The Stern Files (fourth edition)

and on December 9, 2011 ·

Posted in Jurisdiction,Stern Files

The Holidays are here and  Stern v. Marshall, No. 10-179, 2011 WL 2472792 (U.S. June 23, 2011) is the gift that just keeps on giving.  If you don’t get the gifts you want this holiday season there is a silver lining, more time to read Stern related decisions.  For the re-gifters out there, please see the first, second, and third editions of the Stern Files.

We summarize seven recent decisions which have grappled with the Supreme Court’s teaching on the constitutional limitations of bankruptcy court jurisdiction in this post, our fourth edition of the Stern Files:

Executive Benefits Insurance Agency v. Peter H. Arkison, Trustee (In re Bellingham Insurance Agency Inc.), No. 11-35162, 2011 WL 5307852 (9th Cir. Nov. 4, 2011) Background:  The Ninth Circuit accepted discretionary review to consider whether a bankruptcy court erred in granting summary judgment approving a chapter 7 trustee’s avoidance of alleged fraudulent transfers made to a successor corporation of the respondents.  The appellants argued in their brief that the summary judgment decision should be reversed because there is a dispute as to the material facts; namely, whether or not the appellants were a successor of the company that received the alleged transfer.  The appellants further alleged that because they had not filed a proof of claim against the estate, the bankruptcy court was prohibited from hearing the fraudulent conveyance claim in light of the Stern decision.

Stern Impact:  Oral argument was heard on October 13, 2011, after which the court invited supplemental briefs by amicus curiae to address the following questions:

  • Does Stern v. Marshall prohibit bankruptcy courts from entering a final, binding judgment in a fraudulent conveyance action?
  • If so, may the bankruptcy court hear the proceeding and submit a report and recommendation to the district court in lieu of entering a final judgment.

The court stated that all briefs responding to the amicus request shall be filed within 30 days, but, upon a motion by the United States of America, granted a 45 day extension of the time to respond on November 11, 2011.  The current response deadline for amicus briefs is January 19, 2012.

 Liberty Mutual Ins. Co v. Citron (In re Citron), No. 09-08125-JBR, 2011 Bankr. LEXIS 3934 (Bankr. E.D.N.Y. Oct. 6, 2011) Background:  In a motion to dismiss a complaint alleging fraudulent transfers, the debtor asserted that the bankruptcy court did not have subject matter jurisdiction over defendant’s counterclaim for setoff and that the complaint should therefore be dismissed.

Stern Impact:  The court held that (i) Stern did not deprive the bankruptcy courts of subject matter jurisdiction, because bankruptcy courts retain the ability to hear such matters and issue reports and recommendations; (ii) Stern is inapplicable, because the defendant in this case asserted a counterclaim for setoff, which arose under the Bankruptcy Code and which relied upon a finding of defendant’s liability on account of the plaintiff’s claims under sections 547, 548, and 550 of the Bankruptcy Code; and (iii) pursuant to Bankruptcy Rule 7008(a), the defendant had, in its prior pleadings in the adversary proceeding, consented to the entry of a final judgment by the bankruptcy court.

Hawaii National Bancshares v. Sunra Coffee LLC (In re Sunra Coffee LLC), No. 10-90009, 2011 WL 4963155 (Bankr. D. Hawaii Oct. 18, 2011) Background:  Prepetition, a bank obtained a state court default judgment against the debtor and a third party defendant, after which the bank commenced a foreclosure action.  Following the debtor’s chapter 11 filing, the chapter 11 trustee removed the foreclosure action to the bankruptcy court.  The bankruptcy court confirmed the foreclosure and entered a deficiency judgment against the third party defendant (among others), who never appeared nor opposed the motions.  After being served a writ of execution, the third party defendant asserted that most of his property was exempt from such execution.  At the hearing to determine the third party defendant’s interest in the property, the third party defendant argued that the bankruptcy court, following Stern, lacked subject matter jurisdiction over the matter.

Stern Impact:  The court held that Stern does not limit the bankruptcy court’s subject matter jurisdiction because it can still issue reports and recommendations, and that Stern does not affect the bankruptcy court’s power to enter final judgments with the parties’ consent.  Applying this interpretation of Stern, the court found that the third party defendant had impliedly consented to final judgment when he failed to appear or to oppose the judgments against him, and that because he did not file a motion to set aside the judgment against him, that he was procedurally barred from moving to dismiss under Stern.

Development Specialist Inc. v. Akin Gump Strauss Hauer & Feld LLP, No. 11-cv-05994-CM, 2011 WL 5244463 (S.D.N.Y. Nov. 2, 2011) Background:  The plan administrator of the Coudert Brothers bankruptcy estate brought adversary proceedings against ten law firms employing former partners of the defunct law firm, alleging that the law firms were liable under New York state partnership and contract law for profits stemming from “unfinished business” the former partners took with them to their new firms.  Although the parties had been actively litigating these claims in the bankruptcy court for years, soon after the Stern decision the law firms filed a motion to withdraw the bankruptcy reference.

Stern Impact:  The court noted that the Second Circuit established a set of factors, in In re Orion Pictures Corp., 4 F.3d 1095, 1101 (2d Cir. 1993), that courts should consider to determine whether withdrawal of the bankruptcy reference is appropriate.  These Orion Factors include: (1) whether the claim or proceeding is core or non-core; (2) considerations of efficiency; (3) prevention of forum shopping; (4) and uniformity in the administration of bankruptcy law.  The court held that the core/non-core Orion Factor is now outdated because the Stern decision established that a claim’s status as “core” does not necessarily determine if the “bankruptcy court is constitutionally empowered to finally adjudicate the matter.”  Thus, the Orion Factors must now be applied asking not whether the matter can be classified as “core,” but rather “whether, under Stern, the Bankruptcy Court has the final power to adjudicate it.”  A question the court stated is answered, following Stern, by determining whether the matter involves a “public” or a “private” right.

Applying this amended Orion standard, the court concluded that, because the unfinished business claims depended “on state partnership and contract law,” and not any federal statue or scheme, the bankruptcy court lacked final authority to determine the claims.  The court then examined the remaining Orion Factors in light of that determination and held that efficiency favored having the matter heard at the district level because the bankruptcy court would only be able to enter a report and recommendation, and that withdrawing the reference would not disrupt the uniform administration of bankruptcy law because the unfinished business claims are creatures of state law.

Despite the long-running nature of the dispute, the court found the motion timely because Stern had altered the legal landscape since the dispute initially arose and the law firms filed their motion timely after the Stern decision.  The court similarly refused to find implied consent on the part of the law firms, despite holding that Stern confirmed that consent to adjudication in an Article I court satisfies constitutional requirements, because the law firms raised the withdrawal issue soon after learning of Stern.

In re Bujak, No. 11-6038-JDP, 2011 WL 5326038 (Bankr. D. Idaho Nov. 3, 2011) Background:  Chapter 7 trustee filed a complaint against a creditor seeking to avoid and recover transfers under sections 547(b), 548(a), and 544(b) of the Bankruptcy Code.  The creditor moved to dismiss arguing that, following Stern, the bankruptcy court lacked final authority to adjudicate such claims.

Stern Impact:  The court disagreed with the creditor and held that Stern was a narrow ruling limited to state law counterclaims, and thus “of no consequence” to the present case.  In the present case, the trustee’s “claims against the [creditor] are premised solely upon the substantive avoiding powers granted exclusively to a bankruptcy trustee by the Bankruptcy Code.”  The court noted that even section 544(b), authorizing a trustee to avoid transfers that a creditor could avoid under state law, arises under the Bankruptcy Code because it is not a creditor bringing the action, but rather a creature of the Bankruptcy Code – the trustee.  While the court acknowledged the Stern Court’s discussion of Granfinanciera, it found that discussion to be at best dicta.  Moreover, because the creditor field a proof of claim and the court must first decide the avoidance actions to determine if the creditor has a claim, the avoidance claims are “inextricably intertwined with the claims resolution process.”  As such, the court denied the creditor’s motion and held that deciding upon a trustee’s fraudulent conveyance claims is “a task that is particularly well-suited to the bankruptcy court’s expertise.”

Irving H. Picard v. Flinn Investments, LLC, No. 11-cv-05223-JSR, 2011 WL 5921544 (S.D.N.Y Nov. 28, 2011) Background:  Numerous defendants sought withdrawal of the reference to the bankruptcy court in connection with individual adversary proceedings brought against them by the Madoff Trustee, Irving H. Picard.  The defendants raised numerous issues they asserted require “substantial and material” consideration of non-bankruptcy federal laws regulating organizations or activities affecting interstate commerce, the types of issues the Second Circuit held in In re Ionosphere Clubs, Inc., 922 F.2d 984 (2d Cir. 1990), require mandatory withdrawal.

Stern Impact:  One of the arguments brought by the defendants was that the Sterndecision “prevents the bankruptcy court from finally resolving fraudulent transfer actions because resolution of such actions requires exercise of the ‘judicial Power’ reserved for Article III courts.”  The District Court for the Southern District of New York found that resolution of the jurisdictional issue required ”significant interpretation” of both Article III and the Supreme Court precedent analyzing it, and therefore withdrew the reference to determine “whether final resolution of claims to avoid transfers as fraudulent requires exercise of the ‘judicial Power’ that the bankruptcy court lacks.”

The court went on to note that even if the bankruptcy court lacks the authority to finally resolve the fraudulent transfer actions, it may still be able to make a report and recommendation to an Article III court.  The court noted, however, the decision in In re Blixseth, 2011 WL 3274042 at *12 (Bankr. D.Mont. Aug. 1, 2011), where the Bankruptcy Court for the District of Montana held that, unlike in non-core proceedings, there is no statutory authority for the bankruptcy court to render a report and recommendation on core matters that the bankruptcy court cannot constitutionally hear.  Thus, the court additionally withdrew the reference to determine whether a bankruptcy court has authority to make proposed findings of fact and conclusions of law prior to final resolution by an Article III court.

Kirschner v. Agoglia (In re Refco Inc.), No. 07-3060 (RDD), 2011 WL 5984532 (Bankr. S.D.N.Y. Nov. 30, 2011) Background:  Trustee of the Refco Litigation Trust brought an adversary proceeding to avoid and recover various alleged fraudulent transfers and related relief on unjust enrichment and equitable subordination grounds.

Stern Impact:  Judge Drain observed that the Stern decision raised two questions with respect to the bankruptcy court’s power to decide the proceeding.  First, whether the “core” fraudulent transfer and related unjust enrichment claim “so resembles the state law tortious interference counterclaim . . . at issue in Stern, as to preclude th[e] Court’s ability to issue a final judgment.”  Second, “if the Court lacks the constitutional power to issue a final judgment in this proceeding, does it have statutory or other authority to submit a proposed findings of fact and conclusions of law to the district court?” 

Conducting a thorough analysis of the bankruptcy court’s authority over fraudulent transfer claims from the 18th century through the Stern decision, Judge Drain held, that adjudication of fraudulent transfer actions has “repeated[ly] and emphatic[ally]” been found to fall within the authority of the bankruptcy court, a result that has helped ensure a “coordinated response overseen by one judge on behalf of a host of creditor-victims.”

In response to the second question, Judge Drain held that even if it was later determined that he lacked authority to enter a final judgment, that both Stern and applicable case law suggest where a bankruptcy court lacks final authority to issue final judgment on a matter, such matter becomes “non-core” and the bankruptcy court may still enter a report and recommendation to the district court.  Thus, Judge Drain concluded that, to the extent it is later determined that he lacked the authority to enter the judgment he made, his final order should be retroactively deemed a report and recommendation to the district court.

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