Contract Claims Not Necessarily an Ace for Parties Challenging Bankruptcy Court Jurisdiction Under Stern

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Contributed by Sara Coelho

In the months since the Supreme Court handed down Stern v. Marshall, opinions around the country have interpreted Stern’s effect on bankruptcy court jurisdiction in a variety of situations.  Very few, however, have treated in any depth a bankruptcy court’s jurisdiction to hear controversies arising from contracts, even though that issue poses a significant question in the wake of Stern.  Although Stern did not itself treat a contract claim, it discussed Marathon extensively, in which a plurality of the Supreme Court found that the bankruptcy court lacked constitutional authority to decide a breach of contract claim asserted by a debtor.  Marathon precipitated reforms to the jurisdictional scheme of the bankruptcy courts, which continue in effect today.  In Ace American Insurance Company. v. DPH Holdings Corporation, the Court of Appeals for the Second Circuit upheld the bankruptcy court’s authority to interpret, as a core proceeding, the scope of certain insurance policies because that determination was a predicate to deciding whether claims asserted against the debtor by the insurers and by certain regulatory agencies were allowable.

The decision is sparse, and it is an unpublished summary order.  The adversary complaint filed in the bankruptcy court in the Delphi Corporation bankruptcy case, and a bankruptcy court opinion refusing to dismiss the complaint, indicate that the dispute centers around the scope of insurance policies issued by the plaintiff insurers to the debtor.  Some of the policies were prepetition contracts, and some were postpetition contracts.  The insurers sought a declaratory judgment interpreting the scope of the policies after certain agencies of the State of Michigan asserted that the insurers may be liable under the policies for a group of workers’ compensation claims. The insurers also requested that, in the event the court found them liable under the policies, the court find that any such coverage was the result of mutual mistake and reform the policies to clarify that the claims were not covered.  The agencies sought to have the proceeding dismissed for, among other reasons, lack of jurisdiction.  The bankruptcy court and the district court denied the motion, and the agencies appealed to the Second Circuit.

The Second Circuit framed the standard for determining whether a contract matter is core with post-Marathon, pre-Stern precedent.  It found that the issue depends upon whether the contract is a prepetition contract and “‘the degree to which the proceeding is independent of the reorganization.’”  This latter inquiry turns on “‘the nature of the proceeding,’” and proceedings that are “‘unique to or uniquely affected by the bankruptcy proceedings or . . . directly affect a core bankruptcy function’” are core.

The Second Circuit immediately found that the proceeding was core with respect to the postpetition contracts at issue and noted that these contracts were part of the estate.  It found that the proceedings regarding the prepetition contracts were also core because the nature of the proceeding would likely “‘directly affect a core bankruptcy function.’”  Specifically, a determination on the scope of the insurance policies would have the effect of defining whether claims asserted against the debtor in the bankruptcy case by both the insurers and the agencies were valid.  For example, if the group of workers’ compensation claims in issue were covered by the policies, then the insurers would have a substantial reimbursement claim against the debtor, and the claims asserted by the agencies against the debtor would not be allowed because those claims would instead run against the insurers.  The court also held that determination of the adversary proceeding concerned the administration and liquidation of the estate, core bankruptcy functions, because it could have a substantial effect on the estate and the priority of creditors that could “‘set the table for the determination of matters under chapter 11.’

In addition, in rejecting a sovereign immunity defense raised by certain of the defendants, the court characterized the dispute over the scope of the polices as implicating the in rem jurisdiction of the bankruptcy court.  The Ace court found that the contracts were part of the debtor’s estate and held that “interpretation and reformation” of these contacts would “involve adjudication of the estate: the res.”  Accordingly, the court found that the adversary proceeding “implicates” the in rem jurisdiction of the bankruptcy and district courts.  It went further to say that the adversary proceeding could “have substantial ramifications for the size of the estate, . . . allowance . . . of claims . . . and the priority of creditors, all of which implicates the in rem jurisdiction of the bankruptcy court.”  For all of these reasons, the Second Circuit determined, “This contract-based adversary proceeding is core.”

As an unpublished decision, the precedential value of Ace is unclear.  Nonetheless, after Stern, it is useful to see such an important court apply pre-Stern precedent to determine the scope of a bankruptcy court’s authority to decide a contract dispute.  Considering that the courts have been deciding the scope of bankruptcy court jurisdiction to decide contractual disputes for almost thirty years following Marathon, perhaps it should come as no surprise that a court would continue to view the current body of precedent as adequate to address constitutional concerns over the limits of bankruptcy court jurisdiction to hear and determine contract claims.  Indeed, in April, the agencies filed a petition for a writ of certiorari with the United States Supreme Court asking the Supreme Court to review the Second Circuit’s decisions regarding the sovereign immunity defense, but not addressing the Second Circuit’s analysis of the bankruptcy court’s jurisdiction to decide the contract claims.