United States: US Supreme Court Rules That Bankruptcy Courts Can Issue Proposed Findings In "Core" Matters Involving Stern v. Marshall-Type Claims

On June 9, 2014, the US Supreme Court issued a unanimous decision in Executive Benefits Insurance Agency v. Arkison ("Executive Benefits")¹ that resolved a fundamental bankruptcy procedural issue that had arisen in the wake of Stern v. Marshall ("Stern").²

In Stern, the debtor filed in the bankruptcy court a common-law counterclaim for tortious interference against a creditor of the estate that was independent in nature from the claim asserted by the creditor in his proof of claim against the estate. The counterclaim constituted a "core" proceeding under the pertinent Judicial Code statutory provision, which also authorized the bankruptcy courts to adjudicate such a core proceeding to a final judgment. In Stern, the Supreme Court ultimately held that Congress had violated Article III of the Constitution by vesting the power to adjudicate the tortious interference counterclaim in a bankruptcy court. Subsequent courts, including several federal appellate courts, have held that fraudulent transfer claims, which are expressly "core" claims under the pertinent jurisdictional statutory provision, also are Stern claims and that, accordingly, bankruptcy courts cannot constitutionally enter a final judgment in fraudulent transfer actions.

In the aftermath of Stern, there has been uncertainty as to the extent to which, if at all, bankruptcy courts can hear (and take any action with respect to) Stern claims. Specifically, the pertinent jurisdictional statute permits bankruptcy courts to propose findings of facts and conclusions of law in "non-core" matters for subsequent de novo review by an Article III court. However, the statute does not expressly provide a similar avenue for Stern claims—claims that are expressly described as "core" in the jurisdictional statute, but which, under Stern, cannot now be finally determined as a constitutional matter by a bankruptcy court. In light of Stern, and this "gap" in the jurisdictional statute, what action, if any, could a bankruptcy court take in actions involving Stern claims?

With respect to newly filed fraudulent transfer actions, for example, did Stern require the actions to be entirely litigated in the first instance before the district court? And with respect to fraudulent transfer actions that already had been litigated entirely before a bankruptcy court, did Stern result in there being no available procedure other than for the district court to restart the proceedings from scratch, including all discovery that may have been concluded before the bankruptcy court? Could the parties avoid this procedural uncertainty with respect to Stern claims by consenting to jurisdiction in the bankruptcy court for it to enter a final judgment in their action?

Since Stern, courts have addressed these questions in conflicting ways. For example, in Wellness International Network, Ltd. v. Sharif,³ the Seventh Circuit required a fraudulent transfer case where a bankruptcy court had actually purported to enter a judgment to be restarted in its entirety before the district court, including as to discovery. In Waldman v. Stone,⁴ the Sixth Circuit held that the parties could not effectively consent on any basis to jurisdiction in the bankruptcy court to enter a final judgment with respect to a Stern claim.

In contrast to these two appellate decisions, in Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.),⁵ the Ninth Circuit held that the parties could impliedly consent to jurisdiction in the bankruptcy court such that a bankruptcy court could enter a final judgment on a Stern claim, and, alternatively, that a bankruptcy court may issue proposed findings of fact and conclusions of law on Stern claims, subject to a district court's de novo review. In Executive Benefits, the Supreme Court granted certiorari with respect to the Ninth Circuit's decision, but did not reach the consent to jurisdiction issue, instead holding that Stern claims may proceed as non-core claims within the meaning of § 157(c) of the Judicial Code—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."⁶

For a summary of the Court's reasoning in Executive Benefits, please see our June 9, 2014 Supreme Court Decision Alert.

From a bankruptcy practitioner's perspective, the important take-aways from Executive Benefits include:

• It effectively overrules lower court decisions suggesting, if not holding, that bankruptcy courts do not have the power to conduct any type of proceedings, including as to discovery matters, on Stern claims.⁷
• Although bankruptcy courts cannot completely revert to pre-Stern practice, actions alleging Stern claims should be able to be commenced in the pertinent bankruptcy court and, barring a successful motion to withdraw the reference under 28 U.S.C. § 157(d), be able to then proceed through trial and proposed findings of fact and conclusions of law by the presiding bankruptcy judge, which will then be subject to de novo review by the district court.
• The Supreme Court's decision arguably validates the local procedures of the Southern District of New York and the District of Delaware, which extend rules otherwise applicable to non-core claims to Stern claims, see, e.g., Bankr. S.D.N.Y. Local Rule 9033-1, although the decision arguably makes it clear that no such local rules are necessary in order for a bankruptcy court to be empowered to conduct proceedings and issue proposed findings of fact and conclusions of law on Stern claims.

However, several issues of particular interest to the bankruptcy bar remain unresolved after the Supreme Court's decision. For example, the Court did not conclude that the fraudulent transfer claims in Executive Benefits—i.e., fraudulent conveyance claims under § 544 of the Bankruptcy Code and under Washington state law—actually qualify as Stern claims, which the Ninth Circuit had so held. The question was not at issue before the Court, and the Court assumed without deciding that such claims were Stern claims.

The Court also did not reach the questions of whether Article III permits the exercise of the judicial power of the United States by bankruptcy courts on the basis of litigant consent, and, if so, whether "implied consent" based on a litigant's conduct, where the statutory scheme provides the litigant no notice that its consent is required, is sufficient to satisfy Article III.⁸ As noted, affirmative answers to these questions comprised the Ninth Circuit's primary holding in the proceedings below.⁹ While the Sixth Circuit, on the other hand, had concluded that a defendant could not effectively (or expressly) waive the requirement that only an Article III judge may, consistent with the Constitution, enter a final order with respect to certain claims.¹⁰Indeed, it was this circuit split that arguably led to the granting of certiorari in this case.

However, in Executive Benefits, the Court ultimately did not reach this consent issue because it was able to conclude that the petitioner ultimately received de novo review by the district court (and thus the consideration by an Article III court mandated by the Constitution). Based on the Supreme Court's disposition of the case, it would appear that another circuit will have to hold that the parties can consent, impliedly or expressly, to bankruptcy court jurisdiction on Stern claims before a circuit split can again be said to exist on the issue.

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¹ 573 U.S. ___.
² 564 U.S. ___ (2011).
³ 727 F.3d 751 (7th Cir. 2013).
⁴ 698 F.3d 910 (6th Cir. 2012).
⁵ 702 F.3d 553 (9th Cir. 2012).
⁶ Slip Op at 1.
⁷ See, e.g., Wellness Int'l Network, Ltd. v. Sharif, 727 F.3d 751, 776–77 (7th Cir. 2013) (noting that, when presented with a Stern claim, "the only statutorily authorized remedy would be for the district court to withdraw the reference ... and then set a new discovery schedule").
⁸ Slip Op. at 4 n.4.
⁹ See In re Bellingham Ins. Agency, Inc., 702 F.3d at 566–70.
¹⁰ See Waldman v. Stone, 698 F.3d at 918 (finding the defendant's waiver ineffective because it "implicates not only his personal rights, but also the structural principle advanced by Article III").

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