Supreme Court Upholds Bankruptcy Court’s Limited Procedural Power

The United States Supreme Court, on June 9, 2014, unanimously held that certain “core” proceedings (e.g., fraudulent transfer suits ) could still be litigated in the bankruptcy court, but only if that court’s proposed fact findings and legal conclusions are subject to de novo review by the district court. Executive Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency), 2014 WL 2560461 (U.S. Sup. Court, June 9, 2014). Affirming the Ninth Circuit’s fraudulent transfer judgment against the insider defendant “in light of the procedural posture of this case,” id. at *9, the Supreme Court avoided deciding whether a defendant could consent to bankruptcy jurisdiction, an issue that had caused a split among the circuits. See, e.g., In re Bellingham Ins. Agency, Inc., 702 F.3d 553 (9th Cir. 2012) (holding that bankruptcy judge could decide fraudulent transfer claim when parties consent); Waldman v. Stone, 698 F.3d 910, 921 (6th Cir. 2012) (holding that bankruptcy court could not enter final judgment on state law fraud suit by debtor even when defendant had consented); In re Frazin, 732 F.3d 313 (5th Cir. 2013) (same); In re BP RE LP, 735 F.3d 279 (5th Cir. 2013) (same).

The Supreme Court essentially accepted the Ninth Circuit’s alternative holding in Bellingham “that the Bankruptcy Court’s state law fraudulent transfer judgment could . . . be treated as proposed findings of fact and conclusions of law, subject to de novo review by the District Court.” 2014 WL 2560461, at *4, citing 702 F.3d at 565-66. As the Court explained, the “procedural posture” of Bellingham mooted the jurisdiction issue:

"At bottom, [the defendant] argues that it was entitled to have an Article III court review de novo and enter judgment on the fraudulent [transfer] claims asserted by the trustee. In effect, [the defendant] received exactly that. The District Court conducted de novo review of the [bankruptcy court’s] summary judgment [ruling], concluding in a written opinion that there were no disputed issues of material fact and that the trustee was entitled to judgment as a matter of law. In accordance with its statutory authority over matters related to the bankruptcy, see [28 U.S.C.] §1334(b), the District Court then separately entered judgment in favor of the trustee. [The defendant] thus received the same review from the District Court that it would have received if the Bankruptcy Court had treated the fraudulent [transfer] claims as non-core proceedings under [28 U.S.C.] § 157(c)(1). In short, . . . the District Court’s de novo review and entry of its own valid final judgment cured any error [by the Bankruptcy Court]."

Id. at *7-8.

Facts

The defendant in Bellingham had never filed a claim in the bankruptcy court, but the corporate debtor’s Chapter 7 trustee had sued it for having received a fraudulent transfer under applicable state law. “[T]he complaint alleged that [the debtor’s insiders] used various methods to fraudulently convey [the debtor’s] assets to [another affiliate].” Id. at *3. The trustee moved for summary judgment against the affiliate in the bankruptcy court, which granted summary judgment for the trustee on all claims. Id. The affiliate then appealed to the district court, which conducted a de novo review, affirmed the bankruptcy court’s decision and entered judgment for the plaintiff trustee. Id.

The defendant further appealed to the Ninth Circuit. After the defendant filed its opening brief, the Supreme Court handed down its decision in Stern v. Marshall, 131 S. Ct. 2594, 2620 (2011) (holding that non-Article III bankruptcy courts “lack . . . constitutional authority to enter final judgment on a state law . . . claim [by the estate] that is not resolved in . . . [the] process of ruling on . . .] [the] creditor’s claim”). Thus, “Article III of the Constitution did not permit a bankruptcy court to enter a final judgment on a counterclaim for tortious interference.” 2014 WL 2560461, at *4.

The defendant in Bellingham moved to dismiss its appeal in the Ninth Circuit, relying on Stern, arguing that Article III did not give Congress the right “to vest authority in a bankruptcy court to finally decide the trustee’s [state law fraudulent transfer] claims.” Id. The Ninth Circuit relied on the defendant’s implied consent to the bankruptcy court’s jurisdiction, however, reasoning that it had failed to raise the issue in the lower courts. Bellingham at *4, citing 702 F.3d at 566, 568. Alternatively, the Ninth Circuit held that the bankruptcy court’s judgment “could instead be treated as proposed findings of fact and conclusions of law,” which had actually been reviewed, de novo, by the district court. Id., citing 702 F.3d at 565-66. Other circuits (the Fifth and Sixth, as noted above) disagreed with the Ninth Circuit on the consent issue, causing the split that the Supreme Court granted certiorari to address. Unfortunately for scholars, the Court found a neat way to avoid the difficult jurisdictional consent issue with a fact-intensive holding based on the district court’s de novo review of the bankruptcy court’s ruling.

Fraudulent Transfer Litigation to Be Deemed Non-Core

Congress provided in 28 U.S.C. § 157(b)(2)(H) that fraudulent transfer proceedings were “core,” enabling the bankruptcy judge to “hear and determine” these claims and “enter appropriate orders and judgments” under 28 U.S.C § 157 (b)(1). Courts have construed Stern, however, to apply to fraudulent transfer litigation in the bankruptcy court, creating constitutional issues. See, e.g., In re Lyondell Chemical Co., 467 B.R. 712 (S.D.N.Y. 2012) (bankruptcy court cannot, after Stern, enter final judgment on fraudulent transfer claim); In re Adelphia Commc’n Corp., 2012 WL 264180 (S.D.N.Y. 2012) (same); In re Heller Ehrman LLP, 464 B.R. 348 (N.D. Cal. 2011) (same). Indeed, the Supreme Court acknowledged that the fraudulent transfer claims in Bellingham were “not . . . core” because, after Stern, “Article III [of the Constitution] does not permit these claims to be treated as ‘core.’” 2014 WL 2560461, at *8. Nevertheless, because these claims were “related to” the bankruptcy case, the bankruptcy court had jurisdiction under 28 U.S.C. § 1334(b) (“civil proceedings related to cases under title 11”) to hear this matter but not enter a judgment “as [it would] in a typical core proceeding.” Id. at *7. Thus, despite the statutory “core” label, for fraudulent transfer suits, the bankruptcy judge should only propose fact findings and conclusions of law for the district court’s de novo review.

No Statutory Gap

The Stern decision never decided “how bankruptcy or district courts should proceed when a ‘Stern claim’ is identified.” Id. at *3. Following Bellingham, according to the Supreme Court, “when, under Stern’s reasoning, the Constitution does not permit a bankruptcy court to enter final judgment on a bankruptcy-related claim,” the Judiciary Code (Title 28) still “permits a bankruptcy court to issue proposed findings” of fact and law “to be reviewed by the district court.” Id.

The Court thus rejected the Ninth Circuit’s view in Bellingham (702 F.3d at 565) and elsewhere that Stern claims had created “a statutory ‘gap.’” Id. at *7. See, e.g., In re Ortiz, 665 F.3d 906, 915 (7th Cir. 2011) (“bankruptcy courts cannot order proposed findings of fact and conclusions of law in any” core proceeding). It found “a severability provision” in 28 U.S.C. § 151 “that accounts for decisions, like Stern, that invalidate certain applications of the statute.” Id., citing 98 Stat. 344, note following 28 U.S.C. § 151. Thus, if “the claim satisfies the criteria of [28 U.S.C.] § 157(c)(1) [‘related to’ the bankruptcy case], the bankruptcy court simply treats the claims as non-core” (i.e., “hear[s] the proceeding and submit[s] proposed findings . . . to the district court for de novo review and entry of judgment”). Id.

Comments

Bellingham merely ratifies what many courts had already been doing in the wake of Stern over the past three years. By order dated Jan. 30, 2012, the Southern District of New York amended its standing “order of reference” of cases to bankruptcy judges as follows: “If a bankruptcy judge or district judge determines that entry of a final order or judgment by a bankruptcy judge would not be consistent with Article III of the United States Constitution in a particular proceeding . . . and [it is] determined to be a core matter; the bankruptcy judge shall, unless otherwise ordered by the district court, hear the proceeding and submit proposed findings of fact and conclusions of law to the district court.” Delaware has a similar order.

Bellingham will enable savvy courts and practitioners in all future cases to avoid the jurisdiction-by-consent issue. A trustee may bring a fraudulent transfer claim in the bankruptcy court, but any party to the suit or the court itself can always insist on de novo review by the district court. In short, the Supreme Court not only avoided a thorny jurisdictional issue in Bellingham but also blessed a procedure for other cases.

Authored by Michael L. Cook.

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