judge who does not have the tenure and salary protections of an Article III judge, and that Congress' attempt to withdraw matters of private right from determination by Article III judges was an impermissible encroachment on the Constitution's separation of powers.

The ruling that some core proceedings could not constitutionally be finally determined by bankruptcy court judges was perceived as creating a procedural gap, because bankruptcy judges were not explicitly authorized to propose findings of fact and conclusions of law in a core proceeding, but only in non-core matters, under 28 U.S.C. § 157(c).  

The decision in Executive Benefits addresses how courts should proceed when presented with a Stern claim, and rules that the procedures applicable to non-core matters under 28 U.S.C. § 157(c) apply to fraudulent transfer claims, assuming without deciding that such claims are  Stern claims that Article III does not permit to be finally determined by bankruptcy judges.

In Executive Benefits, the Debtor, Bellingham Insurance Agency, Inc. (BIA) was owned by Nicolas Paleveda. BIA became insolvent in early 2006 and ceased operation on January 31, 2006. The next day, Paleveda used Bellingham funds to incorporate Executive Benefits Insurance Agency, Inc. (EBIA) and by the end of the year Paleveda caused BIA's assets to be transferred to EBIA. On June 1, 2006, BIA filed a voluntary Chapter 7 bankruptcy. The Chapter 7 trustee filed a complaint against EBIA to recover the BIA assets transferred to EBIA, alleging claims of fraudulent conveyance under 11 U.S.C. § 544 and under state law. The Bankruptcy Court granted summary judgment in favor of the trustee on all claims. EBIA appealed to the District Court, which conducted de novo review and affirmed, entering judgment for the trustee.

EBIA appealed to the Ninth Circuit Court of Appeals, and after filing its opening brief, the Stern case was decided. In light of Stern'sruling that Article III of the Constitution did not permit a Bankruptcy Court to enter final judgment on a tortious interference counterclaim though statute authorized final adjudication of the claim by the Bankruptcy Court, EBIA moved to dismiss its appeal for lack of jurisdiction. The Ninth Circuit denied EBIA's motion and affirmed the District Court. In re Bellingham Ins. Agency, Inc., 702 F.3d 553 (2012). The Ninth Circuit concluded that Article III does not permit a bankruptcy court to enter final judgment on a fraudulent conveyance claim against a noncreditor unless the parties consent, but the Bankruptcy Court's adjudication of the claim was permissible because EBIA had impliedly consented to the Bankruptcy Court's adjudication of the claim. The Ninth Circuit also observed that the Bankruptcy Court's judgment could be treated as proposed findings of fact and conclusions of law subject to de novo review by the District Court. 702 F.3d at 565-566.

On certiorari, the Supreme Court held that when a bankruptcy court is presented with a Stern claim, the proper course is to issue proposed findings of fact and conclusions of law, which the district court will then review de novo and enter judgment. Executive Benefits, slip op. 4. The Court determined that the case did not require addressing whether EBIA in fact consented to the Bankruptcy Court's adjudication of the claim and whether Article III permits a bankruptcy court to enter final judgment on a Stern claim with consent of the parties, but the Court explicitly "reserve[d] that question for another day." Id., slip op. 4, note 4. 

The Court reviewed the historical distinction between summary jurisdiction of bankruptcy courts and plenary jurisdiction belonging to a district court or appropriate state court prior to adoption of the Bankruptcy Code in 1978, and its determination in Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982) that the 1978 Act could not constitutionally vest bankruptcy judges with jurisdiction to decide a state law contract claim against an entity not otherwise a party. Northern Pipeline distinguished cases involving public rights, which may be removed from the jurisdiction of Article III courts and cases involving private rights, which may not. In the wake of the Northern Pipeline decision, Congress amended the jurisdictional statutes in 1984. The amendments provided for district courts to have original and exclusive jurisdiction of all cases under title 11, and may refer to bankruptcy judges any proceedings arising under, arising in or related to a case under title 11. The 1984 amendments divided matters into core and non-core proceedings. A nonexclusive list of sixteen categories of "core" proceedings includes counterclaims by the estate against persons filing claims against the estate, and proceedings to determine, avoid or recover fraudulent conveyances. § 157(b)(2)(C), (H). The statutes authorize bankruptcy judges to hear and determine such claims and to enter appropriate orders and judgments on them, § 157(b)(1), with appeal to the district court. The statutes provide that in non-core proceedings that are "related to a case under title 11" the bankruptcy court may hear the proceeding and "submit proposed findings of fact and conclusions of law to the district court," § 157(c)(1), which the district court must review de novo and enter final orders or judgments. The statute provides an exception that permits the bankruptcy judge to hear and determine and enter orders and judgments if all parties consent.  § 157(c)(2). 

In Stern, the Court held that by designating a common law counterclaim against a creditor as a core proceeding and authorizing the bankruptcy court to adjudicate such claim to final judgment, Congress had improperly vested the Bankruptcy Court with judicial power which Congress could not, consistent with Article III of the Constitution, confer on the Bankruptcy Court. Executive Benefits, slip op. 8. In Executive Benefits, the Court addressed how the bankruptcy court should proceed when presented with a claim labeled as "core" by Congress, but which may not be adjudicated by a bankruptcy court.

The Court in Executive Benefits disagreed with the view of lower courts and of the Ninth Circuit that Stern claims result in a statutory procedural gap, because § 157(b) does not expressly authorize a bankruptcy court to submit proposed findings and conclusions in a core proceeding, such that the district court is required to hear all Stern claims in the first instance. The Court concluded the statute permits Stern claims to be treated under the non-core procedure of § 157(c), in light of the severability clause in 98 Stat. 344, note following 28 U.S.C. § 151. The Court held that the severability clause closes the so-called "gap." When a Stern claim is identified, the core label and its procedures are invalid, and the provisions of § 157(c) become applicable. The claim is treated as non-core, and "[t]he 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." Executive Benefits, slip op. 10. Treating the invalid portion of the statute as severable and giving effect to the remainder is appropriate because it is not evident that Congress would have preferred no statute at all, and it is consistent with the statement in Stern that removal of claims from core bankruptcy jurisdiction does not "meaningfully change the division of labor in the current statute." Executive Benefits, slip op. 10; Stern, slip op. 37.

The Court noted that the Court of Appeals held and "we assume without deciding" that the fraudulent conveyance claims presented are Stern claims.  Syl., 2; slip op., 11. For purposes of the opinion, the Court stated the application of the "core" label and procedures had been held invalid, and the claims were encompassed by the "related to" provisions of § 157(c)(1). The Court observed that the Ninth Circuit held and "no party disputes" that the claims were not permitted to be treated as core under Article III. The Court stated that fraudulent conveyance claims, asserting that property that should have been part of the bankruptcy estate available for distribution to creditors was improperly removed, are "self-evidently 'related to a case under title 11' under any plausible construction of the statutory text," again emphasizing that "no party contends otherwise." The Court held the Bankruptcy Court was therefore permitted to submit proposed findings and conclusions under § 157(c)(1).

Although this procedure was not followed in Executive Benefits, the Supreme Court affirmed nonetheless. The Supreme Court explained that the District Court did not relabel the bankruptcy order as proposed findings and conclusions because EBIA did not argue the Bankruptcy Court lacked authority, but the District Court did review the Bankruptcy Court's grant of summary judgment de novo and separately entered judgment. EBIA argued it was constitutionally entitled to District Court review of the fraudulent transfer claims. The Supreme Court found it unnecessary to decide whether EBIA had consented to the Bankruptcy Court determining the matter or whether such consent is permissible, because EBIA "received exactly" what it claimed it was entitled to receive: an Article III court reviewing de novo the fraudulent transfer claims. The Supreme Court held the District Court's de novo review and entry of its own order "cured any error."  Slip op. 12-13.

Don Scott practices in McDowell Rice's Bankruptcy, Workouts & Financial Restructuring group.